Is a Bonus Culture Ruining Africa and Our Financial System?

Paul Collier says high compensation doesn’t necessarily bring out the best in those receiving it:

A bonus culture that ruined the City is also ruining Africa, by Paul Collier, Comment is Free: The financial crisis in the developed world and the long, slow crisis of African governance have one feature in common: what economists coyly term “high-powered incentives”. The financial crisis was the consequence of management decisions… For decades people in these positions had behaved prudently, which is why their businesses built up good reputations. Why was the behaviour of the present vintage so different? The answer is the introduction of high-powered incentives – or, more intelligibly expressed, obscenely large payments tied to some specified performance. The theory is that such incentives overcome problems of managerial shirking and niceties such as putting the workforce’s interests before those of shareholders.

This simple theory provided the intellectual veneer for grotesque greed: high-powered incentives are, in reality, very damaging. And I have watched them wreak havoc in the apparently very different context of African politics. The bonuses Africa’s leaders pay themselves are sizable even by the breathtaking standards of the developed world; like financial managers, the politicians have a massive incentive to achieve the performance benchmark. In the financial sector the benchmark has been quarterly measured profits; in Africa it has been winning an election.

These incentives corrode through two distinct routes. The most obvious is that they induce people to bust the rules everyone has previously taken for granted. … One of the better insights from economics is that formal, written contracts cannot always be “complete”; they cannot cover all eventualities. So it is with measures of performance. Because many rules we used to take for granted are not readily expressible in the form of laws, it will usually not be criminal to break them, although it is disgraceful. …The crucial mistake of the theory of high-powered incentives was a naive faith in the conventions that constrain behaviour. … Conventions only work as long as the incentives to break them are modest… If incentives are large enough, greed triumphs over self-respect – not for everybody, but for those most susceptible. And this is the second route by which high-powered incentives corrode: they affect selection. …How can Richard Fuld, the former Lehmans chief executive, imagine that it is ethically reasonable to keep $500m given the appalling damage his mismanagement has caused? How can President Dos Santos of Angola imagine that his rewards are fitting given the impoverishment of his citizens? But some people evidently find no difficulty in living such lives, and so they are the ones attracted to the jobs. And this striking shamelessness probably means they were always so predisposed.

An essential step in cleaning the Stygian stables is to end high-powered incentives. …

Originally published at the Economist’s View reproduced here with the author’s permission.