The Incentive Structure of Executive Compensation
The most important development in economics in the last forty years
has been the study of incentives to achieve potential mutual gains
when the parties have different degrees of knowledge.
—KENNETH J. ARROW, 1972 NOBEL LAUREATE IN ECONOMIC SCIENCES
The unintended and unimagined consequences of man’s enterprise
have been and will always be more potent, more widespread, and more
influential that those he intended.
Incentives have become a governing paradigm of the economic understanding of human behavior, and the incentive way of thinking has become a way of life. A quick Internet search of “Obama AND incentives” makes the president appear as the “Incentivizer in Chief” with headlines such as:
“Obama: Schools Can Improve with Right Incentives”
“Obama Is Focusing on Tax Incentives”
“Obama Announces Middle Class Incentives”
“Economy: Obama Announces Incentives for Businesses”
“Obama Offers Incentives to Stimulate Auto Sales”
“Obama Proposes ‘Green Tax’ Incentives”
The list of similar items goes on and on. We tend to think of “getting the incentives right” as a solution to all of our public policy problems, whether the current problem is securing the correct patent policy, improving higher education, rewarding efficiency, or reducing medical errors.
The long-recognized, unwelcome consequences of setting incentives are the “unintended consequences” of human actions. On happy occasions, these unintended consequences can be beneficial. Perhaps the most famous passage