Welcome to part two of motivating, inspiring, and other ways that leaders get people moving in a particular direction. In the introduction in part one, we were talking about this economic way of conceiving how leaders might motivate people. We're gonna dig even further into the economic perspective in part two. And we're gonna talk about the ideas, but we're also gonna begin to critique the ideas. We're gonna be talking about the ways that people have objected to the model as well. So if we take a look at the way economists have thought about this, and also to some extent, organization theorists we have to start by noticing that there's something a little unusual about an employment contract. Now usually when we talk about a contract, a legal contract, it might be between two parties and the contract might specify exactly what each party will do and what each party will get out of it if everything is performed according to contract. But an employment contract is a little bit different than that, and this has been pointed out by Bernard, also by March and Simon in 1958 in their book called Organizations. They point out that the workers part of the contract is a bit underspecified, that the worker is being asked not to do specific duties often, but to act in general on the owner's behalf within what Bernard called a zone of indifference, and what March and Simon called a zone of acceptance. So the idea here is that the contract for the worker says not you'll do A, B, C, D, E, etc., it says you in general will do what the owner thinks it is important to do or the leader thinks is important to do or what you think is important to do to achieve the objectives of the overall project. So you're not being asked for something specific, you're being asked for something general. The worker's expected to exercise discretion and acquire and use job specific knowledge, not do just exactly what a contract says, but from the leader's perspective, this creates a problem. Because you're asking for a range of behaviors, it also creates the possibility that the worker will do things that might kind of be arguably fit within the objectives of the overall project. But might actually be something the worker wants to do for himself or herself. So, it raises the possibility of opportunistic, self serving behavior by the worker. The worker might secretly act in ways inconsistent with the leader's objectives and the leader might not find out. Now remember, there's an information asymmetry here, in the way the economists talk about this. The leader can't know everything that the worker can know. This give rise to what in economic theory is called principal-agent theory or agency theory. The economist creates a vastly simplified, highly stylized description of an organization. In the economist description, the organization consists of two people. The leader and the worker. Or in the way they describe it. The principal and the agent. The principal is the owner, supervisor, manager, or leader. The agent is the worker, employee, or follower. And the agent expense effort towards the fulfillment of the principal's objective. So the principal has defined some sort of a task, some sort of a objective. The agent works on that in exchange for money, as we said last time. Usually, it's money. And in this economic model the motivations of the two actors are very very simple. The principle's motivation is to maximize the valuable output while paying the agent as little as possible. That's gonna maximize the profit to the principal. If you share as little as you can while getting the worker to fulfill the task, then you get to keep the most. That's maximizing profit. As I say, this is a very simple model with very simple motivation as part of it. The agent's motivation is to get paid as much as possible, while expending as little effort as possible, so, fundamentally, the agent is lazy in this model. The problem is that the worker wants the agent to work really hard but pay him really little. The agent wants to be paid as much as possible without working very hard. And so their objectives are fundamentally opposed. The contract, which includes performance pay then, aligns incentives by giving the worker a reason to work hard or to work harder. So how does this work out? Well, there is mathematics involved. Once you create a model based on this very simple scenario, you can use some mathematics to yield a recommended payment schedule. So if we look at the conclusions of this model, if we take this very simple scenario and we analyze it mathematically, we arrive at a conclusion that's fairly intuitive. The conclusion says that we should pay the agent more when they perform better according to some measure of performance. Now, this is the economic justification for merit pay, for sales commission, for bonuses based on measures of performance and the like. And as I've noted already, this justification has had a major influence on practice. Pay for performance, merit pay, and so forth are widely used and are very well accepted as concepts. Incentives are respectable in management theory as a way of getting people to work towards a cause, but this hasn't always worked as well as advertised. And we knew this a long time ago. In 1955 a sociologist named Peter Blau studied a public bureaucracy. It was an employment office. So this is an office that interviews people who don't have jobs and tries to find jobs for the people. He says except for the information provided by direct observation the number of interviews completed by the subordinate was the only evidence the supervisor had for evaluating him. The interviewer's interest in a good rating and therefore a good salary Therefore prohibited, spending much time locating jobs for clients. This rudimentary statistical record interfered with the agency's objective of finding jobs for clients in a period of job scarcity. So basically what happened here is they were only measured on how many interviews they did. So they did lots of interviews, but they never looked for jobs for the people that they interviewed. And, subsequently, the organization didn't place many people in jobs. Now, it is important to realize this is exactly the kind of measurement scheme that the economist model recommends, but here, it seems decidedly dysfunctional. So let's see if we can dig into that a little bit further. So in the example that Peter Blau provides for us the organization did of course eventually recognize that the system wasn't working the way they intended, and they tried to fix it. And so if we take a close look at the way that they fixed it and the way that things resulted we'll get some deeper insight into some of the difficulties of incentive plans. So what happened is office managers fixed the system observed by Blau by replacing interview counts with eight separate indicators. They use indicators like percentage of interviews that resulted in job placements. Now that one in particular sounds like it might address directly the concern that they were having before. Where the outputs desire placing people in jobs weren't actually being reflected in the measure of performance. So hopefully we've fixed it here. Unfortunately, that didn't prove to be the case. I'm quoting again from Blau. Employees engaged in outright falsification by destroying at the end of the day those interviewing slips that indicated that no referrals to jobs had taken place. So they did the interviews, but they destroyed the record of the interviews that didn't result in job placements, because those lowered their percentage of interviews that resulted in job placements. Again, this is an example of people knowing what the measures are, and if you like gaming the measures to try to look better. They also discovered that when they made further enhancements to the system by adding even more indicators that made it harder to define what performance really meant and it lead to evermore subtle dysfunctional behaviors. So people were getting eve more clever about gaming the measures and the more people got clever the harder it was to see what was really going on. So this was not going in a favorable direction. Many others have provided examples like this, especially in organization theory. The organization theories started to notice this in the 1950s. The economists were not as quick to incorporate these dysfunctional concerns into their models. So we have general observations, for example, that people frequently game or outsmart incentive systems, and these come as early as 1955, 56, 66. Steve Kerr in 1975 writes an article called, On the Folly of Rewarding A While Hoping for B. One of the best titles ever for an academic article. But eventually the economists agree that this is a problem. And then in 1991 Holmstrom and Milgram wrote a paper to adjust principal agent theory to address this problem. It's a very interesting paper. Also as economic theory is, it's quite mathematical, but the primary change in this paper is to decide that the agent should allocate effort to multiple tasks, not just one. And to also concede that some tasks are less measurable than others. And some tasks may not be measurable at all. In this model, the value of the agent's work is determined not only by the amount of effort but also how he or she allocates the effort across the multiple tasks. If no effort is allocated to some tasks, no value can result. So there's certain critical tasks that if you don't do it, no value can result for the overall effort. So, if you don't spend any time trying to find people jobs, a job placement office, however strongly and the measurements is not doing what it should. Another thing that they could see in this model is that the necessary tasks, the ones that you have to do produce any value at all, might also be un-measurable. And, so this begins to complicate the economists situation quite a lot. Holmstrom and Milgrom in 1991 make one final change to the model. They adjust the motivation assumption for the agent. Now you'll recall in the early models the agent was assumed to be very lazy. The worker was trying to do as little work as possible and get paid as much as possible. But in the new model in 1991, Holmstrom and Milgrom assumed that the worker will do some work, even if you pay him a flat fee. A flat salary not conditional on his or her performance still causes the worker to do some work. It may not be as much work as you'd like. The agent to do, but it's some work. This is important to the model. So what happens in the conclusions, this model comes out very differently. The conclusion is that as long as the agent finds it pleasurable to expend some effort that provides value to the principal, the principal is better off offering the agent a flat salary that doesn't depend on measured performance. Now, the intuition here is pretty clear. If you can't measure some task, and that task is necessary, and you are measuring other tasks, then the agent, to look best, will divert all his effort to the measured dimensions and all his efforts away from the unmeasured dimensions. Zero value will be produced. So in that situation, it's far better to pay the agent a flat fee and let the agent do whatever work the agent will do naturally. So the really big headline point here is that pay for performance is no longer recommended in this circumstance. In fact, pay for performance is a recipe for disaster. It's a recipe for people gaming the measures and producing dysfunctional outcomes. What's interesting though, is that this conclusion has had very little impact on practice. Many people, I think, believe that these conditions in which incentive pay stops working are relatively rare, but I think the evidence suggests that they are less rare than we think. So the debate ends up being nowadays, how common are the conditions? That invalidate pay for performance. So the big questions in conclusion, if incentive pay is in these particular situations invalidated, where does that leave us as leaders? If we can't rely on motivations based on incentives, how do we think about motivation for 21st century leaders? In the 20th century, leadership was often about design of incentives. That doesn't work. We need some alternatives, we need some ideas to at least supplement, maybe even replace this idea of how to motivate and how to lead are there alternatives? That's the question we're gonna turn to in part three. Now I'm gonna ask you in between part two and part three to watch a short clip of the Saint Crispin's Day speech. This is from a Shakespearean play, Henry V. And it shows a king trying to motivate his army into marching into battle when they are vastly outnumbered, and the vast majority of people he's talking to will likely be killed. And that's the kind of situation we're gonna talk about in part three. So thank you. I will join you again in part three.
