Tag Archives: incentives

It’s Not What Employers Are Doing, But What They Can Do, That Matters

A few days ago, Buzzfeed reported that Staples, the large office supply chain, had stepped up its enforcement of a cap on hours worked for part-time employees. Despite the company’s unconvincing claim* that the policy is longstanding, it appears that Staples implemented the 25-hour-per-week cap in January of 2014 “to skirt impending rules requiring companies to provide health insurance” to employees who work at least 30 hours a week.

Staples' original memo to store managers, as published by Buzzfeed.

Staples’ original memo to store managers, as published by Buzzfeed.

Staples’ decision will undoubtedly renew arguments that the Affordable Care Act’s (ACA’s) employer mandate – the provision that requires companies with more than 50 full-time workers to insure employees who work at least 30 hours each week – has led to harmful effects on work. These arguments, like parallel narratives about minimum wage laws and paid sick leave ordinances, are largely inaccurate, and advocates of evidence-based, power-balancing policy are absolutely right to debunk them.

However, we cede too much when, as is often the case, we default to a defensive stance. “Yes, the negative incentive is there, but the data show such effects to be small or non-existent” should not be the full scope of our response.

Instead, it’s imperative that we change the nature of these conversations. As Thomas Pynchon astutely observed: “If they can get you asking the wrong questions, they don’t have to worry about answers.”

Opponents of an employer mandate, minimum wage, and paid sick leave want people to focus on what employers will do in response to each policy’s enactment. The more relevant question, however, is about what employers can do.

First, it’s important to remember that businesses can deduct employer-provided benefits from their tax bills, and that the employer contribution to health benefits is widely viewed as coming out of worker salaries. Providing employees with health coverage, decent wages, and paid sick leave costs less money than a lot of people think, though it’s certainly more expensive than offering meager wages and no benefits.

More importantly, providing such benefits is the right thing to do. And it is undeniable that a typical business, when confronted with the prospect of labor cost increases, has numerous options. The business can explore ways to improve its productivity. It can raise its prices. It can reduce the salaries of affluent executives, or maybe make a little bit less in profits.**

In the most recent quarter for which financial information is available, August through October of 2014, Staples made $216 million in after-tax profits. Their CEO, Ronald Sargeant, made over $10 million in total compensation in 2013, while other top executives raked in well over $2 million apiece. Barack Obama didn’t have those numbers when he was asked about Staples’ policy a few days ago, but his suspicion “that [Staples] could well afford to treat their workers favorably and give them some basic financial security” was clearly right on the money. The ACA didn’t make Staples cut its employees’ part-time hours; instead, Staples management consciously chose to prioritize a fifth car or third house for a few wealthy individuals over its part-time workers’ ability to put food on the table. Other large companies, from Starbucks to McDonald’s to Walmart, make similar callous choices on a range of issues all the time.

There are two ways to address this problem. The main mechanism currently at our disposal is to loudly call such decision-making what it is – greedy and unethical – and vote with our dollars for companies that treat their workers fairly. Opponents of labor standards focus on what businesses will do rather than what they can do in part because we let them avoid moral reckoning. We won’t win everyone over, but we must not underestimate the power that moral authority has to shape behavior.

The second mechanism is policy that addresses firms’ decision-making. Some recent legislative proposals, in fact, like Congressman Chris Van Hollen’s CEO-Employee Fairness Act, have the potential to begin to wade into these sorts of waters. If we’re worried that companies will choose to lay people off in response to a minimum wage increase, for example, we could raise taxes on the executives of companies that make this choice.

No matter the policy outcomes, it’s essential that we ask the right questions in these debates. It’s worthwhile and important to document the evidence that policies like the employer mandate, minimum wage, and paid sick leave have minimal consequences on work. But it’s also essential to point out that any consequences these policies do have aren’t inevitable.

*As Buzzfeed’s original coverage explained, Staples claims that their part-time hours policy has been in effect for over ten years, and that the memo Buzzfeed obtained only “reiterated the policy.” Yet the memo contained phrases like, “Beginning with the week ending 1/4/2014,” and “Staples is implementing a policy.” A Staples spokesperson did not respond to follow-up questions about the memo’s language.

**It’s possible, though I’ve never seen a study to prove it, that some businesses actually can’t afford to adequately compensate their workers, that they’re barely squeaking by as is with low executive salaries, non-existent profits, and the highest level of productivity they can possibly attain. To the extent these businesses exist – and I’m skeptical that many of them do – it’s worth asking whether a business’s right to keep its doors open should trump its workers’ right to make enough to provide for their families. I don’t believe it should.

Note: A version of this post appeared in The Huffington Post on February 16.


Filed under Business

Financial Incentives and Social Good: Dan Pallotta’s Faulty Assumptions

At the suggestion of WOVIN founder Darius Golkar, I recently watched Dan Pallotta’s TED Talk on the nonprofit sector.  Golkar recommended this video to me when I asked him why WOVIN donates only 50% of its profits to charitable causes.

Golkar founded WOVIN because clothes we donate to Goodwill, The Salvation Army, and other charities rarely have the effect we intend.  Our hand-me-downs often enrich international “clothing recyclers” who exploit the poor in countries like Ghana and Nigeria.  WOVIN addresses this problem by reconstructing donated jeans into bags, key rings, cardholders, and wallets, selling these products, and then giving a portion of the proceeds to organizations that assist impoverished people.  I sincerely admire this work.

When I first read about WOVIN, however, the 50% number bothered me.  And while Pallotta’s TED Talk may explain why Golkar chose to incorporate WOVIN as a for-profit company, Pallotta’s paradigm reflects many inaccurate and problematic assumptions we have about business.  Several of these assumptions pertain to executive compensation.

Pallotta begins to discuss compensation 3 minutes and 11 seconds into his talk.  He says:

So in the for-profit sector the more value you produce, the more money you can make.  But we don’t like nonprofits to use money to incentivize people to produce more in social service.  We have a visceral reaction to the idea that anyone would make very much money helping other people.  Interesting that we don’t have a visceral reaction to the notion that people would make a lot of money not helping other people.  You know, you want to make fifty million dollars selling violent videogames to kids, go for it, we’ll put you on the cover of Wired magazine, but you want to make half a million dollars trying to cure kids of malaria and you’re considered a parasite yourself.  And we think of this as our system of ethics, but what we don’t realize is that this system has a powerful side effect, which is, it gives a really stark, mutually exclusive choice between doing very well for yourself and your family or doing good for the world to the brightest minds coming out of our best universities…[T]ens of thousands of people who could make a huge difference in the nonprofit sector [are] marching every year directly into the for-profit sector because they’re not willing to make that kind of lifelong economic sacrifice.

He then uses the chart below (the Stanford MBA figure is the median salary for someone ten years out of business school and the CEO figures are averages) to argue, “There’s no way you’ll get people with $400,000 talent to make a $316,000 sacrifice every year to become the CEO of a hunger charity.”

Executive Compensation Bar Graph

While I agree with one aspect of Pallotta’s analysis – current economic and social incentives in the United States disproportionately advantage businesses that contribute little to society over more altruistic endeavors – Pallotta erroneously suggests we can fix this problem and better promote social good by making charitable organizations more like typical U.S. businesses.  This paradigm recurs during his analyses of several topics and reflects an overarching view of economics I plan to address in future posts.  For the purposes of this post, however, I will focus on four faulty assumptions he makes while discussing executive compensation:

Faulty Assumption #1: The value individuals produce in the for-profit sector correlates highly with the salaries they earn.

We erroneously believe personal success indicates remarkable personal characteristics – that belief is a well-documented psychological fact.  Yet chaos theory, regression to the mean, and intelligent analysis indicate that luck and privilege influence success considerably more than talent – even narrow definitions of luck in recent economic analyses show that luck plays a much larger role in market outcomes than most people think.  Whether it’s even possible for someone’s “talent” to produce the kind of value Pallotta describes is a hotly debated question.

In US society, our lack of regulation and accountability for moneyed elites helps promote inflated CEO salaries even when the individuals receiving these salaries have very clearly reduced a company’s value.  The bank bailout of 2008 and the huge profits reaped afterwards by executives directly responsible for the financial crisis clearly demonstrate the inaccuracy of Pallotta’s assumption.

Faulty Assumption #2: People make career decisions based primarily on monetary incentives.

Money certainly drives some people’s career decisions, but many people care at least as much, if not more, about some combination of prestige and ethics.  Teach For America (TFA) is an excellent example of an organization that knows this fact – while TFA can offer corps members only beginning teacher salaries in its placement districts, the organization attracts the top graduates from the best colleges in the country.  Why?  Acceptance into TFA impresses nearly everyone, looks fabulous on a resume, and helps corps members feel like part of a larger “movement for educational equity.”  While it’s certainly possible that some corps members join in hopes of the long-term payout TFA’s connections might provide, the vast majority of corps members I know applied because of TFA’s mission and status.

Faulty Assumption #3: High levels of compensation promote increased productivity.

Education research suggests that incentives only improve performance when they focus on behavioral inputs– to improve, students and teachers need to know exactly what behaviors they must produce to receive rewards.  They must also have the ability to execute desired behaviors.  Examples of input-based incentives that have produced desired outcomes include paying students to read books or paying teachers to relocate to more challenging schools.  Students and teachers who are instead offered prizes for behavioral outputs like student grades or test scores, on the other hand, do not improve their performance. Executive salaries and bonuses, like student grades and test scores, are often based on outputs (like company economic performance) and therefore unlikely to increase productivity.  I believe this phenomenon helps explain why researchers agree that merit pay initiatives are misguided.

Even when incentives are offered for clear, achievable tasks, the magnitude of the incentive drastically changes its impact.  Recent research suggests that when incentives are very high, performance actually declines.  Behavioral economist Dan Ariely conducted an innovative study which found that individuals offered substantial amounts of money for winning games succeeded considerably less often than individuals offered low to moderate amounts of money (Ariely believes that the stress we experience when confronted with high stakes causes this effect).

Faulty Assumption #4: High levels of compensation in the nonprofit sector will motivate more people to work for social good.

Wealthier individuals are, on average, less empathetic than the rest of society.  As Chris Hayes (in Twilight of the Elites) and Daniel Goleman have suggested, powerful people tend to surround themselves with other powerful people and often forget about or are ignorant of the circumstances of those less fortunate.  But psychology also plays a role – the mere mention of money predisposes people to behave less altruistically.  Since external incentives also erode internal motivation, a focus on salary in the nonprofit sector could potentially diminish compassion in that sector.

Our current incentives are highly problematic regardless of the flaws in these assumptions – on that point Pallotta and I agree.  But the remedy isn’t to embrace a business model that promotes selfishness and greed while failing to generate clear economic value.  In terms of executive compensation, a better solution would reduce exorbitant salaries across the board, call selfish career decisions what they are, and use psychology and behavioral economics research to increase the prestige associated with more ethical jobs.


Filed under Business