Incentive Structures - Moral Hazard and Behavior

The problem with most institutional incentive structures, ie. those promulgated by major corporations, is they overemphasize increasing revenues and maximizing profit to the detriment of customer experience/service. The reason is, they already have the customers, they are now just milking them with sales and marketing gimmicks and internal employee incentives to achieve their goal of profit maximization.

At some point they will go too far. But because these organizations are so large, the cost (in fines) or damage to reputation are not sufficient for customers to move away (they already have them locked in and switching costs are high).

The other thing about the incentive plans is they are invariably unbelievably complicated. That is because, as with most things bureaucratic, they are heaping performance measures on performance measures (when new ones come along, they usually don't scrap the old ones), which will also ultimately be self-defeating due to their complexity. A structural issue which can effect employee morale is when incentives and bonuses are based on unrealistic goals, then either behavior becomes severely distorted (really leverage and exploit the client) or employees lose motivation. Both circumstances are bad and should be watched out for.

Fines are other penalties are just considered a cost of doing business.

If there are so many things wrong with these plans/structures, why don't companies reform them or change?

One reason is that they are the most effective way to exact more money out of clients. Another reason is that senior management is served by these and this effect with bigger bonuses.

One of the real problems is employees become demotivated and begin seeing the absurdity of the company and its business.

More On The Purpose and Role of Active Management

Most retirement plans offer a menu of index funds and active funds. The active funds typically comprise brand name, "institutional quality" managers. They are in essence a safe bet from a performance, business and career risk perspective. They will likely deliver somewhere between 1% outperformance to -2% underperformance (which incidentally is acceptable). They are the proverbial closet indexers. You may wonder what is their role. If they can't and aren't trying to generate genuine outperformance (alpha), then why use them. I think the reason is as alluded to previously (business, career and performance risk management) but also because they serve several other important purposes.

Namely, they provide the potential for outperformance (an important psychological factor). And they do provide some degree or potential of downside mitigation. Both of which meet the needs of most investors to believe that their fund is being managed by an expert and provides them with a positively skewed opportunity set.

Hard to know whether this is a cynical take on active managements role or simply the reality, which although it is unlikely to deliver alpha, actually does provide investors with a degree of comfort.

If plan providers were to offer "genuinely active" managers then the outcomes could be a real mess. The hit rate on finding and getting a genuinely active manager who then outperforms is pretty low. Not worth the risks and hassles associated with it.

Genuinely active = relatively new fund (less than 3 years old), concentrated bets, small amount of assets under management.

'Tis a truly sad day

The Supreme Court's decision to allow corporations to spend what they want on political free speech is the final nail in the coffin of US democracy.

Not a matter of if, but when.

I imagine it will take many more years of decay and erosion before it fragments into fiefdoms. The eventual overrunning of the ramparts will likely coincide with a major financial crisis.

We Need a Revolution

Just as Jesus threw the money changers out of the temple, so to do we need to do a purging of US political, legal, and economic institutions.

The system is weak, decrepit and bereft of integrity with various parasites feeding off the host. Money talks, and when you're talking about the wealthiest country in the world, there is a lot of money at stake. And it is precisely this money and the power surrounding it that will continue to eat away at the foundations of society.

Sadly, as with any unsustainable imbalance (think healthcare inflation, tertiary education inflation, rising debt levels, oil consumption, disproportionate military spending, etc.), nothing will be done until a catastrophe occurs. And even then, if the current response to the financial crisis is any indication, we are unlikely to achieve true reform. It is a bad position to be in, to be a Jeremiah, when you have no clue as to when the walls will come down. But the writing is on the wall, and history shows that when something is corrupt, economically unsustainable, and being eaten away by parasites, the result is foregone.

The current healthcare debate is just another symptom of the rottenness in the system. With it so hard to create good policy, is it any wonder that we can't get true reform until it is too late.