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What is incentive-caused bias?

Incentive-cause bias is the impact of incentives (punishments and rewards) on changing human behavior and cognition. These incentives (and disincentives) work as conscious and subconscious drivers of your thoughts and actions.

You are incentivized to believe to be true the things that you want to be true.

If the significance of this idea does not immediately capture you, be patient. Sit with it. Lay with it. Fight with it. And then accept it, because fewer ideas are more important to your everyday life.

Charlie Munger, Vice-Chairman of Berkshire Hathaway and investing partner to Warren Buffett, has taken the idea of incentive-caused bias as seriously as anyone throughout his life. He still gets surprised by the power of incentives.

In an expanded version of a speech to Harvard University that he gave in 1995, called “The Psychology of Human Misjudgment,” and printed in Poor Charlie’s Almanack, Charlie writes:

I think I've been in the top 5% of my age cohort all my adult life in understanding the power of incentives, and yet I've underestimated that power. Never a year passes but I get some surprise that pushes a little further my appreciation of incentive superpower.

Here’s another quote from Charlie that lives as my desktop background:

Show me the incentive and I will show you the outcome.

Incentives and disincentives should be the very first thing you examine when trying to understand someone’s behavior or thought process.

Examples of Incentive-Caused Bias

Fed-Ex Shipping

Here’s an example of the power of incentives at Federal Express that Charlie writes about in his talk…

FedEx could not figure out how to get the night-shift workers to move packages as quickly as was necessary from one airplane to another overnight. The speed of transfer was integral to the success of their delivery business, and it just wasn’t fast enough.

They tried a few solutions, before realizing that the night crew was paid by the hour. They were being incentivized (rewarded) to work more hours, not fewer.

So, the management team switched the compensation from hourly to a fixed shift rate, with a rule that the workers could go home when the job was done. The workers would now get paid the same rate no matter how long it took to get the planes loaded.

Can you guess what happened? Of course, the employees moved as quickly as possible to complete the job so they could go home. Transfer times improved, and the change was a success.

Incentives in Sales

It’s easy to see how incentives could work in sales. A salesperson could push an inferior product on a customer if he or she is incentivized to do so with a greater reward than if they sold the superior product. Suddenly, sales reps are doing the company a disservice because the incentives are misaligned.

Here are a few common incentives to be aware of:

• Money

• Equity

• Sex

• Friendship

• Companionship

• Higher Status

• Freedom (working from home)

Naval Ravikant & Incentives

How you incentivize employees with rewards is incredibly important.

Naval Ravikant, the founder of AngelList, says:

Incentives are superpowers… The number one job of a manager, after recruiting and retention is incentive design. You pick your strategic goals, you know what you want, and you hire the people for it. Then you design the incentives properly to hit those goals.

Naval knows that you generally get the outcome that you reward for. So you need to be very careful about how you design those rewards. If the incentives aren’t aligned with the goals of the company, you are incentivizing your employees to hit the wrong targets.

Bias Points-of-view

On a personal level, incentive-caused bias can lead to bias points-of-view.

A breaking-news anchor is incentivized to see breaking news everywhere he looks, even when the event is not worth reporting on in the first place.

A gallbladder surgeon is incentivized to see your gallbladder as the cause of your ailment and remove it, even if your ailment has nothing to do with this particular organ.

What’s worse is that over time, if you are not careful, you’ll come to believe what you’re being incentivized to believe: that every event is breaking news and that that gallbladder simply must come out.

How can You Prevent incentive-caused bias?

Here are three ways Charlie Munger recommends you guard against incentive-caused bias in the world of professional advisers:

1. especially fear professional advice when it is especially good for the advisor. (your gallbladder must come out because it’s the surgery I get paid to perform!)

2. learn to use basic elements of your advisor’s trade as you deal with your advisor; and

3. double-check, disbelieve, or replace much of what you’re told, to the degree that seems appropriate after objective thought.

Assume it’s all bullsh*t until proven otherwise.

Your thoughts and behaviors are being consciously and subconsciously subverted by incentives just as the other people and organizations around you are.

Fear not, though, because you’re already one step ahead. You now understand the superpower that is incentives. You’ll begin to see them at play in your own life. You’ll question your assumptions, and begin to see the incentives behind your actions.

It may not be possible to overstate the power of incentives.

As usual, Charlie gets the last word:

Never, ever, think about something else when you should be thinking about the power of incentives.

Your secret superpower.

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Munger, C. T., & Kaufman, P. D. (2008). Poor Charlie's almanack: The wit and wisdom of Charles T. Munger. Virginia Beach, Va: Donning Co. Pub.

Naval Ravikant on incentives as superpowers: https://podcastnotes.org/2019/02/13/naval-scott-periscope-2-12-18/

Naval Ravikant on incentives and artists: https://angel.co/blog/why-naval-ravikant-hires-artists