Identify the correct incentives: Charlie Munger discusses the "most important management lesson"

 Identify the correct incentives: Charlie Munger discusses the "most important management lesson"

Identify the correct incentives: Charlie Munger discusses the "most important management lesson"

The late Berkshire Hathaway vice chairman was infamous for emphasizing incentive-generated bias excessively.

Charlie Munger passed away at 99 years old.

At the 2016 annual meeting, Charlie Munger, the late vice chairman of Berkshire Hathaway, observed, "You get what you pay for." Munger issued a stern warning on the perils of an inadequately designed incentive scheme.

"If you have a stupid incentive system, you're going to get stupid results," he said.

Munger said, "Maybe the most important rule in management is 'get the incentives right'" in a subsequent lecture.

See also: Charlie Munger's mental models that contributed to the creation of his "30-second brain": Upside down, always upside down

One month before to his 100th birthday on January 1st, Munger passed away on November 28.

His opinions on incentive schemes have been summarized and cited several times. "Show me the incentive and I'll show you the result" is a well-known quote of his, however it's unclear exactly where he stated it. It's evident that he had strong views on incentives and even claimed that they have "superpowers".

In a lecture titled The Psychology of Human Misjudgment, he went into much detail on this subject.

He spoke about this under the heading of the reward and punishment superresponse propensity in humans.

Munger spoke about Federal Express as an example. Every night, all packages had to be quickly moved between flights due to this need. The organization did all it could to encourage staff members to do this task as soon as possible, but nothing was successful until a systemic weakness was found. Because they were paid by the hour, workers found that putting in long hours was beneficial. When FedEx began paying employees by the shift and allowed them to leave when the work was finished, employees united to do the task more quickly!

He used Xerox as the example for the second time. Joseph (Joe) Wilson, the company's creator, was baffled as to why consumers were purchasing outdated models rather than new ones. He then found out that salespeople received significant rewards for pushing the outdated product over the updated one.

He also mentioned others who were forced to endure hardships as a result of receiving insufficient support.

Munger recounted the story of an in-house attorney at an investment banking company who, rather than threatening to "smithereens" his client for disobeying his counsel, instead appealed to his ethical obligation. will be inserted.

He said that in the situation he saw firsthand, the client and the attorney both suffered professional setbacks.

Munger also emphasized the need of making inappropriate conduct challenging in this situation.

He even referred to these individuals as some of the "effective sages of our civilization," saying that they made it "harder to accomplish dishonest behavior" by designing devices like cash registers.

He explained that in addition to "behavior-preventing" procedures and equipment like cash registers, personnel must adhere to a stringent code of conduct. Strict internal audits are also implemented to weed out "mischief-makers." People may be discouraged from misbehaving by harsh public punishment for "mischief-makers" and "antidotes" such as this one.

He said that one of the main reasons free market capitalism has succeeded is because it lacks incentive-generated biases.

"The majority of capitalist owners in the intricate web of free-market economic activity are chosen based on their capacity to endure fierce competition from other owners, and they have a strong motivation to eliminate any waste from the processes under their control.They ultimately depend on the difference between their competitive pricing and overall expenses; if costs rise beyond revenue, their company will fail," he said.

"If you replace these owners with state paid workers, you would likely see a significant decline in total productivity since each worker will be biased by incentives when deciding what to perform in return for their pay. "He will face pressure from many of his fellow employees who do not wish him to established any strong performance model," he said.