The Ethics of Pay for Performance

The Trouble with Wall Street, by Michael Lewis. The New Republic, February 4, 2013.

Earlier this year, Michael Lewis addressed how firms on Wall Street in general, and Goldman Sachs in particular, have fostered a culture that systematically incentivizes unethical behavior. Analyzing the tell-all of Greg Smith, the former Goldman employee who famously publicized his decision to leave the company in 2012, Lewis drew attention to Goldman’s 2005 shift to a pay-for-performance model of compensation:

There was a time in Goldman Sachs’ history when bonuses were very subjective. At the end of the year, your manager made an assessment based not just on how much business you’d brought in, but also on how good you were for the organization. These two factors combined indicated your true economic value to the firm. But from 2005 until the present day, the system has become largely mathematical: you were paid a percentage of the amount of revenue next to your name. In some years, it would be 5 percent of that revenue; in better years, it would be 7 percent…. The problem with the new system was that people would now do anything they could—anything—to pump up the number next to their name.

In her recent book Cultivating Conscience: How Good Laws Make Good People, ethical systems researcher Lynn Stout describes how pay-for-performance models lead to negative outcomes by focusing too much on material incentives, regarding people as rational maximizers of their own self-interest. Stout proposes that, while cost/benefit analysis plays a role in individual decision-making, people tend to look to signals from their social context to determine whether to act selfishly or unselfishly. People, Goldman Sachs employees included, are naturally predisposed to act in accordance with their conscience. But a culture of pay-for-performance signals an environment in which self-interested behavior is to be expected (and rewarded). If an ordinarily ethical employee observes that his managers and colleagues are all gunning for the biggest possible paycheck, he too may be tempted to act without regard for the interests of his clients, his company, and his community.

Material incentives are often appropriate in the workplace, but if they come to dominate the culture, they will crowd out the influence of conscience, encouraging gamesmanship over results and ambition over accountability. The accumulation of wealth is a fine goal for anyone in financial services, but it must be tempered by social cues indicating that it is acceptable (even laudable) for employees to think about responsibility, consequences, and the interests of others.