Recognizing Perverse Incentives in Standard Business Situations
In many standard business situations, business leaders are stuck relying on service providers that have perverse incentives. The structure of the situation gives the person or firm you’ve hired a natural incentive working against your interest.
Examples include:
- A buyers real-estate agent would prefer you pay more than less (percentage-based commission)
- A litigation attorney would prefer the litigation never end (billable hours)
- A recruiter would prefer that your business pay more than less for a new hire (percentage-based commission)
- A consultant would prefer that you continue to tweak, modify, extend, and refine the project (billable hours)
Each of these scenarios is commonplace. Each has its own attempts at workarounds (e.g. fixed fee instead of commissions or billable hours). However, fixed fees are often fail in situations where it is impossible to estimate the fee accurately in advance.
Often attempted workarounds fail at removing the perverse incentive, so that is why there are a number of standard perverse incentive structures in common business situations.
The mere presence of a perverse incentive is not bad. Many of the professionals working in perverse incentivized businesses work hard to maintain a reputation for not succumbing to those incentives and for fighting for the client.
Spending time trying invent fancy ways of working around these standard situations is not worth the hassle. A better approach is to consciously recognize when these situations exist and maintain extra leadership and scrutiny to ensure good outcomes are reached.
How do you handle situations of perverse incentives?