Charlie Munger Incentives Quotes

Show me the incentive and I'll show you the outcome.

18 NEVER PAY YOUR LAWYER BY THE HOUR Incentive Super-Response Tendency To control a rat infestation, French colonial rulers in Hanoi in the nineteenth century passed a law: for every dead rat handed in to the authorities, the catcher would receive a reward. Yes, many rats were destroyed, but many were also bred specially for this purpose. In 1947, when the Dead Sea scrolls were discovered, archaeologists set a finder’s fee for each new parchment. Instead of lots of extra scrolls being found, they were simply torn apart to increase the reward. Similarly, in China in the nineteenth century, an incentive was offered for finding dinosaur bones. Farmers located a few on their land, broke them into pieces and cashed in. Modern incentives are no better: company boards promise bonuses for achieved targets. And what happens? Managers invest more energy in trying to lower the targets than in growing the business. These are examples of the incentive super-response tendency. Credited to Charlie Munger, this titanic name describes a rather trivial observation: people respond to incentives by doing what is in their best interests. What is noteworthy is, first, how quickly and radically people’s behaviour changes when incentives come into play or are altered and, second, the fact that people respond to the incentives themselves and not the grander intentions behind them.

tendencies, two of which are exceptionally prone to cause trouble: 1) incentive-caused bias, a natural cognitive drift toward the conclusion that what is good for the professional is good for the client and the wider civilization; and 2) man-with-a-hammer tendency, with the name taken from the proverb “To a man with only a hammer, every problem tends to look pretty much like a nail.

One: Reward and Punishment Super Response Tendency I place this tendency first in my discussion because almost everyone thinks he fully recognizes how important incentives and disincentives are in changing cognition and behavior. But this is not often so. For instance, I think I've been in the top five percent of my age cohort almost all my adult life in understanding the power of incentives, and yet I've always underestimated that power. Never a year passes but I get some surprise that pushes a little further my appreciation of incentive super power.

As Charlie Munger has said, “I think I’ve been in the top 5% of my age cohort almost my entire adult life in understanding the power of incentives, and yet I’ve always underestimated that power. Never a year passes but I get some surprise that pushes a little further my appreciation of incentive superpower.” An example from FedEx is one of his favorite cases in point. As he explains, the integrity of the FedEx system relies heavily on the ability to unload and then quickly reload packages at one central location within an allotted time. Years ago, the company was having a terrible problem getting its workers to get all the boxes off and then back on the planes in time. They tried numerous different things that didn’t work, until someone had the brilliant idea of paying the workers by the shift as opposed to by the hour. Poof, the problem was solved.2 FedEx’s old pay-by-the-hour system rewarded those who took longer to get the job done. They were incentivized to take longer. By switching to pay-by-the-shift, workers were motivated to work faster and without error so they could go home, yet still earn the wages of a full shift. For the workers, finishing early amounted to a higher effective hourly wage. By aligning the business’s interests with the worker’s incentives, FedEx got the outcome it and its workers both desired. The

With that focus on quality and discipline, NI has been profitable nearly every year, a record that Buffett claimed has left others in the dust. The key has been having incentives in place to get the right employee behavior. And for that, you must think the business through. Munger

INCENTIVES – “From all business, my favorite case on incentives is Federal Express. The heart and soul of their system—which creates the integrity of the product—is having all their airplanes come to one place in the middle of the night and shift all the packages from plane to plane. If there are delays, the whole operation can’t deliver a product full of integrity to Federal Express customers. And it was always screwed up. They could never get it done on time. They tried everything—moral suasion, threats, you name it. And nothing worked. Finally, somebody got the idea to pay all these people not so much an hour, but so much a shift—and when it’s all done, they can go home. Well, their problems cleared up overnight.” – Here Charlie is talking about incentives. All of us who have held hourly jobs know that if workers are paid by the hour they will work more slowly than if they are paid them by the job. Why? Because if they are paid by the hour, they have an incentive to work more slowly in order to put more hours on the clock and make more money. But if they are paid by the job, there is an incentive to work quickly so they can get onto the next job and make more money. Federal Express aligned management’s goals with employee incentives. With hourly pay their employees were never in a hurry, but when pay was given for a specific task—getting a plane loaded—suddenly they were in a rush to get the job done. The key wasn’t paying workers by the task or shift; the key was letting them go home if they finished early, which was a kind of financial reward in that they were getting paid for the full shift even if they left early.

1) Incentive-caused bias, a natural cognitive drift toward the conclusion that what is good for the professional is good for the client and the wider civilization;

What this accounting saga constitutes is one more sad example of evil rewarded dying hard, as a great many people conclude that something can't be evil if they are profiting from it. "Pleasure is the greatest incentive to evil." -Plato The

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

Perhaps the most important rule in management is "Get the incentives right.

training. To find the best educational narrow-scale model, we have to look not at unthreatened schools of education and the like, too much driven by our two counterproductive psychological tendencies and other bad influences, but, instead, look where incentives for effective education are strongest and results are most closely measured. This leads us to a logical place: the hugely successful education now mandatory for pilots.

It's very, very important to create human systems that are hard to cheat. Otherwise, you're ruining your civilization because these big incentives will create incentive-caused bias and people will rationalize that bad behavior is OK.Then,

This history shows the enormous incentive you create if you give a guy a trademark [he can protect]. And this incentive is very useful to the wider civilization. As you see, Carnation got so that it was protecting products that it didn't even own.That sort of outcome is very, very desirable [for society]. So there are some very fundamental macroeconomic reasons why even communist countries should protect trademarks. They don't all do it, but there are very powerful reasons why they should. And, by and large, averaged out around the world, trademark protection been pretty good.

maker.As usual in human affairs, what determines the behavior are incentives for the decision maker., and "getting the incentives right" is a very very important lesson.

cheaper.You must have the confidence to override people with more credentials than you whose cognition is impaired by incentive-caused bias or some similar psychological force that is obviously present.

...one great advantage of scale taught in all of the business schools of the world is cost reductions along the so called experience curve. Just doing something complicated in more and more volume enables human beings, who are trying to improve and are motivated by the incentives of capitalism, to do it more and more efficiently. The very nature of things is that if you get a whole lot of volume through your operation, you get better at processing that volume. That's an enormous advantage. And it has a lot to do with which businesses succeed and fail.

What benefits an investor most in avoiding problems such as those Munger discusses above is a financial planner who “eats his own cooking” with incentives, which causes him to suffer and benefit right alongside his client. An example of a really responsible system is the system the Romans used when they built an arch. The guy who created the arch stood under it as the scaffolding was removed. It’s like packing your own parachute. —CHARLIE MUNGER, BERKSHIRE ANNUAL MEETING, 1993

It is not usually the conscious malfeasance of your narrow professional adviser that does you in. Instead, your troubles come from his subconscious bias. His cognition will often be impaired, for your purposes, by financial incentives different from yours. And he will also suffer from the psychological defect caught by the proverb “To a man with a hammer, every problem looks like a nail.

You must have the confidence to override people with more credentials than you whose cognition is impaired by incentive-caused bias or some similar psychological force that is obviously present.

Extreme economic ignorance was displayed when various experts, including Ph. D. economists, forecast the cost of the original Medicare law. They did simple extrapolations of past costs. Well, the cost forecast was off by a factor of more than One Thousand Percent. The cost they projected was less than ten percent of the cost that happened. Once they put in place various new incentives, the behavior changed in response to the incentives, and the numbers became quite different from their projection. And medicine invented new and expensive remedies, as it was sure to do. How could a great group of experts make such a silly forecast? Answer: They oversimplified to get easy figures, like the rube rounding pi to 3.11. They chose not to consider effects of effects on effects. and so on.

To control a rat infestation, French colonial rulers in Hanoi in the nineteenth century passed a law: for every dead rat handed in to the authorities, the catcher would receive a reward. Yes, many rats were destroyed, but many were also bred specially for this purpose. In 1947, when the Dead Sea scrolls were discovered, archaeologists set a finder’s fee for each new parchment. Instead of lots of extra scrolls being found, they were simply torn apart to increase the reward. Similarly, in China in the nineteenth century, an incentive was offered for finding dinosaur bones. Farmers located a few on their land, broke them into pieces and cashed in. Modern incentives are no better: company boards promise bonuses for achieved targets. And what happens? Managers invest more energy in trying to lower the targets than in growing the business. These are examples of the incentive super-response tendency. Credited to Charlie Munger, this titanic name describes a rather trivial observation: people respond to incentives by doing what is in their best interests.