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Good intentions perverse incentives


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Contributor(s): Professor Luis Garicano

Released on 4 February 2009.

The current financial crisis and boring, defensively played football matches may seem to have little in common, but according to Professor Luis Garicano, Centre for Economic Performance at LSE, both can be understood as failures of the same underlying mechanisms. In this video, Professor Garicano uses the theories of organisational economics to describe how people react to incentives - and how their behaviour can often differ from the intended effect of the incentive. He points out, for example, that the financial system is driven by an incentive structure that encourages and rewards traders for behaviour which is ultimately detrimental to the health of the economy. 'It's clear that bankers were being rewarded for taking excessive risks.' says Professor Garicano. 'The short term nature of their pay - whereby bonuses are accrued over a year - encourages short term, risky decision making. This has to change. Bonuses need to be accrued over longer periods - three or five years. This would mean that if you do something crazy that ends up making you a lot of money this year but, because it is crazy, ends up losing the bank money in five years time, you will not benefit from it.' Professor Garicano goes on to describe how FIFA's attempt to encourage more goal scoring in football matches failed as the result of players responding in unforeseen ways to incentives.

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