Baffled by bankers’ bonuses? Read agency theory

I am writing this post, as is my wont, to record some notes from a paper I read:

Azevado, R.E and Akdere, M.  (2011). Examining Agency Theory in Training and Development: Understanding Self-Interest Behaviors in the Organization.  Human Resources Development Review, Volume No Not Known, 18 pages. If you want a copy, both authors are presently at the University of Minnesota.

I read the paper because agency theory is the theory behind the big bonuses that are provoking so much controversy.

The application of agency theory to Training is new and nothing to do with bonuses.  But I wanted to tidy up my own thinking about agency theory and if you do too, I’d recommend reading Azevado and Akdere’s paper.  They explain the basic precepts of that school of thinking very well.

I don’t like agency theory and I wanted to pinpoint exactly why I think it is misguided.  I’ve boiled my objections down to three essential points:  the distaste agency theorists have for self-interest, their belief in a zero-sum game, and their belief that the world is so static and unchanging that any one person knows best.

Self-interest

Adam Smith said:

“It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest”.

Some people are sincerely concerned about self-interest, and like the far left, so are agency theorists.

Personally, I am delighted that the self-interest of the butcher, the baker and the brewer leads to a butcher, a bakery and a pub on the high street. I believe in caveat emptor (buyer beware) but I am not panicking that the butcher, the baker and the brewer might from time-to-time charge me 1p too much.

I also don’t panic that today the butcher tries to sell me something that he is trying to ‘move’.  Provided he has taken my self-interest into account and sold me something to fit my needs, we are ‘square’.

I get my needs met now. I get my needs met over the long term because his shop stays open.  And my business does better because he can buy from me!

(Funny that – the last female butcher that I met was my own grandmother.)

Generativity vs zero-sum gains

Agency theorists begin with an assumption that if I pursue my self-interest, then I am not pursuing yours.

Or at least, they believe that inherent in belonging to an organization is the need for the organization to ask me not to pursue my self-interest in some form or another.

It certainly is the case, for example in a soccer game, that I shouldn’t pass the ball to the opposition on purpose, or showing off to my mates in the crowd and not pay attention to the game.

But why should my self-interest be sacrificed as a matter of principle or practice?  If we need to sacrifice anything, let’s compromise and make sacrifices all round.  And wouldn’t it better to put our efforts into making a business environment which is rich enough for us all to pursue our self-interest?

To take a simple example, does it matter if I am miner, metallurgist, engineer, accountant or diamond cutter, provided that all of us work together to mine the diamonds safely and sell them profitably to people who want them?

I’ve found that where people stand on this point is fairly key to their choice of work and choice of organization.  Some people want quick returns. They really don’t believe an organization is more than the sum of its parts.  So be it. We’ll help them go where they need to go.

Those of us who don’t believe that life is zero sum game should stay away from organizations run in terms of agency theory. We will hate them.  And we need to put our money where our mouth is. We have to make our own organizations as good as we want them to be – and successful commercially.

‘Gap’ thinking vs positive management

Agency theory seems tremendously old school to me in the notion that there is a right way to do things and that someone somewhere knows what this right thing is.

Now there are definitely wrong ways to do things.  There have to be things we wouldn’t countenance no matter what.

Expertise is also real. And it takes time, a long time to learn.  Indeed, good organizations arrange themselves so that people can develop expertise and learn from each other.

But the idea that we know the whole answer and we can insist that people do things our way is very unrealistic.  If it was ever possible, it is not possible in today’s world where we rely on networks of experts.  We each bring our own perspective to a problem and we are richer for it.

Returning to agency theory, if no one knows what the best answer is until we have discussed, how do we evaluate whether our agents are pursuing our interests vigorously?

Worse, if we do not allow the room to work out what our interests are, haven’t we built into the organization the very thing that we fear most – that our agents withhold information that is valuable to us?

So in short, these are my three objections to agency theory.

I think self-interest is good, not bad.  We want people to think about their self-interest because we will have a healthier, sounder and more resilient organization (and economy).

I don’t see the world as a zero-sum game. I don’t see the world as a cake to be divided up.  At best I see the world as having no cake until we’ve baked it.  And there are cakes and cakes. Real wizards will make us a cake even when the ingredients for their favourite recipe are not available.

I don’t think we know upfront what our self-interest is.  Good organizations are forum where negotiations and bargaining lead to mutually prosperous ventures.

How does any of this help me understand bankers’ bonuses?  Well they are mystery, to be sure.    Agency theory is not standard organization and management theory but to turn away from thinking that captures attention with promises of large rewards, we need not only an alternative but an understanding of the thinking itself.  Do read Azevado and Akdere’s paper.  I found it helpful even though, or possibly because it was about the less emotive topic of Training.

Positive psychology and an adult response to the financial crisis

The day I crossed the Rubicon to adulthood

It was a hot, in October. The rainy season was approaching but had not yet arrived. A fan was going full tilt in my office. Behind me, my windows were shut. Below my window, our lorries belched diesel fumes as they queued to exit the factory gate and take flour and maize meal for hundreds of miles around.

My phone rang and in the brisk and formal business culture of Zimbabwe, I answered it promptly: “Jo Jordan. Good afternoon.”

My caller came from outside the company. We had been at university together. And she had a lot to say about the local psychological association. I agreed. And said so.

Then I drew myself to a halt. I was the Secretary of the Association and had been for 3 months. If there was anything that needed to be done, it was my job to get it done.

And hence, I crossed an important Rubicon. I was no longer teenager/student/young adult . I was a citizen fully responsible for the way we ran our affairs.

When did you make the transition from adolescent to adulthood?

Some people never make that transition. Forever, everything is someone else’s responsibility.

Today, something in my feed caught my eye and jolted my memory of when I grew up on a stifling hot and dusty day when we were waiting for the rain and for the new agricultural season to begin.   The story was about the general loss of respect for employers in the wake of the banking crisis.

Employment is not a private activity

A feature of employment law is that the manager, representing the owner, knows best. It is an absurd assumption but some people insist upon it. When we do, we take on a mantle of responsibility, not just to the owners, but to people on whom we imposed our judgement. And to deliver, we have to manage events not just inside the company but outside too.

We cannot manage the rains, perhaps. But we are responsible for responding adequately to the weather, whatever it brings.

Our outrage at the bank failures and MP expenses

The reason why the bank failures and the MP scandals have shocked us so is not the professional errors themselves. Few people understand exactly what happened in the banks or the mysterious absence of accountants and auditors in the Houses of Parliament.

But we do understand that both groups claimed status that put their judgement above ours. And they weren’t able to deliver on their promises they made when they arrogated status about ours.

We are hearing arguments from bankers and MPs that the privileges of office must be sufficiently high to warrant the responsibility they carry.  So they do understand what they promised!  But their arguments are back to front, of course. First, they need to show they can carry out even the basic responsibilities of public office before we worry about awarding privileges!

All public office, being a prefect at school, being secretary of the sport club, and for that matter, being a director of a private company carries the same basic responsibilities.

Implicitly, we promise to

  • Speak up when something is blatantly wrong
  • Live up to the procedures of contract and documentation that our culture has worked out over the centuries
  • Understand where the world is going and make adequate provision for the range of events that might occur
  • Show uncompromising loyalty to the people we represent and presume to order about
  • Represent the whole team without whining and making excuses

There is a big difference between nitpicking and exercising our office responsibly

You may feel my argument is completely wrong

It may be that you see no connection between the behaviours I listed and things going right or wrong. If you don’t, I’d be happy to see a rebuttal but experience tells me that you will not advance a logical argument. You may argue that no one will notice any way. You will probably just dismiss me with contempt.

You may dislike nitpicking implied by rules

You may also have an inherent distrust of nitpicking. Exercising judgement and compassion, I would argue, is different. People who exercise judgement and compassion don’t hide behind rules. They judge the situation and manage it so that we achieve the outcome we want and help the person we assisted grow into a leader themselves – responsible, thoughtful, effective, loyal and with good moral & practical judgment.

You may feel you have no responsibility to anyone but yourself

It is also possible you see your job about looking after you and your own rather than every one around you and beyond. You are likely to have made up your mind on this point quite early in roles that you held at school, college and university. Early on, you will have decided how you would execute collective responsibilities.  Is the group there for you, or you for it? Did you speak up when things were plain wrong.  Or did you allow rubbish to accumulate thinking you would be out of the picture before the results became evident.

All that is necessary for evil to triumph is for good men to do nothing

You will know your own opinion, of that I am sure, and you might tell me here.

But it is likely that I have divided opinion. One group will dismiss me with contempt and pity.

They other would like to know more about acting responsibly and would like to work in environments where responsibility is more highly valued.

Is it too much to agree with Edmund Burke that we all allowed the system to drift into such disarray?

Where are doing exactly the same thing – keeping our heads-down because we believe so little in the people around us that we don’t believe they will listen or care?  Where are we speaking up contentiously and carping and whining rather than engaging on matters that we are responsible for?

Should we begin by ticking off parts of the system that work well and doing more of them?

Pay professionals – data slurpers – data visualizers – wanted

Do you believe that executives are worth their pay?

85% of people voting on The Economist debate beginning today vote NO.

You can vote as well! 

Yes or No?

Do you have a professional interest in pay?

If you are a

  • work & organizational psychologist
  • HR manager
  • union official
  • manager
  • politician
  • political activist

I encourage you to log in to the debate and read the comments.  It is free.

I usually skim over the contributions from the public because I doubt anyone is reading.

But this time, the comments from the public on executive pay provide invaluable data.

Would you like to join a research team on the executive pay debate?

This is an unusual opportunity to document the pay debate and to establish a reputation in compensation management.

Could you help with

  • recording the comments (or slurping them off the net)?
  • listing the arguments by parsing and analyzing them with software or by hand?
  • summarizing which questions were asked & answered?
  • writing up the report?
  • preparing compelling visual presentations?
  • marketing & distributing the report?

Please let me know what you can do, and I will put together a team.  If you aren’t particularly internet-literate, that is fine too.  We could do with people who contribute substantive questions and who review and edit the project as it proceeds.