One of the most common justifications for hefty C.E.O. compensation packages is that if the leaders of industry are not paid well, the so-called best and brightest will no longer flock to fill the corporate ranks, and will instead go elsewhere. High salaries (and bonuses, etc) are said to both motivate and retain these brilliant minds.
While this sounds somewhat plausible, as it turns out, a new study shows that it’s just not true. One driver of executive pay, called the peer-group benchmark, compares the salaries of executives among ostensibly similar companies as a way of keeping salaries competitive and within reasonable market limits. The problem is, this measure assumes that a C.E.O. at one company could pick up and leave for greener pastures at another, which, as it turns out, is a false presumption.
The study, conducted by Charles M. Elson and Craig K. Ferrere, shows that many of the skills C.E.O.s possess are specific to the company in which they are acquired, and are not readily transferable to other companies. Their analysis shows that almost every attempted transplant at the top ranks has resulted in failure.
What this means is that all this benchmarking makes the market of C.E.O.s seem like a market with high mobility, allowing for C.E.O.s to move to other companies when in fact a C.E.O. who manages one company well is unlikely to be successful in another. Therefore, a company looking for a C.E.O. cannot actually consider all C.E.O.s as potential candidates. Benchmarking, then, is little more than a way to inflate executive salaries by comparing jobs in markets that are essentially incomparable.
Ultimately this study shows that determining executive salaries needs to be reevaluated and reconfigured with an eye to empirical data, even if that means reducing C.E.O. pay. After all, we are all shareholders in these companies and they are giving away our money for what turns out to be no good reason.
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Here’s my Q&A column from the WSJ this week — and if you have any questions for me, just email them to AskAriely@wsj.com.
I am an avid football fan. When the team I am supporting is leading by, say, seven points, it doesn’t seem like a lot (we are leading by JUST one touchdown). On the other hand, when we are trailing by seven points, it seems like a lot (we are trailing by ONE touchdown). The same thing happens with runs in baseball and points in basketball. As a result, I’m always nervous while watching close games! Why do I feel this way? Is it just me?
I must admit that I don’t follow sports, but as luck would have it, I recently had a chat with Mark Cuban, the owner of the Dallas Mavericks. We talked about various links between behavioral science and basketball, including the idea of loss aversion. Loss aversion means that our emotional reaction to a loss is about twice as intense as our joy at a comparable gain: Finding $100 feels pretty good, whereas losing $100 is absolutely miserable.
When your team is ahead, you think that the game is yours, so you largely focus on dreading that it might be taken away from you. On the other hand, when you are behind, all you can do is look forward to a positive change in the lead.
As this suggests, we might benefit in other areas of life, beyond sports, by adopting the perspective of being behind and looking for the upside.
Several years ago I gave my 90-year-old mother $5,000 to pay off the bank loan for her 2007 Honda Civic. She recently decided she didn’t want to drive anymore and would sell the car, for which she should receive $6,000 to $8,000. She had originally planned to give the car to my nephew (her grandson), but since he can’t afford the upkeep, she was going to sell the car and give him the proceeds. My finances have improved significantly since the time I gave her the $5,000, but she also offered to give me back $5,000 from the sale, which would leave my nephew with very little money. What should I do?
When we face such questions, we usually engage in what is called a cross-personal utility comparison. We ask ourselves how much we would benefit from this amount of money and compare this to how much the other person (your nephew, in this case) would benefit. When we carry out this comparison we naturally have a somewhat egocentric view of the world, which means that we usually over-weigh our own benefits and under-weigh the benefits of the other person.
However, recent research by Elizabeth Dunn and Mike Norton (their forthcoming book is called “Happy Money: The Science of Smarter Spending”) shows that giving money away has tremendous benefits for the giver. In their studies, whether people buy a cup of coffee for a friend or give up their yearly bonus to help a nonprofit, the givers experience happiness beyond their expectations, and it remains high for longer than they anticipate.
In your case, the giving would be particularly powerful because both you and your mother are involved. You would feel happiness because you facilitated the gift, your mother would feel happy because she is helping her grandson, and you would feel further happiness for making your mother feel good. With all of this good feeling around, is there any doubt that you should help your nephew?
I just paid for yoga classes for the next six months, but the studio mistakenly credited me for a year. They have made many past billing errors in their favor. Should I correct the mistake or just see it as the universe making things more even?
Of course, it is the world restoring karma—but why did it take so long?
One of economists’ common critiques of the study of behavioral economics is the reliance on college students as a subject pool. The argument is that this population’s lack of real-world experience (like paying taxes, investing in stock, buying a house) makes them another kind of people, one that conceptualizes their decisions in altogether different ways. And although many decision-making studies in behavioral economics have shown that young adults do not act much differently than adult adults when it comes down to their core behavior (think of MDs whose diagnoses are influenced by defaults and the framing of choices, for example), the argument persists as a sweeping dismissal of using students as the main testing ground.
One area where we can test this assumption is with the endowment effect. Simply put, the endowment effect shows that we value the things we own more than identical products that we don’t own. This causes a mismatch between buyers and sellers, where buyers are often willing to spend less than the seller deems an acceptable price.
If we are to assume that consumers hold constant, well-defined preferences, this puts the stability of valuations into question. As such, the endowment effect has puzzled economists for quite some time because in principle, valuations should not be affected by ownership; if a purple hat is worth $15 to you, it should be worth $15 to you whether or not you have purchased it, and this value should remain consistent both before and after you purchase it.
Let’s say that undergraduate A receives a mug and is asked how much money she would require to sell it to undergraduate B. Studies find that undergraduate A will have a much harder time parting with the very same mug that undergraduate B has no attachment to. Now, these students don’t have much experience with real-world markets. So the question is — would those who do have experience in these markets behave differently than their inexperienced undergraduate counterparts?
In his senior research paper, Sean Tamm studied exactly this*. He approached 30 car salespeople and 46 realtors, a population that presumably has much experience with negotiating their maximum willingness to accept (when selling items), as well as with a maximum willingness to pay (when purchasing items). He endowed half of these participants with mugs, and asked the sellers what it would take to sell the mugs and the buyers what it would take to buy the mugs. And despite the extensive real-world market experience of these participants, willingness to accept was about three times higher than willingness to pay, demonstrating that even expert negotiators are susceptible to the endowment effect. This is consistent with previous research, showing an overvaluation of owned goods of about 2.5 times that of unowned goods.
This is just one more example of real-world experience not playing the protective role that we often assume comes with experience. It also suggests that our brains and the way we make decisions are similar, and that for the most part, students are operating under the same constraints as those with much more experience. In the end, we may just have to accept that students are real people (most of the time).
*“Can Real Market Experience Eliminate the Endowment Effect?” by Sean Tamm, Stetson University
Here’s my Q&A column from the WSJ this week — and if you have any questions for me, just email them to email@example.com
My husband and I are childless. We’ve lived in the same house in the same town for 17 years. Each day he comes home and says, “What do you want to do tonight?” I think we’ve tried every restaurant in a five-mile radius. Neither of us enjoys shopping or watching movies at a theater. His hobby is aviation, and I don’t fly. I work from home and would love to go somewhere in the evening occasionally, but we usually end up watching TV. And we don’t even like TV! Can you shed some light on this problem?
The basic challenge you are facing is what economists would call a problem of coordination, where both you and your husband have to agree on a course of action. This is no easy thing to do when your preferences don’t align. On top of that, you have the suboptimal default option of watching TV—something that neither of you enjoys but is a simple resolution to your coordination problem.
One approach is to switch from a simultaneous coordination issue to a sequential one—that is, agree up front on a plan that will make only one of you happy on a given night but, ultimately, will let both of you do more things you enjoy. On a set of cards, write down activities that each of you wants to do, mix the cards and draw one card every evening to pick that night’s activity. This approach should lead to higher enjoyment overall. After all, it’s better to have some enjoyment on some nights of the week than to have no joy on every night.
Here’s one final suggestion: Add a few wild cards into the mix (singing, poetry, pottery, volunteering, square dancing, etc.), activities that you aren’t sure you will like (or even things you suspect you will dislike), and you both might just find some new activities that you enjoy.
I recently stumbled upon a website offering customers help with creating alibis—and even manufacturing corroborating “evidence” for their absences (for example, to reassure your wife when you were really with your mistress). Other sites offer married people help finding paramours for extramarital affairs. Do you think these sites are increasing dishonesty?
The basic answer to your question: Yes. I think that these websites do increase dishonesty.
Many of these websites are constructed to look like any basic service provider. In one case, there are pictures of smiling people with headsets, waiting to fill your order, and tabs for services ranging from producing and sending fake airline tickets, to impersonating hotel reception. The testimonials are positive and very general. And the slogan—”Empowering Real People in a Real World!”—is downright uplifting, until you realize that by “empowering” people, they mean lying on their behalf.
I suspect that all these trappings help people to rationalize their actions as socially acceptable. And with all the testimonials from so many regular people, why not you?
I also think that the “real world” rhetoric may further lull people’s objections; the idea is that this is how things work in the real world, not a fairy-tale land of perfect honesty.
For my part, I’m left feeling a little worried about what kinds of ads might pop up in my browser after looking at this page…
Is there any correlation between political party affiliation and whether someone is more or less honest?
Of course. The politicians you and I support are much more honest. You can’t even compare them to the crooks on the other side of the aisle. How can they even say those things with a straight face?
Fans of Stephen Colbert are probably familiar with the term Truthiness, which he introduced in the inaugural episode of the now extremely popular Colbert Report. He explains the word as what we feel to be true rather than what’s factually or arguably true. For instance one might argue that it’s okay not to report a little side income to the IRS because it was insignificant and not from one’s primary employment, and it just feels like found money rather than real taxable income. Your gut tells you so! Or, in one of Colbert’s examples, he explains that it may be possible to find holes in the argument to go to war with Iraq (keep in mind this aired in 2005), but that it felt right to take out Saddam Hussein.
It’s essentially a comical take on the tension we all feel between what we want to be true and what we can argue objectively. To be sure, we can justify a lot of bad behavior this way. We know all kinds of things from traffic violations to cheating on a test to lying about income are wrong, but we do them anyway and justify them with any number of rationalizations. These rationalizations have the flavor of truthiness, and we eat them up.
I think that the term truthiness gives us a way to distinguish this kind of behavior and to remind us to keep watch for it. Colbert mocks the truthiness politicians use to sell their ideas to the public; we can follow suit and mock the truthiness we use to sell rationalizations to ourselves.
Not only do I find examples of behavioral economics in literature (see this recent post), sometimes I get research ideas from it. This passage from Wallace Stegner’s Angle of Repose was one such instance:
Touch. It is touch that is the deadliest enemy of chastity, loyalty, monogamy, gentility with its codes and conventions and restraints. By touch we are betrayed and betray others… an accidental brushing of shoulders or touching of hands… hands laid on shoulders in a gesture of comfort that lies like a thief, that takes, not gives, that wants, not offers, that awakes, not pacifies. When one flesh is waiting, there is electricity in the merest contact.
We already know that touch can change our behavior, for instance, holding something for a few seconds makes us much more likely to buy it. But what about how touch, as slight as described here, changes interpersonal dynamics? How exactly might I test this idea? What might an experiment look like? And could I possibly get approval for it from the Institutional Review Board? More on this soon, I hope…
Artists from around the world are invited to attend a discussion on self-control entitled “Restraining Order: The Art of Self-Control” as the next part of the “Artistically Irrational” exhibition series on Wednesday, September 26th at 7 PM EST. (Artists who do not live within driving distance of Durham, NC will be able to watch the forum streaming online.)
Interested artists should RSVP to the curator, Catherine Howard, at firstname.lastname@example.org by Monday, September 24th by 9 PM.
After the forum, artists interested in creating artwork in response to the research will submit a 1-page proposal and 2-3 digital images of past work. To be considered, applications must be submitted by Friday, October 5th at 9 PM.
Artists will be notified if they are selected to participate by Monday, October 8th and will receive a $100 stipend to complete their piece. There is no limitation to the style or media of pieces created for “Restraining Order,” but the exhibit includes an exercise in self-control embedded in the artistic process. All selected artists will be required to work on their pieces for the entire period leading up to the due date and will send weekly photos to document the progression of the piece. All completed art works must be received by Friday, December 7th.
Artwork created for “Restraining Order” will be on display at the Center for Advanced Hindsight from December 14th, 2012 to February 22nd, 2013 with a reception on Saturday, January 26th, 2013 from 6-9 pm.
Artists will retain all rights to their piece. Works will be returned to artists after the exhibit by March 15th, 2013. If the piece is purchased, the $100 stipend will be deducted from the purchase price.
September 26, 7pm — Forum at the Center for Advanced Hindsight
October 5, 9pm — Deadline to submit artwork proposal
December 7, 9pm — Drop-off deadline
January 26, 6–9pm — Opening reception at the CAH