How Managerial Incentives Affect Economic Performance

Andrew Smithers

Published: March 2016

The impact of managerial incentive structures on corporate behaviour has been a neglected area of economics. New theoretical work by Nobel Prize winning economist Jean Tirole demonstrates that ‘bonus culture’ managerial incentive systems can increase inequality while lowering investment, work ethics and welfare. The negative impact of managerial incentive systems in the US and the UK have been studied empirically by the author for a number of years and the evidence backs up this theory. Modern management remuneration systems provide strong incentives to change corporate behaviour by encouraging aggressive pricing, discouraging investment and other measures to improve productivity. The author argues that demographic and productivity changes, and not the aftermath of the global financial crisis of 2007-08, are the dominant causes of the current economic slowdown in many of the world’s largest economies. Since this can only be reversed by increasing investment it is necessary to recognise the problem of distorted incentives as the first step to remedial action. Solutions include linking bonuses to increases in productivity and providing tax incentives to reinforce changes in behaviour.

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