> Posted by Julian Sosa and Sergio Guzmán
Incentives are among the most controversial of issues in finance. They raise provocative questions: Why they are necessary? Who receives them? How should they be given? Various stakeholders are active in the debate, from Wall Street to microfinance. There are numerous arguments for and against incentives that match an equally sizeable slew of theories about human behavior. In a recent publication, Ron Schmidt from the University of Rochester discusses “Are Incentives the Bricks or the Building?”
Incentives are able to promote positive results from their collaborators through well paired with individual motivations and with organizational goals and culture. Administering incentives is important because they promote work and personal motivation, however, as Professor Schmidt argues that, “incentives can be powerful enough to encourage employees to ignore trade-offs beneficial to firm performance when making [such decisions] leads to reduced incentive pay.” This is a story familiar to us in microfinance: sometimes loan officer incentives are designed to reward portfolio growth over quality which can motivate individual loan officers to make decisions based on self interest rather than sound credit decisions that might make loan sizes smaller and reduce incentive pay accordingly. This is why we have argued in the Smart Campaign that in order for institutions to prevent overindebtedness “[p]roductivity targets and incentive systems [must] value portfolio quality at least as highly as other factors, such as disbursement or client growth. Growth is rewarded only if portfolio quality is high.”
Additionally, Schmidt argues that some of the above issues can be curbed by looking at the staff you hire. “[E]ffective choice of personnel and attention to incentives can help minimize the complications resulting when actions motivated by private interests differ from the actions that contribute to increases in shareholder value.” This is important for microfinance because MFIs need to hire qualified personnel who also share ethical values akin to the institutional mission, as the Smart Campaign posits under the Client Protection Principle on ethical staff behavior.
Schmidt provides general principles on pay and incentives, relevant to microfinance even though they weren’t written with that in mind.
- Pay what the labor market demands to get the right talent, but don’t break the bank.
- Be careful! Keep bonus plans simple and open to adjustments for changing circumstances.
- If the company does well, give everyone a temporary (not ongoing) bonus.
- Give especially generous rewards to teams or individuals when special contributions can be unambiguously demonstrated.
- Reward character-rich behavior; give those individuals opportunities to advance.
The Microfinance industry faces important questions: How do we select character-rich individuals as loan officers (and keep them from being poached by the competition)? How do you encourage the development of an ethical corporate culture within an organization? And also how do you establish an adequate mix between staff incentives, financial performance, and social mission in order to operate sustainably? Please share your thoughts.
For a field perspective on incentives and microfinance, see the contribution from our guest blogger, Eleanor Coates, “Dispatch from the Field: Loan Officer Incentives – A Delicate Balancing Act.”
Flickr credit: nurpax