The Limits of Organizational Theory and Incentives (Or, Why Corporate Success Is Not Just About Money)

Most economists begin their study of organizational behavior by taking for granted that incentive compensation influences behavior. Managers and employees are assumed to have “utility functions” that reflect a very basic set of “preferences”—preferences for things like money and leisure and job security. And, as clearly simplistic as it is, this “model” of human behavior has been shown to have considerable predictive power. But it is equally clear that financial incentives and rewards are not all that matters in motivating people within large organizations. What economists have failed to recognize is the important subjective consequences for employees of acting in accord with well‐designed incentives that have been “internalized”—viewed not just as leading to financial rewards and corporate success, but as “the right thing to do.” In the language of economists, a well‐designed incentive program can end up influencing not only people's behavior, but their underlying “preferences,” or what non‐economists like to call “values.” And it is these preferences and values that are at the core of an organization's “culture.”