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February 12, 2010 by Scott Sommer Scott Sommer

The Blind Pursuit of Self Interest … or Machiavelli’s Mistake

Green shoots. 5.7% growth in the fourth quarter. Goldman Sachs distributes billions in bonuses. The Saints win the Super Bowl for the first time ever. And Kim Jong Il announces he’s giving up his nuclear weapons program so North Korean scientists can instead focus their attention on developing stylish eyeglass frames and non-flame retardant jumpsuits. Whew! I’m sure glad we’re out of the woods and all our Gonzo financial institutions can rest easy and cruise through 2010.

021210-1Oh if only that were the case. Even though Americans enjoyed a brief smile and toe-tapping while watching the failed “Pants on the Ground” American Idol tryout from an energetic 62-year-old songwriter, the longer term mood ain’t looking so good. A January 2010 USA Today/Gallup poll found that two-thirds of Americans don’t think the economic recovery will start for two more years while 28% believe it won’t start for at least five years. In a fairly short period of time we have swung on the pendulum from irrational “exuberance” to potentially irrational “pessimism” where the national mood becomes a self-fulfilling prophecy, keeping our economy in the doldrums when other signs point to the fact that maybe it shouldn’t be.

Banks aren’t tone deaf to this obliteration of consumer confidence, and their actions are feeding the economic stagnation. The Federal Reserve published an October survey where it asked banks why they weren’t lending. The responses, in order of priority, aren’t surprising:021210-2

  • Reduced tolerance for risk
  • Unfavorable economic outlook
  • Worsening industry-specific problems

If banks don’t make loans, the economy doesn’t grow, and if the economy isn’t growing banks are reluctant to lend – the death spiral continues. Our capitalist structure needs speculation and risk taking; it’s the secret sauce that has produced the world’s largest economy – a benefit we all enjoy through a higher standard of living and modern comforts. However, too much of a good thing has a way of turning, well, not so good. Speculative trading/investments in financial instruments by individuals and firms rather than in activities that produced a tangible contribution coupled with the blind pursuit of self interest is what set off our housing bubble and the onset of our Great Recession.

This tension between activities taken in pursuit of self-interest and activities taken that can benefit society at large is not a new one and is a topic political philosophers ranging from Aristotle to Machiavelli to Hobbes have grappled with for centuries. The question is whether we, as human beings, are fundamentally driven to pursue actions that benefit us first and foremost or whether our actions are tempered or even driven by some type of greater moral, cultural or ethical cause. It’s clear where Hume fell on that spectrum:

In contriving any system of government … every man ought to be supposed to be a knave and to have no other end, in all his actions than private interest. By this interest we must govern him, and, by means of it, make him, notwithstanding his insatiable avarice and ambition, cooperate to public good.

021210-3At a recent series of Yale-sponsored lectures titled, “Machiavelli’s Mistake,” the economist Samuel Bowles makes the persuasive case that Machiavelli, who believed that ethical and moral motivations are crowded out by naked financial incentives, was dead wrong. In his lectures, Bowles spoke of the long term decline in worker productivity in the United States (3.2% average annual growth of business output per labor hour from 1948 – 1973; 1.9% from 1973 – 2008), much of which he attributes to the loss of “hearts and minds” of workers and investors. One of Bowles’s key themes was the “error of thinking that a high-performance economy could be based on self interest alone. And he warned of the overuse of incentives that appeal to individual gain.” (Robert J. Shiller, New York Times)

While some of his material is fairly dense, and this short Gonzo article is not meant to be a politico-economic treatise, Bowles makes a strong point we can all relate to. For anyone that has ever pledged a fraternity or sorority, been in the military, played on a competitive sports team or even been in the croquet club at Sun City, you understand the sense that individual actions are important only so long as they contribute to the greater good of the team, or your battalion, or your club.

The question GonzoBankers should ask themselves is how successful their institutions have been at fostering this type of environment. Those “rogue” traders at AIG and the assorted big banks/investment banks who brought down our financial house of cards have been lambasted as taking outsize risks so they could line their pockets with outsize bonuses gained from short term profits. This resulted in government diving deep into compensation issues and entertaining the Volcker drumbeat to prohibit certain types of proprietary trading and other “speculative” activities. But as I look around our mid-size bank clients, I have a difficult time finding real differences in how they compensate and incent their employees from what the big, bad banks do. Compensation and incentives are key ingredients in any corporate culture, and the focus on individual performance and short term gain are pervasive in our industry whether a bank is a trillion dollar organization or a hundred million dollar organization.

While there is no “best practice” incentive compensation model since every plan has to support unique bank strategies, Machiavelli’s Mistake should cause management teams to take a hard look and ask some important questions about whether their plans strike a balance between rewarding the individual and promoting the greater good. Below are my top 10 to consider:

  1. Does the bank’s plans primarily reward individual performance, or do they include group/team performance goals? What about overall bank performance?
  2. In plans where there is a group or team based incentive, is it limited to an individual line of business (e.g. the commercial area) or does it cross silos and reward, for example, commercial bankers selling/referring wealth management and vice versa?
  3. If a lender’s portfolio sours above an acceptable level, can a bonus paid in a prior year be “clawed back” so that long term credit quality takes on heightened importance?
  4. Are incentives paid out on a monthly basis (like many retail plans)? A quarterly basis? An annual basis? What balance do the bank’s plans take between short and long term goals?
  5. For the highly paid incentive earners in the organization, does a portion of their bonus vest over a three+ year period to ensure strong bank performance was achieved, or is a full bonus paid to individuals at the end of a plan year? Maybe it’s time to consider a deferred compensation program.
  6. Are commercial lenders compensated on volume or on building customer relationships by cross-selling other bank products and services with their line of business partners? Same question for the mortgage group.
  7. Does the management team actively review and critique each other’s incentive plans on an annual basis to ensure plans support corporate strategies and cross-sell/collaboration objectives, or are plans decided upon in silos?
  8. Is there a significant compensation gap between superstars and low performers, or does everyone tend to “band” in the middle? Tolerance and overcompensation of low performers can be extremely demoralizing in a corporate culture.
  9. Do back office support areas share in the success of a line of business?
  10. Do the organization’s plans reward non-production activities like training, professional development, mentoring and community service, all of which enhance the capabilities and reputation of the institution?

Bankers that don’t buy into any of this “pursuit of the greater good” nonsense should heed a fair warning to stick with their Machiavellian incentive programs and reward the hell out of the blind pursuit of self interest. We hope they don’t get left “lookin’ like a fool with [their] pants on the ground.”

All for now.


A good foundation for setting performance-based compensation is a comparison against peer banks. Cornerstone Advisors’ proprietary benchmarking database of mid-size bank statistics can help you see how you measure up against peers in hundreds of metrics. 

Here are just a few of the many performance-based metrics for which we have significant data:

Direct consumer loans closed per direct FTE/mo.
Indirect consumer loans closed per indirect FTE/mo.
Consumer loans closed per centralized underwriting FTE/mo.
Consumer loan pull through rate (closings per applications)
Mortgage loans closed per mortgage origination FTE/mo.
Retail mortgage loans closed per originator/mo.
Retail mortgage loan applications per processor/mo.
Mortgage loans closed per closer/mo.
Retail loan applications per underwriter/mo.
Personal trust assets managed per personal trust FTE
Personal trust revenue per personal trust FTE
Institutional/corp. trust assets managed per inst./corp. trust FTE
Trust/employee benefit assets per portfolio management FTE
Monthly revenue per dedicated investment representative
Average annual revenue per insurance agent
Average private banking loans outstanding per private banker

Cornerstone’s Web site to learn about our Benchmarking and Best Practice Assessment.

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3 Responses to “The Blind Pursuit of Self Interest … or Machiavelli’s Mistake”

  1. Nick says:

    While I appreciate the suggestions around incentive plans and the like, I think you have a key point terribly wrong.

    You say: “For anyone that has ever pledged a fraternity or sorority…you understand…that individual actions are important only so long as they contribute to the greater good of the team…”

    What you have missed is that self-interests are directly served when the team wins.

    What good is it for a lender to make $50,000 in bonuses this year if the bank fails next year – who on earth would consider that a self-serving philosophy. What it is, is just stupidity.

    A very slight percentage of folks may not actually care what happens to their insitiution so long as they are compensated today – but those people will find loopholes in anything. Look, my bank pays my salary today, and I hope tomorrow and the next day. Preserving the safety and soundness of the bank is not noble, it’s selfish. I want more paychecks.

    The persuit of self-interest is not blind. Stupid people are blind. Smart people persuing self-interest will consider the broader picture and behave accordingly.

    So I say quit adding fuel to the fire that is dissent towards capatilism and call it how it is. People made mistakes in judgement. NO system will EVER prevent that.

  2. Scott Sommer Scott Sommer says:

    No bashing of capitalism meant Nick. It is a system that has treated me well. I do agree with your point that pursuing self-interest can benefit the greater good. But I also think that what happened in the big banks was “blind” in the sense that it brought many of them to their knees.

  3. Dustin Brown says:

    Incentivized bonus plans are complex. Scott, you have done an admirable job of pointing out the difference between plans that encourage individual parasitic relationships, and plans that are also driven by self interest but encourage a more symbiotic relationship.

    Many traditional bonus structures pit individual employees in a sort of zero sum game. While I agree with Nick that self interest ultimately benefits the company, I think there is more of a net productivity gain by awarding monetary compensation for small teams, and then progressivley larger group performance.

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