Vol 9 (2012) - Issue 3

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Changes in Regulations on Executive Remuneration in UK Banks Have Achieved Little in Remedying the Underlying Human Frailties that are Exacerbated by Variable Pay – Part Two

Chapter 4: Human behaviour
This paper will now go through the various areas of human behaviour and examine how they affect the actions of executives. The actions and activities of executives prior to the recession will be used to illustrate the negative effects of performance-based pay. The various regulations and rules concerning remuneration of executives in the UK will then be examined under each of the different areas of human behaviour to see whether they address the problems highlighted.

1. Incentives and behaviour
1.1. Crowding out
Psychological research has provided an interesting analysis on the effects of monetary incentives and has established the important motivational theory of crowding out. The theory postulates that providing monetary incentives to individuals in return for carrying out a particular task results in their 'intrinsic motivation to perform the task well' to be set aside by the extrinsic monetary incentive. The consequence of this is that monetary incentives become an overriding motivation for an individual to carry out the task required of them. Applying this to economic relations the crowding out effect is evident. There are various theories explaining the crowding out theory. However, the theory that appears the most plausible is that put forward by Harvey James. He acknowledges that an extrinsic monetary incentive can provide intrinsic motivation when it connotes the competence of the employee. However, if the incentive is deemed to be controlling in the sense that it is the primary source of the employee’s motivation to work then this has the effect of displacing the intrinsic motivation of a worker to perform his task. This is because he attributes his effort to the monetary incentive rather than to his personal preferences to complete the task. James also perceives large incentives to be controlling because they are more likely to have an impact on employees’ perception of work in that they are working for the reward rather than the satisfaction of completing the task well.

1.1.1. Crowding out in banking
The concept of crowding out has particular application to the banking sector due to it relying on high levels of variable 'incentive based compensation' as a means to attract talented individuals to work for them. The fact that they perceive monetary incentives as the primary means of attracting people to work for them results in creating a work culture that is based on monetary incentives and are in turn indicative of the crowding out process. The prevalence of this concept within banking has produced negative consequences. Indeed, the motivation of high levels of remuneration is said to have driven executives to engage in excessive risk taking that has been held to have been a contributory factor to the rise of the recession. Indeed, remuneration structures were fashioned in such a manner that executives received remuneration on the basis of shortterm profits.