Never, ever, think about something else when you should be thinking about the power of incentives.” — Charlie Munger

"Incentives are what drive human behavior. Understanding incentives is the key to understanding people. Conversely, failing to recognize the importance of incentives often leads us to make major errors."

In the One of my favourite book Poor's Charlie Almanak suggested two examples for this:

Federal Express. The heart and soul of their system – which creates the integrity of the product – is having all their airplane come to one place in the middle of the night and shift all the packages from plane to plane. If there are delays, the whole operation can’t deliver a product full of integrity to Federal Express customers. And it was always screwed up. They could never get it done on time. They tried everything – moral suasion, threats, you name it. And nothing worked. Finally, somebody got the idea to pay all these people not so much an hour, but so much a shift and when it’s all done, they can all go home. Well, their problems cleared up overnight.

Early in the history of Xerox, Joe Wilson, who was there in the government, had similar experience. He had to go back to Xerox because he couldn’t understand why this new machine was selling so poorly in relation to its older and inferior machine. When he got back to Xerox, he found out that the commission arrangement with the salesmen gave a large and perverse incentive to push the inferior machine on customers, who deserved a better result.

"It is difficult to get a man to understand something, when his salary depends on his not understanding it."