UPDATE: Watch a Reuters video interview with Ariely.
What do turn of the century lab rats, clutch NBA players like Michael Jordan, and Wall Street's highest-paid executives have in common? Dan Ariely has some ideas.
"We study the irrationality of people and markets. 2008 was a very good year for us," the behavioral economist noted wryly at the Poptech conference on Thursday.
As pay czar Kenneth Feinberg prepares his plan to slash bonuses at bailed-out banks and automakers, perhaps it's time to question one of the central assumptions of the exec comp status quo: Does more compensation always make people more motivated and better at their jobs?
Ariely's research suggests that past a certain level, it can have the exact opposite effect. "People have the tendency to villainize Wall Street," Ariely said, "but the real enemy is human nature."
Rewind the clock to 1909, when economists Robert Yerkes and John Dillingham Dodson put some rats in a maze. Parts of it were electrified. The question: Would higher levels of electricity (and hence pain, avoidance of which is a powerful incentive) make the rats learn the maze any faster?
The answer was yes, to a point. But past a certain level, the electricity became more of a stress than a motivator, and performance declined.
Ariely and his team took the so-called Yerkes-Dodson law and applied it to people and financial incentives. Subjects were asked to perform certain tasks and received a monetary reward. Sure enough, the money increased cognitive performance to a point, and then became a drag.
"Money is a two-edged sword," he said. "It's a motivator and a stressor."
He tried pitching this idea to a Wall Street bank in the hopes of repeating the experiment with traders and other financial executives who are exposed to massive incentives and stresses every day.
Their response?
"They said, 'We are special people. We're not like everybody else, we thrive on stress, this is how we work, how we function,'" he said. "I said, 'maybe you're right, but why don't we test it out? Come to the lab.' They weren't that interested."
Instead he turned to another high-stress, high-reward environment: The NBA. His team culled a list of perceived "clutch players" known -- and financially rewarded -- for having ice water in their veins when the game is on the line, and crunched their stats.
Ariel found the players did score more points than other players, but by taking more shots rather than improving their accuracy. This effectively juiced their stats like a mortgage broker signing up every loan applicant that walks through the door.
"Their success rate doesn't change, but people's belief that they are clutch players makes them try more," Ariely said.
So what does this mean for executive compensation?
Ariely's research shows that because of people's strong propensity for loss avoidance, clawing back bonuses could dramatically increases the stress of financial incentives. Loss avoidance means that people fear losing a dollar more than they get pleasure in gaining one.
But even without clawbacks, the cost of maintaining a lifestyle of second homes, private schools and the like means that many of Wall Street's best-paid executives are already operating in loss-avoidance mode.
Surely some Wall Street banks would love to tell their employees that their bonus is being capped for their own good. Or maybe there is a customized, optimum salary for each and every person, based on their motivation and capacity for handling stress. But most of all Ariely's research suggests that Kenneth Feinberg has a tough task on his hands.
One can only hope for the Pay Czar's sake he isn't getting paid too much for the trouble.
For further coverage of Poptech visit Reuters.com and contribute to our live blog.
Further coverage:
Good: Mo' Money, Mo' Problems
Huffington Post/Sharon Glassman: What is Work?
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