Incentive Design

Activate when: user asks why a team keeps doing the wrong thing despite training; user is designing compensation, bonuses, or commissions; user says 'people are gaming the metric' or 'our OKRs aren't working'; user wants to fix a performance management system; user asks what incentives are driving a behavior; user is drafting contracts or platform rules to shape behavior. Do NOT activate when: the situation is clearly individual misconduct with no systemic pattern; user wants psychological persuasion tactics rather than structural system design.

Overview

Behavior follows incentives more reliably than character, intent, or training. Get the incentives right and mediocre operators produce excellent results; get them wrong and talented teams produce dysfunction. This is Charlie Munger's "Reward and Punishment Superresponse Tendency" — his first and most important of 25 psychological tendencies (1995 Harvard Law School lecture). The operational question: when behavior is undesirable, ask "what incentive makes this rational?" before asking "what's wrong with these people?"

Composes with principal-agent, goodharts-law, signaling-games, okr-goal-setting, prisoners-dilemma.

When to Use

• Designing compensation, bonuses, commissions, OKRs, or performance management
• Diagnosing why a team is producing undesirable behavior despite training or management
• Drafting contracts, regulations, or platform rules where behavior must be shaped
• Evaluating an existing system for hidden perverse incentives

Not when: clearly individual misconduct unrelated to systemic incentives; using incentive framing to excuse deliberate bad-faith behavior.

Coaching Novices (Adaptive Front Door)

• Engine mode: user has a concrete incentive design challenge → run The Process directly.
• Coach mode: user is new to the framework → guide step by step.

In Coach mode, respond one step at a time. Each [WAIT] is a hard stop — output only that step's question, then stop.

1. One-line: rational actors produce the behavior incentives favor, regardless of stated intent — check incentives before character.
2. Check fit. If the behavior is clearly individual misconduct, this framework adds less value. Otherwise, apply.
3. Elicit the goal and current incentives. What behavior do you want? What incentives exist now? What are those incentives producing?

[WAIT — do not advance until user responds]

4. Diagnose and design. What behavior do current incentives make rational? Where's the gap? What would make goal-behavior the rational choice?

[WAIT — do not advance until user responds]

5. Close: redesigned structure + gaming countermeasures + monitoring plan.

[WAIT — do not advance until user responds]

The Process

Step 1 — Goal and actors: desired outcome · required behavior · actors · time horizon. Step 2 — Map current incentives: rewards (financial, status, autonomy) · penalties · timing · observability. Step 3 — Diagnose alignment gap: what behavior do current incentives rationally produce? where's the mismatch (metric, magnitude, timing)? Step 4 — Design new structure (7-item checklist): (1) alignment (2) measurability (3) timing (4) threshold structure (5) anti-gaming predictions (6) long-short balance (7) tampering defense. Step 5 — Anticipate Goodhart's Law: whatever you incentivize will be optimized — map the most-likely gaming pattern and close it. Step 6 — Implement and monitor: pilot first · monitor 3-6 months · review cycle every 6-12 months · build in actor feedback.

Output Template

text

Incentive Design: <system>
Goal/actors | Current incentives | Alignment diagnosis
Redesign (7-item) | Pilot scope / Monitoring / Review cycle

→ Method in Action: Munger 1995 + FedEx + Modern Applications

Pack: Application Patterns

Domain	Common misalignment	Aligned design
Sales	Pay on closed deals only	Mix acquisition + retention + customer-fit
Executive comp	Options vest 1-4 years	Multi-year vesting + clawbacks + risk-adjusted metrics
Engineering	Promote on velocity	Add quality + on-call + cross-team metrics
Customer support	Pay on tickets closed	Add reopen rate + satisfaction
Recruiter	Bonus per hire	Add 12-month retention + performance ratings
Health system	Fee-for-service	Outcomes-based; bundled payments

Applying It Well

• Look at the incentives before you look at the people
• Incentive-caused bias is invisible to the actor — they sincerely believe they are doing the right thing
• The most important incentive design is at the founding moment; embedded structures become hard to change
• "Roughly right" incentives often produce dramatically wrong behavior at scale — precision matters

→ Primary sources: references/sources.md

Common Rationalizations

[D] = designed upfront | [O] = observed in real use. [O] entries are more valuable.

Fake move	Reality
[D] "Our people just need more training"	Training rarely fixes incentive misalignment. Fix the incentives.
[D] "We hire for character"	Even good character bends under bad incentives. Incentives reliably dominate character in systematic behavior.
[D] "The incentive structure is industry-standard"	Industry-standard structures produce industry-standard dysfunctions.
[D] "Our team understands the goal"	Understanding the goal doesn't override misaligned incentives.
[D] "We can't change comp mid-year"	Real constraint — but plan the change for next cycle, don't accept the misalignment indefinitely.
[D] "Goodhart's Law is overstated"	Wells Fargo, standardized testing, gaming KPIs say otherwise. Pre-commit anti-gaming defenses.
[D] "We can't anticipate gaming"	You can. Spend time pre-launch imagining how it'll be gamed. The probabilities are higher than you think.
→ Add [O] entries here after each real use — paste the actual failure pattern	What went wrong and why

Red Flags

• Behavior attributed to character/capability rather than incentives
• New people hired or fired without examining the incentive structure
• Compensation or KPI system not reviewed in 2+ years
• Previously-functioning incentive system starting to produce gaming
• Anti-gaming countermeasures absent from a metric-driven system

Verification

• Goal-behavior explicitly specified
• Current incentives mapped
• Alignment gap diagnosed
• Redesigned incentives address the alignment
• 7-item checklist applied
• Goodhart-style gaming anticipated
• Monitoring and review cycle in place

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