Incentives - turbo or vicious circle?

Well I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther. [1]

I simply had to start the 50th edition of Gutmann Viewpoint with Charlie Munger. Hardly any other investor who is presently active has inspired me so much and left such a lasting mark on my world of thought. This applies not only to investment topics, but also to many other areas of life.

Incentives everywhere

The quote about incentives comes from a speech at Harvard University in June 1995. Believe me - once you start looking at incentives, you see them everywhere! During our vacation in Italy this year, my youngest son (he turned three in February) fell on a flight of stairs. A horror for parents, you can imagine our shock. The laceration to his head had to be treated at the hospital. What was my first rational thought? How is the hospital compensated by the Austrian health insurance? Does it make a difference whether the wound is stitched or glued?

We had no choice but to trust the local doctors. They certainly acted in the best interest of the child - just as we expected. However, the fact is that every professional group is exposed to different incentives. We are talking about financial incentives, career incentives, status incentives and many other forms.

Too much of a good thing

Every successful organization needs incentives; they are unavoidable and are often employed quite specifically. For example, how can a team be managed to make it faster, better, more efficient, happier, more motivated and more persistent? The solution is a matter of defining the right incentives!

Unfortunately, this is not always so simple in practice and it can also backfire. The major U.S. bank Wells Fargo [2] gave its sales staff a strong incentive to push cross-selling. The idea behind this: the more different products a customer uses at Wells Fargo, the more data Wells Fargo has about the customer. This enables the bank to generate better decisions on loans, product offerings and pricing. In principle, this is a good approach, but the topic should not have been taken to extremes.

At the end of the journey, Wells Fargo paid a fine of three billion U.S. dollars - not to mention the damage to its image. To achieve the extreme sales targets, employees had been given free rein to their creativity. Customer accounts were opened and credit cards were issued without the customers' knowledge.

Independence - a unique selling point of Gutmann

You remember MiFID II? Banking regulation was a big topic in the European banking sector. The efficacy of different regulations can be debated, but one thing the regulator and legislator understood well: Incentives play a big role. Bank Gutmann has decided to offer independent investment advice under MiFID II [3]. We do not accept any benefits from third parties; we are completely independent of commission payments from product providers. What do you think, do commissions constitute an incentive? Are customers offered the best solution regardless of this? Regarding ourselves, the question does not arise at all - the financial incentive is not provided.

We also do not issue our own certificates or other structured products. If you are presented with an investment idea by us, we see a current market opportunity from which you can potentially profit from. For us, only the quality of the various products counts.

Let's talk about it

For you as customers, it is important to know the incentives of your business partners. Question our incentive system at Gutmann and discuss it with us. Please do the same with the many banks offering dependent investment advice. I can assure you, it pays off.

[1] Here you can find the entire lecture by Charlie Munger. For those who prefer to read, here is a transcript.

[2] If you are interested in the details, I recommend the Stanford Closer Look paper titled "The Wells Fargo Cross-Selling Scandal."

[3] Bank Gutmann has decided to offer independent investment advice in accordance with the MiFID II regulations. We do not accept any proceeds from third parties and are independent of commission payments from product providers. We are also required to offer a wide range of products and issuers. You can find more information here.

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