Chapter 1. The Economic Way of Thinking 20 in the last chapter in the book on international trade; for now we wish to emphasize that we have demonstrated that, through trade, both Harry and Fred are better off. This was demonstrated even though we postulated that Harry was more efficient than Fred in the production of both fruits! Communal Property Rights To many, the ideal state of affairs may appear to be one in which everyone has the right to use all resources, goods, and services and in which no one (not even the state) has the right to exclude anyone else from their use. We may designate such rights as “communal rights.” Many rights to scarce property have been and still are allocated in this way. Rights to the use of a university’s facilities are held communally by the students. No one admitted to the university has the right to keep you off campus paths or lawns or from using the library according to certain rules and regulations. (Such rules and regulations form the boundaries, much as if they were natural, within which the rights are truly communal.) The rights to city parks, sidewalks, and streets are held communally. Before our country was settled, many Indian tribes held communal rights to hunting grounds: that is, at least within the tribe’s territory, no one had the right to exclude anyone else from hunting on the land. During most of the first half of the nineteenth century, the rights to graze cattle on the prairies of the western United States were held communally; anyone who wanted to let his cattle loose on the plains could do so. Granted, the United States government held by law the right to exclude people from the plains; but as long as it did not exercise that right, the land rights were communal. The same can be said for all other resources whose “owner” does not exercise the right to exclude. Communal property rights can be employed with tolerably efficient results so long as one of two conditions holds: (1) there is more of the resource than can be effectively used for all intended purposes (in other words, there is no cost to its use) or (2) people within the community fully account for the effects that their own use of the resources has on others. Without the presence of one of these conditions, the resources will tend to be “overused.” Under communal ownership, if the resource is not presently being used by someone else, no one can be excluded from the use of it. Consequently, once in use, the resource becomes, for that period of time, the private property of the user. The people who drive their cars onto the freeway take up space on the road that is not in use; no one else (they hope!) can then use that space at the same time. Unless the drivers violate the rules of the road, they cannot be excluded from that space; and if they are rational, they will continue to use the resource until the marginal cost of doing so equals the marginal benefits to them. They may consider most of the costs involved in their use of the road, but one that they may overlook, especially as it applies to themselves personally, is that their space may have had some alternative use: that is, by others. 13 Their presence also increases highway congestion and the discomfort of the other drivers. As a result, they may overextend the use of their resource, meaning they continue to drive as long as the additional benefits they, themselves, get from driving additional miles is greater than the 13 Environmentalists argue that many roads should not have been built; the alternative use in this case would be scenery, for example. Chapter 1. The Economic Way of Thinking 21 additional cost. However, they can overlook the cost they impose on others, which can mean that the total cost for everyone driving additional miles is greater than the total benefits. The state can make the driver consider the social costs of driving in an indirect way by imposing a tax on the driver’s use of the road equal to the distance between a and b. This is called “internalizing the social cost.” Once the state does this—and it is commonly done through gasoline taxes and/or tolls—the rights to the freeway are no longer “communal”; the rights have been effectively taken over by the state. There are two additional ways that social costs can be internalized. First, people can be considerate of others and account for the social cost in their behavior. Second, the right to the road can be turned into private property, meaning that individuals are given the right to exclude others from the use of the resource (i.e., the road). This may seem to be a totally undesirable turn of events unless we recognize that private owners can then charge for the use of the road: they can sell “ use rights,” in which case the marginal cost of driving will rise, resulting in an increase in the cost that individual drivers incur. The prime difference between this private ownership and government taxation is that with private ownership, the revenues collected go into the coffers of individuals instead of to the state; this is either “good” or “bad,” depending upon your attitude toward government versus private uses of the funds. Furthermore, under private ownership and without viable competitors (and we have an example in which competition may not be practical), the owners may attempt to charge an amount that is greater than the social costs in the figure; they may attempt, in the jargon of economists, to acquire monopoly profits, and in so doing cause an underuse of the road. 14 (A monopoly is a single seller of a good or service that can charge higher prices and reap greater profits than if it had to worry about the actions of other competitors.) For that matter, the state-imposed taxes may be greater than the social costs. The state may also act like a monopolist. State agencies may not be permitted to make a “profit” as it is normally conceived, but this does not exclude the use of their revenues for improving salaries and the working conditions of state employees. Monopoly profits may be easy to see on the accounting statements of a firm but may be lost in bureaucratic waste or over-expenditures under state ownership. State ownership does not necessarily lead to waste, but it is a prospect, and one only that the naïve will ignore. More is said on the subject at various points in the book. We have now considered the distinction between private and communal property. Several examples will enable us to amplify that distinction and to understand more clearly the limitations of communal property rights and the pervasive use of private property. 14 To provide for competition and to prevent monopoly profits from emerging, private rights can be assigned to similar units of the same resource. Although this may not be practical in road construction, it is quite practical in the cattle business, for example. Many different people can own all the resources necessary for cattle production. If one tries to raise his price to achieve monopoly profits, the others can undercut him, forcing him to lower his price. As a general rule, competition requires the dispersion of property rights among different people and groups. Chapter 1. The Economic Way of Thinking 22 Pollution Pollution can be described as a logical consequence of communal property rights to streams, rivers, air, etc. The state and federal governments, by right of eminent domain, have always held rights to these resources; but until very recently they have inadequately asserted their right to exclude people and firms from their use. As a result, the resources have been subject to communal use and to overuse, in the same sense as that discussed above. By dumping waste into the rivers, people, firms, and local governments have been able to acquire ownership to portions of the communal resource—they use it and pollute it. Furthermore, because of the absence of exclusion, those people doing the polluting do not have to pay to draw the resource away from its alternative uses (such as pretty scenery) or to reimburse the people harmed by the pollution for the damage done. Under communal ownership, in which government does not exercise its control, the firm with smoke billowing from its stacks does not have to compensate the people who live around the plant for the eye irritation they experience or the extra number of times they have to paint their homes. Pollution is often thought to be the product of antisocial behavior, as indeed it often is. Many who pollute simply do not care about what they do to others. However, much pollution results from the behavior of people who do not have devious motives. People may view their behavior as having an inconsequential effect on the environment. The person who throws a cigarette butt on the ground may reason that if this cigarette butt is the only one on the ground, it will not materially affect anyone’s sensibilities, and in fact it may not. However, if everyone follows the same line of reasoning, the cigarette butts will accumulate and an eyesore will develop. Even then, there may be little incentive for people to stop throwing their butts on the ground. Again, a person may reason on the basis of the effects of his own individual action: “If I do not throw my butt on the ground here with all the others, will my behavior materially affect the environment quality, given the fact that other butts are already there?” This type of reasoning can lead to a very powerful argument for conversion of communal rights to private or state rights, with the implied power for someone to exclude some or all of this kind of use. 15 Fur Trade According to Harold Demsetz, the hunting grounds of the Indian tribes of the Labrador Peninsula were held in common until the emergence of the fur trade there. 16 The Indians could hunt as they wished without being excluded by other members of their tribe. Presumably, given the cost of hunting and the limited demand for meat, there was no inclination to “over-hunt,” that is, until there was an adverse effect on the stock of animals in the area. 15 For a similar discussion of why university campuses have dirt paths on the campus lawns, see Richard B. McKenzie and Gordon Tullock, The New World of Economics (Homewood, Ill.: Richard D. Irwin, Inc., 1978), chap. 2. 16 Harold Demsetz, “Toward a Theory of Property Rights,” American Economic Review, vol. 57, pp. 347– 59, May 1964. Demsetz cites Eleanor Leacock, “The Montagnes ‘Hunting Territory’ and the Fur Trade,” vol. 56, no. 5, part 2, Memoir No. 78. Chapter 1. The Economic Way of Thinking 23 However, when fur trading commenced and the Indians hunted animals for their skins, the demand and therefore the price of animal skins increased. This provided an incentive for the Indians to hunt beyond their demand for meat. Under communal ownership, when a beaver was killed, an Indian hunter did not have to consider the effects that his action had on the ability of the other hunters to trap and hunt. Each hunter, through his own efforts, imposed a cost on the others; when a beaver was killed by one hunter, the task of finding beavers was made more difficult for the other hunters. The cost may be construed as a social cost, much like the congestion a driver can impose upon the other drivers around. Furthermore, under a communal rights structure, there was little incentive for hunters to avoid trapping or incurring the costs of increasing the stock of animals. If a hunter refrained from killing a beaver, perhaps someone else would kill it. In addition, if one person tried to increase the stock of animals, perhaps many others would benefit from his efforts in terms of more animals for them to kill. There was, in other words, no assurance that the Indian who built up the stock of animals would reap the benefits. (For the same reason, we doubt that many buildings would be built if the developers could not reap the benefits of their investment or if what they built would be communal property upon completion.) The Indians’ solution to the problem of overkill was to assign private property rights to portions of the hunting grounds. Each individual, by virtue of his right to exclude others, had an incentive to control his own take from the land and to take measures, much as ranchers do, to increase the potential stock of furs. Whales and Seals Whales have been hunted for centuries, but there has never been a problem with their possible extinction until the last two centuries. Whales have always been more or less communal property; however, because people in bygone centuries did not have the technology we now have to kill and slaughter whales far at sea, the sheer cost of hunting them prevented men from exceeding the whales’ reproductive capacity. Theoretically, the problem could be solved by applying the same solution to the whale overkill as the Indians applied in their hunting grounds: establish private property rights. However, whales present a special problem. The annual migrations of whales can take them through 6,000 miles of ocean. Establishing and enforcing private property rights to such an expanse of ocean is an ominous task, even without the complications involved in securing agreement among several governments to respect those rights. These costs have, without doubt, been a major reason that whales remain communal property and are threatened still with extinction. Communal property rights can also have an effect on the way animals are treated and slaughtered. Armen Alchian and Harold Demsetz have provided us with a vivid description of the seal slaughter in Canada: In 1970, the newspapers carried stories of the barbaric and cruel annual slaughter of baby seals on the ice floes off Prince Edward Island in the Gulf of St. Lawrence. The Canadian government permitted no more than 50,000 animals to be taken, so hunters worked with speed to make their kills before the legal maximum was reached. They swarmed over the ice Chapter 1. The Economic Way of Thinking 24 floes and crushed the babies’ skulls with heavy clubs. Government offices received many protests that the seals were inhumanly clubbed (by humans) and often skinned alive. The minister of fisheries warned the hunters of the strong pressure he was under to ban the hunt and that he would do so unless the killing methods were humane. 17 Alchian and Demsetz point out that the Canadian government had effectively made the first 50,000 baby seals communal property among the hunters; the seals became private property when and only when they were killed. Possession of only the first 50,000 baby seals was legal. The rights to the seals were allocated communally on a first-come, first- served basis, and Alchian and Demsetz stressed that such a rationing system tends to encourage “rapid hunting techniques and to make a condition of their success the degree to which the hunter can be ruthless.” 18 MANAGER’S CORNER I: How Incentives Count in Economics and Business We noted above that much of this book and course is concerned with the problem of overcoming a basic condition of life: scarcity. Firms are an integral means by which the pressures of scarcity are partially relieved for all those people who either own or work for or with the firms. However, in order to get people involved in or with firms to work diligently for the firms, they must have some reason or purpose—some incentive—to do that which they are supposed to do. Within sections of this book that we have titled “Manager’s Corner,” we seek to apply the economic principles developed in the first part of the chapter to problems that all MBA students will confront in their “real world” careers, that of getting incentives within firms right. Doing that is no easy assignment for managers mainly because incentives are powerful—both when they are wrong as well as right, as we will see by taking up an array of incentive issues that range from how workers’ compensation can affect firm output to how a firm’s finances (debt and equity) can affect management risk taking and, hence, firm profitability. Incentives are growing in importance as a tool of management for several important reasons: • Production of goods and services in many industries has become unbelievably sophisticated and complex, which has required managers to draw on the creativity, skills, and human capital of line workers who often have local information about their work—what can and cannot be done—that is not, and cannot be, available to their supervising managers. • Production processes for many goods and services have become global in scope, which necessarily means many workers must work far removed from their supervisors, who have no way of monitoring what the workers are doing on a daily basis. 17 Armen A. Alchian and Harold Demsetz, “The Property Rights Paradigm,” Journal of Economic History, vol. 33, p. 20, March 1973. 18 Ibid. Chapter 1. The Economic Way of Thinking 25 • Firms have, to a growing extent, relied on “outsourcing,” which means firms are buying more and more of their inputs—from parts to human resource services—from outside suppliers whose business goals are not in line always with the business goals of the buyers. • The hierarchical organizational structures of many firms have been “flattened,” which implies fewer layers of managers and supervisors. • Moreover, the pace of technological and organizational innovations and change has speeded up, increasing the extent to which decision making has been devolved to lower and lower levels within firms’ organizational structures. These ongoing, far-reaching changes in the economy have long been documented. What has not been fully appreciated is the fact that these changes mean that a growing number of workers must work apart from the direct supervision of their bosses. Because managers are less able to directly monitor the workers under them, old command-and- control methods of management have begun to wane. Managers have become less able to tell their employees what to do simply because the managers, in highly sophisticated and complex production processes, don’t have the skills and knowledge to do what their employees can do or even figure out exactly what their workers should do with a substantial share of their time. Production has truly become “participatory,” which means that higher managers must rely on their underlings to do what they are supposed to do. Under the circumstances, managers must find ways to entice workers to use their creativity, skills, and human capital to pursue firm goals. In short, managers must use incentives. They can no longer manage by commands, at least not to the extent that they once could. They must now manage through incentives, which they are doing in growing numbers. The count of firms that tie manager and worker incomes to performance is not known, but few doubt that it is growing rapidly. 19 We submit that incentives are a popular solution for today’s management dilemmas for a simple reason: Incentives work and always have, often with dramatic effect. Incentives at Work In the late nineteenth century, British boat captains were paid to carry prisoners from England to the wilds of Australia, just to rid England of its crime problem and reduce the cost of housing criminals. The captains were paid a flat fee for each prisoner who boarded at an English port, giving the captains had a strong incentive to board as many 19 In 1945, there were only 2,113 firms in the United States that had deferred compensation or profit- sharing plans for their workforces. In 1991, the count of firms with such group incentive plans had risen to nearly 500,000 (as reported in Haig R. Nalbantian and Andrew Schotter, “Productivity Under Group Incentives: An Experimental Study,” American Economic Review, vol. 87 (no. 3), June 1997, pp. 314–41). One researcher predicted in the late 1980s that by the turn of the century, a quarter of all firms listed on the American, New York, and over-the-counter Stock Exchanges will, because of distribution of shares of stock and stock options to workers, have more than 15 percent of their shares owned by their workers [Joseph R. Blasi, Employee Ownership: Revolution or Ripoff? (Cambridge, Mass.: Ballinger Publishers, 1988)]. Chapter 1. The Economic Way of Thinking 26 prisoners as they could, but only a weak incentive to deliver them to Australia alive. In other words, the incentive system was perverse. If prisoners died along the way from lack of food and care, the cost of the trips was lowered. And the survival rate was a miserable 40 percent, a fact that outraged humanitarians then, as it would now! But despite the moral outrage at the time, the survival rate of the prisoners didn’t budge until the incentive was changed. Edwin Chadwich, the government official in charge of the deportation of criminals in the 1860s, had a bright idea for restructuring the incentive system: pay the captains not by the count of prisoners who boarded the boats in England, but by the number of prisoners who disembarked in Australia. The survival rate rose quickly and dramatically to 98.5 percent! All because the captains then had a strong incentive to take care of their charges. 20 Under the former Soviet Union, there was more than an ounce of truth in the widely circulated Soviet witticism: “We pretend to work, and they pretend to pay us.” In the new economy, the pretense of work will not be rewarded. Former (and last) premier of the Soviet Union Mikhail Gorbachev made much the same point when he wrote that “amazing things happen when people take responsibility for everything themselves. The results are quite different, and at times people are unrecognizable. Work changes and attitudes to it, too.” 21 Many world leaders worry that the Soviet people have become accustomed to being communists and will not make the transition to market thinking without grave difficulty. Further, they worry that instituting property rights and the attendant incentives may not have all the beneficial effects that they have had in the West. After all, the Soviet citizens need to rebuild their economy, and the rebuilding process has imposed a major disruption on economic activity. We also harbored such grave concerns until we heard an American diplomat talk about the resale of burned-out light bulbs in the black (or just gray) markets of Moscow. Light bulbs were scarce in Moscow under the communist regime, partly because of the inefficiency of the Russian light-bulb producers and partly because light bulbs were underpriced and producers had only weak incentives to meet customer needs. To get light bulbs, Russians had to wait in long lines, possibly two or three hours. Reducing the shortage was impaired by the fact that many producers still did not have the right to own, buy, and sell all of the materials that go into light bulbs and the light bulbs themselves. The planners, however, forgot about imposing such restrictions on the ownership and resale of used light bulbs, which were of no use to anyone, or so it might have been thought. Russian consumers found a use for them, however. They could buy the burned- out light bulbs, take them to work, and exchange them with good bulbs in their work places. They could then call the maintenance department to have the bulbs replaced. The bulbs are typically replaced with unusual quickness. Why? Because the maintenance people knew that they could claim ownership of the used bulbs, once they replaced them with good bulbs, and they could then sell the used bulbs back to the Moscow black market. The diplomat reported that used bulbs had a life cycle of approximately twenty- four hours. Within that time, the used bulbs would be back for resale again. To 20 As described by Edwin Chadwich, “Opening Address,” Journal of the Royal Statistical Society of London, vol. 25 (1862), as cited in Robert B. Ekelund and Robert F. Hebert, A History of Economic Theory and Method. 21 Mikhail Gorbachev, Perestroika (New York: Harper & Row, 1987), p. 97. Chapter 1. The Economic Way of Thinking 27 paraphrase Gorbachev, amazing, unexpected things happen when people are given meaningful incentives to lay claims to the benefits of their actions. Like most other universities, the University of California, Irvine, has graduate student apartments that are heavily subsidized. That is to say, the rents charged for on- campus apartments are several hundred dollars lower than the rents charged for comparable off-campus, privately owned apartments close to campus. The university claims that the apartments must be underpriced in order that “good” but “poor” graduate students can afford to follow their degree programs at the university. The university also argues that if it were to raise the rents, the quality of the graduate students the university could attract would fall unless graduate student assistantship and fellowship payments were raised. Naturally, the incentives in the subsidized rents lead to consequences that undermine the official explanation for the subsidies. First, students will likely use the subsidies to rent apartments that are larger than they would choose to rent if they had to pay market prices, soaking up space that could be used by other students. Second, the quality of the apartments has deteriorated with deferred maintenance, which has been made necessary by the low rents. Third, and perhaps most important, the graduate students tend to stay much longer than you would think graduate students would need in order to finish their degree programs. Indeed, many of the student-residents have been in their apartments for more than a decade, using all sorts of means to prolong their graduations (for example, sending spouses to school, taking years off in the middle of their programs, and pursuing post-doctorate research). In extending their stays, they deny the spaces to other students who might otherwise choose UC-Irvine. Moreover, we must question the official argument—they “can’t afford higher rents”—for maintaining the low rents. Of course, the students could afford higher rents. If there is a problem, the university could raise the rent and hand the additional revenue back to the graduate students in the form of cash. If the rent were raised by $400 and the students were given the $400 back, then they could clearly afford what they had. The question is whether they would actually continue to rent the same apartments. Not likely. Many students would take the cash and run to buy other things, after accepting a smaller place to live (because the price of space would then be higher). Instead of increasing the quality of the university’s graduate students, the rent subsidies are very likely lowering the quality. If the rent were raised by $400 and the revenue were transferred to departments for distribution as assistantships and fellowships, then surely potential graduate students would be happier by having the $400 in cash than $400 in rent subsidy. With the cash, the students could still rent the apartment at the higher payment, but then they could do other more valuable things with the cash. When the subsidy is in the form of a reduction in the price of a particular good, then it is locked in, limited to the good in question, a point that has escaped the thinking of the university officials. This is one general reason why businesses—not just universities—should think seriously before they give their workers in-kind work-related benefits in lieu of salary. Chapter 1. The Economic Way of Thinking 28 Tying Pay to Performance Of course, incentives have been found to be important for more mundane, everyday business reasons. Tying compensation to some objective measure of firm performance can cause the affected workers’ productivity to rise substantially, a point that is covered in detail later. As would be expected, appropriately structured incentive pay can increase a firm’s rate of return and stock price, as well as the income of the affected workers. One study of thousands of managers of large corporations found that adding a 10 percent bonus for good performance could be expected to add .3 to .9 percent to the companies’ after-tax rate of return on stockholder investment. If the managerial bonuses are tied to the market prices of the companies’ stock, share prices can be expected to rise by 4 to 12 percent. The study also found that the greater the sensitivity of management pay to company performance, the better the performance. 22 Another study found that firms don’t have to wait around for the incentives to have an impact on the firms’ bottom line to get a jump in their stock prices; all they have to do is announce that executives’ compensation over the long haul is going to be more closely tied (through stock options or bonuses) to performance measures and the stock will, within days, go up several percentage points, increasing shareholder wealth by tens, if not hundreds, of millions of dollars (depending on firm size). 23 Of course, if managers are paid just a straight salary, they have little reason to take on risky investments. They gain nothing from the higher rates of return associated with risky investments, which is why they may shy away from them. Accordingly, it should surprise no one to learn that when managers are given bonuses based on performance, they tend to undertake riskier, higher paying investments. 24 But then, if the bonuses are based on some short-term goal—say, this year’s earnings—instead of some longer-term goal—say, some level for the stock price—you can bet that managers will tend to sacrifice investments with higher longer-term payoffs for smaller payoffs that are received within the performance period. The managers’ time horizons can be lengthened by tying their compensation to the firm’s stock value and then requiring that they hold the firm’s stock until some later date, for example, retirement. 25 Although incentives have always mattered, they probably have never been more important to businesses interested in competing aggressively on a global scale. Greater global competition means that producers everywhere must meet the best production 22 The study covered the pay of 16,000 managers from 250 large corporations over the 1982-1986 period (John M. Abowd, “Does Performance -Based Managerial Compensation Affect Corporate Performance?” Industrial and Labor Relations Review, vol. 43 [special issue, February 1990], pp. 52S–3S). 23 See James A. Brickley, Sanjai Bhagat, and Ronald C. Lease, “The Impact of Long-Range Managerial Compensation Plans on Shareholder Wealth,” Journal of Accounting and Economics, vol. 7 (1985), pp. 115–29. 24 Y. Amihud and B. Lev, “Risk Aversion as a Managerial Motive for Conglomerate Mergers,” Bell Journal of Economics (Fall 1981), pp. 605–17; B. Holmstron, “Moral Hazard and Observability,” Bell Journal of Economics, vol. 10 (1979), pp. 74–1; S. Shavell, “Risk Sharing and Incentives in the Principal and Agent Relationship,” Bell Journal of Economics, vol. 10 (1979), pp. 55–3; and C. Smith and R. Watts, “Incentive and Tax Effects of Executive Compensation Plans,” Australian Journal of Management, vol. 7 (1982), pp. 139–57. 25 Michael C. Jensen and William H. Meckling, “Property Rights and Production Functions: An Application of Labor-Managed Firms and Codetermination,” Journal of Business, vol. 52 (1979), pp. 469–06. Chapter 1. The Economic Way of Thinking 29 standards anywhere on the globe, which requires having the best incentive systems anywhere. Incentives will continue to grow in importance in business as the economy becomes more complex, more global, and more competitive. Although incentives are both positive and negative, when structured properly, incentives can ensure that managers, workers, and consumers prosper. Like it or not, business people will have to learn to think about incentives with the same rigor that they now contemplate their balance sheets and marketing plans. They will need to justify the incentive structures they devise, which means they will have to understand why they do what they do. High pay and golden parachutes for executives and stock options for workers will need to be used judiciously. They can’t be employed just because they seem like a nice idea, or because everyone else is using them. Investors who find it easier and easier to move their investment funds anywhere in the world will not allow their capital to be used for “nice ideas.” Unless well thought out, “nice ideas” can spell wasted investments. The multitude of ways that incentives can matter in business must be incredibly large, which makes a study of them mandatory—if managers want to get them right. Unless policies are carefully considered, perverse incentives can be an inadvertent consequence, mainly because people can be very creative in responding to policies. Lincoln Electric is known for achieving high productivity levels among its production workers by tying their pay to measures of how much they produce. But the company went too far. When it tied the pay of secretaries to “production,” with counters installed on typewriters to measure how much was typed, the secretaries responded by spending their lunch hours typing useless pages of manuscript to increase their pay, which resulted in that incentive being quickly abandoned. 26 In seeking to reduce the number of “bugs” in its programs, a software company began paying programmers to find and fix bugs. The goal was noble but the response wasn’t. Programmers began creating bugs in order that they could find and fix them, with one programmer increasing his pay $1,700 through essentially fraudulent means. The company eliminated the incentive pay scheme within a week of its introduction. 27 Incentives almost always work, but they don’t always work well or in the way that’s expected (a fact that has led to harsh criticisms of even attempting to use incentives, punishments, or rewards 28 ). In the twenty-first century world economy, business incentives will be commonplace; getting them right will be an abiding and taxing concern of managers. The Role of Incentives in Firm Successes and Failures Some firms prosper while other firms fail. Why? An easy answer is that some firms produce a better product or provide a better service. The fortunes of many fast-food 26 See N. Fast and N. Berg, “The Lincoln Electric Company,” Harvard Business School Case (Cambridge, Mass.: Harvard Business School Press, 1971). 27 S. Adams, “Manager’s Journal: The Dilbert Principle,” Wall Street Journal, May 22, 1995, p. 14. 28 For criticisms of incentives, see Alfie Kohn, Punished by Rewards (Boston: Houghton Mifflin, 1993). See also Jone L. Pearce, “Why Merit Pay Doesn’t Work: Implications for Organization Theory,” Perspectives on Compensation (1987). . Economic Way of Thinking 23 However, when fur trading commenced and the Indians hunted animals for their skins, the demand and therefore the price of animal. relieved for all those people who either own or work for or with the firms. However, in order to get people involved in or with firms to work diligently for