Why your Boss is Overpaid

Dilbert: “My problem is that other people keep trying to bring me down, Bob. My theory is that people denigrate me because it makes them feel superior in comparison.”
Bob: “Sounds like a stupid theory to me.”
—Scott Adams, Dilbert

It seems as though this is a question that’s always on people’s mind. Why is your boss paid a fortune while your talents go unrewarded? The office can sometimes come across as the most illogical place on the planet, but is there a reason for it all? We recently came across a chapter on this very subject in “The Logic of Life” by Tim Harford and couldn’t resist summarizing his main points here. It makes for an interesting case.

The Information Problem

In order to reward people accurately you need information – who’s the most honest, the hardest working, the most talented etc. In some cases, this is easy to come by. For instance, take the example of an author. The author is rewarded specifically for the amount of books they sell and this number is easily measurable. If they sell hundreds of thousands of books, then their pay will reflect it.

This is also the case when, say, you’re making widgets. If you produce more widgets, you receive greater pay. Again, it’s easy to identify who should be rewarded (or not) and to what degree.

However, office life doesn’t quite work like that. How do you define “good work” in an office environment and how is it measured? In these cases, managers need to take a far more holistic approach when identifying good performance and the process becomes much more discretionary. As it becomes more discretionary, it’s less effective at motivating people. Who’s going to believe a manager that promises raises for the best workers but isn’t specific on what people have to do to earn them?

Tournament Theory

It turns out, the rational way around this problem is something called “Tournament Theory” (it’s exactly what it sounds like). In this scenario, workers are paid relative to the performance of their colleagues.

Who’s paid on a relative basis? Well, Roger Federer for one. He’s not paid based on the number of winners he hits in a match, or the number of aces he drops, but for beating his opponent. If he beats his opponent, that’s all that matters – he doesn’t even need to play particularly well. In the office this translates to a higher bonus the better you perform relative to your peers. While it’s not always easy to decipher the best performance, it’s far easier to do so when comparing your performance to others.

The Role of Luck

So, what does this all have to with your boss getting overpaid? Well, we’re getting to that. One interesting result of rewarding employees by measuring their achievements relative to others is the role of luck. There’s always a high degree of luck when someone is successful at a particular task or assignment, so when they’re rewarded on this basis how does that affect the motivation of others? They were simply lucky, how does working any harder motivate me? The larger the role of luck in these cases the larger the incentives must be in order to motivate. For instance, if your promotion turns out to be 95% luck and 5% hard work it’s rational to goof off in the face of incentive schemes. Does anyone work hard to win the lottery? It’s 100% luck, but if you working hard meant that you had a 5% chance of winning the lottery you would give it everything you had!

Workplace Tournaments

As a result, people demand higher and higher pay packages (something approaching the lottery I suppose) in order to maintain a certain level of motivation in the face of all that luck. It also requires your colleagues higher up the corporate hierarchy (i.e. your boss) to demand larger pay packages because they have fewer and fewer opportunities for upward mobility. For instance, when you first started out your less than stellar pay was balanced with all that opportunity to move up.

As one of the creators of tournament theory, Ed Lazerar, commented “The salary of the vice-president acts not so much as motivation for the vice president as it does as motivation for the assistant vice-presidents”.

So your boss being overpaid seems, quite frankly, to be rational after all?