The Stag Hunt: A Lesson in Strategic Compensation Policy
While it is not uncommon for companies to talk about strategies in key areas of business like financial, risk management or sales strategies, a company’s human resource strategy often simplified into a more generic and vague form: “acquire the best in class talent”. Oftentimes what this really means is: recruit and offer market value in base salary and competitive discretionary performance incentives as needed.
While thinking rarely goes beyond this level of depth from a strategic perspective, today’s knowledge-based economy would dictate a comprehensive strategic perspective of the company’s most important assets is a critical factor in driving organizational success and achieving its goals. Having the right structures to incentivize the desired behaviors is only one aspect of a strategic human resource management.
By looking through the lens of Game Theory, we can illustrate the impact of compensation structures on human relationships and behaviors in relation to organizational success.
Game Theory and the Nash Equilibrium
Game Theory is the study of models and systems traditionally used by mathematicians and economists to analyze behaviors, relationships and outcomes. Within the study of Game Theory, one of the key purposes is to identify the Nash Equilibrium: the course of action where the individual is motivated towards without sacrificing the rewards of others. It is known to be an important principle due to its applicability in economic, social and natural research and strategies.
The Stag Hunt is one of the classic games often analyzed to highlight the Nash Equilibrium. The Stag Hunt was a story made famous by philosopher Jean-Jacques Rousseau in his Discourse on Inequality. Rousseau described a situation in which two individuals go out on a hunt. Each can individually choose to hunt a stag or a hare. Each player must choose an action without knowing the choice of the other.
- An individual can hunt a hare by himself for a lower payout but also lower risk of not achieving the result as well as no risk of the other player deviating from the agreed upon goal.
- If an individual hunts a stag, both players must cooperate in order to achieve the desired payout and therefore, the player takes a higher risk, relying on the other’s behavior. While the risk is higher because some control is lost, the reward should be higher.
Economists agree that all things being equal and neutral in the Stag Hunt game, there are two pure strategy Nash equilibria – one that is less risky but more stable in outcome and one that is risky but with a bigger payoff because it depends on how the individuals trusting each other to cooperate.
- Both individuals will do the bare minimum and individually hunt a hare for a lower payoff
- Both individuals will collaborate and share in the mutually greater payoff of the hunted stag
Theory Meets Practice
Imagine a Stag Hunt in which both players are clearly better off in hunting the stag with no clear, objective, quantifiable reason to settle for the hare. Now throw in real life examples of poor management and any number of hindrances may result in the uncertainty in achieving the desired organizational outcome.
Higher compensation in absolute terms does guarantee individual players’ motivation – If one player sees a disproportionate compensation through reward or recognition, an imbalance in engagement and reduced morale may lead to behavioral uncertainty, reducing the effectiveness of the strategy.
Each player must have full trust in the integrity of the rules – In the real world, dysfunctional office politics play a role in leading to mistrust which may render higher incentives ineffective and untrustworthy.
Even the most effective and perfectly designed structure serves no purpose if there is no clarity or transparency around it – Ineffectively designed goals, unclear performance evaluations and compensation structures that are not aligned with performance reduce the certainty that players will cooperate for the greater prize.
Players may have perfect clarity on the goal and the incentive but without proper leadership, compensation as a motivating factor reaches its limits – Even if all players have every incentive to outperform and hunt a thousand stags, if the players are mistreated and lack leadership engagement, they may seek a whole new game entirely.
The Stag Hunt represents an example of compensation structure in theory. On the other hand, real life examples of poorly designed compensation structures that create organizational inefficiencies and hinder success are not uncommon. Imagine a mortgage sales representative at your local bank branch that earns commission based on the value of each new originated mortgage loan. The counter-balancing organizational control is that each new loan requires a credit risk manager’s approval, whose compensation is entirely salary based. In this scenario, the hare represents losses (or the avoidance of them) and the stag represents new originated loans.
The conflicting interests and goals are only further amplified by the diverging compensation structures. In this notable example, the most likely organizational behavior that will arise is exactly what the compensation structures had in mind: internal conflict.
Leading the Stag Hunt
Once equipped with the knowledge of its importance, the challenge of leadership is to strategically design compensation structures that incentivize all players organizational success by leveraging their individual motivations. A more optimally designed structure in the live example of the mortgage representative vs the credit manager is to offer shared incentives based around the risk-adjusted profitability of new business. All players move in the same direction, all players see the benefit of hunting the stag.
Whether the goal is retention, performance excellence or employee engagement, compensation structure plays a key role in any corporate strategy and its importance should not be ignored. And while no company absolutely ignores the relationship between compensation and motivation, Payscale.com estimates that only 39% of organizations have a compensation strategy, meaning that only a minority consciously and deliberately design strategies to leverage their importance in overall corporate success.
Furthermore, it should be noted that just having a compensation strategy does not necessarily mean that it is a good one. It is therein that true leadership becomes all the more important. As Herzberg noted: