A behavioral economist’s model of responsible leadership: Guest Post by Gerhard Fehr, RECOL 2014

 
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Following our RECOL Forum guest post by Dr Katrin Muff, we are delighted to welcome Gerhard Fehr, CEO FehrAdvice & Partners AG.  Gerhard discussed ‘The right incentives for balancing short- and long-term behaviour of leaders’ at the Forum.

Today he reflects on his discussion in line with Katrin Muff’s Four Dimensions of Responsible Leadership model, developed as part of the 50+20 Vision.

 

A behavioral economist’s model of responsible leadership – Gerhard Fehr

Responsible leadership is about making business decisions that, aside from the interests of the shareholders, also take all the other stakeholders, such as workers, clients, suppliers, the environment, the community, and future generations into account. (source: RECOL Circle)

During the last RECOL Forum in Switzerland, Dr. Katrin Muff, Dean of Business School Lausanne, presented an interesting model for responsible leadership.

Dr.-Katrin-Muff-at-RECOL_fixed

In this model, any leader constantly shows reflective awareness, which allows him or her to take a universal perspective on his company. He or she is a responsible person with distinctive ethical skills and knows what is right and what is wrong. And he or she demonstrates “enlightened statesmanship“, as Dr. Muff calls it, which allows a wider societal and political perspective. And beyond that, the leader is a sustainable entrepreneur as well, visionary and always with the long term-perspective in mind.

 

Does the average person really behave as described?

A look at the scientific research of behavioral economists quickly makes us aware of many behavioral patterns that prevent humans from acting like this:

  1. Our awareness is bounded, because our predictions about other peoples’ behavior are predictably wrong.
  2. The sustainability of our decisions is bounded because we are impatient.
  3. Our ethicality is bounded because people do not behave ethically in the moment of truth.
  4. When it comes to cooperation, we are bounded as well. Behavioral economists have shown in many experiments that a breakdown of cooperation is the norm and not the exception.

 

Fehr_RECOL_Forum_FAP Model_v01

I will now explain these four points in more detail:

 

Bounded awareness: Focus on fairness norms

The work of behavioral economist George Loewenstein has shown us that people have difficulties assessing how they would respond to a situation that is different from their current one – regardless of whether they have to take the perspective of another person, or that of their future self. And, unfortunately, there is almost no cure for bounded awareness.

To escape this trap, leadership should include respectful feedback, given in a cold rather than in a hot emotional state. In addition, fairness norms must be defined and implemented. They ensure that no one feels treated unfairly.

 

Bounded sustainability: The entrepreneurship fallacy

People start businesses for all kinds of reasons. Other people do not start businesses for all kinds of reasons. The former group, however, have distinctive preferences on average. They tend to take more risks, they are more over-confident, and they sometimes do not care about norms. While these characteristics are essential for successful entrepreneurs, they may harm sustainability and norm compliance in certain organizations.

When employees occasionally see this behavior, they might perceive it as socially desirable, when in fact it is the opposite. However, observing these habits may encourage them to assume new norms: ones in which risky behavior and egocentrism are the standard.

Moreover, most people are impatient: A representative online-experiment conducted by FehrAdvice & Partners investigated how willing the participants were to give up something that is beneficial for them today in order to reap more benefits in the future. The results: roughly 60% of the population showed impatient behavior. Impatience leads not only to unsustainable consumption and to unsustainable sex, it also leads to unsustainable investment, triggered by short-term thinking.

To avoid these traps, the right incentives must be set. Short-term bonus schemes can neither resolve the problem of impatience nor unnecessary risks. The design of long-term incentives reflecting managerial performance over a longer period of time are essential in this case.

 

Bounded ethicality: In the moment of truth, people do not behave as they should

Imagine you have a certain disease. To find out what will be the best cure, you go to five different doctors from different disciplines. An experiment shows that you will get five completely different recommendations for treatment, from surgery to homeopathic globules.

Why is this case? All five doctors believe that they provide the perfect recommendation for your disease. But like other people, they overestimate their performance and abilities, and their beliefs are biased in a self-serving manner.

Even when doctors are confronted with these results, they show no doubts about their ethical behavior: It is always the other who behaves unethically.

This is a typical sign for bounded ethicality in case of the personal behavior, and in predicting the ethicality of others. In fact, these patterns can be observed not only on the individual level, but also on the social and organizational levels: without high awareness and high willingness to behave ethically in the moment of decision, it is very likely that someone will behave unethically.

 

Bounded cooperativeness: Is it possible to cure cooperation?

A highly regarded experiment by Ernst Fehr and Simon Gächter showed that most people are willing to cooperate – but only if they see others cooperating as well. These conditional cooperators are crucial for keeping a behavioral norm alive. As soon as they see others cease cooperating, norm compliance breaks down within a short timeframe.

What can be done to maintain cooperation? Most of the commonly used measures have only limited effects on the sustainability of norm compliance, no matter whether they are communication measures, rewards for cooperators, belief management (introduction of a cooperative leader) or change of people (replacement of non-cooperators).

All these are necessary to introduce change, but their effect is not strong enough to achieve norm compliance, i.e. cooperation with prosocial norms, in the long-term.

Here once again, the findings of behavioral economists help: experimental results show that sustaining norm compliance can seldom be achieved without sanctioning mechanisms. We know that a large share of the population is willing to sanction those who do not comply with behavioral norms, even if punishment is costly. The introduction of an appropriate punishment opportunity thus leads to a strikingly higher level of norm compliance.

 

Do not change people, change their behavior!

In summary, one can say: to make Katrin’s leadership model work, you have to focus on the following actions:

  1. Incentives: Apply long-term incentives to make people’s acceptance of norms more sustainable
  2. Culture eats strategy for breakfast: Use sanctions (punishment) to establish cooperative behavior
  3. Fairness beats empathy: Establish fairness norms
  4. Character complements talent: Get the right people with the right character

 

You can read more about Dr. Katrin Muff’s model and the RECOL Forum 2014 in our Building Responsible Leaders in Switzerland post.

 

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