Incentive Hygiene: No Winks, No Nods, No Side Deals
Delete the pay structures that make bad behaviour rational, don't preach at people.
- Difficulty
- Advanced
- Time to result
- ~months to results
- Steps
- 6
- Confidence
- 88%
The mechanism treats compensation as the actual control system and everything else as commentary. First you make risk expensive internally: with proper risk controls in place, capital-hungry leveraged strategies stop being profitable to the person running them. Then you remove the structures that reward individuals for particular outcomes (side deals, private three- and five-year arrangements, pay tied to a single book) so nobody has a private economic reason to override the firm's risk posture. The profit-pool share is capped or removed where it scales with leverage, because a 20% share on 30x leverage is a mathematical argument for 40x. Finally you state the override explicitly and accept the attrition, since the people who leave are the ones the old plan was selecting for.
Origin
Extracted from Acquired. Dimon describes stripping side deals and leveraged profit-pool arrangements out of JP Morgan's investment bank ahead of the 2008 crisis.
Core principles
- 01Behaviour follows incentives, so the lever is the incentive, not the exhortation.
- 02Pay tied to one deal or one book buys you that deal and nothing else.
- 03Private side arrangements create two cultures inside one company.
- 04A profit share plus leverage is an instruction to add leverage.
- 05Losing the people who leave over this is part of the mechanism working.
How to run it
- 1
Install the risk controls first
Put in place controls that charge each activity for the capital it would consume in a stressed scenario. This alone removes the profitability of leverage-driven strategies.
Pro tip Look at earnings through the cycle rather than at the current period when setting the internal capital charge.
- 2
Find and kill every side deal
Audit for private arrangements: three-year deals, five-year deals, bespoke splits for senior producers. Cancel them rather than grandfathering.
Watch out Side deals are, by construction, not in the plan documents. You will only find them by asking directly.
- 3
Break the link between pay and a particular thing
Stop paying almost anyone on one specific deal, book or product. Where arrangements remain, make them known across the leadership group.
Pro tip The test is not whether the deal is defensible but whether everyone who should know about it does.
- 4
Remove the leverage-scaled profit share
Where a team receives a percentage of profits on a leveraged book, the percentage times the leverage is the real incentive. Cut the share, the leverage, or both.
Watch out At 30x leverage and a 20% share, moving to 40x adds roughly 25% to the bonus for no additional skill.
- 5
State the override and mean it
Tell people directly that regardless of what the plan pays, they do not do the wrong thing, to the firm or to a client. Anchor it to a reciprocity test: how would you want to be treated if you were the client?
- 6
Open an escalation channel and re-review
Make it normal for employees to report that a plan is incentivising the wrong behaviour, and re-examine plans regularly because the distortions move.
In the wild
Dimon found that the investment banks of the era, JP Morgan included, ran extensive private compensation arrangements for senior bankers: three- and five-year side deals negotiated individually. He removed almost all of them, so that by his account there are no winks, no nods, no side deals and almost nobody paid on a particular thing. In parallel he cut the leveraged profit-pool arrangement, where a 20% share of profits on a 30x-levered book made expanding to 40x worth roughly 25% more bonus. He lost people over it.
→ The bank entered the crisis with roughly a third of peer investment-bank leverage and far more liquidity.
Common mistakes
Exhorting instead of restructuring
Telling people to behave well while paying them to do otherwise leaves the actual control system untouched. The plan is the policy.
Grandfathering the existing arrangements
Leaving legacy side deals in place preserves exactly the two-tier culture the change is meant to remove, and signals the new rule is negotiable.
Treating attrition as failure
The people who leave when leverage-linked pay disappears are the ones the old plan was selecting for. Dimon lost people and treats that as expected cost.
Is it for you?
Best for
Leaders of firms where individual pay is tied to deal, desk or book outcomes.
Not ideal for
Small teams with fully visible economics, where the plan is already transparent to everyone.
From the transcript
“There are no winks there are no nods there are no side deals there's almost no one paid on a particular thing”
“if you have 30 times leverage and you're getting 20% of the profits you'll go to 40 times leverage”
“I don't care what the incentive is don't do the wrong thing. And and don't do the wrong thing to a client.”
From the episode
The Jamie Dimon Interview