Where’s the incentive?
By Fenwickefinancial On August 15, 2016


Every now and again you will see an outcome or some behaviour that just doesn’t make sense on the facts presented.

How did CHEP lose 14 million pallets in the early 2000’s?
They are a pallet company, in essence all they do is rent pallets to customers, collect them, repair them and rent them out again. It doesn’t make sense that they could lose this many. So what’s the answer? CHEP had just started making plastic pallets and had put in place a manager incentive scheme which meant that managers were paid a higher bonus for ordering new plastic pallets than they were for collecting old wooden ones.

Why did so many people buy timber/forestry managed funds in the 10 years leading in to 2008?
Was it because of the good income or solid and certain IRR? No, it was because of the 100% tax deduction and the fact there was a highly motivated sales force who were being paid up to a 10% commission on these products versus 1-2% on other investments. This commission differential was rarely transparent to investors and the tax deduction meant they weren’t highly motivated to do proper due diligence.

Why did Dick Smith go broke while JB Hi-Fi and Harvey Norman were riding them boom of ever cheaper technology based products?
Rebates! Apparently widespread in retailing, you order some products from a supplier for $10 and they pay you a $1.50 rebate – to help with marketing and other selling expenses. There are some suggestions that these rebates were being booked immediately as profit or at least as income for purchasing managers. When this happens purchasing managers go hunting for the biggest rebates regardless of the suitability of the stock and they over order because the rebate becomes more important for their remuneration than the eventual sale of the item. Eventually, you have a whole lot of crap stock that no-one wants and the slow sales and write-offs kill the company.

The lesson – if you don’t understand why something is happening, dig deeper and try to discover the incentives for the individuals involved as these may not align with wider corporate interests, and if you are running a business, make sure that you regularly review any incentives you put in place to ensure they still make good business sense.

Jim

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