Perverse Incentives

A perverse incentive occurs when a reward accidentally encourages the very behavior it was designed to prevent. In the city with the rat problem, offering money for dead rats led people to start breeding them, making the problem worse.

This happens because the incentive rewards a simple, measurable action (turning in a dead rat) instead of the true, harder-to-measure goal (reducing the live rat population). It's a classic case of people working to the metric, not the mission.

Ask this: 'How could this new rule be cheated or exploited?'

Perverse incentives arise from a misalignment between the metric you reward and the outcome you desire. People, acting rationally, optimize their behavior to maximize their reward. If the easiest way to get the reward isn't the same as achieving the system's goal, unintended—and often opposite—results can occur.

This is a common failure mode in policy, business, and even personal goal-setting. The core issue is choosing a convenient proxy metric over the true objective because the true objective is often harder to measure.

For example, a sales team rewarded solely on the number of new contracts signed might push costly, low-profit deals that hurt the company's bottom line. The metric (contracts signed) is easy to count, but it's a poor substitute for the real goal (sustainable revenue growth).

In education, when schools are funded based on standardized test scores, some may narrow the curriculum to 'teach to the test.' This can improve scores but at the cost of students' critical thinking, creativity, and love of learning—the actual goals of education.

Even in technology, rewarding software developers for the 'lines of code' they write can lead to bloated, inefficient programs instead of elegant, effective solutions. The key to avoiding this is to constantly question if your incentives truly align with your ultimate purpose.

The study of perverse incentives is central to economics and public policy, highlighting the gap that can emerge between intention and outcome. This phenomenon is closely related to concepts like Goodhart's Law, which states that when a measure becomes a target, it ceases to be a good measure. The classic cautionary tale is the 'cobra effect,' a story from colonial India where a bounty on cobras allegedly led people to breed them. These situations are often analyzed through the lens of principal-agent theory, which examines conflicts of interest and information asymmetry between a principal (e.g., an employer) and an agent (e.g., an employee).

• Kerr (1975): This foundational paper, 'On the Folly of Rewarding A, While Hoping for B,' outlines numerous organizational examples where reward systems systematically undermine stated goals, such as valuing simplistic, quantifiable metrics over complex, desired qualities like teamwork or creativity. [1]
• Holmstrom & Milgrom (1991): In their analysis of multi-tasking agents, they demonstrated that if an employer offers strong incentives for one easily measured task, the employee will focus on that task to the exclusion of other important, but harder-to-measure, duties. [2]
• Vann (2013): Historical research into bounty systems during colonial rule in French Indochina confirms that officials were aware of, and struggled with, people gaming the system—such as by breeding pests like rats to claim more rewards. [3]

While a powerful concept, not every unintended consequence is a perverse incentive; some are simply unforeseen side effects. The strength of the perverse behavior often depends on the size of the incentive and the ease of 'gaming' the system. Furthermore, attributing a negative outcome solely to a perverse incentive can oversimplify complex situations where multiple social, economic, and political factors are at play.