What Are Perverse Incentives? Definition and Examples

Incentives are commonly used to encourage specific behaviors or achieve desired outcomes. These motivators, while typically designed with good intentions, can lead to unexpected and counterproductive results. This phenomenon, known as a perverse incentive, occurs when an incentive unintentionally encourages behavior that works against the original goal.

A perverse incentive often creates a situation where the pursuit of the reward generates an outcome worse than the problem it aimed to solve. Such situations can arise in various sectors, from public policy to corporate compensation structures. Understanding these unintended consequences is important for anyone seeking to design effective systems.

Defining Characteristics

Perverse incentives are marked by several distinct features that highlight their counterproductive nature. A primary characteristic involves unintended consequences, where the negative outcomes are an unforeseen byproduct. The incentive, despite its initial positive aim, inadvertently steers behavior in an undesirable direction.

Another defining aspect is goal misalignment, where the incentive structure encourages behaviors detrimental to the overarching objective. This means the system rewards actions that move away from the intended purpose. Individuals or entities responding to these incentives often act rationally from their own perspective, seeking to maximize their personal gain.

This rational individual behavior can aggregate into an undesirable collective outcome, illustrating how rational actions can lead to irrational system-wide results. Incentives frequently tie to easily measurable metrics, sometimes at the expense of broader, less quantifiable objectives. This focus on narrow, measurable targets can inadvertently neglect other important aspects of the overall goal, contributing to the perverse outcome.

Real-World Instances

Perverse incentives manifest in various practical scenarios, often leading to outcomes far removed from initial intentions. A widely cited historical example is the “Cobra Effect,” stemming from British colonial rule in India. Authorities offered a bounty for every dead cobra to reduce the snake population, but residents began breeding cobras to collect the reward, ultimately increasing the wild cobra population when the program was discontinued. A similar situation occurred in French colonial Hanoi, where a bounty for rat tails led to people breeding rats for profit.

In the financial sector, sales compensation plans can create perverse incentives. If salespeople are heavily rewarded based solely on the volume of new sales, they might push unsuitable products or neglect post-sales service, leading to customer dissatisfaction and undermining long-term profitability. Similarly, investment advisors paid a success fee only if a transaction closes may prioritize closing a deal over client interest.

Healthcare also provides examples of perverse incentives, particularly related to payment structures. Systems that primarily reimburse medical professionals for treatments rather than preventative care can encourage conditions to be ignored until they require more expensive interventions. This can lead to unnecessary procedures or the over-prescription of medications, as providers may be incentivized to maximize revenue from billable services.

Formation Mechanisms

Perverse incentives often arise from inherent challenges in designing effective systems. One common reason is a narrow focus in design, where incentives are crafted to address a single problem without fully considering broader systemic impacts or interdependencies. This limited perspective can overlook how individuals might react in ways unintended by the designers.

Information asymmetry also plays a role, occurring when incentive designers lack a complete understanding of how recipients will truly behave or the full context in which the incentive operates. This incomplete information can lead to unforeseen behavioral adaptations that undermine the incentive’s purpose.

Incentives sometimes focus heavily on achieving short-term results, neglecting potential long-term consequences. This short-term thinking can encourage actions that provide immediate benefits but create larger problems over time. Perverse incentives can also form when the metrics chosen for rewards do not accurately reflect the desired ultimate outcome. If an incentive measures a proxy rather than the true objective, individuals will optimize for the measured proxy, potentially at the expense of the actual goal.

Finally, a lack of feedback loops means there are insufficient mechanisms to detect and correct unintended outcomes, allowing perverse behaviors to persist and become entrenched within a system.