Joachim Andersen

Accelerated Learning

Incentives: Why People Do What They’re Rewarded For

Incentives illustrated by an elderly white-bearded patron in a dark velvet jacket, seated in an ornate leather armchair, holding out a gold coin to a dark-haired errand boy in a linen shirt and brown waistcoat who reaches for it, in a candlelit room with gilded frames and dark wood at night.
Incentives illustrated by a gold coin held out to an eager errand boy: show me the incentive, and I will show you the outcome.


Incentives are the rewards and punishments that shape what people do. Money, status, praise, fear, convenience and belonging all push behavior in one direction or another. It’s one of the mental models I find most powerful, because when I want to understand why people, companies or governments behave the way they do, the best first question is almost always: what are they rewarded for?

The essence of Incentives is to ask: “What behavior does this system actually reward, and is that the behavior I really want?“


Origin: Smith, Munger and the Power of Rewards

The idea is as old as economics. In The Wealth of Nations (1776), Adam Smith wrote: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” Two centuries later, Steven Levitt and Stephen Dubner put it even more bluntly in Freakonomics (2005): “Economics is, at root, the study of incentives.“

No one has done more to popularize incentives as a mental model than Charlie Munger, Warren Buffett’s long-time partner. In his famous talk “The Psychology of Human Misjudgment“, he put incentives first and said: “Never, ever, think about something else when you should be thinking about the power of incentives.” A line often attributed to him sums it up: “Show me the incentive, and I will show you the outcome.“

His favorite example was Federal Express (FedEx). Its night shift had to move packages quickly between planes at a central hub, but the work kept running late, and appeals to the employees didn’t help. The problem was solved when someone realized it was foolish to pay by the hour, and instead paid per shift and let everyone go home when the planes were loaded.


Key Concepts

  • Incentives Drive Behavior, Often Unconsciously
    Munger called it “incentive-caused bias“: decent people can drift into bad behavior when they are rewarded for it, and then rationalize it. Most people don’t see how strongly their own incentives shape their judgment.

  • Goodhart’s Law
    In 1975, the economist Charles Goodhart observed that a statistical regularity tends to break down once it’s used as a target for control. The anthropologist Marilyn Strathern later phrased it in the way most people know it: “When a measure becomes a target, it ceases to be a good measure.” See Goodhart’s law.

  • Rewarding A, while Hoping for B
    In his classic 1975 paper “On the Folly of Rewarding A, While Hoping for B“, the management scholar Steven Kerr showed how often organizations reward one behavior while hoping for another. Universities hope professors will teach well, but reward them mostly for research and publications. Orphanages are meant to place children in good homes, yet when budget, staff and prestige grow with the number of children enrolled, it becomes rational to make adoption difficult. A reward that pays for the wrong thing is a perverse incentive.

  • Principal–Agent Problems
    When one person, the agent, acts on behalf of another, the principal, their interests are rarely perfectly aligned. Michael Jensen and William Meckling described this in their 1976 paper “Theory of the Firm“: managers, brokers, lawyers and employees may serve themselves when the principal can’t fully observe what they do.

  • Intrinsic vs. Extrinsic Motivation
    Intrinsic motivation comes from within, like curiosity, pride or a sense of duty, while extrinsic motivation comes from external rewards and punishments. Research by Edward Deci and others shows that external rewards can sometimes crowd out intrinsic motivation, so paying for something can make people care about it less.


Some Examples

  • The Day-care Fine
    In a study published in 2000, Uri Gneezy and Aldo Rustichini introduced a small fine for parents who picked up their children late at day-care centers in Haifa, Israel. Instead of falling, late pickups increased, and they stayed high even after the fine was removed. The fine turned a moral obligation into a price that parents felt they could simply pay.

  • Sales Targets at Wells Fargo
    Aggressive sales targets at Wells Fargo pushed employees to open millions of accounts that customers never asked for. The scandal became public in 2016, cost the bank billions of dollars in fines and settlements.

  • Commissions and Advice
    Munger described how Xerox’s new, better machine sold poorly because the salesmen’s commissions gave them a larger reward for pushing the older, inferior one. When someone paid by commission advises me, I ask how their pay depends on my choice.

  • Teams and Organizations
    Reward only individual results, and people stop helping each other. Reward short-term numbers, and you get short-term thinking.

  • My Own Life and Habits
    I use incentives on myself too, like making good habits easy and rewarding, and bad habits inconvenient. I also try to notice when my own incentives might be biasing my judgment.

    To learn more, read about Introducing Habits & Habit Stacking in How to Optimize your Daily Routine

Applying Incentives

When I want to use this mental model, this is the simple process I follow:

  1. Follow the Incentives
    Before judging what people say, look at how they are rewarded and punished: money, status, recognition, career and convenience.

  2. Define the Real Goal
    Be clear about the outcome I actually want, not just what is easy to measure.

  3. Ask How It Could Be Gamed
    For any reward or target, imagine how a clever person could hit the number without achieving the goal.

  4. Align Interests
    Design rewards so that people win when the principal wins, for example by sharing ownership, paying for results rather than effort, and keeping skin in the game.

  5. Protect Intrinsic Motivation
    Use autonomy, purpose and recognition, and be careful not to replace them with money where they already work.

  6. Watch the Results and Adjust
    Incentives often have unintended consequences, so review what behavior they actually create and change them when needed.


Pitfalls and Limitations

  • Measures get gamed. As Goodhart’s law warns, people optimize for the target instead of the goal, from test scores to quarterly earnings.

  • Incentives can backfire. As the day-care fine shows, a poorly designed reward can create more of the problem it was meant to solve.

  • Money is not everything. Treating people as if they only respond to financial rewards ignores fairness, pride, identity and meaning, and can crowd out the motivation that matters most.

  • Seeing only incentives can make me cynical. Not every action is self-interested, and assuming the worst about people can damage trust and relationships.


Related Mental Models


Incentives remind me that behavior rarely happens by accident. By following the incentives, designing rewards that match the real goal, and protecting the intrinsic motivation that makes people care, I can understand the world better and build systems, teams and habits that bring out the best in people.



To learn more about economics and how key parts of our world work,
check out: Wise: How to Attain a Deep Understanding of the World, History, Our Place in It, and How to Live Well



📚 Sources and References


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