The problem with most incentive systems is not that they are too complicated -- it's that they don't explicitly forbid the kind of shenanigans that will inevitably make them unsuccessful.

Incentives are good in principle, but did Bear Stearns get competent risk management in return for the $4.4 billion bonus pool it distributed in 2006? Does any organization have to give its CEO a $40 million bonus to secure his services? If you pay people enough money to make any future payment beside the point, don’t be surprised when they take vast long-term risks for short-term wins. In almost any pattern, overshooting produces negative returns.

People respond almost too well to monetary incentives. That is, 'firms get what they pay for', but since these schemes cannot be targeted well, what firms get is often not what they want.

If an organization is going to function well, it should not rely solely on monetary compensation schemes. The ability of organizations to place workers into jobs with which they identify and the creation of such identities are central to what makes organizations work. Research shows that production is enhanced when organizations hire workers who share the organization's mission, and that an employee who identifies himself as 'an insider' in an organization needs little monetary inducement to perform his job well.

Most boards believe that rewarding managers through stock options is an effective incentive leading to long term shareholder value. Equity ownership, by definition, aligns managers and shareholders. But effective incentive implies a motivation to do something, as opposed to a simple desire to see the share price go up. Most senior executives, right up to the CEO, will tell you that movement in the stock price over several years usually has more to do with exogenous factors than with the actions of management.

Management actions do matter, but they matter indirectly, over a long period of time and in often unpredictable ways, all of which tend to make equity ownership a weak motivator. While the alignment provided by equity ownership does motivate managers to seek out the drivers of shareholder value, equity by itself is inherently unable to provide a sufficiently detailed guide for value-creation to managers.

Conventional incentive plans work only with current value, leaving future value-which is often the larger amount-up for grabs.

In short, "Do this and you'll get that" makes people focus on the "that" not the "this." Do rewards motivate people? Absolutely. They motivate people to get rewards.

The failure of any given incentive program is due less to a glitch in that program than to the inadequacy of the psychological assumptions that ground all such plans.