The Paradox of Incentives: The Power That Creates Heroes and Fools

What do 19th-century cobra hunters, 21st-century bankers, and kindergarteners with markers have in common? They are all influenced by the invisible force that moves the world: incentives.

• Success stories of incentives and failures represented by the ‘Cobra Effect’
• Psychological reasons why incentives backfire (overjustification, cognitive dissonance)
• Wise motivation strategies beyond simple rewards: Nudge

The Clear Power of Incentives: Carrots and Sticks

The Basic Principle That Moves the World

We live surrounded by incentives—rewards or punishments that drive certain behaviors. Most people weigh the benefits and costs before acting.

From receiving praise for good grades as children to making one more sales call for commission as adults, incentives are like visible pillars supporting our economy and social structure.

Successful Incentive Design Examples (Ford & Netflix)

Properly designed incentives become powerful drivers of positive change. A classic example is Henry Ford, who doubled workers’ daily wages and saw productivity explode. This is a representative case of the ’efficiency wage theory,’ where higher wages led to increased loyalty and reduced turnover, resulting in greater profits.

Today, Netflix attracts and retains top talent with industry-leading salaries, based on the belief that one outstanding employee is better than several average ones. Successful incentives are not just financial transactions but powerful communication tools conveying organizational values. How you give matters far more than what you give.

The Trap of Misguided Incentives: The Cobra Effect

What Is the Cobra Effect?

Now, let’s explore the dark side of incentives. During British colonial rule in Delhi, India, the government offered bounties for dead cobras to reduce their numbers. Initially effective, people soon started breeding cobras at home to collect the bounty instead of catching wild ones.

When the government abolished the bounty, the now-worthless cobras were released into the city, causing the cobra population to surge beyond pre-policy levels. This unintended consequence of a well-meaning policy is called the ‘Cobra Effect’ or ‘Perverse Incentive.’

Bizarre Failure Cases Worldwide

The cobra effect has appeared repeatedly in history.

In-Depth Analysis: Wells Fargo Ghost Account Scandal

The worst form of perverse incentives in corporate settings is the Wells Fargo scandal. The bank aggressively incentivized employees to sell at least eight financial products per customer.

Under unrealistic quotas, employees cheated the system by opening millions of unauthorized ghost deposit accounts and credit cards without customer consent. This was not mere individual misconduct but a systemic failure akin to the ‘boiling frog syndrome,’ where management ignored the toxic incentive system, paralyzing organizational awareness. The obsession with short-term results trampled core values of honesty and customer priority.

The Psychology of Backfire: Why Good Intentions Fail

Overjustification Effect: How Money Kills Enjoyment

Incentives can ruin not only bad behavior but also ‘good’ behavior through the ‘overjustification effect.’ This phenomenon occurs when external rewards (e.g., money) for an already enjoyable activity reduce intrinsic motivation.

In the famous marker experiment, kindergarteners who loved drawing stopped drawing once promised a certificate (expected reward) and later when the reward was removed. Their intrinsic motivation “drawing for fun” was replaced by extrinsic motivation “drawing for a certificate.”

Intel Factory Experiment: Pizza, Praise, and Cash Bonuses

Behavioral economist Dan Ariely’s Intel factory experiment clearly demonstrated this effect. To boost productivity, employees received either cash bonuses, free pizza, or praise from supervisors.

• Day 1 performance: Pizza (6.7%) > Praise (6.6%) > Cash (4.9%)
• After one week: Productivity of the cash bonus group plummeted 13.2% below baseline. Only the praise group maintained steady high productivity.

Cash creates a ’transactional relationship’ signaling “your effort is worth exactly $30,” while praise forms a ‘relational contract’ sending a social signal that “we value your effort.”

The Art of Self-Justification: The Brain That Rationalizes Everything

Cognitive Dissonance: The Uncomfortable Itch in the Brain

Why do people justify irrational behavior driven by perverse incentives? Psychologist Leon Festinger’s ‘cognitive dissonance’ theory explains this. Our brains crave consistency, so when beliefs and actions conflict, we feel strong discomfort.

To relieve this, we change behavior, distort beliefs, or create plausible excuses—rationalizations. Wells Fargo employees resolved the dissonance between “I am honest” and “I create ghost accounts” by rationalizing “I’m just following management orders.”

The ‘Shield of Responsibility’ Created by Authority and Crowd Psychology

Individual rationalizations amplify in social contexts.

• Milgram Experiment (obedience to authority): People commit terrible acts when authority assumes responsibility.
• Asch Experiment (conformity): People conform to obviously wrong group opinions to avoid discomfort.

Perverse incentives, authority pressure, and group conformity form a ’toxic cocktail.’ The Wells Fargo scandal was possible because these three combined to create an environment where unethical behavior was easily rationalized.

Smarter Incentives: The Art of Nudge

Beyond simple carrots and sticks, we need more sophisticated tools: ‘Nudge,’ which gently guides better decisions without restricting freedom of choice. It’s not about pushing people forcibly but creating paths they naturally want to follow.

• Fly in the urinal: Amsterdam Airport reduced cleaning costs dramatically by painting a fly in urinals.
• Power of defaults: Changing retirement plans to ‘automatic enrollment’ or organ donation to ‘opt-out’ dramatically increased participation.

New Horizons in Motivation: Google and Patagonia

• Google’s OKR: Ambitious goal setting separated from direct monetary rewards encourages employees to take bold risks without fear of failure. True incentives are conversation, feedback, and recognition (CFR), not bonuses.
• Patagonia’s culture: Offers benefits linked to core values, like paid leave for environmental activism. The strongest incentive is not money but intrinsic rewards from belonging to a community that shares your values. From my experience, the most powerful force moving people is not money itself but the meaning and vision behind it.

Comparison: Bad Incentives vs. Wise Incentives

Checklist: 5 Questions for Better Incentive Design

1. Are you measuring the process, not just results? (short-term vs. long-term value)
2. Does it avoid destroying intrinsic motivation? (check for overjustification effect)
3. Can the system’s loopholes be exploited? (predict cobra effect)
4. Is the approach relational rather than transactional? (cold deal vs. warm recognition)
5. Can you use nudges? (design environment instead of coercion)

Conclusion: Becoming Better Designers of Choice

Incentives are not simple levers but complex signals deeply rooted in human psychology and social context. Key takeaways:

• Incentives are double-edged swords. Used well, they are powerful drivers; used poorly, they cause disasters like the cobra effect.
• Respect intrinsic motivation. External rewards can destroy pure enjoyment and mission (‘overjustification effect’).
• Wise design is essential. Instead of coercive rewards, nudges that naturally guide better choices can be more effective.

Now, the final question for you: What hidden incentives and nudges operate in your workplace, home, and daily life? Are they leading you toward better outcomes or encouraging “crazy behaviors”?