I was recently reminded of one of the most powerful forces in the world.
It governs the progress of humanity, the success (or failure) of business, and every relationship you've ever been in.
This driving force is called: incentives.
In particular, I was reminded about the importance of aligned incentives.
I come from the technology industry where ownership in a company is given as part of compensation.
So I never questioned this when I hired executives. I simply gave them equity.
If the business did well, they could sell their equity and make money.
But here's the rub.
Those incentives are not aligned with shareholders.
Let's look at that scenario in more detail:
If the business did well the executive could make a lot of money, at no cost to them. And the investors would make money too.
If the business did not do well. The executive could simply walk away, at no cost. But the investors could lose all their money.
Therefore:
Shareholders have ✅ Downside, and ✅ Upside
Executives have ❌ no Downside, only ✅ Upside
Business is not all sunshine and roses.
Every business in history has had good times, and it has had bad times. As a shareholder, you don't want your executives to only stay when things are good, and to leave when things get bad. You want them to stay and fight for your investment. Because you had to fight hard to make that money in the first place.
The only way to get a person to stay and fight when things get hard is to have aligned downside.
That's why we don't give equity to anybody for free anymore.
You can buy equity in the business. And to buy that equity the company can give you a loan. But this is your money.
So when things get hard you fight through it.
I encourage you think about incentives in your own life. Whether it's your boss, your friend, a restaurant server, or other people you interact with. Consider their incentives. Then try to align your needs with their incentives as closely as possible.
One of my favorites...
Warren Buffett has one of my favorite comments on aligned incentives:
💡 "if you want to solve the US budget deficit, you pass a law that no congress people or senators may apply for re-election as long as there is a deficit. You would quickly solve your deficit problem."
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