About a year ago, I wrote a short article on whether there is any relationship between guaranteed high bonus and excessive risk taking by the management of a company. You can see the post here. Basically, such guaranteed high bonus gives a negative incentive to the board of directors to take higher risks in order to gain better benefit for the company. While higher risks might be translated into higher profits, they can also cause higher costs and losses which would trouble the company and the shareholders. In other words, big payment might actually produce worse results.

Apparently, Dan Ariely, a Professor of Psychology and Behavioral Economics at Duke University, has a similar view on this issue, though he reached the conclusion from different perspective. In his latest book, The Upside of Irrationality, he discusses his experiment which more or less shows that higher payment does not always work. The experiment was conducted in India, where several participants were asked to play some games in which they will receive financial compensation if they completed certain objectives within the games. The tests were divided randomly into 3 categories (the games were same, though), the first category gave very small payment (equal to payment for 1 working day in India), the second category gave mediocre payment (equal to payment for 1 week of work), and the third category provide the highest payment (equal to payment for 5 months of work). FYI, the average costs of one month living in India is US$11, so 5 months means US$55. That's why Dan had enough funds to conduct his research :).

What's the result of the experiment? Well, you might have guessed this: statistically, those who play the games in the third category end up as the worse players. It seems that the thought of having such a huge payment in the end of the game gave them a huge pressure, so huge that most of them fell under the mental pressure. This is interesting and yes, I can relate this to myself. As an example, when I do online shares trading, the bigger the stake is, the harder I make the final decision. It is a very stressful experience! The case is different when the stake is low, and I definitely can make a better decision in such case.

Therefore, it is quite easy for me to understand the result of the above experiment. When you know that the stake is very high (i.e. the end rewards), there is always a possibility that you will fall under the pressure which eventually will affect your overall performance. The similar thing can happen to those CEOs who are promised with guaranteed big fat bonuses. Since they need to establish a sufficient evidence that they are worthy enough to receive such payment, they take actions that might be riskier which then turn out to be a deep trouble for the company. Hence, lower performance.

I must say that Dan Ariely experiments entertain me most of the time. Like it or not, men are not always rational. There are certain conditions where our rationality might be defeated by our impulse. Only by accepting this fact that we can actually improve ourselves from such weakness. For more information, I suggest you to quickly buy the book. It's available in Times, as far as I know.

I've been twittering for some time and realized that Twitter is a really bad choice for storing your thoughts. So, in order to preserve some of my ideas there, I will post my tweets collection from time to time here, starting with my Lawyering Tweet Series. Enjoy :)

A robber goes to a bank, takes a hostage and demands the bank teller to give the money or the hostage will die. The teller looks at the amount the bank holds, US$3,000, a petty amount of cash for a bank as big as this. But he refuses the robber's demand, and quickly rings the alarm. The robber goes panic, shoots the hostage and runs away. A few days later, the heirs of the hostage bring a suit to the court, asking the bank to pay a huge amount of damages due to the negligence of its teller. According to those heirs, considering the amount of the cash, it is not worthy to let the robber killed the hostage, so based on fairness, the heirs have reasonable arguments to claim the bank for damages due to the failure of its employee to make the right decision. Assuming that the there is no exact regulation concerning the claim, what should the court do?

Although the court might have unlimited options, in reality, all of those options can be simplified into two category, to look backwards or to look forward. Looking backwards or using the Ex Post Perspective means that the court will only review how the event occurred and decide what to do about it or how to clean it up. Using this approach, the above case will be considered as a simple dispute between parties. One will win and one will lose. The court can look at past precedents or try to define what fairness really means based on various methods. In the end, either the bank or the heirs will come as the winner, and the case stops.

The other option, looking forward or using the Ex Ante Perspective means that the court will consider the effects of its decision upon this case in the future, particularly on parties who might enter into similar situations and have not decided what to do, and whose choices may be influenced by what the law will say upon such case. This means that the court must carefully consider the incentives it may create through its decisions to other parties that might be affected by such decision in the future.

Now, let us try to analyze the above case using both perspectives. First, let us use the Ex Post Perspective. Since we won't put much attention to the effect of the judgment, all we have to do is trying to analyze the case based on sources which have already existed before the event. We can try to find the answer from regulations and precedents. Or, because we have already made an assumption that the regulation is not clear on this issue, we can turn to the opinion of scholars and famous literature discussing this issue. Further, we can work on the most acceptable definition of fairness and try to implement such definition in this case in order to answer whether the teller's refusal to give the money to the robber is a fair action or not, and if it is not fair, whether the bank should pay damages to the heirs. Quite complicated, I must say.

What about using the Ex Ante Perspective? Try to think the immediate effect of the court's decision if the court decides that the bank must pay a huge amount of damages to the heirs and suppose such decision becomes a final and binding precedent. This decision will affect other similar cases where robbers are holding hostages for the sake of getting money from banks. Logically, other banks will try to avoid the obligation of paying a huge amount of damages and therefore they would most probably instruct their employees to give the money to the robber especially when the robber has hostages in his hand.

As a result of this, the probability of bank robberies that involves hostages will most likely increase. Why? Well, the robbers might not even know about the decision, but they can learn from the banks behavior. When they realize that having hostages in their hand increase their robbery success, they would quickly understand that having hostages is beneficial and therefore the use of hostages will increase naturally. Through this perspective, we learn that the effect of consenting the payment of damages to the heirs might be harmful to the society. Yes, from fairness point of view, it might not be fair for the heirs that the bank is not deemed liable for the death of the hostage, but for the sake of greater purpose, the court must make the right decision.

Of course, other argument can be made in different conditions. An an example, suppose that it can be proofed in the court that the robbery occurred because the bank did not maintain a reasonable security force within the bank's office. Using the Ex Ante Perspective, the court should grant the payment of damages to the heirs on the basis of the bank's negligence to provide sufficient security force. What is the expectation here? The decision might provide an incentive to other banks who have less security force to actually increase such force in order to avoid the obligation of paying the damages. As a result of such increase, logically, the rate of robbery should go down as bank robberies become harder.

Notice from both cases that although the results are different on who win the case, the intended effect is similar, i.e. preventing more crimes that will harm the public. And yes, the arguments that serve as the foundation of the decision must also be clear since it will definitely affect the incentives that the decision will create to the relevant parties.

In my view, Ex Ante Perspective is very useful in drafting laws, regulations, and other public policies. We might not always know the actual effect of a law to the society, but, we must always remember that the law will definitely affect the society, even if it is only a little. Only by understanding this fact that legal drafter and judges will be more responsible in "creating" the law.

For further reading material on this issue, I would suggest you to read The Legal Analyst by Prof. Ward Farnsworth. This is a good book for law students and lawyers who wish to develop their analytical skill to the next level. See you in other Legal Analysis Tool Kit Series.

Here is another post in Indonesian language on why the Indonesian Legislative (DPR) cannot reject the two candidates for Chief of the Indonesian Anti Corruption Commission (KPK). I must admit, writing in Indonesian language is a lot easier, far, far easier than writing here in English :p.

So the Playboy case has been decided by the Supreme Court and its former Editor in Chief will serve 2 years in prison. If you ask me, I don't have any concern with the fact that FPI was the one who reported the Indonesian Playboy magazine to the police. Anyone can do that, including myself. What really concerns me is the considerations of our judges and prosecutors in handling this case, especially with respect to the definition of morality and the acts that can be deemed as against such morality.

Further comments will be made after I receive and read the decision. Stay tune.