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You Can?t Polish a Sneaker

By Ryan Roberts

Have you ever tried to polish your sneakers? I have. And no matter what method or device I used to refurbish my sneakers, they remained unrefurbished sneakers. The problem wasn’t my washing machine, detergent, or shoe polish–it was that my sneakers just weren’t worth the attempt. Unlike other forms of footwear, sneakers just aren’t made to be polished.

This can be a valuable lesson for startups attempting to incentivize their employees: not all employees have the ability to be incentivized.

A startup can choose from a variety of carrot-and-the-stick incentive options to get the most out of their employees (capital-willing, of course). These options include salary, commission, bonus, stock, vacation, health insurance, retirement accounts, stock options, warrants, phantom stock, and other deferred compensation plans. But a startup must realize that some employees will not respond to any combination of incentives. Thus, your startup may have the right incentive plan but the wrong employee.

In Economics, the problem of motivating an employee to act on behalf–and in the best interest of–the startup company is known as “the principal-agent problem.” This problem arises when a principal compensates an agent for performing certain acts that are useful to the principal and costly to the agent, when it’s costly for the principal to supervise the agent. (Sound like your startup?) Basically, you solve the principal-agent problem by finding the right combination of incentives for the employee. However, the difficulty of selecting the optimal structure is reflected by the multitude of carrot-and-the-stick compensation mechanisms.

Economics assumes a lot of things, and the biggest assumption Economics makes is that people will act in a rational manner. But as we all know, people don’t always act in a rational manner.

Thus, you should not assume that your employee will respond in a rational way to your startup’s incentive offering. It may not matter what or how many carrots you dangle in front of your employee. Not all employees are made to be incentivized, just like not all footwear is made to be polished.

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Full post as published by The Startup Lawyer on July 23, 2008 (boomark / email).