Chapter Six, Part II

In September 2003, Richard Grasso, who was then the head of the New York Stock Exchange, became the first CEO in American history to get fired for making too much money. Grasso had run the NYSE since 1995, and by most accounts he had done a good job. He was aggressively self-promoting, but he did not appear to be incompetent or corrupt. But when the news broke that the NYSE was planning to give Grasso a lump-sum payment of $139.5 million—made, up of retirement benefits, deferred pay, and bonuses— the public uproar was loud and immediate, and in the weeks that followed, the calls for Grasso’s removal grew deafening. When the NYSE’s board of directors (the very people, of course, who had agreed to pay him the $139.5 million in the first place) asked Grasso to step down, it was because the public’s outrage had made it impossible to keep him around.

Why was the public so outraged? After all, they did not have to foot the bill for Grasso’s millions. The NYSE was spending its own money. And complaining about Grasso’s windfall didn’t make anyone else any better off. He had already been paid, and the NYSE wasn’t going to take the money it had promised him and give it to charity or invest it more wisely. From an economist’s point of view, in fact, the public reaction seemed deeply irrational, Economists have traditionally assumed, reasonably, that human beings are basically self-interested. This means a couple of (perhaps obvious) things, First, faced with different choices (of products, services, or simply courses of action), a person will choose the one that benefits her personally. Second, her choices will not depend on what anyone else does. But with the possible exception of business columnists, no one who expressed outrage over how much Dick Grasso made reaped any concrete benefits from their actions, making it irrational to invest time and energy complaining about him. And yet that’s exactly what people did. So the question again is: Why?
The explanation for people’s behavior might have something to do with an experiment called the “ultimatum game,” which is perhaps the most well-known experiment in behavioral economics. The rules of the game are simple. The experimenter pairs two people with each other. (They can communicate with each other, but otherwise they’re.anonymous to each other.) There given $10 to divide between them, according to this rule: One person (the proposer) decides, on his own, what the split should be (fifty-fifty, seventy-thirty, or whatever). He then makes a take-it-or-leave-it offer to the other person the responder). The responder can either accept the offer, in which case both players pocket their respective shares of the cash, or reject it, in which case both players walk away empty-handed.

If both players are rational, the proposer will keep $9 for himself and offer the responder $1, and the responder will take it. After all, whatever the offer, the responder should accept it, since if he accepts he gets some money and if he rejects, he gets none, A rational proposer will realize this and therefore make a lowball offer.

In practice, though, this rarely happens. Instead, lowball offers—anything below $2—are routinely rejected. Think for a moment about what this -means. People would rather have nothing than let their “partners” walk away with too much of the loot. They will give up free money to punish what they perceive as greedy or selfish behavior. And the interesting thing is that the proposers anticipate this—presumably because they know they would act the same way if they were in the responder’s shoes. As a result, the proposers don’t make many low offers in the first place. The most common offer in the ultimatum game, in fact, is $5.

Now, this is a long way from the “rational man” picture of human behavior. The players in the ultimatum game are not choosing what’s materially best for them, and their choices are clearly completely dependent on what the other person does. People play the ultimatum game this way all across the developed world: cross- national studies of players in Japan, Russia, the United States, and France all document the same phenomenon. And increasing the size of the stakes doesn’t seem to matter much either. Obviously, if the proposer were given the chance to divide $1 million, the responder wouldn’t turn down $100,000 just to prove a point. But the game has been played in countries, like - Indonesia, where the possible payoff was equal to three days’ work, and responders still rejected lowball offers.

It isn’t just humans who act this way, either. In a study that was fortuitously released the day Richard Grasso stepped down, primatologists Sarah F. Brosnan and Frans B. M. de Waal showed that female capuchin monkeys are also offended by unfair treatment. The capuchins had been trained to give Brosnan a granite pebble in exchange for food. The pay, as it were, was a slice of cucumber. The monkeys worked in pairs, and when they were both rewarded with cucumbers, they exchanged rock for food 95 percent of the time. This idyllic market economy was disrupted, - though, when the scientists changed the rules, giving one capuchin a delicious grape as a reward while still giving the other a cucumber slice. Confronted with this injustice, the put-upon capuchins often refused to eat their cucumbers, and 40 percent of the time stopped trading entirely. Things only got worse when one monkey was given a grape in exchange for doing nothing at all. In that case, the other monkey often tossed away.her pebble, and trades took place only 20 percent of the time. In other words, the capuchins were willing to give up cheap food—after all, a cucumber slice, for a pebble seems like a good deal—simply to express their displeasure at their comrades’ unearned riches. Presumably if they’d been given the chance to stop their comrades from enjoying those riches—as the players in the ultimatum game were—the capuchins would have gladly taken it.

Capuchins and humans alike, then, seem to care whether rewards are, in some sense, “fair.” That may seem like an obvious thing to worry about, but it’s not. If the monkey thought a rock for a cucumber slice was a reasonable trade and was happy to make it before she saw her comrade get a grape, she should be happy to make the trade afterward, too. After all, her job hasn’t gotten any harder, nor is the cucumber any less tasty. (Or if it is, that’s because she’s obsessed with what her neighbor’s getting.) So her feelings about the deal should stay the same. Similarly, the responders in the ultimatum game are being offered money for what amounts to a few minutes of “work,” which mostly consists of answering ‘yes” or “no.” Turning down free money is not something that, in most circumstances, makes sense. But people are willing to do it in order to make sure that the distribution of resources is fair.

Does this mean people think that, in an ideal world, everyone would have the same amount of money? No. It means people think that, in an ideal world, everyone would end up with the amount of money they deserved. In the original version of the ultimatum game, only luck determines who gets to be the proposer and who gets to be the responder. So the split, people feel, should be fairly equal. But people’s behavior in the game changes quite dramatically when the rules are changed. In the most interesting version of the ultimatum game, for instance, instead of assigning the proposer role randomly, the researchers made it seem as if the proposers ha earned their positions by doing better on a test. In those experiments, proposers offered significantly less money, yet not a single offer was rejected. People apparently thought that a proposer who merited his position deserved to keep more of the wealth.

Put simply, people (and capuchins) want there to be a reasonable relationship between accomplishment and reward. That’s what was missing in Grasso’s case. He was getting too much for having done too little. Grasso seems to have been good at his job. But he was not irreplaceable: no one thought the NYSE would fall apart once he was gone. More to the point, the job was not a $140 million job. (What job is?) In terms of complexity and sophistication, it bore no resemblance to, say, running Merrill Lynch or Goldman Sachs. Yet Grasso was being paid as much as many Wall Street CEOs, who are themselves heftily overcompensated.

The impulse toward fairness that drove Grasso from office is a cross-cultural reality, but culture does have a major effect on what counts as fair. American CEOs, for instance,, make significantly more money than-European or Japanese CEs, and salary packages that would send the Germans to the barricades barely merit a moment’s notice in the United States. More generally, high incomes by themselves don’t seem to bother Americans much— even though America has the most unequal distribution of income in the developed world, polls consistently show that Americans care much less about inequality than Europeans do. In fact, a 2001 study by economists Alberto Alesina, Rafael di Tella, and Robert MacCulloch found that in America the people whom inequality bothers most are the rich. One reason for this is that Americans are far more likely to believe that wealth is the result of initiative and skill, while Europeans are far more likely to attribute it to luck. Americans still think, perhaps inaccurately, of the United States as a relatively mobile society, in which it’s possible for a working-class kid to become rich. The irony is that Grasso himself was a working- class kid who made good. But even for Americans, apparently, there is a limit to how good you can make it.

There’s no doubt the indignation at Grasso’s retirement package was, in an economic sense, irrational. But like the behavior of the ultimatum ‘game responders, the indignation was an example of what economists Samuel Bowles and Herbert Gintis call “strong reciprocity,” which is the willingness to punish bad behavior (and reward good behavior) even when you get no personal material benefits from doing so. And, irrational or not, strong reciprocity is, as Bowles and Gintis term it, a “prosocial behavior” because it pushes people to transcend a narrow definition of self-interest and do things, intentionally or not, that end up serving the common good. Strong reciprocators are not altruists. They are not rejecting lowball offers, or hounding Dick Grasso, because they love humanity. They’re rejecting lowball offers because the offers violate their individual sense of what a just exchange would be. But the effect is the same as if they loved humanity: the group benefits. Strong reciprocity works. Offers in the ultimatum game are usually quite equitable, which is what they should be given the way the resources are initially set up. And whenever the NYSE thinks about hiring a CEO, it will presumably be more rigorous in figuring out how much he’s actually worth. Individually irrational acts, in other words, can produce a collectively rational outcome.

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