A Lesson on Elementary Worldly Wisdom: Incentives and Human Behaviour in Business and Investing

In his speech A Lesson on Elementary Worldly Wisdom given at the University of Southern California in 1994, Charlie Munger, the legendary investor and Berkshire Hathaway vice-chairman, highlighted the importance of common sense and everyday wisdom when it came to investing. He encouraged aspiring investors to develop a mental toolkit of sorts that would help them make sound investment decisions, relying on traits like understaffing their circle of competence, recognising their internal biases, recognising good opportunities and seizing them at the right time, etc.

One of the many mental models he spoke about is that of incentives, why they matter, and how humans respond to them.

Munger on incentives and human behaviour

Munger said that whether it was business operations, corporate leadership, or investment management, people tend to respond rationally to the rewards and penalties placed in front of them. And for investors, understanding incentives is not optional, but essential.

• Why incentives matter: Munger said that at the most basic level, incentives shape how we behave far more than intelligence, ethics, or intentions. Munger frequently cited the example of Federal Express to illustrate the power of incentives. In business, incentives determine whether employees focus on quality or speed, long-term value or short-term metrics. Munger cited the example of Federal Express. FedEx once struggled with packages being left undelivered overnight, even though employees were working long shifts. Management initially blamed poor performance on laziness or operational inefficiency. The real problem, however, was incentives. Once FedEx changed compensation so that workers were paid per shift completed rather than per hour worked, behavior changed almost instantly: workers would sort packages and head home, rather than stay longer hours.
• Incentive-caused bias: Munger also highlighted the dangers of invectives - that people (and managers) may often act in self-interested ways that benefit them, not necessarily the client or company, leading to poor decisions. This could be seen in the world of investing itself, where fund managers may be rewarded for gathering more assets and clients as opposed to generating more returns. Higher fees, commissions, and complex financial products often serve the seller rather than the investor.
• Designing the right incentives in business: Munger stated, “The constant curse of scale is that it leads to big, dumb bureaucracy—which, of course, reaches its highest and worst form in government where the incentives are really awful.” He argued that in business and companies, incentives must be aligned with long-term value creation. This means rewarding durability, capital efficiency, and ownership-like thinking. The same principle applies to individual investors. When your own incentives favour short-term gains, you may make mistakes. When they favour long-term outcomes, restraint, and discipline, results improve.

The key takeaway

Understanding incentives can help us make better decisions both in investing and in life. By digging deeper into how rewards shape actions — whether it’s in companies, in fund management, at work, or in school —  we can predict behaviours more accurately.