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Weekly Thoughts: The Day Care Problem

Here is something that caught our eye this week:

The Day Care Problem

Many assume that the potential for monetary gain or loss drives outcomes.  Compensation schemes are often built with the hope that people will perform better if paid more (i.e., a bonus), and will be deterred from undesirable behavior if tied to a financial penalty (i.e., a fine).  Regarding the latter point, a Journal of Legal Studies article titled A Fine Is A Price written by researchers Uri Gneezy and Aldo Rustichini summarized the findings of the field of deterrence stating that “When negative consequences are imposed on a behavior, they will produce a reduction of that particular response. When those negative consequences are removed, the behavior that has been discontinued will typically tend to reappear.”

This brings us to the day care problem. Conducted by Gneezy and Rustichini in 2000 and popularized by both Stephen Dubner and Steven Levitt’s 2005 Freakonomics and Dan Ariely’s 2008 Predictably Irrational, the researchers studied the pick-up patterns at day care centers in Haifa, Israel and came to some puzzling conclusions.  As it stood, the centers, which uniformly opened at 7:30AM and closed at 4PM, asked parents to sign contracts with the stated hours of operation but with no mention of late pick-ups.  The centers simply relied on parents to pick up their kids on time, which seemed to work, as parents were rarely late.  When a parent was late, one of the teachers was tasked with staying behind with the child.

Based on prevailing deterrence theory, the researchers theorized that imposing a financial disincentive, such as a fine, would discourage parents from showing up late entirely and set out to test their hypothesis.  They targeted 10 day care centers across the city and imposed a fine of 10 New Israeli Shekels (NIS) for parents who showed up more than 10 minutes late in six of the centers, while the others remained fine-free.  The fine, which would be added to the parents’ monthly bill, was designed to be “relatively small but not insignificant” as at the time, day care was priced at NIS 1,400 per month and the average monthly gross salary was NIS 5,595.

Contrary to expectations, the researchers found that centers with the fine immediately experienced a dramatic increase in late-pick ups, which eventually stabilized at twice the pre-fine level.  Tardiness within the control group – day care centers without the fine – didn’t change at all.  Furthermore, even when the fine was removed, parents continued to show up late.  Dan Ariely explained his thoughts on the results:

“Before the fine was introduced, the teachers and parents had a social contract, with social norms about being late. Thus, if parents were late — as they occasionally were — they felt guilty about it — and their guilt compelled them to be more prompt in picking up their kids in the future. [ . . . ] But once the fine was imposed, the day care center had inadvertently replaced the social norms with market norms. Basically, the fine removed the guilt and replaced it with a price tag.”

At Chenmark, we spend a lot of time thinking through how to incent certain behaviors effectively.  When those incentives are financial, we have found it is important to consider both the magnitude and structure of any program.  While the day care fine clearly didn’t work as intended, what if the cost was set far above the comparable rate for a babysitter (according to the researchers, between NIS 15 and NIS 20 per hour) instead of NIS 10?  Moreover, what if the fine escalated as the tardiness escalated, or potentially even culminated in expulsion (as is the case at some day care facilities locally)?

Beyond any structural considerations, our biggest observation having now spent several years involved in small businesses is that the most effective method to incent good outcomes or to deter bad behavior is not financial, but rather cultural and social.  The opportunity to have a tangible impact, the disappointment associated with letting the team down, and/or the pride that comes from leaving a collection of employees or a brand in strong hands for the future are all emotions that we have witnessed take precedence over financial considerations.  While there is certainly a role for deep analytical work, sometimes there is no substitute for sitting across the table from someone and forming a relationship, which is something nobody can put a price on.

Have a great week,

Your Chenmark Capital Team

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