Cambridge, Mass. — An MIT Sloan School of Management professor is turning upside down the failure-is-not-an-option mindset that drives many business executives and other leaders.
“Failures are often the result of legitimate attempts to explore or innovate,” says MIT Sloan Assistant Professor of Finance Gustavo Manso. “Therefore, to stimulate innovation, one must be willing to tolerate (or in some cases even reward) failures.”
While Manso's view crosses some traditional economic theory, he says it reflects the realities of today's innovation-driven economy. “If you really want to induce more innovation and exploration, you must be willing to accept and even honor short-term failures,” he says. “In Silicon Valley, if you fail once or even many times, you can start fresh. But in other places, if you fail even once, it becomes hard to get a new job, let alone start a new business.”
In an older economy, where workers performed routine tasks, the standard pay-for-performance model worked well. “But that model has changed with an economy in which more workers are involved in creative tasks,” says Manso. “If the worker experiments with new untested ideas he is initially likely to fail, but also acquires knowledge that improves performance in the long-run. Therefore, to motivate creativity, you have to tolerate (or even reward) short-term failure and reward long-term success.”
Manso says his reward-failure approach also extends much higher up the corporate chain.
“People complain about golden parachutes given to CEOs, because they reward CEOs for bad performance. Some even propose regulations to limit the use of these instruments. These proposals, however, do not take into account the effects that such instruments may have on innovation. If you cannot offer CEOs golden parachutes or other similar instruments, it may be hard to motivate CEOs to explore and innovate, because they will be too concerned with the negative consequences of failure.”
Even debtor-friendly bankruptcy laws, while under assault under many fronts, may serve to encourage exploration by helping protect an agent from failure, says Manso. “We have to be careful when we change such laws, because it can have an adverse effect on innovation.”