Via Reddit.

I submitted this because the incentives are very similar to those involved in startup equity, and the resulting proportions are roughly the same. Startups must choose how to divide the pot (i.e. equity) with each new hire. Each employee can then a.) accept the proportion, working hard to make the startup succeed or b.) reject it, slack off, and make them all walk the plank. There's another complication in that a pirate's coworker may catch him at b.) and tattle, forcing him and just him to walk the plank.

Why does this work like the pirate game, where only the senior pirate walks the plank? Well, think about why the senior pirate ends up with all the loot. It's because he's able to play the remaining pirates off each other: he can get away with offering 0 to pirate B, because he knows that B will be outvoted by the pirates that B is about to screw over. Similarly, a shirking employee is "outvoted" by his peers in a startup, who stand to gain handsomely (even if the founders take the lion's share) if the startup succeeds. They have a strong incentive to tattle on any shirker, which forces the shirker to work hard or get nothing. 0.1% of the company is a lot more than 0, even if the founder gets 50%.

This game also explains a lot of other accumulated startup wisdom, such as:

Why founders typically own 10-25% of the company each, while individual employees start at 1.5% of the company and decrease exponentially. Each new employee has decreasingly less ability to make the whole company walk the plank, and so the founders can get away with giving up less equity.

Why your first 10 employees are the most critical hires, and should be self-motivated hackers who want to see the startup succeed for its own sake. At this point, the startup has little peer pressure: if the founders are off negotiating a business deal, there's nobody to tattle on the workers, so if the founders own 80% of the company and each worker owns 1%, there's a strong incentive for them to goof off en masse. If, however, you have 10 people that don't care that the founders are making 10 times as much as them, then they will tattle on the next 10 hires that want to shirk, letting you give those hires very little equity.

Why tolerating a single shirker often kills the whole startup. Employees see that they will not lose their 0.1% if they shirk, and they figure that working hard so that the founders get 90% of the reward isn't worth it.

Why big companies are incapable of getting anything done. As the company grows and equity gets diluted, the options granted to any one employee become minuscule. Thus, employees have more to gain by making friends with their fellow shirkers than turning them in and boosting the stock price, and a culture of mediocrity settles in.

Why certain big companies have managed to avoid this. There are two basic approaches, carrot and stick. The "stick" approach is used by Intel and GE, and consists of firing the bottom 10% every year. Employees figure that $60K salary is better than $0 salary, even if they aren't sharing in the company upside while the CEO makes $100M. Unfortunately, this approach often means the company loses out on promising new hires who don't want to work in this environment. The choice for them isn't $60K or $0, it's $60K and the constant threat of being fired or $55K and decent working conditions.

The "carrot" approach is to give really generous cash bonuses for performance - often 2-3x the normal salary. This is used by Nucor and Goldman Sachs. Employees will not only work hard if it means the difference between $40K and $130K, but they're more likely to tattle on underperforming peers who bring their group productivity down.