The common bonus structures that can lead to corporate corruption scandals

No CEO wants a grilling like the one ex-Wells Fargo chief John Stumpf faced from Elizabeth Warren.
No CEO wants a grilling like the one ex-Wells Fargo chief John Stumpf faced from Elizabeth Warren.
Image: AP Photo/Susan Walsh
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Wells Fargo CEO Tim Sloan didn’t mince his words last month when reflecting on why the biggest banking scandal of 2016 was caused by his firm: ”We had an incentive plan in our retail banking group that drove inappropriate behavior,” he said.

The bank held employees to quotas for the number of new customers they signed up and the number of accounts they had to open each day, and paid a big chunk of wages in bonuses linked to how well they did according to those goals. Perhaps unsurprisingly, workers ended up creating as many as 3.5 million fraudulent accounts, on which the bank then charged fees to real customers.

After being slapped with a $185 million fine, the bank revamped its bonus system in early 2017. It made bonuses a smaller part of pay and de-linked them from sales, instead handing them out based on metrics like customer satisfaction. It was the logical move, but it came too late to save the bank’s longstanding, carefully projected image, stagecoaches and all, of being a trustworthy, old-fashioned bank from Main Street, in contrast to the amoral titans of Wall Street.

Wells was far from alone in inviting a scandal caused largely by a warped bonus system, joining the likes of EpiPen (paywall) and GlaxoSmithKline (paywall). The lesson is that no matter how much compliance training you give your employees, there’s only so much that can do if your pay structures are still encouraging them to be corrupt.

“The unfortunate reality is that firms don’t seem to be addressing this until they are bitten by it,” says Richard Bistrong, an anti-corruption advocate and consultant who served jail time for paying bribes in pursuit of financial incentives as a defense-industry sales executive.

Indeed, there’s often little incentive for companies to change their pay structures unless pushed. When Glaxo stopped sales-based bonuses for drug reps after a scandal in China, it was open about the effects on its bottom line. “If you look at the short-term business performance, it’s not great,” the company’s China head said in 2015, as competitors declined to make similar changes and merrily jumped into the gap Glaxo was leaving in the market.

“The reason we find ourselves falling into the trap of paying bonuses and corrupting the organization is that it’s so much easier to play the short-term game,” says Julian Birkinshaw, deputy dean of London Business School, pointing out that this is particularly difficult for publicly traded companies. “To some degree, we’re hostages to the shortermism of financial markets.”

Those who work in compliance understand that unless a company ends up with an outsize problem like Wells Fargo did, the way it moves forward on the issue will look more akin to “evolutionary change,” as Bistrong puts it. “They should address this in a way that makes sense, that doesn’t alienate the workforce” by taking away wholesale the bonuses that people rely on for income.

To figure out the incremental ways companies can do that, we spoke to Bistrong, Birkinshaw, and New York University business ethics professor Marc Hodak, who outlined seven common ways corporate incentives can warp behavior. Often the difference between ethical and shady behavior by employees comes down to:

1. How much of your earnings come from your bonus

Imagine you’re a sales rep for a massive multinational company, working in a developing country with flimsy rule of law. It’s the day before the deadline to meet sales targets for your bonus and some goods you have a big contract for are stuck on the border with customs officers, looking for a bribe. You can either call officials in the capital and work through a load of bureaucracy, and the goods could either be released in an hour or in a few days, depending on how everybody’s feeling. Or, you could just pay out a smattering of cash and they’ll be back on the road in minutes—guaranteed to make it to the destination in time for your bonus.

No matter how well you’ve been trained in compliance practices, the size of your conundrum here is going to depend on how much of your earnings are at risk, says Bistrong. “The higher the percentage of your earnings as incentives, the more risk they might take,” he says. If you only expect 10% of your yearly income to come from your bonus, you might be happy to wait. If it’s more than 50%, you’re going to be pretty desperate to get those goods past the border.

2. How often bonuses are paid out

Let’s take the above scenario and imagine it takes place on March 31. You’re going to have a markedly different reaction to the situation depending on the time period over which performance is measured. “If the measure is an extended period, maybe biannual or annual, they’ll say, ‘I’m gonna report to my company, say it’s delayed and we’ll see what happens,'” says Bistrong. If, however, the company pays bonuses for your performance over a quarter (as many firms do), “They’ll say I’ve gotta make my quarter—if I have to pay a bribe I’m gonna do it,” Bistrong says. “To take a person like that and give them quarterly measures—that is a very loud and spoken message of win above all else.”

3. How much of your sales target you have to hit to get a payout

So, how can we put more ticks in the ‘reasons not to bribe’ column? Clearly, we should minimize the percentage of total pay this bonus represents for our harried sales rep. In addition to basing bonuses on annual rather than quarterly performance, another way of easing the risk is to make a sliding scale for the proportion of the target you meet versus the proportion of the bonus you get paid out.

For example, if you’ve hit 94% of your target but you need to make 95% to get paid a large chunk of your bonus, then “that’s a real landmine,” says Hodak. The risk is much lower if you start paying out at 90%—at which you get a very small bonus—and the amount goes up in small increments with each percentage point, until you get the full payout. That way, “if you’re at 89% there’s much, much less of an incentive to do something stupid to get up to 90 or 91” because the bonus is comparatively small, says Hodak.

4. Who gets paid a bonus

Even if we adjust every incentive to reduce bribery risk for our sales rep in a country with weak legal institutions, the very fact that they work in a high-risk area means their exposure to bribes is high. There’s only one way of fixing that: eliminating sales-based bonuses for them entirely. That can mean getting rid of bonuses altogether or linking them to potentially less bribery-prone metrics, like customer satisfaction.

5. Whether incentives are based on individual, team, or company performance

The kind of bonuses discussed so far have all been based on one thing: Individual performance. This “eat what you kill” model means that one employee can take an illegal risk and get a big personal payout. That risk can be eased with the following logic, Birkinshaw says: “For virtually everybody in a big company, what you do is linked to what somebody else does.”

So, why not pay out bonuses based on team performance—which spreads the danger between managers and team members based out of headquarters with other employees who are more exposed? Or total company performance? Birkinshaw points to the examples of Swedish bank Handelsbanken, which reinvests above-forecast profits into shares for employees, and British retailer John Lewis, which pays a bonus at an equal salary percentage for all its staff every year. “It’s a pretty broad incentive, but it’s actually a celebration and creates a bonding within company—unlike banking, in which bonus season is a time for deep frustration and resentment because essentially it’s seen as a dog-eat-dog world,” says Birkinshaw.

6. How you set bonus targets

Compliance risks are often created well before employees are faced with a bribery opportunity. The problem can start when management decides what a sales target should be. That process, Bistrong says, is often “fraught with, for lack of a better word, lies.” The team responsible for achieving the goals will want them to be as easy as possible, while management will want to stretch employees—often beyond the bounds of market reality, Bistrong says.

He points to an example in his own career when the market had taken a downturn and he warned his superiors that the numbers weren’t going to be as good the following year—only to be told, he says, “Richard, we’re a public company, we don’t do sales decreases.” Bistrong says a statement like that is “a leadership failure, because they’re dictating conditions that have run afoul with market reality.” But “the Richard Bistrong failure is saying, ‘Ok, I got this, we’ll get the sales increase’—as opposed to putting a line in the sand.” Managers can make a big difference by sending “a loud message that you never will be financially penalized even day the before a quarter expires by coming to us and telling us that you’re being held up by a small bribe,” Bistrong says.

How management responds to the prospect of unmet goals is “a difference between a well-managed company and a poorly managed company,” Hodak argues. Well-managed ones are prepared to disappoint investors with a bad quarter, knowing that “in the long run, we are dramatically reducing risks of something crazy going on that’s gonna land us in much more hot water,” he says.

7. The bonus structure at the top of the house

Small tweaks to each of these factors can add together to make bribery risks considerably smaller for employees in the field. But companies also need to think through the impact of the bonus system for those at or close to the top of the org chart.

Though boards may think they’re making a smart move by making executive pay bonus-heavy, with the upshot being that senior leaders make decent money in a poor year and perhaps tens of millions a good one, it creates “the ultimate risk that the company is going get involved in horrible scandals,” says Hodak, arguing that the Wells Fargo scandal, though executed at the branch level, started at the top. “When you have that much at stake, it makes you blinder in terms of what’s going on in the organization.”

The ultimate incentive

Even if you’re unfussed by things like bribery risks and company cultural rot, thinking through each of these measures can bring another tangible benefit, at least to American companies: If you ever do get caught up in a corporate scandal, the US Department of Justice now says (pdf, p.6) it’s going to look into whether your firm has “incentivized compliance and ethical behavior.”  So all the better, Bistrong says, to view compliance teams as partners and not as “the bonus prevention department.”