When Bonus Incentives Go Bad—and How to Prevent It

Variable pay incentives—those goals which, when met, trigger large bonuses—are once again in the news, and the news is not good. Financial services company Wells Fargo is embroiled in scandal following accusations that its aggressive incentive program and dysfunctional culture led front-line bank employees to manipulate customer accounts so they could earn higher incentive payouts.

In December, the firm said it will stop paying bonuses to brokers who sell banking products, following the disclosure that the company's brokers opened 2 million fake bank accounts.

While the Wells Fargo scandal may be unique in its scope, it's not unique for a bonus incentives program—and the management practices behind it—to deviate from its intended purpose at the cost of an organization's reputation.

For compensation program managers, a Wells Fargo-like scandal can be prevented when designing an incentive program, and HR can take steps to ensure that the management and oversight of such a program is rigorous and consistent.

Avoid Design Flaws

The design of an incentive pay plan can include any number of missteps, including putting too much pay "at risk" and relying on poorly thought-out metrics such as targets that are too aggressive.

Pay Mix
"If you put a lot of pay at risk, you have a lot more risk of dysfunctional and unethical behaviors," said Mark Blessington, president of sales management consulting firm Mark Blessington Inc. in Asheville, N.C.

An incentive plan with a mix of, say, 95 percent base pay and 5 percent incentive pay is unlikely to lead to bad behavior "because the additional money to be made by engaging in those behaviors is not worth the risk of getting fired or worse," Blessington noted. "If a problem with incentives is going to occur, it will likely involve positions with much more pay at risk—say, a 50/50 split between base pay and incentives—because there is more to be gained by gaming the system."

Paying attention to the pay mix is particularly important when designing incentives for customer-facing positions. "Companies need to be very alert to any positions that touch the customer and have a high amount of pay at risk," Blessington said. Can the company really justify that amount of pay at risk in those situations? Is the incentive creating a strategic advantage, or is it creating an ethical and financial risk for the company?

Plan Metrics
Employers need to rely on incentive plan measures that are carefully thought out and monitored. For example, a retail store manager might earn an incentive based in part on improving store operating margins. "One way to achieve that is by cutting staff or not delivering appropriate pay to those workers," said Laura Sejen, managing director of talent and rewards with Willis Towers Watson in New York City. "That behavior on the part of store managers could lead to strong bonus payouts in the short term, but it could also damage customer satisfaction" over the longer term if service levels suffer.

[SHRM members-only toolkit: Designing and Managing Incentive Compensation Programs]

Plan Monitoring
Incentives require diligent monitoring, even when they appear to be operating as intended. "There is an old philosophy that focuses on walking around and asking people penetrating questions every once in a while," Blessington said. He suggested having an HR or compensation specialist assigned to those areas of the organization with a great deal of customer contact. "Part of their jobs should be getting soft information on the floor about what is going on and what people are doing," he said.

When it comes to the top performers, managers may not be looking closely at how those employees are achieving their results. If they are doing something unethical and are not questioned about their behavior, they often take that as tacit approval.

In these cases, employees' bad behavior is likely to continue unchecked. If they are promoted on the strength of their results, it creates an even more fertile environment for greater and more widespread dysfunction.

"If checks and balances [to curtail unethical behavior] don't already exist, it is up to HR to change things and identify how the organization is going to monitor incentives" going forward, Blessington said.

Financial modeling can show the likely results and costs of an incentive plan for various performance scenarios. This can be a good first step to identify potential problems.

Beyond that, "it is important to audit the incentive plan design to gauge its effectiveness and what kind of behaviors and outcomes it is driving," Sejen said. "Conduct a periodic review of plan designs to make sure that they are doing what you want them to do and that they are not doing what you don't want them to do."

Good questions to ask include:

• What cultural challenges does the organization face regarding employees' pay expectations?
  
  
• How can employee habits, attitudes and motivation impact the incentive plan, and vice versa?
  

By continually asking these types of questions and insisting on answers, employers can ensure that pay incentives are working, as intended, to improve individual and organizational performance.

Joanne Sammer is a New Jersey-based business and financial writer.

Related SHRM Online Articles:

Bonus Binge: Variable Pay Outpaces Salary, SHRM Online Compensation, August 2016

Variable Pay: Ready to Make the Leap?, SHRM Online Compensation, June 2016

Private Companies Typically Award an Incentive Pay Mix, SHRM Online Compensation, March 2016

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