by Lisa Higgins, Contributing Editor
Where did Wells Fargo wrong, and what can employers using variable pay learn from its experience? Several lessons can be gleaned, and chief among them is that companies walk a fine line between incentivizing employees enough to improve company results without promoting undue risky behaviors.
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“Wells Fargo employees secretly opened unauthorized accounts to hit sales targets and receive bonuses. Because of the severity of these violations, Wells Fargo is paying the largest penalty the Consumer Financial Protection Bureau (CFPB) has ever imposed. Today’s actions should serve notice to the entire industry that financial incentive programs, if not monitored very carefully, carry serious risks that can have serious legal consequences.”—CFPB Director Richard Cordray, September 8, 2016.
According to the CFPB, the problem occurred because the bank’s employee incentive programs were not matched by proper oversight and monitoring. Employees opened accounts on behalf of customers without their knowledge or consent to the tune of 1.5 million unauthorized transactions.
Regulations Weren’t Enough
A variety of regulations emerged in the wake of the Enron scandal of the early 2000s and as a result of the 2007 recession. Some were designed to ensure that performance-based compensation did not improperly incentivize employees to take unnecessary risks, as happened in the case of Wells Fargo.
In February 2016, Mercer released a survey addressing these issues worldwide. The 11th edition of Mercer’s Global Financial Services Executive Snapshot Survey asked about pay practices at 71 global financial services companies, like banks and insurers, based in 20 countries in Europe, North America, Asia, and South America.
Highlights of the report reveal that pay has shifted more toward fixed than performance-based, among other findings. Of those answering the survey, 61% said they had increased their employees’ fixed pay by more than 5% while 58% had reduced variable pay by more than 5%. This marks a significant shift in pay mix in recent years.
“There continues to be a concern that increasing the focus on fixed guaranteed pay breaks the link between pay and performance, and may actually be counter-productive for aligning pay with risk,” said Dirk Vink, Mercer Principal and Financial Services project manager.
“We have concluded that the most positive impact on sound risk-taking behaviors and decision-making has come from significantly improved governance and increased involvement of risk management in the performance management and compensation process.”
Respondents were asked how their organization is fostering a strong risk culture: 93% said they penalize misconduct and non-compliant behaviors. The second most common response, given in 89% of cases, involved the role of risk management in performance expectation setting and evaluation.
For example, respondents pointed to the importance of setting the right tone at the top of the organization, through top management leadership, communications and meting out real consequences, along with training and coaching managers on sound risk culture.
In its survey, Mercer found that a great degree of importance was placed on fostering a sound risk culture among staff. Of the companies surveyed, 62% said they have carried out initiatives to penalize misconduct and noncompliance to what they call a “great degree,” 60 % referred to setting the right tone at the top of the organization, and 58% said they clearly communicate risk culture objectives.
“It’s encouraging to see companies engaging senior leaders to set an example when it comes to risk taking and compliance behaviors,” said Vicki Elliott, senior partner and financial services talent leader at Mercer. “The best way to foster a sound risk culture and combat excessive risk taking is with strong, authentic leaders who are willing to manage consequences for good and bad behavior.”
Performance Management and Culture
The survey indicates that performance management plays a key role for financial services organizations. More than one-half of the respondents said their performance management approach works well. Still, they indicated that change is coming. One-half of the banks said they plan to change their performance management processes in the next 12 months, while 16% of insurers said the same.
“Establishing an effective employee performance management system continues to be a highly challenging task for financial services organizations,” said Vink. “However, when done right it can have a greater impact on behavior and performance than just changing compensation plans. Performance management is a key lever to help manage toward desired culture change.”
The Federal Deposit Insurance Corporation (FDIC), the agency that regulates the banking industry, offers its own guidance for incentive compensation practices in a Statement of Policy at https://www.fdic.gov/regulations/laws/rules/5000-5350.html. To be consistent with safety and soundness, according to the agency’s statement, incentive compensation arrangements should:
- Provide employees incentives that appropriately balance risk and reward;
- Be compatible with effective controls and risk management; and
- Be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.
While these principles are aimed specifically at the banking industry, they may just as easily apply to any other business paying employees with incentive compensation.