Ethics and Incentive Compensation: A Ticking Time Bomb

Richard Bistrong,  Anti-Bribery Consultant & Speaker

"This Article First Appeared In Corporate Compliance Insights And Is Reprinted With Their  Permission"

*Look for bad behavior hiding behind good performance

* Incentives are having a significant and now measurable impact on corporate conduct and individual ethical behavior. Is it time for a mine sweep? 

In a recent Wall Street Journal article, it was reported that “some drug-industry watchers say Mylan’s incentives may have played a role in its steep price increases for the EpiPen.” The article addressed one-time awards for doubling earnings per share as well as “shorter-term pay tied to equally ambitious targets.” Without wading into the debate on this issue, we only need to look at other recent events including the Volkswagen diesel scandal, and the recent Wells-Fargo $185 million fine, including a $100 million penalty from the Consumer Financial Protection Bureau, to appreciate that incentives are having a significant and now measurable impact on corporate conduct and individual ethical behavior.

The issue of incentives seems to have a polarizing effect in the compliance debate. On the one hand, it’s reasonable to argue that people should not be compensated to behave ethically and that ethical people can’t be ‘tipped away’ through incentives towards bad conduct. But there is a body of research and opinion that indicates otherwise, and from my front-line perspective, having spent over a decade in the field of international sales management, where lucrative incentive compensation plans intersected with commerce, I think it’s becoming more center to the discussion and critical to the discourse.

In a compelling article “Top Five Business Flaws that Could Lead to a Corporate Scandal,”, co-published by the Institute for Business Ethics (IBE), the authors found that two “warning signs of a poor and potentially damaging culture which could lead to corporate scandals” were high levels of corporate stress and flawed remuneration policies. The report stressed that “an obsessive focus on short term targets” was a significant contributing factor with respect to unethical “bad behaviors.”

Indeed, as Marc Hodak, Adjunct Professor at NYU and Managing Director of Hodak Value Advisors shares, “most incentives are invisible to management” to which I would add, until the tide recedes. As Marc shares, “bad behavior hides behind good performance” and that can often be a strong contributor as to why it too often goes unnoticed and unchecked. After all, if someone is meeting and exceeding financial targets, quarter after quarter, what’s the motivation to ask “how is that happening,” especially in unstable markets and in erratic economic conditions. So how and where can we look for the incentive “ticking bombs” as Marc calls them? Can we perform such a mine-sweep? I would offer a few variables to consider, especially for organizations which have teams working in high-risk, low integrity, regions, where risk and opportunity abound. I would also consider them relevant to multinationals which operate in unstable and unpredictable markets.

1. How much of total compensation should be variable?

For those working in high-risk “frontier” markets, where lucrative business opportunities often intersect with corrupt third parties and end-users, how much of total compensation should be performance based? If you are looking towards long-term, sustainable, and ethical business growth, in such regions, that takes time. Someone might be working for years in their territory, identifying ethical partners, making sales presentations, with no measurable results. Should that person be penalized for non-performance due to taking such a long term, patient view of the marketplace, where progress might be sluggish in the initial stages of a sales cycle?

2. How should the variable compensation be indexed?

There are a number of possibilities in terms of how a bonus might get indexed, including corporate, group, or personal performance. In the field, we called personal performance compensation “eat what you kill.” Again, for those working in lucrative markets, where the institutions of state are often weak, marked by procurement instability, what kind of message does “eat what you kill” send to the field? Would it be better to reward such front-line personnel on corporate performance, as to promote the social and team goals of ethical business, and a collective measure of success? Or perhaps some mix of the three, depending on the risk profile of the region? Should the index be the same for someone working in Western Europe as the Middle East?

3. How often should incentive compensation be indexed?

I worked for a public company, and appreciate the need and expectation for quarterly forecasting and quotas. But I ask, in a worst case scenario, if you have someone on the front-lines of international business, and what stands between that person and meeting the quarter’s quota and bonus, is a shipment stuck in customs and inspection, which can easily be released via a small bribe, what’s the message? Is it, “no matter what, no,” even at the cost of the quarter. Do your field personnel embrace and understand a corporate culture which promotes ethics above forecast? Do they ‘fall back,’ knowing that the sale can easily be rolled into the next quarter, while everyone works together to solve the problem? Or is there a loud, yet unspoken message of “get the deal done.” Remember, line personnel report into regional managers, not compliance personnel. So, what’s the tone from the middle as the end of the quarter approaches? I’ve been on those forecast calls, and they can be quite stressful, both individually, and as a team.

Those are but a few variables which might be worthy of an “incentive mine sweep.” Let’s remember, when the language of “get the deal done,” along with the incentives to win, are louder than “we care how you get the deal done” then Marc’s ticking time bombs tick away.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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