At the heart of the drama over Wells Fargo employees having opened fake accounts was an incentive structure that promoted unethical outcomes. But that structure was hardly limited to one bank or even limited to the banking industry.
This scandal finds its origins in an incentive architecture – encouraging bad behavior to happen and failing to punish that behavior (enough) when it does happen – that plagues other industries as well as the government.
One of the fundamental tenets of economics is that economic actors respond to incentives. While this may seem obvious, economists take great care to prove across different countries, historical periods and business sectors that people respond to the incentive structure within which they are asked to perform. Driving this structure is what is known as the "principal agent problem." Without an incentive system rewarding effort, an employee hired to perform a task exerts the least amount of effort possible, which is the detrimental to the firm.
Higher-powered incentives are the "solution" to this problem, allowing employers the ability to structure rewards based on performance. The ubiquity of how economic actors respond to all incentives of varying degrees explains why thousands of people at Wells Fargo acted in largely the same way.
The widespread nature of the incentive disease that permeated Wells Fargo, however, extends far beyond its walls. Since the financial services sector is so politically important and therefore politically connected, the incentive problem in banking affects other stakeholders, such as politicians, regulators, U.S. attorneys, rating agencies, etc. They either explicitly or implicitly promote ethical violations or fragility-creating actions.
For politicians facing relatively short elections cycles, for example, legislation that produces positive outcomes for voters faster (such as mortgages) are often prioritized relative to those that take longer to bear fruit (such as education.) Politicians eager to win votes in the early 1990s not only passed legislation promoting homeownership for low-income groups – using Fannie Mae and Freddie Mac to carry out this objective – but required the mortgage giants to maintain portfolios with at least a certain percentage of low-income loans (50%).
Presented by the government with an incentive structure rewarding a larger percentage of low-income loans, employees and subsequently loan officers followed suit, resulting in an increasing (and ultimately unsustainable) fragility in the financial sector. Thus, the ability and incentives of politicians to influence financial services led to an insidious incentives structure.
It is because the underlying incentive disease transcends the boundaries of one firm or industry that real change addressing these issues is such a monumental task. Focusing instead on placing blame squarely on one individual, like former Wells Fargo CEO John Stumpf, will be unproductive in truly changing outcomes. It ignores the fact that all economic actors respond similarly to the same incentive structure. Nor should we blame higher-powered incentives themselves, as they provide the fuel for the engine of growth in our system by motivating employees to pursue extraordinary work. Without them, we would, in effect, be an effortless society. This is not to say that individuals and companies are not culpable, rather that culpability extends far and wide.
It is not the person, but the underlying system that needs change, as all economic actors respond to incentives similarly. Instead, effective reform of the incentive architecture almost by definition requires a holistic, coordinated and cohesive approach by regulators and policymakers, transcending company and even industry boundaries. Yet in the case of Wells Fargo, cohesion is currently absent, as evidenced by the no less than six separate current investigations of Wells Fargo by six separate agencies.
True change in how incentives affect behavior would come from a thorough analysis of the incentives of the major companies, industries and executives. A more cohesive and coordination examination of the incentive architecture would also help policymakers find a unified voice across stakeholders in dealing with industry ethics in general.
Sharon Poczter is an economics professor at Cornell University who studies the bank sector and emerging economies. She can be reach on Twitter @SharonPoczter.