The problems caused by incentives and quotas in the retail banking operation at Wells Fargo are still front page news. However, the actual goal of the bank's program — and in other companies with similar programs — remains nebulous.
The only goals for shareholders are maximizing profits and share-price appreciation. Did Wells Fargo's management have the same goal? It's not really clear. In the fallout over the scandal, one less-discussed detail is that whatever the bank's objective was in creating the incentive program, the benefit to Wells Fargo's income statement was limited at best.
The Wells Fargo incentive program had been in effect since 2011. The bank's reported financial results for 2014 and 2015 suggest the incentive programs and quotas — and the negative behavior they caused as managers tried to reach their sales quota — did not produce the desired profit targets the bank may have been seeking. Sales rose only slightly (2%), while net profits fell slightly year over year. Sure, other reasons such as a low interest rate environment could account for the sluggish growth. But another contributing factor may have been that, as managers focused on boosting sales they were not focused enough on boosting profits.
To understand why growing sales may not mean growing profits, a personal example may help. I deposit money at a large regional competitor of Wells Fargo. Last year, my bank was bombarding me with offers of cash for new credit cards, or short-term promotional money market accounts that paid much more than current rates for new money. I already had the issuer's credit card, so I signed up for the money market account. After the paperwork was completed, the sales consultant suggested that to earn more, I should consider investing in one of the bank's proprietary mutual funds. His sales pitch was tepid at best, and when I asked him about the ratings issued by the two mutual fund research companies, he did not have the information readily available. As such, it appeared to me that the mutual fund pitch was secondary to the money market product, and that it was easier to fulfill whatever sales quota he had to meet by pushing the promotional money market product.
At the end of the six-month period — the amount of time it took to earn the promotional rate — I closed the money market account and moved my cash to one of the virtual banks offering a higher rate.
Did the consultant meet his sales quota and earn an incentive payment? No doubt. However, if the goal of that sales consultant was to maximize profit, not revenue, he should have spent more time on offering the annuity products (assuming he had the proper license to do so) and less time on the money market product. If his goal was to maximize revenue, then it was easier to push the money market (which basically sold itself because of the yield). Since the branch was crowded with customers signing up for the promotions, the consultant likely chose the easier way of selling money market accounts to make the sales quota.
Examples outside of banking point to businesses appearing to boost sales but not gaining financially from it. Just ask (former) shareholders of Levitz Furniture or Circuit City — companies that had booming same-store sales but that could not cover their overhead and ultimately filed for bankruptcy.
There is a concept that behaviorists call "goal congruence" which, in simple terms, means that the internal rewards system should foster the alignment of management with the goals of the shareholders while also earning the company maximum profits. Yet a well-regarded economist, William Baumol, argues that management's goal is to maximize sales (revenue), not profits.
Companies never really ignore profits. But once profits reach levels that stock market analysts consider acceptable, all further effort is devoted to growing sales by offering promotions, discounts and so forth. This focus, as Wells Fargo's fiscal 2015 results demonstrate, may not enhance profits.
So if, according to classical economics, the goal of any shareholder-owned company is to maximize profits, then any incentive program has to produce maximum goal congruence. As individual managers have their own goals that may or may not overlap with the corporate goal, banks should include these five elements into their incentive programs to maximize congruence:
Management should not reward sales of promotional accounts and credit cards — products and perks that basically sell themselves. Instead, they should reward employees for bringing in new customers, both retail and commercial, and for selling the high-margin investment and insurance products.
Internal audit and compliance functions can measure achievement. Banks can easily measure adding new customers or sales of high profit products and they should do so.
Reward the group (the branch as a whole) and not individual effort. This approach may motivate all employees to work together to achieve the desired goal.
Make quotas voluntary, rather than compulsory. In the case of the Wells Fargo scandal, it was inevitable that managers cut corners since failing to make quotas meant risking termination or transfer to a branch in an undesirable location. Sure, there will be some managers satisfied with the status quo if the incentive is voluntary. However, there will be other managers seeking promotion and recognition that will go the distance without being compelled to do so. It is those managers who deserve the larger rewards.
Recognize not all managers are motivated by the same incentives. And despite what many believe, research has shown that some managers are motivated by nonmonetary rewards, such as prestige, security and more.
Marvin Weiss is retired as a tenured professor of the Accounting and Business School Dean at the NY Institute of Technology. He has been a visiting faculty member at Fordham, NYU and Columbia University. He holds a Ph.D. in business from NYU-GBA.