Can We Create a Conflict‐Free Commission Payment System?

Abstract

Key to any successful organization are compensation systems and the degree to which they motivate employees to be increasingly more productive. Research has shown that performance-based compensation such as piece-rate pay plans, commissions, profit-sharing, gainsharing, and small group incentives can all increase performance. What research hasn’t shown, however, is how performance-based compensation affects employees’ ethical decision-making. Those who create incentives that are designed to encourage employees to generate revenues for the firm, while simultaneously making money for themselves, fail to consider that these same incentives may encourage employees to ignore their customers’ needs. As a matter of fact, the 1997 Ethics Officers Association’s survey of its 350 members, corporate ethics officers from some of the largest corporations in America, found that among the major principal obstacles these members faced in performing their duties, was a “compensation system inconsistent with corporate values.” Consider the following: In 1992, auto repair advisors at Sears were accused of overcharging auto repair customers in order to earn higher commissions. When news of these practices became public, Sears’ CEO denied any intent to deceive customers, but acknowledged management’s responsibility for putting in place compensation and goal-setting systems that “created an environment in which mistakes did occur.” Sears’ total cost to settle pending lawsuits was estimated at $60 million. In October 1993, as a result of the first of several governmental sales practice investigations of the insurance industry, Metropolitan Life Insurance Company was “investigated in several states for using questionable tactics to sell thousands of life-insurance policies across the country.” In the mid-1990s, Prudential Securities and Paine Webber, to a lesser degree, were both ordered to set aside significant funds to repay customers who suffered losses due to factual misstatements in the sale of investment products. It has been widely thought that some of the root causes for these and other similar abuses were lax ethical management and poorly structured incentives that invited abuse. Interestingly, compensation “malpractice” doesn’t limit itself just to the corporate world. In September 1997, the director of the United States Internal Revenue Service publicly apologized to taxpayers for the Service’s abuses—abuses caused by IRS compensation system incentives that rewarded high taxpayer collections and penalties and, in so doing, often resulted in significant misconduct of agents—at the expense of honest taxpayers. These examples illustrate a growing concern that performance-based compensation, such as commission, may provide incentives for employees to act unethically. Daily we read in the newspaper of ethics abuses involving commissions. In the financial services industry we hear of scandals involving trading on insider information, penny-stock fraud, inappropriate use of highly leveraged investments, all linked in some way to individual incentives and raising serious questions about Wall Street’s integrity. And potentially more troubling, we look at the