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​Incentives and Ethics: Transparency International Speaks Out

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​Transparency International (TI) is famous for its Corruption Perceptions Index (the link is to the 2015 publication).

Recently, its U.K. chapter published Incentivising Ethics: Managing Incentives to Encourage Good and Deter Bad Behavior.

The foreword starts off with a description of the challenge:

Incentive schemes are an important part of encouraging the right kind of behaviour from staff, be it to improve quality or drive up profitability.  Unfortunately, incentives have also historically been one of the main dri​vers of corrupt practices in many industries. Pressure to meet targets, the imperative to "get the job done" and the need to win business have frequently led to shortcuts resulting in various forms of corrupt and unethical behaviour, including fraud, trading in influence, anti-competitive practices and the offering, promising or payment of bribes.

The authors continue:

… for incentives to work as intended and to avoid perverse and distorted outcomes, the company must first ensure that it has an open and ethical culture in which staff are encouraged to do the right thing and feel able to challenge management decisions and targets they think are unethical or dysfunctional. 

This should be reinforced by a strong tone at the top and the alignment of business objectives and company values. Incentives cannot operate in a vacuum. They should be linked to the company's overall business strategy and should be aligned with the company's values, code of ethics and compliance programme.  

Finally, incentive schemes should move beyond mere alignment with values and ethical codes and actively encourage ethical behaviour. This means that they should not be based solely on financial targets, but should contain nonfinancial targets that reflect and drive ethical behaviour. Ultimately, this mix of incentives should support the long-term sustainability and success of the company.

Like some other recent publications, TI has 14 Key Principles in 5 areas:

  • Ensuring strong culture and values.
  • Risk assessment.
  • Designing ethical incentives.
  • Embedding ethical incentives.
  • Monitoring and evaluation.

Like other publications, their guidance is risk-based. It suggests that the risk from misaligned or ineffective incentives be assessed.

I very much like how the authors have taken the different forms of incentives and identified "how they can go wrong."

But I am not encouraged by their suggestions on how to assure ethical behavior. They are traditional and don't give me a great deal of hope that ethics can be incentivized.

I have yet to see a completely satisfying incentive compensation program.

I have seen those that are based on corporate or departmental performance. But, that doesn't reward exceptional individual performance. For example, when I was with Coopers & Lybrand in Los Angeles, my primary objective in the bonus plan was selling non-audit services. I was lucky and sold more services than any other manager in the U.S., only to be told that because the region and office had not met its targets I would not receive a bonus. After I complained I was awarded a small bonus.

I have also seen programs that base the award on the achievement of five or so goals. Even though as an executive I was responsible for performance on a wide front, typically some smaller number is selected for evaluation. Unfortunately, managers frequently focus a disproportionate amount of their time and attention on those few at the expense of the many. At Home Savings, I was responsible for contingency planning. But the manager responsible for a major portion of our network refused to provide any support for the initiative because it was not one of his goals. Frankly, that behavior was not, IMHO, ethical.

How do you incent people to behave ethically? Perhaps the only way is to punish unethical behavior.

Yes, you can make efforts to express, inform, and even monitor and evaluate ethical values.

But do you reward people for behaving ethically?

The TI report has some very useful discussion, but I am not sure it has all the answers.

I am encouraged that it sees an important role for internal audit. But, it does not suggest that internal audit review how goals are set, performance measured, and bonuses awarded. This could and should be expanded.

I would also like to see an expanded discussion of the roles of the board and the compliance and risk managers.

Perhaps the board can ask management a simple question (with follow-ups) that defies a simple answer:

"How do you know that everybody will behave the way you want them to behave? Will they be ethical and live up to our values? Will they work for the collective good? Will they take the right amount of the right risk?"

I encourage you to download and read the piece.

Please share your comments — and especially let us all know if you have seen incentive programs that work very well, rewarding performance and ethical behavior.


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