The alleged misdeeds of Wells Fargo (WFC) employees are now well known. To meet aggressive sales quotas, thousands of branch employees engaged in unethical practices such as signing up customers for products without their knowledge and creating fictitious customer accounts.
When these practices became known to the bank’s executive management, the employees who engaged in them were fired, but this has not spared the company from close to $200 million in fines by federal regulators and the grueling cross-examination of CEO John Stumpf before congressional committees.
Until this scandal was revealed, however, Wells Fargo had enjoyed a reputation as one of the country’s best-managed banks. Its executives had avoided the worst of the 2007/8 mortgage crisis. Warren Buffett was sufficiently impressed that he owns $23 billion of the company’s stock, making it the second-largest equity holding of Berkshire Hathaway (BRK-A).
But this scandal has clearly taken the gloss off the bank’s shiny reputation. Senator Elizabeth Warren (D-MA) angrily told Stumpf during the Senate Banking Committee proceedings that he should resign, give back the money from the appreciation of his personal stock holdings, and be criminally investigated. Irate senators, regulators, and political commentators will soon be demanding new rules to reign in wrongful practices. The most egregious of these practices, they will claim, are high-powered incentives linked to stretch targets for sales and cross-selling. The logical consequences are regulations that ban or severely limit these practices. Anticipating this pressure, Wells Fargo has announced that it will ban retail product sales goals altogether.
Such “solutions” are misguided. If enacted, they would be harmful to businesses and the economy. That said, such activity can go astray when some employees, falling short of performance goals, choose to take unethical or unsanctioned actions to meet their targets. When you combine pressure to hit targets with opportunities to bend the rules, some employees will always be tempted to cross the line.
Generally, however, people do not engage in unethical activities unless an additional ingredient is present: the ability to rationalize behavior. Rationalizations can take many forms, including “I’ll never get caught,” “Everyone is doing it,” “No one will be hurt,” and “I’ll fix the situation next month.”
To inoculate a business from bad behavior, managers must eliminate at least one of the three ingredients that motivate fraudulent behavior: pressure, opportunity, and rationalization. Attempting to learn from the Wells Fargo situation, politicians and regulators want to legislate a reduction in pressure by banning cross-selling goals and limiting variable compensation.
But performance pressure is, and always has been, a driver of innovation. Highly innovative, entrepreneurial, and competitive companies embrace performance pressure to motivate exceptional effort. Just think of the pressure facing entrepreneurs as they try to build a business from scratch. Or the pressure facing athletes as they meet their opponents. Such pressure—properly channeled—leads to unparalleled effort and performance.
Rather than legislating away the use of pressure to stimulate performance, the focus should be on controlling opportunity and rationalization for bad behavior. The opportunity to engage in bad behavior should be limited through strong internal controls, such as independent checks, whistle-blowing programs, internal audits, and strong audit and risk committees of the board. These are standard, proven approaches that dramatically reduce the opportunity for misbehavior.
Management must also eliminate employees’ ability to rationalize their errant behavior. They must make significant investments in core values and strategic boundaries. Core values, communicated through mission statements, credos, and executive actions, must be clear about whose interests come first (customers, employees, or shareholders) when faced with tough decisions. Regardless of how this choice is made and communicated, everyone in the business must be made aware of their responsibility to protect the interests of all the constituents of the business.
Most important, clear boundaries must be set and communicated so that every employee knows what behaviors will not be tolerated. Like nine of the Ten Commandments, such boundaries are always stated in the negative, such as “We will never engage in any activity that is not pre-approved by our customer.”
Those who choose to cross these boundaries thus know in no uncertain terms that they will face severe disciplinary action, including losing their jobs.
When considering how to curb the kinds of abuses that occurred at Wells Fargo, think of a highly-competitive, innovative business as a racing car. Given that the car could crash if not properly controlled, one solution would be to regulate engine size and install a governor to limit speed so that the driver cannot drive fast enough to get into trouble. The alternative would be to allow the racing team to install both a high-powered engine and comparably powerful steering and braking systems. This would allow the driver to go as fast as possible on straightaways and still have the confidence and ability to manage the inevitable twists and turns as well.
We vote for the latter approach. Management control systems should incorporate stretch goals and incentives that encourage innovation and entrepreneurship. But they must also include effective internal control systems, communication of values, and clear boundaries to guide and enforce the propriety of the day-to-day actions of every employee.
Robert Kaplan and Robert Simons are professors in the Accounting and Management Unit at Harvard Business School.