Audit Director, Sarah Pumfrett, contributed to Transparency International's recently published report on incentivising ethics and managing incentives. In this blog, Sarah gives an insight into some of the report's highlights.

When Professor Paul Moxey approached me with a request to provide input to his report on incentivising good behaviour and deterring bad, I was hooked by his catchy working title of ‘Carrots, Sticks and Rotten Apples’. To me it summed up the whole problem with incentives schemes in just five words.

It brought back a vivid childhood memory, my first exposure to incentive-induced immorality and its unintended consequences; my father’s attendance at a black tie dinner, in a high-class hotel, hosted by a blue chip company, that left a number of people hospitalised with food poisoning and hepatitis.  So what went wrong?  The company used a reputable hotel, which sourced top quality seasonal fruit from well-respected local producers for their spectacularly gluttonous sweet menu.  No one envisaged that berry pickers, paid by the weight of their baskets, would urinate on the soft fruit to inflate their income!

Culture and incentivisation play their part in bad behaviour

Yet it seems incentives schemes routinely drive wrong human behaviour in every organisation.  This often results in significant and sometimes catastrophic consequences for the entity, the perpetrator and the victims.  Whilst it is easy to point to the bankers and their LIBOR (London Inter Bank Offer Rate) and PPI (Payment Protection Insurance) trades, or the car manufacturers manipulating emissions tests, look deeper and you will find universities accused of immigration offences, bus drivers keeping time by failing to pick up passengers and charities targeting vulnerable donors.  Immunity appears absent.

The immediate scandal reaction of executives, regulators and even governments, appears to scapegoat a few individuals as ‘bad apples’.  This provides a convenient closure without scrutiny, to establish how culture and incentivisation contributed to the crisis, enabling ‘business as usual’ whilst maintaining plausible deniability of a bigger problem. 

Managing incentives to encourage good behaviour

The report describes the different types of incentive which influence behaviour and how formal incentive schemes can go wrong and lead to unethical and sometimes illegal behaviour. Some of these incentives come from outside the organisation and some are created within it.

It highlights the requirement to align the organisation’s espoused and commercial values.  Considering the role of peer pressure and investor expectations, it notes the significant statistical correlation between dysfunctional behaviours and the pressure under which organisational leaders operate.

The report goes on to identify that progressive employers have discontinued annual appraisals as they feel they reveal more about the appraiser than the appraised.  It references research from both the Harvard Business Review and the Association of Chartered Certified Accountants.  The former identified “significant problems with bonus and performance related pay that often resulted in a reduction in overall performance and an increase in unethical behaviour” concluding “the risks may outweigh the rewards”.  The latter noted “that gaming performance measures to achieve targets at the expense of real performance, deliberately understating risks or overstating benefits to get approval for a proposal, and giving optimistic or pessimistic forecasts to avoid criticism or reduce expectations were commonplace”.

Incentivising ethics

The report provides case studies, some of which came from organisations in response to incidents they’d suffered.  It offers a list of key principles designed to incentivise ethics and promote effective risk management.  It considers the use of ethical incentives and declarations and the advantages of cross functional teams in risk management.  Finally it recognises the role of actively engaged employees, which is often referred to as an organisation’s most precious resource, but can equally be its biggest risk if disengaged.

It may not change the world overnight, but it is well worth a read and, if you will pardon the pun, the carrots and rotten apples provide food for thought for any executive seeking to shake a stick at corruption by, and within, their organisation.

Download the report, 'Incentivising Ethics: Managing Incentives to Encourage Good and Deter Bad Behaviour' on Transparency International’s website now.