“The whole commission structure in both prime and subprime was designed to reward salespeople for pushing whatever programs Countrywide made the most money on in the secondary market,” the former sales representative said. – Gretchen Morgenson, Inside the Countrywide Lending Spree, The New York Times, August 26, 2007

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The Dr. Phil question for the mortgage industry: And, how is that working out for you?

For many of us, there has been considerable concern over the years that sales incentives were designed to maximize the money for the lender at the expense of the borrower. Sure enough, in the recent excesses of the mortgage meltdown we have ample examples that Countrywide and other mortgage players worked hard to devise just such an incentive system. It has given the whole industry a black eye not to mention an economic train wreck. In fairness, politicians, the government, rating agencies, and a number of customers also brought their own greed and incompetence to the party.

What was less apparent was just how flawed these incentive systems were in accomplishing their strategic goal. I mean, if they had really worked the way they had intended, Countrywide would not have had to be rescued by Bank of America right? If they had worked really well, the whole mortgage industry would not be on the ropes, right? The strategy must have been wrong.

This is bigger than just the mortgage business. Incentives across all of the financial services industry are now being examined. The Wall Street Journal recently stated it this way: At every level of the financial system, key players from deal makers on Wall Street and in the city of London to local brokers … often get a cut of what a transaction is supposed to be worth when first structured, not what it actually delivers in the long term. Now as the bond market wobbles, takeover deals unravel and mortgages sour, the situation is spurring a re-examination of how financiers get paid and whether the incentives the pay structure creates need to be modified …

What is bad for customers is also bad for the bank. Why? Because in a true longer-term business relationship, both parties – customer and provider – must be able to succeed and flourish. Rogue behavior, incented by exorbitant and immediate gains, eventually steals long term value from all the parties. It moves the business relationship from a plant, cultivate and grow model to harvest model that stunts development. It is this short-term, transaction model that is now wreaking havoc. It is an old movie that thousands of managers had seen before.

So why did some of the smartest people on the planet fall for it again? I am not sure. What I am sure of is that these overly aggressive incentives are a lazy man’s approach to management and motivation. Just turn the dogs out and say sic’ em. These systems are the approach of the greedy to disproportionate and immediate gain. They undermine character. Like steroids in the world of sports, these systems relegate the non-abusers to the back of the bus or off the bus. And they attract rogue players. Adverse selection of employees means that eventually you only attract those willing to rip off customers for a fee. In the long run an incentive system run amok leads to ruin.

It comes down to a simple fallacy: financial incentive is the primary tool for managing the goals of an organization. The larger the pile of incentive money, the more direct the incentive to the desired narrow behavior, the shorter-term the payoff – the more powerful the outcome and the greater the risk.

The question is can management, customers, employees or shareholders trust a system that places a higher value on compensation than on ethics, values and purpose? Can a system that dances almost exclusively to the tune of financial incentives, perform effectively over a longer period of time and do the right thing even when it is unpopular, painful, and requires financial patience?

The point is not that incentives are bad. The point is that management must build a culture, set goals, and reward performance with currencies other than just money. Customers default to price when there is no discernable difference in the value of a product or service. Employees do the same thing. There is a certain self-fulfilling prophesy. If money (price) is the only component of your incentive system, then you will only attract customers and employees who are focused on financial reward. It is a form of bribed behavior that precludes real loyalty. However, if you create a culture, goals, quality of work, sense of meaningful accomplishment and, yes, financial rewards that touch the full humanity of the workforce, you will not only create loyalty, but you will also get better decisions and actions for all stakeholders.

I have said in this space before: loyalty is what is left after the bribes are all gone. I would now update that to say: loyalty and performance are what is left when bribes are replaced by effective management.

(Column appeared originally in ABA Bank Marketing magazine – March 2008)

By ROBERT E. HALL

Not to be reproduced without written permission. All rights reserved. © Copyright Robert E. Hall 2008