Rewarding Ethical Behavior

By Carol Vallone Mitchell, Ph.D., and Patricia M. Schaeffer, Talent Strategy Partners,
and Katherine A. Nelson, the Wharton School, University of Pennsylvania.
Originally published in workspan, the magazine of WorldatWork in July 2005.

For years, a discussion has raged in management circles The results are legendary.
about “rewarding” ethical behavior: Of course, people In 1992, the California Department of Consumer Affairs’
can be punished for bad behavior, but why and how Bureau of Auto Repair (BAR) released the results of an
should we reward people for doing the right thing? 18-month investigation into the practices of Sears Auto
Should people be rewarded for being ethical? Centers. BAR concluded that the auto centers habitually
But if other types of desired behavior are rewarded, why overcharged customers for repairs, recommended
not reward ethical behavior? Should employees be unnecessary repairs and charged for repairs that hadn’t
rewarded similarly to the way people are rewarded been done. The resulting class action suit focused on
when they meet financial targets, regardless of how Sears’ commission-and-quota compensation system as
those targets are met? Or should people be rewarded the culprit.
differently depending on how they make their targets? Sears provided compensatory relief in the form of $50
coupons issued to class members and paid class
Unintended Consequences counsel costs of $3 million. The compensation system
The link between rewards and ethical behavior is far was redesigned and Sears’ CEO apologized to
from murky; it is, in fact, crystal clear. The link is so strong customers in full-page newspaper ads. Unfortunately,
that ignoring the ethical ramifications of rewards can the ill-conceived reward system — designed with the best
result in real disaster. intentions — had encouraged unethical behavior and
damaged what had until then been a sterling corporate
Consider the case of Sears Auto Centers in the early
reputation for superb customer service.
1990s. Profit margins in the merchandising group col-
lapsed under competitive pressures. The least profitable
of the group’s units were the auto centers. In an effort to Rewards: Where the Rubber Meets the Road
spur performance, Sears introduced a cost-cutting and Smart companies have listened closely to what
productivity-enhancing program that included, among regulators, legislators, the courts and public sentiment
other things, a productivity incentive for auto mechanics. have had to say about ethics programs. Many compa-
Mechanics’ base pay was reduced and replaced by a nies have inspirational corporate vision statements, clear
fixed dollar amount in addition to base salary for corporate policies, lengthy codes of conduct, employee
completing a job within a specified period of time. (This hotlines and comprehensive training and communication
type of pay is also known as “piece rate.”) Mechanics around ethics. They tout their high ethical standards in
were given quotas, such as a certain number of brake employee publications, on plaques hanging in
jobs. Service advisers, who were responsible for corporate offices, in consumer advertising and on their
consulting with mechanics on a vehicle’s condition and Web sites. Enron had a wonderful values statement and
then advising customers on potential repairs and parts, a comprehensive ethics
were put on a base salary plus commission plan. They policy. All of that implod-
also had to meet product-specific sales quotas. ed as a result of wide-
spread unethical behavior that extended up, down and Quick Quiz:
across the organization.
How Does Your
Ethical behavior is really driven by how it is encouraged
and rewarded. If companies are serious about ethics,
Organization Rate
they must have the elements of an ethics infrastructure in Linking Ethical Behavior and Rewards?
Strength Neutral Weakness
and a real commitment from the leadership on the sub- Our performance management
ject of ethics. But they also need to define ethical behav- program includes ethical behavior/ ❑ ❑ ❑
integrity as a performance expectation.
ior in the corporate context and develop a strategy to
Employees in my organization are
reward the desired behavior. rewarded not only for the results they ❑ ❑ ❑
achieve, but also for how they achieve
those results.
Defining Ethical Behaviors
Executives’ pay levels in my organization
Based on experience, most employees in most organi- are tested for reasonableness using a ❑ ❑ ❑
zations want to act ethically, but often they don’t know rigorous process of competitive
compensation analysis.
the “rules.” This might be a first job, or perhaps an
employee is new to a particular industry or company. Our board members receive clear,
complete and accurate information ❑ ❑ ❑
Or, like the majority of employees, they might learn well in advance of meetings in which
policy only on a need-to-know basis. Communicating they have to approve executive pay
recommendations.
policy — the “rules” — is one of the biggest challenges
organizations face. Our board is free of undue management
influence when it makes executive pay ❑ ❑ ❑
But, for the sake of argument, assume that employees decisions (e.g., the CEO is not a voting
member of the board).
have the corporate policy committed to memory — they
do know the rules. Employees still need to understand
My organization swiftly deals with ❑ ❑ ❑
unethical behavior.
what ethical behavior looks like. They need clear Our stated organizational values
descriptions of ethical behaviors in the context of their are reinforced and reflected in our ❑ ❑ ❑
industry, their organization and their job. And they need performance management system.
to see their managers modeling this behavior.
For most professionals who have worked in the area of • Maintains confidentiality
performance and rewards in the past 15 years, this is not • Is truthful
a new concept. Precious time and money has been • Confronts potentially unethical behavior (does not
invested to help companies define competencies, then look the other way)
use them as criteria for selection, development, perform- • Avoids conflicts of interest
ance management and, yes sometimes, rewards. Isn’t
In health care, however, it would be far more powerful
this really the same thing? Ethical behaviors can be
to define “acting ethically” in more specific terms. For
defined the same way competencies have been
example:
defined.
• Maintains confidentiality of patient and other
The key to success, as with competencies, is to focus on
sensitive information
the right ones, not a long list. Also, despite the fact that
• Is truthful in recordkeeping and reporting
“acting ethically” has some universal themes, companies
need to understand what the common ethical dilemmas • Confronts and counsels others who could be
are in their specific business environments and describe jeopardizing a patient’s dignity (does not look the
what employees can do to act ethically. “Acting other way)
ethically” could be described in behavioral terms such as: • Treats all patients equally according to the level of
care needed for their condition, regardless of who
they are or who they know.
Incorporating Ethical Behavior into Performance and Build ethics and other values into non-cash rewards pro-
Rewards grams. An outstanding and courageous demonstration
Note that these behaviors are observable — people can of ethics, such as blowing the whistle on a suspicious
be seen doing or saying them. Because they are accounting practice or suggesting a novel approach to
observable, the occasions on which people demon- safeguarding confidential data, can be an award-wor-
strate them (or fail to demonstrate them) can be tracked, thy event in a recognition program that has significant
and positive reinforcement or corrective feedback can non-cash rewards.
be provided. In short, people can be held accountable Ensure managers are committed to modeling ethical
for their achievements as well as their behaviors, and behavior, encouraging that behavior and praising
success in both areas can be rewarded. employees who demonstrate it.
Importantly, there also must be consequences for failure
to act ethically, just as there are, or should be, conse- Compensation Professionals’ Obligations
quences for failure to achieve results. At Sears Auto Whether managing compensation in a for-profit or
Centers, there was a consequence for not achieving non-profit organization, there are certain ethical respon-
quota: the mechanics made less money than they had sibilities that come with the job.
under the base salary-only system. Suppose the
In designing incentive programs, think about whether
compensation professionals at Sears also had designed
there are any unethical or otherwise undesirable behav-
the mechanics’ incentive program with a consequence
iors that the program might encourage. If so, build in
for failing to act ethically; in other words, if they had
behavioral expectations that will make it clear how the
defined specific behavior criteria that described how
results should be achieved.
the mechanics should achieve their results.
Push toward a performance culture. This means getting
For example, one behavioral criterion might be, “deter-
acceptance for a rigorous process of setting meaningful
mine if brakes are likely to be a hazard or fail before the
performance expectations — both results and behaviors
next service interval before recommending replace-
— and for holding people accountable for meeting these
ment.” Obviously, Sears would have had to enforce this
expectations.
by inspecting the brake parts coming off customers’ cars
to ensure they were worn, but it would have prevented Ensure that pay, especially for executives, is reasonable
the precipitous drop in customer confidence and loss of from a competitive perspective. Use a process for testing
business that resulted from the unethical behavior reasonableness that is rigorous and transparent. Present
encouraged by the incentive program. information to the board of directors in an easy-to-under-
stand fashion and ensure it is complete, so the board
Building ethical standards into an incentive program isn’t
can make informed decisions.
the only way to link ethical behavior and rewards. Here
are other ways smart companies can forge the link: As performance and rewards professionals, we have an
important role to play in ensuring that company employ-
Incorporate both the what and the how into perform-
ees demonstrate high ethical standards, and that role is
ance expectations. Results are the what. Ethics and other
as important as that of the “official” ethical watchdogs:
values, such as teamwork and open communication, are
general counsel and the compliance officer. We have
the how. Make achievement of results and demonstra-
an opportunity to go beyond reinforcing compliance.
tion of values equal considerations in determining
Well-articulated, well-structured programs can enlighten
the size of merit salary increases. This is becoming
and encourage a higher standard of ethics and values.
increasingly common, too. Of the clients we have
worked with to design performance management pro-
grams, 70 percent incorporate ethical behavior/integri-
ty into performance expectations.