Corporate executives must be held accountable

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Photo Credit: Caleb Kuntz | Daily Texan Staff

Federal authorities began investigating Wells Fargo this September for its unauthorized opening of two million accounts for customers. During a Senate hearing, CEO John Stumpf was revealed to have urged employees to open eight accounts per customer in order to boost company value, raising in effect not only the value of Wells Fargo stock but his own holdings as well.

Recent Nobel economics laureates, professors Oliver Hart and Bengt Holmstrom, provide us insight into why cases like Wells Fargo’s are so problematic. Awarded for their work on contract theory, the study of how two parties construct and develop legal agreements, Holmstrom and Hart have researched the growing dangers of “pay-for-performance” contracts with executives, where short-term outcomes are overly incentivized. This is apparent in Wells Fargo’s case: the incentive to show good quarterly numbers and raise shareholder value motivated Stumpf’s push for impractical sales quotas.

Holmstrom criticizes such motivation by arguing that linking manager performance with stock prices causes an individual to be rewarded for good luck and punished for bad. 

Since certain factors of stock prices are out of managers’ control, Holmstrom said this can incentivize “shortsighted” and “at times illegal managerial behavior.” He cited Enron as an example, where executives reported fraudulent numbers that inflated the energy company’s stock value. In an interview with Open Markets, Holmstrom said that the lesson we learn from Enron is to avoid awarding executives too quickly when the company shows growth. 

UT management Senior Lecturer Kristie Loescher, who studies organizational ethics, adds that the Enron case embodies a common defect in companies where the focus on producing good numbers overshadows how they were made.

“If all you focus on is [the] outcome and you don’t have any measurement or any focus on the process, these kinds of problems happen,” Loescher said.

In the case for Wells Fargo, Loescher argued that the practice of opening illegal accounts proliferated when management still rewarded employees for duplicitous sales.

“Once you have somebody do bad things and get rewarded for it,” Loescher said, “it spreads.”

And indeed it does. Over 5,300 accused Wells Fargo employees were laid off, while Stumpf dubiously cashed out $65.4 million from stock sales months before the Feds investigated. He would be hard-pressed to defend this as he sold 10 times more stocks than he did last year.

The solution to our problematic system of executive compensation is to prioritize long-term growth. In practice, this means that companies should withhold rewards for short-term fluctuations and scrutinize how they influence such outcomes.

Holmstrom noted that when the numbers look good, “investors and the board are likely to be less critical.” 

Loescher pointed out that if companies want to be successful in the long run, they must emphasize the importance of an ethical process as much as the outcome and pay attention to long-term goals rather than a bad quarter. An example she provided is the SAS Institute, a privately-held North Carolina software company worth billions that has no record of layoffs. 

After 2008, we are sick and tired of corporate misbehavior. If companies listen to Holmstrom’s research, learn from our history of crooked business practices and reform accordingly, we may be afforded some relief that Wells Fargo’s catastrophe will become a rarity. However, at this time, this does not seem to be the case.

Zhao is a history and corporate communications junior from Shanghai, China. Follow him on Twitter @_AlbertZhao.