Finding the Right Balance: Sales Incentives and Internal Controls
When you look at the core of several major financial scandals, it is easy to point to problems with sales incentives and corporate culture. A company can rapidly grow due to the extraordinary performance of a company’s sales culture. In many cases, this sales culture creates real and significant risks for misconduct.
To address such potential for misconduct, companies rely on internal controls to constrain improper sales conduct, especially when it comes to financial reporting, foreign bribery, fraud and other illegal schemes. The problem is that internal controls often are insufficient to counter the powerful incentives for sales programs to reward individual actors.
The poster-child in this case is Wells Fargo (of course) – a stark example of how sales “incentives” or mandates from top management pushed down to sales staff who were required to meet an 8 to 1 requirement: for each existing customer, sales was required to sign up each customer to at least 8 accounts (that is credit card, CD and other products).
In response to this draconian and inflexible program, no one was surprised when misconduct and fraud resulted. Sales staff was punished and retaliated against when they failed to meet sales targets.
Wells Fargo had controls in place – they had a hotline, compliance staff, internal audit and other basic systems. Unfortunately, as the record demonstrated, all of these elements were overwhelmed. Whistleblowers who complained about the system were fired and no one in management ever raised serious concerns about the program and its inevitable result.
Wells Fargo is an extreme case but there is an important point. Sales incentives are important to a company and help to ensure effective performance of sales staff. But such incentives and conduct has to be subject to appropriate financial controls.
To this end, financial controls have to ensure that reported and booked sales are in fact real transactions. The potential for misconduct rises significantly when sales incentives are structured around reporting quarters. Sales staff can face pressure to record sales by the end of the quarter or the year to match a reporting period. In these cases, sales staff have an incentive to close deals, report them in order to meet a target amount.
When sales incentives programs are not contained by appropriate controls, the risk of misconduct rises significantly. Sales staff may “game” the system to earn immediate rewards and even worse seek to meet sales targets by fraud.
Financial controls have to be built in a way to reduce these risks. For example, individual bonuses for meeting sales targets should only be paid when money from a sale is actually collected and approval of any sales contract should be scrutinized by supervisors to ensure that it is real and accurate.
In the end, a system of financial controls surrounding sales activities has to be built on reasonable assurances and ultimately , accountability. Sales staff that operate without financial controls are more likely to engage in fraud. Such incentives are exacerbated when the corporate leadership and culture are predicated on a company’s revenue performance. A narrowly-focused definition of success built solely on sales performance is a recipe for disaster. In the end, companies can only succeed when they find the right balance between sales incentives, accountability and financial controls.