Wells Fargo's scandal is a cautionary tale about incentive pay
One remarkable aspect of this story is that the abusive practices were often unprofitable for the bank, where I worked from 2005 to 2009. As the New York Times describes:
In many cases, customers took notice only when they received a letter in the mail congratulating them on opening a new account.
Many of the questionable accounts were created by moving a small amount of money from the customer's current account to open the new one.
Shortly after opening the sham account, the bank employee closed it down and moved the money back, according to regulators.
But Wells employees were still most likely able to get credit for opening new accounts in meeting their sales goals, the regulators said.
Opening and closing unauthorized accounts like this is illegal and annoying for customers, and it doesn't do anything to make money for Wells Fargo.
When they're done properly, account openings drive profitability because they create deeper, stickier customer relationships that will generate revenue far into the future. That's not true of small accounts that are opened using money already on deposit and then quickly closed.
One account-opening scheme described by the Los Angeles Times even sounds like it caused the bank to collect less in money-transfer fees than it would have without shenanigans:
Estrada said employees would open premium checking accounts for Latino immigrants, enabling them to send money across the border at no charge. Those accounts could be opened with just $50, but customers were supposed to have at least $25,000 on deposit at Wells Fargo within three months or pay a $30 monthly charge.
To get around those requirements - and keep earning credit toward their quotas - Estrada said employees would downgrade the original accounts and open new premium ones for the customers before the fees kicked in.
So why did so many employees do things like this? Because they were evaluated and paid based on how many new accounts they opened.
When you pay people to do something measurable (like open accounts) they do more of it - and not necessarily in a way that actually increases the underlying figure (profit) that you wanted to raise.
This is similar to "teaching to the test." Absent consequences, test scores are an excellent measure of underlying educational achievement. But when you make the stakes around a test very high for teachers, they adjust their educational methods to focus on improving test scores, whether or not those shifts actually make students better-educated overall. And in some cases, the teachers will cheat.
I'm not saying incentive comp is useless - indeed, I suspect a reason Wells Fargo failed to clamp down on these practices for so long is that the high pressure to cross-sell that spawned these scams was also quite effective at motivating employees to sell real, profitable products to willing customers.
But it's a reminder that paying for performance is difficult, and when you do it you need to carefully monitor whether your compensation program is inducing employees to break the law, and/or to run up the compensated metrics without generating profits.