Your employees would never do something illegal just to keep their job, would they? Attorney Hanna Hasl-Kelchner says the right incentives are pivotal to good legal risk management.

Meet Betty Vinson. In 1996, she began a midlevel accounting job at a small long-distance telephone company. As her company grew during the early days of the telecom boom, so too did Vinson’s job duties. She was eventually promoted to senior manager, responsible for compiling quarterly reports. By all accounts, the company was doing well, but one day she was asked to make some questionable accounting entries, the kind that would generate false profit.

Outraged, she initially refused to cooperate and even threatened to quit. But the reality of a family dependent on her income, insurance benefits, and the prospect of being a middle-aged job seeker made her reconsider. Finding another job would be difficult. Being unemployed would create family hardship. But staying would mean compromising her principles. How could she do that? She was teetering on an ethical tightrope.

When the company’s CFO assured her that nothing was illegal, that sales would catch up in the next quarter and the entries would be offset, Vinson saw her way clear. The assurances muzzled her fears. It was to be a one-time event. That one-time event, however, was the first step down the proverbial slippery slope resulting in illegal entries totaling more than $3.7 billion and forcing Vinson’s employer, WorldCom, to fall off its Wall Street pedestal amid serious criminal allegations.

Betty Vinson knew the accounting entries she made were wrong, but she did it anyway. Why? She justified her decision as helping the company and protecting her family, and she was not alone. The conspiracy of silence was such an entrenched part of the corporate culture that employees who knew about the accounting shenanigans were afraid to speak up for fear of not being perceived as “team players.” They even resisted the efforts of the colleagues who ultimately blew the whistle.

Stand in their shoes
It’s easy to be judgmental about the failure of employees to step forward and report legal problems. After all, reporting fraud or other compliance issues is the “right” thing to do. Indeed, no legitimate business would openly encourage its employees to break the law. Most companies have mission statements or corporate principles that extol the virtues of ethical behavior.

Yet outsiders who make such judgments do so from the safety of their reading chair. Standing in the employees’ shoes, the view is much different—the fear of losing a job or displeasing a supervisor is a negative incentive that can drive risky behavior and negatively impact a company’s legal risk profile.

The power of incentives and how they are created is important to note because if negative incentives can push good people to suspend their judgment and engage in criminal acts, how likely is it for such pressures to cause employees to engage in lesser infractions where lesser corporate liabilities are at stake? Exactly: it’s very easy. That is why incentives are pivotal to good legal risk management.

Business leaders must be careful about the messages they send. Unfortunately, they are often unaware of the incentives created by organizational politics and how they can have a chilling effect on the amount of information available to the organization, which affects how much unwanted risk gets assumed.

Lessons from a final exam
“Negotiate a fair deal,” I told my MBA students as I handed out their final exam, a mergers and acquisitions case study simulation. “That’s your assignment.”

The class was divided into transaction teams and given a fact pattern that included an unfolding due diligence process. Some of the new information was accurate and relevant; some was not. Some of it was communicated to everyone, and some of it was not. Would the team openly share information, or would individuals hoard it? What kind of corporate culture would they embrace in their negotiations? How would it impact the amount of legal risk each team was willing to take?

On the last day of class, the teams reported their results. The overwhelming majority reached what they thought was a fair deal. Less than 5% of the transactions resulted in gridlock due to irreconcilable differences.
When I asked how many students would have walked away from the deal if their own money were on the table, an amazing 95% of the hands flew into the air. “If we found this many problems now,” one student volunteered, “there’ll only be more later.”

“Okay—then why would you spend the company’s money when you know it’s a bad deal?” I asked. “Why accept these liabilities?”

“It was expected,” most of them said. “It’s what you told us to do.” Well, not exactly. But it is how they interpreted my instruction. Their incentive: passing the course and graduating. Self-interest and the desire to please trumped doing the right thing.

What the students didn’t know at the time was that the simulation was cobbled together from various real deals, including some deals that weren’t consummated due to unacceptable legal risks. It was literally a combination of the best of the worst.

But even with the facts stacked against a good deal, very few were willing to stand up and say it wasn’t good at any price when wearing their team hats. The prevailing thinking was that the right discount would compensate for the risk, even though in their hearts they knew that some actions shouldn’t be taken at any cost.

Companies benefit from the intellectual horsepower of their organization when employees are allowed to risk displeasing their boss and challenge the status quo. Such loyal opposition facilitates legal risk management, letting companies identify problems and fix them while they are still small and relatively inexpensive.

Leaders must therefore be aware of what incentives they may be creating and whether those incentives are driving behaviors that are consistent with the organization’s core values. They should strive to never let the risk of retribution outweigh the value of open and honest communication.

Hanna Hasl-Kelchner is the author of The Business Guide to Legal Literacy: What Every Manager Should Know About the Law (Jossey-Bass, 2006) and a frequent speaker on business legal issues. Visit her Legal Literacy blog at www.legalliteracy.com.