Profit-based incentives go under the microscope

  • By Andrew Starke

Professional body FINSIA on Thursday released new research findings into risk culture across the financial services sector, based on a Macquarie University experimental study.

The aim was to design and conduct an experimental study to demonstrate that financial services corporate culture experiments could be meaningfully conducted in a lab environment.

“The results of this new experimental research into risk culture, conducted with over 300 financial services executives - all members of FINSIA - sheds light on the compliance behaviour of financial professionals,” said associate professor Elizabeth Sheedy.

“It reveals the impact of incentives and how signals from managers and co-workers affect organisational culture. The key finding of the study is that profit-based incentives have an adverse impact on compliance.

“When staff incentives are linked to profits, rates of compliance with risk management policies fall.  The effect is felt via risk culture.”

Chris Whitehead, CEO of FINSIA said the experimental study revealed the relationship between risk culture, incentives and the behaviour of financial services staff.  

“We knew this research was very timely given current community concerns and falling trust in the sector,” he said. “The research is also very valuable to the financial services sector as it can be used to investigate further how risk culture may be improved in financial institutions.”

Whitehead added that the key results of the study supported the careful consideration of profit-based incentives currently being debated within the financial services industry and as reviewed recently in the Sedgewick report released by the Australian Bankers Association.

“In FINSIA’s view this type of research points to the need for professionalism in financial services. Incentives need to be balanced and individuals also need demonstrated competency, a clear and enforced code of conduct and an ethical culture,” he said.
 

Compliance behaviour

As Sheedy explained, the aim was to design and conduct an experimental study to demonstrate that ‘culture’ experiments can be meaningfully conducted in a lab environment. The study validated the view that risk culture is an important determinant of compliance behaviour effected by incentives and the behaviour of managers and co-workers.  

“To ensure it was based on real life scenarios, the participants had to do some simple analysis (with a calculator) and then decide whether to invest. During the one-hour lab session, they could invest in up to 60 transactions. The experiment also reflected the industry context where the participants were given a risk policy/limit to follow,” she said.

Key findings included:

  • When the burden of calculations on participants were reduced an increase in compliance with risk policy was noticed. This is probably because people are less able to resist the temptation to breach policy when they are tired. This suggests that to increase risk compliance it is important for the industry to take better account of cognitive load — i.e. to automate analysis where possible and design work patterns in such a way that staff are not unduly depleted when making crucial decisions.
  • Personal attitudes to risk management/compliance are a significant determinant of compliance behaviour. This finding has implications for the screening of job candidates, such as considering candidates’ attitudes towards risk management in recruitment/promotion decisions.
  • Workers from the superannuation sector were less likely than others in financial services to comply with risk policy. This finding should be treated with caution due to the small sample (10 per cent of sample) but it warrants further investigation. If confirmed, it may mean that additional work is needed to improve risk culture in this sector.