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Pay Policies Can Prevent Employee Theft, Fraud, Studies Show

Wednesday, November 28, 2012

A well-designed compensation program can not only help attract, retain, and motivate employees, but also reduce employee theft and questionable corporate ethics, recent research shows.

A University of Illinois-Harvard Business School study, for example, found that paying slightly higher wages to lower-level retail workers reduced employee theft enough to finance a large part of the raise.

At the other end of the corporate hierarchy, investigators have shown overly generous stock option incentives can encourage senior executives to commit fraud, forcing companies to restate their financial statements to reflect lower real earnings usually resulting in reduced stock prices.

Combating Retail Theft

Paying retail workers marginally better wages makes them less likely to steal from the store, two university professors said in the study, “Can Wages Buy Honesty? The Relationship Between Relative Wages and Employee Theft.”

Although the study focused on convenience store workers, the “takeaways can be applied to other types of retailers, such as restaurants, department and drug stores, and service or consumer product firms,” that employ about 66 percent of all low-wage workers, said Clara Chen, a business professor at the University of Illinois, co-author of the study.

Overall, companies lose about $52 billion a year to employee theft, according to allfoodbusiness.com, a food industry-related blog.

Retail companies in particular lose about $15 billion a year to employee theft, the National Retail Federation said.

About 35 percent of retail employees admit to stealing merchandise or cash from employers, the Illinois-Harvard study found.

Theft occurs most often where workplace monitoring is ineffective and workers are not paid enough to care about losing their job, said Chen, who conducted the research with Tatiana Sandino, a professor at the Harvard Business School.

Paying slightly higher wages can discourage employee theft, the professors said.


 

An extra $1 an hour can help reduce employee theft, with the savings funding part of the raise.

 


With increased wages, employees are less motivated to steal because they want to keep the well-paying job, they said.

The higher-paid workers, who might be grateful for better wage treatment from employers, also tend to police other employees who are inclined to pilfer, the researchers said.

Also, firms that offer relatively higher wages generally attract more honest workers, the study said.

In terms of costs and benefits, Chen and Sandino found that paying an additional $1 an hour reduced employee theft enough to finance 40 percent of the raise.

After taking into consideration indirect benefits such as lower employee turnover, reduced training costs, and a more productive and motivated workforce, the total savings increased to at least 61 percent of the pay increase, the study said.

Executive Stock Options and Fraud

Poorly designed executive pay programs also can have a major influence on corporate integrity and profit, which both compensation and corporate governance professionals should consider, according to research by the nonprofit Ethics Resource Center and the Hay Group consulting firm.

The probability that company managers might commit fraud, for instance, is related to the percentage of their total executive compensation that is stock-based, according to a study by the University of Chicago, University of Michigan, and the University of North Carolina.

An increase by one standard deviation in the proportion of stock-based executive compensation to the industry standard boosts the probability of fraud by about 68 percent, the study said.

A University of Minnesota study not only said the level of stock options held by senior managers influenced the likelihood of fraud happening but also “companies that have a very good year have a propensity for faking numbers the next year” if they are unable to replicate the previous year's stellar performance.

Julie M. Wulf, a professor at the Harvard Business School, said her research showed that companies paying chief financial officers large stock-based bonuses tend to be sued more by federal regulators and investors for reporting miscues than other firms.

Since 40 percent of Securities and Exchange Commission enforcement actions involve questionable revenue recognition, close monitoring of reported fourth-quarter sales and expenses is an effective way to spot suspect financial activity, she said.

Because short-term incentives are linked to annual performance, managers may be tempted to adjust revenue near the end of the fiscal year when they know how close they are to meeting goals, Wulf said. In turn, “we have found that CFOs with a large number of stock options have a tendency to report higher discretionary current accruals and larger excess sales during the fourth quarter in order to make their bonus numbers,” she said.

Employers can curb this temptation to fiddle with financial statements by diluting the CFO's bonus and stock options and increasing their base salaries, Wulf said.

By Larry Reynolds  

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