Pressure for Profits : Tough Goals Put a Strain on Honesty

Harold L. Casale always seemed more likely to end up before a Chamber of Commerce testimonial dinner than a federal prosecutor.

A one-time assembly-line worker, Casale had sweated his way through night school to a degree and had risen to vice president of AEL Industries, a Philadelphia area defense contractor. Everyone at work thought him kind and conscientious; one Pentagon official was impressed by his “honest good deeds,” such as the time he saved the government money by recommending a less expensive metal tubing.

But Casale was also a man who feared that his bosses would not tolerate failure. They reminded him often of the importance of the bottom line. When he was 34 and a junior manager, Casale had been demoted and his boss fired when their division lost money on a contract.

“It does not require a psychiatrist’s insight to sense the impact of that decision on the defendant,” Casale’s attorney wrote last summer in urging a federal judge to give him a lenient sentence.

Casale spent six months in jail for inflating government labor bills by $1.6 million in a clumsy fraud that cost his employer a $2.66-million fine and stinging public embarrassment.

His case illustrates how generally honest managers are motivated to commit unethical acts when they are under pressure to meet deadlines and make profits. It also points to one of the knottiest problems American business faces: How to avoid such ethical crises by communicating a concern for honesty, and at the same time set performance goals that don’t create such dangerous pressures.

Bank, Contractor Scandals

Many companies are making new efforts to deal with this type of conflict, which recently has ignited a series of headline-making scandals. Pressures to meet lofty performance goals played a key role in the General Electric defense-contract fraud of 1985 and in the money-laundering conviction involving the Bank of New England in Boston.

“When people are under pressure to meet overambitious goals, companies are most vulnerable to unethical behavior,” said Kirk O. Hanson of Stanford University’s graduate business school.

Deregulation of industry and increased foreign competition have made the problem more urgent, for they have caused many companies to set higher goals and seek ways to sharpen competitive skills. Today, more companies are tying pay to performance, for example, as a means of spurring productivity.

Such incentive systems pose the risk that employees will trample other values on their way to a weightier paycheck.

Conveying a sense of ethics may be particularly important in large corporations, where such notions can become blurred in the long distance from the executive suite to the front lines of production. Perhaps the most important audience for these communications are the mid-level managers who direct front-line operations.

Executives at the highest levels succumb to temptation to cut corners, too, of course. Top officials of E. F. Hutton were not prosecuted in the multimillion-dollar check-kiting scheme that came to light last year, but some state regulators and congressmen believe that some of the top brass at the brokerage encouraged the illegal activities.

Yet middle managers face unique ethical pressures. They don’t usually take part in setting corporate goals, but they are given responsibility for seeing that they are met. And if the goals are too high, the middle managers may have to choose between cutting corners and telling their bosses that the objectives can’t be met--and appearing incompetent.

Harold Casale understood that financial performance was an imperative. His Emtech division was responsible for two contracts--a profitable Army radar contract and a money-losing contract to make similar radar equipment for the South Koreans.

Viewpoint of Defendant

“Here’s an up-from-the-ranks guy who’s now head of the division and suddenly running into profit problems,” recalled Gerard C. Egan, a Philadelphia lawyer who prosecuted the case as an assistant U.S. attorney. “He’s seen what had happened to his former boss, and he’s scared.”

Casale’s solution was to direct clerks to change entries on some 26,000 employee time cards between 1977 and 1980, so that the government picked up some of the labor costs for the unprofitable Korean contract. Eventually, Army auditors noticed the pencil erasure marks on the cards, and began an investigation.

AEL’s top management may have needed to clarify another ethical point--that it did not subscribe to the widely held view that soaking the government is a victimless crime. “Casale may have tried to ease his conscience with the thought that the government’s got a pile a money and you can’t hurt them anyway,” Egan said.

In settling the case, AEL agreed to retain a lawyer to act as company ethics director, and to take steps to tighten its accounting procedures. AEL officials refused to comment on the case, as did Casale, whom the company rehired to work on civilian contracts after he was released from prison in April.

Federal prosecutors concluded that Casale’s bosses didn’t know what he had been up to, but such cases often raise questions about just how much superiors knew--and whether they exerted pressure, hoping they would not be told if any unethical act were committed.

Conflict of Demands

Bosses who want to avoid misconduct among their subordinates should not give orders that seem to suggest that ethical breaches are permissible, says James O’Toole, management professor at the University of Southern California.

Too often “the boss will say, ‘I don’t care how you do it--get it done,’ ” O’Toole said. “When they do that, they’re sending the wrong signal, they’re asking for trouble.”

The wrong signal can be sent, too, through the pay-for-performance compensation programs that are rapidly gaining popularity.

A recent survey of 1,100 companies by Sibson & Co., a compensation consultant, showed that 64% of them had some type of pay-for-performance program, compared to about 55% a year earlier. Companies find them valuable for motivating employees as they take on stiffer competition from abroad, enter tough, newly deregulated markets or simply try for maximum earnings to lessen the threat of a takeover, says Jill Kanin-Lovers, a vice president of compensation consultants Towers, Perrin, Forster Crosby.

“These have really become the chic thing,” she said. Yet she acknowledged that companies do not always spend a lot of time thinking about how such plans can tempt employees to take shortcuts in the race to reach sales goals.

Perils of Pay Motive

The perils of pay-for-performance plans and the risks that newly deregulated companies confront can be seen in the recent pattern of abusive sales practices at Pacific Bell’s residential telephone marketing unit.

Since the breakup of the Bell System in 1984, the telephone company has been trying to transform itself from a slow-moving, regulated utility into a keenly competitive company. “We knew we had to develop a new attitude for our new environment,” said Ronald De Principe, the vice president for residential marketing in Southern California.

The Public Utilities Commission found in May that some Pacific Bell sales people, under pressure to achieve maximum profits, had broken state regulations by charging residential customers for “custom” telephone services they had not ordered, and by misleading poor families about the low-priced, basic phone service available to them.

Sales representatives had to reach sales quotas or be sent back for retraining--or, eventually, dismissed. Their bosses, whose pay was determined in part by the employees’ sales performance, knew that their superiors wanted residential telephone service to become a highly profitable part of the company’s business.

Some sales people say that they became demoralized by the need to pitch a relentless hard sell. “We hurt a lot of senior citizens, and we were selling to Koreans, Filipinos and Thais who didn’t understand a lot of what we were saying and would take anything,” a sales rep from the company’s central Los Angeles office said in an interview.

Several sales people, who requested anonymity, said that their bosses never urged them to mislead customers. They noted that Pacific Bell has a set of ethical guidelines, and that until last year, it required employees annually to watch a videotape emphasizing the company’s commitment to honesty.

“They never told us to cheat,” said one salesperson, “but if your boss takes you into his office and says you won’t have a job unless you meet your quota, what are you going to do? I really felt like I had left my integrity at home.”

Pacific Bell’s top marketing officials learned of the abuses last fall. They discontinued the quota and incentive systems and began retraining the sales staff.

Pay-for-performance systems need not erode ethics, the specialists say, as long as a short-term financial result is not the sole criterion for compensation. They say that a well designed plan also measures how well employees live up to the organization’s other values--such as equal opportunity in hiring, harmonious community relations, and teamwork.

While financial performance is easier to judge than these other criteria, “it can be done, if the boss is willing to make the effort,” said Kanin-Lovers.

Some companies look at a division’s long-term financial performance in deciding how much the manager of that division should make, says Kanin-Lovers. “That removes the incentive to do anything that will eventually come back to hurt the organization.”

Last year’s General Electric case illustrates how easily ethical standards can become blurred in large organizations:

The Fairfield, Conn., manufacturer was fined $1.04 million for overcharging the Air Force $800,000 for labor in the building of warhead re-entry vehicles for Minuteman missiles.

GE has long tried to nurture a good reputation, and has set out ethical rules for the behavior of its managers. The middle managers involved in the overcharges were “good people,” said Asst. U.S. Atty. Ewald Zittlau, who prosecuted the GE case.

In pressured situations, however, “a certain kind of corporate mentality develops that makes it easy for people to do these things and sleep at night,” Zittlau said.

Pressure grew as GE slipped a year behind schedule in building equipment that the Air Force said should be deployed immediately for the nation’s security. There was pressure from another source, too: The company was over budget on fixed-price portions of the contract and was losing every additional dollar it spent.

The managers, acting under instructions to cut costs wherever possible, transferred labor costs from fixed-price portions of the contract to other areas. The contract specifically prohibited such maneuvering, said Zittlau, but the managers justified it to themselves with the rationalization that the tasks were related.

Roy Baessler, a former GE manager who given immunity from prosecution for helping the government, told a grand jury he had believed the mischarging was justified because of the “synergy” between the tasks. In his own mind he was innocent, he said.

Zittlau believes there was blame to go around in the case, as in other such cases of misconduct by middle managers. GE had not communicated its concern for ethics, but rather, had created “a climate, an atmosphere” in which it was easy for managers to commit such breaches.

But if the organization bears some responsibility for the misconduct, the managers cannot escape blame. “I don’t think anything the company did could justify their actions,” Zittlau adds.

Stepped-Up Ethics Program

GE tried afterward to shore up its ethical lines of defense. The company appointed a corporate ombudsman to hear complaints of wrongdoing, added sections to its corporate-conduct handbook and stamped time cards with an explicit warning that mischarging is a crime.

Last year’s conviction of the Bank of New England suggests that the bank had not succeeded in communicating its ethical concerns, either: The Boston-based lender was fined a record $1.24 million. The evidence showed that several branch managers were “plainly indifferent” to rules that they must report large cash transactions to the government, said John Markham, the assistant U.S. attorney who prosecuted the case.

He said that the bank’s headquarters had notified branches of the requirements, but they had ignored them, apparently in the belief that filing such reports would alienate customers.

Two other cases, at food processor H. J. Heinz and at a Chevrolet plant in Flint, Mich., are considered classic examples of how ambitious performance goals can lead to dangerous corner-cutting.

Performance goals should be high, management specialists say, to encourage managers and staffs to do their best, but they can be dangerous when they bear no relation to what can be achieved, or when subordinates feel that their bosses simply will not accept failure to meet them.

In the Heinz case, hard-charging young managers in the company’s Heinz USA unit improperly juggled profits so their divisions could log large and steady increases in quarterly earnings--a goal set out by Heinz’s top management, in part to please Wall Street analysts. If the managers met the company’s profit-growth goal in one year, they would “bank” any extra profits until the following year by misdating invoices and paying suppliers in advance.

One manager explained to an investigative committee of the Heinz board of directors that if a division logged profits above the goal, the manager earned no extra points with his boss--in fact, he would be penalized, in effect, with a higher goal for the following year.

The company’s management incentive program also played a part in the scheme, in which Heinz profits were overstated by $8.4 million between 1972 and 1979.

The incentive program determined managers’ pay, and, some believed, their chances for advancement. Falling short of the goal was a “mortal sin,” one manager told the investigating panel.

The committee concluded that the emphasis on regular profit increases and the company’s failure to enforce its own rules of conduct “created an atmosphere that was perceived by some to be an endorsement of a less than satisfactory level of control consciousness.”

Heinz fired its accounting firm and tried to tighten up audit control, but didn’t fire any of the managers, who included some of Heinz’s best and brightest. Heinz didn’t change the incentive program, either.

George C. Greer, administrative vice president of the Pittsburgh-based company, says today that the episode had no substantial effect on company profits, and that the juggling of figures did not greatly increase the compensation any of the young managers received.

“It was the kind of thing young managers do as part of their effort for advancement,” he said, adding that Heinz still believes in setting high goals. “Our corporate achievements come from good goals.”

In the Chevrolet case, three plant superintendents facing a huge backlog of orders for light trucks secretly installed a control box in their office that allowed them to speed up the assembly line surreptitiously.

This enabled the Flint plant to meet its production goals and won praise for its superintendents. But it was a violation of General Motors’ contract with the United Auto Workers, and angry assembly line employees threatened to strike when the device was discovered in 1979.

The UAW said the workers had turned out at least 1,600 additional trucks in the more than 18 months that the box was in use. The superintendents were suspended from their jobs, then transferred to another part of the company.

“It took several years to re-establish the trust of the work force after that,” said Robert W. Truxell, who became manager of the plant in 1981 and now heads General Dynamics Land Systems Division in Detroit.

As the episode suggests, cutting corners can help production and quarterly profits for a while, says USC’s O’Toole, but he adds that it carries the risk of shareholder suits, employee morale problems--and, if the edge-shaving harms product quality, disaffected customers.