Performance Management & Incentives in the Era of Sarbanes-oxley

In the wake of Enron, WorldCom and other corporate governance and accounting scandals, federal legislators in 2002 enacted the Sarbanes-Oxley Act (SOX), which was designed to improve the accountability of corporate managers to shareholders and to improve public confidence in publicly traded companies.

While most of its provisions do not directly apply to the use of incentive programs, SOX is giving corporations new reasons to apply even more rigorous research-based standards and professional practices to the design of their employee recognition awards and incentive programs.

Introduction to the Sarbanes-Oxley Act

The SOX legislation applies to publicly traded firms with a minimum market capitalization of $75 million. The act’s purpose is to raise the standard of corporate governance and financial disclosure. Specifically, it establishes accounting oversight for corporate boards and managers, limits the type of work that accounting firms can do for their clients, bans corporate loans to executives, expands protection for corporate whistleblowers and, most importantly, requires more accurate and more detailed financial reporting.

SOX requires companies to create and maintain internal controls and processes for financial reporting, provide for full disclosure on any material changes in their financial condition or operations, set up procedures for detecting fraud and ensure that their financial records are complete and up-to-date.

While the Sarbanes-Oxley Act does not address incentive plans directly and does not legally apply to private companies, there is an impact as companies in general seek to improve their ethical, recordkeeping and accounting practices to increase the transparency of all expenditures throughout their organizations. Many companies are looking for more precise and accurate tracking and justification of all of their marketing efforts, including incentive programs, in order to provide a better rationale for business development and any expenditures related to compensation, rewards or recognition. This may help explain why the use of professional incentive companies for program planning purposes has almost doubled in the last two years, according to a recent study by the Incentive Federation (www.incentivecentral.org).

Greater Scrutiny of All Compensation-Related Practices

SOX controls give companies, their officers and their managers additional reasons to be more stringent in their maintenance of financial records - including incentives and recognition programs. If a current incentive plan is not well defined and awards are distributed without tracking, these programs could face elimination or other repercussions arising from internal or external audits.

It will take time to clarify many of SOX’s new requirements and definitions, some of which are still somewhat broad and uncertain. But in the meantime, enforcement agencies like the Securities and Exchange Commission, NASD and state attorneys general seem to be applying the broadest possible definitions and using the law as a springboard for investigation and legal action in some industries targeting compensation-related practices and other payment arrangements. Some of these actions do not specifically relate to SOX statutes but help contribute to an atmosphere of greater scrutiny of all compensation-related practices. The financial services and insurance industries have been particular targets of some of these investigations. This new scrutiny gives corporations very good reasons to use incentive and recognition programs that meet professionally recognized standards based on research.

How SOX Affects Incentive and Recognition Programs

The SOX legislation does not mean that incentive programs are likely to become line items on corporate financial reports, but that companies subject to SOX are likely to become more demanding about justifiability, recordkeeping and reporting throughout their organizations, especially as it pertains to undisclosed incentive payment in the form of cash or noncash awards.

Corporate executives who are signing off on a company’s financials are more interested in the details of what they’re signing, and these companies are looking for more detailed documentation from their suppliers, including incentive program suppliers. Corporate executives are more reluctant to sign off on incentive programs unless they can be assured of a clear business purpose and benefit, as well as detailed and accurate records.

At the very least, with these tighter financial reporting requirements, public companies will be looking for more detailed reporting and “transparency” in their incentive programs of all types.

SOX doesn’t mean the end of motivational or relationship-building events, but a new emphasis on their underlying business purpose. Because properly designed incentive programs can have a clearly demonstrated ROI, all SOX does, in effect, is obligate public companies to take these programs more seriously.

That means designing programs based on measurable best practices. A lavish event can land an executive in jail if used to circumvent accounting practices, or be part of a formal strategy that helped earn him or her a bonus for achieving a double-digit sales increase and near-perfect customer satisfaction scores. By running formal programs with well-documented performance improvement benefits, organizations in every industry can clearly distinguish their results-based motivational and rewards and recognition efforts from ad hoc entertainment or payments that distort financial reporting.

SOX, in fact, has created an additional need for incentive and recognition programs to help draw organizational attention to new corporate standards of reporting. Many of the organizations most affected by the new statute have enormous employee audiences with whom the same marketing and promotional practices used for consumers come into play. These include incentive and recognition programs that single out behaviors that support corporate values.

Proper program design and documentation can justify almost any noncash or motivational event with clear, research-based benefits, based on the dozens of research studies showing that such programs - those that fairly and equally recognize and reward people for the right actions and outcomes - have a significant impact on the bottom line and shareholder return.

About Dittman Incentive Marketing

This article was provided by Dittman Incentive Marketing (http://www.dittmanincentives.com), a quality leader in the field of people performance improvement. Since 1976, Dittman has helped companies achieve critical corporate goals via original, one-of-a-kind sales team motivation programs that inspire a sales force to sell more, customers to buy more, and others to do more.