This past June, Whole Foods (WFM) got in some real hot water for overcharging its customers in New York. To be fair, Whole Foods is overcharging everyone all the time, but in New York they took it to a new level by overstating weight for products — old-school, thumb-on-the-scales sort of chicanery.
So what is it going to cost Whole Foods? The company settled for $500,000. As in 1/82 of their average daily revenue last year. Basically, Whole Foods will have one sort-of bad day because they lied and cheated. It’s indicative of a much bigger problem with our regulatory system. When the cost of your company breaking the law represents 1.2% of one day’s take, that fee’s not exactly creating a reason for you to go out of your way to make sure it doesn’t happen again.
As such, I think it’s time to make the case for why, despite the protestations from many on Wall Street, (much) bigger fines for corporate malfeasance of all varieties are actually good for businesses.
Whole Foods Enriching their Bottom Line can Leave the Rest of us Malnourished
I don’t mean to pick on Whole Foods. This fine, based on the specifics of the case, may actually be pretty reasonable. That $500,000 is probably enough to ensure that Whole Foods ends up losing more money than it made by overcharging. Throw in the pretty drastic PR hit the company took and I think it’s a safe bet that management is taking steps to ensure it doesn’t happen again.
But that belies the broader problem of how we punish corporations, particularly the largest ones, when they do things that ultimately hurt consumers and the economy.
Publicly-traded corporations are engines built to do one thing and one thing only: maximize returns for shareholders. The how and why can vary, but the entire corporate structure is built on this simple goal, be it Whole Foods, Apple (AAPL), or Martha Stewart Living (MSO). Cutting corners or breaking laws to achieve the goal of profitability is the result of the broader system that Whole Foods functions within more than a problem that’s specific to Whole Foods, making it unrealistic to expect that it won’t happen.
Unrealistic, that is, unless there’s a counter-balance to ensure that cutting those corners won’t actually result in better shareholder returns.
Incentives are What Matter
Imagine for a moment a situation wherein Whole Foods is forced to pony up a full week’s worth of revenue for defrauding customers, a little under $300 million based on 2014’s FY figures. Is that excessive? Sure. Does that send a pretty big message to Whole Foods and every other grocery store out there about the consequences of trying to squeeze an extra buck out of a pint of curried chicken salad? You’re damn right it does.
Whole Foods has a clear incentive to cut whatever corners it can to make more money for its shareholders. The only way to prevent this is by aligning incentives. Counting on the effects of bad PR and its requisite loss of business is a part of that, but fines and penalties imposed by government is another important one.
If Whole Foods were facing a $300 million fine for cheating the scales, you can bet that the pressure to ensure it never, ever happens again would begin with C-level executives and trickle right down, molding a culture built on the principle of acting aggressively to prevent wrongdoing. If the disincentive is strong enough, it creates value for shareholders through effective compliance. That won’t eliminate the existence of fraud, but it will certainly minimize it.
Penalizing Bad Behavior Creates Opportunity
Of course, in the world of corporate crime, Whole Food’s overcharging represents pretty small potatoes (or at least, smaller than their label indicates). The same principle, though, applies to the sort of examples of corporate negligence that have much more serious consequences.
What if the fine levied against a company for operating a deep-water oil rig that blows up and destroys the economy and ecology of an entire region was large enough to force even an oil super-major into bankruptcy? Might employees of BP (BP) at every level have been more attuned to stopping the sort of negligence that created the Deep Water Horizon spill? Maybe even attuned enough that they would have prevented it?
It’s pure speculation, but I would have to say the answer is at least a strong “maybe.” Even if that disaster wasn’t preventable, the lesson rippling across the industry would be unmistakable: this is one error that your company cannot afford to make under any circumstance. Make sure your house is in order or it will be foreclosed on.
This would create a lot chaos. You don’t fine a company as big as BP out of existence without some pretty severe consequences. But that chaos would also create opportunity.
The periodic crippling or death of certain major corporations would send shocks through the economy, but the result would be bad actors getting culled from the herd. Their illegal or negligent actions would actually make them less competitive as businesses, ultimately hurting shareholder returns. What’s more, those competitors with an effective compliance culture would be periodically rewarded by the chance to opportunistically snap up the business lost by their more ethically-challenged contemporaries.
In such an example, the biggest incentives would lie with building a responsible corporate culture that emphasizes hard work and innovation . That’s an environment that builds an economy and business culture that’s stronger and more productive over time.
Corporate Leaders Won’t Behave...Unless they have a Reason
In the end, a new approach to our regulatory environment is better for business. That seems counter-intuitive, but it’s simply applying the principles of incentives to corporate behavior. Certainly, balance is necessary, but right-sized regulations can ultimately help large and small players alike.
Public corporations have driven innovation and growth for decades by way of their dogged pursuit of shareholder returns. It’s a system that has created prosperity for wide swaths of the American people. But a government committed to severely punishing ethical lapses isn’t just about getting bad corporations, it’s about helping direct this powerful engine for change in the direction of long-term prosperity. Without the incentive to find shortcuts, the full strength of these corporations could be committed to the sort of business practices that bear the most fruit in the long run.
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