Ethics Series Part 1: Empire Building

One of my favorite moments in sports is when a baseball runner gets caught in a pickle. Trapped between two bases with fielders chasing him down from both sides, the runner’s athletic talents along with his decisiveness are put to the test. Sadly, it usually doesn’t work out well for the runner.

Over the next few weeks I’m going to explore two pickles, or ethical considerations, modern business leaders will likely face in sales organizations. Part one (below) is about empire building and turnover costs. Part two is about incentives and compensation. In part three we’ll discuss solutions. I’ll analyze these issues through an allegory about a hypothetical manager named Tom.

The Situation

Tom Hansen is a territory sales manager at Ethics Corp, a global cloud computing solutions company. Tom supervises eight employees. His team is responsible for securing new accounts and renewing existing accounts for the Northeastern US company territory. His compensation package includes a salary plus bonuses based on his sales performance.

The Mid-Atlantic territory sales manager just left the company, and Tom is considering asking his boss Rob if he can absorb the other unit’s work. “This is a great opportunity for me,” Tom thinks. “Taking on more responsibility improves my worth to the company, my job security, my internal resume, and my chances at bigger bonuses. An aggressive move like this would also impress Rob.”

Absorbing the Mid-Atlantic territory would give Tom the largest revenue generating territory in the company, and, with sixteen direct reports, Tom would have the most employees. “Hm, sixteen employees. I think I can do it.”

The Cost of Tom’s Growth

Tom probably can handle the extra work, but he knows the quality of his work will suffer. He can’t give the same leadership to sixteen employees that he gives to eight. This is the agency cost known as empire building. The agent, Tom, expands his influence motivated by selfish factors like bigger sales-based bonuses, but as work scope increases he provides diminishing value to the company.

In his widely cited paper on agency costs, Michael Jensen predicted that managers grow their responsibility beyond its ideal size, decreasing operating performance and destroying firm value (Jensen, 1986).

In 2006, O.K. Hope found that companies without public disclosures preventing empire building grew sales, but, when market conditions worsened, lost firm value twice as quickly as companies with disclosures that prevented empire building. Hope also found that profit margins decreased as sales volume increased, demonstrating the inefficiency of selfishly motivated expansion (Hope, 2006).

The Cost of Denying Tom

But is there a cost to the company if it denies Tom the opportunity to grow? In a thorough benchmark study Paul Bernthal found the top two factors for Tom’s retention are opportunity for growth or advancement and his relationship with his supervisor. The same study found that over 40% of employees thought there was a moderate to high chance they would leave the organization within a year (Bernthal, 2001).

So what’s the big deal if Tom quits? Can’t Ethics Corp just replace him? Probably, but turnover can cost the organization up to 46% of the employee’s annual salary, according to Bernthal. And those per employee costs add up. For the companies studied, on average, turnover costs totaled $27 million per year.

So what are Tom, his boss Rob, and the company, Ethics Corp, to do? If Tom’s territory grows he provides diminishing returns to Ethics Corp. If the company does not challenge him, or if Tom begins to resent his boss for denying him the opportunity to grow, he could leave the company. It appears they must choose between agency costs or turnover costs.