Posted: January 31st, 2022

Commission salespeople are paid their commission after they write successful

Commission salespeople are paid their commission after they write successful insurance policies or consummate the sale of financial products.
The Ethics of AIG’s Commission Sales

The advantage of commission sales is that if the salesperson puts in effort and makes a sale, then both the company and the salesperson benefit. The salesperson receives a commission, and the company receives the proceeds of the sale, net of the commission. Referred to as a first-best contract, its purpose is to align the interests of both the company and its sales force. In addition, companies often reward their leading salespeople with expensive trips and holidays. They are considered thank-you gifts for generating so much revenue for the company. But commissions and holidays can be problematic. Consider the case of AIG. American International Group, Inc. (AIG) was among the five largest financial companies in the world.1 A diversified company, its primary business was selling both personal and corporate insurance, but it was also involved in businesses, such as lease financing, real estate, and selling financial products. With respect to insurance, AIG did not have agents but, rather, sold insurance through independent brokers. In this way, AIG had to pay a commission only if the broker was successful at selling one of AIG’s products. If the independent broker was unsuccessful at making a sale, then there was no cost to AIG. Only successful sales were rewarded with a commission. In 1987, the company formed a subsidiary, AIG Financial Products Corp., to sell a variety of financial products, including credit default swap (CDS) contracts. These products were designed to protect investors against defaults on fixed-income investments.2 This business flourished under the leadership of Joe Cassano. At one point, it had sold protection on $441 billion of assetbacked securities, including $57.8 billion that were related to subprime mortgages.3 Cassano and his team were paid a commission of 30% on every dollar of business generated. As the market for these CDSs increased, the sales staff received more and more commissions. In the eight-year period from 2000, Cassano was paid $280 million.4 In 2007, the subprime mortgage market turned as the housing crisis in the United States deepened. As a result, losses in the Financial Products subsidiary on CDSs began to increase. In February 2008, AIG said that the swaps lost $4.8 billion in October and November 2007. By the end of February, the losses had reached $11 billion, and Cassano was replaced as CEO of the division. He collected his bonuses of $34 million and was then hired back as a consultant at $1 million per month to oversee winding down the CDS business.5 But the losses generated by Financial Products kept increasing. On September 16, AIG reported losses of $13.2 billion for the first six months of 2008. That same day, the government announced that it was prepared to pay $85 billion to bail out the company. Meanwhile, at the beginning of October, as the company was being supported by the government to forestall bankruptcy, AIG paid $444,000 for a California holiday for its senior sales personnel. Although relatively small, the optics of this was questionable. The cost of their weeklong retreat at the St. Regis Resort, a luxury resort and spa, was $200,000 for rooms, $150,000 for meals, $23,000 in the spa, $7,000 in greens fees, $1,400 in the salon, and $10,000 in the bar.6 Congressional leaders were appalled. “This is unbridled greed. It’s an insensitivity to how people are spending our dollars,” said Congressman Mark Souder. “They’re getting pedicures and their manicures and the American people are paying for that,” said Congressman Elijah Cummings.7 When asked why Cassano, who had been responsible for the losses incurred by the Financial Products subsidiary, had been hired back as a consultant after he had been fired, Martin Sullivan, the former CEO of AIG, said, “I wanted to retain the twenty-year knowledge of the transactions.”8

Questions

1. Commission salespeople are paid their commission after they write successful insurance policies or consummate the sale of financial products. Should their commissions be recovered if the company subsequently suffers a loss as a result of the business written by the sales staff? Should there be an upper limit placed on commissions so that no one employee receives $280 million in commissions over an eight-year period? How could such an upper limit be selected if a company wished to establish one?

2. Is it right that perks such as holidays at luxury resorts are provided only to senior executives and the sales staff but not to the other employees of the firm?

3. Should senior officers who have extensive firm-specific knowledge be hired back as consultants to help rectify their mistakes?

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Commission salespeople are compensated after successfully writing insurance policies or selling financial products.
The Ethical Implications of AIG’s Commission Sales

The benefit of commission sales is that if the salesman works hard and closes a deal, both the company and the salesperson gain. The salesman is paid a commission, and the company receives the net proceeds of the sale. The goal of a first-best contract is to align the interests of the firm and its sales team. Furthermore, firms frequently reward their top salespeople with extravagant trips and vacations. They are thought of as thank-you gifts for bringing in so much money for the corporation. However, commissions and holidays can be a problem. Consider the following scenario:

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