Sometimes, contract provisions result in unintended consequences. In Cobras, Mortgages, and Violas: What are Your Contracts and Policies Incentivizing?, I discussed how a contract provision might incentivize (or disincentivize) human behavior. In that article, a music teacher had disincentivized students from switching from violin to viola by giving them poor grades when they couldn’t immediately play the new instrument well. I discussed how modification of the incentives might have changed the result.

Sometimes, policies also can backfire and create unintended consequences. For instance, in 2014, the Maryland legislature responded to university presidents’ concern about student alcohol consumption by outlawing the sale of grain alcohol, which contains 95% or more alcohol. The legislation was lauded for protecting college students from consuming high-proof alcoholic beverages.

Unfortunately, the well-intentioned law had an unintended consequence on the string instrument industry. Matching varnish color when repairing a string instrument is tedious. Plus, the varnish must dry quickly to prevent a gummy effect or damaged varnish if the instrument is bumped. 190-proof grain alcohol is the perfect base for violin varnish.

In Virginia, there is a similar ban on the sale of high-proof alcohol. But there, lawmakers included an exception for use of alcohol in medicine or in industry. Maryland lawmakers did not include a similar exception for industrial use. 

The Maryland law did not make it illegal to own 190-proof alcohol, only to sell it. Therefore, luthiers imported the product from Delaware, the closest state where the high-proof grain alcohol could be sold. Since possession wasn't outlawed, college students likewise could make the same trip to Delaware to purchase the contraband alcohol. And they might start drinking it during the trip back, creating another undesirable consequence of the Maryland law.

Businesses can be victims of unintended consequences from their own policies. This happen due to inadequate research and planning to foresee how these policies will affect the business. Lack of follow through by management also can cause a policy that was sound when made to cause havoc for the business.

This article provides some real-life examples of businesses that experienced unintended consequences. It also discusses what businesses can do to prevent similar experiences.

Real-Life Example: Bonus Plan that Doesn’t Require Continued Employment

Bonus programs are a favorite way to incentivize desired employee behavior, whether it be high quality work, or simply remaining on staff.

Once I represented a business, which I’ll call Company A, that was launching a new subsidiary, which I’ll call Subsidiary A. Company A had two key employees working on that new subsidiary. Company A’s management felt that the project’s success depended on those employees remaining on board and engaged in the project.

Company A’s management didn’t want to pay an immediate retention bonus to keep the key employees engaged. Instead, management wanted to tie the key employees’ bonuses directly to the success of Subsidiary A. Therefore, Company A gave the key employees fully vested stock in Subsidiary A when it launched.

However, Company A failed to consider the consequences of this bonus plan. First the key employees weren’t the only Company A employees involved with Subsidiary A. Company A needed other employees’ skills for a successful launch.

Once these other employees realized only the key employees would reap the benefits of their hard work on Subsidiary A, they had no incentive to work hard on Subsidiary A’s launch. Instead they focused more on other Company A projects where the bonus program was more equitable. As a result, Subsidiary A’s launch was delayed several times.

Second, the key employees who received the bonuses had no incentive to remain with Company A once Subsidiary A launched. As stockholders, they would receive the entire benefits of Subsidiary A’s growth no matter where they were working.

Shortly after Subsidiary A’s launch, Company B approached them both and offered a higher salary.  The employees had no incentive to stay at Company A.  Therefore, they started working for Company B on a program which would compete with Subsidiary A.

When Subsidiary A became profitable, the two former employees quickly sold their stock for a large sum. Adding insult to injury, Company B’s new program, developed by the same two employees, subsequently put Subsidiary A out of business.

Real-Life Example: On-Call Policy

One of my clients occasionally needed to have certain staff on-call on weekends on a voluntary basis. The employer placed no restrictions on what the on-call employees could do during weekends when they were on call.

However, the employer wanted to encourage employees to sign up for on-call duty. Therefore, the employer agreed to pay employees at overtime rates for their time commuting to the office and working on the weekend even if they otherwise would not be entitled to overtime that week. The employer also agreed to reimburse the employees for automobile mileage costs when called into work.

Several months later, the employer noticed its payroll and automobile reimbursements had skyrocketed. The employer had complaints from hourly employees that they didn’t have an opportunity for the lucrative overtime. And customers were complaining they frequently waited hours before their weekend concerns were addressed.

The employer checked its records. It saw that the overtime and automobile reimbursements were going to a single, salaried manager who lived 100 miles away from the office. The manager, who was the highest-paid of the employees in the department, had assigned all on-call duty to himself.

As a manager, he ordinarily wouldn’t have been entitled to overtime. The employer didn’t know that because it hadn’t consulted with an attorney before developing its on-call policy. Therefore, the salaried employee supplemented his already robust salary with overtime pay for a four-hour roundtrip commute along with a hefty mileage allowance for the trip.

The employer hadn't considered what behavior the on-call policy might incentivize. I helped the employer change its on-call policy. First, opportunity for on-call duty was rotated. Also, on-call employees were required to be able to be in the office within 30-minutes after a call. Finally, only hourly employees could receive overtime pay for on-call work.

Real-Life Example: Pepsi Bottle Cap Contest

Unintended consequences also can result from a failure to follow through. In 1993, Pepsi announced a contest in the Philippines. A lucky Pepsi drinker could win a million-peso prize with a bottle cap bearing a to-be-announced number. Pepsi’s contest was a sound marketing idea, but its follow through left much to be desired.

The goal was to increase Pepsi consumption in the Philippines. In that regard, the contest was wildly successful in that regard. People rushed to buy Pepsi so they could collect numbered bottlecaps. 

However, Pepsi did not carefully track what numbers were being printed on bottle caps. After announcing the winning number, Pepsi learned that approximately 800,000 bottlecaps bearing that number had been distributed. Tens of thousands of people came forward to claim a prize.

Pepsi was not able to pay so much in prize money. Eventually, a court excused Pepsi from paying the money.

The contest created negative press and a bitter attitude toward Pepsi among consumers. Pepsi’s failure to follow through caused the opposite consequence Pepsi intended.  

Thinking Ahead and Looking Back

To prevent outcomes like this, companies need both to think ahead and to look back. They need to conduct research and consider all possible outcomes of their decisions. They also need to consider what behavior they might be incentivizing.  Additionally, businesses need to track policies and follow through to assure future developments do not interfere with the desired outcome.

When developing policies, business should consider W-R-I-T, which spells the legal term for a written command (usually by a legal authority):

• What If–Evaluate all possible outcomes of a policy before adopting it. A decision tree (flow chart of outcomes) can be helpful in organizing this process and in determining the likelihood of outcomes. A business may adopt a policy that has possible negative outcomes if their likelihood is low. But that decision should be made intentionally, rather than due to neglect to consider those outcomes.

• Research–Research the area to fill knowledge gaps. The Maryland legislature probably didn’t research non-beverage uses of high-proof grain alcohol. Businesses should research industry standards, local culture, and economic forecasts. Businesses should consult their attorney about legal requirements before making a decision.

• Incentives–Even well-researched policies can fail if the incentive undesirable behavior. Management should put themselves in the shoes of all stakeholders and employees and evaluate how they might be incentivized by the proposed policy. The policy can then be modified to prevent improper incentives.

• Track–Management should maintain policies in a central location so they aren’t forgotten. Management also should regularly evaluate policies for effectiveness. Regular monitoring of the policy also can enable correction of flaws in planning before they cause harm. Pepsi should have known how many winning bottle caps were to be created. And someone should have followed through to verify how many winning bottle caps had been printed before announcing the winning number. 

This series draws from Elizabeth Whitman's background in and passion for classical music to illustrate creative solutions for legal challenges experienced by businesses and real estate investors.