Citizens United Decreases Governance Effectiveness in Both Government and Business

The challenge with Citizens United vs the Federal Election Commission (Library, 2010) is how to approach it. One can view it through the lens of ethics (Silver, 2014), through which it is a terrible decision. You could examine it from an empirical standpoint and, even given the limited time since it was decided, there’s already sufficient evidence to suggest it is (further) corrupting the electoral process in the United States (Spencer & Wood, 2014). One could also view it from a governance standpoint, examining whether it will increase or decrease the efficacy of boards over their corporations (Coates IV, 2012). Since the narrow definition of the role of the board it to increase corporate value, it is fairly straightforward to measure the effects of Citizen’s United and, according to Coates, it has been surprisingly negative.

The lens through which I want to address Citizens United is that of electoral and governance accountability: Does Citizens United increase or decrease the ability to hold our elected officials and our corporations accountable for their actions? I think, in spite of some commentators claims to the contrary (Bedford, 2010; Meyer, 2012), Citizens United exacerbated the already existing problem of what Monks calls “Drone Corporations,” (Monks, 2013) those in which ownership is too diffuse to apply any power over the Board and, consequently, instilling more power in the managerial class. By giving corporate executives even more unrestrained power to lobby, bribe, hire, and otherwise influence political decision-making, it allows them to continue to tip the scales away from workers and toward themselves, and takes away more of the influence of the electorate and puts it squarely in the hands of deep-pocketed business interests.

First, electoral accountability. Citizens United essentially takes the previous legal fiction of corporate personhood and makes it a both metaphysical and legal fact. The decision gives corporations the power to anonymously spend unlimited amounts of money influencing the electoral process based on the First Amendment’s free speech guarantees. The managerial class has done a very effective job of increasing the amount of money that goes into their pockets and decreasing worker pay over the last 30 years (McCall & Percheski, 2010). Through their destruction of/decrease in participation in unions and conducting race-to-the-bottom labor arbitrage, the rich have become richer and the poor, poorer. While money does not determine elections, in competitive, non-incumbency races, campaign contributions have a significant effect on a candidate’s chances of winning (Erikson & Palfrey, 1998) and it buys influence and access. Thus, with corporations having significantly more money than individuals, they will be able to significantly affect elections and elected representatives will feel most accountable to them for their continued support. Thus, Citizens United takes power away from actual people and decreases electoral accountability.

Nearly as concerning is the effect it has on accountability in corporate governance. While the problems of drone boards, interlocking directorates, powerful chairmen and passive/diffused investors, all of which serve to decrease the power of the shareholder and increase the power of the managerial class existed before Citizens United, the decision gives managers increased powers in the halls of government (Monks, 1913). An excellent example of the way this effects governance is through the activity of the Business Roundtable, an organization of CEOs of large (mostly drone) corporations in fighting all “say-on-pay” provisions of the Dodd-Frank act, as toothless and merely advisory as those provisions are. Thus, by giving managers even more power, effective governance becomes ever more difficult. The managerialism that has increased in the U.S. for the past three decades (Locke & Spender, 2011) seems likely to significantly increase as a result of Citizens United. Thus, both corporations and the government move further out of our democratic control.

References
Bedford, K. (2010). Citizens United v. FEC: The Constitutional Right That Big Corporations Should Have But Do Not Want. Harvard Journal of Law & Public Policy, 34(2), p639–661.
Coates IV, J. C. (2012). Corporate Politics, Governance, and Value Before and After Citizens United. Journal of Empirical Legal Studies, 9(4), 657–696. doi:10.1111/j.1740-1461.2012.01265.x
Erikson, R. S., & Palfrey, T. R. (1998). Campaign Spending and Incumbency: An Alternative Simultaneous Equations Approach. The Journal of Politics, 60(02), 355–373. doi:10.2307/2647913
Library, H. O. U. S. S. C. Citizens United v Federal Election Commission (2010).
Locke, R., & Spender, J.-C. (2011). Confronting Managerialism: How the Business Elite and Their Schools Threw Our Lives Out of Balance (Economic Controversies). London: Zed Books.
McCall, L., & Percheski, C. (2010). Income Inequality: New Trends and Research Directions. Annual Review of Sociology, 36(1), 329–347. doi:10.1146/annurev.soc.012809.102541
Meyer, J. M. (2012). The Real Error in Citizens United. Washington and Lee Law Review, 69(4), 2171–2232.
Monks, R. A. G. (2013). Citizens DisUnited: Passive Investors, Drone CEOs, and the Corporate Capture of the American Dream. Miniver Press.
Silver, D. (2014). Business Ethics After Citizens United: A Contractualist Analysis. Journal of Business Ethics, 127(January 2014), 385–397. doi:10.1007/s10551-013-2046-y
Spencer, D., & Wood, A. (2014). Citizens United, States Divided: An Empirical Analysis of Independent Political Spending. Indiana Law Journal, 89(1), 315–372.

Corporate Governance and Behavioural Ethics

There are two ideas that underlie most theories about corporate governance, and those reflect the assumptions of the classical economic theory of homo economicus, or economic man (or, more politically correctly, economic person). Economic man encapsulates two assumptions about human behaviour, i.e., that human beings always act in ways that are both rational and self-interested. While these assumptions are the bedrock of most classical and liberal economics, they have only recently begun to be tested empirically in the fields of behavioral economics and behavioral ethics. As I wrote in my 2011 article in Compliance and Ethics Professional, the empirical examination of rational self-interest has exposed some substantial faults in these assumptions. What has not yet happened, as far as I can see, is for these insights about human behaviour to be propogated to the study of corporate governance.

There are two primary theories of corporate governance, the shareholder/agency theory and the stakeholder theory. Each makes different moral assumptions about the purpose of the corporation and the ethical and practical responsibilities of the senior-most decision makers in the corporate structure, the board of directors. The agency theory is more representative of the Friedmanite view that the sole responsibility of the corporation is to maximise legal returns to shareholders. Stakeholder theory holds that society gives the corporation its license to operate and therefore there are other groups, or stakeholders, to whom are owed consideration in addition to shareholders. Examples of these stakeholders are customers, workers, suppliers, communities, and society at large as representative of common/societal goods, such as the environment.

What both both these theories have in common, however, is that they both view the actors within the corporate system as self-interested and rational. In fact, agency theory is a direct expression of the assumption of selfishness. It suggests that because management and ownership are separated, the agent (the manager) will be motivated to behave in his or her best interest, not in the best interest of the principle (the shareholders/owners). Without the assumption of selfishness, the principle/agent problem disappears (or is at least diluted). This in turn calls into question many of the incentives used to align shareholder interests with those of the management (stock options, restricted stock, and contingent bonus plans). Much of the research done into employee motivation suggests that, beyond a certain minimal level, compensation is one of the least effective motivators of employee performance. This thus provides an ex post facto indictment of the belief in the centrality of selfishness for corporate governance.

While stakeholder theory demotes the importance of self-consideration, it places a greater emphasis on rationality. In fact, it requires an assumption quite the reverse of selfishness, in that assumes that managers and/or corporate boards can place their own self-interest in abeyance and, without bias, consider the interest of other actors. Prominent researchers (Kahneman, Tenbrunesel, Messick) have empirically demonstrated several varieties of self-interested decision-making bias. Perhaps even more consequentially, these biases are usually unconscious and/or self-deceptive, so the decision-maker doesn’t know he or she acting in a self-interested way, even when the entire project of stakeholder consideration is to combat narrow self-interest.

The practical implication of the outdated assumptions of both agency and stakeholder theories is that there can be a substantial mismatch between the intentions of corporate board, the decisions that boards make, and subsequent behaviour of management. At the very least, new systems of remuneration and incentives need to be developed to align corporate direction with management activity. Additionally, when incorporating a stakeholder approach to corporate governance, it is important to verify the interests of other stakeholders with those stakeholders themselves as self-interest biases can yield incorrect assessments in this regard. There are considerable opportunities in both academic and practitioner realms for the development of new, comprehensive theories of corporate governance and practical frameworks to control for bias and diverse motivations.

My Philosophy regarding Business Ethics, the short version

I’ve left this for posteriority. My views have changed substantially since I wrote this nearly a decade ago. If you must read it, please do so with generosity.

The Essential Challenge of Ethical Business

Being ethical in today’s world isn’t easy. There are a host of systemic, structural, political, and cognitive factors in the business context that make discerning the right thing to do and then acting on it more challenging than ever before. Despite this, another set of developments has created a world where acting ethically in all areas of business is perhaps the most imperative driver of business success. Business ethics has undergone a change from regulatory requirement or inconvenient distraction to a necessity for the global marketplace and source of competitive advantage.

We humans are meaning-making beings. More than reason, the ability to use tools, or the ability to create complex social systems, what sets us apart from other species is the ability to ask ourselves “why?” and consider the answer important. Philosophers from Aristotle in the 4^th century BC to 20^th century philosophers like Paul Tillich and Jean-Paul Sartre have pointed out that it is the ability, in fact the indispensability, of answering questions of existential import that defines humanity. Our responses to the questions of “why” and “how” go a long way to defining who we are. How we spend our lives, whom we choose to love and why, and what we find ourselves called to do in our careers are the central questions of value that make us who we are.

Paradoxically, the economic system we live under has no such values. Capitalism, in its pure form, is amoral. Although many libertarians argue that there is an implicit moral code to capitalism, it is inchoate and partial at best. Whereas we human beings choose what we will do based a variety of existential and practical factors, capital responds only to cash flows. Notwithstanding recent trends toward socially responsible investing, the vast majority of investment decisions are made not in terms of what makes the world a better place but strictly on the basis of risk-adjusted net present value. Milton Friedman, in his famous 1970 New York Times Magazine article, argued that the only responsibility of a firm is to increase profits and to consider any social impacts was in fact unethical.

Beyond lacking a moral compass, there are several factors within modern market-oriented capitalism that actually militate against ethical and socially responsible decision-making. Friedman felt that as long as something was legal, it was permissible. However, the structure of western democracies allow large corporations a voice in making the laws, thereby encouraging all sorts of externalities and, in some cases, outright fraud. The recent “Citizens United” decision by the U.S. Supreme Court has given corporations an even greater role in governmental policy, and the quarterly reporting structure of the capital markets encourages short-term thinking without consideration for the long-term impacts of meeting each period’s earnings estimates.

Beyond these structural and political factors, there are also cognitive and social factors that make consistently good ethical decision-making challenging. Recent academic and popular works by authors Dan Ariely, Max Bazerman, Zoe Chance, and Francesca Gino (among others) have focused on the ways our minds and our social situations influence our ethical decision-making, usually without our even knowing it. A successor to behavioural economics, this nascent field of “behavioural business ethics” was the sole topic of the most recent British Journal of Management, one of the most respected academic journals in study of business. What Ariely, et al, have done is shown how even people with the best intentions and motivations can be led astray in their decision-making by mental blind spots and distortions like anchoring, overestimating the ethical behaviour of both ourselves and those in our social group, and underestimating the creative and technical contributions of others. Whereas ethical behaviour has historically been considered a simple issue of character and will, these scholars have shown it to be the result of a complex interplay of factors that make context and corporate culture almost as important as moral fibre.

The New World of Consumer and Employee Power

Even if the combination of the amorality of capitalism, the systemic challenges of capital-driven corporate performance, and the emerging understanding of the complexity of ethical decision-making were the totality of why principled business performance was important, it would still be one of the most important aspects of business one could study and, hopefully, effect. These factors are, however, only half the story. In spite of all these challenges to effective ethical decision-making, a series of cultural, social, and technological innovations in recent past have elevated the significance of business ethics to what should be the highest place among the concerns of management.

Corporations were previously able to craft their image to control information and perceptions of themselves and used command-and-control, hierarchical governance structures to insure employee performance. These methods no longer function. Customers and employees now demand that the firms they buy from and work for are in alignment with their values and the ways they make meaning in their lives. Even though many of the factors discussed in the first section traced from the dawn of industrial capitalism, both employees and consumers couldn’t do (and, in many cases, didn’t want to do) anything to change them. There was a dearth of information about the ways companies did business and what information was available was carefully managed. Companies had extensive marketing operations that were aimed at instilling a specific set of ideas, associations, and feelings about the firms. Very little was left to chance and what customers knew about a company and operations was what the company wanted them to know.

With the advent of the collaborative Internet, where anyone can express any opinion and share any information, this way of doing business is rapidly going the way of the buggy-whip. Blogs, forums, easy to set-up protest web sites like bankofamericasucks.com, and, most recently, Wikileaks, are creating a totally transparent (if not always accurate) world where nothing about a firm can be hidden from the public. The corporate communications department is no longer primarily a shaper of perceptions but is instead focused on engaging the public in co-developing brands. Due to this information chaos, whatever a company does will eventually come to light. No longer can a firm engage in ethically suspect behaviour presuming it is the manager of public perception. With this new transparency, and with the increasing engagement of customers as intentional consumers, the need for proactive transparency has become paramount.

It’s not just consumers who require that companies align with their values, but employees, as well. In the past two decades, we’ve seen a wholesale shift from industrial work to knowledge work and consequentially a shift in how employees see themselves and their relationship to their employers. As Peter Drucker noted, knowledge workers don’t exist thrive within the traditional industrial command-and-control framework but instead are co-creators of value and, as such, are responsible for managing themselves. They therefore have come to demand more meaningful work, more meaningful participation in governance, and closer alignment of their work to their values. And, as with consumers, they are increasingly able to determine whether the work they do indeed matches their higher aspirations. Nothing will cause an exodus of the very knowledge workers who are essential for business success faster than internal politics and hierarchical governance systems, except for perhaps outright unethical business practices.

Principled Business Culture = Winning Competitive Strategy

The shift from marketing and branding to transparency for consumers and the shift from command-and-control industrial governance to participative knowledge work for employees have combined to exponentially magnify the importance of ethical and sustainable business practices. Business ethics is no longer something limited to the compliance department so that it can check the appropriate boxes to stay out of trouble with regulators and enforcement agencies. It’s a critical aspect of competitive advantage. And as such it’s something that has to be part of everything a company does, in its DNA, its corporate culture.

This, I think, is the crux of the matter regarding ethical business and principled performance. It goes far beyond training and risk management where it’s traditionally lived and is instead a vital part of a company’s strategy. A principled corporate culture can’t be duplicated easily, if at all. In a business world where innovation and continuous improvement are the necessary conditions for success, the value of an engaged and passionate workforce can’t be overstated.

Unanimity is rare in academic literature, but the closest I’ve ever seen is the consensus that corporate culture is the primary determinant of ethical behaviour. My own experience bears this out, as well. When I worked for Washington Mutual’s corporate technology group, the ethical standards were very high and it was assumed that one owed a primary allegiance to the truth. In the rare cases when ethical dilemmas presented themselves (such as accepting gifts from vendors), there was, once acculturated, no question of what the right thing to do was, nor was there really any question of not doing it. Conversely, when I worked for Long Beach Mortgage Company (the sub-prime business unit of the same corporation), a business unit that had been acquired and which had an entirely different culture, it was very difficult to raise these ethical issues. It was, in fact, the realisation of how easy it is for good people to make bad decisions when influenced by corporate culture that inspired me to change careers back to one that was more aligned with my ultimate values. There were times when I should have spoken up, to question the investment bankers and the corporate leadership, but because I was new in my position and the culture inhibited that sort of dialogue, I remained silent. Though I’m not so self-centred as to believe that I could have averted the sub-prime crisis (see the fantastic The Big Short http://www.amazon.com/Big-Short-Inside-Doomsday-Machine/dp/0393072231, Michael Lewis’s newest book, for more reasons why) , I might have at least cushioned the blow for WaMu and left with a clear conscience.

Since then I’ve done quite a bit of time reflecting on these issues, and I’ve concluded that, for the reasons above and given my experience as a consultant, teacher, and researcher, helping businesses achieve principled performance is the best possible path for my career. There are many people who can do business strategy consulting, many others that can do technology strategy consulting. In trying to figure out my unique value in the world of business, I realised that there are very few people with the business and technology background I have who are also deeply committed, interested, and sophisticated about business ethics. As a strategist, you help companies determine what their unique capabilities are and how they can bring those to the market. In the past two years, I’ve turned my strategist lens on myself and realised that working for a company whose mission is helping companies deliver principled performance would be the best use of not only my skills and experience, but my passion and my sense of what’s ultimately important. It’s this pursuit of significance, of existential as well as commercial success, that has driven me to explore the possibility of working with try to find a position with a firm that specialises in ethics and compliance.

Rules, Risk, and the Dodd-Frank: They Earned It

Whenever I see a parent who has a toddler at the end of a leash, my first reaction is one of horror. But my girlfriend always reminds me that nobody just gets the leash. No parent arbitrarily decides putting their kid at the end of a tether would be a good idea; they do it because, at least once, their toddler tried to run out into the street. Though the Chamber of Commerce seems to be horrified by the proliferation of regulation under the Dodd-Frank Act, it’s precisely the same situation. The financial services industry earned the leash.

I try to steer away from political topics on the blog. They tend to divide people more than they bring them together and often provide more heat than light. A post by the formerly mainstream, now free-market-fundamentalist Chamber of Commerce has inspired me to break that proscription, however, because it goes directly to the issues of ethic, risk, and compliance.

The page, http://www.chamberpost.com/2011/01/dodd-frank-unleashes-a-tsunami-of-regulation-a-visual.html, features a very well-done graphic on the number and scope of rules and regulations mandated by the Dodd-Frank act. The contention is clearly that the overwhelming profusion of regulatory activity is going to damage U.S. competitiveness as a provider of capital market services.

What it missing from the discussion is a review of why Dodd-Frank was enacted in the first place; the capital markets have proved, over and over, utterly incapable of regulating themselves. The fact is that there were trillions of dollars of real value lost in the financial meltdown of 2007/2008, and no one has gone to jail, and almost no one lost their job, and all the bankers and bond traders and rating agency executives got to keep the billions of dollars in bonuses they made in the run up to 2007. So the scoreline reads Wall Street 3-0 Main Street.

We have laws for a reason. In a world with both limited resources that must be competed for and the unlimited right to stockpile those resources, some people will do things that may not be illegal but that are unethical. In some spheres of life the social pressure against doing the unethical countervails the reward. Additionally, some people are just decent and won’t exploit others on principal. But as the rewards grow into the millions and billions, like they do in the capital markets, internal and external non-legal pressures fail and we get collusion, insider-dealing, and revolving-door quid-pro-quo deals.

Furthermore, risk is hard. All the academic research suggests that people are not wired to understand risk well, especially when it occurs at the far ends of the bell curve (we tend to overestimate rare risks and underestimate common risks). Without incentives to understand it correctly (i.e. that the companies themselves will be left holding the bag in case of failure), it gets ignored and/or externalised.

And that’s precisely what happened in the subprime, derivatives, and insurance scandals of the last half of the decade. And, as above, what essentially resulted was a huge wealth transfer from the investors and taxpayers to the financial services companies. Through both the bonuses that happened in the run-up and the the bail-out in the aftermath, the capital markets firms internalised return but externalised risk.

So while the infographic on the COC website might make Dodd-Frank seem like an overreaction, remember what it is reacting to. There is absolutely no reason, given the evidence of recent and/or past history, to think that the capital markets can overcome the human tendencies for greed and risk ignorance. In the long run, prudent regulation makes the capital markets more competitive by increasing stability and transparency. And that’s what really want out of Wall Street, not seven figure bonuses.

A Yellow Card for the "In-Group Regarding Instinct"

I’m a big fan of game theory, especially when looking at strategic or ethical questions. By stripping away extraneous information and formalizing interactions among actors, interesting and sometimes surprising consequences emerge. I find this particularly interesting when looking a possible responses by competitors to my clients’ strategic initiatives. Lately, though, I’ve been thinking about what actual games can tell us about how people view themselves, others, and third parties in the context of business ethics. My experience of refereeing soccer matches has led me to conclude that there are some substantial barriers to effective ethical decision making that need to be taken into account when designing systems to increase the likelihood of ethical behaviour.

For the past several years, in addition to coaching my kids’ teams and playing the occasional match myself, my son and I have traveled throughout our area as hired referees for leagues and tournaments. Since my son is young we usually work with younger players (U12 and under) but I’ve occasionally worked up through the adult leagues. It’s a difficult job that requires a knowledge of the game as well as quick reflexes, a degree of fitness, and a thick skin. Over the years, I noticed what can only be called a failure in perception on the part of coaches, parents, and players. It is simply this: no one ever thinks the referee is biased toward their team. Of the 100+ matches I’ve been the centre ref for, in perhaps half of them I’ve been accused by both sides of being biased against them. Now this might be just a thing that soccer parents and coaches say, but if it is something these people believe (and I think they do) I think it tells us something important about human nature which has important consequences for how we teach people about business ethics.

If you look at this issue formally, we’d say that for every match, there are three possible cases regarding the referee’s bias: he/she is unbiased, biased for the home team, or biased toward the away team. Leaving aside the fact that no referee I know cares at all who wins the matches they officiate, if we allow for the possibility of referee bias we have only those possibilities. To be biased against both teams would be nonsensical. Therefore, if the perception of the fans is accurate (and assuming a random, symmetrical distribution of bias), on average you would find that of the times when fans thought the referee was biased, half the time it would be against your team, half the time against the other team. And yet anyone who spends any time around soccer (and I’m assuming other sports) knows that this is not true. As above, almost no one ever says “boy, that referee was certainly biased in favour of our team”.

It might be tempting to write this off as something that is purely the domain of recreational supporters of sports teams, but I don’t believe it is. I think it tells us something very important about the way people view the members of their in-groups (in this case, members of the team they support) and how they privilege those members with an assumption of moral superiority. People imagine or assume that people belonging to their in-group (whether it is a sports team, company, church, etc.) have good intentions and that any transgressions are the result of a mistake, a misinterpretation, or ignorance. Instead of judging the actions by both in-group and out-group members by the same ethical/behavioral yardstick, we adjudge the wayward actions of the other team or the other company to be the result of malice or intentional wrongdoing.

The philosopher and theologian Reinhold Niebuhr wrote about this same tendency in individuals calling it the “self-regarding instinct.” He thought it was universal and believed that it was the basis for much of what passes for institutional evil in the world. What I’m suggesting is that we often do the same thing in terms of groups we belong to and that much of what we allow in our companies that is clearly not ethical to an outsider falls under this same distortion of perception. When a fellow employee bends the rules or falls a little short in their compliance duties, because he or she is a member of our team, we are likely to see it as unintentional, unavoidable, or not his or her fault. There is a sort of “reality distortion field” around members of our own team/group/company.

I’m not suggesting that we should never understand the context of our own and other’s actions as a mitigating factor in ethical judgments. I’m actually suggesting two things: that we design systems that take this perceptual distortion into account when we are looking at our own firms and that we keep try to contextualise the behaviour of people in other firms.

I’m not naive enough to think soccer moms and dads are going to take time to reflect about how they favour their own kids’ teams and therefor give me a break when I’m officiating their matches on Saturday mornings. I do hope one day they, as a group, will become a little more balanced in their expectations (see http://www.youtube.com/watch?v=r0qGeADPzAs for more), but part of the fun is really in rooting for your team. In the business world, however, the “in-group regarding instinct” can lead to the excusing of clearly unethical behaviour in one’s firm and the assumption of guilt in others. While clearly more research needs to be done in this area (and please, if you have any references on similar research, I’d really appreciate them), just the knowledge of this perceptual shift may be enough to mitigate some of the worst of the resulting transgressions.

Why (or When) Do People Comply? Ethics v. Compliance part I

On the Society for Corporate Compliance and Ethics web site forum, I came across this post. Though personally I’m very distressed (perhaps overly so) by people who cut lines, don’t use their turn signals, etc., I don’t think that the original author’s point (whose name I’ve omitted) is supported by his argument. People, by and large, only follow rules if:

(a) They are rules against something morally wrong and/or
(b) The overal negative consequences of the act are high.

My response is a bit roundabout, but I do think it makes the point:

——————————————

Original Message:

Sent: 06-28-2010 11:41

Subject: Ethics Without Compliance

This message has been cross posted to the following eGroups: Ethics Forum and Chief Compliance Ethics Officer Network .

——————————————-

On Friday I saw some behavior that made me wonder if a faith in ethics is worth having, absent a strong compliance regime.

I was on a plane and, after the doors closed, the flight attendants made the usual announcement about turning off all electronic devices until ten minutes after take off. It’s a rule that is announced on every flight, but as every frequent flyer knows, it is poorly enforced. The flight attendants often don’t notice people breaking it, and many hide their use of the devices. Plus, some people honestly forget and leave their phones on the entire flight.

Such was the case on the flight I took on Friday. After the announcement was made many people pretended not to hear it and went on tapping away at keyboards. When the flight attendant spotted them and told them to turn their devices off immediately, some did, but my seatmate only pretended to. As we were taxiing out to the runway, I saw her checking Facebook statuses on her iPhone. All I could think was “I know your iPhone is highly unlikely to cause the plane to crash, but is it really worth taking a risk on the safety of a couple of hundred passengers just to read that Cindy is psyched for the weekend?”

Bottom line is, she didn’t believe in the rule, knew no one would be monitoring it effectively, and chucked any ethical considerations.

She wasn’t alone. Within seconds of the plane’s liftoff I was amazed at the number of iPads, iPods and other devices that were up and running. I seemed to be the only one waiting to hear the double chimes indicating it was now safe to use approved electronic devices.

Why did they do it? There was a rule that they didn’t believe was worth following, it got in the way of what they wanted to do, and there was no real effort at compliance. And what about the ethical considerations about potentially putting others at risk? They made a calculus and, not surprisingly, found in their own interest.

It’s no different, as I’ve written before, at the ten item or less line at the supermarket, another weak compliance environment. It’s exceedingly rare for a clerk to turn anyone away for having too many items. So, a significant percentage of the population will try and sneak in with as many items as they can.

All this makes me wonder: can we talk seriously about business ethics without their first being regular and strict compliance? To be fair, not everyone cheats on the 10 item or less line or turns on their phone when they shouldn’t, but the numbers are high enough to make me wonder about the potential mayhem it would create in a business setting.

Ethics is often discussed as being useful for navigating the gray areas, but that assumes someone is policing the line between black and white.

There are many who argue that we should put ethics first and compliance second. I’m starting to think it would be a disaster.

Am I onto something or should I stop flying so much?

My response:

It coincidental that I’ve just been working on a blog post on this very topic, that is the way the terms “ethics”, “compliance”, “social responsibility”, etc., get used. And beyond that, like you I sometimes despair at the fact that people so flagrantly ignore rules which are based solely on the fact that their universal compliance would mean a safer and/or more convenient world for everyone. However, Steve, I think your analysis of the situation goes in the wrong direction because you assume that people only follow rules because they are explicit and, therefore, what chance do ethical strictures, which are not, have? Especially since, as you point out, people often do not follow the explicit rules.

I think there are several different categories of judgement for of rules of behaviour. On one hand, we have the purely utilitarian view: does this behaviour affect people (myself included) in a positive or negative way. On the other, we have the purely ethical/moral dimension, which philosophers call deontological judgement and which is usually segregated from the utilitarian judgement. I actually think that people use a calculus in which they weigh the two against each other before deciding just how permissible an act is. You see, I think that, beyond the utilitarian aspect of compliance (I’ll have a negative effect if I get caught), compliance is actually not a significant motivating factor in the examples you suggested.

I think of it like an x/y graph, with ethics on one axis and utility on the other. We judge each other, and ourselves, by the combination of these factors. If we think something (even if it is against certain rules or regulations) has no negative effect on anyone else and there is no moral prohibition against doing it, rules will not stop many people from doing it. Cell phone usage on the plane is the best example I can think of. No one believes that there is any chance that their 3G iPad is going to bring a plane down so, crew member instructions or not, people will do it if they can get away with it.

Move up the utility scale a bit to the grocery 10 items and under line and more people start to judge others badly. There is a real (if minor) effect on other people if you get into the 10 items line and count your 6 gallons of milk as one item (it’s the same item!): they have to wait longer to get their items checked out. And while there is not a universal moral code against getting in the wrong line at the supermarket, we do tend to think badly of people who don’t care enough about others to follow these kinds of rules.

Further still up the utility scale is a particular peeve of mine: people that don’t use their turn signals at intersections. I’m not sure why, but the neighborhood I live in (Belmont Shore in Long Beach, CA) has an incredibly high ratio of people who think using their turn signal at intersections is optional. On one hand, it inconveniences people in the same way supermarket line libertine does: by not signalling, others have to wait before making their turns, thereby delaying them. Even more seriously, though, it creates a real danger for intersection vehicle accidents. I have to admit a certain sense of schadenfreude when I see the daily non-injury accidents on 2nd Street, assuming as I do that at least one of the people involved didn’t use his or her turn signal. But I think we would rate the lack of turn signals as more morally suspect than the people in the supermarket lines because it does put real people in real danger, in addition to being a time-wasting nuisance.

On the other axis, most people rate dishonesty, especially when in pursuit of money, as being ethically indefensible. We know that the entire edifice of enterprise depends on a certain amount of veracity so we can do business. Without a degree of trust, no one would ever buy or sell anything. Additionally (perhaps more importantly for this post), lying is something that is fairly universally considered wrong. There are certain exceptions to that, of course (when a greater evil would be prevented by lying, for example), but that’s not the case in sales, however. On the other hand, since the total effect of a salesman’s dishonest tends to be pretty limited, although we judge him as having done the wrong thing, the severity of the judgement isn’t as great as it might be. We expect a certain amount of, shall we say, imaginative truth-construction among sales people, so the fact we anticipate the dishonesty of the used car salesman lessens our judgement of him/her.

The people we reserve the most severe judgement are those who both do the wrong thing (from an ethical perspective) and whose actions have a large effect on people’s well-being (utility). People who have perpetrated large accounting frauds or who have gamed the capital markets are two particularly relevant recent examples. Those who brought down Enron, WorldCom, etc., both lied and destroyed peoples lives. Similarly, the investment bankers who both created secondary mortgage instruments that they knew were bad, sold them to their customers, and then bet against them, causing the global financial meltdown and bringing on the worst depression since the 30s, are generally judged very harshly.

This may seem like a long way around to my point, but it’s important. I don’t think you can draw any conclusions about whether ethics in the absence of a compliance motive would result in chaos based on your examples. If a rule is neither useful nor ethically motivated, many people will ignore it as officious, and why not? The supermarket example is more interesting, but not much because it is still pretty low on both axes. I contend that if we educated people on both the ethical dimension *and* the utility of their actions, the compliance motive would far less necessary. The compliance aspect is a part of utility (I’ll lose my job if I get caught) but that is quite a low bar to hit. What we want is people acting better than just barely compliant and if you focus on compliance, I think, you only get the bare minimum. Ultimately I think compliance is a necessary but not sufficient condition for ethical behaviour in most companies. It’s necessary to keep people out of the very worst behaviour but I think you need ethics training and/or motivation to inspire them to their best.

Strategic Value of Ethics and Compliance

Like most consulting and audit firms’ white papers, this report from KPMG Advisory, The evolution of risk and controls: From score-keeper to business partner is long on sales and short on specifics. There is enough meat to make it worth reading, however, and it addresses an important question: are audit, compliance and/or corporate ethics programs ever more than a cost of doing business or can they add strategic value? I think the latter can be the case, but because most businesses see compliance and ethics as constraints and not as enablers, they lack the imagination to see where ethical business practices can give them an advantage in the marketplace. Clearly, since this is close to the central question I’m looking at these days from a research standpoint, more will come on this topic.

Powerful People Are Better Liars

A recent article in Harvard Business Review looks at a study by Professor Dana Carney that concludes that Powerful People are Better Liars. This is one more nail in the coffin of the idea of the charismatic CEO (I’ll post other references to this problem when I get a chance to look them up). Relying on a single charismatic leader, combined with several social cognitive biases, can add up to very dodgy ethical behaviour. If anyone has any contrary opinions on this, I’d be interested to hear it because all the evidence seems to be pointing in one direction. On the other hand, a charismatic leader is sometimes what’s needed to really motivate people to sacrifice for a cause, so it’s a bit of a catch-22. Comments?

The Ethics Of, and Response To, "Strategic Default" (part 3 of 3)

Part 3: How lenders should handle the situation

So, if strategic default is clearly unethical, financially irresponsible and certainly legally questionable, how are the banks to respond? In the days before the sub-prime meltdown, this would have been an easy question. Since banks were assumed to have the superior ethical standing, they could afford to take a hard-line approach to defaulters and quickly use whatever legal and financial means at their disposal. Now, however, the ethical presumption lies with the borrowers, so the lenders have to be very careful about how they respond.

We will need to approach this issue sensitively and creatively. I have to admit that my first reaction upon hearing about this trend was neither sensitive nor particularly creative. Given the ethical in-defensibility and dire consequences of strategic default, it’s an understandable reaction. Lenders are going to have to resist the urge to play hardball with these borrowers, however. For one thing, it probably won’t work. Since debtors prison hasn’t existed for two hundred years, the borrowers already know that the worst that can happen is that their credit will be ruined; they’ve already worked that into the cost benefit analysis.

The first step will be to draw a profile of who the strategic defaulters are. Since no one bank is likely to have enough data to draw solid conclusions from, there will need to be inter-bank or, preferably, industry-wide cooperation. I’m assuming, since I don’t have access to that sort of data, that a statistical picture of the strategic defaulter is possible and that a predictive model could be constructed. Again, this would have to be an industry effort to aggregate enough data to make meaningful predictions.

Once the picture of the likely defaulter is developed, banks would need to develop individual ways of dealing with them. The most effective way will be to proactively approach the borrowers that fit the profile and offer them some kind of pre-emptive workout plan. It will be harder for the borrowers to default if they feel they’ve been treated fairly by their banks. It would be a way of building brand loyalty and it would skew the cost benefit analysis toward keeping their homes. While it will cost the lenders in the short run, given the fall in value in some real estate markets, the cost of foreclosure and disposition of the defaulted properties will likely even out. Beyond that, should the effects of strategic default become systemic, the losses would be far greater. Dealing with this problem is going to require foresight and a long-term view of these assets and the market as a whole.

Once these proactive workout plans are offered, there will be several further practical steps required to adequately address this problem. First, so that strategic defaulters do not get lumped into the category of those who merely borrowed beyond their means or were victims of the economic downturn, additional means testing would have to be added to work-out planning by the banks. This adds a further burden to non-strategic defaulters, but this is one further consequence of the strategic defaulters’ actions (in other words, the banks can’t be blamed for this…blame the people walking away from their homes).

Second, government regulators and legislators should be brought into the conversation. This sort of activity by individuals borders on fraud and theft and while it may not be universally popular, the systemic danger of strategic default becoming widespread and having a serious impact on the functioning of the lending ecosystem transcends short-term popularity.

Finally, a coordinated publicity campaign about the dangers of strategic default to the society at large and its ethical indefensibility should be undertaken. If the presumption of ethical activity could be more neutral (i.e., neither with the banks nor with individuals), the peer pressure that used to exist that kept people from walking away from their homes could be revived. While it’d require careful execution, I think the intuitive reaction of most people to strategic default is negative, so merely pointing out the possible dire consequences of such defaults might be enough to turn public option strongly against it.

It goes without saying that all three responses would have to be cautious, careful, and sensitively planned and executed. Banks and other mortgage lenders have fallen into the same category as lawyers and politicians in terms of public esteem and ethical estimation. Because of the possibility of systemic consequences such as the possible disruption of the entire mortgage ecosystem (which would have ripple effects in real estate, building, tax revenues, and ever other system that depends on a functioning lending system), I don’t think it should be ignored. The challenge will be convincing the public, regulators, and government officials that the concern of the banks isn’t merely with coughing short-term gains out of already struggling homeowners. By offering proactive help to borrowers who could fall into strategic default, lenders could demonstrate that they are working in the best interest of not only their customers but the economic wellbeing of the entire home owning ecosystem.

Good Reads on Strategy and Ethics

Though they tend to be a bit short on data and long on supposition, two recent reports by the Institute of Business Ethics (IBE) and Chartered Institute of Management Accountants (CIMA) tackle the issue of the link between ethics and strategy head-on. “Managing Responsible Business,” the more comprehensive of the two reports, is written jointly by the IBE and CIMA. It suggests that in future, an ethical and/or sustainable business model (it seems to conflate the two at times) will be a universal necessity for doing business in the long term. The other report, which is a discussion paper really, is titled “Incorporating ethics into strategy: developing sustainable business models.” They are both well worth reading and I’m interested in feedback from anyone on these papers. I’ll have some further comments once I’ve finished the series on strategic default.