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Thursday, 3 September 2009

Moral Corporations: An Oxymoron?

Ethical Management

In the wake of the fin de siècle scandals involving Enron and Worldcom came a new focus on business ethics. Most MBA courses these days routinely run courses where bored wannabe rich, thrusting junior executives are preached to about how money is not the most important thing. This situation is rich in comic potential, but one can’t help suspecting that the students are, if they’re paying any attention at all, simply constructing a checklist of how not to get caught.

The problem is that the unconstrained free market seems to encourage behaviour that in the normal context of human life would be regarded as completely unacceptable. Many of the ethical problems of corporations occur when their managers are unable to apply the morality of normal human interaction to that of business life.

Maximising Profits, Setting Incentives

Back in 1970 Milton Friedman argued in “The Social Responsibility of Business is to Increase its Profits” that ... well, you can probably guess. His argument was based on the premise that executive officers have no right to spend company money on anything other than maximising profits because to do so is to defraud the rightful owners of the money – that’ll be us, the shareholders. He sets the limit of lawful action at the boundary of corporate law – whatever is permissible in law is permissible in business.

A related argument is that business people will only behave ethically if their incentives – their financial recompense and the strictures of the law – are set so as to ensure that they do so. There’s no need for any concept of ethics in this view – people behave as they’re incentivised to do and if they behave immorally then that’s because the framework they operate in is incorrect.

We’ve had a taste of what happens if these approaches to ethics are allowed to run amok, back in mid-nineteenth century Britain when the free market was allowed to flourish, almost unimpeded by regulation of any kind. By the normal human standards of morality it wasn’t a pleasant experience, albeit one that allowed the dark satanic mill owners to maximise their returns at the expense of a decrease in the average workers lifespan even as economic growth was exploding.

The point is, of course, that we can’t just rely on the argument from incentives or even the attenuated ethical model advanced by Friedman. These systems have obviously never stopped any determined shyster from pillaging the system, from Charlie Ponzi through to Bernie Madoff, nor dubious investments in dodgy regimes or ethically reprehensible policies like selling dried baby food to Third-World countries without clean water supplies. We simply can’t turn the debate about right and wrong over to remuneration committees and legislators.

Immorality is Behavioural

The reason we can make this call on ethical behaviour is that personal and business morality are closely related: we frequently behave unethically outside a business environment so it should be no surprise that we do so inside one. All that’s different is the context – although, as we’ll see, that can make a big difference. You’ll be unsurprised to know that at the root of these problems is a behavioural issue. Simply, we don’t recognise or accept when we’re being unethical. In the encouraging words of Tenbrunsel (1998):
"People believe they will behave ethically in a given situation, but they don’t. They then believe they behaved ethically when they didn’t. It is no surprise, then, that most individuals erroneously believe they are more ethical than the majority of their peers."
We have multiple strategies for dealing with the nasty reality that we aren’t as honest as we’d like to think. My favourite is our use of euphemism to avoid facing up to unpleasant truths. So “right-sizing” means people getting fired and “downsizing” means people getting fired and “rationalizing” means ... Yeah, well, you get the idea.

Travelling Hopefully Not Ethically

In all probability there’s an underlying evolutionary reason for self-deception. People who see the world in a less self-centred manner are given to more frequent bouts of depression: we may simply need to view ourselves through rose coloured glasses in order to survive. The theory is that we’re born liars because we need to be able to convince other people that we’re truthful – and to do that the person we most need to convince with our lies is ourselves.

Regardless, most people’s self-predictions generally reflect their hopes rather than any realistic self-understanding. The more socially desirable the behaviour that’s being predicted the less realistic tends to be the prediction – behaving ethically is, of course, socially extremely desirable. And, of course, people tend to be completely unaware of these biases.

In a business situation we’ll frequently be given a reason to cast our morals aside. Here our natural inclination to self-deception can collide with business imperatives to create the kind of ethical scandal that gets onto the front pages of the gutter press. To prevent this many businesses have introduced ethical monitoring systems to check up on our behaviour. As you’d obviously expect the introduction of such systems has a noticeable effect on ethical behaviour: people start behaving less ethically.

Much, much less ethically.

Framing the Situation

The monitoring systems seem to cause us to “frame” the situation differently. We no longer have to judge for ourselves what constitutes ethical behaviour. We frame the situation as a business one: the cost of misbehaving isn’t an ethical issue but simply a question of price.

A practical example of this was shown by Gneezy and Rustichini (2000) who studied day care providers. The nurseries introduced a fine to encourage more timely behaviour in parents who were persistently late to pick up their children. Naturally this resulted in a dramatic change in parent timeliness. As you’ve probably guessed – many, many more parents arrived late.

The introduction of the fine had changed the frame from a moral one “it’s not right to be late” to a business one “if I’m late it’s OK because I’m paying for it”. So much for financial incentives.

When we take together our ability – even our need – to engage in self-deception along with the tendency to frame business situations in a different way from those of our personal lives it’s not hard to see how business morality can be eroded. In particular when ethical degradation occurs in small steps we’re more likely to accept it – the road to Hell is paved with small transgressions.

Moral Ambiguity Rules, OK?

When corporate leaders fail the ethical test it’s almost always when they get muddled up between business morals and personal ones. Business morality and that of everyday life mustn’t be separated. We should respect the reality that many business decisions are sunk in moral ambiguity without demanding that executives leave their morals at home. Is it right for western clothing companies to pay third-world children a pittance for their labour? Or is it OK that they pay those children an above average wage for their society and ensure they receive a schooling that would otherwise be impossible? And where do we stand when both these situations are the same situation?

Corporations tread a difficult path between profit maximisation and an ethical quagmire. However, a company that encourages its employees to abandon their limited personal morals at the entrance can’t be trusted to tell the truth to its shareholders. Remember that “creative accounting” is a business euphemism, for “we’re lying to our shareholders”.

Related Articles: Hedge Funds Ate My Shorts, You Can't Trust The Experts With Your Investments, Pascal's Wager - For Richer, For Poorer


  1. I thought life expectancy increased during the Industrial Revolution which was why the population grew dramatically

    Life in the mills might have been pretty grim, but I think the alternatives were even worse.

  2. Hi Rob

    Fair comment, although I think the statement's justified if you take context into account. Over the whole of the Industrial Revolution average lifespan did increase significantly. However, in the early part, when the experiment in capitalism unfettered by regulation was taking part, the data is much less clear.

    Edwin Chadwick in 1842 records the average lifespan of factory workers in Manchester, Liverpool and Bolton (aka the home of the dark satanic mills) at 17, 15 and 18 respectively. A fair bit lower than the average of around 40.

    The first regulation was in 1833, when the Factories Act was passed to control the use of child labour. Four inspectors were appointed to cover the country. The minimum age of factory workers wasn't raised to 12 until 1901.