Business Leadership Failures: Can Teaching Ethics in Business Schools Help?

Business Leadership Failures: Can Teaching Ethics in Business Schools Help? Bill Guth New York University

The Story Continues and Gets Scarier • October, 2005 • Enron, WorldCom, Global Crossing, Kmart, Polaroid, Arthur Andersen, Xerox, Quest • Increasingly frequent images of disgraced and sometimes handcuffed corporate executives appear on television screens and in major newspapers • April, 2009 • Global financial and economic crisis starting Fall of 2008, and lasting through …..? • Endless reports of failed financial services firms, government bailouts, big businesses begging in Washington, mortgage foreclosures, increased unemployment, unavailability of credit, etc.

Who or What’s to Blame • October, 2005 • Who’s to blame? • Only the culprits themselves (crooks or stupid)? • Mom and Dad? • Priests, Rabbis, Mullahs? • Primary and secondary school systems? • Business schools? • The business system in the U.S.? • Materialistic culture in the U.S.? • Self-interested human nature? • All of the above? • April, 2009 • What’s to blame? • A growing consensus? • Neoclassical economics • Self-interest – greed is good • Individuals are rational • Markets are always right

Self-interest: Greed is Good • A word from a political leader: • “We have always known that heedless self-interest was bad morals; we now know that it is bad economics.” • A word from Milton Friedman • Milton Friedman - Greed.flv

Individuals are economically rational • “All actions by individuals are directed toward the gain of pleasure or the avoidance of pain.” What is “good” gives pleasure – what is “evil” gives pain. Jeremy Bentham • ‘Utility’ is simply a subjective measure of the pleasure, or avoidance of pain, that results from consumption. • Individuals are fully capable of making completely rational choices about how to allocate their resources so as to maximize their ‘utility’ • Individuals make their choices about how to allocate their resources in a social context, which includes laws, culture, and group affiliations • Part of individual calculations about how to maximize utility is determining the likelihood and amount of pain that might result from choices that violate laws, cultural norms, social affiliations • The concepts of Duty or Responsibility to a larger community are absent from neoclassical economic thought – (because unquantifiable, unscientific? )

As economically rational beings…. • Individual values and emotions only confuse rational decision-making • If others cheat, individuals who don’t cheat are behaving irrationally – the Prisoner’s Dilemma • Individual’s can derive no utility inherently from making “moral” choices based on their sense of duty/responsibility to larger communities of which they are a part • Trying to “be good” increases an individual’s risk of losing “utility” when in competition with those behaving economically rationally

Markets are always right • According to neoclassical economic theory, resources in any economy will be allocated fairly and efficiently by markets – there is no other way to allocate resources fairly and efficiently • SO LONG as those markets function PROPERLY– i.e., allow individuals to make rational choices (for example, transparently, competitively, non-coercively, with price as the measure of the exchangeable value of goods)

Markets are always right • October, 2005 • Principal causes of market “failure” • Monopoly power • “Public goods” • External effects • Information asymmetry • High transaction costs in confronting “abusers” • High costs of monitoring behavior under conditions of “moral hazard” in contracts • April, 2009 • Additional causes of market “failure” • Mob psychosis • Mark to market ->mark to imagination • Only “losers” withdraw when the market is going up – the housing market will always go up • Delusional belief in “it is a new economy”

Self-interest and economic liberalism • “It is not from the benevolence of the butcher, the brewer, or the baker that we expect out dinner, but from their regard to their own interest. We address ourselves not to their humanity, but to their self-love, and never talk to them of our own necessities, but of their advantages” • Adam Smith, The Wealth of Nations, 1776

But, must self-interest be constrained? • “One individual must never prefer himself so much even to any other individual, as to hurt or injure that other, in order to benefit himself, though the benefit to the one should be much greater than the hurt to the other…the man within immediately calls to him…that he is no better than his neighbor, and that by…unjust preference he renders himself the proper object of contempt and indignation (and he deserves punishment) for having violated one of those sacred rules, on the tolerable observation of which depend the whole security and peach [output] of human society” • Adam Smith, The Theory of Moral Sentiments, 1759

The Corporation – flawed institutional character? • “Corporate social responsibility is the new creed of business leaders today, a self-conscious corrective to earlier greed-inspired visions of the corporation. Despite this shift, the corporation itself has not changed. It remains, as it was at the time of its origins....,a legally designated ‘person’ designed to valorize self-interest and invalidate moral concern. Most people would find its ‘personality’ abhorrent, even psychopathic, in a human being, yet curiously we accept it in society’s most powerful institution. The troubles on Wall Street today, beginning with Enron..., can be blamed in part on the corporation’s flawed institutional character, but the company was not unique for having that character. Indeed, all public companies have it....” • Balkan, Joel, The Corporation: The Pathological Pursuit of Power and Profit, (Free Press, 2004, p. 28)

Descriptive or Normative Theory? • Is the “self interest” relationship with market value creation descriptive or normative? • If descriptive – unconstrained, we can only expect people to behave in their self interest • If normative – we want people to behave only in their self interest because that is how to maximize market value creation • Does “Greed is good” transform what is accurate descriptive theory into very bad normative theory?

When markets fail • Managers still have to make decisions about how to use the resources of their companies • To protect the interests of the larger society, laws may be passed to guide/punish managerial decisions • In the absence of relevant laws, managers can attempt to apply ethical analysis to guide decision-making towards integrating the interests of the larger society with the interests of the company • In the absence of relevant law and/or ethical analysis, managers will be guided by their self-interested human nature

Business Prudence and Business Ethics • The prudent manager seeks to maximize the long-run risk-adjusted value of the firm to its shareholders • The ethical manager avoids violating the rights of other parties in the economy. (note: avoidance of harm versus creation of value) • Any decision will be prudent, ethical, both, or neither, as follows:

Ethics/Prudence Decision Types • Bad Decision – Violates a party’s rights (e.g., fraud) and the firm is found out and punished (e.g., Prudential Securities $1.4 billion settlement) • “Good Ethics is Good Business” – Honoring rights can be linked to longer run shareholder value (e.g., building reputation and loyalty). Sometimes rhetorically embellished as “enlightened self-interest.”

Ethics/Prudence Decision Types (Cont’d) • Exploit Market Failure – Violates a party’s rights, but there is little risk of retaliation (e.g., aggressive billing hours, churning accounts, skimping on workplace safety), so on a risk-adjusted basis shareholders’ interests are served, but at the expense of someone’s rights • Exercise Moral Restraint – the market fails, but instead of exploiting it (even with low risk of getting caught), the decision respects the rights of affected parties, thereby lowering returns to shareholders – Often confronts, “all our competitors are doing it, so we have to do it – e.g., bribery in foreign countries)

Applying ethical theory – Can it help? • Ethical relativism • Individual • Cultural • Normative ethics • Teleological • Evaluates outcomes for individuals or groups, rather than the moral quality of the actions taken • Deontological • Defines moral duties that restrain certain actions irrespective of the value of the consequences

Teleological theories of ethics • Egoism – a person (corporation) ought to do whatever is in his/her (the corporation’s) best interest – (which is also the best interest of its shareholders) • Utilitarianism – one ought to seek to produce the greatest possible balance of good over evil, or the least possible balance of evil over good, for all who will be affected by one’s actions – the stakeholder versus stockholder approach to management decision-making

Deontological theories of ethics • Kantianism – moral behavior is a matter of holding, without exception, to certain principles • Categorical imperatives • A person should be willing to live in a world in which the action they chose to take would be repeated for the same reasons whenever the same situation arose, even if he/she happened to be on the receiving end of such action • A person may not use other human beings as means to achieve his/her own purposes • The Mirror Test at GE – an application of Kant’s categorical imperatives? • Contractarianism (Hobbes) – social exchange “contracts” are morally binding, even if not formally discussed and signed (Japanese approach to business contracts)

Modern Normative Ethics • NORM – neutral, omni-partial rule-making-an attempt to integrate teleological and deontological ethical theory Ronald Greene – 1994 • Integrative Social Contracts Theory – differentiates between macro and micro social contracts and proposes a method for integrating them Thomas Donaldson, Thomas Dunfee – 1998 • Normative vs empirical research in ethics

Will teaching ethics in business schools help • Virtually all AACSB accredited business schools now have ethics offerings in their curricula – wide range of variation in offerings • Unheard of before middle 1980’s – rapid expansion of offerings in 1990’s – current “failed” business leaders with MBA’s missed the whole effort • Widely held belief that exposing business school students to ethical theory and reasoning will make a difference

Evidence of Impact?March 2009 Aspen Institute Study of MBA student opinion

Will some simple questions help? • Always ask: how will my choice impact the larger communities of which my company is a part? • Shareholders • Other stakeholders • Country • World society of human beings • Should I change “doctors”? Dr. Milton Freedman is not the only cognitive specialist committing people to thought asylums. (Particularly when you feel you are behaving badly, but have to because you are committed to an asylum where the “mob” is going that way)

Business Leadership Failures: Can Teaching Ethics in Business Schools Help?