Economists’ Hubris – The Case Of Business Ethics In Financial Services

Shahin Shojai
Capco Institute

February 9, 2016


This is the sixth article in the Economists’ hubris paper series, which aim to critically examine the practical applications of academic thinking. The focus of this article is business ethics, with a specific focus on the financial services industry. The main challenges that one faces in determining whether businesses do in fact act unethically, intentionally or otherwise, are that there are no universally agreed parameters for describing ethical behavior, that ethicality seems to be in the eye of the beholder and that since we are relying solely on external data, and do not have access to the thinking processes that lead to different business decisions, we are unable to state categorically that the management knew ex-post that a given decision would result in an unethical outcome. Given these difficulties, this article suggests that firstly, while most businesses don’t necessarily set out to act unethically, when ethics and profitability collide the latter seems to win most of the time and secondly, that should companies decide to, or inadvertently, act unethically they have learned from the actions of western governments how to manage the ramifications. The increasing influence that businesses now have over those that monitor them, including governments and the media, could potentially lead to corporations becoming less concerned about the ethical ramifications of their actions and consequently result in the concept of business ethics becoming even less viable from a practical perspective.

Economists’ Hubris – The Case Of Business Ethics In Financial Services – Introduction

The recent global financial crisis, which somehow never seems to end, has brought the issue of business ethics to the fore once again. Many are asking why the banks behaved the way they did in the run up to the crisis and why they were allowed to simply pay financial penalties without having to admit any wrongdoing. More importantly, as Ben Bernanke, the Chairman of the Federal Reserve at the time of the crisis and one of the men credited with saving the banking system, has recently stated [Page (2015)], why weren’t there more prosecutions of the executives at these financial institutions? Executives whose actions prior to the crash he judged to be “bad business and immoral.”2 It is a fair question. Why were they behaving that way, and why were they able to avoid having to accept they behaved wrongfully. Of course, the people who are asking these questions now are either too young to know or have simply forgotten how the banks behaved during the Internet boom of the late 1990s.

Those of us who followed the endeavors of Elliot Spitzer remember vividly the types of emails he was able to uncover about what investment analysts really thought about some of the stocks they were issuing buy recommendations on that their colleagues were pushing onto clients, institutional or otherwise. The famous clarification of what Henry Blodget meant by PoS will forever be etched on the minds of those of us who knew that the Internet bubble of the late 1990s was nothing but that [Cassidy (2003)]. But, the issue is that even during those investigations most financial institutions simply paid their penalties and neither accepted nor rejected any wrongdoing. They simply paid a fine and moved on.

Of course, some of the more recent issues that financial services firms have faced, such as the LIBOR-fixing scandal or money laundering, have resulted in some accepting criminal behavior, and it would be interesting to see what impact they might have with regards to U.S.-style class action suits by investors. But, by and large the so-called too-big-to-fail institutions that perpetrated these deeds have remained intact and their share prices seem to go up with every penalty paid.

Business Ethics

In response to the recent crisis, the public fury at the use of tax-payer funds to bail-out a number of these institutions, the never-ending series of wrongful behaviors by the banks and the need for the governments to be seen to be doing something, a number or initiatives were undertaken. These ranged from ring-fencing investment banking activities away from the retail and commercial banking activities of banks (as suggested by The Independent Commission on Banking: The Vickers Report),4 to the myriad of regulations, which are just too long to mention here, that were introduced by the Dodd-Frank Wall Street Reform and Consumer Protection Act,5 to the limits on bonuses that were introduced by the European regulators and, of course, MiFID II and Solvency II. The list and the requirements of the new regulations introduced are just too long and too complicated to be tackled in this article and are beyond its scope.

However, one of the responses of the U.K. regulators is of import to this article, and it is the issue of “risk culture”. Hector Sants, the CEO of the Financial Services Authority between 2007 and 2012, made a number of speeches about the importance of culture within financial services firms and how steps needed to be taken by regulators to ensure that unacceptable cultures within firms are identified [Sants (2010a, b)]. Sants (2010a) stated that: “Historically regulators have avoided judging culture and behavior as it has been seen as too judgmental a role to play. However, given the issues we continue to see over time, I believe this one-dimensional approach has to be questioned. Every other aspect of the regulatory framework is under scrutiny and we should not shy away from debating the culture question.”

Business Ethics

Since Sants’ speeches many have started looking at the topic of risk culture and how to implement the guidelines that FSA, now the Financial Conduct Authority (FCA) and the Prudential Regulatory Authority (PRA), as well as the Financial Stability Board (FSB)6 have set for these firms. While the number of academic studies in this space is still quite small, with the most comprehensive so far being Power et al. (2013) and Jackson (2014), most consulting firms have published numerous reports on the topic and advised how firms should go about implementing the guidelines set by the FCA.

Clive Adamson, Director of Supervision at the FCA, stated at the CFA Society’s U.K. Professionalism Conference in London that the FCA’s approach to assessing culture is: “to draw conclusions about culture from what we observe about a firm – in other words, joining the dots rather than assessing culture directly. This can be through a range of different measures such as how a firm responds to, and deals with, regulatory issues; what customers are actually experiencing when they buy a product or service from front-line staff; how a firm runs its product approval process and the considerations around these; the manner in which decisions are made or escalated; the behavior of that firm on certain markets; and even the remuneration structures. We also look at how a board engages in those issues, including whether it probes high return products or business lines, and whether it understands strategies for cross-selling products, how fast growth is obtained and whether products are being sold

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