Harm / Trust Issues

The potential for loss of trust and other types of harm can have a powerful bearing on the analysis and resolution of various COI issues, as will be examined here.

An important real-world conflict of interest experiment

In today’s NY Times, Michael Greenstone, an economics professor at MIT, writes about a study on auditor COIs that he –  together with Esther Duflo of M.I.T.;  and Rohini Pande  and Nicholas Ryan, both of Harvard – recently published.   The study was conducted in Gujarat, India, where industrial plants with high pollution risks are required  “to hire and pay auditors to check air and water pollution levels three times annually and then submit a yearly report to” a governmental body. In the study, for a randomly selected set of companies, but not for a control group, “auditors were paid a fixed fee from a central pool of money, a subset of the audits was chosen to have its findings re-examined, and auditors received payments for accurate reports, judged by comparisons with the re-examinations. The control group continued under the status quo system in which auditors were chosen and paid by the plants they were auditing.”

The results of this real-world experiment  powerfully demonstrate the impact on the ethicality of conduct that financial incentives can have – even on the judgment of individuals who, by virtue of their professional norms, are supposed to be resistant to COIs.  That is: “While many of the plants violated the pollution standards, few of the auditors in the control group reported these violations. In the case of particulate matter, an especially harmful air pollutant, auditors reported that only 7 percent of industrial plants violated the pollution standard. In reality, 59 percent of plants exceeded it.” However, “[t]he rules changes [in the experiment] caused the auditors to report more truthfully. In the restructured market, auditors were 80 percent less likely to falsely report a pollution reading as in compliance, and their reported pollution readings were 50 to 70 percent higher than when they were working in the status quo system. This difference was as large even when comparing reports of auditors working simultaneously under the two systems. Finally, and most important, the plants that were required to use the new auditing system significantly reduced their emissions of air and water pollution, relative to the plants operating in the status quo system. Presumably, this was because the plants’ operators understood that the regulators were receiving more accurate information and would follow up on it.”

Three comments on this important study.

First, while most directly relevant to auditors, these results can, I believe, be broadly applicable to COIs generally.  That is, if professionals who are trained to rise above COIs fare this poorly, one can only imagine the impact of COIs on the rest of us.

Second, the more important compliance and ethics program efforts become to society, the greater the need for not just C&E auditing but other forms of checking – such as monitoring, as was discussed in a piece in Corporate Compliance Insights.   But monitoring  (as a general matter) is even less independent than is auditing, so this recent study underscores  the considerable  challenges for making forms of checking beyond auditing effective.

Third, research to determine “what works”   is vitally important for the C&E field to mature and realize its full promise,  and real-world studies such as this one can be particularly valuable in that regard.  Interestingly, another article in today’s NY Times describes how in the UK there is now an government-run effort (headed by a “Behavioral Insights Team”) to use research to determine what works with respect to various public policies, including some compliance-related ones. I hope that the US and other countries will follow the UK’s lead here.

Finally, here is a prior post on auditor COIs

 

Thanksgiving edition: conflicts of interest and cholesterol

For millions of individuals (including me) Thanksgiving is not only a time for giving thanks but also for thinking about cholesterol.  And  if guidelines recently issued by the American Heart Association and American College of Cardiology are followed, the number of us who use  statins – cholesterol reducing drugs – will increase substantially, as described in this piece from Forbes.   But as described in this piece in Time (and also in the Forbes article) “the chair of the panel responsible for the new advice, which many see as favorable to … statins, had previous ties to a number of drug makers that manufacture those very same medications,” as did six of the other fourteen members of the panel.

I should add that the financial ties were duly disclosed and applicable guidelines (issued by the Institute of Medicine) were complied with, in that the guidelines do not prohibit any such COIs – only COIs by a majority of members of a panel.  Still, one cannot help feel uneasy about this situation for several reasons.

First, with respect to the panel’s report, one should not assume that disclosure cures the COI.  Indeed, as described in earlier posts in this blog, behavioral ethics experiments have shown just the opposite – that disclosure may “license” conflicts-inspired decision making.

Second, it is not clear to what extent the disclosures here are sufficiently processed.  As described in this article in MedPage Today by a faculty member at Harvard Medical School: “[A]midst all the late-breaking clinical trial presentations and ask-the-expert sessions, what I didn’t hear were the speakers’ financial conflicts of interest. Don’t get me wrong — the AHA mandates that all speakers present a disclosure slide at the beginning of every talk, and this rule was reliably followed by all presenters … in the following manner: ‘Here are my disclosures’ — PowerPoint slide flashes on screen with a list of pharmaceutical/device companies. Yet, by the time the speaker finishes speaking those four words, the slide deck has already advanced to the next slide. I, and my fellow audience members, didn’t even have enough time to read the disclosures, let alone process them.”

Finally, and on a broader level, COIs of this sort could have a more pernicious effect beyond directly impacting the patients involved, because of the great extent to which health-care costs are borne by the country as a whole.  As discussed in this recent post:

–          there are certain challenges (such as climate change and public debt) that both pose great risks to society as a whole and will require broad-based sacrifice to successfully address; and

–          COIs can imperil the likelihood that all relevant parties will be willing to make such sacrifices.

Health care costs fit into this category, too, and, like the others, key players in these areas have, in my view, a higher (i.e., “Caesar’s wife”) duty when it comes to addressing COIs ethically.

Two conflicts of the apocalypse

The COI Blog has, since its launch in 2011, examined a host of different types of conflicts.  (For those new to the blog, you can explore this “parade of horribles” through the various tabs and sub-tabs to your left on this site.)  But, of course, not all conflicts should be of equal concern. Rather, and as described in this earlier post,  worrisome conflicts typically involve one of several types of “market failures,” as those are the conflicts  for which market mechanisms provide insufficient corrective capacities. Indeed, that is only part of the picture, because while a market failure analysis can explain the likelihood  of an unaddressed COI, the possible impact of a COI is important tooAnd, at the risk of drifting into the realm of politics (which I have tried to keep this blog out of in its young life) there seem to be two areas involving COIs that could have a  truly apocalyptic impact on our society, both politically charged.

One of these is public debt, and particularly the conflict in saddling future generations with an insurmountable debt burden.  Indeed,  two of the principal areas of focus of this blog are highly relevant to the risks here: behavioral ethics, and particularly the phenomenon of overly discounting the future; and moral hazard (i.e., present generation takes the risks, future generations bear the costs).

But in addition to these two structural conflict-like challenges in dealing with public debt there are also plain-old COIs to be identified and addressed.  As noted in an article last week in the NY Times – in discussing an investigation by New York’s financial services superintendent into COIs in the handling of the state’s pension funds – COIs may have played a role in leading Detroit to what is clearly a financial apocalypse: the city’s “municipal pension fund suffered severe losses on real estate investments, among other problems, and now that the city is bankrupt, investigators are trying to find out exactly what went wrong. In some cases, certain Detroit pension trustees were taken on junkets dressed up as investment site inspections. And in one instance, an investment promoter paid a bribe to win pension money for real estate projects in the Caribbean but then spent the money building an $8.5 million mansion in Georgia.”

Of course, whatever COIs may have existed or still exist in any state or municipality likely cannot explain more than a small fraction of the entity’s debt.  But conflicts can undermine the trust and sense of shared sacrifice that will be needed to work our way out of these debts – in the same way that a COI can undermine the sense of organizational justice needed to promote compliance and ethics generally in an organization, as discussed in this post.  Another way to think about this is that COIs not only directly cause individual harms but they can make it harder to prevent and remediate a broad range of harms. For this reason, COIs in the public pension area seem to deserve an extra degree of attention, and investigations like that now taking place in New York are, in my view, worth pursuing.

The other area where – given the potential harmful impact at issue – we need to be extra careful about COIs is, of course, climate change.  Here the prospect of an apocalypse dwarfs even that in the area of public debt.

The principal COI issues here concern the science of climate change, and particularly the extent to which those speaking to those issues as experts have conflicting interests.  This recent post on the web site of the Union of Concerned Scientists– while clearly weighing in on one side of that issue – makes a lot of sense to me, and I urge readers of the COI Blog to read it.

Of course, I’m not a scientist and am in no position to say anything meaningful about the science involved in climate change.  But I do know something about conflicts of interest, and when – as the above post describes – scientists who have no financial interest in the issue are accused of COIs by climate change deniers who receive fossil fuel industry funding, that to me suggests not only a flawed ethical analysis but a strategy of deflecting attention from the merits of the scientific issues at hand.

More generally, given what is at stake in getting such issues right, those involved in all sides of the climate science debate have a particularly important obligation to get the ethics right. And that includes avoiding spurious charges of COIs, which can have the same trust-destroying harmful impact that actual ones do.

.

Massive but (mostly) harmless conflicts of interest

The conflicts of interest will be enormous when  the recently announced merger between Publicis and Omnicom – each a giant ad agency (or collection of agencies) in its own right – is finalized.  Both companies, through their respective subsidiaries,  represent major players in such industries as automotive,   telecommunications,  food,  beverages, and beer (as described in this article) .   Are conflicts of this sort something that business-ethics-minded individuals should find of concern?

Not in my view – because such conflicts can, at least as a general matter,  be addressed by market forces.  By contrast, truly dangerous conflicts typically involve one of several types of “market failures.”

The first such failure is “information asymmetry,” meaning where market players lack the information needed to make an informed – and hence optimal – decision.  In the COI context, this can occur when a conflict isn’t fully disclosed, which, in some cases, can be seen not only as an ethical breach but a legally actionable instance of fraud or corruption.  To this classic type of information asymmetry one should add the various findings of behavioral ethicists – some discussed in this earlier post – showing that, for a variety of reasons,   even when COIs are disclosed the information doesn’t seem to be processed in an optimal manner. (I’m not sure if this would truly count as an information asymmetry, but it is in that neck of the woods.)

The other most often relevant market failure to COIs concerns externalities, meaning where the cost of a COI is not borne by the individual/entity in a position to address it but by a third party who doesn’t have a seat at the decision making table.  COIs in the health care field – the costs of which are passed on in large measure to taxpayers and insurance companies – are a prominent example of the great harm that externalities can cause.  Moreover, the phenomenon of   “moral hazard” – also addressed in various prior posts – can be seen as causing harm in this way.   Of course, some COIs – like public-sector corruption – involve more than one type of  market failure.

COIs caused by the mergers of ad agencies certainly don’t raise the issue of externalities, at least not as a general matter. For the sake of completeness, I should note that if the merger creates a monopoly that would be yet another form of market failure –  but this seems very unlikely to ever happen, due to (what I assume are) relatively low barriers to entry in the advertising industry.

Finally, while it is possible that the above-mentioned behaviorist findings about the weakness of disclosure does raise the prospect  of information asymmetry (or the behaviorist version thereof) in this setting,  I think that the strong presence of market forces in the form of competitors pointing out to advertisers  the risks of staying with a conflicted agency would largely negate harms of this sort too.  Indeed, astute ad agencies looking to recruit new clients could do worse than trying to utilize some of this behaviorist science for their commercial advantage.

For further reading:

here’s a description of the various forms of market failures;  

here’s a piece about another context  – joint venture governance  – in which COIs should not be seen as inherently troublesome; and

here’s something on how market failures should factor into anti-corruption risk assessment.

A telling tale to end the year

One of the most closely watched COI stories of the year concerned the Facebook IPO.  As a piece in today’s Wall Street Journal  notes, this IPO is seen as a “telling example of the divided loyalties at many firms, which woo lucrative investment-banking clients and then prod brokerage customers to buy the same stocks even if they look bruised.”

What is particularly noteworthy about this example is how  starkly quantifiable the apparent conflict seems to be: “Among the 33 firms that sold Facebook shares to the public in the $16 billion deal, 62% of the 208 analyst reports have urged investors to buy the shares, according to Thomson Reuters. None has suggested investors sell the shares.”

For the COI Blog, statistics like these are relevant not only to the financial services industry. They also help inform a broader view of conflicts – one that suggests that, for a variety of reasons, mitigating conflicts generally tends to be much more difficult than is often appreciated.

And, as this blog begins its second full year, we are eager to watch each new “fresh hell” (to borrow from Dorothy Parker) in the realm of conflicts of interest emerge, as many of these do present teachable moments.  See you then, and thanks for reading the COI Blog in 2012.

Fracking, conflicts of interest and adverse inferences

Being reasonably informed about the issues of the day is fundamental to participating meaningfully in the democratic process, but as those issues become more technically (and otherwise) difficult to understand the bar to such participation gets raised.   And, given the crucial role that experts play in helping others try to understand such issues, the related ethical bar – by which I mean the need for experts involved in a public dialogue to be either conflict free or conflict transparent – is raised as well.

Take the example of “fracking,” an area of considerable complexity, and my own attempts – as a citizen who wants to be reasonably informed – to understand it.   Initially, I was skeptical about the wisdom of the fracking but the more I read the more it seemed, on balance, like a good idea (assuming strong environmental safety measures are put in place and that the embrace of fracking does not diminish the development and deployment of renewable energy sources).

But now I’m a bit less sure – given recent stories like this piece   and this one   about undisclosed ties to the energy industry by those publicly opining on various aspects of fracking.  These and similar pieces make me wonder, if fracking really is a good thing, why do its proponents need to pursue unethical means to promote it?

From the perspective of a citizen seeking to be informed, it can be hard to avoid drawing an “adverse inference” from these sorts of undisclosed conflicts, by which I mean suspecting that the reason a conflicted expert is playing a key role in opining/researching a given matter is because a conflicts-free one would view the merits of a matter differently.  Note that adverse inferences based on wrongdoing are not always logical. (In this connection, here’s a law review article on “adverse inferences about adverse inferences” ).  However, they have long played a powerful role in our thinking and, in addition to having a force born of habit, they have enough logic to be attractive.

Further, as the issues of the day become more complex and difficult to address on their merits, the adverse inference becomes a more attractive – if not necessarily more logical – way to resolve issues.   This is a possibly non-obvious reason why, in my view, the ethical bar for disclosing COIs in research is, in effect, raised as the need of the public to be able to trust experts in understanding significant public policy issues grows.  (But, of course, the main reason is to  prevent the public from being misled by undisclosed COIs. )

Finally, for more information on the danger of overreactions to COIs see this post on “reverse conflicts of interest.”

 

Compensation consultants and conflicts of interest

An analysis published this week in The Guardian  found of the “50 most valuable UK public companies, 33 hired pay consultants who also sold services to other parts of the same company during 2011. The list includes businesses that attracted some of the greatest attention during the shareholder spring, in which investors began rebelling against pay awards.” Both the consultants and companies involved denied any conflicts but, as the paper reported: “the High Pay Commission was ‘concerned at the extent to which remuneration consultants are encouraging the ratcheting up of executive pay. In particular we are concerned that remuneration consultants have a direct conflict of interest where they provide executive pay advice and cross-selling for other business.’ [The Commission] added: ‘While the voluntary code for remuneration consultants specifies that they should not cross-sell services, anecdotal evidence and interviewees the High Pay Commission met during this research suggest this practice is widespread.’ ”

But is there truly harm in these sorts of COIs? The research in this paper  –  Compensation Consultant Independence and CEO Pay – published last year suggests that  there is. As described by the authors: “Using a unique data set of compensation consultant service fee in U.S. S& P 500 firms in 2009, we find strong evidence that compensation consultant’s conflicts of interest is associated with higher CEO pay…evidence shows that that CEO receives 7% more salary, 22.9% more bonus and 15.6% more total compensation in firms where compensation consultants provide other services than that of firms where the consultants do not provide other service. In addition, we also document that CEO’s pay-for-performance-sensitivity (PPS) is lower in firms where the consultants have potential conflicts of interest.”

CEOs’ COIs

F. Scott Fitzgerald famously said that “The rich are different than you and me,” and, along the same lines, CEO conflicts of interest can be pretty different than those involving people like you and me.  Consider this story – which likely would not have taken place with anyone other than a CEO – about what in going on at Chesapeake Energy.

As background, the company permits its CEO, Aubrey McClendon, to take personal stakes in the wells it drills.   By itself this arrangement – while unusual and controversial – does not, in my view, inherently involve a COI.  Indeed, one could argue that by investing side by side with the company, the CEO aligned his interests with those of the company’s shareholders.

However, “[i]n order to pay for stakes in new wells, McClendon borrowed money — using his stakes in existing wells as collateral — from a group that Chesapeake was trying to sell assets to. Investors complained that the arrangement raised a conflict of interest. They worried that Chesapeake might have sold its assets to the firm because the firm agreed to lend McClendon money, and not because the terms of the deal were the best Chesapeake could have received.  The arrangement was not previously disclosed to shareholders.” Or, as noted in another (more bluntly written) account:  “The overlapping relationship has led many analysts to say that there was at least the appearance of a conflict of interest since Mr. McClendon could give his lenders a sweetheart deal in exchange for a preferential interest rate on his loans.”  (Perhaps some of these analysts recall the harm caused by the tangled personal financial dealings of then CEO Bernard Ebbers at WorldCom.)

Where was the board – which included a former governor of Oklahoma and former US Senator – when this was going on? According to this story, Chesapeake’s general counsel initially claimed that the board “was fully aware of the existence of the loans” but the company soon reversed course on this.   As described by Ben Heineman, a former General Electric Co. general counsel who teaches corporate governance and business ethics at Harvard: “the Chesapeake board, in effect, is declaring that it would ‘rather just look ill-informed and negligent than complicit in McClendon’s deals.’”

Adding to this turmoil – a story has now surfaced of an undisclosed financial tie between the CEO and a director  (albeit one dating back several years).  And, the Securities and Exchange Commission has opened an internal  investigation.

What does all this mean for the shareholders (i.e.,  people like “you and me”)?  Many have apparently lost faith in senior management and the board, which has led to a massive loss in their investments in the company. This is, of course, entirely predictable when a CEO creates an apparent COI of this magnitude and the board – the only meaningful check on a CEO – is either negligent or complicit.

CEO conflicts really can be unique, not only in terms of what they are but also the impact they can have.

 

 

“Organizational Justice” and Conflicts of Interest

According to research conducted by the Corporate Executive Board (the “CEB”) of about 600,000 employees of more than 140 companies, one of the most important steps to promoting compliance is maintaining “organizational justice.”  The CEB notes: “A firm’s culture has organizational justice when employees agree that 1) their firm responds quickly and consistently to proven unethical behavior and 2) that unethical behavior is not tolerated in their department.”

What does this have to do with conflicts of interest?

In many organizations COIs constitute one of the most common – and commonly observed – types of wrongdoing.  And, I believe that  – more so than with most types of C&E violations – when COIs that are harmful to a company are permitted to exist, that undermines the sense of justice within the organization.

The special harm that COIs can cause to organizational justice arises from their frequently personal nature: because COIs often involve a personal benefit to an individual employee that is denied to others, the latter (i.e., rule abiding employees) can feel personally harmed (from a relative perspective) by the COI in a way that they would not feel, for example, with an antitrust offense or violation of export regulations.  This  impact has been brought home to me in various client engagements, such as recently hearing at one company how employees “monitor” each other regarding COIs or from a focus group in another company where employees questioned the organization’s commitment to C&E generally based upon its handling of certain COIs.

Given the outsized impact that COIs can have on the overall efficacy of a company’s C&E program, addressing them effectively should be a top priority for companies.  That is, the danger of poor COI mitigation is not only the immediate impact  from individual COIs (e.g., distorted procurement or hiring decisions) but a broader risk to the entire program.

COIs in the News (033112): the Cost of Conflicts

From Chris MacDonald’s The Business Ethics Blog, a piece on the far reaching costs of COIs, occasioned by a story about employees of a public school system receiving gifts from vendors: “when conflicts are accepted and fostered… they erode confidence in the judgment not just of individuals, but of entire institutions.”  As Chris notes, the fault is not with  the receiver alone – and he uses subordination of perjury as a metaphor for the giver’s culpability in third-party situations such as these. We definitely agree with him that not causing COIs in others is a topic worth greater attention, and, also feel that that the costs to society of COIs need to be better understood.

What about the costs to the wrongdoers themselves? Here, the news of the week is mixed (as it likely is in any given week).

Reflecting a strict approach, the head of the Dutch arm of Deloitte resigned due to violations of the firm’s policy regarding investing in audit clients.  This can be seen as a relatively high cost for what was (based on my knowledge of prior similar cases) probably an inadvertent violation, and a reflection of the need for strong compliance measures for businesses (such as auditing) where independence and trust are of the highest importance.

At the other end of the spectrum, in a criminal COI case – where the wrongdoing concerned  receipt of $385,000  in a side deal on maintenance contracts, and thus went well beyond a technical policy violation  – a former general manager of the Los Angeles Memorial Coliseum will escape prison in return for repaying the ill-gotten gains, doing 1,500 hours of community service and possibly paying additional fines.  Indeed, “[a]fter he serves three years of probation, he will be eligible to apply to reduce the felony charge to a misdemeanor, according to the plea agreement.”  While I’m sure there is a lot about the case of which I’m unaware, it is hard to look at this resolution as reflecting the serious impact that conflicts have on our world.