Moral Hazard and Bias

These two “cousins” of COIs – which are related in that they tend too fall outside of traditional COI analysis, but still can be harmful in ways similar to the harm caused by COIs – will be the source of relatively consistent focus in the blog, with each discussed under its respective tab below.

Point-of-risk compliance

Here is my latest column from C&E Professional – on  “point-of-risk compliance.”

I hope you find it useful.

Behavioral ethics program assessments

Rebecca Walker and I have an article in the Spring 2019 issue of Ethical Boardroom on behavioral ethics program assessments.

We hope you find it interesting.

Being a parent as a source of ethics risk

In 1973, in speaking to colleagues on the  Cook County Democratic Committee, Mayor Richard Daley of Chicago defended his having directed a million dollars of insurance business to an agency on behalf of his son John with the immortal words: “If I can’t help my sons, then [my critics] can kiss my ass. I make no apologies to anyone.”

I thought of this when I read about the college admission bribery scandal that emerged this past week. The scandal called to mind other cases where parents violated the law to benefit their children. A famous instance of this sort from the 1980s concerned the hiring (by a former Miss America) of a NY judge’s daughter to influence the judge’s decision on a pending case.  In 2016, JP Morgan settled a “Princeling” case, which involved the bank’s hiring the sons and daughters of important Chinese officials in return for business. And there are many other cases like these – presumably going back to our early history.

The behavioral ethics and compliance perspective focuses on structural causes of wrongdoing. There are many fruitful avenues for behavioral ethics inquiry suggested by the college admission bribery scandal. The one that most interests me is whether it is easier to commit a crime when one is doing so not to help oneself but to help one’s child.  (Note that I understand that there are also personal reputational benefits that parents get from having their child admitted to a prestigious university but still think that the principal beneficiaries of this corruption are the children.)

Given how powerful the drive to help one’s offspring is – both as a matter of the instincts we are born with and the social norms that we adopt – the answer is almost certainly Yes, at least as a general proposition. If this turns out to be an operative fact in the admissions bribery scandal, then I hope a lesson will be that parents should refrain from doing things for their children that ethically they wouldn’t do for themselves.

As the scandal unfolds I’ll also be interested in learning what was the role – or lack thereof – of risk assessment and auditing in the respective compliance programs of the universities involved. Based on the press accounts it seems as if this kind of corruption was probably fairly common. If that is so, where were the compliance programs?

Behavioral ethics and compliance assessments

New from the Compliance Program Assessment Blog.

Rebecca Walker and I hope you find it interesting.

Behavioral ethics and compliance index 2019

While in the more than seven years of its existence the COI Blog  has been devoted primarily to examining conflicts of interest it has also run quite a few posts on what behavioral ethics might mean for corporate compliance and ethics programs. Below is an updated version of a topical  index to these latter posts.  Note that a) to keep this list to a reasonable length I’ve put each post under only one topic, but many in fact relate to multiple topics (particularly the risk assessment and communication ones); and b) there is some overlap between various of the posts.

INTRODUCTION 

– Business ethics research for your whole company (with Jon Haidt)

– Overview of the need for behavioral ethics and compliance

Behavioral ethics and compliance: strong and specific medicine

– Behavioral C&E and its limits

Another piece on limits

– Behavioral compliance: the will and the way

Behavioral ethics: back to school edition

A valuable behavioral ethics and compliance resource

BEHAVIORAL ETHICS AND COMPLIANCE PROGRAM COMPONENTS

Risk assessment

–  Being rushed as a risk

–  Too big for ethical failure?

– “Inner controls”

– Is the Road to Risk Paved with Good Intentions?

– Slippery slopes

– Senior managers

– Long-term relationships

– How does your compliance and ethics program deal with “conformity bias”? 

– Money and morals: Can behavioral ethics help “Mister Green” behave himself? 

– Risk assessment and “morality science”

 Advanced tone at the top

Communications and training

– “Point of risk” compliance

–  Publishing annual C&E reports

– Behavioral ethics and just-in-time communications

– Values, culture and effective compliance communications

– Behavioral ethics teaching and training

– Moral intuitionism and ethics training

Reverse behavioral ethics

The shockingly low price of virtue

Imagine the real

Positioning the C&E office

– What can be done about “framing” risks

Compliance & ethics officers in the realm of bias

Accountability

– Behavioral Ethics and Management Accountability for Compliance and Ethics Failures

– Redrawing corporate fault lines using behavioral ethics

– The “inner voice” telling us that someone may be watching

–  The Wells Fargo case and behavioral ethics

Whistle-blowing

– Include me out: whistle-blowing and a “larger loyalty”

Incentives/personnel measures

– Hiring, promotions and other personnel measures for ethical organizations

Board oversight of compliance

– Behavioral ethics and C-Suite behavior

– Behavioral ethics and compliance: what the board of directors should ask

Corporate culture

– Is Wall Street a bad ethical neighborhood?

– Too close to the line: a convergence of culture, law and behavioral ethics

–  Ethical culture and ethical instincts

Values-based approach to C&E

 A core value for our behavioral age

– Values, structural compliance, behavioral ethics …and Dilbert

Appropriate responses to violations

– Exemplary ethical recoveries

BEHAVIORAL ETHICS AND SUBSTANTIVE AREAS OF COMPLIANCE RISK

Conflicts of interest/corruption

– Does disclosure really mitigate conflicts of interest?

– Disclosure and COIs (Part Two)

– Other people’s COI standards

– Gifts, entertainment and “soft-core” corruption

– The science of disclosure gets more interesting – and useful for C&E programs

– Gamblers, strippers, loss aversion and conflicts of interest

– COIs and “magical thinking”

– Inherent conflicts of interest

Inherent anti-conflicts of interest

Conflict of interest? Who decides?

Specialty bias

Disclosure’s two-edged sword

Nonmonetary conflicts of interest

Charitable contributions and behavioral ethics

Insider trading

– Insider trading, behavioral ethics and effective “inner controls” 

– Insider trading, private corruption and behavioral ethics

Legal ethics

– Using behavioral ethics to reduce legal ethics risks

OTHER POSTS ABOUT BEHAVIORAL ETHICS AND COMPLIANCE

– New proof that good ethics is good business

How ethically confident should we be?

– An ethical duty of open-mindedness?

– How many ways can behavioral ethics improve compliance?

– Meet “Homo Duplex” – a new ethics super-hero?

– Behavioral ethics and reality-based law

Was the Grand Inquisitor right (about compliance)?

Inherent anti-conflicts of interest

A post some years back explored the idea of “inherent conflicts of interest,”  COIs so embedded in a situation that they are essentially impossible to resist. In an important column this week in Wired UK , the eminent behavioral ethicist Dan Ariely describes an approach he has developed which might be considered inherent anti-COIs. He writes:

An example of this, with which I am involved, is Lemonade, an insurance provider. In the standard insurance model, consumers pay fees and, when something bad happens, they file a claim. The problem is that in this model, an insurance company benefits financially when it refuses to pay out, creating a conflict of interest in its staff between the needs of consumers and the need for the company to make a profit. This is a tremendous conflict and some staff are likely to misbehave.

Lemonade, on the other hand, is not set up as a two-sided game between the consumer and company. Instead, we have made it a game with three players: the consumer, the insurance company and a charity that the consumer chooses. The consumer makes their payments. Lemonade keeps a fixed percentage, say 20 per cent, and pays claims from the remaining 80 per cent. Any money left over at the end of the year goes to the charity. Under this system, Lemonade makes the same profit whether it pays claims or not. And, if a consumer decides to inflate their claim, they are taking money from the charity they have nominated.

The shift here is a move from a system where companies simply ask customers to trust them, to a system where companies deliberately set up their business model in order to create trust.

In 2019, I believe we will see more companies using this approach and more consumers rewarding them for it. We are every day becoming more weary of the conflicts of interest and dishonesty that plagues so much of business and soon we will start choosing companies that have systems in place to avoid them.

I think that this is a terrific idea and hope that we will indeed see more examples of it in the coming year.

Finally, part of my wish list for 2019 is that we will also  learn from this experience more about what works generally and what doesn’t when it comes to messaging/marketing to turn ethical behavior to commercial advantage.  Among other things,  inherent anti-COIs should be a marketing “plus” not only in the insurance business but also in selling medical services and investment advice, among other things.  But actually making the cash register ring this way seems likely to be a real challenge.

Hire the guilt prone

In a recent edition of Knowledge at Wharton, Maurice Schweitzer of that school discusses a paper, “Who is Trustworthy? Predicting Trustworthy Intentions and Behavior,” he co-authored with T. Bradford Bitterly, a postdoctoral research fellow at the University of Michigan’s Ross School of Business, Taya R. Cohen, a professor at Carnegie Mellon University’s Tepper School of Business, and Emma Levine, a professor at the University of Chicago’s Booth School of Business. Schweitzer notes:

We tapped into a personality trait that hasn’t received as much attention as say, the “Big Five” personality traits [extraversion, openness, agreeableness, neuroticism and conscientiousness.] The personality trait we tapped into is something called guilt proneness, or how prone someone is to feeling guilty. Imagine you’re out at a party. You have a glass of red wine, and you spill some red wine onto a white carpet. How would you feel? The people who would feel extremely guilty about that are the people who are prone to feeling guilt. Now what’s interesting is that people who are prone to feeling guilt, they don’t actually experience a lot more guilt because they spend a lot of effort trying to avoid putting themselves in that position. Those are the people who would say, if I’m if I’m going to be drinking wine over a white carpet, I’m having white wine. Those are the people that are thinking ahead to make sure they’re not missing deadlines. They’re not falling short of your expectations. They’re going to take their time and work extra hard to take other precautions. Those are the guilt-prone people. And it turns out that those people are pretty reliable. And when it comes to being trustworthy, those are the people we should be trusting.

This makes sense to me as an intuitive matter. But more than that, we have only to look at the example set by President Trump, who seems to show no guilt about anything – and who is as untrustworthy as any leader can be.

I’m not sure how compliance officers can operationalize this research. But for citizens the implications couldn’t be clearer.

Moot compliance court for corporate directors?

In their paper, “Short-Changing Compliance,”  John Armour (University of Oxford), Jeffrey N. Gordon (Columbia Law School), Geeyoung Min (Columbia Law School), argue: “Corporate compliance programs play a central role in society’s current response. Prosecutors give firms incentives—through discounts to penalties—to implement compliance programs guiding and monitoring employees’ behavior. However, focusing on the incentives of firms overlooks the perspective of managers, who decide how much firms invest in compliance.” They further note: “stock-based pay, ubiquitous for corporate executives, creates systematic incentives to short-change compliance. Compliance is a long-term investment for firms, whereas managers’ time-horizon is truncated at the date they expect to liquidate stock. Moreover, investors find it hard to value compliance programs, because firms routinely disclose little or nothing about their compliance activities.” Also, “stock-compensated managers prefer not to disclose compliance, because it can reveal private information about a firm’s propensity to misconduct: the greater a firm’s misconduct risk, the more valuable to it is an investment in compliance. As a result, both managers and markets are likely myopic about compliance.”

To remedy all of this they “propose more assertive directors’ liability for compliance failures,…” but which would avoid incenting directors to overinvest in compliance.

I agree that the prospect of director liability for compliance failures under existing law is weak, as described in this recent post.. However, I don’t see the political will among shareholders, courts or legislatures to change that.

But should it come to pass, the next issue would be how the standard would be applied. In this regard, the authors propose: “[I]f the firm resolves a compliance enforcement action, criminal or civil, through payment of a fine or accepting some other sanction, an appropriate board committee, perhaps the governance committee, should trigger an ‘accountability proceeding.’ This proceeding could be presided over by a panel of compliance and industry experts, perhaps three, who would conduct an internal investigation that would (i) evaluate the compliance system within the firm as well as the particulars of the compliance failure, (ii) assess the extent of directors’ responsibility, and (iii) determine the appropriate clawback of the accumulated stock of responsible former and current directors.”

Indeed,  one might – as part of board compliance program governance –  deploy a “moot court” accountability proceeding to help directors avoid ever having to face the “real deal.” I suggest this because much of the underlying logic of compliance programs is based on the realization that merely threatening punishment is not enough to prevent wrongdoing. And just as employees need training in various compliance areas for that threat to be meaningful, so directors should be periodically reminded about the risks they face.

As noted above, the heightened standard of board liability for compliance failures proposed by the authors is a long way from coming to pass. But, even under the current, relatively lax standards, the “moot court” idea might be worth trying, as it would undoubtedly cause some directors to focus on compliance more than they currently do.

For an earlier post on compliance incentives and managers click here.

Imagine the real

 

An early post on this blog noted that among the more interesting phenomena of behavioral ethics was the impact that knowing or not knowing a party could have on how one treated that party.

A set of circumstances that is relatively likely to lead to an ethical shortfall is where we do not know who will be impacted by a contemplated act.   As described in this paper by Deborah A. Small and George Loewenstein,  in one study “subjects were more willing to compensate others who lost money when the losers had already been determined than when they were about to be” and in another “people contributed more to a charity when their contributions would benefit a family that had already been selected from a list than when told that the family would be selected from the same list.”   Beyond their direct application to the area of charitable giving, these findings may be relevant to a broader range of ethics issues, and, for instance, could help explain the relative ease with which so many individuals engage in offenses where the victims are not identifiable.  

One example of this is insider trading – a crime which, although widely known to be wrong, seems utterly pervasive (based, among other things, on the extent of trading in securities right before public disclosure of market moving events).  A behavioral ethics perspective suggests that (at least part of) the reason for this “inner controls” failure is that the victims of insider trading are essentially anonymous market participants. 

Another offense of this sort is government contracting fraud (where the victims tend to be everyone),  and indeed Ben Franklin famously described the risks of an ethics shortfall here as well as anyone could: “There is no kind of dishonesty into which otherwise good people more easily and more frequently fall than that of defrauding the government.”   Understanding why “otherwise good people” do bad things is much of what behavioral ethics is about.

But what about COIs? The picture there is mixed, as some COIs do involve identifiable victims – such as the job applicant who does not get hired because the position was filled by the boss’s son. Similarly, an organization might suffer identifiable harm when its procurement process is corrupted by a COI – e.g., paying too much or getting too little.

However, with other sorts of COIs the harm is less apparent. It is the damage to trust in key relationships.

For this reason, organizations might consider including the following question in their COI resolution protocols: “How likely would it be at that the COI would diminish the trust that stakeholders (shareholders, employees, customers, business partners, suppliers or regulators) would have in the Company or otherwise adversely impact the Company’s reputation?”

Of course, this thought experiment works only if you truly try to put yourself in the shoes of one of these parties. Or, to use the memorable words (albeit from  another setting) of philosopher Martin Buber: “Imagine the real.”

Compliance & ethics officers in the realm of bias

Bias and conflicts of interest are, of course, related to each other;  but they also differ, in that the former can be based purely on thoughts (or feelings or beliefs) whereas the latter generally requires something truly tangible, such as an economic or familial relationship. Prior postings on bias – particularly those underpinning the field of behavioral ethics – can be found here. But, the world of bias is a vast one, and there is much to be explored about it.

A study recently summarized on the Harvard Law School Forum on Corporate Governance and Financial Regulation offers an interesting example of one type of bias among CEOs. The author of the study – Scott E. Yonker, of Cornell University – sought to determine “Do Managers Give Hometown Labor an Edge?”, based on a review of certain employment-related decisions affecting company operations of varying distances from the hometowns of the companies’ respective CEO’s. The answer – somewhat unsurprisingly, at least to me – was Yes: “The results show that following periods of industry distress, units located near CEOs’ hometowns experience fewer employment and pay reductions, and are less likely to be divested relative to other units within the same firm. Units located closer to CEO birthplaces experience 4.1% greater employment growth and 2.4% greater wage growth compared to similar units. Since employment and wages fall by 3.0% at the average firm unit following industry distress, these findings suggest that hometown units are largely spared. Moreover, these differences have seemingly permanent effects, the wage differences last at least three years, while employment differences revert about three years after industry downturns. With regard to divestitures, units that are more distant from CEO birthplaces are about 6% more likely to be divested.”

Is this at all relevant to the work of compliance & ethics professionals? I think the answer to that is Yes, as well. Or more accurately, It should be.

Of course, “hometown” forms of bias are not as pernicious as are those concerning race, gender and other categories of individuals who have historically been the victims of societal oppression. But the true promise of C&E programs extends to addressing all forms of unfairness, both because non-merit-based decision making in the workplace is (from an economic  efficiency perspective) presumptively bad for businesses (i.e., an inefficient use of resources); and because such decisions can lead to demoralization of a workforce (adversely impacting, among other things, the ethical conduct of those so affected).

Ultimately, for a company to have not only a strong compliance program but also an ethics one, the CEO and other leaders would empower the C&E officer to identify and challenge decisions that may be based on bias. (Note that I don’t mean literally  all such decisions, but those that are significant in potential impact and have a meaningful  ethics/fairness dimension.) The leaders would do so because they would understand that being fair is not just a matter of good intentions; rather, it can  also require expertise and effort – both  of which the C&E officer can bring to a challenging set of circumstances.

The C&E movement has  made a lot of progress in the past quarter century, but we are a long way from getting to such a place. Still, as is often said, it is good to have a goal.