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.

Moral hazard and ethical habits of mind

“Moral hazard” means the provision of incentives that encourage unduly risky conduct by shifting the impact of a bad decision to a party other than the decision maker.   Perhaps the most consequential area of moral hazard ever is climate change, as those individuals most likely to bear the brunt of it (young and not-yet-born people) are largely different than those creating the risk of the harm.  Another example is refusing to receive the COVID-19 vaccination, as this puts others at risk. However, individuals who do this are also putting themselves at risk– so this can be considered a case of partial moral hazard.  Still, even a partial moral hazard can, in some circumstances (like these), have grave consequences.

Moral hazard  – an economic concept – dovetails somewhat with the behavioral ethics phenomenon of “victim distance,”–  a psychological one.     That is, the more distant we are from the possible victims of our actions the less weight we’ll likely give to their interests.

Together, these two phenomena present formidable challenges to companies and individuals seeking to promote compliance and ethics (“C&E”), because they may negatively  shape habits of mind that may affect behavior in ways that are difficult to dislodge.  This is true not only of workplace ethical issues but also in other realms as well.

But habits of mind can be forces of good too. Indeed, the full promise of C&E programs goes beyond the business realm to nurturing habits of mind that can be helpful to addressing a wider range of challenges than traditional corporate law abidance and ethicality. Among other things, such habits could include thinking systemically about risk, having a deep appreciation for the interests of other individuals, insisting on transparency where it is reasonable to do so, embracing meaningful approaches to accountability for doing what is right and for stopping what is wrong and protecting truth telling at all costs.

None of these ways of thinking were invented by C&E practitioners. But for many millions of Americans and others there is now a steady reminder through C&E programs of the importance of thinking in these and related ways – and this could provide a foundation for promoting greater ethicality in the broader societal realm, including addressing moral hazard.

There is a lot more that can be said about how ethical thinking in one realm can inspire and support such thinking elsewhere. See this prior post for the somewhat similar suggestion that ethical thinking in the private sphere can strengthen C&E in the business world.  Here is another

2021 behavioral ethics and compliance index

While in the more than nine 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

– Strengthening your C&E program through behavioral ethics

–  Ethics made easy

 Have you checked your behavioral externalities?

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

 Sweating the small stuff

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

– Behavioral ethics training for managers

Assessments

– Behavioral ethics program assessments

Positioning the C&E office

– What can be done about “framing” risks

– Compliance & ethics officers in the realm of bias

 Behavioral ethics, the board and C&E officers

 Lawyers as compliance officers: a behavioral ethics perspective

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

– More on conflicts of interest disclosure

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)?

– Is ethics being short-changed by compliance?

Have you checked your behavioral externalities?

In The Case for Adding Darwin to Behavioral Economics posted on the Ethical Systems web site,  Robert H. Frank  of Cornell University’s Johnson Graduate School of Management writes:

I use the term “behavioral externalities” to describe choices that affect social environments… Because social environments influence us so profoundly, both for good and ill, we have a powerful and legitimate interest in them. We would prefer to live in ones that bring out the best in us and to avoid those that harm our interests. Yet behavioral externalities have received virtually no serious attention from policy analysts, and it’s here that lie many of the most exciting opportunities for young researchers. Once you’ve been alerted to their existence, it quickly becomes apparent that behavioral externalities are ubiquitous. Careful empirical studies have documented the importance of behavioral contagion in such diverse domains as, among many others, excessive drinking, sexual predation, cheating, bullying, obesity, greenhouse-gas emissions, and compliance with public-health directives. Research has tended to focus on negative peer influences, but there is also compelling evidence of positive influences. The adoption of rooftop solar panels, hybrid cars, and plant-based diets, for example, have all been shown to be highly contagious…. As Darwin understood clearly, our fate depends not only on our own decisions and capabilities but also on those of rivals and partners. And that, in a nutshell, is the case for a broader and more inclusive behavioral economics, one that incorporates the rich insights of behavioral biology.

Several points about this.

First, in addition to policy analysts and young researchers, the notion of behavioral externalities should be of interest to compliance and ethics professionals seeking to understand and address cultural risks facing their respective organizations. (Among other things behavioral externalities are relevant to risk assessment.)

Second, I like the idea of adding to behavioral economics  information from other fields of knowledge. My personal favorite in this regard is moral hazard, which – like  Frank’s example – also involves choices that entail  a “rational man” making decisions that work for her/him but which are bad for the relevant larger group.

Finally, for those of you who haven’t read it I strongly recommend Frank’s Passions Within Reason: The Strategic Role of the Emotions. It is one of the most important works in our field.

Are you a member of the “compliance elite”?

In “Compliance Elites ”Professor Miriam Baer of Brooklyn  Law School writes:

“As corporate compliance has expanded its influence, so too has the status of those who implement and oversee the firm’s compliance function. Chief compliance officers (CCOs), who are often (but not exclusively) lawyers by training, increasingly boast the types of resumes one associates with elite lawyers. In many ways, this is good news for compliance. There may, however, be several downsides to a strategy of relying so heavily on a cadre of compliance elites. The aim of this Article is to discuss one of these downsides.”

At the outset, I question how significant the phenomenon of compliance elites is.  (As used by Baer, “the term ’elite’ refers to an attorney’s academic and postgraduate achievements: her education, her awards while in law school, her clerkship, and the various positions she held after law school.” )  In my nearly thirty years in the field I have encountered many CCO’s who, while not elite, have been very successful in developing and implementing sound compliance programs. We still have a ways to go before elite is the norm,  And that to me is a good thing.

Still, as noted above, there are many “pluses” to having elite compliance personnel. Baer lists here recruiting top-flight human capital and otherwise securing necessary resources for the compliance program.  To me this is key, both as a matter of common managerial sense and because the U.S. Department of Justice places great emphasis on these factors in its criteria in evaluating programs.

Additionally, by hiring members of the compliance elite, “the organization emits potent internal and external signals. Within the firm, the CCO’s arrival affirms to its rank-and-file employees that corporate management is committed to improving its compliance effort. That, in turn, improves morale among those inclined to follow the law and potentially induces broader and earlier internal whistle-blowing.”

Finally, on the downside,  Baer argues: “imagine a new CCO confronts a series of performance targets upon entering the firm. Which ones merit the closest attention, and which ones deserve to be shelved immediately? If the firm is emerging from a scandal, the worst systems may be obvious to everyone. Beyond this, however, reasonable people will differ. It will be the CCO’s responsibility to tread carefully but thoroughly in determining which additional performance goals merit a closer look, and it may not be the goal itself that is the problem. It may be how the firm measures the goal, how it compensates (or punishes) performance aimed at achieving said goal, or how quickly it expects its employees to meet its goal that induce different degrees of misconduct. It is within this ambiguous gray zone that performance blind spots are most likely to emerge and do their damage. Absent blunt evidence to the contrary, someone who has repeatedly scored in the top percentiles nationally on standardized tests; who has then followed up that performance by scoring at the top of a law school’s grading curve; and who has bested many of her competitors in series of workplace mini tournaments might not find a series of severe or unforgiving performance targets problematic.”

This is interesting but, in my view, a stretch. While lots of life experiences can contribute to cognitive biases, I just don’t think doing well on  a standardized test rises to that level.

Mapping the field of “”behavioral business ethics”

In “Toward a Better Understanding of Behavioral Ethics in the Workplace,”  David De Cremer of the Business School, National University of Singapore, and Celia Moore of the Cambridge Judge Business School, review literature that is part of the growing area that they call “behavioral business ethics.” They use this formulation to “build a bridge between business ethics and behavioral ethics,” and they consider the various implications of “behavioral business ethics” research.

As their article is itself largely a compilation of summaries of various studies I won’t attempt to summarize it, but do note generally that the article considers the significance of this body of knowledge on three levels: intrapersonal, interpersonal and organizational. They “conclude by recommending future research opportunities relevant to behavioral business ethics and discuss its practical implications.”

For instance, they note that on an intrapersonal level, “understanding what drives people to act unethically is essential to the behavioral ethics approach. Behavioral business ethics helps us identify psychological processes that can be harnessed to ensure that employees and managers do not fall prey to basic human frailties that can derail one’s good behavior. One important practical goal of a behavioral business ethics approach is to gather evidence so managers can be trained to act more ethically themselves, and elicit more ethical behavior from their subordinates, as well as to refrain from moral licensing, where people give themselves credit for initial ethical behavior, allowing them to follow it up with unethical behavior ….”

The article is filled with useful and interesting information, and I do think the “behavioral business ethics” formulation works. And this also poses an appropriate occasion to take note of the formulation I have used in this blog and elsewhere – “behavioral ethics and compliance” – and the mapping (in this blog and elsewhere) relevant thereto.

In brief, behavioral ethics and compliance seeks to:

– Use the overarching message of behavioral business ethics that we are not as ethical as we think to persuade boards of directors and managers of the need for strong C&E programs.

– Use that same message to persuade governmental bodies of the need to adopt enforcement approaches that incent business organizations to develop and maintain effective programs.

– Provide C&E professionals with information that can be used to develop and utilize risk assessments, training, enforcement approaches and other C&E program elements in a behaviorally informed way.

– Provide a similar approach with respect to specific types  of wrongdoing, such as conflicts of interest and insider trading.

The current iteration of the map for this can be found here. I hope you find it interesting.  Finally, note that there is obviously a lot of overlap between the two fields. But hopefully having one specifically tied  to compliance is worthwhile, particularly for compliance personnel.

The gut as accomplice

A review of core behavioral ethics concepts (“Rule-breaking without Crime: Insights from Behavioral Ethics for the Study of  Everyday Deviancy” by Yuval Feldman, Benjamin van Rooij and  Melissa Rorie) noted: “Behavioral Ethics has shown that … people relying on System 1 cognition (characterized by intuitive and emotional decision making, more so than System 2’s deliberation and planning) are more likely to be unethical.”

For the past three years we have seen countless examples of President Trump relying on his gut in making decisions for the country – most recently in saying he would trust his instinct in deciding when to reopen the economy. More generally, as described in an article in The Atlantic ,“Trump’s Most Trusted Adviser Is His Own Gut. The president’s glandular instinct has become a substitute for all expertise and all nuance.”

Even if he loses the election in November, Trump’s triumph of instinct over reason will have caused lasting damage to the moral fabric of our country. To counteract that, we need to strengthen the moral imperative not just to be honest but also to be careful and deliberative, particularly when making decisions that will significantly impact others.  We should heed these words of  Samuel Johnson: “It is more from carelessness about truth than from intentionally lying that there is so much falsehood in the world.” And carelessness is obviously at the root of many other types of wrongdoing too.

One specific  example is suggested by a presentation – “Beyond Agency Theory: The Hidden and Heretofore Inaccessible Power of Integrity,” by Michael Jensen and Werner Erhard – discussed in this earlier post. The authors argue that honesty requires more than sincerity: “When giving their word, most people do not consider fully what it will take to keep that word.  That is, people do not do a cost/benefit analysis on giving their word.  In effect, when giving their word, most people are merely sincere (well-meaning) or placating someone, and don’t even think about what it will take to keep their word. This failure to do a cost/benefit analysis on giving one’s word is irresponsible.”

There are many other examples of how more deliberative thinking can lead to less gut-led actions.   Big picture: ultimately we need to get to a place where being  uncareful is broadly seen as unethical in the same way that being dishonest is. 

The oldest conflict of interest

Many years ago a client being vetted for a high-ranking post asked me if a question about prior ethical violations required him to disclose a long since concluded extramarital affair. I replied that this seemed beyond the scope of the question, and I would give the same answer if asked today. But a recent paper suggests a different way of looking at this area.

In “Personal infidelity and professional conduct in 4 settings”,  John M. Griffin and Samuel Kruger, both of the McCombs School of Business, University of Texas at Austin, and Gonzalo Maturana of the Goizueta Business School, Emory University: “study the connection between personal and professional behavior by introducing usage of a marital infidelity website as a measure of personal conduct. Police officers and financial advisors who use the infidelity website are significantly more likely to engage in professional misconduct. Results are similar for US Securities and Exchange Commission (SEC) defendants accused of white-collar crimes, and companies with chief executive officers (CEOs) or chief financial officers (CFOs) who use the website are more than twice as likely to engage in corporate misconduct. The relation is not explained by a wide range of regional, firm, executive and cultural variables. These findings suggest that personal and workplace behavior are closely related.”

The ramifications of these findings indeed  seem significant. Included is the negative implication for behavioral ethics: “our findings suggest that personal and professional lives are connected and cut against the common view that ethics are predominantly situational. This supports the classical view that virtues such as honesty and integrity influence a person’s thoughts and actions across diverse contexts and has potentially important implications for corporate recruiting and codes of conduct. A possible implication of our findings is that the recent focus on eliminating sexual misconduct in the workplace may have the auxiliary effect of reducing fraudulent workplace activity.”

For more on the connection between personal and professional ethics see this prior post.

The moral hazard moment

For governments, business organizations and even individuals every moment might have a “moral hazard” dimension. But it would be hard to find one as potentially consequential as that presented by the US general election. Does the compliance and ethics field have a role to play in addressing this?

The concept of moral hazard was used originally to refer to the phenomenon that providing insurance tended to promote risky behavior by insured parties.  Subsequently, the idea has been applied more generally to mean the provision of incentives that encourage unduly risky conduct by shifting the impact of a bad decision to a party other than the decision maker.

Most recently, moral hazard was seen as playing a major role in the economic crisis of 2008, as some of the individuals creating the risks at issue there evidently did not have interests sufficiently aligned with those jeopardized by their actions.  A perfect example of this can be found in an SEC report on ratings agencies quoting an e-mail between two analysts concerning their plans to give positive ratings to certain financial instruments that were, in fact, unworthy of such ratings: “Let’s hope we are all wealthy and retired by the time this house of cards falters.”

Notwithstanding its name, moral hazard is generally viewed as more of an economic phenomenon than a moral one.  Moreover, moral hazard risks are often seen as somewhat distinct from COIs, perhaps because the interests at issue in the former are not external or unknown to an affected organization.  (A typical COI concerns ownership of or compensation from an entity other than one’s employer, whereas a typical moral hazard risk is likely to be based on the employer’s own compensation scheme.) However, the two are similar in that both tend to diminish the fidelity of employees to their employers’ interests – a decidedly moral consideration in the traditional sense of the word.

Something similar concerning the misalignment of risks and incentives can be said about the political realm. Most importantly, with climate change those who are most likely to be affected by this unparalleled calamity are generally not the same as those who have the power to slow it down (and ultimately reverse it). The same phenomenon is at work with a host of other risks (including incurring dangerous levels of public debt) where the consequences will be borne by individuals who were not the primary causes of the risks.

Where does C&E fit into this picture?

The full promise of C&E programs goes beyond the business realm to nurturing habits of mind that can be helpful to addressing a wider range of challenges than traditional corporate law abidance and ethicality. Among other things, such habits could include thinking systemically about risk, having a deep appreciation for the interests of other individuals, insisting on transparency where it is reasonable to do so, embracing meaningful approaches to accountability for doing what is right and for stopping what is wrong and protecting truth telling at all costs. It should also – in my view – include identifying and addressing situations of moral hazard

None of these approaches were invented by C&E practitioners. But for many millions of Americans and others there is now a steady reminder through C&E programs of the importance of thinking in these and related ways – and this could provide a foundation for promoting greater ethicality in the broader societal realm, including addressing moral hazard.

There is a lot more that can be said about how ethical thinking in one realm can inspire and support such thinking elsewhere. See this prior post for the somewhat similar suggestion that ethical thinking in the private sphere can strengthen C&E  in the business world. It is not a new idea. But I doubt the importance of adopting a robust approach to moral hazard will ever be greater.

 

Program assessments and moral hazard

Rebecca Walker and I hope you enjoy this article from today’s edition of Corporate Compliance Insights.

The 2020 behavioral ethics and compliance index

While in the more than eight 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

Strengthening your C&E program through behavioral ethics

–  Ethics made easy

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

 Sweating the small stuff

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

Behavioral ethics training for managers

Assessments

Behavioral ethics program assessments

Positioning the C&E office

– What can be done about “framing” risks

Compliance & ethics officers in the realm of bias

 Behavioral ethics, the board and C&E officers

 Lawyers as compliance officers: a behavioral ethics perspective

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

More on conflicts of interest disclosure

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)?

Is ethics being short-changed by compliance?