Research

Your career, our economy: Stakes are high when finance professionals let ethics slide

Bernie Madoff. AIG. Allen Stanford. When Marianne Jennings talks to her undergraduate students about business ethics these days, those are the subjects they want to talk about. Not surprisingly, Jennings says, the students often take a somewhat black-and-white view of things: Madoff was a crook; Stanford was a swindler; those execs at AIG were reckless, irresponsible, and had absolutely no right to take those big bonuses — not after the carnage they caused. Blame it on the executives, the students say. It's the guys in the executive suite who can't be trusted. Not so fast, says Jennings. The lesson to be learned, she says, isn't that executives have to act more ethically. Instead, it's that everyone must act more ethically.

2009-06-30

Bernie Madoff. AIG. Allen Stanford. When Marianne Jennings talks to her undergraduate students about business ethics these days, those are the subjects they want to talk about. Not surprisingly, Jennings says, the students often take a somewhat black-and-white view of things: Madoff was a crook; Stanford was a swindler; those execs at AIG were reckless, irresponsible, and had absolutely no right to take those big bonuses — not after the carnage they caused.

Blame it on the executives, the students say. It's the guys in the executive suite who can't be trusted. Not so fast, says Jennings. "They're really quite jaded because they've seen so much," she says. "They believe everyone in business is corrupt. They think that's the way they'll have to behave to get theirs, and they do seem to seize on things like executive compensation.

But that's a risky and narrow focus when there's so much more that they have to consider. "So I say, 'No — you don't get off that easy.' I tell them, 'You've got to take a little bit of responsibility for yourself.' … Because it's not just the schmucks up in the board room that did this. They can't do it alone.'"

That's the message that Jennings has been preaching to her students since the Wall Street meltdown last year. A W. P. Carey Professor of Management and author of "The Seven Signs of Ethical Collapse: Understanding What Causes Moral Meltdowns in Organizations," Jennings admits that the current economic troubles make for a very "teachable moment." But Jennings also says she has to work really hard to make sure the right lesson is being taught.

That lesson, she says, isn't that executives have to act more ethically. Instead, it's that everyone must act more ethically. Here's why: AIG didn't fall because of the actions of one man; Bernie Madoff and Allen Stanford didn't act alone; the world's banks were not brought to their knees by one guy in a corner office.

"It's easy for us to say, 'Well, look at Bernie Madoff — I'm not capable of stealing $50 billion,' and that's probably true," says Jennings. "But Bernie didn't start that way. It was probably a progressive kind of thing. We tend to demonize people and not dig deeper or ask, 'How did he get away with it for so long?' Those are the real issues, the ethical issues, the choices that people make from day to day that allow these kinds of things to keep progressing. You're the demon and you didn't realize it."

There is plenty of blame to go around, Jennings says. Each of these crises could have been prevented if enough people simply did the right thing — the ethical thing — when they had the chance. "What we really ought to be focusing on is how these situations result from the day-to-day decisions that employees make," Jennings says.

"If we reduce this down to the schmucks who took the big bonuses, we're missing the point, because they can't do this without complicity. How you do your books, how you handle your sales, what's going on the loading docks — like, for instance, shipping a product today even though you know it's not ready and you say, 'Well, we'll fix it in the field' — these are the day-to-day issues that can lead up to the kind of big mess that we have."

Time to change for the better

Jennings believes we need a fundamental change in the way American companies do business. For too long, she says, companies have acted lawfully. The time has come, she says, for them to actually act ethically. Many companies don't act ethically, which is surprising, since careers and companies in the financial sector are built on trust. Enron CFO Jeff Skilling is barred, by law, from ever working again at any publicly traded company.

But as L. Wendell Licon, a W. P. Carey Clinical Assistant Professor of Finance, jokes, the ban is hardly necessary. "The way I look at it is this: Let's just say for a moment that the Feds couldn't make anything stick on Madoff, legally speaking," Licon says. "So what? Basically, he's done anyway. Nobody would ever trust him again. These guys have no trust any more, and anything they've done or can do of value has basically gone out the window."

Licon argues that those working in finance should act ethically because they cannot survive in finance if they are even perceived as being unethical. Taking it one step further, Licon said that sometimes, being right isn't even enough. Licon remembers an incident that happened while he was working as a trader in the foreign exchange market where, in this instance he was selling dollars and buying pounds sterling.

The usual procedure, Licon says, is for the buying and selling traders to agree to a rate for the currency during a phone conversation. The deal is not committed to paper until it reaches each trader's back office. At that point, the traders are asked to confirm that the written deal matches what they agreed to on the phone.

On this day, Licon negotiated to sell dollars and buy pounds, but when his back office gave him the paperwork to confirm the trade, it showed that he was selling pounds, not dollars. "I called the other trader and I asked her what she had — she confirmed the back office version," Licon recalls. "We were at a gentleman's bypass." They decided to listen to the recording of the call, and Licon was vindicated — the trade was to sell dollars.

Ironically, however, the trade represented by the erroneous paperwork — pounds for dollars — was actually more profitable. Realizing this, Licon's colleague in London offered to stand behind her mistake, giving Licon the profits, but he said no. He was technically right, but taking advantage of the situation would have damaged his relationship with the London trader.

Trust, he said, is more important in the long term than any short term profit. He understood the value of his London colleague's trust. If everyone understands this, why have there been so many high-profile fraud cases? Unfortunately, some people can't resist that the short-term, one-time gain — especially if it's large.

"In some cases these are one-time events, and the penalties maybe aren't high enough," Licon says. "The one-time payout from 'winning' is big enough to outweigh the cost of getting caught. If you know this is the last point in the game, you're willing to break all the rules. This seems to be an area where laws or regulations might be beneficial."

Compliance vs. the right thing — always the same?

Even highly respected companies sometimes push the envelope. Take Apple. The tech giant is one of the most celebrated and revered companies in the world, pumping out one hit product after another, grabbing enormous market share and managing to remain 'cool' in the process. There are certainly dozens of geniuses stoking the Apple machine, but there is only one genius that stockholders know and trust: Apple founder Steve Jobs.

Widely viewed as the creative force behind the company's success, Jobs may be more closely linked to his company than any executive in the world, yet Apple has been consistently evasive about Jobs' various health problems. Most recently, the company failed to disclose to shareholders that Jobs had undergone a liver transplant. Technically, Apple didn't have to disclose Jobs' health problems.

Regulations state that the health of a CEO is not "material" to a company's financial health. But in this particular case, Jennings says, the right thing to do — the ethical thing — may have been to tell shareholders about Jobs. "That Steve Jobs situation — that's really a finance issue, isn't it?" she says.

"One of the main things behind financial reporting is disclosing everything that's 'material.' Well, is Steve Jobs' health material? What a great ethical issue." Jack Welch provides another example. There may be no more celebrated CEO in history than Welch, who almost single-handedly saved GE back in the 1990s.

The company was struggling when Welch arrived, and he was merciless in his efforts to get the company back on track. He earned the nickname "Neutron Jack" for his mass layoffs; the workers disappeared, the buildings were left standing. His plan worked, though. GE stock value rebounded, and by the time Welch left, the company was among the most powerful in the world.

But recently, even Welch has begun to question his actions — and his strategy of boosting stock price at all costs. As he told the Financial Times: "On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not strategy. … Your main constituencies are your employees, your customers and your products." In essence, Jennings says, Welch came to realize the health of a company goes much deeper than the numbers on a financial statement.

It's a lesson U.S. banks learned last fall. "In finance, there are so many tools of that trade that will allow you legally to do certain things," Jennings says. "I mean, these banks, on paper they looked great. Then when you dug deeper you saw a lot of manipulation. That's a profound ethical issue.

These banks were well within accounting standards and laws. But ethics? Was that really full disclosure? And financial statements are never the product of one person. Sometimes I don't think people even realize they're in the midst of an [ethical dilemma]. But that should be our [entire] focus now."

Will the lesson be learned?

Encouraging ethical behavior should be our focus, Jennings says, not only because acting ethically is by definition right, but also because unethical behavior always has consequences. Like Licon, she says that too many fail to realize that unethical behavior jeopardizes not only individual careers, but the viability of the economy as a whole. "For a short term, [unethical behavior] works really well," Jennings says.

"Maybe it helps the company perform well. Shareholders are happy. The stock price climbs. But then there's a price to be paid. That's the part of the story that nobody seems to get. All of those subprime mortgages were perfectly legal, but they created this long-term difficulty. When the bubble bursts, we're all in trouble. We all have to pay."

What is most remarkable, Jennings says, is that this latest meltdown occurred less than a decade after the previous meltdown — the Enron-Tyco-WorldCom trifecta of fraud that caused shareholder uproar, sent executives to jail, and eventually led Washington to enact sweeping new regulations. Sarbanes-Oxley demanded more accountability and transparency from American corporations.

And for a while, the rules seemed to work; years passed without an Enron-sized blowup. But did the regulations really work? Jennings isn't so sure. And her great fear now is that the business world will count on the latest regulatory rules from Washington to "fix" the current broken Wall Street culture. History speaks for itself, she says. Washington can't fix Wall Street. Only Wall Street can fix Wall Street.

"These are the same lessons we should have learned in 2001-2002. These are the same lessons we should have learned in the Savings & Loan crisis," Jennings says. "We're repeating the same thing. And I worry that my students think regulation can fix this. We should be taking all of these cases and really zeroing in on what went wrong on a very human level."

"Even with Bernie Madoff, I mean, come on. How come there was only one person with access to the computers? How come we had these statements that were being generated but nobody knew, or asked, how we were getting to those numbers? All of us play a role in this. But we never talk about it."

Bottom Line:

• The scandals involving Bernie Madoff, Allen Stanford, AIG and others have once again raised questions about ethics in the world of finance.
• But while the focus in many of these cases is on the executives at the top, it's important to note that none of these executives actually acted alone.
• Every day, employees in financial institutions are faced with ethical dilemmas large and small. It's just as important for those staffers to make the right decisions as it is for the executives to make the right decisions.
• Moving forward, government may enact strict new regulations to keep companies honest. But in the end, it's up to the companies to act ethically. If they do, they will benefit in the long run.

Finance Management Faculty