Wednesday, December 30, 2015

On the Financial Crisis of 2008: Why Business Ethics Failed

I submit that the academic field of business ethics failed in not being able to anticipate the fraud and exploited conflicts of interest that precipitated the financial crisis of 2008. That is to say, business-ethics scholars, including myself, failed utterly. To the extent that the general public relies on us to shoot off flairs in advance of a high likelihood of icebergs in the water ahead, we failed in our social responsibility, ironically as many of us were admonishing corporate managers to be socially responsible. Many who did so used could use their programs as advertisements or even window-dressing. In this essay, I point to some of the academic reasons why business-ethics scholars failed so miserably.

I think the focus on ethical decision-making is culpable here, as it diverts attention from the institutional level(e.g., inter- and intra-institutional conflicts of interest that are themselves systemic).  Also, the focus assumes that managers want at least to consult the ethical dimension (or worse, that they can become ethical by knowing how ethical decisions are or should be made). The  2015  film, "The Big Short," makes the point that this assumption is faulty at best.

Relatedly, the "managerialization" of the field, as evinced in coming up with procedures by which to make decisions in terms of ethical principles (and, in the field of Business & Society, in CSR2), may mean that business-ethics scholars think too much like managers, so we didn't see the systemic failure coming. We did not have a vantage-point by which we could have seen what the Wall Streeters couldn't (except for a few of them).

I think the hegemony of the individual and firm levels in the field has also contributed to the failure in that business ethicist scholars missed even the obvious ethical problem in how rating agencies are compensated. We also missed the inherent conflict of interest in a bank having its own proprietary holdings apart from those that serve as counter-parties to client trades.

In short, I contend that business ethics is too managerial in perspective (and content) and too micro. My intuition tells me that business ethics scholarship missed (and misses) the forest for a few trees. I would even say, moreover, that scholarship from business schools is not sufficiently distanced from the phenomena being studied. I suspect that many professors of business are caught between identifying themselves as managers and scholars, and this is no doubt reflected in their work because they are actually in neither camp.

The department of business environment and public policy at Pitt, in which I studied as a doctoral student, was an exception in that most of the faculty members had doctorates in disciplines including political science, sociology, and psychology, as well as institutional economics. While the make-up was not managerial culturally--the department was quite obviously the part that was "not like the others" in the school (quoting here from PBS's "Sesame Street";); yet even so, the academic orientation was managerial! I suspect that that department's faculty tried especially hard to be managerially useful because they had come from disciplines in the social sciences. With the subfields being Business & Government, Business & Society, and Business Ethics (though I would argue that it was an exogenous field on account of the lack of ethical theory courses), such a department was in theory almost uniquely (along with Berkeley and Minnesota, at the time) in a position to see the iceberg in the dark (trading) water ahead. Scholars in "Business, Government & Society" were too managerial--too wedded to the system to be really critical--and not academic enough--in the sense of not grasping the real significance in the subject matter--to get the big picture: that the system itself was (and still is) riddled with fraud and self-serving behavior shamelessly at the expense of the whole system. Not seeing the Wall Street culture of greed and opportunism as the proverbial canary in the coal mine, the scholars missed the blatant fraud at Wall Street banks, mortgage servicers such as Countrywide, and the related rating agencies at the expense of investors, clients, and the general public. Scholars at business schools should have had megaphones to warn the American people of the baleful existence of the major institutional conflicts of interests that should be rather obvious to everyone. The silence of the learned enabled the self-satisfied business practitioners to assure the public that the institutional "firewalls" could be trusted to prevent such conflicts from being exploited even as they were!

Meanwhile, I "overshot" while I was in the doctoral program, taking the macro orientation to the point of the business SYSTEM as an entity in relation to other systems in society (e.g., the system of government). Hence I missed the inter-institutional conflicts of interest WITHIN the business system (e.g., the way CPA firms and rating agencies are compensated). I was resisting the gravitational pull of the manager and firm-level managerial orientation of the field of "Business, Government & Society." I had taken a MBA seminar at Indiana on the environment of international business, which studied economic, financial, governmental, and cultural/religious systems, and I patterned my doctoral studies at Pitt on that course (even getting a MA and Ph.D. minor in religious studies and taking substantial coursework in international political economy in political science).

Looking back, I'm astounded that through the coursework in "Business, Government, & Society" at Pitt, the only coverage of conflicts of interest was confined to the "regulatory capture theory," wherein regulators depend on the regulated for information. Even for that conflict of interest, the siphon of information now strikes me as hilariously minimalist. How about the revolving door? How about political pressure on the SEC from government officials who have accepted political donations from Wall Street banks? How about ex-CEOs of those banks serving as high up as Secretary of the Treasury?

We should not count on practitioners to recognize even monstrous institutional conflicts of interest. When I briefly worked as a staff-auditor (before going back to academia out of sheer boredom and lack of brain-stimulus), I had used a tickmark, "As per comptroller, discrepancy resolved" without even noticing how inherently ethically problematic it is. An independent audit that takes the word of the comptroller. Decades later, I was shocked to hear the man in charge internationally of that CPA firm's internal "firewall" tell me that such a device is effective. I submit that it was not, is not, and in fact cannot be so, and yet the Dodd-Frank financial reform law of 2010 looks the other way. Nice.

That structural conflicts of interest are still in place in public accounting and the rating agencies, as well as at post-Glass-Steagall banks in spite of the financial crisis and even the Dodd-Frank Act suggests to me that the pedestrian "scholars" (aka managerialists) in the field of business ethics still don't get it. The public is still left unprotected.  The American people really needs scholars of business ethics who DO get it and can inform the public honestly even if future consulting gigs take a hit. Sitting in on a doctoral seminar in business while visiting a school before the financial crisis, I was stunned when the professor told his students (who had been bankers) to run their research conclusions from surveys (i.e., empirical research) by the managements of the firms surveyed and change the conclusions as needed so as to keep consulting possibilities open. What if one of those students went on to knowingly publish a flawed risk-analysis metric? As we know from the case of systemic risk in 2008, the financial system could hang in the balance. Perhaps the "regulatory capture" theory should be applied to business schools. Astronomers who study Mars certainly don't live there or try to act like Martians; likewise, business scholars should not conflate themselves with their subject matter. A certain distance between the scholar and the thing being studied is necessary for good scholarship--that is to say, scholarship that gets the big picture concerning the object of study.  

Anyway, all this is to explain my gut reaction at the end of the film: Business ethics failed. It was the sort of immediate intuition that falls with a thud on concrete. My field failed. I failed. How could I have not seen it? How presumptuous of me to think that the financial crisis would be a great case study for me to teach and write about, my past studies, beginning at the masters level, of the environment of business notwithstanding. Relatedly, how presumptuous of the people at the helm in government and business who missed the danger signals to go on to consider themselves vital in saving the financial system and economy. The U.S. Treasury Secretary and the Chairman of the Fed--a scholar whose dissertation is on the Great Depression!--didn't see the iceberg ahead and yet both presumed to be the men of the hour to fix the ship.