By Lee E. Biggerstaff, PhD Candidate, University of Tennessee, David Cicero, Assistant Professor of Finance, University of Alabama, and Andy Puckett, Associate Professor anf the Massingale Scholar in the Department of Finance, University of Tennessee. Originally published at VoxEU.
Curbing corporate misbehaviour is a key policy goal but fixing the problem requires an understanding of what causes it. This column develops an innovative empirical approach that identifies unethical CEOs as an important cause of unethical corporation behaviour.
One of the great features of the modern economy is that firms can be owned by a diverse group of outside investors while day-to-day business operations are delegated to full-time managers. Such ownership arrangements allow for immense economic gains since capital is allocated to its highest use and risk is born more efficiently.
- This modern ‘separation of ownership and control’ introduces potential problems in that managers do not always invest the resources delegated to them as the owners would like (Fama and Jensen, 1983).
In addition, mangers sometimes fail to accurately inform investors about how business is going – especially when it is not going as well as was hoped.
- The costs that can result when managers exploit information asymmetries to intentionally mislead investors can be quite dramatic.
This can be seen in the market losses associated with financial statement frauds uncovered at firms such as Enron, WorldCom, Tyco, and HealthSouth.
As a result of these frauds and others, the US Federal Government passed the Sarbanes-Oxley Act in 2002 in order to help restore investor confidence in the modern corporate structure.
Business Ethics and Sarbanes-Oxley
The subject of business ethics and the refinement of provisions in the Sarbanes-Oxley Act continue to occupy a prominent role in on-going public policy debates. Of particular importance in the current dialogue is an understanding of (and potential means to mitigate) the forces that drive firms to mislead investors and cause the misallocation and destruction of scarce societal resources. In short:
- Where does an unethical culture originate?
Anecdotal evidence suggests that these fraudulent firms were often characterised by an unethical culture that permeated a nexus of employees, whose cooperation was necessary to perpetrate extensive corporate malfeasance. For instance, approximately thirty employees at Heathsouth and Peregrine Systems were convicted or pled guilty to charges related to financial statement fraud.
Our recent research suggests that it may be driven by the actions and attitudes of those at the very top level of corporate leadership – in particular the CEO (Biggerstaff, Cicero and Puckett 2013). Our findings are consistent with a growing literature that emphasises the influence of those in the upper echelons of corporate leadership (Chatterjee and Hambrick, 2007; Hambrick 2007).
The challenge when exploring the influence of an executive’s character on corporate culture is that the character of top executives is inherently difficult to measure.
- We propose a novel way to identify an unethical pattern of behaviour, based on an executive’s systematic participation in options backdating.
Options backdating refers to the manipulation of stock option grant or exercise dates (and therefore grant or exercise prices) in order to maximise an individual’s eventual pay-out – without reflecting the magnitude of the compensation on firm financial statements (or to the tax authorities).
- Option grant dates were often backdated to reflect grant on an earlier date when the stock price was lower.
This meant the corresponding option strike price was also be reduced.
- Option exercise dates were at times backdated to correspond with dates with low market stock prices.
This was to minimise the tax burden incurred by the executive receiving new shares of their underlying stock.
One might recall that a great deal of attention was focused on this controversial practice, common in the late 1990s, following a series of articles published by the Wall Street Journal in 2006.1 Options backdating for top executives likely indicates stealth (nefarious) activity undertaken for personal gain and to the detriment of shareholders and taxpayers.2
In a nutshell, we assume systematic participation in options backdating serves as a reasonable indicator of unethical behaviour on behalf of the chief officer. This allows us to test whether this behaviour is associated with an unethical corporate culture.
We use a largely data-driven approach to identifying CEOs who personally benefitted from options backdating.
- We consider CEOs to be ‘suspect’ if at least 30% of their options events (grants and/or exercises) were likely backdated.
- Using data from 1992 to 2009, we identify 249 suspect CEOs using this rule, and augment this list with 12 additional CEOs who were specifically named in enforcement actions or backdating settlements.
Our results indicate a strong association between the identified executives and other forms of corporate misbehaviour.
- Firms with backdating CEOs are almost 15% more likely than other similar firms to narrowly meet or beat analysts’ quarterly earnings forecasts – a tendency previous researchers have pointed to as evidence of accounting manipulations aimed at bolstering stock prices (Hayn, 1995; Degeorge et al, 1999).
- Consistent with this interpretation, firms with backdating CEOs also use significantly more positive discretionary accruals (i.e. accounting manipulations) in the quarters when they narrowly attain these thresholds.
We extend our analyses by investigating the investment activities of firms with backdating CEOs. We find:
- Firms with backdating CEOs make significantly more acquisitions and that their acquisition announcements are met with a significantly lower market response.
Prior studies (Jensen, 1986) provide evidence that excessive acquisitions (i.e., ’empire building’) provide numerous pecuniary benefits for bidder firm executives but often damage the welfare of shareholders. Interestingly, these firms were particularly more likely to acquire private targets. This may reflect a practice by unscrupulous managers of acquiring opaque assets, the reported values of which may be manipulated at the time of combination in order to gain flexibility for further earnings manipulations.
- It is also notable that the questionable acquisitions and earnings management activities that we document are concentrated in firms that hired their suspect CEOs from outside of their firm.
This pattern suggests that the greater information asymmetry faced by boards when bringing in external candidates may at times lead to costly adverse selection of chief executives who are ethical ‘lemons’.
- Our tests also demonstrate that there are significant increases in earnings management and acquisition activity after backdating CEOs arrive at their new firms, relative to that observed around CEO transitions at other similar firms.
These results suggest that hiring a CEO with low character can lead firms to adopt questionable corporate practices, and illustrate the importance of rigorous due diligence by boards when selecting new executives.
Impact on Market Valuation
Our study concludes by assessing possible adverse consequences that might result from hiring an unethical CEO.
- We find that the market did not penalise firms with unethical CEOs during the run-up of the late 1990s and early 2000s.
- However, during the ensuing market correction, these firms were 25% more likely to experience severe stock price declines (defined as at least a negative 40% annual return).
If there was a silver lining to that storm, it is that it helped the boards of firms with unethical CEOs to see the error of their ways, as they also replaced their ill-chosen CEOs with a greater frequency.
This work suggests that integrity – in particular, executives’ integrity – matters for corporate outcomes. It provides evidence that the ethics of corporate leaders is an important determinant of the ethical cultures of the firms they manage, in support of an ethical dimension to the “upper echelons theory” of corporate behaviour first proposed by Hambrick and Mason (1984). It also should serve as notice to investors and directors of the extent of damage that can accompany a poorly managed executive search.
Biggerstaff, Lee, David Cicero and Andy Puckett, “Unethical Culture, Suspect CEOs and Corporate Misbehavior”, working paper, the University of Tennessee.
Chaterjee, A and D Hambrick (2007), “It’s All About Me: Narcissistic Chief Executive Officers and Their Effects on Company Strategy and Performance”, Administrative Science Quarterly 52, 351-386.
Degeorge F, J Patel and R Zeckhauser (1999), “Earnings management to exceed thresholds”, Journal of Business 72 (1), 1-33.
Fama, E and M Jensen (1983), “Separation of Ownership and Control”, Journal of Law and Economics 26(2), 301-325.
Hambrick, D (2007), “Upper echelons theory: An update”, Academy of Management Review 32 (2), 334-343.
Hayn, C (1995), “The Information Content of Losses”, Journal of Accounting and Economics, 125-153.
Heron, R and E Lie (2007), “Does Backdating Explain the Stock Price Pattern around Executive Stock Option Grants?”, Journal of Financial Economics 83, 271-295.
Jensen, M (1986), “Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers”, The American Economic Review, 76 (2): 323-329
Lie, E (2005), “On the Timing of CEO Stock Option Awards”, Management Science 51, 802-8
1 Credit for suggesting the widespread backdating of stock option grants is normally attributed to Lie (2005), and the Wall Street Journal was apparently motivated to begin their investigation of backdating by this paper and Heron and Lie (2007).
2 There are dimensions of dishonesty, misrepresentation and personal enrichment associated with options backdating for top executives that may not necessarily be implicated by options backdating for the benefit of non-executives.
One of the great flaws of the modern economy is that a firm can be owned by a diverse group of outside investors who don’t give a rat’s ass what the firm does as long as it maximizes their rate of return. Fixed it for ya, as they say.
The bigger flaw is that they can own a diverse group of politicians (through campaign bribes) that are willing to waeken the corporate laws to their suiting. Political corruption permits corporate greed. Actually flaunts it. ONLY public funding of campaigns will fix it, and ONLY a near-100% turnover in 2014 will get us started.
Although I wound enjoy seeing a 100% turnover, the truth is that the next bunch would probably become just as corrupt as the last bunch within a year or so, even with public campaign financing.
Why such moral cynicism?
As a rejoinder, I would cite Jonathan Schell from The Uncounquerable World:
Because hope would ignore the truth that the problem is very much systemic? That one “good man of such stout heart” (gods I can hardly write that laughably earnest rhetorical tripe without laughing my ass off) is going to change even one of any number of interlocking, interdependent, mutually protective institutions that are considered the right, proper and exclusive franchise of a particular elite social class?
Pathos is pathetic, perhaps even by definition. Look what it’s gotten us so far!
@FMexico… Here’s a quote from a fair dinkum lefty.
“this isn’t about a moral argument it’s about mapping reality.” – D
skippy… personally I find it more compelling
I don’t think so. Public funding would eliminate the campaign payola, but we’d also have to stop the Koch Brothers and Soros from bribing politicians through outside PACS and media ads. The key is getting VOTERS to understand that it is the MONEY that is thin nation’s #1 problem.
Yeah, corporate governance is one of the big issues that gets swept under the rug. I remember how the Obots went nuts when a few people dared to question what exactly Rahm Emanuel did on the Board of Freddic Mac. That was fun :)
And then for publicly traded firms, there’s the Vanguard externality – dump the cost of ownership onto Someone Else.
Who was it that said, “A fish rots from the head”?
And, of course, the optimum solution is to punish the fins who actually do all the work. [Snark]
There will always be crooks, thieves and liars who need to be regulated. There are regulators who are hired to police these corporations. They do not do their jobs. The laws and regulations are there; they are just not enforced.
If the cop does not enforce speeding, more people will speed. More people speed, others see the speeding, then they speed. Soon most are speeding. Very simple.
So, the problem is not business organization, it is political organization. Why is the political system responsible for regulation so corrupt? How can it be changed? Citizens United would be a good start.
The perfect example of all the above is right before our eyes. AG Holder bashing a few foreign, Japanese auto parts companies is not going to slow down the American, home grown, accelerating and Massive Crime Wave. Holder himself will soon be on the other side of the Trade, raking in the profits due him for his inactivity of the past five years.
True but when rules disregard human nature and the current reality, they will be broken no matter how much we try to enforce them. When we put rules that can not be respected by everyone, enforcing them can easily turn into zealotry.
All one has to do is read a good book on neurology and then analyze the structure of our system that was put in place based on principles from the 1700-1800 when the global population was something like 500M to 1B and there was still land to conquer and one easily sees many contradictions.
The irony as that instead of looking forward, there is a growing movement trying to overthrow science and another one trying to guess what the founding fathers would have done.
And with good reason. As John Maynard Keynes wrote in Essays in Bigography (1933), “Economics is a very dangerous science.”
I do agree with that, but at the same time, im pretty damn sure thats not the ‘science’ he was referring to Mex.
Specifically, I think he was referring to Robert Malthus, and more generally to classical economics, which in contemporary parlance has been rebranded as “neoclassical” economics.
What we hear a lot of these days is the no true Scotsman fallacy, that is “economics is not a science.”
Keynes, however, lived in an age which disabused one of any romantic delusions about science. Science is Janus-faced, something which comes through loud and clear in Keynes’ discussion of Nazism and Einstein. The Nazis, Keynes wrote,
It should come as no surprise that, after the Nazis had been dispensed with, it was the other “blond beasts,” the American and European capitalists, who should “vent a particular fury against” Einstein, as Susan Neiman explains here:
The MSM and leading intellectuals on both sides of the Atlantic dismissed and marginalized the socialist Einstein as “Luftmenschen, “the bumbling professor with the German accent,” “a comic cliche,” “an eteral child,” “a wise Naivität,” “childlike,” “wholly without sophistication,” “innocent,” and “lacking a certain closeness to reality.” As Neiman concludes, “the picture of Einstein as clown is alive and well on both sides of the Atlantic.”
So choose your science: Einstein or the blond beast.
Actually, I was referring to neurology.
@FMexico…. about Einstein, he didn’t – like – the Heisenberg principle. Why?
skippy… false choice thingy.
Speed of light and sound are not equal… you can imagine what kinds of data manipulations our brains must make to place all the packets in order.
If you want to read about weird brain distortions, read the book The Man Who Mistook His Wife for a Hat.
Every time science digs a little deeper, we find out a little more… maybe there is determinism at the quantum level but we are so unevolved that we still see it as random.
@Moneta… I get your drift, although my point of order was the false choice offered. Highlighted by Einstein’s personal dislike (bias) over all other considerations. Just think its prudent not to use popular figures with to broad a brush, we are human after all… eh.
The Man Who Mistook His Wife for a Hat thingy… Yep, have seen many manifestations of that via trauma, drugs, high emotional states, et al. BTW wife is a paramedic and teaches at two University’s so there is even more observation, common discussion with in family settings.
skippy… DS/FM is kick ass in my book, just quibble from time to time.
Economics is made up of mathematics, chemistry, neurology biology, ecology, physics, etc.
However, most economists don’t master any of these. In fact, they often manage to apply scientific models without truly understanding them.
Case in point: CAPM.
I don’t buy this “there will always be crooks” and that dealing with the problem is a question of better policing. Better policing just moves us into a police state mentality. I’ve lived in societies that tend to police themselves where it is considered dishonorable to cheat and the steal. Not that this eliminates crime or cheating but that it is rare and therefore manageable with police procedures.
Even in this country cheating and dishonesty was frowned upon I talked to an old Wall Street guy after the 2008 mess and the gist of the conversation was that his generation had codes of honor that this one did not and he was thoroughly appalled and I have found that old-timers, very successful professionals, from many professions had, basically, the same thing to say.
It is not a question of better regulations or better regulators today’s American society is, for the most part, hopelessly corrupt becuase that is the culture we live in. We honor selfishness and gaming the system, we think it is cute and sexy whether it is gangsta music that extols materialism, status and brutal self-assertion or anything else. Morris Berman tells us that U.S. society has always been about “hustling” yes, that is true but there was also always a strong layer of morality that tempered that tendency and most people lived by a that strong code and social institutions enforced it whether it was church, schools, movies and mass media or anything else. Marhall Dillon the main character of *Gunsmoke* avoided gunplay, avoided strong-arm tactics and tried his best to bring in the outlaws to stand trial to follow procedures–he was the opposite of the current cop ideals who always cut corners and have contempt for the limitations of the law.
It’s pointless, in my view, to try to get more cops on the street because if the culture is crooked in every sector you’ll just have more corrupt cops.
All this may be true, but what can be done about it? Its next to impossible for a small group of individuals to change the culture of a nation of 300 million people.
Well, a small group of individuals without expansive capital reserves and extensive media apparatus anyway… And a few decades to work…
I think the “what can be done about it” question is premature. We cannot “do” anything until we have a good handle of our situation and who “we” are to “do” anything. Another way of putting it is that this sort of movement for a new ethics has to come from some ethical foundation. Can we articulate an ethics that makes sense today? This is been a preoccupation of mine for twenty years. I predicted back then the outline for what has occurred because I saw that there was no ethical framework so if there is no strong ethical foundation in this society why not cheat? Why not break the law? Why not game the system? So that is what has happened.
So what to do? Articulate an ethical framework first and then move to communicate that framework to others and create something most of us can agree to.
So then, question two: How does one articulate an ethical framework, and then work to make it more popular?
Maybe the creation of a new ethics involves some of the following issues:
Is the necessary first step in the creation of a new culture the act of individual mental separation or succession from the culture that presently exists?
Are there then a variety of individual practices or disciplines which could eventually result in virtue seeming like a second nature?
Could such practices eventually produce a type of positive asceticism necessary for the creation of a new culture?
Does the creation of a new ethical system require the creation of a different mental state– more capable of observing our present bad habits?.
In creating a new cultural/ethical system are we also talking about a movement from a more passive mode of existence to a more active mode of existence?
Is it possible to subvert the existing culture or do we, in some way, need to almost jump over it?
Does such a jump involve some type of individual strengthening where we make a new life for ourselves and for society?
Has the traditional left paid any attention to such issues?
There is an interesting film done in Britain whose name escapes me that looks at crime in Yorkshire and shows pretty convincingly that when all the money and power in British life migrated to the London area from the 1960s on the local elites abandoned areas like Yorkshire and left them in the hands of real estate “developers”, crooks, local career politicos, and rudderless local police forces that became more and more corrupt. This sounds like most of the US today.
This sounds like much of the United States today. Local elites have either disappeared or fled to NYC, DC, or LA. Without such men (and the occasional woman) local affairs fall into the hands of the local party boss, the District Attorney, the Police union, and the real estate types who supply the “juice.” These petty, amoral, small-time operators sustain a culture of impunity for those on the inside, and spread a debilitating “can’t fight city hall” cynicism which is destructive of a Republic.
How we reinvigorate America’s local culture I have no idea.
It goes on and on. As people move to more rural areas, it is hard to take on the already entrenched corrupt local governments. With the wealthy, older, or retired moving to these areas, there are multiple additional issues of cooperation, trust, ethics, and mindfulness that generate a many faceted culture gap. In a more personal way, there are also issues of individual exposure to liability from organization/community involvement [many local NGOs do not have liability insurance or D&O insurance at all]. It’s very hard to take sophisticated talent and make it fit into cultures. I’ve seen parallels in corporate life, including startups. It’s a jungle out there, and great talent is going to waste every day.
Fareed Zakaria, in a book a few years back, made a case sort of like this, that the culture of the elites is very different from what it was in the early 20th century. In particular I remember him contrasting the college experience between the two cohorts: in the older generations, the dorms were austere, literally Spartan environments, intended to instill a mental and physical toughness, and perhaps “character”; in contemporary dorms at elite schools, the focus has flipped to providing all the amenities of wealth and luxury, even before these children of privilege have begun their careers.
Elites that brought the USA to the pinnacle of power possessed a sense of mission and responsibility and honor that is missing today. Often, these people caused much harm but just as often they were good stewards for the institutions they ran.
I always thought the that movie *Animal House* represented the moral change that came over this country. I, of course, was on the side of the “animals” in those days but I was wrong and a part of me knew it. We did need to break out of the straight-jacket of tired morality to be sure and cultural liberation was a good thing but we did not, sadly, create a new dispensation–we did not know that we had thrown the baby out with the bathwater. The worst of the animals was the Belushi character and the fact he was to become a Senator was one of the more brilliant parts of the movie.
Here we unfortunately bump into that thing called Religion. The call to conscience for the majority unfortunately is through the system of Religion. In America this responsibility was largely abdicated by the Church both organized and unaffiliated. The Christian Evangelicals in America abandoned Christian values to whore themselves out to the GOPers and Corporations. This does not look like changing anytime soon. I am a Church going Christian and have searched fruitlessly for a TV Evangelist or charismatic Pastor who is also against rapacious corporations and greed and is truly an ‘evangelist’ of the values of Jesus Christ. So far I have found none.
Recently with the leadership of Pope Francis there has been a change in Rome’s approach. We see austerity being challenged, gutting safety nets being questioned. I think the Democrats and Liberals have also abdicated from their responsibility to consider that a political system which allows no room for organizing based on religion is doomed to fail. Sometimes I feel it is absurd for the Democrats and Progressives to think that all their flock MUST always think in terms of converting either to being atheist or attending a Unitarian Universalist Church or a Bahaai Temple. Are there no Christian or Hindu or Muslim Progressives or Democrats? From one point of view especially its totally impractical. Take the average person on the street, do you want to wager that they are a Godless atheist or are totally indifferent to religion? Most of these people use religion as a basis for their moral and ethical values even if they are staunchly non-judgemental. How are we going to organize these people or speak to them? How do you re-infuse Society with ethical and moral values? Can we do this without religion and God men? I think its impossible. I must caution that I do not necessarily advocate Christianity as an organizing tool although it would make sense in the Bible Belt and the South (something King did)but there has to be some sort of organizing approach undertaken under every religion which uses a weekly or regular gathering paradigm or creates a mini social network. Just as we take the Evangelicals to task we must also chide the Jewish Rabbis who have been completely absent in this debate. When people like Madoff and Andrew Fastow conduct looting on an astronomical scale did we ever hear any Rabbi standing up to say that I am ashamed of THIS person who professes the principles of my faith? Nope. They have all fallen silent or they couch their disapproval in berating ‘materialism’ from their pulpits.
• PaulArt said:
I think the problem is a little bit more complicated than that. As Eric Hoffer said: “An empty head is not really empty; it is stuffed with rubbish. Hence the difficulty of forcing anything into an empty head.”
Ayn Rand became the latest poster child for the selfishness-is-good religion, a faith tradition which can be traced back five centuries to Machiavelli. As David Sloan Wilson explains in Evolution for Everyone, for “the religous zealot” Ayn Rand “selfisness has been turned from a win-lose proposition to a win-win proposition.” What is good for Rand and bad for you over the short term, according to the tenets of her faith, proves good for her and for you over the long term. Thus, when she and everybody else behaves selfishly, everybody wins.
• PaulArt said:
Yes, but don’t ever believe King didn’t have his hands full with fellow Christians whose heads were “stuffed with rubbish”:
It may also be necessary for the left to rethink the nature of religion–to try and be more explicit.
What if the nature of religion has primarily to do with asceticism, exercises and practices?
Would it be possible to develop a despiritualized asceticism more like different types of training?
Is it possible that after 3000 years or so that we are back to the point where the first step towards a new culture and a new ethics is the necessity of disengagement from the present culture?
Is it time to invent new forms of secession from the corrupt present?
Isn’t the thievery ethic part of the old generation of finance professionals as well–Blankfein, Rubin, Paulson? Or are they the exceptions? A lot of people in the industry regardless of generation saw their chances to steal as much as possible given the moves toward deregulation and the invention of risky investment products geared toward high returns and decided to take advantage of the situation.
Just wondering where HCA, Rick Scott fit on that list?
Yes, profound, I was waiting for the list to see where Lloyd Blankfein was on it. I would rather read William K. Black who has the facts and names the names. Of course, if a CEO backdates options in order to make more pay, he will do many other nefarious deeds to profit even more. Why would a CEO be unethical in some areas and not in others?
Name the names!
Well it looks like we have finance professors ignoring behavioral economics.
Basically almost everyone cheats … a little. In addition the further one is disassociated from the physical cash gain the more likely one is to cheat (backdated options versus a cash bonus). Then there is the slippery slope … a small cheat uncaught leads to a bigger one … Personally I would suggest a much bigger role for the environment that the CEO is in (and the basic nature of humanity) than solely for the CEO, and of course a bigger role for the oversight or more likely lack thereof by the board.
What the professors may be missing is that firms that hire outside CEOs or firms that use backdated options, or firms that go through an acquisition boom may actually be in an environment that causes that behavior.
For example: A company is doing fine, but a new competitor comes along stressing performance. The stock price takes a hit, the CEO may be fired, and shareholders want action. So a new CEO is brought in and tries to prove his/her worth, but faced with the competitive stresses soon finds that to save his/her skin a little accounting massaging is required, and maybe an acquisition or two. And then when the stock price pops a bit (on some or other move) then backdating options becomes a nice way to reward “success”.
The idea of rogue CEOs may make us feel good, but I seriously doubt it will help solve the problem. The real problem is more systemic – human nature and the structure of the relationship of corporate boards and their CEOs.
Behavioral economics has a tainted base line ie: studying humans that grow up in a system and then proclaiming everyone does it – is rubbish in – rubbish out data.
skippy… this is what the classical’s did, hows that working out.
There’s something really wrong with this article that I can’t quite put my finger on.
So, I’d start with the first few words of the first sentence:
“Curbing corporate misbehaviour is a key policy goal….”
and ask, ” In whose policy and on which planet is this a key goal?” I’ve just not seen a lot of policies or goals aimed at curbing corporate misbehavior here on earth is all I’m sayin’.
And who knew that the word “misbehavior” had a “u” in it in Tennessee and Alabama? Is there royalty in Tennessee and Alabama?
What is wrong with this article is the author is clueless about corporate governance. Directors are the biggest problem. They are hired by top executives to rubber stamp executive giveaways, nothing else. For the most part they are celebrity tokens- this one a female, that one a retired general or admiral or congress critter, the other one a minority, occasionally a former executive determined to keep his hand in the cookie jar. These directors serve on multiple boards, and their careers depend on collaboration with executive manipulation and looting. Their compensation looks like chump change, but it adds up by amassing as many as a dozen directorships per individual. You might as well expect these clowns to police executive misconduct as to hope the next Senator or Congressman elect will mount a crusade for effective banking regulation.
The financial statements of just about every public corporation are misleading and obfuscated by impenetrable footnotes. Fraud is not a bug; its a feature.
You say the primary problem is non-exec directors who don’t care, or who are in on the looting. So a solution is to appoint non-execs who do care? How would we do that
1) Have a regulator appoint the non-exec,
2) Have them elected??,
3) Have them appointed by outside consultants,
The profs must show their ideas make sense by backing theory with evidence. There’s no such constraint on your theory. You may be right but you can’t, scientifically, prove it.
Assuming the problem originates with non-exec directors. A leading shareholder could demand that such appointments are outsourced to a consultant. The explicit director recruitment mandate to include an ethical stance on corporate governance.
This is such an obvious possible solution. Has this ever been tried?
We Canadians and the Brits use the “u” in lots of words where the Americans go for efficiency (where less is more):
e.g., behaviour, neighbour, honour, flavour, saviour, armour, glamour, belabour, arbour, colour, clamour, etc.
Businessmen are the worst criminals.
If a murderer kills two people, the next murderer does not feel compelled to go out and kill three people.
If a thief robs a convenience store, the next thief does not feel compelled to go out and rob two convenience stores.
But if one businessman cheats on his taxes, the next businessman must cheat on his taxes, just to compete.
And if one businessman dumps his waste for free in the river, the next businessman must dump his waste for free in the river, just to compete.
But by this ‘just to compete’ business, isnt the real criminal the structure of the economic system and not the individuals?
Of course I do want to point out that individuals with any ethics get weeded out by the system, but that only reinforces the point that its more of a systemic issue than a personal one.
Agreed that our economic structure provides incentives to engage in unethical behavior. However, only some economic actors actually engage in said behavior, despite all actors facing the same or similar sets of incentives. Therefore we can conclude that unethical individuals are at least partially to blame. I think just about any economic structure will have incentives to cheat, but only the unethical will actually follow those incentives. I tried to make this point yesterday in a comment on a paper about fraudulent Yelp.com reviews.
Agree. It is the system. Competition is irrational and unregulated. Because we have lived in this free-for-all for a century. It has been a culture of easy money, but now it isn’t easy any more and capitalism has lately resorted to all sorts of theft by accounting and deception and blatant appropriation. We live in a lawless economy. Strangely enough capitalism still needs its “consumers.” What would happen to capitalism, “capitalism”, if we all stopped buying things? All of us.
One of the major myths of the traditional left is that it is just the economic system which must be changed,
Such an assumption flowed directly from a largely materialistic conception of reality where the base (economic reality) had more power to bring about effects than all other spheres–like culture–which was condemned to the label of mere superstructure for the base.
Starting in the mid-1960s Neo-Marxist theory began to pay more attention to individual psychological/biological structures (think Marcuse) .because many of its major theorists realized the ideology was in crisis.
They then attempted to preserve their ideology by moving from an examination of the production process to an examination of psychic/biological reality of the individual but they only ended up discovering that class society was deeply embedded in all of us.
Such a discovery seemed to narrow the potential of human beings — thus reinforcing an erroneous assumption about the impossibility of changing human nature and consequently they settled for changing only the class system. rather than both ourselves and our class society.
In the last 40 years the left has become incapable of recognizing or appreciating individualized forms of self-creation or the desire for individual self-improvement despite the supposedly all-powerful class system of domination.
And since the left no longer is capable of speaking directly to individuals (only classes as agents of domination and dominated) it has destroyed its mobilizing potentiality.
A thoughtful analysis. I see some hope in the tone of a website such as NC which elicits a healthy response, warts and all, from its readership. Individuality is given its due here.
I’d like to see that list of 249 ‘suspect CEOs.’ Do I recognize any of them? Better yet, does the CEO of the Boxxstore I toil away in ‘make the grade?’
Oh tempura, oh s’mores!
This has nothing to do with where unethical culture comes from. It is merely a description of some metrics to use to gauge the level of corruption in any large corporation. Ethical and unethical behavior has a very different origin.
Endorsed. The profs wrote this article because they believe they can show a causal like and so get published in a proper journal.
Doh… link not like
You want to know where the current corporate culture comes from?
The structure of incentives in capitalism.
“Curbing corporate misbehaviour is a key policy goal but fixing the problem requires an understanding of what causes it. This column develops an innovative empirical approach that identifies unethical CEOs as an important cause of unethical corporation behaviour.”
Dear Mr. Lee E. Biggerstaff, PhD Candidate, and friends,
While you struggle to understand, and while you struggle to develop an innovative empirical approach that identifies unethical CEOs (yadda yadda yadda)….
…..we are only beginning to get started.
From here on, you can expect an inundation produced by the entity Evil, and by the powers of darkness enthroned in power, a terrifying contemporary innovation.
And while you struggle to understand, we will move at the speed of lightning and find a thousand new ways to become even more diabolical and gain even more inspiration from the Principle of Evil.
Your complete annihilation, is, then, no longer a metaphor.
This great Tribulation to come will manifest itself as an inexplicable war, the war of the 0.01 percent against the hapless 99.9 percent, of which historical wars have merely been vague examples.
The following scene shows you, more or less, how things will play out.
See if your innovative empirical approach can identify which one is you, and which one is us:
We are the Peter Pinguid Society, we are the 0.01 percent
The Peter Pinguid Society returns! And there could hardly be a more appropriate post!
While I approve of this article overall, I have to take exception with this statement:
This is the kind of easy, all-encompassing statement, that far too many economists are prone to make. I don’t know of any other science (even social) where a serious scholar could get away with this.
Who, exactly, determines what the “highest use” is? That is a nonsensical phrase. In practice, “highest use” is assumed to be whatever use capital is actually being put to. But who wants to argue that devoting massive amounts of resources to making Swiffers™ and Glade Plug-ins™ is putting our resources to their “highest use”?
The definition of “highest use” turns out to be entirely circular: the highest use of capital is that use to which capital is put by the capitalist system. But even in an ideal, fraud-free, environment, the capitalist system will devote resources not to the “highest use” (however defined) but to that use which provides the capitalist owner/manager with the greatest amount of personal profit. Maybe the way to do that is to use a bunch of money marketing your carbonated sugar-water to the masses. Profitable? Yes. Highest use? I don’t think so…
Since it’s Sunday, I will just respond AMEN.
and again, amen!
on the article yesterday where the discussion turned towards the Mount Pelerin Society, I wondered why the “efficiency” of the all-knowing market was so obviously pre-eminent that they adopted it like a god and set forth like the apostles to spread it over the earth.
efficiency in what? waste creation? resource extraction? shipping things around the world using priceless oil resources that will fall apart within a few years? shipping FOOD around the world? making people pay for things that they need which are designed with planned obsolescence? making people pay for things that they need, but used to produce locally? spending untold resources on convincing people that they NEED glade plug ins and the latest iPod?
this is another claim without evidence, seems to me.
Swiffers don’t look so bad to me.
Sometimes the laziness sets in and digging the vacuum cleaner out of the closet, plugging it in, connecting the hose, putting on the right head, adjusting the brush height for floor or carpet . . . get me a Swiffer already!
I wouldn’t put all society’s capital into Swiffers, but I wouldn’t mind if some businessman puts a little into it. Faaaak, I’ll lay back and have a Coke, umm a sugar water, while I watch the floor, just checking out how clean the Swiffer got it — with almost no work on my part. No vacuum required! hahaha
To quote Bill Hicks: “How about let’s figure out this whole food-air deal first?”
Seems to me that with all the homeless/ jobless folks kicking around that providing life basics for everybody might be a “higher” use to put our capital to…just sayin’. I don’t have anything against Swiffers or Coke per se, but claiming that making and marketing them is the “highest use” to which capital can be put is just, well, craaaaaazy.
I am missing the Swiffer trope. Is there something in the zeitgeist I should be watching, here?
I only use it because of this old Onion article which forever tied swiffer and stupid-consumer-goods together in my mind.
The Onion was better before the web:
A keeper, along with this and this.
Kudos to the authors for placing the blame for unethical behavior squarely on individuals. While, as Massinissa points out above, the structure of our economic system is rife with perverse incentives that make unethical behavior profitable, not everyone responds to those incentives in the same way. Many, perhaps most, businesspeople would not knowingly commit fraud, despite the presence of positive incentives to do so. Those that do respond to perverse incentives should not be allowed to hide behind a “the system made me do it” defense. If the system made them do it, then everyone would be doing it, and that is not the case. The system itself, of course, is hugely flawed and in need of serious re-jiggering, but this fact does not provide unethical actors a release from culpability.
(shameless self-promotion: http://threadingthepearls.blogspot.com/2013/09/problems-with-business-ethics-discourse.html )
The corporation is simply the latest and greatest method of getting, ‘something for nothing,’ the desire nearly all human beings appear to lust after like nothing else.
People will do anything and everything to this end; lie, cheat, steal, defraud, go to war, sell-out their children, etc., etc., etc., just so they can transfer anothers labor-value earned to themselves.
Human beings, scourge of the planet.
So, was this article posted to, usefuly, show how out of touch the academics are? I mean, the comments here appear to just destroy the shallow presumptions these guys hold about what currently is and where came from the active corupt/unethical/amoral/wholly selfish/wholly conceited corporate, legal, and judicial govenance we currently have.
Baby steps! I think it’s pretty amazing that they’re even admitting that CEOs can be unethical, even if 15% seems rather low, especially in the FIRE sector.
what is this here today, the Karl Marx Society?
There’s some good corporations out there, like Coleman that makes camping equipment like tents and lanterns. Not that I go camping a lot, but I like to think I would if I were living another life. At least I think about it and all the trees and mountains come into my mind.
Also, the corporation that makes salmon burgers you can buy in the supermarket freezer. They’re pretty good. Also the one that makes Seasoned French Fries under Shop Rite brand (I think). They are incredibly good!
This will enrage some people, but I like McDonald’s, Budweiser, Lipton Tea and barbeque potato chips from several brands, also Nikon Camera Corporation is OK, so is Epson the fine art printer company. They both do good jobs. Several ice cream companies are OK, like Breyers. It’s OK if they have executives who make money. Then there’s the corporation that makes the New York City busses — my oh my have those busses been good to me, just sitting in the back staring out a window. It’s amazing what you can See, after you’ve checked out the hot women. Then there must be a corporation that makes the fuel — we won’t go there. but you need it, frankly. Then there’s probably a corporation that makes the metal they build subway cars from. It really is quite shiny and nice when it’s new. It’s not so bad. Then there’s the corporation that makes glass for computer screens, like the one right now. How do they do that? I have no idea, I guess you need somebody to show you how. Let them do that, since I have no time to learn. it’s OK if they make money. I don’t mind. it goes on like that and it stops after several hours of typing but this is enough/
So the question then, is could those goods be provided by any other structure than the limited-liability corporate structure that we have today? And would any of those structures tend to lead to more just outcomes than those we are currently experiencing? I argue that the answer to both questions is yes. Gore-Tex, Mondragon, etc. (worker-owned-and-managed coops).
And of course, craazy, it’s fine for the execs to make money…just not all the money. The problem isn’t that execs make money, it’s that they pay themselves way more than they, or anybody else, could possibly be worth. Maybe I wouldn’t mind the CEO’s salary so much if the janitor wasn’t condemned to poverty…know what I’m sayin’?
As for Coleman stoves, I wouldn’t recommend them, FWIW. If you want a good camping stove, I suggest an MSR Whisperlite. Also produced by a corporation, of course…
Surely you do not mean to suggest that worker-owned co-ops you mention do not enjoy limited liability. It would be malpractice for a business associations lawyer to organize such an association without taking advantage of limited liability laws.
In truth, the significant difference between business associations is not whether they enjoy limited liability, but whether they distribute the profits to someone called “shareholders” or whether they do something else with them. Either way, they have to make profits. If they continually make losses, they will run out of capital and go bankrupt.
Coleman was acquired by “Chainsaw Al” Dunlap, CEO of Sunbeam in 1998. Like the crooks of Wall St, this abominable psychopath got away with fines and no jail time. Where were the regulators and DoJ back then?
A corporation is not a moral agent. Therefore, a corporation cannot be “good.”
Would you then argue that a corporation is an amoral agent? If so, what set of guidelines would rule: business, community, regional, international, theological? Is it a question of scale? Local businesses respond to local needs, while international businesses respond to strictly international needs? So, what buffers the effects of the corporations actions on the individual, the most local of spheres? The individual is essentially powerless against the corporation. Hence, individuals band together and form corporations of their own, Governments. In the Meta Corporation Wars, now going on in a community near you, and you, and me, what rules control? There, I’ve said it, control. No more rugged individualist. No more Captains of Industry. The Hand can no longer be hidden. We are not in Platos Cave. Time to wrestle with the Angel.
I don’t know. We’re discovering and inventing…
Suppose all options needed to be registered with the IRS on the date they were given. Problem solved?
Problem not solved. Did you not read the posts be billwilson and ‘s spade’? This is just an example of the system being gamed. There are an endless number of ways to game a system.
“Curbing corporate misbehaviour is a key policy goal”
Is there evidence to support this statement?
Absolutely friggin’ right! Man, the first paragragh alone is nothing but BS statements. Lambert, where are your colour crayons! (it was crayons that Control used in “Tinker, Taylor, Soldier, Spy”, wasn’t it?)
No, Carla. What a nifty allusion, though!!!
Fraud is nearly always about a network of people who can scratch each other’s backs. The origins are often in family, clan or social-training events where the participants can meet and make suggestions to each other (sex is often involved).
One of the things we teach managers is networking. In business schools we might teach what Middle Eastern wasta systems are but are unlikely to explore our our fraudulent dealings based on a combination of dirty hands morality and the bottom line excusing all. Fraud is built-in to many accounting systems through ‘discount deals’ – as in me having to bill a project for Dell laptops I can buy for £500 at £1000 each. I don’t get the money – it comes back to central accounts in the discount deal. The loser is the research fund who get the £1000 bill. This and much worse goes on in our universities.
These researchers don’t get anywhere near origin.
On fraud as networking: I agree. If there’s one approach to a critique of Black’s work on accounting control fraud that I would make, it would be that he seems to take the firm as his unit of analysis. But clearly accounting fraud in the housing crash happened across firms, for example the servicers outsourcing fraudulent document creation.
This back-scratching can be quite supple. You can’t draw a line between mutual aid and back-scratching. In the profs example not all CEOs see themselves as looters. They are just bending the rules a little.
By definition, actual fraud means breaking laws.
Monday 30 September 2013
The Reserve Bank of Australia is meant to maintain stability in the nation’s financial sector. It is supposed to be above reproach in its behaviour. But is it?
Why did bank-appointed officials and employees break sanctions in Iraq and cosy up to Saddam Hussein through a “front man”? Why did a former Deputy Governor and other directors hand-picked by the Reserve Bank to safeguard its subsidiary companies from corruption, end up — over a decade — overseeing some of the most corruption-prone business practices possible? Why did they allow millions of dollars to be wired to third parties in foreign countries, including an arms dealer, in order to win banknote contracts in deals police now allege involved bribery and corruption?
Next week on Four Corners two whistleblowers-turned star police witnesses from RBA companies, Note Printing Australia and Securency, reveal for the first time how they discovered bribes were allegedly being paid… and how the most senior figures in Australia’s worst corporate corruption scandal got away with allegedly egregious governance failures.
“That someone can get away with it so blatantly, a board, and a chairman… you know it, it’s not right.” Whistleblower
For the past four years the Governor of the Reserve Bank, Glenn Stevens, has maintained that neither he nor officials knew about the alleged payments before 2009. We find out exactly who knew what and when.
Until now the Federal Police and the corporate watchdog, the Australian Securities and Investments Commission (ASIC), have been unwilling to investigate board members of the Reserve Bank companies, despite evidence that some of them allegedly failed in their duties, allowing corruption to flourish.
“This is the worst corruption scandal in our history, not because of the amount of money that’s been involved, but because the most respected institutions of our country have failed to discharge their responsibilities to the public.” Dr David Chaikin, University of Sydney Business School
skippy… this is how the game is played… been there done that thingy… from top to bottom. It is – our – culture.
It comes from educated liberals who have made millions of small choices over the years which, in aggregate, have amounted to enabling the fraudsters.
Rule of law, not ethics, is the only way an individualistic society like the US can ostracize and restrain the psychopaths. Shame and social status and so forth don’t work in our context.
That’s the beauty of the Constitution – an ever present beacon guiding us out of the darkness whenever we wish to follow.