The Decline of Moral Behavior in Business

How should managers respond?

Manfred Hoefle

 

Moral behavior is having a hard time, especially with the pressures of an increasingly globalized world and the nominal (financial) economy. The businesses mostly at risk are (too) big corporations and conglomerates. Nevertheless, moral failings in commerce are reported elsewhere, all the time. Effective countermeasures are called for: but not the American way of control. Not even more auditing, compliance, governance and certification, which has grown into a big consulting business over the past two decades. That solution is unsustainable and does not fit the commercial culture of Europe (except for the UK, perhaps).

After a leadership seminar at a renowned bank, the staff met informally and chatted about their leisure pursuits, vacations and past student days. The department head took the opportunity to boast of his past and what a smart fellow he had always been.
He told two stories: first, while he was a student he had worked part-time as a car-park attendant. On the first day, his older colleagues gave him a quick induction on how to falsify the parking tickets without being caught. Therefore, he ended his first fraudulent shift as a new member of a cartel of crooks. He told his subordinates how the risk of discovery had been small, the job was only temporary anyway, and the swindle was very profitable. Secondly, also while a student, he had worked for a wholesale meat merchant who ordered the drivers to deliver rotten meat. The regular drivers forced this illegal task onto the student drivers, who agreed for fear of losing their well-paid vacation jobs. He, however, had no moral objections whatsoever about delivering rotten meat. Why not? Only a fool would say no, he said.

Because this happened so long ago, the department head told those stories without hesitation. His subordinates listened with interest and in silence. Only one disapproved, and left, quietly. This prompts the question: Is such behavior exceptional or typical?

STAGES OF MORAL DECLINE

We can learn a lot from the bad example set by that manager. After all, moral decline does not happen suddenly, but gradually. Its willing helpers are craftiness and selfishness. That is the pattern followed: first, you realize that swindling and fraud is easy; then you discover loopholes in the system. Next, you guess your fraud will be easy to conceal and will remain undetected. Then, you justify or morally rationalize your behavior, by saying to yourself this is an excellent opportunity, too good to miss, other people will not suffer directly, and I am owed more money anyway, because I am paid less than I deserve.

Swindling and thieving may then be followed, suddenly and unexpectedly, by elation, if you have gotten away with it. Just like a kid who has stolen from a cookie jar. The technical term for this is the cheater’s high (1). Studies by inter-university researchers found that, contrary to popular opinion, unethical behavior does not generate a guilty conscience, but satisfaction. In addition, because success breeds success, more behavior that is immoral will usually follow. In fact, some people find that cheating, swindling and theft (unless caught and punished) give them a feeling of pleasure and achievement.

Where and when are moral lapses probable?

There are, of course, different levels of risk, but at high risk are:

1. Closed, highly competitive groups
When business managers disrespect customers, competitors and colleagues — when departments, coteries and self-interested groups become decoupled from the rest of the business, then caution is the watchword. Here is a recent example: After the 2008 financial crisis, media reported that some bankers had called German client investors "dumb German money", while Goldman Sachs bankers called "unsophisticated" customers "Muppets". I have myself observed the arrogance of prominent strategy consultants toward managers of a client company. Trainees straight from university imagined themselves superior to experienced management staff and even ridiculed them behind their backs. A prime example of arrogant consultants is a long-time boss of McKinsey who was convicted of insider crime.(2) A
Professor of Business, Bala Balachandran, claims to have warned that CEO well in advance: "... if you are in a herd of pigs, you will also smell." Another business badly impacted by consultants behavior, although now only of historical interest, was Enron where aggressive consultancy practices became the company standard and insider groups began to conspire for personal advantage whenever an opportunity arose.

The case of the automobile emissions scandal at VW demonstrates how managing boards and employee representatives can also unashamedly collude — even under the supposedly watchful eye of local politicians and media. As soon as the VW emissions swindle became public knowledge, VW managers acted surprised and looked for sacrificial pawns, although everyone knew or at least guessed that it would take more than PR propaganda for their close inner circle to escape accountability. In fact, historically, corruption is always practiced by a close inner circle.(3)

2. Anonymous relationships and depersonalized, complex worlds
Dark dealings by people with no name and face (opaque and anonymous transactions) are a breeding ground for dishonesty. Studies show that if the other party in a commercial transaction is a legal entity and not a real person, there is less inhibition about swindling that entity. Without transparency, as in many large organizations, some people will try to cheat the system for personal advantage. Where dealings involve algorithms, ultra-fast transactions and only a few actors (who are hard to supervise due to their specialist knowledge and privileged access to asymmetric information), these actors are tempted to take personal advantage of loopholes in the system. Dishonest candidates, in particular, are attracted to such jobs. Recent decades have also brought a marked increase in people who devote their energy, albeit legally, to discovering and exploiting market anomalies and liability gaps. Their sole objective is to extract value and not to create value — for them value creation is an alien concept.

There is no more honesty in a cashless world than in a world of cash.(4) In fact, the growth of the nominal (financial) economy and the internet means that now there is structurally a greater danger of cheating and swindling. Cyber crime has become common with dishonest practices committed by states as well as private actors: from the hacking of access data to identity theft. These actions require exceptional criminal intelligence to invent, but are easy to distribute internationally on the internet.

3. Excessive incentivization and huge pay gaps
Ever since the spread of the doctrine of shareholder value and accompanying incentives for management, the pay gap within businesses and between peer groups (national and international) has widened significantly.(5)
Despite outrage at exhorbitant executive pay in manageristic (6) corporations — VW is, again, an example — much less is heard about the direct consequences it has on workforce morale. Studies show that if employees believe the pay of top managers is unjust, they will inwardly resign or even plan to grab some of that corporate wealth for themselves.(7)

4. Self-interest and globalization
Too little attention is given to studies that show how smart, ambitious and other-directed (8) youngsters will choose university courses (mostly MBA courses) that promise the highest starting salaries. Research at U.S. universities also shows that business students — compared to students of natural science or engineering (applied science) — have a significantly higher tendency to cheat.(9) Declarations by McKinsey of a "war for talent", a social-Darwinist attitude to business, have also contributed to declining moral standards in business. Attitudes of that kind undermine the natural human motivation to work hard and work well, and instead encourage naked self-interest and greed.

Of course, greed, swindling and crime have always been part of human behavior, especially in the world of commerce. However, what changes over time is their occurrence. Moral behavior can be the generally accepted norm, while at other times it is not, and instead becomes a social and political problem. We need only look at U.S. capitalism in the early 20th century (the age of the robber barons) and compare that with the relatively civilized behavior of U.S. corporate managers during the 1950s and 1960s. (10)
There are, of course, differences between cultures and countries. For example, small countries with a traditionally strong work ethic and Christian history consistently rank high on the moral scale of, for example, corruption perception indices.

Globalization has lowered obstacles and objections to unethical behavior in commerce and has created more opportunities for deviation from accepted moral standards. One example is the systematic abuse of commercial businesses for the 'national interest' with state and corporate complicity in the theft of intellectual property. Closer commercial relations between European and other cultures, and especially big countries like China, India and Brazil, has not led to greater mutual trust and shared ethical standards. This is demonstrated by the relative moral conduct of such partners in the real world of global commerce.

If, in the past, wrongdoing was considered the action of individuals, today it is a group activity and is concentrated in certain sectors, cities and offshore islands, or crime shops in obscure locations. General experience confirms that in a highly competitive commercial world, governed by private interests, unethical conduct spreads rapidly and that wrongdoers are probably one-step ahead of the regulations and the law.

WHAT LESSONS CAN WE LEARN?

As in earlier times of moral decline, it is necessary to remoralize both individuals and groups of people. Almost every society has its share of dishonest people with a tendency to cheat. That is true of businesses run by hired managers, who reflect, more or less, a cross-section of society. It is less true of businesses that are run by family-owners, trusts and foundations.
The share of dishonest people is higher among groups who are selfishly ambitious or who feel that their group is unfairly disadvantaged. Numerous studies have investigated the causes of dishonesty in business: these include bad role models, no penalties for minor rule breaking, and unprincipled and narcissistic characters as business 'leaders'. It is noticeable in manageristic businesses that while social competence is supposed to be a key promotion criterion, that claim is made in the safe knowledge that it is not taken seriously by top executives. On the contrary, some CEOs consider their personal image as action men and omnipresent decision-takers to be much more important than behaving as a role model for decent and responsible behavior.(11)

The socialization of a business — understood as the collective of all its employees including its executive managers — will have a major influence upon its imperatives (and practices): such as local/regional integration, ownership structure, type of business, size and history. Family-run or family-supervised businesses — in German-speaking countries the mittelstand — tend to be, ethically speaking, a relatively intact group.

What can be done, or at least attempted, to revitalize moral conduct?

First: Start with individuals and small groups — Top-down role models

A prime criterion for the selection of leaders must be moral character — no ifs, no buts. This essential character attribute should be given serious attention because leaders must be positive role models and bad behavior spreads rapidly. As that great management teacher, Peter Drucker, wrote: "But if (a man) lacks in character and in integrity – no matter how knowledgeable, how brilliant, how successful – he destroys. He destroys people, the most valuable resource of the enterprise."(12) The good character of a manager – honesty, dependability, trustworthiness, sense of justice and fairness – is an essential criterion. (13) These virtues are embodied in the traditional role model of the honorable merchant. That role model is still valid today, and should be recalled, revitalized and reinterpreted for contemporary commerce.(14) In contrast, the modern CSR approach (Corporate Social Responsibility) is inefficient and ineffective: it is superficial, PR and image-oriented and formalistic. The illusory nature of this stylized system, which has already been turned into a management-consulting product, is all too apparent. (15)

Because it is easier to identify problematic people in advance than to reeducate them afterward, the selection of managers is crucial. Negative signs of problems of character are: taking no interest in associations or groups (professional, social, political, religious or class), history of broken family relationships, previously employed by fraudulent firm, lack of social engagement, and conceited or arrogant (16). Most important is the successful socialization of prospective managers. To put this in a wider perspective: a civilized society is built upon trust and lawfulness, and the same applies to business enterprises and managers. A good character is fundamental for successful human interaction and therefore also for long-term success in commerce: good character is the mortar that binds together the bricks of a business.

Second: Overseeable size — Simplicity and self-organization

A proven means of discovering and, even better, of preventing manager misbehavior is to create overseeable structures and simple processes. These have a self-regulating effect: misbehavior is more likely to be discovered, checks are more effective and can even be dispensed with, and responsible and accountable teams can be self-supervising. Businesses that are structured in small units and have flattish hierarchies, where direct person-to-person contact prevails, are less vulnerable to fraud and other wrongdoing.(17) Big businesses should downscale (by demerging), become decentralized, overseeable and simplified.(18) Managers should realize that size is a double-edged sword: economies of scale also create diseconomies of scale. While large scale can facilitate technology and power, it is often incompatible with flexibility and agility.(19)

Third: A moral regime not moral laissez-faire — Moral reminders

It has been shown that repeated reminders to abide by the biblical Ten Commandments can have an amazing positive effect on conduct. In other words, the success of an ethical policy is best achieved with moral reminders: constant reminders of pledges and obligations. At Princeton University, such reminders are issued before every examination and students must confirm them in writing. This contrasts with the one-time public oaths introduced by other U.S. universities and business schools after the 2008 Financial Crisis; oaths whose effectiveness rapidly faded (20). Admonishment (cautioning, advising and counseling) is more effective than threats of punishment. Warnings are more effective than penalties.

A moral regime means, firstly, accepting that being too trusting is an invitation to deception (and self-deception). Secondly, realize that moral conduct must be cultivated, like a garden. Finally, keep to a few proven rules: swift and certain penalties for even minor transgressions, communicate penalties, automatic expulsion and social ostracizing of recalcitrant managers (especially effective for top executives). In addition, on a case-by-case basis, unannounced and concealed inspections by those who bear overall responsibility.

Comprehensive non-liability clauses and costly management insurance policies (D&O insurance) are counter-productive. Managers are only credible if they are always accountable for their actions. Therefore, many corporations that claim to practice a strict moral code must fundamentally reform their corporate policy on management liability. Although there is proof enough that deterrence is only partly effective and stiffer penalties do not prevent managerial abuses, they are still called for repeatedly.

The U.S. American whistleblower method, now copied in Europe, is unsatisfactory. It turns suspicion and mistrust into a general principle. In fact, the whistle blowers themselves risk being ostracized within the company. In some spectacular cases, whistle blowing has been abused for self-enrichment.

Fourth: Governance as a framework — And benevolent practical advice

It is the degree of supervision that counts. Demands for the greatest possible transparency go too far. As in all human and social affairs, the measure matters. A standard or extreme approach will not work.(21) Instead, acting like a prudent businessperson is the simplest and most effective way of preventing rule breaking or the hazardous risk- taking that became standard management practice, also outside the finance sector. To be effective supervision must prevent collusion (cliques, secret relationships, political favoritism on boards, or as in Germany on works councils). Even employee representation on supervisory boards, as already exists in Germany, does not prevent collusion. Once again, Volkswagen is the bad example.

From a corporate governance perspective, infringements of good business management are usually attributable to short-termism (quarterly reporting) combined with incentivization. Because quarterly reporting is mandatory for stock-exchange listed companies, such businesses must be awake to its side effects and guard against them, as far as possible.

Generally speaking, regulations introduced more recently, a prime example is the Sarbanes Oxley Act,(22) have had a formal and bureaucratic effect, rather than a genuine positive impact, on managerial behavior. Instead, the implementation and support of these governance and compliance regulations have given birth to armies of consultants, auditors and certifiers, who discovered a new and highly lucrative business opportunity. The supervision and legal disciplining of behavior and the threat of high penalties is a deeply rooted U.S. tradition.(23) Continental Europe has a different legal and regulatory tradition and other forms of moral discipline, although U.S. American methods are now being widely copied. (24)

WHAT IS WRONG WITH BUSINESS ETHICS TODAY?

Ever since the 1980s, many public corporations have shown signs of declining moral conduct in business. The theory of shareholder value, the introduction of the principal agent concept (25) by management and the widespread adoption of incentivization by public corporations has been an ethically questionable and toxic mixture. This has also taken place against a social background of individualism and weaker community identity.

Over the past 25 years, ever since the internet revolution began (which made digitization possible) a new business model has evolved, now known as the digital, intermediate and sharing economy. Typical for this business model are the Big Five of Silicon Valley: Alphabet (Google), Amazon, Apple, Facebook and Microsoft as well as new intermediaries (Airnb, Uber and so on) who, in their drive for profitable growth, are committed to a monopolizing strategy with the intention of creating dependencies and destroying established structures. If their behavior so far is any measure of their moral disposition, we must draw negative conclusions.(26)

Business models whose purpose is the privatization of publicly forward-funded research and development without giving anything in return, to muddle through with minimum assets and employees, to create numerous dependent service providers, and to invest mostly in marketing, are not only non-sustainable, they are irresponsible and anti-social. Their guiding idea is absolute growth and the highest possible share price. That is the driving force behind the digital industry, which has spread from Silicon Valley to all continents and has contributed to a general decline in managerial responsibility (accountability and liability). The relationship between the rights and duties of users and those of providers has become extremely one-sided. The decline in business ethics has gone on for some time now, and will not be strengthened by these new national and transregional dependencies, which continue to grow at an unprecedented rate. It is now often standard business practice to exceed or test legal limits and ignore moral considerations because to behave irresponsibly is the most profitable choice.

We are experiencing a structural shift in the economy: with a smaller share for manufacturing industry and a larger share for the retail, services, finance and internet sectors:. Overall the trend is toward a much larger monetary or finance sector. That this will create more opportunities for wrongdoing is certain. The only effective response is to 'regulate', but not with detailed rules and regulations, instead by constantly revising general accepted codes of good business behavior (commercial principles of right and wrong). In addition, incongruities and imbalances, in particular on pay, must be fundamentally reformed.(27) Good performance should be rewarded, but only if it is genuine and enduring. Incentivization is the wrong approach, because it is an open invitation to craftiness and creative embezzlement (fraud).

CONCLUSION

To return to the aforementioned moral lapses: so far, the managerial reaction in Europe has been to copy the American way: with compliance, codes and sometimes draconian penalties. Upon closer examination, these are only running repairs. So far, too few lessons have been learned from the 2008 Finance Crisis (the biggest since the 1929 Wall Street Crash) and from the upsurge in digital crime.

Now the root of the problem must be addressed: namely, the moral character of management practice. This complicated task must be taken on, even though tedious and painful. Alan Greenspan (former chair of the US central bank), who said quite clearly, “… rules cannot substitute for character”, shares this challenging insight.

This leads us to the question of character building and the role of formative education, vocational training and moral conscience. (28) It is a well-known fact that people of good character get by with fewer rules. In addition, ever more investment in supervisory systems has yielded, over the past two decades, a poor moral return. Therefore, there is no alternative but to invest in moral conduct; this is the only investment that pays back long-term. Capital spending on inspections and supervision must be kept within limits. Tolerating the morally unstable or morally deficient, especially in executive positions, is no way to manage a business. It is bad management.

Responsible business leadership means finding the right balance and the right way. This means considering the common good, fairness and transparency, appreciating and respecting other people. Managerism is the complete opposite of this and therefore it must be replaced.

 

"The world would be a better place, if the effort exerted in intellectualizing over moral questions was instead spent in practicing the simplest of moral laws."
Marie von Ebner-Eschenbach

 

LITERATURE

Ariely, Dan; The (Honest) Truth About Dishonesty, HarperCollins, 2012.
Hopper, Kenneth & William; The Puritan Gift, Reclaiming the American Dream Amidst Global Financial Chaos, L.B. Tauris, 2007, London.
Drucker, Peter, F.; Management Tasks – Responsibilities – Practices, Harper & Row, 1974, New York et al.
Riesman, David; The Lonely Crowd: A Study of the Changing American Character, Yale University Press, 1950, (rev. ed. 2001),

 

Footnotes

(1) A study by Nicole E. Ruedy, Foster School of Business, University of Washington; Celia Moore, London Business School, London, United Kingdom; Francesca Gino, Harvard Business School, Harvard University; Maurice E. Schweitzer, Wharton School, University of Pennsylvania; Journal of Personality and Social Psychology, 2013, Vol. 105, No. 4, 531–548.
(2) www.managerism.org, Thinkpiece No. 9: McKinsey – The Insider Company.
(3) Another was a corruption case at the telecommunications group of Siemens. Poor competitiveness, unrealistic business targets and irresponsible line managers fostered criminal behavior despite corporate rules for proper business conduct.
(4) The assertion that cash in big bank notes facilitates criminal practices is a fallacious argument. Hiding in the Deep Web and Dark Net and virtual currencies like Bitcoin can be used for secret money transactions.
(5) See Thinkpiece No 10: Directors‘ Pay – Something Has To Change.
(6) "Manageristic" describes a deviant form of business leadership and management culture, which is characterized by the appropriation of the business by employed management, a one-sided capital market orientation and decoupling from employees.
(7) This pattern of response was analyzed over ten years ago by Professors Bruno Frey and Margit Osterloh of Zurich University in “Yes, Managers Should be Paid Like Bureaucrats”. (Working paper, No. 187, July 2005)
(8) An expression used by David Riesman (1909 - 2002), US American lawyer and Sociologist.
(9) Donald McCabe, Academy Report: Crisis of Cheating, Rutgers University, 2006.
(Excerpt: "They not only cheat, they brag about it.")
(10) There were similar developments in Germany. After German re-unification, numerous irregularities around ex-GDR (East Germany) public assets, which were entrusted to Treuhand Public Trust Authority for privatization.
(11) One example is CEO of Siemens, Joe Kaeser, who has journalists accompanying him to publicize his hard work, coolness and 'polite and polished manner'; and they do. In this regard, some salaried CEOs of corporations have a lot in common with heads of state, but little in common with genuine entrepreneurs.
(12) Drucker, Peter, F.: Management, Revised edition, New York, p. 287.
(13) Conclusions of two distinctly different people: Theodore Roosevelt (1858 - 1919), 26th President of the USA: "Character, in the long run, is the decisive factor in the life of an individual and of nations alike." and Albert Einstein (1879 - 1955), natural scientist and philosopher: "Most people say that it is the intellect which makes a great scientist. They are wrong: It is character."
(14) See Lesson No. 48: CSR – A Poor Substitute for The Honorable Merchant http://www.managerism.org/lessons
(15) See Lesson No. 48: CSR – A Poor Substitute for the Honorable Merchant
(16) Reinhard Mohn (former Head of Bertelsmann) said, "When selecting executive trainees in the past I always paid attention to the personality and character of the candidates. But I must admit, now with so many managers who are failures, in the past I did not think long and hard enough about arrogance."
(17) Compare VW with W.L. Gore & Associates (a U.S. materials science business), which has business units (technically possible, of course) of around 200 employees each. Staff members are called "associates" and it does not have a classical hierarchy.
(18) See Thinkpiece No. 5: Too Big To Fail versus Rightsized – The Dilemma of Oversized Companies
(19) The philosopher Leopold Kohr argued for "Überschaubarkeit" (understandable, manageable, transparent) and that our living world must small and human sized to be a humane world." (according to Rupert Riedl). See also Michael Breisky, Lesson No. 16: Leopold Kohr and the Limits of Complexity, http://www.managerism.org/lessons
(20) Another example of "moral reminders" is U.S. tax return forms for which a signature is required before and after filling them in.
(21) The philosopher Immanuel Kant (1724 - 1804) wrote, "One might not think this possible, but virtues also must have their limits."
(22) This US federal law passed in 2002 was a response to the accounting scandals at Enron, Worldcom and others and was meant to ensure the reliability of financial reporting.
(23) The commercial influence of the USA has spread this practice to the rest of the world. The principal beneficiaries are US service providers.
(24) The US dominance of regulation and its influence on other regional economies continues to grow. The EU has too small a role in this.
(25) The Principal Agent Problem refers to the conflicting interests of the principal (owners) and the agent (managers). In the case of business corporations, the management (the agents) has an advantage in access and control over company information to the disadvantage of the shareholders (the principals).
(26) A rough analysis of the 'key players' (mostly founders, CEOs and main shareholders) like Jeff Bezos of Amazon, Mark Zuckerberg of Facebook or Travis Kalanik of Uber, from a moral point of view is disturbing.
(27) The new governments in the UK and USA could initiate reforms.
(28) Immanuel Kant thought that your moral conscience is like an internal court, and just like a court, you must never be ambiguous, careless or unjust.