Ethics and regulation: complements, not alternatives

Last week former Taoiseach and President of IFSC Ireland, John Bruton, said that the banking industry needed "to focus on ethics rather than regulation". As someone who strongly supports the idea of ethical codes and a more central role for ethics in business, I found this remark and the casual way it was accepted unhelpful on many levels. Ethics are not an alternative to regulation; rather regulation is needed to support ethical behaviour. 

First, what do we mean by ethics in business?  There are many approaches; to illustrate why ethics are not an alternative to regulation, consider just three. 

You can take a deontological approach, like that that of most religions, and impose an absolute moral code.  Something is either right or it is wrong, no exceptions. You can see aspects of this in some corporate codes of conduct: some things such as fraud, insider trading or forced labour are simply prohibited, regardless of the consequences at the time. These things are unethical – everything else is OK. Because of the inflexibility of prohibiting an action, the list tends to be a short one, and not very useful for complex “grey area” situations. 

In contrast, a utilitarian or consequentialist approach hinges on the idea that the morality of any action is completely determined by its consequences.  So in its purest form, faced with a decision, you could weigh up the impact on all parties and choose the course of action that minimises harm or maximises good. So while stealing might be “wrong” under a deontological approach, utilitarian ethics might allow it under some circumstances, such as the theft of food from a profitable business to save the life of a starving child. This is pragmatic and useful, but depends on the person making the decision having been really well trained; unless business schools and professional institutes put serious weight behind teaching the process of ethical decision-making, it is unreasonable to expect individual employees to respond in the best possible way when making snap decisions in a fast-moving and high-pressure environment.   

As a final example, a virtue-based approach to ethics comes from Aristotle’s ideas of how to be, rather than what to do.  A decision on a particular situation could be reached by asking, “Am I the sort of person who would ...?” or, “Are we the sort of organisation that ..?” This can work really well for individuals, but won’t work in business unless everyone in the organisation is aware of and supports the sorts of virtues or values that the firm as a whole espouses.  Since these values are not based on rules, they must be embodied by the leaders within the organisation – a kind of ethical role-modelling which be either positive or negative, depending on who’s in charge and how they behave. 

Now the question is: which of these approaches, bearing in mind that they are only three of a myriad of ways of describing and understanding business ethics, could credibly act as an alternative to regulation in an industry as cut-throat and prone to moral hazard as banking? 

The absolute moral code of deontological ethics is barely compatible with capitalism, and would be either limited or diluted by its application to profit-seeking financial innovation. The utilitarian approach is pragmatic but time-consuming, and depends heavily on training. Virtue-based ethics comes close to a personal ideal, but depends on individuals to an unsustainable degree.   

They are all good to have in an industry, but will never work alone.

The trouble with ethics in isolation is that unless they seem coherent with the overall climate in which an individual is working, he or she will lack the confidence to “do the right thing” even where the “right thing” is clear.  I might know that stealing is wrong, for example, but if all of my peers are routinely cleaning out the stationery cupboard and falsifying expense claims, then my personal belief is constantly challenged by the daily experience. This is where regulation – clear rules of law with penalties and consequences for non-compliance – will support ethical standards, reinforcing rather than replacing them.  

Of course regulation also has the happy advantage of being effective even for people who would never embrace an ethical code. Even sociopaths fear the law. In that sense, regulation has a wider impact than business ethics, and is a baseline if we are to expect better corporate behaviour. Without punishments, some people will never obey rules.  But most employees are not sociopaths, so training in ethical decision-making will also have a useful effect, enhancing the impact of regulation, and ensuring that it is implemented in spirit as well as in statute. 

What the industry needs is not "to focus on ethics rather than regulation," but to enforce regulation and resource ethical training. Then we might see the change we need. 

Sheila Killian

@islandtotheleft

Economic impact of radical reform of 'shareholder value' in company law

Paul Sweeney: A couple of weeks ago, David Jacobson raised the issue of the conflicts which the auditing profession can have, and how its role can be conflicted when it acts on other business matters for the same firms which it audits.

With the economic crisis, important microeconomic issues can be neglected. Reform of these issues a decade ago could have contributed to a much reduced economic crisis today. For example, it is widely recognised that the lack of control by the boards of major financial companies of their own top executives, led to the crisis (in this regard, today's piece in the Financial Times, on the manner in which mutual funds have contributed to excessive executive pay in the States by voting in favour of compensation plans, is of interest). Yet this vital issue of corporate governance is little discussed in Ireland.

A key debate now has to be to question the fundamental basis of company law in Ireland (and in the UK and US). The Anglo-Saxon model is based on shareholder value, almost exclusively. To focus exclusively on shareholder value leads to managements’ interests dominating, especially where shareholders are diffused. It also leads to short-termism. But all is not lost. Things are changing, and radically. However, in Ireland, we have hardly noticed.

On 12 March, the “Father of Shareholder Value”, Jack Welch, admitted that the whole basis of company law, based on shareholder value was wrong. He had espoused this narrow view everywhere in his syndicated columns, and as the domineering CEO of the huge conglomerate GE.

Welch did not just recant. He said that the shareholder value was “a dumb idea”. He had promoted “shareholder value” since he made an influential speech in 1981. Now, he says “shareholder value is the dumbest idea in the world”. Today, he admits that it is a result and not a strategy. He now admits that employees, customers and products matter!

It is essential that there is a debate on this important micro-economic area by economists, academics and business-people. It seems obvious after the economic debacle that the broader “stakeholder interests” should now be rooted in Irish company law, and the sooner the better. This would also help ameliorate Ireland’s tarnished enterprise reputation.

Even with the existing narrow standards of Irish company governance, much of which is based on voluntary codes of practice, it is still poorly executed by companies. A recent Grant Thornton Governance review on the extent of compliance with the Combined Code by Irish Companies found approximately 50% of Stock Exchange companies non-compliant. It concluded that the voluntary approach to the Code has failed, and that the only acceptable solution is to incorporate governance principles into legislation. The report pointed out that too many Irish companies are lacking in their standards of practice and adherence to the Combined Code or core principles of transparency and independence.

The government must ensure that it enacts legislation to enforce existing corporate governance measures, otherwise it will be difficult to restore international confidence in Ireland as a suitable place to invest and to do business. But just as importantly, the balance of power is too narrowly vested in top executives under the shareholder value dominated Irish company law. This must be radically reformed.

Ireland has a Company Law Review Group but, to my knowledge, it is not even debating this vital issue. The government should ask the Group to conduct a review of the area, and to recommend fundamental changes in the basis of company law. The corporate governance laws must be broadened out to give certain rights in law to all other stakeholders in companies, from suppliers, customers and employees to the community, the environment etc. However, noting the conservative composition of the CLRG, this won’t happen unless the Group itself is changed to reflect society’s interest, and not largely those of what is perceived to be business interests.

The best way to demolish Cosy Irish Capitalism, as the too oft-quoted “Financial Times” editorial called our economic governance system, is to shift power from shareholders only (usually including the top executives) to all stakeholders. Let’s try and have a debate.