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«Global TrusT and EThics in FinancE Innovative Ideas from the Robin Cosgrove Prize Carol Cosgrove-Sacks / Paul H. Dembinski Editors Trust and Ethics in ...»

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/    / / & / The internationalism of financial firms poses major challenges for their ability to behave ethically. Two specific challenges arise out of this situation (see Figure 1). The first challenge arises from the embeddedness of firms in the local legislative and cultural context. Operating in different regimes raises the complexity of ethical issues a financial firm Internationalism, Institutions and Individuals 227 faces. Differing conceptions of ethics in the different cultural contexts and the different laws that govern firm behavior prevent the firm from defining a global ethical standard. Without a common definition of ethics, actions in one part of the firm can be excoriated by its critics in another part of the world, often with just cause.

The other challenge arises internally. Culture across a transnational firm is far from uniform, frequently patchy and often inconsistent, thus leading to blind spots in detecting internal corporate practices that lead to unethical behavior. Business units in different parts of the world could adopt different practices making it difficult to ensure ethical decision-making. The differences in managerial structures under this international setting pose problems for firms trying to pursue one-dimensional solutions that assume compliance across the board. Instead, financial firms need to pursue solutions that address this international dimension of ethical behavior. An example of this internal inconsistency in structures is exemplified by a study of Japanese brokerages with operations in both New York City and Tokyo. Although they belonged to the same company, many firms ended up adopting different reward systems in their different locations: New York branches had a market-oriented reward system while the Tokyo branches had a hierarchal-oriented reward system (Zaheer, 1995).

These two problems are exacerbated by one last aspect of internationalism. Competitive pressure from outside a country can erode the stability of agreed-upon codes of conduct within the financial industry in a country. As ethical codes for an industry are developed largely on a national level, based on a common cultural context and over time, the entrance of a foreign competitor or the desire to overtake a competitor abroad can erode codes of conduct at the national level.

Financial firms have gone international and their internationalism is here to stay. Thus, it is imperative that we develop measures to address 228 Trust and Ethics in Finance both the external challenge and the internal challenge to ethics posed by internationalism.

A demand for a global ethical standard Ethicists have proposed various solutions to the external challenge of differing ethical demands and context caused by firms’ embeddedness in different country contexts. Relativists believe that firms should tailor local policies and operations to the ethical demands in each country. However, such an approach is inappropriate for financial firms as it clashes with the cross-border realities of the financial industry. UBS’s problems juggling tax secrecy laws in Switzerland, where it is headquartered, and its alleged attempts to aid tax evasion elsewhere in the world, is an example of how inter-connected markets demands a global ethical standard.

In a world of inter-connected markets, firm operations between different countries are linked even in the most localised of firms. Business units in a firm share common resources that make units of a firm in one part of the world ethically culpable for actions in another part of the world. For example, the capital flow across borders that takes advantage of arbitrage opportunities links business units across countries. HSBC, which claims to be the world’s local bank, sells a common brand across countries that would be tarnished by inappropriate actions taken in any part of the world. These interconnections demand a global ethical standard.


The important integration of all cultures

Ethical imperialists argue the opposite: instead of the endless conflict between localised ethics, firms should adopt a single and effective firmwide code of ethics. Underlying this approach is the belief that a fundamental set of ethical obligations is relevant to all cultures and to all Internationalism, Institutions and Individuals 229 companies. In particular, a globalised financial industry should be most receptive to such an approach.

Such a rigid code is easily criticised as cultural imperialism. Critics have observed that a universal ethical code is often based on Western standards. Differences in interpreting ethics exist between different societies, and financial firms need to be able to adapt some of their processes and procedures to these differences.

Perhaps gift-giving for the purpose of cultivating business ties is frowned upon within Anglo-Saxon circles, but should such an action be as intolerable from an ethical viewpoint in China or Japan? For investment bankers in China, gift-giving is often fundamental to building the guanxi necessary for long-term business relationships, although such actions can easily become a slippery slope. For their counterparts in Japan, friendships are often built on the exchange of gifts. In these countries, gifts do not necessarily have the same connotations of direct bribery as in the West but instead fall into an ambiguous grey area. New approaches are needed to address these problems.

Consensus can exist

Some ethicists and philosophers have argued for a third way that attempt to find common ethical ground in the major cultures of the world.

The late philosopher of business ethics, Thomas W. Dunfee (Dunfee and Donaldson, 1999) argues that an Integrated Social Contract underlies ethical business behavior. Hypernorms, norms common to most if not all of the world’s major cultures, form the ethical standards firms should conform to. In each society, micro-social contracts exists that business units in these countries can then obey separately. While Dunfee does not specifically identify what these norms would be, he argues that they can be identified for relevant industries and communities. Perhaps this allows financial firms to escape the external challenge of internationalism by binding them to a world-wide code of conduct on ethical issues 230 Trust and Ethics in Finance where consensus exists, while allowing them the flexibility to adapt their operations elsewhere.

Agreeing on this global code of conduct should be an urgent task for the financial industry. This can help ensure that ethical behavior crosses borders. In addition, financial firms need to be constantly aware of the external challenge as ethical standards are evolving and changing. De Bettignies argues that a new mindset will develop in China that espouses the traditional and the western simultaneously in ways that are neither Western nor traditional Chinese (see info.emeraldinsight.com/learning/management_thinking/interviews/betti gnies.htm?PHPSESSID=4cte414vc4303vfk93r4idbmc7&). The fusion of thoughts in various countries around the world will lead to a different set of ethical demands in the future. Financial firms have to adapt their operations to these changes to conform to changing ethical standards.

An ethics audit system to face internal challenge

Unlike the external challenge, the internal challenge arises not from incongruence between the firm’s behavior with its environment’s demands, but from the difficulties of managing the modern financial firm.

The modern financial firm is a complex international entity. Many banks have operations spread across the globe. This internationalism poses a practical challenge: ensuring compliance with codes of ethics for an entire firm, across the world, is incredibly difficult, especially since business units’ attitudes towards ethics in different parts of the world might differ. A headquarters-imposed ethics requirement might be ignored by operations at the country-level.

The challenge is to make monitoring and enforcement of codes of ethics more effective for transnational financial firms. Audit systems play a major role in monitoring country or regional level performance, and perhaps a similar audit system can play a role in ensuring ethical performance. For an ethics audit system to work, the audit team needs to Internationalism, Institutions and Individuals 231 have an explicit focus on “accounting for ethics”. The current accounting system fails to uncover ethical failures effectively as such failures, when they do not directly influence balance sheet results, often fall outside of the system’s purview. Furthermore, when an ethics audit team exists and has an explicit goal of uncovering ethical failures, their awareness of what they are looking for can greatly increase the chances of detecting ethical failures.

Such ethical audit teams need to be hired and managed out of headquarters if they are to be effective. Conflicts of interests are prevalent in the accounting industry. If the company desires to crack down on ethical violations, its ethical audit teams must be free of such conflicts of interests to be effective. This is possible if they are hired externally and are responsible to senior level management instead of local operations.

Isomorphic pressures at the institutional dimension

At the institutional level, isomorphic pressures restrict the domain of ethical options faced by individuals. Organisations adopt similar processes or structures when facing similar environmental constraints. Organisational behaviorists call this institutional isomorphism. Isomorphic pressures influence the structure and culture of an organisation, shaping the ethical choices of a firm at the institutional level.

Different forms of isomorphism exist. Financial firms adopt similar reporting measures of assets to seek legitimacy in the eyes of external stakeholders (coercive isomorphism). Professionalisation leads to similar behaviors between different financial firms, made all the more apparent by the constant flow of talent between firms on Wall Street (normative isomorphism). Under uncertainty, Wall Street firms also engineer similar financial products and pursue similar trading strategies, consoling themselves by noting how their competitors are doing the same (mimetic isomorphism). We can make financial firms more responsible by shaping these isomorphic pressures to influence firm behavior.

232 Trust and Ethics in Finance Changing the underlying isomorphic pressures in the industry to reinforce firm-level ethical decisions is about changing the fundamental behavioral drivers in the industry. Current ad-hoc measures introduced to ensure ethical behaviors are often relegated to superficial box-ticking that can be easily circumvented by the talented people that work in the financial industry. This is because such measures fail to truly change the institutional structure of financial firms in any meaningful way.

A common story that reflects this problem emerges from risk control departments at investment banks. In theory, traders are supposed to be answerable to the risk control department for their trades. In reality, highly profitable traders perch at the top of the corporate hierarchy and employ a range of strategies to delay or avoid compliance with risk controls. Requests for information can be brushed aside, risky trades are explained as being sophisticated, and evasive answers buy time. Isomorphism has resulted in a common industry structure where revenue centers are prioritised in decision-making processes over cost and control centers, leading to ethical lapses.

What can be done?

The firm is embedded in a network of social institutions that control and shape its behavior. To achieve the deep-rooted ethical changes in the financial industry we are arguing for, we need to shape isomorphic pressures to lock in desirable institutional characteristics.

The relatively free flow of talent between financial firms poses a critical challenge. The constant inflow of personnel shaped by the cultures of other firms dilutes measures taken by any firm to ensure ethical behavior. As soon as Lehman Brothers collapsed, top executives at the failed firm were recruited by other Wall Street firms. Thus, measures promoting ethics have to influence the industry as a whole, instead of being atomised actions taken by individual firms – brave actions that will unfortunately by weakened by the constant inflow of personnel.

Internationalism, Institutions and Individuals 233

The professionalisation of finance

Professionalisation of the financial industry would be a bold step forward in building a common ethical culture for financial professionals.

Parts of the financial industry that deals with complex financial instruments are remarkably similar to professions such as law or medicine.

The practitioners have a consensus on a body of knowledge surrounding their work, and are asymmetrically equipped with this knowledge vis-àvis their customers. Professionals in finance also have relatively homogenous backgrounds – coming from a small set of universities or business schools. Given the importance of finance for the modern economy and the shared backgrounds of practitioners, the industry is ripe for professionalisation.

Professionalisation of finance is meant to allow the industry to develop a common set of ethics and sense of responsibility to society. By having financial professionals uphold industry-specific ethical standards, we force them to confront the responsibilities their importance to society entails, and become more conscious of the impact of their decisions. By socialising them to an industry-standard for ethics, we enable these professionals to understand how their profession as a whole should approach ethical dilemmas. Such a professional body also allows firms to overcome the problem of atomised socialisation to codes of conducts: by having an industry code of conduct, the flow of professionals between firms poses less of a challenge in maintaining an ethical culture.

Full professionalisation of finance can take place by developing a national or regional body to build consensus on financial issues. Given that many financial professionals are trained in business schools, such training grounds have to be included in the professionalisation process. A business degree (or programme) should be a prerequisite in the industry, and much thought should be given to how individuals are socialised through this programme. The next section looks at this in greater detail, 234 Trust and Ethics in Finance but with a focus on how ethics in general is affected by the current business school process, which I argue is flawed and self-destructive.

Room for individual decision-making While the international structure of firms and the institutional isomorphism of firms influence ethical outcomes, we cannot ignore the role individuals play at all levels of the firm in ensuring ethical behavior.

While I argued that a set of forces circumscribe the domain of possible choices individuals can make, they do so in ways that still leave considerable room for individual decision-making. The ethical compasses of individuals still influence how they choose over their remaining options.

I recommend an approach to reshaping ethics in individuals in the financial industry by focusing on the main socialisation process for such individuals. A large proportion of financial elites in the commanding heights of the financial industry (i.e. those who work in the top investment banks, private equity firms and hedge funds) come from a small set of business schools. Business schools (both at the undergraduate and graduate level) play a significant role as a gatekeeper for the financial industry, socialising individuals who go on to wield influence in finance.

But this system is broken.

It is essential that we reform the process by which financial talents are trained. In addition to developing professional ethics in support of the professionalisation of the industry, business schools need to work with companies to ensure that ethics become an integral and useful means of selecting potential employees. This has to go beyond simply having more ethics classes or mandatory ethics components. Instead, we need a reform in the overall environment of many business schools. The current environment creates unhealthy social pressures that retard student ethics. Some schools have taken the lead in changing this environment, but more has to be done.

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