WHY MANAGERS FAIL TO DO THE RIGHT THING

From INSEAD Knowledge

When Societe Generale said in January that a relatively junior trader had lost the bank billions of Euros in unauthorized derivatives trading, there were predictable comparisons to Nick Leeson, the trader who brought down Barings. The media coverage has been reminiscent of that for companies such as Enron and Tyco, and of Martha Stewart -- the style guru who was jailed for five months for lying to investigators about her sale of shares in ImClone.

The investigations at Societe Generale continue. One finding is certain. Somewhere along the way, one or more employees failed to do the right thing.

Craig Smith, the INSEAD Chaired Professor of Business Ethics and Corporate Responsibility, is fascinated with understanding why managers act this way, and discovering practical ways that unethical behavior can be deterred and prevented.

"You just need to look in the newspapers," he says. "It's in every issue, be it bribery, options backdating, be it accounting fraud. It's all there and regulators are responding and companies are paying attention because regulators are responding."

Reputations can be harmed -- even if a manager stays on the right side of the law. "It may be behavior that's not necessarily proscribed by the law but is unethical. That too can add adverse reputational effects on companies -- they've certainly got economic reasons to pay attention to." After all, one unethical act can wipe millions of dollars off the value of a brand.

Smith's latest published research called "Why managers fail to do the right thing: an empirical study of unethical and illegal conduct," which he did with Sally S. Simpson of the University of Maryland and Chun-Yao Huang of the National Taiwan University, may disappoint people who say punishments should be more severe for such white collar crimes.

Corporate fraud, such as plundering a pension fund, may not physically harm anyone. But it can ruin thousands of lives as jobs are lost and investments are wiped out. Jail sentences of 25 years or so are becoming more common for high-profile wrongdoers.

But Smith says perhaps the most surprising finding of the team's research is that the threat of long custodial sentences does not seem to affect the thinking of managers when they consider the consequences of behaving badly.

"We're not saying that the formal sanctions are unimportant but in terms of the severity of the sanctions, the evidence from our study at least suggests there may be a ceiling effect," Smith says. "Policy-makers might give more attention to the likelihood of being caught rather than the severity of the sanction if you are caught."

Shame can also be a powerful inhibitor: What would a manager's family and colleagues think if they knew he or she had done something wrong?

"The key here for regulators is to not just focus on the law but focus on what's underlying the law -- which is what society believes about good, right, moral conduct."

One practical measure is for companies to make discussion about ethics part of the culture of the organization. The research suggests that people are less likely to act unethically if they have clearer ideas about what is actually right and wrong.

That could mean having ethics hotlines for employees to seek reassurance that their boss is not ordering them to behave unethically. Smith's research tends to confirm previous studies that show people are more likely to obey orders to do something illegal than if they are left to make their own decisions.

"A hotline provides a way of doing this (seeking reassurance) in a potentially 'below the radar' sort of way," Smith says. But he warns that "blowing the whistle is a very major step for anyone to contemplate in an organizational setting."