Platt Perspective on Business and Technology

Macroeconomics and the fallacy of a pure meritocracy system – 4: internalizing ethical best practices into corporate cultures and management and leadership training

Posted in macroeconomics by Timothy Platt on September 13, 2012

This is my fourth posting to a series that can perhaps best be seen as addressing the longer term and macroeconomic impact of business ethics, and of what happens when they fail (see Macroeconomics and Business, 108 and loosely following for parts 1-3.) I ended Part 3: operationalizing and enforcing best practices with an observation and a question:

• Outside regulatory control and the sanctions and other consequences of its breach can only go so far.
• How do we effectively internalize this into the businesses and business leadership chains that are at greatest risk of failing?

And I will add to that as a working criterion of evaluation:

• Business ethics, bottom line is all about risk distribution, and unethical business practices are unethical because and to the extent that they create unnecessary and avoidable risk and disproportionate risk to stakeholders.

And I find myself thinking back over my own career to some of the people I have worked with, and particularly to those managers I have worked with who were more focused on their own personal agendas and goals than on anything else – people who I saw in action who saw virtue in cutting corners and at whatever risk or detriment to others, and certainly if those actions would lead to their own personal gain. Most of the people I have worked with have been both effective in what they do and ethical in how they do it, but with time we all see people who might have technical, hands-on skills but who should not be in positions of leadership, trust or responsibility.

Developing at least a loose analogy, consider the gambling addict and a “sure bet” opportunity that they know would work in their favor 98% of the time. So they take the chance and win. But what if they, in their greed for the winning reward keep playing that same game again and again? So they keep making this same bet at those same per-play odds, hoping for the best. If they continue this 35 times their overall probability of succeeding every time drops below 50%. So if they keep putting everything on the table every time, they have less than even odds of walking away with anything in their pockets from this effort. But what if the risk per transaction is actually higher than initially assumed and they would be expected to win only 95% of the time per-play? That still sounds like a sound bet and certainly for a single round of play. But they would only have to play that bet 14 times for the overall likelihood of failure at least once to rise to over 50%. And if the actual risk per-play is greater still: if the probability of winning is only 90%, they face an overall probability of winning every time that is greater than 50% only if they do this a maximum of 6 times. More than that, their rate for loosing at least once goes above that 50% mark.

Life involves risk. Gamblers take chances and have to accept that. And investors take risks too, but presumably they can distribute their investments in multiple buckets that are not all likely to go down in value at once. And presumably the expert investment advisors they pay fees to, to help them find and invest in a best risk probability, best return on investment balance are actively trying to help them succeed. And I return here to a crucial point that I raised in my series on regulatory best practices (see Considering a Cost-Benefits Analysis of Economic Regulatory Rules – 2):

• The absolute levels of potential risk and benefit are not as important as the symmetrical distribution of risk and benefit shared – equally at least ideally, by all involved stakeholders.
• The real risk of instability and crisis comes from risk and benefits distribution asymmetry.

What happens if an investment advisor faces essentially zero risk but their clients face significant risks for the investments they arrange? And more to the point, what happens when the investment advisor is secretly hedging and stands to gain personal profits if their investment clients loose? In this case and for investment advisors and their clients in general, any given play at the gaming table does not simply represent one bet and with one risk level per bet. It represents two, and two very different risk profiles for the same investments – two for the same seemingly-managed gambles.

• Senior managers should advance up-and-coming, hands-on talented colleagues who understand that, as well as advancing and promoting them on the basis of their hands-on and more technical skills and performance.
• And compensation and career advancement should, in this case as a working example, be based on investment performance and on impact on the investor – and not simply on the number of trades made and fees accrued to the company from them. That would link the investment advisor’s and the investor’s risks and returns, and add greater stability to this system.

When I write of enlightened self-interest, I am not citing emotionally or idealistically based sentiments or wishes. I am calling for clearly defined operational practices and standards, and standards and systems of accountability within industries and within individual businesses. And as recent experience has shown, even the best and most effectively contrived barriers to personal accountability and risk within a business for individual employees or executives cannot and will not remove overall risk and loss to the business as a whole, when the houses of cards so built begin to collapse. If nothing else, our recent Great Recession has validated that. And so have our more troubling marketplace experiences since then, with for example, JP Morgan Chase’s 2012 high risk derivatives trading losses coming out of their London offices (see Considering a Cost-Benefits Analysis of Economic Regulatory Rules – 12.)

I am going to step back from the within-business accountability and oversight issues that I have primarily focused on here, in my next series installment. I am going to turn there to consider the potential roles that supply chain and larger value chain systems can play in managing risk, and in leavening technical meritocratic skills with risk management judgment and business ethics standards. I will also discuss industry standards and best practices, and extra-legal regulatory frameworks. Meanwhile, you can find this and related postings at Macroeconomics and Business.

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