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July 17, 2012 12:03 PM Do Business Schools Incubate Criminals?

By Luigi Zingalesto

The recent scandals at Barclays Plc, JPMorgan Chase & Co., Goldman Sachs Group Inc. and other banks might give the impression that the financial sector has some serious morality problems. Unfortunately, it’s worse than that: We are dealing with a drop in ethical standards throughout the business world, and our graduate schools are partly to blame.

Consider, for example, the revelations about two top executives at the elite consulting firm McKinsey & Co., which has avoided public vilification despite the transgressions of its former employees. McKinsey director Anil Kumar, — a graduate of the University of Pennsylvania’s Wharton School — pleaded guilty to providing insider information to hedge-fund manager and fellow Wharton alumnus Raj Rajaratnam. Rajat Gupta, a graduate of Harvard Business School who served for nine years as McKinsey’s worldwide managing director, was convicted of insider trading in the same case.

Although Gupta had long left McKinsey when the actions leading to his conviction took place, it would be shortsighted not to take the problem seriously. While every firm can have its bad apples, when these bad apples are at the top, it suggests that a company has either a corrupt culture or a defective selection process, or both. This is particularly troubling at a company like McKinsey, which cites the integrity and quality of its consultants as key advantages. “Keep our client information confidential” is one of its credos, proudly displayed on its website.

Where did Gupta, Kumar and others get the idea that this kind of behavior might be OK? Most business schools do offer ethics classes. Yet these classes are generally divided into two categories. Some simply illustrate ethical dilemmas without taking a position on how people are expected to act. It is as if students were presented with the pros and cons of racial segregation, leaving them to decide which side they wanted to take.

Others hide behind the concept of corporate social responsibility, suggesting that social obligations rest on firms, not on individuals. I say “hide” because a firm is nothing but an organized group of individuals. So before we talk about corporate social responsibility, we need to talk about individual social responsibility. If we do not recognize the latter, we cannot talk about the former.

Economics and Greed

Oddly, most economists see their subject as divorced from morality. They liken themselves to physicists, who teach how atoms do behave, not how they should behave. But physicists do not teach to atoms, and atoms do not have free will. If they did, physicists would and should be concerned about how the atoms being instructed could change their behavior and affect the universe. Experimental evidence suggests that the teaching of economics does have an effect on students’ behavior: It makes them more selfish and less concerned about the common good. This is not intentional. Most teachers are not aware of what they are doing.

My colleague Gary Becker pioneered the economic study of crime. Employing a basic utilitarian approach, he compared the benefits of a crime with the expected cost of punishment (that is, the cost of punishment times the probability of receiving that punishment). While very insightful, Becker’s model, which had no intention of telling people how they should behave, had some unintended consequences. A former student of Becker’s told me that he found many of his classmates to be remarkably amoral, a fact he took as a sign that they interpreted Becker’s descriptive model of crime as prescriptive. They perceived any failure to commit a high-benefit crime with a low expected cost as a failure to act rationally, almost a proof of stupidity. The student’s experience is consistent with the experimental findings I mentioned above.

In other words, if teachers pretend to be agnostic, they subtly encourage amoral behavior without taking any responsibility. True, economists are not moral philosophers, and we have no particular competence to determine what is ethical and what is not. We are, though, able to identify behavior that makes people better off. When a theater catches fire, the individual incentive is to rush to the exit as fast as possible. Yet if everyone in the audience rushed at once, the crowd near the door would allow fewer people to escape — indeed, many could die. Not surprisingly, there are social norms against this behavior. People who violate those norms are judged rude, egotistical, ill-behaved, or in certain cases even criminally negligent.

When the economist Milton Friedman famously said the one and only responsibility of business is to increase its profits, he added “so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” That’s a very big caveat, and one that is not stressed nearly enough in our business schools.

Free Competition

Lobbying to secure a competitive advantage from the government certainly does not represent “open and free competition.” Similarly, preying on customers’ addictions or cognitive limitations constitutes deception, if not outright fraud. Not to mention using clients’ confidential information for personal gain, manipulating a major interest-rate benchmark such as Libor, or selling financial products you know to be flawed.

Luigi Zingalesto is a professor of entrepreneurship and finance at the University of Chicago’s business school.

Comments

  • Anonymous on July 18, 2012 2:02 AM:

    Where did they get the idea? Well, they all came from India, which is a cesspool of ethical trash.

    Thousands of Indian students hoping to enter American colleges will have to retake the Graduate Record Examinations and English-language proficiency tests in January, because copies of the tests were widely sold before the tests were taken.

    What do you get when you combine Indian technical wizardry with a desperate shortage of spots in higher education? Some really fancy exam cheating.

    Delhi police this week arrested five men they said are part of an elaborate scam to crack the entrance exam for elite public postgraduate medical schools.

    It's time after time after time. Indians view the US as a place ripe for the picking. We need to cut WAAAAYYYYYYYYYY back on Indian visas.