Do business schools incubate criminals?

by Luigi Zingales, Published TODAY, 18 Jul 2012

The recent scandals at Barclays, JPMorgan Chase, Goldman Sachs 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 behaviour might be okay? 

ETHICS CLASSES - OF A SORT 

Most business schools offer ethics classes, which 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 organised group of individuals.

So, before we talk about corporate social responsibility, we need to talk about individual social responsibility. If we do not recognise the latter, we cannot talk about the former. 

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 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 behaviour and affect the universe.

TEACHING GREED , 

UNINTENTIONALLY

Experimental evidence suggests that the teaching of economics does have an effect on students' behaviour: 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, Dr 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. While insightful, Dr Becker's model, which had no intention of telling people how they should behave, had some unintended consequences. 

A former student of Dr 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 Dr 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 behaviour 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 behaviour that makes people better off. 

When economist Milton Friedman 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 is a very big caveat - and one that is not stressed nearly enough in our business schools. 

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. 

The way to teach these ethics is not to set up a separate class in which a typically low-ranking professor preaches to students who would rather be somewhere else. This approach, common at business schools, serves only to perpetuate the idea that ethics are only for those students who aren't smart enough to avoid getting caught. 

MAKE IT A VITAL CORE SUBJECT

Rather, ethics should become an integral part of the so-called core classes - such as accounting, corporate finance, macroeconomics and microeconomics - that tend to be taught by the most respected professors. 

These teachers should make their students aware of the reputational (and often legal) costs of violating ethical norms in real business settings, as well as the broader social downsides of acting in one's individual best interest. 

Of course, no amount of instruction can prevent some people from engaging in bad behaviour. It can, however, contribute to a social consensus that would discourage diffuse fraud, like the widespread misreporting of Libor rates or the wilful self-delusion and dishonest dealing that helped turn the sub-prime crisis into a global financial disaster. 

The daily scandals that expose corruption and deception in business are not merely the doing of isolated crooks. They are the result of an amoral culture that we - business-school professors - helped foster. The solution should start in our classrooms. BLOOMBERG

Luigi Zingales is a professor at the University of Chicago Booth School of Business and the author of A Capitalism for the People: Recapturing the Lost Genius of American Prosperity.