Finance Processes
18 minute read

Evaluating the Nature of Business Ethics in Practice

Martin is an seasoned real estate and PE executive that has completed over $200m of projects and advised a range of Fortune 500 companies.

Executive Summary

With regards to the nature of business ethics, what are the core theories that apply?
  1. Plato's concept of ethics is the theory of Virtues, these are deep-seated characteristical traits of people, and when they are fully expressed in a person, that person is ethical.
    • The defined four specific Virtues are temperance, fortitude, prudence, and justice.
  2. Kant took a very different view from Plato in his own philosophy of ethics, at the core of which is the categorical imperative. A categorical imperative is a moral statement that is true in all cases, and which can be relied upon to decide if a certain action is ethical. For example, one can say, "you should not steal." This can be viewed as true for all people and may be relied upon in all cases.
  3. John Stuart Mill took another viewpoint on ethics in his argument for utilitarianism. His argument was that rather than looking at the actor (Plato), or the action (Kant), one should look at the results. The concept is that society should define utility in some way, utility being loosely thought of as well-being of the whole society, and then look to improve that well-being.
    • People's actions may then be measured in terms of the utility produced on the whole, and whatever choice maximizes utility for everyone as a whole is the correct one.
What's missing in business ethics in the 21st century?
  • There are nuances between personal ethics ("singular ethics") and those that occur within a business context ("organizational ethics").
  • The viewpoint of singular ethics is useful in trying to narrow in on what might be ethically right in a situation that a single person is facing in their lives. It's not as useful when considering a large, complex, multifaceted organization.
  • Agency Theory is a popular tool to consider within situations of ethical quandary in organizations. Yet it also has its limits. Incentives are not always easy to see and understand in an organizational context and are even harder to change without creating unexpected and potentially negative side effects.
  • Businesses also have a tendency to rely on ethics falling under the umbrella of culture within the organization. This can be too vague though, unless concepts of fairness, communication, and wider organizational principles are clearly defined within the cultural footprint.

In a recent Deloitte survey, respondents were asked to agree or disagree with the proposition that businesses behave in an ethical manner. 48% disagreed. Asked then to opine on the statement that businesses focus on their own agenda, rather than considering wider society, 75% agreed. A similar survey in Britain resulted in just 52% of respondents saying they felt businesses behave ethically.

Did you catch that? Approximately half of the people (or at least those surveyed) believe that business is unethical and even more think businesses aren’t even trying; a pretty dire viewpoint given the wide-ranging and all-encompassing activities of business, and its involvement in nearly every element of our lives.

At the same time, as a businessperson myself, it’s hard to square these percentages with my own experiences in the business world. I’ve worked with countless businesses and run a couple myself, and through it all have largely, with a few notable exceptions, found they are filled with normal people. That is – people who are concerned with doing the right thing and trying to behave ethically.

And so, the conundrum – how is it that:

  1. The business world is mostly filled with good people who want to do the right thing, yet,
  2. Half of the world appears to think that business – as an institution – is unethical

How can we reconcile these two viewpoints, which both seem valid?

Are We Looking at Business Ethics the Right Way?

Or put another way – what exactly is business ethics? How is it different from any other type of ethics?

Maybe a good place to start is to look at how we are teaching ethics to those that we would one day aspire to behave ethically as business leaders. Does that education provide the necessary tools for their future lives as business leaders?

The nature of business ethics education today relies on much the same set of underlying principles as ethics in general. In my own business and general ethics education, the coursework could be broken into two general areas:

  1. What is the basis of ethics – which focuses largely on a discussion of past philosophical thoughts on ethics – how did Plato, Immanuel Kant, John Stuart Mill, and others view the ‘why’ and ‘how’ of ethics?
  2. How to deal with ethical quandaries – that is, given some challenging ethical situation, how does one parse and decide what is right and what is wrong, and make a decision?

When it comes to a general education in ethics, these are probably good places to start. And they do have some use in business as well, but I would argue that as a foundation for business-people thinking about organizational morality, they are lacking.

Are Traditional Views of Ethics Useful to Business?

Traditional ethical education is not a bad jumping off point. And an education in the basics can benefit everyone in their day-to-day lives. But let’s take an example from the business world and see how this knowledge of philosophy and moral quandaries can totally fail in a real-world business situation.

The Wells Fargo Fraud Case

On September 8, 2016, Wells Fargo was hit with a $185 million fine related to allegations that its employees had created millions of unauthorized bank and credit card accounts without their customers’ knowledge or consent. At the same time, approximately 5,300 employees were fired for their roles in the scandal – an enormous group of people to be complicit in this kind of activity. The following video provides an overview of what happened:

The scandal revolved around a cross-selling program the bank had implemented for retail accounts. The goal of the program was to create incentives for customer-facing employees (mostly tellers) to recommend add-on services to existing customers. Aggressive goals were set by management for cross-selling, and stern penalties were put in place for employees that failed to hit their performance targets, up to and including the loss of one’s job.

The goals set by management turned out to be too aggressive (and some would say unreachable), and many employees chose to create fake accounts for customers in lieu of actually cross-selling them into other services provided by the bank. These fake accounts were often free and with little revenue potential for Wells Fargo, but would technically qualify as cross-sales and allow the employees to meet their performance goals. At the same time, the bank ran a huge regulatory risk as scrutiny of financial service companies has increased since the great recession, and the creation of unauthorized accounts is viewed as a serious offense by regulators (hence the exceptionally large fines and penalties).

Over the two years following the emergence of the scandal, the following events transpired at Wells Fargo:

  1. The bank and several of its executives were punished and panned publicly, in addition to facing financial clawbacks.
  2. CEO John Stumpf first gave up a seven-figure salary, and then eventually stepped down.
  3. The bank ultimately paid a settlement of $142 million to its customers related to its actions.
  4. The Federal Reserve, in an unprecedented move, announced in 2018 that the bank would not be allowed to grow assets until it cleans up its act.
  5. The board was overhauled, with key members removed.

These would already be a painful enough set of punishments for the bank, and they do not even consider the cost to the bank in the form of bad press and the potential impact to its business in terms of loss of customers.

On the other side of the ledger, the amount of revenue Wells Fargo made against all of these fines, penalties, and lost goodwill? The estimates are around $5 million. An amount that is essentially meaningless to a bank with about $1.9 trillion assets in 2016, and certainly tiny relative to the costs incurred in penalties.

The Nature of Business Ethics According to Plato, Immanuel Kant, and John Stuart Mill.

Could Classical Ethics Have Saved the Day?

Let’s look at how three core ethical philosophies could have been applied (or rather would have failed in their application) to help Wells Fargo avoid this costly and unproductive scandal.

Plato

The concept of ethics proposed by Plato is the theory of Virtues. The concept is that there are traits (called Virtues) that are deep-seated characteristics of people, and when they are fully expressed in a person, that person is ethical. Plato went further, though, and defined four specific Virtues: temperance, fortitude, prudence, and justice.

The underlying nature of this theory is that ethical behavior is a state of being. Plato does not necessarily try to define people’s actions as right or wrong (as Kant and Mill do) but rather considers that a person in full possession of the Virtues will do what is right when faced with a decision. To Plato, it’s about being moral down to your core, and then behaving in alignment with yourself.

Plato would say that the solution to Wells Fargo’s problem would have been to encourage the development of the Virtues among its employees. While this is a noble goal, it’s tough to apply at this scale. As of 2017, Wells Fargo had about 260,000 employees – equivalent to a mid-sized city. Like any city, those 260,000 will include a huge variety of people. Hoping that everyone will choose to be virtuous and to focus on the development of their Virtues (even with substantial coaching and development) is too unreliable a premise to rest any business’s actions upon.

People are employed based on the best assessment managers can make about them, and developed to the degree possible, but it’s just not feasible to hire or train a company of saints. Sure, coaching and training programs can help, and many companies have such programs. But as a clear solution to this kind of misbehavior, Plato falls short.

Immanuel Kant

The next major school of ethical thought is that proposed by Immanuel Kant. Kant took a very different view from Plato in his own philosophy of ethics, at the core of which is the categorical imperative. A categorical imperative is a moral statement that is true in all cases, and which can be relied upon to decide if a certain action is ethical. For example, one can say, “you should not steal.” This can be viewed as true for all people and may be relied upon in all cases.

What would Kant say about the Wells Fargo case? Kant would likely suggest that the company should develop a code of conduct based on categorical imperatives, and then enforce that code of conduct. While this is perhaps a more practical solution than the one proposed by Plato, there are challenges here as well. It’s nearly impossible for a complex business to set a code of ethics detailed enough to give straightforward guidance to employees in every situation. Even if the code could somehow be made complete enough to address every situation, and communicated clearly, its enforcement nonetheless remains a challenge. Beyond that, it’s hard to believe that Wells Fargo has not already codified somewhere in its institutional policies that creating unauthorized accounts is not allowed. And yet 5,300 people were nonetheless adequately involved in the scandal to be let go after it erupted.

So, a code of conduct appears limited in its usefulness if it is not supported and enforced, and Kant does not suggest much in the way of enforcement in his theory.

John Stuart Mill

Next, let’s turn to John Stuart Mill. Mill took another viewpoint on ethics in his argument for utilitarianism. His argument was that rather than looking at the actor (Plato), or the action (Kant), one should look at the results. The concept is that society should define utility in some way, utility being loosely thought of as well-being of the whole society, and then look to improve that overall well-being. People’s actions may then be measured in terms of the utility produced on the whole, and whatever choice maximizes utility for everyone as a whole is the correct one.

The Wells Fargo fraud case is especially interesting when viewed under utilitarianism – because it seems to make no sense. Often, when corporate scandals hit the news there is an element of corporate or managerial enrichment at the cost of ethics, and the utilitarian mold fits for analyzing the situation - Bernie Madoff wrongfully enriched himself at the cost of his investors, and the utilitarian argument is that he improperly optimized for his own wealth rather than that of his investors. This is a convenient argument because it makes sense: the wrongdoers did wrong because it enriched them to do so, and they hoped not to be caught. The ethical concept then is that if the right set of interests are optimized for, then ethics is served. We just need to create an environment where the right set of interests is being attended to.

How does this look in light of Wells Fargo? The company, its employees, and several key executives seem to have taken an enormous amount of regulatory and legal risk to make a meaningless amount of revenue. If this was an optimization of some kind, one can certainly be forgiven for being confused as to what was being optimized for.

Another potential viewpoint applying utilitarianism is that the employees optimized for their own benefit, weighing the value of their own livelihoods and income against the risk of being caught and fired. But, if this is true and every person in an organization is their own agent and optimizing their own situation, it brings into question whether the concept of an organization having its own ethical existence even applies. After all, what is the value of fining Wells Fargo if its actions are defined by its employees, whose exposure for wrongdoing is limited? The concept that the employees of Wells Fargo acted of their own volition also does not read correctly as their actions were certainly limited (in some ways) by their managers and by the culture of the company. Without some level of organizational complicity, they could not have made the choices they made.

So, utilitarianism, while it has some explanatory power, and maybe can suggest ways of thinking, doesn’t seem to completely explain this situation, how it came to be, or how it could have been avoided.

To summarize, the foundations of ethics seem to fall short of providing guidance or solutions to the ethical situation faced by a real business. They provide a good underpinning to what ethics are, and some of the ways in which ethics may operate, but will often fail to provide useful solutions in the real world.

Was it a Moral Quandary?

Let’s move on to the other pathway pursued in ethics education – the use of ethical quandaries. These are stylized ethical scenarios where some decision needs to be made that has ethical consequences.

Probably the most well-known ethical quandary is the so-called “Trolley Problem.” It goes as follows – you are standing near a railroad switch that determines the path of a trolley coming down the track. You look up the track and see a trolley barreling down it, the trolley has lost its brakes and is unable to stop. You look down the track and see that a Chaplin-esque villain has tied people to both legs of the track. On one leg of the track, he has tied five people. On the other, just one.

The switch is currently set so that the trolley will continue down the path with five people on it. You have the option to turn the switch and redirect the trolley. Do you do it?

Visualization of the "Trolley Problem."

Many people will hear of this situation and decide to turn the switch, taking the utilitarian view that five peoples’ lives are worth more than one. But others will argue the Kantian view that if you turn the switch then you are taking the immoral action of killing someone. Whereas letting the trolley continue on its path leaves your hands clean – the people are the victims of the villain, not of you.

But are moral quandaries useful in the Wells Fargo fraud case? I would argue they are not. The reason is this – either the ethical situation is unambiguously right or wrong, in which case there is no moral quandary. Or, if there is a legitimate quandary, then the ethical answer is legitimately obscure and will necessarily be a judgment call (that’s the ‘quandary’ part). Take the Trolley Problem – the very reason it is interesting to discuss is that there is not a clear ethical answer to it. There are arguments to be made in either direction. But what use can this have for an organization? Situations that are judgment calls are just that, and you can’t really blame someone for choosing differently - that is operating from a different ethical basis than you would have. Returning to the Wells Fargo fraud case, I don’t think there is any objective observer that would say the organization faced a moral quandary. Creating the unauthorized accounts was wrong. There was no ethical upside to be balanced against. It wasn’t a quandary at all.

How is the Nature of Business Ethics Different from Personal Ethics? What’s Missing Here?

The reason it is so difficult to marry general ethics, what I will call “singular ethics,” to problems like those of Wells Fargo, which I will call “organizational ethics” is that the focus is on the wrong problem. The viewpoint of singular ethics is useful in trying to narrow in on what might be ethically right in a situation that a single person is facing in their lives, or a situation that an organization as a whole is facing. It’s not as useful when considering a large, complex, multifaceted organization.

Singular vs Organizational Ethics

Singular ethics provides frameworks for assessing a particular decision and suggests bases (the three main philosophical viewpoints) that can be used as frameworks for analyzing what is meant by right and wrong. Singular ethics also provides a tool, in moral quandaries, that allows for the development of an ethical map of a situation. One can take the base situation and alter some of the elements of the choice and see how the underlying ethics change. Using that knowledge, one can come to a firmer understanding of the ethics of the situation and make more informed decisions.

Where singular ethics falls apart, however, is in the context of a larger organization where there are multiple actors that may have vastly different backgrounds, goals, and perspectives about the ethics of a particular action. Often this can lead to situations where the individual parts make sense on some level, but the sum of the actions don’t make sense. Wells Fargo is a perfect example. The individual actors took actions that were horribly ineffective and inefficient for the organization as a whole, but on some level may have made sense to them individually.

Unfortunately, to date, limited research has been done to develop an understanding of the types of situations that unfold with respect to organizational ethics, and to provide prescriptions for improvements.

What follows are some of my ideas for business leaders to consider as they set up and monitor the practices of their organizations.

1. Agency Is Important

Arguably, the most complete set of thinking on organizational ethics has been in the area of agency theory. Agency theory takes the utilitarian viewpoint, but rather than taking the organization as the basis of consideration, looks at the individual actors within the organization. The diagram below shows how agency theory exists through the agent and principal relationship.

Agency Theory visualized.

For example, as discussed above in the case of Wells Fargo, its tellers may have looked at the situation presented to them as one where they could choose to create unauthorized accounts and keep their jobs, and perhaps not get caught. Or they could do the right thing and not create unauthorized accounts and potentially lose their jobs. They chose to optimize their own situations, with the result that a large number of them created unauthorized accounts. Looking at things this way, we can at least understand why the tellers would have taken this action (although we continue not to condone it).

This view also provides some potential ideas about how the scandal could have been avoided – if Wells Fargo hadn’t tied cross-selling goals to such painful penalties, employees may not have seen the cost of not creating unauthorized accounts as high enough to cross their own ethical boundaries. Alternately, if Wells Fargo had better compliance practices for the creation of new accounts, the tellers may have felt that the cost of trying to create unauthorized accounts was too high (because of the likelihood that they would be caught doing so).

The agency view is useful. But it has limitations as well. Incentives are not always easy to see and understand in an organizational context and are even harder to change without creating unexpected and potentially negative side effects. In fact, one could argue that the Wells Fargo scandal itself is a case of incentive-setting gone awry. The initial point of the cross-selling goals was to incentivize the opening of new customer accounts, a goal the bank wanted, not to get employees to create unauthorized accounts.

The other criticism of agency theory as a basis for people’s actions is the same as the criticism of utilitarianism in general – people don’t act solely based on incentives. They have an ethical life that goes beyond simple transaction-oriented thinking, and if that is ignored, then the picture will be incomplete.

2. Is Culture Too Vague as a Guide for Ethics in Business?

The other elements that are worth thinking about are those that can be loosely framed under a business’ culture. But culture is too vague of a word to be useful in thinking about a company’s policies, so let’s try to drill down to three specific concepts that organizations can use in practice.

Fairness

First, we can define the concept of organizational fairness. Fairness here meaning that the organization is perceived as doing the right thing with respect to the individuals or constituencies within it. The power of fairness is that we as people are wired to reciprocate when others are fair to us (and when they’re not). In addition, often when the incentives within an organization are misaligned, the sense of fairness within the organization disappears before other effects are felt.

Imagine an employee who has worked long and hard for a promotion. A promotion which is then awarded to a less-tenured, and less-qualified person. The employee’s sense of fairness is violated, and likely that employee’s focus and commitment to their job will suffer following the lost promotion. But long before their work begins to suffer, they will share with their trusted friends that what happened was unfair. Fairness can act as a canary in the coal mine, predicting when individuals in an organization may be most open to acting in ways that are not aligned with the organization’s goals. In keeping with the fairness concept, the Wells Fargo tellers likely felt that the cross-selling goals set by the company were unfair, and therefore they were ‘justified’ in violating the company’s practices for setting up new accounts. Had the company’s executives noticed the sense of unfairness in this group of employees, they might have known to explore this area with more focus and could have avoided the problems it created.

Communicativeness

A second useful concept is that of organizational communicativeness, that is, how freely information is exchanged between parties in the organization. A friend in the military once told me that the moment to get worried is when those under one’s command stop complaining. Similarly, when employees stop complaining to their managers, it means that important information is being held at a level where it may not be properly and promptly acted upon. In a sense, a lack of openness to organizational communication blocks appropriate oversight and allows problems to fester and grow. One of the areas that is focused on in modern ethical studies of businesses is the concept of retaliation – where the organization punishes individuals for being forthcoming with negative information. Not only does this kind of behavior feel wrong to us in general, it creates a situation where an organization’s leaders can’t see the issues they are charged with managing. And it is hard to fly blind.

Organizational Principles

A final element to consider is an organization’s tacit or explicit organizational principles. Nearly every human organization has principles - rules or opinions held by the organization’s members that allow its members to decide how to act.

These can be as simple as the way people in an organization tend to dress, and as complex as lengthily written codes of conduct that members agree to live by. Explicit principles are those that are codified and shared, and held up within the group, whereas tacit principles are those that are held and reaffirmed by observation and imitation. Going back to the example of dress, an example of an explicit principle is a school’s written dress code requiring students to wear a specific uniform while at school. An example of a tacit principle is what happens when there is no dress code – the students nonetheless will dress similarly, as anyone who has been to high school knows, but with more variation. Some students may even choose to define themselves ‘out’ of the group or in defiance of it by dressing differently from the mainstream students.

The point to consider is that organizational principles are emergent and can be defined both explicitly and tacitly. If an organization is looking for specific behavior from its employees, it needs to consider how its principles are being created, shared and supported. Going back to Wells Fargo, while there was likely a policy document somewhere stating that unauthorized accounts shouldn’t be created (an explicit principle), the tellers, in reliance on observation and imitation defined a more powerful tacit principle – that it was OK. That principle was missed entirely by management, who likely felt that the explicit principle was the governing light of the organization.

Better Tracking Methods and Research will Ultimately Help to Improve Ethics in Businesses

While these concepts come across as common sense, it is easy to lose sight of how an organization is performing ethically when there are many people involved, many issues being considered, and a business to run as well. Coming back to these ideas from time to time as policies are being considered and implemented and tracking them on a regular basis will help organizations ensure that they live out the ethics they intend to, and avoid unproductive scandals.

It should also now be clear that the topic of organizational ethics (as opposed to singular ethics) needs further consideration and research. What exists today in terms of concepts and practices regarding the importance of business ethics, while useful, falls short of providing direction on best practices in organizations, particularly when it comes to getting organizations to live out the ethical intent laid down by their leaders.

Improvements in this area will not only lead to more confidence in our business organizations across the world but will also help businesses avoid costly unforced errors.

Understanding the basics

What is John Stuart Mill's theory of utilitarianism?

Mill's ethical views were that rather than looking at the actor (Plato), or the action (Kant), one should look at results. Society should define utility through the well-being of the entire populace, and how to improve that well-being. People’s actions may be measured in terms of total utility produced.

What are Plato's four virtues?

The concept of ethics proposed by Plato is the theory of Virtues. There are traits (called Virtues) that are deep-seated characteristics of people, and when they are fully expressed in a person, that person is ethical. Plato defined four specific Virtues: temperance, fortitude, prudence, and justice.

What is Kant's moral theory?

Kant’s ethical theory is known as the categorical imperative. This is a moral statement that is true in all cases, and which can be relied upon to decide if a certain action is ethical. For example, one can say, “you should not steal.” This can, therefore, be viewed as true for all people.