The Business Ethics Blog

Here’s a very useful piece by economics prof Thomas F. Cooley, writing in Forbes: The Real Bank Pay Scandal.

Cooley notes (and sympathizes with) the pattern of outrage over executive compensation. But he also reminds us that, when designed properly (which it isn’t always) compensation packages are designed to give executives incentive to build long-term shareholder value. That’s why, for example, the modern trend is towards paying CEO’s predominantly in stock options: it aligns the interests of CEOs with the interests of shareholders.

Of course, CEOs are humans, and humans are complicated. Motivating them is not straightforward. So different companies use different combinations of salary, stocks, stock options, and other perks. Well-organized Boards of Directors have “compensation committees” set up to figure out how best to incentivize senior execs, and there are consulting firms available to offer advice.

Well, how well do firms generally do? Cooley’s research (with his colleague, Gian Luca Clementi) suggests that, over all, CEO compensation is in fact pretty strongly correlated with gains for shareholders.

The first figure shown below is a plot of net shareholder gain in billions of 2005 dollars (the horizontal axis) against total compensation in millions of 2005 dollars (the vertical axis) for CEOs of all publicly traded companies…
What one would hope to see in such a plot is that the observations would lie in the lower left and upper right quadrants, which by and large they do. …There are some [exceptions] and one can identify them by name, date and company. The important point is that there are very few.

So, with a few exceptions, it looks like firms are doing pretty well at aligning executive compensation with the interests of shareholders. But in an age characterized by massive government bailouts, that’s not the whole story. Cooley’s concluding paragraph:

At the heart of the anger about bankers pay is the very legitimate concern that the bankers and their shareholders and debt holders benefit from a subsidy paid for by taxpayers–the subsidy that is implied by the notion that they are too big to fail. That subsidy empowers them to take bigger risks and earn bigger returns for themselves and their shareholders with all of the down side risk born by Main Street. That is the real outrage.

Hey, folks.

I’ve been nominated for an interesting new award, the “Shorty” award, “Honoring the best producers of short real-time content.” I’m nominated in the CSR category (apparently despite my frequent criticism of the term “CSR”. Oh well.

Voting is Twitter-based. So if you have a twitter account, and feel inclined to vote, go here:

http://shortyawards.com/ethicsblogger

And check out the other nominees, all of whom do interesting and useful stuff.

http://shortyawards.com/category/csr

A little over a year ago, I blogged about the current state of evidence regarding the effectiveness of one particular herbal remedy: Ginkgo Biloba a Dud for Alzheimer’s: Ethical to Keep Selling It? I noted that there was little good reason to think it an effective remedy, and suggested that, as a result, it was ethically problematic for companies to keep selling it.

Just yesterday, Scott Gavura at the Science-Based Pharmacy blog, posted an important update on the evidence regarding Ginkgo Biloba: Forget to take your Ginkgo biloba? Turns out, it doesn’t matter. Gavura’s posting is based on a new study reported in a recent issue of the Journal of the American Medical Association. Gavura (a licensed pharmacist) notes that he was once guardedly optimistic about Ginkgo Biloba, But given the most recent science, he says that hope is gone:

The largest and best-designed study to examine Ginkgo biloba has found it ineffective in reducing the incidence of dementia, Alzheimer’s disease, or in reducing the rate of cognitive decline in older adults. This is a persuasive study. In a population that is very close to the “real world” that might consider taking the product, no effect of ginkgo has been shown.

Importantly, Gavura ends with this ethical prescription:

It’s time for pharmacists to start recommending against self-treatment with Ginkgo biloba for the treatment or prevention of dementia or cognitive decline. [His emphasis.]

I agree. And it’s worth noting that the ethical constraints on pharmacists are stricter than the ethical constraints generally imposed on companies. Pharmacists are granted a collective monopoly on a particular field of practice, and we trust them to advise us on complicated matters that are deeply important to us. So, when supplement companies insist on their freedom to sell Ginkgo Biloba, on the very thin grounds that, hey, after all, people want it, it falls to pharmacists to do what they can to keep the public from wasting money on product that, while once promising, we now know to be useless.

Ethics, at its most basic level, consists in acting in principled ways to resist the urge to indulge in short-term gratification of our desires. It’s about resisting temptation, and thereby adopting ways of acting that, in the long run, are mutually beneficial. In the world of commerce, temptation isn’t merely passive: in many cases, temptations are thrust upon us. And when we make purchasing decisions with money that is not our own, the problems multiply.

See this short bit from the CBC’s Money blog: Air Canada marketing unethical: U of O prof

A University of Ottawa business professor says an Air Canada marketing tactic is crossing an ethical line.

Mike Miles, director of the MBA program at the University of Ottawa, said Air Canada offers frequent flyers, like him, coupons to upgrade their flights to business class. However, travellers have to purchase their tickets at a higher fare to qualify for the upgrade.

Miles said because much of his travel is for his work as a business professor, those extra costs would be passed on to the university, and it’s unethical for the airline to put him in that dilemma….

Basically, Miles is saying to Air Canada, ‘you shouldn’t tempt me like that to misuse my institution’s money!’ And I think there are certainly cases where we do think it’s unethical for one party to tempt another that way. I’ll quote a blog entry of mine from 2008:

…this falls very generally into the very broad category of doing things that encourages, promotes, makes more likely, that someone else will do something bad. Think of suborning perjury. The lawyer who puts a witness on the stand, knowing that witness is planning to lie, is doing something very bad, even if she herself isn’t the one doing the lying. Now, I’m not saying there’s a direct parallel here….

Now for what it’s worth, notice that in this case, Air Canada isn’t targeting business travellers exclusively: anyone who wants to use an upgrade coupon faces the same dilemma, namely whether to spend more to get (a lot) more. The difference is that for people like Miles (and me), whose travel is mostly paid for either by our institutions or by research grants, Air Canada’s policy amounts to a temptation to spend more of someone else’s money. And that difference constitutes a problem (an agency problem) for any institution that empowers employees to spend money on its behalf.

But then again, Air Canada surely knows that the vast majority of its frequent fliers are travelling on someone else’s dime, so a policy like this is bound, intentionally or not, to create huge numbers of agency problems. The question then becomes, at what point do the rewards for acting against your employer’s interests (e.g., by spending more than necessary) become sufficiently attractive that we start to think of the party offering those rewards as doing something unethical?
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Addendum / Clarification: I don’t think Air Canada’s practices here are unethical. But I do wonder at what point simple temptation becomes unfair inducement in cases like these.
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Thanks to Samantha for the story!