Archive for the ‘finance’ Category

Buffett, Sokol, and Virtue Ethics

Warren Buffett (photo by Mark Hirschey)

What kind of person do you want to be? What kind of businesspeople do you think worthy of imitation?

The world’s most successful investor, Warren Buffett, was recently caught up in a scandal. He himself is not accused of any wrongdoing, though some have accused him of responding to the scandal — one involving a senior employee of his, one David Sokol — in a lackadaisical manner.

For the basics of the story, see here:
Berkshire doesn’t plan big changes after scandal (by Josh Funk, for the AP)

Berkshire Hathaway CEO Warren Buffett says he doesn’t think his reputation has been hurt much by a former top executive’s questionable investment in Lubrizol shortly before Berkshire announced plans to buy the chemical company….

Sokol is accused of a form of insider trading, essentially a kind of betrayal that is unethical at best, and illegal at worst. Now, Sokol himself is, not surprisingly, keeping pretty quiet, and speaking only through his lawyer. I’m more interested, at this point, in Buffett’s response, and what it says about his character. I’m not the first person to suggest that you can learn a lot about a person by the way he or she responds to a crisis. But when the man in the spotlight happens to be one of the world’s most successful businessmen, there’s some reason to think that the lessons learned might just be more interesting than most.

For more about Buffett’s response, see here: Buffett Takes Sharper Tone in Sokol Affair (by Michael J. De La Merced, for the NYT.)

Despite the critics, I think Buffett comes out of this looking pretty good. To begin, Buffett gets points for demonstrating his loyalty to a long-serving employee:

[Buffett] was harsh in his assessment of Mr. Sokol’s trading actions, he pointedly declined to personally attack Mr. Sokol, instead highlighting the executive’s years of service and good performance.

Buffett also has a sense of context and proportion. Not that the wrong of which Sokol is accused is small. But it is wise, and ethically correct I think, for Buffett to resist the urge to pounce on an employee who has, in Buffett’s own experience (up until the present crisis), been a diligent and morally-upstanding employee:

“What I think bothers some people is that there wasn’t some big sense of outrage” in the news release, Mr. Buffett said. “I plead guilty to that. But this fellow had done a lot of good.”

Buffett’s business partner, Charles Munger, likewise gets points for showing restraint:

“I feel like you don’t want to make important decisions in anger,” Mr. Munger said, defending Berkshire’s press release. “You can always tell a man to go to hell tomorrow.”

All of this is set against a background of Buffett insisting on the importance of having a reputation for integrity in business. Buffett is no slacker when it comes to ethical standards. The NYT piece quotes Buffett from 20 years ago, on the topic of the significance of reputation in business:

“Lose money for the firm, and I will be understanding. Lose a shred of reputation for the firm, and I will be ruthless.”

Finally, it’s worth pointing out that this focus on Buffett’s character, and on the example he sets, represents an importantly different approach to business ethics. The approach here is akin to what philosophers call “virtue ethics,” a stream of thought that goes back to Aristotle. The idea here is that, rather than focusing on principles (or, more cautiously, in addition to focusing on principles), what we really ought to do when thinking about ethics is to focus on character. Rather than asking, “what rules apply to this situation?” this way of thinking asks, “what would a good person do in a situation like this?” And in between crisis points, we should be asking, “when a crisis comes, what kind of person do I want to pattern my behaviour after?” I don’t know nearly enough about Mr Buffett to hold him up as a moral exemplar, but I think that the kind of character he has displayed in the Sokol affair is worthy of emulation.

Who Else is Too Big to Fail?

The notion that some companies are “too big to fail” — too large and too interconnected with the rest of the economy for their failure to be permitted by government — is lamentably familiar to most of us in the wake of the 2007-2010 financial crisis. The term has most famously been applied to the biggest American banks (e.g., Bank of America) and insurance companies (e.g., AIG), and it motivated the multi-multi-billion-dollar government bailouts of 2008/2009. In some ways, it’s a radical notion: for most of modern economic history, the assumption has been that the economy could operate according to something like survival of the fittest. If a company is so mismanaged that it fails, so be it. That’s life in a competitive market. Of course, governments have from time to time propped up companies seen as particularly important employers, but such moves are always divisive. There has seldom been such widespread agreement that certain companies really are so big, and so important, that they cannot be allowed to fail.

But outside of the financial industry, what companies might reasonably be thought of as “too big to fail?” Are there companies the failure of which would be truly catastrophic? What companies are there such that, if they suddenly ceased operations, the result would be disastrous not just for individual customers, employees, and shareholders, but for society as a whole?

I’ll mention a few possibilities, and then open the floor for discussion:

BP, Chevron, and the other very large oil companies. As unpopular as they are, it’s hard to deny that their product is utterly essential, at least for the time being. Any one of the biggest companies going out of business would, I suspect, have a terrible impact on the reliability of supplies of gasoline and heating fuel, and would most certainly result in increased prices. On the other hand, most of the world’s oil supply flows through the big state-owned oil companies of the middle east, rather than through private companies like Exxon and Shell the others, the ones that come most readily to mind for North American and European consumers.

Big pharma. Again, not a popular industry. And much of what they produce — treatments for baldness, erectile dysfunction, etc. — is far from essential. But some of their more important products, including things like antibiotics and vaccines, truly are essential and an interruption in their supply could have catastrophic consequences, from a public health point of view. But then, that industry has enough players in it, with overlapping product lines, that it’s unlikely the collapse of any one company would have a huge impact. But really, I’m guessing here. Perhaps the collapse of the maker of whatever the single most antibiotic is would be catastrophic. (Does anyone know?)

What about UPS? That one may surprise you, but the company handles something over 5 million packages per day, which I’ve heard adds up to a non-trivial percentage of American GDP. If UPS disappeared tomorrow, of course, Fedex and the USPS would take up some of the slack, but the short-term effect on American business (and hence consumers) would be significant.

Locally, surely, there are lots of companies that might be considered essential. Companies involved in ensuring the quality of municipal water supplies might count (including the ones that provide the chemicals needed for water purification). And in places where fire departments are privately-run, those would obviously count. But really, I’m looking for examples of companies the failure or disappearance of which would have widespread effects from a social point of view.

Of course, the phrase “too big to fail” isn’t just descriptive. In the world of finance, it is seem as having immediate policy implications. In 2009, Alan Greenspan, the former chairman of the US Federal Reserve (and no fan of government intervention in the economy), said “If they’re too big to fail, they’re too big.” Are there companies outside of finance where such an argument could be made?

Unethical Innovation

Innovation is a hot topic these days, and has been an important buzzword in business for some time. As Simon Johnson and James Kwak point out in their book, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, innovation is almost by definition taken to be a good thing. But, they also point out, it’s far from obvious that innovation is in fact always good. They focus especially on financial innovation, which they say has in at least some instances led to financial instruments that are too complex for purchasers to really understand. Innovation in the area of finance — often lionized as crucial to rendering markets more efficient and hence as a key driver of social wealth — is actually subject to ethical criticism, or at least caution. And the worry is not just that particular innovations in this area have been problematic. The worry is that the pace of innovation has made it hard for regulators, investors, and ratings agencies to keep up.

In what other cases is “innovation” bad, or at least suspect? One other example of an area in which innovation might be worrisome is in advertising. Consider the changes in advertising over the last 100 years. Not only have new media emerged, but so have new methods, new ways of grabbing consumers’ attention. Not all of those innovations have been benign. When innovative methods have been manipulative — subliminal advertising is a key example — they’ve been subject to ethical critique.

Some people would also add the design and manufacture of weaponry to the list. But then, almost all innovations by arms manufacturers have some legitimate use. Landmines and cluster bombs are controversial, largely because of their tendency to do too much “collateral dammage” (i.e., to kill civilians). But they do both have legitimate military uses. So it’s debatable whether the innovation, itself, is bad, instead of just the particular use of the innovation.

Are there other realms in which innovation, generally taken to be a good thing, is actually worrisome? One caveat: the challenge, here, is to point out problematic fields of innovation without merely sounding like a luddite.

Insider Trading at the FDA

A scientist employed by the US Food and Drug Administration has been arrested and charged with insider trading.

Here’s the story, from Diana B. Henriques at the New York Times: U.S. Chemist Is Charged With Insider Stock Trades

A 15-year veteran of the federal Food and Drug Administration and his 25-year-old son were arrested on Tuesday and charged with systematically using confidential information about pending drug applications to reap millions in illegal trading profits since 2007.

As part of its drug-approval process, the FDA is given sensitive information by companies seeking such approval. And the status of a company’s application within the FDA’s own decision-making is itself sensitive information. Since FDA approval is essential to getting a drug to market, the announcement that a company’s drug has been granted, or denied, approval by the FDA can have a huge impact on the value of a company’s stock. And what FDA chemist Cheng Yi Liang did is to use information available only to FDA insiders to make profitable trades on the stock of companies then seeking FDA approval.

Just what was so wrong with what went on here?

In a statement announcing the case, Lanny A. Breuer, the assistant attorney general for the criminal division, said: “Cheng Yi Liang was entrusted with privileged information to perform his job of ensuring the health and safety of his fellow citizens. According to the complaint, he and his son repeatedly violated that trust to line their own pockets.”

Now Mr Breuer is clearly engaging in a bit of prosecutorial rhetoric. He’s right of course that Cheng Yi Liang was entrusted with privileged information, but there’s no obvious reason to think that his use of that information for personal gain jeopardized anyone’s health or safety. But fair enough: Mr Breuer is playing his role in an adversarial system, and that licenses a certain amount of hyperbole.

But what really is wrong with the kind of insider trading that Cheng Yi Liang engaged in? The precise worry about insider trading is the subject of some debate, and I’ve blogged about that before. (See: Ethics of Insider Trading.)

There are several ways we could get at just what was unethical about what Cheng Yi Liang did. One worry is that he profited unjustly, gaining money that he didn’t earn and had no right to. Also, in engaging in insider trading, he traded on information not accessible to others. That means that the people he traded with were at an unfair advantage, and likely lost money as a result. It also means that, subject as it was to significant information asymmetries, the market in which he traded was rendered slightly less efficient, as a whole.

There is of course another ethical worry: if chemists working for the FDA take a personal financial interest in the fate of various approvals, that could quite easily corrupt the work they do. In other words, it puts such a chemist into a conflict of interest. In a conflict of interest, what is fundamentally at stake is our trust in an individual’s judgment. If FDA scientists have a personal stake in their scientific work, then we have reason to doubt their judgment. And, worse, if the judgment of FDA scientists becomes subject to doubt, then the public ends up having a reason (though perhaps not a sufficient reason) to doubt the work of the FDA as a whole.

Ethics of Profit, Part 3: The Profit Motive

3 coinsThis is the third in a 3-part series on the ethics of profit. (See also Part 1 and Part 2.) As mentioned in previous postings, we should distinguish between our ethical evaluation of profit per se (which, after all, just means financial “gain”), and our ethical evaluation of the profit motive. After all, I don’t worry at all that Big Pharma makes big profits — that just means that they make products that lots of people think are worth paying for — but I do have serious worries about what people inside the pharmaceutical industry are willing to do to maintain those profits.

But we should be cautious about jumping too quickly to criticize the profit motive, either in particular cases or as a force in the economy as a whole. Here are just a few points:

1) People often suspect the profit motive — or at least, excessive focus on the profit motive, in the form of greed — of being responsible for a lot of corporate wrong-doing. But, anecdotes aside, that intuitive hypothesis isn’t necessarily well-supported by the facts. I’ve mentioned previously a paper by philosopher Joseph Heath* that points out that there are problems with the theory that greed is the root cause of a lot of wrongdoing. Corporate crime is actually more often aimed at loss-avoidance than at profit-making. And it’s also worth noting that we see lots of white-collar crime occurring at the top of organizations, committed by people who are already rich and who hence have relatively little to gain in financial terms. As Joe points out, the criminological literature has long since discarded the notion that greed is the root of all (or even most) evil.

2) Despite the fact that the traditional corporate (and anti-corporate) rhetoric has focused on the significance of profits, it’s probably much more likely that corporations and the key decision-makers within them are moved by a much broader range of motives, including things like:

  • A desire to increase market share;
  • The desire to innovate;
  • The desire to create cool products;
  • Basic competitive drives to be (and prove yourself to be) bigger, stronger, faster, smarter, etc.;
  • The CEO’s desire to build his or her personal legacy;
  • etc.

Of course, each of those motives can almost certainly result in wrongdoing too. But that just reinforces the point that even if the profit motive causes trouble, it isn’t unique in that regard.

3) The profit motive, whatever else it may do, plays 2 absolutely essential roles in any modern economy. Economist Steven Horwitz points this out in his “Profit: Not Just a Motive”. One role (as Adam Smith pointed out) is the basic one of motivating productive activity. Now, Smith never said that the profit motive is the only thing that motivates people to engage in production and trade. But what he did say is that even someone who doesn’t happen to have much love for his or her fellow human being is liable to end up doing something productive, even if only because he or she wants to earn a living. The other role for the profit motive is more subtle, and has to do with information. As Horowitz puts it:

What critics of the profit motive almost never ask is how, in the absence of prices, profits, and other market institutions, producers will be able to know what to produce and how to produce it. The profit motive is a crucial part of a broader system that enables producers and consumers to share knowledge in ways that other systems do not.

4) The profit motive also plays an essential role in modern corporate governance. Most large corporations are “owned” (in a very loose sense) by shareholders, to whom corporate managers and directors owe a fiduciary duty. In particular, managers and directors are obligated to try to make a profit. (Note that, contrary to what many seem to think, there is no obligation to actually make a profit, and the need to make a profit is not, in fact, legally binding or overriding. Shareholders only ever get a profit after a number of other, legally-binding, obligations — such as the obligation to pay workers, to pay suppliers, to provide refunds for consumers who bought faulty products, etc. — are met.) The strong obligation to try to make a profit for shareholders provides focus for managers. Rather than being pulled in 20 different directions by 20 different stakeholders, corporate managers have in mind that, yes, they need to keep in mind various stakeholder obligations, but all of that has to be part of an overall plan aimed at shareholder profits. Many people believe that this imposes a kind of discipline on corporate executives, without which those executives would be free to feather their own beds, throw lavish parties for their favourite charities (not necessarily the most needy ones), hire under-qualified siblings for key roles, etc.

5) Getting rid of the profit motive would essentially mean abolishing private ownership. When we talk about “profit”, we’re typically talking about the money that flows from owning something. It might be the landlord’s profit (i.e., whatever’s left after costs are subtracted from rent) or the shareholder’s profit (i.e., the dividend that might be paid out on the shares he or she owns, if the corporation happens to make a profit). Abolishing the profit motive basically means and end to permitting individuals to own things. So why do critics of the profit motive so seldom (in the last, say, 4 decades) propose ending private ownership? Hmmm. As Joseph Heath put it in “Learning to love the Psychopath” [PDF] (a review of the movie, The Corporation), “If public ownership is not the solution, then private ownership cannot be the problem.”

6) Even if we could keep our attachment to private ownership and wish into existence more “positive” motives than the profit motive, it’s not clear that we would be better off. Even if large numbers of executives (and shareholders) could be convinced not to aim at profit, but instead to aim at things like charitable deeds or the public good or world peace, it’s not clear that that would solve the problems we are most worried about. Does anyone really think that fraud couldn’t be, or indeed hasn’t been, committed in the name of charity? Does anyone believe that lies haven’t been told and thefts committed in the name of the public good?

None of this is intended as a blanket endorsement of profit-seeking. It’s just a reminder that in our haste to criticize the profit motive, we ought not ignore important questions about just what role the profit motive plays, what current institutions do to transform a range of motives into a range of outcomes, and what alternative motives and institutions are available to us.

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*Joseph Heath, “Business Ethics & Moral Motivation: a Criminological Perspective,” Journal of Business Ethics 83:4, 2008. Here’s the abstract.

Financial Speculation & Ethics

Friday I gave a talk as part of a terrific workshop on the ethics and law of financial speculation, held at the University of Montreal. (The event was co-sponsored by U of M’s Centre for Business Law and the Centre for Research in Ethics.)

As I mentioned in a posting last week, financial speculation is the subject of some controversy. Indeed, there has been plenty of discussion of regulating various forms of speculation, though whether that is possible and how best to do so is also subject to controversy.

Very roughly, “speculation” can be thought of as involving any of a range of forms of relatively high-risk investment. In a way, it is the exact opposite of a slow, safe investment such as buying government savings bonds. But it’s also different from pure gambling: in most forms of gambling, you have no reasonable expectation of making money. You might well win big, and it’s nice if you do, but really all you can expect is to have fun playing the game. Speculation on the other hand involves taking what are hopefully well-informed risks, in the hopes of exceptional returns.

Here are 3 stereotypical examples of speculation:

  • Imagine that a wheat farmer is considering whether to plant wheat an additional, previously-unplanted, field. Imagine that the farmer’s total cost for doing so would be $5/bushel of wheat. If the current price of wheat is hovering right around the $5 mark, that turns planting into a risky proposition. The risk of a loss might make planting just too unattractive. Now imagine a speculator comes along and is willing to take that risk, so she offers the farmer $5.25/bushel for the wheat that has not even been planted yet. With the promise of a modest-but-guaranteed profit in hand, the farmer plants the crop. If, at harvest time, the price of wheat has gone up to $6/bushel, the speculator stands to make a tidy profit. If the price has gone down to $4/bushel, the speculator suffers a loss — but she’s in the business of speculating precisely because she has the resources to absorb such losses, and will just hope that her next investment pays off better.
  • Imagine someone whose job is to invest in futures contracts on commodities such as oil or gold. A futures contract is basically a commitment to buy a specified quantity of something, at a specified price, at some date in the future. The example above involved a kind of futures contract, except in that example the investor actually did intend to buy and take possession of the farmer’s wheat once harvested. But in the vast majority of futures trading, nothing but paper ever changes hands. If a trader finds that other traders have been paying above-market prices for oil futures, she might decide that it’s worth buying some herself, in the hope that the price of oil will continue to go up because of this demand. Other traders are likely to notice, and imitate, her behaviour, with a net effect of pushing oil prices up. None of this needs to reflect any underlying change in consumer demand for oil, or any change in oil’s supply. It can all happen as the result of a combination of hunches about the future of oil and a dose of herd behaviour.
  • Imagine I have a dim view of the future prospects of a company, say BP, so I decide to “short” (sell short) shares in BP. What I do is I borrow some shares in BP, say an amount that would be worth $1,000 at today’s prices. I then sell those borrowed shares. If all goes as I expect it will, the price of BP shares may drop — let’s imagine it drops 25%. I can then buy enough shares in BP, at the reduced price ($750 total), to “return” the shares to the person I originally borrowed them from. And I get to pocket the $250 difference (minus any expenses). Basically, this form of speculation — short selling — is unlike standard investments in that it involves betting that a company’s shares will go down, rather than up, in value.

There is disagreement among experts regarding just what the net effect of speculation (or indeed of particular kinds of speculation) is likely to be. Some think that speculation, as a kind of artificial demand, has the tendency to increase prices and perhaps even to result in “bubbles” that eventually burst, with tragic results. But the evidence is unclear. In particular cases, it can be very difficult to tell whether a) speculation caused the inflationary bubble, or whether b) some underlying inflationary trend spurred speculation, or whether c) it was a bit of both. And even if it’s clear that some forms of speculation sometimes have such effects, it’s not clear a) that speculation has negative effects often enough to warrant intrusive regulations, or b) that regulators will be able to single out and regulate the most worrisome forms of speculation without stomping out the useful forms.

And defenders of speculation do point out that at least some forms of speculation have beneficial effects. Speculators of the sort described in my first example above take on risk that others are unable to bear, and hence allow productive activity to take place that otherwise might not. They also add “liquidity” to markets by increasing the number of willing buyers and sellers. Speculators, through their investments, can also bring information into the market and thus render it more efficient. When one or more speculators takes a special interest in a given commodity, it is likely to be on account of some special insight or analysis that suggests that there will be an increased need for that commodity in the future. In other words, in the best cases at least, expert financial speculation isn’t idle speculation — it is well-informed, and informative.

Of course, it’s also worth pointing out that pretty much any technology or technique can be used for good or for evil. The techniques of financial speculation can be used to attempt to manipulate markets or to defraud consumers. Whether the dangers of such uses outweigh other considerations is up for debate.

But from the point of view of ethics, it’s worth at least considering exercising caution in some areas. Perhaps speculators with a conscience, for example, should be particularly risk-averse when it comes to commodities that have a very direct impact on people’s wellbeing, such as food. Recently Andrew Oxlade, writing for the financial website “ThisIsMoney”, asked Is it ethical to invest in food prices? As Oxlade notes, at least some critics believe that recent surges in food commodity prices have at least something to do with the activities of traders engaging in speculative trades.

Oxlade offers this advice to investors:

To sleep easier at night and still get exposure to this area, you may want to consider investing in farming rather than in food prices via derivatives. In fact, your money may even do some good.

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p.s. thanks once again to the organizers of the workshop mentioned above, namely professors Peter Dietsch and Stéphane Rousseau.
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Note also: If you’re interested in this topic from a professional or academic point of view, then this book should be on your bookshelf: Finance Ethics: Critical Issues in Theory and Practice, edited by John Boatright.

Ethics of Profit, Part 2: Profits Unjustly Gained

This is the second in a 3-part series on the ethics of profit.

As I noted in the first in this series, profit is often subject to ethical criticism. But the reasons for that are not clear. To begin our analysis, we need to distinguish between the ethical evaluation of profit itself, and the ethical evaluation of the profit motive. The first 2 parts in this series are focused on profits per se. The next one will focus on the profit motive.

Our focus last day was on unjustly large profits. Today’s focus is on profits that are gained unjustly, regardless of the size of those profits.

There are several distinct circumstances in which profits might be said (by at least some people) to have been unjustly gained.

  1. Profits gained through exploitation. Under this heading, we might include the profits earned by drug companies that jack up the prices for life-saving drugs, or profits earned by tow-truck operators who cruise the highways during snowstorms, offering to rescue stranded motorists at exaggerated prices. I’ve blogged before about exploitation, and in particular about how hard it is to define. The big problem is that, generally, situations that get called “exploitative” involve none of the usual factors that make transactions unethical, factors like force, fraud, or deception. When we say that profits have been gained through “exploitation,” we typically mean that the situation in which such profits were earned were — in some vague way — unfair, but it is notoriously difficult to say just what is unfair about them.
  2. Profiting from vice. Under this heading, we might include profiting from legal sale of tobacco, alcohol, pornography, and sexual services. Many people think one or more of these ways of making a living are morally suspect. We might want to distinguish among different cases, however, including based on factors such as choice and information and power. The janitor at a cigarett company, for example, might be held less blameworthy than the company’s lawyers and advertising executives.. We might also include, under the general heading “profiting from vice,” things like doing business with bloodthirsty dictators.
  3. Profits from financial speculation. This one may strike some as odd. But there is a long history of suspicion with regard to those who engage in financial speculation, including especially things like short selling (which involves betting that the price of a stock will fall). After all, the speculator is essentially a gambler, and the sense that many people have is that such gambling is of no social value: speculators don’t build things, after all. And there are worries that speculators contribute to the growth of dangerous market bubbles. But defenders of speculation argue that speculators, unlike gamblers, do have beneficial effects. They add liquidity to markets, and their speculation, made visible by their investments, adds valuable information to the market.
  4. Unethical business practices. Here we have what is potentially an enormous grab-bag of business practices that constitute legal, but unethical, ways to make a profit. I tend to agree with Joseph Heath’s view*, that we should delineate the boundaries of this category in terms of what Heath calls (socially) “non-preferred competitive strategies”. Heath’s idea is basically that agressive competitive behaviour on the part of companies is generally a good thing (when, e.g., they compete by innovating and by seeking efficiencies), but their behaviour becomes fundamentally anti-social when they compete by using strategies that tend to make markets work worse overall (i.e., make markets less able to perform their social function of increasing social well-being). So the “forbidden” strategies here would include any attempt to profit from information asymmetries (e.g., by misleading customers), externalities (e.g., pollution) or monopoly. Profits gained in those ways may rightly be criticized.

We might add to this list the gaining of profit by individuals or institutions that we think ought, for various reasons, not make profits at all. For some people, at least, that includes government agencies and public universities.

Are there other ways in which profits (even small profits) can be unethical, ways that don’t fit into one of the categories above?

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*Heath’s argument about non-preferred competitive strategies can be found in his paper, “Business Ethics Without Stakeholders,” Business Ethics Quarterly, 2006 (Vol. 16, No.3).

Ethics of Profit, Part 1: Excessive Profits

This is the first of a 3-part series on the ethics of profit.

Is making a profit ethically good, or bad, or neutral? Or, better still, are there situations in which making a profit is either good, or bad, or neutral?

Profit is often the subject of criticism. The film, “The Corporation”, has as its main target not corporations per se, but the profit motive in particular. Michael Moore appears in the film, saying that while some corporations do good things, “The problem comes in, in the profit motivation here, because these people, there’s no such thing as enough.”

Now, the idea of profit is often tied up with money, with ‘filthy lucre.’ After all, everyone knows that saying about money being the root of all evil. But in the abstract, profit needn’t be defined in terms of cash. In the abstract, profit is just the “cooperative surplus” that results from a mutually-beneficial exchange. When I buy an apple (for, let’s say, $1) at my local market, both the owner of the market and I end up better off. We both “profit.” My own “profit” is the amount by which I value the apple over the $1 that I paid for it. And the market owner’s profit is the amount by which the sale price of $1 exceeds her own costs (apple + labour + overhead, etc.). And the fact that we both profit from the exchange is precisely what makes the exchange good for both of us.

Now, I think we need to distinguish between our ethical evaluation of profit, and our ethical evaluation of the profit motive. Because even if we agree that profit is generally OK, we can still worry about the things that people (or companies) will do in the pursuit of profit.

I’ll focus another day on the profit motive. Today I want to focus on profit itself. It seems to me that there are 2 kinds of circumstances in which profit itself is subjected (rightly or wrongly) to ethical criticism. One is when profits are excessively large; the other is when profit is gained unjustly. Today I’ll focus solely on the idea of excessive profit.

Several industries are commonly singled out as having unjustly large profits. One is the banking industry. Another is the pharmaceutical industry. Likewise, if we expand the category of “profit” to include individual profit in the form of salaries, then Wall Street is regularly singled out as a place where excessive profits are to be had. The fundamental ethical question with regard to large profits is what philosophers would call a question of “distributive justice.” Basically, is it fair that some people have so much money, while others in the world have so little?

A few points are worth making about big profits:

1) It’s worth remembering that very large corporate profits don’t necessarily translate into large amounts of personal wealth for anybody. Consider the fact that a company that has several billion dollars in profits — a lot of money, by anyone’s accounting — might have hundreds of millions of shares outstanding, spread across thousands (or even millions) of shareholders, and might pay out only a tiny dividend (say, a dollar per share). So a massive profit doesn’t necessarily translate into massive personal wealth for anyone.

2) Although many of us have intuitions that say that large disparities in wealth are unjust, it has proven incredibly difficult to translate those intuitions into anything like a coherent ethical theory. Despite our best efforts, we simply have no sound explanation of a) why it is that differences in wealth (fairly acquired) ought to be considered unfair, or b) just how large a difference has to be in order to be considered unfair. The lack of such a theory doesn’t negate our intuitions, but it should give us pause before we assert that particular disparities are “obviously” or “grossly” unethical.

3) It’s worth noting that what I referred to above as our “intuition” about injustice might also be referred to as a form of envy. And envy is far from admirable. As philosopher Anthony Flew once pointed out*, “this envy which resents that others too should gain, and maybe gain more than us, must be accounted much nastier than any supposed ‘intrinsic selfishness’ of straight self-interest.”

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*Anthony Flew, “The Profit Motive,” Ethics, Vol. 86, No. 4 (Jul., 1976), pp. 312-322
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Update: Part 2 of this series is here and Part 3 is here.

Regulating Wall Street Bonuses

The U.S. Securities and Exchange Commission has just announced its intention to exercise oversight over levels of pay on Wall Street. Is this an example of overreaching regulation, or of justified intervention in the public interest?

Here are the details, from Ben Protess and Susanne Craig, on the NYT‘s DealBook blog: S.E.C. Proposes Crackdown on Wall Street Bonuses:

Lavish Wall Street bonuses, long the scorn of lawmakers and shareholders, have met a new foe: the Securities and Exchange Commission.

The agency on Wednesday proposed a crackdown on hefty compensation awarded at big banks, brokerage firms and hedge funds — a move intended to rein in pay packages that encouraged excessive risk-taking before the financial crisis.

The proposal would for the first time require Wall Street firms to file detailed accounts of their bonuses with the S.E.C., which could then ban any awards it deemed excessive. The rules would be aimed at top executives and hundreds of rank-and-file employees who receive incentive-based pay….

In general, we should probably have as our starting point a healthy skepticism about government attempts to regulate pay in particular industries. Remuneration for high-level jobs is typically based on some combination of rewarding past performance and incentivizing future performance, in addition to sensitivity to things like skill, experience, and the scarcity of the particular talents the job requires. And it’s highly unlikely, again speaking in generalities, that government agencies are going to have the right information and motives to allow them to determine with any degree of precision and efficiency just what a private company’s pay structure should be. Now of course governments aren’t the only ones who could err in setting up compensation schemes; private companies are perfectly capable of screwing that up pretty badly themselves. But for the most part, if private companies screw up in that regard, it’s their shareholders that should hold them accountable, just as it is shareholders who ought to hold them accountable for any other foolish spending.

But there are likely to be justified exceptions to the general presumption in favour of the government taking hands-off approach to compensation. If it is the case — and this seems to be the S.E.C.’s conclusion, here — that compensation schemes in a particular industry are seriously and chronically causing harm beyond the walls of the organization, that seems to be a pretty good argument in favour of government action. This is especially true when the damage being done is not “merely” damage to particular individuals or groups, but to the stability of the economy as a whole. And as Protess and Craig point out, “The move by regulators to have more say on Wall Street pay highlights the huge role financial institutions play in the economy.” That is what arguably makes the harm done by Wall Street compensation not just a matter of private wrongs, but of public ones.

But of course, this argument doesn’t mean the S.E.C. should rush in like a bull in a china shop. All of the concerns mentioned above still apply — there are reasons why Wall Street firms have the compensation policies they have, and it’s pretty likely that at least some of those reasons are pretty good ones related to the necessities of the industry. Indeed, the S.E.C.’s chairwoman, Mary L. Schapiro, says that “This is an area where we want to be very attuned to unintended consequences.” The S.E.C.’s objectives here, seem to be good ones; the question will be whether the quality of the agency’s methods live up to the nobility of its goals.

Madoff, Accomplices, and Complicity

It takes two to tango. How many does it take to sustain a ponzi scheme?

See this tantalizing piece by Diana B. Henriques, for the NY Times: From Prison, Madoff Says Banks ‘Had to Know’ of Fraud

In many ways…Mr. Madoff seemed unchanged. He spoke with great intensity and fluency about his dealings with various banks and hedge funds, pointing to their “willful blindness” and their failure to examine discrepancies between his regulatory filings and other information available to them.

“They had to know,” Mr. Madoff said. “But the attitude was sort of, ‘If you’re doing something wrong, we don’t want to know….’”

Of course, as Henriques notes, “Mr. Madoff’s claims must be weighed against his tenuous credibility.”

But Madoff’s claims that others, including financial institutions and sophisticated investors, “had to know” something was wrong will ring true to anyone who knows the Enron story in detail. For a wonderful, if exhausting, tour through the Enron scandal, see Bethany McLean and Peter Elkind’s Enron: The Smartest Guys in the Room. As McLean and Elkind make clear, Enron’s shenanigans only went on as long as they did because a lot of people, at a lot of financial institutions (and accounting firms and law firms) spent years and years with their eyebrows raised but kept their mouths shut.

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