KARL MOORE : This is Karl Moore of the Desautels Faculty at McGill University, talking management for The Globe and Mail. Today I am speaking to Tom Donaldson, who is a professor at the Wharton School in Philadelphia.
Good afternoon, Tom.
TOM DONALDSON: Good afternoon.
KM: We're in the midst of the worst recession of our lifetime. It's never been this bad probably since the Depression, certainly World War II. It's not the end of it yet, but it's certainly been tough. How has ethics played a part in terms of how this bad economy came about, in your mind?
TD: Well, it's interesting. You think ethics and the current financial crisis, the financial crisis of 2007 and 2009, and the first thing that comes to our minds are some of the real sleazy incidents. We think of Mr. [Bernard]Madoff, we think of those people who took out loans they knew they couldn't pay off. We think of the [debt]collateralizers who were taking bad information. We think of the credit rating agencies. But, actually, there are some more subtle ethical ways in which we can understand this crisis, and one of them is through the phenomenon of the normalization of questionable behaviour.
Psychologists talk about the normalization of risky behaviour, dangerous behaviour; that is, if you live in an environment that's dangerous long enough, it starts to look normal. If you think on an industry level, what happens again and again and again, with haunting regularity, is that industries - with behaviour that many people have a feeling inside is questionable - slowly begin to germinate a pattern of activity and, after a few years, they don't see it the way the outside world sees it.
One of the greatest examples, I think, has occurred in the investment banking industry. You probably recall, a decade or more ago, investment banks [had not]decoupled quite so well the analysis part of what they did from the part that dealt with corporate customers. I recall working with investment bankers in the 1990s at Wharton and remember now that one of them would say, 'How about that research that showed that if an investment bank has a particular corporate client, their stock analysts tend to rate that stock higher than other analysts.' Everybody knew about that research. But, what do you suppose they said? Well, they said, 'Hey, it's not that big a deal and everybody does it. Are you telling us that we should go on the road show to sell a corporate client without bringing along our analyst? We'll get driven out of business!'
These smart people and - whatever else you think about investment bankers, they're smart people - didn't have a clue of what it was going to look like to the ordinary investor on the front page of The Wall Street Journal or The Globe and Mail when they read, guess what, the investment banking side of the house is in cahoots with the analysis side.
KM: You mentioned some other things as well. What are some of the other issues that come to mind that cause a crisis from an ethical viewpoint?
TD: One of the most interesting aspects of this, actually, has a clear analogue in other areas of ethics. You've heard and read, no doubt, about medical ethics. Medical ethics struggle with end-of-life questions and so on. One of the things that we see there and elsewhere is new technology testing the ethics of collections of peoples and industries and so on, and it takes quite a while for us to get our arms around that.
I mean, to take an obvious one, a very low-tech technology right now, [over]the last 100 years, with oxygen, feeding tubes and so on, we've extended life long beyond where we were able to before. But, when that first began to happen, we didn't know what to do. We applied the Hippocratic Oath - that doesn't give us much clarity. It took us a long time to get living wills, hospital committees to deal with those issues and, if you think of derivatives, we're in a similar situation. The collateralized debt obligations and credit default swap arrangements that played such an important role in the meltdown, were so complex, even some of the originators didn't understand them. And, certainly, from the standpoint of ethics, systemic risk, what this means for society, we didn't and still don't, by the way, have our arms around these things.
KM: A lot of people around the world would blame America, to a certain degree, for creating this. As you point out, part of this is some ethical things, partly because people just seem to just keep piling on the debt, buying stuff from trying [to go]beyond what they should have. As a society, do you see it as a uniquely American thing or do other societies also share some blame in that?
TD: Well, I recall speaking in Cairo, Egypt. And as I stood up I said - now this was at the height of the crisis - 'I understand I come from the country that you probably believe caused this and also from the school that sent a lot of people onto Wall Street that helped make it happen. I think, unfortunately, as much as many other countries would like to just blame this on the American style of business, blame goes around a long way. Institutions that had no business taking on some of these securitized products in places like Germany or Taiwan have as much responsibility as some of the people who packaged those products.
KM: So, when you look at it, the Obama administration is adding some additional oversight to the financial industry particularly, but to the economy [in general] Do you see this as a positive move or is there an approach that would be better than the current approach?
TD: There was a piece that appeared in the newspaper two days ago and it showed the pictures of [U.S. Treasury Secretary Timothy]Geithner and [U.S. President Barack]Obama and [former U.S. Treasury secretary Henry]Paulson, [U.S. Federal Reserve Board chairman Ben]Bernanke, and so on, and the caption was, 'Just what if they got it right?,' 'Just what if they got it right?'
And I thought, we're so fond of criticizing what happened, we fail to remember that sinking, falling feeling that we had back last fall. I don't give the administration an A by any means - for what it did - and, some of what happened was excessive. I think, in particular, there are questions that are being raised about how AIG [American Insurance Group]and its creditors and so on were bailed out. But, in general, I think a bit more regulation of the financial markets and a bit more openness, transparency - especially including hedge funds - is in all of our interests.
KM: One last question, Tom. Superstar CEOs' huge bonuses - unbelievable amounts of money being thrown at some of these people. From a contractual view, perhaps they've earned it, but, what is your sense? Is this something that we have really gotten carried away? Do we need to pull back or is this just the market forces working?
TD: One thing we'd better face up to is that what some of the recruiting firms want to say, the head-hunting firms, namely, that you've just got a nice market out here and you have to let it act, is not true. I mean, the highest-paid executives at one point in the world were Brazilian during the period of the Brazilian Miracle, a period that was shortly followed by the biggest, almost 10 lost years, in Brazil. The ratios between CEO compensation in America and Europe and Asia, as you know, vary widely. It's not clear that we really have that much better leaders. But, at the same time, the amount that the CEO, or even the people at the very top, the top five or six, are paid, is actually a very small number relative to the amount of revenues and profits that the firm is paying out.
So, I would like to see better practices on boards and I'd like to see consulting firms that serve compensation committees not also serve the company in another direction. We get second opinions in medicine; I'd like to see second opinions sometimes in compensation. But, in general, we're not going to make our country better by slashing the salaries of the people at the top.
I think it's much less important than, for example, compensation schemes broadly, which I do think are incredibly important. The pay-for-peril activities that we engaged in, where we allowed people to take tails-up gambles - gambles in which 'heads I win, tails you lose' using other people's money - now these can include traders, they can also include the people that benefit at the top, the VP level and so on. That pattern needs to change and, while I don't agree with the European approach of forcing regulation of those pay systems, firms have got to get their arms around how to claw some of that money back at some point in the future and how to make it, in one way or another, more dependent on long-term success.
KM: This has been Karl Moore, talking management with Tom Donaldson, a professor at the Wharton school in Philadelphia.