Final Overview (3) PDF

Pre-midterm review: What makes an investment bank successful? 1. Making profit 2. Strong relationships with their clients 3. Calculated risk 4. Eye on the short-term and long term 5. Trust is the #1 criterion people look for when choosing a bank G20/OECD Principles of Corporate Governanc...

Pre-midterm review: What makes an investment bank successful? 1. Making profit 2. Strong relationships with their clients 3. Calculated risk 4. Eye on the short-term and long term 5. Trust is the #1 criterion people look for when choosing a bank G20/OECD Principles of Corporate Governance - Corporate Governance: Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. - Happens at the top of the organization → relationship between top executives and how the board is configured (whole system to do with people, structure, etc.) → OECD LUMPS THIS DEFINITION TOGETHER - No single model of corporate governance: There is no single model of good corporate governance. However, some common elements underlie good corporate governance. The Principles build on these common elements and are formulated to embrace the different models that exist. For example, they do not advocate any particular board structure and the term “board” as used in the Principles is meant to embrace the different national models of board structure. (used to be the case → model with a board that has inside vs. outside directors) - Incentive structures should correlate with ethical and professional values: To be effective, the incentive structure of business needs to be aligned with its ethical and professional standards so that adherence to these values is rewarded and breaches of law are met with dissuasive consequences or penalties. - The Principles recognize the interests of employees and other stakeholders and their important role in contributing to the long-term success and performance of the company. Other factors relevant to a company’s decision-making processes, such as environmental, anti-corruption or ethical concerns, are considered in the Principles but are treated more explicitly in a number of other instruments / documents) Two Ways to Think about Governance - Normative: values, law (related to corporate purpose) - Empirical: social science, economics (not about how things ought to be, but how they will be / how they are)  - Economic lens of corporate governance - Individual economic agents who are trying to self-optimize (where is the cooperation in a free market with self-interested agents) OR firm is like any other individual economic agent or the firm is a group of individual agents Components of a governance system Resources: 1) leadership 2) talent 3) other resources Governance activities: 1) policies and rules 2) agreements 3) statements (e.g., Credo / Mission) 4) Plans Governance objectives: 1) identity 2) direction 3) discipline - Identity and direction are related to corporate purpose → connected to the normative lens Structures: 1) decision making groups 2) senior management group 3) board of directors 4) shareholders meeting 5) family council 6) compliance What is the purpose of business? - Aggregate economic welfare (interpreted through Pareto optimality) - Optimized collective value (satisfaction of intrinsic values) via economic functions of exchange, distribution, and production - Focus on how the individual firm should benefit society - Which firm governance structure best achieves business’s purpose?: optimize profits, hybrid (optimize profit plus), firm designed The firm and its boundaries - The economic literature has long described a firm as a nexus of contracts (jensen and meckling 19970s) - Moral / fiduciary duty that the agents have to the principal: shareholder to not buy the jet if it is not good to them - Coase (1937): what is the efficient scope or boundary of an individual firm? Which persons should be made patrons of a given firm? - English common law: focused on the pyramid and the master/servant relationship - Created the pyramid conception of an organization - He focused on a deal without a contract (flexible and more efficient) - In 2010, Vizio grew to become the largest brand of flat screen television in the US (beating Sony and Samsung) - 200 Vizio employees in 2010 → contracting out production and relying on commodity parts, could undercut big brands on price - Also a wheel model (hub and spoke) - Harry hansman model of UCLA law school  - Different configuration of structure are more/less efficient - When there is more synergy, the risk is diversified and each section is running their own capital (can give money to specific section of the firm) Why partnerships in professional firms? (Hansmann) Employee-owned firms: - Employee-owned firms have long been conspicuous in the service professions (law, accounting, engineering, investment banking, etc.) Theory 1: Work incentives for hard-to-manage [senior] employees. Theory 2: Equal profit sharing or cross subsidizing makes a firm more reliable for clients, avoiding risk of talent dilution. Theory 3: Prevent the firm from behaving opportunistically towards employees—e.g. re firm- specific skills. - BUT recent trend towards investor ownership in some but not all of those industries - Possibility: quality of professional services and individual professionals is becoming easier for customers to value, reducing firms ability to avoid paying competitive wage - Capital requirements for some of these industries is growing - ^ seen in investment banking THE IPO - “A public currency in the hands of an expansive management team is like a bazooka in the hands of a 9 year old” → David Viniar, Goldman CFO - How did Goldman achieve its reputation? - Clients - Trust - Diversity of clients - Clients chosen for future benefits and their network - Values: client-first mentality, the 14 Commandments (client was first) → teammate, honesty, reputation - Teamwork, long-term relationships - GS was the first to enshrine their values on Wall Street - Long-term focus - Personal autonomy (shared internal compass though) - Did not take up the business of hostile takeovers → helped them defend against takeovers - Workforce - Pay really well - Teamwork - Hiring top talent  - Why change? - Goldman goes public → partners become billionaires - 1990s saw consolidation in investment banking (ex: MS w/ Dean Witter and Travelers-Salomon Brothers) - Need for stable, permanent capital to fund growth and global expansion, reducing partner liability - What has happened to Goldman since the IPO? - Partnership vs. public → prefer to work for partnership - Bumps and successes: Lloyd Blankfiled → testifying in front of Congress for 1 week (billions everyday he testified) - April 2010: SEC charged Goldman with defrauding investment client through the marketing of a financial product linked to subprime mortgages - Taibbi: “The first thing you need to know about Goldman Sachs is that it’s everywhere. The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.” - 2015: Malaysia’s former Prime Minister: Najib Razak → accused of channeling nearly 700 M USD from 1MDB (malaysia development berhad), gov. Strategic development company to personal bank accounts - Federal Reserve Board barring senior executive at Goldman from banking industry → $3.9B settlement with Malaysian government - Partnership vs. IPO - When Goldman was a partnership, sense of collective responsibility that guided individual decision-making. The oversight of other partners + direct stake each individual banker held in the success or failure of the firm → lost when banks became publicly traded entities. Distribution of risk from the executives to the mass of investors who remain faceless to those working at Goldman. - Clients delight the fact that your skin is in the game - Expanded operations → a change of governance needs to match the strategy of the firm that is changing Theranos Who are the stakeholders of Theranos and what lessons did they glean? - Board members - Theranos employees → there should be anonymous reporting mechanisms - Investors - US government - Job applications Theranos - Founded by holmes in 2003 - 2014: achieved $9B valuation - How did Theranos become a “miracle” company for investors and the public? - Lead up to disaster - Feb 2015: Stanford professor John Ionnidis wrote in journal of AMA that no peer reviewed research from Theranos had been published in medical research literature - May 2015: UToronto Professor Diamandis concluded that most of company’s claims were exaggerated - Response: tour VP Biden → fake lab - Tyler Shultz - Theranos employee (2013-2014) - Grandson of then Theranos director, George Shultz, was a key source of WSJ - Joined as an intern in 2012 - Observed restricted access to theranos devices, disjointed research process, data manipulation - Syphilis assay had poor accuracy but reported inflated performance figures - Attempted to bring concerns to company management - Spoken to Carreyrou and under an alias, reported the company to NY State Department of Health - Oct 2015: Carreyrou WSJ reported that Theranos was using traditional blood testing machines instead of Edison devices, company’s Edison machines might provide inaccurate results - Holmes - 11 year sentence in prison in Texas: fraud and conspiracy in 2022 - Reduced by several months - New projected release date is 2032 - Ordered to pay $452 M in restitution to victims - Ramesh Balwani: 13 years in prison and also ordered to pay - Theranos board members 2016 - Elizabeth Holmes, founder and CEO - Riley Bechtel, former Bechtel Group CEO - David Boies, a founder and the chairman of Boies Schiller Flexner - William Foege, former director of the CDC - Richard Kovacevich, former CEO and chairman of Wells Fargo - Jim Mattis, later U.S. Secretary of Defense  - Fabrizio Bonanni, former executive vice president of Amgen Lessons of Theranos - Composition of board: not merely capital, networking, but also technical proficiency - Before you accept board seat, talk to people at all levels of the firm → diversify sources of information - Small stakeholders can have a large impact on the firm - Research suggests that you should go to a colleague Class 16 Why don’t people speak up??? - Wells Fargo (5000 people creating false accounts to create bonuses) - Miniscribe (shipping bricks to customers) - United Nations (broke U.S. law) - Walmart (bribery in mexico) - Volkswagen (dieselgate) - LIBOR scandal The Milgram Obedience Experiments - People do not vary by age, income, gender, education or psychological type → a disposition to obey authority is hardwired - Yale University - Relating to knowledge: male, paid, interviewed - In the room for 30 minutes, they get to know each other - Up to 450 volts, big red x on 200 - 66% go all the way - What changed the outcome? - Perception of authority (not Yale) - If there is another person in the room - So many people are willing to shock the total amount under obedience from authority → diffusion of responsibility - Lessons: - Practice having unpleasant conversations - Talk to people in common spaces and have skip level meetings Intrinsic Values and Human Rights: Corporate Duties Depend on Intrinsic Values (Donaldson) - Chiso (dumping mercury → plankton → fish), Japanese company - Brought into court, landmark case because they still have to compensate the victims - Justification for a corporate action - Intrinsic (non-derivative values) + non-intrinsic (derivative values) = policy  - Corporations must respect human rights but are not obligated to the full scope of human duties - Their duties include: - Not depriving individuals of rights - Protecting individuals from rights violations - For-profit companies in industries denominated by intrinsic values (health, education, justice) have heavier responsibilities when it comes to honoring the human rights reflected in their industry identity (adopt it as a mandatory focal value) - Optimized collective value: defined in terms of satisfaction of intrinsic values → gives special meaning to firms operating in industries defined in terms of intrinsic values Intrinsic values are incommensurable but doesn’t mean they cannot be used in rational ways Mandatory vs discretionary Mandatory: non-negotiable goals tied to intrinsic values Discretionary: self-defined, optional goals Purposes Discretionary Mandatory Focal “To save people money so Shareholder welfare they can live better” Legal compliance → intrinsic (Walmart) values of fiduciary duties to “To organize the world’s owners and social economic information and make it welfare universally accessible and **Health (firm in the useful” (Google) healthcare industry) Contextual Matching gift philanthropy Optimize collective value (J&J) Human dignity threshold Intrinsic values Firms Health - Pharmaceutical - Health insurance - hospital Knowledge - For-profit education - journalism Justice - Law firms (incorporated) - Legal services Thinking ethically about inclusivity  - Various barriers to inclusivity by region - 38% gov policy, 41% class discrimination, 49% gender discrimination, 58% racial discrimination, 60% poverty - America: race, gender, poverty - Latin America: poverty, unemployment, gender - MENA/SSA: poverty, unemployment, gender - UK: race, poverty, class - Asia: poverty, religion, class Very famous study in Los Angeles, California (studied areas of lots diversity), less trust between diverse groups, within and between groups Inclusivity in business - Wharton is the first elite MBA program to enroll more women than men - Global Gender Gap Index examines gender gap in: - Economic participation and opportunity - Educational attainment - Health and survival - Political empowerment - Much worse in North Africa and surrounding countries - United States (ranked 45/144) → #1 in educational attainment - Women still miss out on management in finance - Women outnumber men in many FinServ organizations → but no company achieves gender equality in senior roles - Tesla employee: women stochastic parrots / LMs too big (she was fired) → google started protesting Bhargava and Velasquez → Ethics of the Attention Economy: The problem of social media addiction - The Attention economy: social media platforms monetize users’ attention by designing products that maximize engagement → incentivizes platforms to keep users hooked, as attention is sold to advertisers - For social media, addiction is not just a contingency, it is the actual product - Like gambling (intermittent variable rewards) - Social validation (snapstreaks, likes) - Removal of stopping cues (infinite scroll) - Addiction is marked by 6 common components: - salience (the addictive activity dominates the addict’s thoughts, feelings and behavior) - Relapse (unable to control himself, the addict reverts to the activity after trying to stop) - Tolerance (must engage in increasing amounts to achieve its former effects) - Withdrawal (distress or physical effects when unable to access the activity) - Conflict (conflicts within himself or those around him) - Mood modification (produces a buzz or high) - Three moral arguments  - Harms (human capabilities diminished) → cause unjustified harm to users that cannot be offset by their benefits - Insult added to injury (adaptive algorithms that exploit users’ psychological vulnerabilities with bottomless scrolling) → exploit user data to make themselves more addictive - Objectionable exploitation (disrespect toward the object of exploitation) → taking advantage of a person’s vulnerability to advance one’s own ends (addiction, pervasiveness of the internet) - Nussbaum’s human capabilities → violate her approach by undermining human dignity by impairing essential life capabilities - Life - Bodily health: poor sleep, physical inactivity, and unhealthy habits - Senses, imagination, and thought - Emotions (love, grief, longing, gratitude) - Practical reason - Affiliation - Play - Almost 50% of Gen Z wishes Instagram and Tik Tok were never invented - Pervasiveness: internet is essential in modern life, making it nearly impossible to avoid, exacerbating addiction vulnerabilities - Does the company have the responsibility to mitigate harms, - Often the people inside that are more informed than regulators - New regulations - EU’s new laws for regulation of AI → DMA Digital Markets Act - Prohibits social scoring and requires high-risk AI applications to meet stringent requirements for transparency, oversight and safety - GPAI models adhere to specific standards, especially if they could present systematic risks - Document training processes, track incidents and ensure cyber security - Prohibits indiscriminate facial recognition for law enforcement purposes - California AI transparency act (SB 942) → requires developers of gen AI to disclose when content (like images, videos, or audio) has been AI-generated and requires AI providers to offer free detection tools for public use - Enforces transparency in training data, publicly disclose types of data used in AI training Google and Project Maven (AI)  - Project Maven: an AI initiative with the U.S. department of defense to analyze drone surveillance footage - Overview: - Launched in 2017 - Google’s AI technology was leveraged to automate object recognition in drone footage - Emphasized project was non-offensive, yet critics argued it could facilitate lethal targeting - Broader context - AI Arms race: US, China, and Russia were competing for AI dominance - Former google CEO eric schmidt supported DoD collaborations, arguing that AI was crucial for national defense - Ethical dilemma and employee backlash - Over 3000 google employees signed an internal memo opposing the company’s involvement (moral responsibility, reputational risk, talent retention) - Called for immediate cancellation of project maven, publicized policy prohibiting Google from developing warfare tech. - May 30th 2018: NYT described maven contract as an identity crisis for Google - As early as Sep 2017, Dr. Fei Fei Li urged her colleagues at Google to downplay mentions of AI when speaking about military applications - Dozens of Google employees had resigned over the issue → publication of an open letter signed by academic ethicists and cs ppl supporting opposition to project maven - The day after the NYT expose, diane greene informed employees that Google would not seek renewal of the Project Maven contract once the current agreement was fulfilled - Google stepped out of the running for DoD’s Joint enterprise Defense Infrastructure cloud contract - Organized internal debate - Violate longtime motto of “don’t be evil” and irreparable damage Google’s brand → changed from Don't do evil (killing people with drones) - Ex: polaroid provided film to imprison people in Apartheid - Government response: why are they saying the U.S. military is evil? Soldiers face real evil on battlefields Permit calls for violence against Russians and Russian soldiers in the context of the Ukraine invasion? - Meta’s mission: to give people the power to build community and bring the world closer together - Meta’s universal rule: should not be taking political stances → BUT apolitical can be immoral if you believe there are universal truths  - Facebook ends up allowing it 1. Possible dangers of successful AI application a. Unhealthy addiction b. Encouragement of digital surveillance state i. Sleepwalking towards a surveillance state (biometric technology is valuable for medical research but can also have malign uses) 1. Governments and corporations are increasingly using digital surveillance technologies to collect vast amounts of personal data, often under the guise of public safety and security ii. Excessive surveillance erodes individual privacy, a cornerstone of democratic societies 1. Chilling effect on free speech and activism with marginalized communities being disproportionately targeted iii. Risks normalizing constant monitoring iv. No longer the custodians of our personal data c. Increase of psychological distance among humans i. Psychological distance: the quality of being removed from one’s direct experience of reality or of lacking a sense of psychological immediacy → United Airlines incident, 2017 (AI) → people dictated based on the algorithm ii. Re-engineering has automated and obliterated middle management d. Programming around the naturalistic fallacy 2. The need for interpretable AI a. Manager: insight into customer, market, why algorithm predicts one thing or the other b. Customer: why was my loan rejected Taking Principles Seriously: A Hybrid Approach to Value Alignment in AI → ties into programming around the naturalistic fallacy on some of the dangers of successful AI applications (Kim, Hooker and Donaldson) - Value alignment: - VA ensures that AI systems act in ways consistent with human values - Involves addressing how AI can acquire moral intelligence and navigate ethical challenges - Mimetic VA / ML-based VA (following people) → imitating the ways in which humans respond - Problems: AI-powered wheelchair (trained on NY pedestrians so it becomes a demon wheelchair) or Microsoft’s chatbot Tay - NY’s sidewalks are so packed, pedestrians are taking to the streets  - Datasets have implicit / explicit biases (imitate human biases) - Moral machine: bias in favor of woman vs. man, prosperous vs. homeless, young vs. old from MIT study - Problems with logic-based VA - Lacks adaptability and empirical grounding - Known as good old-fashioned AI (GOFAI), it uses symbolic logic but struggles with complex, real-world scenarios - Most algorithmic bias comes from ML-based VA, which uses data sets from humans who already have implicit or explicit biases (the moral machine experiment) - Proposition: - Designers of VA systems incorporate ethics by utilizing a hybrid approach in which ethical reasoning and empirical observation play a role - Combination of ML-based VA (bottom-up learning) with logic-based VA (top-down ethical principles) - Avoids committing the naturalistic fallacy, derive “ought” from “is” - Using quantified modal logic, formulate principles derived from deontological ethics and show how they imply particular “test propositions” for any given action plan in an AI rule base - Deontological principles => reasoning that is more rigorous - Using quantified modal logic to formalize ethical principles such as universalization, utility maximization, and respect for autonomy - Principles from deontological ethics - Universalization principle: an action is ethical only if it can be universally applied without contradiction - Utility maximization: actions should maximize overall wellbeing - Respect for autonomy: actions must not violate the autonomy of others unless ethically justified - Integration of empirical VA - Empirical data informs the context and factual validity of ethical decisions - Test propositions - Hybrid: both ethical reasoning and empirical observation The need for interpretable AI - Explainability matters → customer wants to know why their loan was rejected - Apple Card: sexist (wife gets 1/20th of the loan) - About 60% of 5,000 executives in IBM expressed concern with AI’s black box Current Streams in Algorithmic Transparency → almost all of these efforts are failing - Explainable ML: Model-level  - Given a blackbox, create transparent algorithm that mimics blackbox with high fidelity - Explainable ML: instance level - Given a blackbox, create an algorithm that explains the blackbox’s prediction on a particular data point - Transparent box design problem - Design high performing algorithms that are already transparent from the beginning - Blackbox inspection problem - Given a blackbox, provide a textual or visual representation for understanding how it works FAT ML → fairness, accountability and transparency in machine learning Wheat vs. Rice - Wheat people vs. rice people (Luhrmann) - Rice → work together, complex irrigation systems (east), interdependent - Needs a community of farmers working together in integrated ways for irrigation to succeed - More focused on the background families - Tend to value collectivism and holistic thinking (considering relationships, and the bigger picture) - Wheat → more individualistic (west), independent - Just needs rainfall but not irrigation → less labor-intensive and relies on individual effort - Feeling bad about yourself and its impact on health - Focused on the central figure (ex: the bigger fish) - Societies rooted in wheat farming (e.g. Europe) tend to value individualism and analytical thinking → breaking problems into components and focusing on specific tasks - Markets in rubber (interaction occurs, but very difficult to assess instantly) vs. rice (process is routinized) - “Which two of the three belong together” - North American students can be expected to speak up in class more than their Korean American counterparts - Japanese Olympic gold medalists discuss their failures and faults more than their successes and virtues, in comparison with American medalists - Helping others is a moral obligation that holds whether or not one likes the person in Indian contexts Robert Putnam → Italy, building community structures, medieval 6-700 years ago Values in Tension: Ethics Away from Home (leaving legal jurisdiction or leaving cultural values) → Donaldson The challenge of ethical standards across cultures - Multinational managers often face ethical tensions when operating abroad, particularly when a host country’s standards differ from their own → What happens when a host country’s ethical standards seem lower than those of the home country? Values Kyosei (Japanese): living and working together for the common good Dharma (Hindu): the fulfillment of inherited duty Santutthi (Buddhist): the importance of limited desires Zakat (Muslim): the duty to give alms to the muslim poor Western: individual liberty, egalitarianism, political participation, human rights The limits of cultural relativism and ethical imperialism - Moral relativism vs. moral absolutism - Moral cultural relativism: no culture’s ethics are better than any other’s; therefore, there are no universal rights and wrongs - When in rome, do as the romans do - Insider trading in Belgium is morally permissible → flawed when practices violate fundamental human values like child labor or toxic waste dumping - Moral absolutism: there is a single list of truths, that these truths can be expressed only with one set of concepts, and that these truths call for precisely the same behavior around the world - Moral cultural imperialism: individuals should do everywhere as they do at home - Imposing home-country values universally → BUT ignores cultural differences and leads to impractical or disrespectful decisions - Sexual harassment training in saudi arabia the same as that of USA Donaldson → core values set a threshold (absolutism) + respecting local traditions (relativism) - Moral free space (software piracy) Confucianism: one should share what one creates Christianity: thou shall not steal/one should honor one’s promises (contracts) Business Software Alliance (BSA) and the International Data Corporation (IDC) publish software piracy ratios. They are constantly changing, but here are some rough numbers:  China: often reported above 60%. India: often reported around 50% to 60%. United States: often reported around 20% to 30%. United Kingdom: often reported around 20% to 30%. Respect for core human values: companies must adhere to universal values that form the absolute moral baseline like respect for basic rights, respect for human dignity and good citizenship, respect for local traditions: companies should recognize and respect cultural traditions that do not violate core human values, context matters Conflicts of Relative Development Ethical standards conflict because of the countries’ different levels of economic development E.g., low wages TEST: Would the practice be acceptable at home if my country were in a similar stage of economic development? Conflicts of Cultural Tradition Ethical standards conflict because of the countries’ different moral, religious or cultural values E.g., gift-giving in Japan TEST: Is it possible to conduct business successfully in the host country without undertaking the unethical practice? And, is the practice a violation of a core human value? Practical guidelines: - Treat corporate values as absolutes - Establish conditions for suppliers and customers - Engage local units in ethical decision making Indian Billionaire Gautam Adani charged in $250 million bribery scheme - Fredonia construction company - 3M donation to foundation → does good work - Competitor is not very scrupulous → thinks they will cut corners - People think their products are safer than others, ex: boeing vs. lockheed → consequential argument makes no difference on the side of the law - Sons are part of FFF - Common for bribery laws to exist, but obfuscated mechanisms for this go to through (ex: donations to charity) → every country has laws against bribery, the only that is excluded is very small payments Current Laws against Bribery - Domestic vs. extraterritorial  - All nations have laws prohibiting the bribing of government officials - FCPA and the OECD counterparts (extraterritorial) - (UK’s strict interpretation) Bribery - The offering, giving, receiving, or soliciting of something of value for the purpose of corrupting the action of someone in the discharge of his or her duties. - Ex: Lockheed bribing Japanese government officials $14 million What’s wrong with bribery? - Deontological - Facilitating the violation of a duty: - “The offering, giving, receiving, or soliciting of something of value for the purpose of influencing the action of an someone in the discharge of his or her duties” (definition). - Consequential - Negative economic impact. The business case for complying with bribery laws (P. Nichols) A business contemplating the payment of a bribe must take into account three types of “dynamic vs. static” costs of corruption: 1. direct costs 2. costs imposed by damaged relationships 3. contingent costs of criminal liability. a. Ex: airbus paying massive fines because of bribery scheme 19 top executives leaving as a result of Walmart Mexico bribery scandal Singapore is amazing at avoiding bribery, also best in Scandinavian countries Class 25 - World Bank: elimination of corruption is one of its biggest goals for development - Problems: - Unpredictability of corruption (ex: 10% of it is being taken) - Donaldson: Bribery has no solution - Adjust the background institutions through a coordinated effort between NGO, government, business + level of private sector and public sector input - Transparency International Rankings 2023 - Positive correlates of inefficiency: - Unpredictability of corruption - Level of corruption Policy distortion (e.g. existence of a large black market) Predictability of judiciary  Merit-based recruitment Ratio of civil servant pay with manufacturing pay Used car negotiations - Have a reservation price in mind + negotiation principles - Better-off if you can exchange information (reciprocal exchanging of information) Ethics of negotiation - Buyer relies on the counterparty - Repeat play makes a difference - No absolute falsehoods - Catastrophic physical harm - Relationship - culture Managing systemic operational risk Barclays LIBOR scandal - What is LIBOR: inter-bank lending rate (rate at which company and families borrow at) - Banks send their rates in: aggregated into LIBOR through trade association (BBA), not the government → submitted daily and BBA calculated LIBOR using a trimmed mean - Used in financial markets for loans, mortgages, derivatives and future - What was done wrong? - Manipulation of LIBOR between 2005 and 2009 - Rate manipulation (2005-2007) - Barclays traders pressured the bank’s Money Market Desk to submit artificially high or low LIBOR rates to benefit their derivative trading positions - Lowballing rates (2007-2009) - During the financial crisis, Barclays submitted lower-than-actual borrowing rates to avoid signaling financial distress and negative media coverage - What caused this catastrophe? - Unethical trading activity - Status discrepancy - Culture of get it done at all costs, profit-driven mentality - Walls between money market and trader people - Libor system was flawed - Estimates - Not run by government - Government was negligent in not applying corrective action  - BBA changes system, but not significantly → replacing the BBA as LIBOR administrator - Barclays and the LIBOR scandal (Barclays) - Despite scrutiny from regulators, market, and media, practices continue for years - RBS, HSBC, Deutsche Bank, JP Morgan, Citibank and ICAP implicated - Increased scrutiny, negative PR, and calls for greater regulation have followed - Who was receiving these signals and interpreting them into actionable items? - April 2008: New York Fed learns of False reports (regulators fail to stop the illegal activity, which persisted through 2009) - May 2008: british regulators informed of rate problems - Documents show timid regulators - 2012: Barclays $450M settlement - Leadership fallout: CEO Bob Diamond, COO and Chairman resigned and diamond denied personal involvement but acknowledged a strong sense of responsibility - Big British bank reported bogus figures that in some cases had influenced a benchmark for student loans, credit cards and mortgages - Traders seeking favorable rates received a welcome reception from bank employees - UBS: $1.5 Billion settlement - “I need you to keep it as low as possible - Royal Bank of Scotland: $612 Million fine (2013) - 2013: ICAP $87 Million fine - Altered the reported figures for which Libor is compiled in exchange for promises of curry meals, steaks, a Ferrari and financial payments - Rabobank: $1 Billion settlement - 8 financial institutions: $2.3 billion fine - RP Martin: $2.2 million fine - JP Morgan Chase, Deustche Bank, UBS, etc. Standard Corporate Compliance and Ethics structures Corporate Criminal Sentencing Guidelines 1990s: compliance principles - Consulting companies: every single major company put compliance principles in place 5 separate studies: ethics training and dissemination of code of ethics, slight but positive correlation with bad things ?? - Causation vs. correlation (doctors follow the disease) - “Help lines” - Ethics training - Codes of conduct  - Credo statements (Values and mission statements) - Investigation policies - Audit committee monitoring - Company employee surveys - Ethics officer/ethics office - Communication initiatives - Written standards of conduct in the US are more common - Ethics training has mushroomed - ^ BUT levels of pressure that employees feel to compromise standards are not improving Dangerous Currents → How Good People Get Swept Into Ethical Danger (And How to Avoid It) (Donaldson) - Parable of the Sadhu - 6 months sabbatical to himalayas - Unconscious body, holy man - Nobody was willing to help him - Wrong to choose getting to the top over life → he had strong values though (religious person) Article overview: identifies the subtle but powerful organizational forces that can drive ordinary individuals to engage in unethical behaviors, leading to corporate ethical disasters → should be independent information conduits to monitor incentive structures, leadership culture, etc. Why do people act 180 from their values like the guy who left the sadhu? - 1) Blind precedents (normalization of unquestionable behavior) - Barclays/ financial crisis / professional quandaries / morrisons - Investment banks’ biased analyst ratings were tolerated because “everyone did it,” ignoring the ethical implications for investors - 2) uncommon stress - Extraordinary stress, fatigue and pressure impair judgement (Bhopal disaster working under extreme sleeplessness) - 3) isolated teams of high performers - Financial crisis / barclays - Excessive autonomy and lack of oversight for high performers or “rising stars” → barings bank collapse caused by Nicholas Leeson, an unsupervised trader - 4) discussion vacuum - Cultures where critical topics cannot be openly discussed create ethical blind spots - Tobacco hush in the tobacco industry prevented conversations about the link between smoking and health  - Barclays / financial crisis - 5) failure to anticipate challenges - Often establish values but fail to clarify their application during crises or ethical dilemmas - Guidant / gender and free speech at google - 6) goal mesmerization - Barclays / financial crisis - Unreasonable targets or incentive systems create pressures that lead individuals to compromise ethics (like Enron’s rank and yank culture) Class 21 - Aaron Beam: healthcare services company (CFO) of Health Sout, trappings of success - Everybody does this like Richard Scrushy - Sarbanes Oaxley: held CEOs to higher standards Irrational targets vs. stretch goals Self-Inflicted Industry Wounds (Donaldson) and Schoemaker Systemic Risks: catastrophic risks arising from industry-wide interdependencies can lead to major failures (ex: 2008 financial crisis, pharmaceutical industry standards like Vioxx and BP’s deepwater oil spill) - These risks are often ignored until disaster strikes, requiring a collaborative approach among industry leaders to address them proactively Self-inflicted industry wounds: when industries fail to recognize early signs of systemic risks, leading to contagion effects - Ex: auditor independence compromised by consulting firms like Enron and Arthur andresen - Deregulated mortgage standards in financial services - Selective reporting of clinical trial in pharmaceuticals Pelican’s Gambit: a strategic move towards cooperation in a highly competitive environment that limits systemic risk to the firm, industry and society → collaborate to address systemic risks that are low-probability, high-impact - In nature, pelicans give nesting materials to outsider males Balance between outsiders and insiders knowledge What’s wrong? - Nobody wants to cooperate first - Low probability - Collusion vs. cooperation Industry warning signs  1. High pace of technological innovation: pressure to adopt new technologies or practices quickly 2. Hush climate and cover-up mentalities: silence around issues to avoid litigation or reputational harm 3. Lack of knowledgeable outside experts: few specialists create information asymmetry 4. Weak regulators or poor oversight regime: ineffective oversight often lagging behind industry advances 5. Much remains hidden or is hard to assess 6. Critics not welcome; bunker mentality (Why companies need to start sharing more information about cyberattacks)