2010 President's Report

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How do businesses balance profitability and ethical behavior? A LONG-TERM VIEW HELPS COMPANIES KEEP ETHICAL BEHAVIOR			IN SIGHT.

Success doesn’t always breed success. In fact, sometimes it results in unethical behavior.

A study led by assistant professor of management Yuri Mishina and his colleagues found that just as some star athletes feel pressure to take performance-enhancing drugs to stay at the top of their game, unrealistic pressure on high-performing companies to continually improve increases the likelihood that managers will choose profitability over ethical behavior.

“We saw this happen to companies like Enron and Arthur Anderson, which were considered some of the best companies in the world,” says Mishina, who studied 194 U.S. manufacturing firms on the S&P 500 between 1990 and 1999. “And we continue to see a slew of scandals and illegal corporate behavior. Our study was an attempt to explain this.”

While illegal activities like fraud, false claims, and environmental and anticompetitive violations often are attributed to corporate greed, Mishina says that the more likely drivers are internal pressure, including company officials’ perception of how they’re faring against the competition, and external pressure that is driven by heightened investor expectations brought about by strong market performance.

“It doesn’t excuse their behavior, but it makes it understandable,” says Mishina. “Even if managers don’t give the orders, they create the climate.”

The researchers found that three factors potentially fuel illegal behavior: loss aversion; hubris, in which managers come to believe they cannot fail; and the house-money effect, in which employees perceive themselves to be gambling with “the house” money.

Mishina says that companies often have a choice between cutting corners to be able to meet high expectations or accepting the consequences of not meeting performance goals and being punished. Those choices can affect consumers in the form of more expensive goods, shabby products, and a polluted environment.

While the research findings indicate that companies are most apt to engage in illegal activity once they become prominent, findings also suggest that it’s the prospect of poor performance in the future—not the past—that compels firms to break the law. So tighter regulatory oversight of high-performing companies may be needed, but a firm’s prominence and performance relative to industry peers also should determine which firms receive closer scrutiny.

And the pressure is on even during an economic downturn.

“If everyone is doing poorly, does it matter?” asks Mishina. “You still have to do better than your peers. And if the entire economy is doing poorly, everyone feels pressure.”

In a world where money is power and legal loopholes are a dime a dozen, solutions to wiping out corporate crime are complex, and, Mishina says, addressing them may require analysts, investors, and company directors to take responsibility.

“We have to ask if investors should be putting these pressures on companies all the time,” says Mishina. “Instead of measuring performance by quarters, a company’s performance might be measured in five- or 10-year increments. Or maybe we reward corporations for things like job creation and stimulating the economy.”

By considering long-term viability over short-term financial success, perhaps fewer managers will crack under pressure—and break the law.