Jailing Unethical Executives

Financial journalist Bethany McLean has co-written two of the best books on recent financial scandals—The Smartest Guys in the Room about the Enron debacle and All the Devils Are Here about the subprime mess.  In her blog, McLean recently addressed the question: “Does Jailing Executives Make Much Difference?”

Judging from public reaction, jailing white collar criminals would at least make a lot of people feel better.  The Obama administration and its securities and financial regulators have been roundly criticized for launching too few criminal prosecutions in the wake of the numerous misdeeds leading to the Great Recession.

There were many criminal prosecutions after the Enron-era scandals—Arthur Andersen, Ken Lay, Jeff Skilling, Andy Fastow, Bernie Ebbers, Dennis Kozlowski, Martha Stewart, the Riga family, etc.  Yet, McLean points out, just a few years later we went through it all again with all the financial shenanigans involving mortgage scams, dangerous mortgage-backed securities, hedge fund insider trading, and the like.

When financial scandals occur, Congress often reacts, as it did with Sarbanes-Oxley (less so with Dodd-Frank) by cranking up the civil and especially criminal penalties that can be imposed by government authorities.  The theory is that if the penalties for financial fraud are doubled, the likelihood that a crime will be committed will be halved.  This theory is consistent with some economic models of crime prevention, but not with the way that actual people usually make decisions.

While it would be more satisfying for most of us to see people like Citigroup CEO Charles Prince go to jail than be rewarded with $14 million in cash as his bank “hurtles toward collapse,” to use McLean’s phrase, there are serious doubts as to whether it would make a meaningful impact on criminal activity.  As McLean points out, “a lot of what most of us would call wrongdoing doesn’t involve intent—a necessary ingredient for a criminal prosecution.  Instead, you find the very human capacity for self-delusion—and, sometimes, sheer stupidity.”

In his enlightening book The (Honest) Truth About Dishonesty, Dan Ariely points out that the simple economic model of crime deterrence that assumes people weigh just three factors in deciding whether to commit a crime—(1) the benefit that one stands to gain from the crime; (2) the probability of getting caught, and (3) the expected punishment if one is caught—is, to be kind, utterly inadequate to account for how people actually make these decisions.

Few things are clearer from the psychological research of the last decade or so than that people simultaneously want to (and do) think of themselves as good people while they simultaneously lie and cheat quite frequently to get things that they want, to please their superiors, to be part of the crowd, to help their reputation, etc.  The accomplice that allows people to do bad things yet think of themselves as good people is their brain.  It accommodates by often hiding the ethical dimensions of the decision (ethical fading) and by being incredibly adept at inventing rationalizations for unethical acts.  Ariely’s studies show that “[e]ssentially, we cheat up to the level that allows us to retain our self-image as reasonably honest individuals.”  Obviously, we can’t rob banks or commit murders and still think of ourselves as honest folks, but short of that we often give ourselves amazing amounts of leeway.

If there are any economists still out there who still put stock in the simple economic model of crime deterrence created by Gary Becker and described above, they would do well to watch our Ethics Unwrapped videos, particularly those relating to Bounded Ethicality, Overconfidence, the Self-Serving Bias, and Ethical Fading.  All demonstrate that doubling, tripling, or even quadrupling criminal penalties will not do a lot to reduce crime by people whose minds have hidden the ethical dimensions of a decision from them or enabled them to rationalize unethical or even criminal activity.

 

See Dan Ariely, The (Honest) Truth About Dishonesty (2012); Max Bazerman & Ann Tenbrunsel, Blind Spots (2011)

Bethany McLean, “Does Jailing Executives Make Much Difference,” (Jan. 22, 2013).

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