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Do Cheaters Prosper In Business?

The appearance of honesty is always necessary, but lying sometimes works

10Oct

Consumers do not trust business. In Edelman's 2017 Trust Barometer, just 37% of the general population said they believed CEOs were credible, and if we look back over the past few years it is not difficult to see why. Since the financial crisis alone, we have seen numerous scandals make the headlines, from Volkswagen cheating emissions tests to Deutsche Bank failing to prevent $10 billion of Russian money laundering. Indeed, according to academic research, one out of every seven large US public corporations commit fraud every single year, both detected and undetected. In industries such as finance, the problem is endemic. Even the president of the American Finance Association acknowledges that fraud is no longer just a bug in the US finance industry, it is a feature.

These are not just cases of petty fraud either, they cost society upwards of $380 billion every year. This should, in theory, also be a serious problem for the businesses who perpetrate them. It should, in theory, see one in seven public corporations go out of business. However, by and large, this is not the case. There are massive fines handed out, widespread condemnation in the press, the usual grovelling apologies by senior executives, and then it all fizzles out. Volkswagen, for example, this year reported a 10.3% increase in sales to €56.2 billion and a 7.8% increase in operating profit to €4.4 billion. It may have had to pay a substantial fine for its misdeeds, but its actions do not appear to have damaged its relationship with consumers, even though they did tremendous harm in a myriad of ways. Equally, revelations around the tax affairs of the likes of Google, Amazon, and Starbucks hardly seem to have dented their bottom lines, despite a number of social media campaigns to get people to boycott their products.

So why are consumers so quick to forgive, if not perhaps forget? When it comes time for a business to choose whether they should color outside the lines, is it simply worth the risk of being found out when you know that you'll probably be forgiven by the public? And what does this mean for the way we regulate the market?

First of all, it is important to understand what constitutes honesty. Honesty is abiding by the spirit of the rules, not necessarily the letter of the law and looking for loopholes, a mindset that is all too common in business.

This attitude is perhaps best summarized by one man who was found out and paid the price - former CFO of Enron, Andy Fastow. In a recent talk in Las Vegas, Fastow questioned why Enron is still considered 'the largest accounting fraud in history when every decision was approved? The reason he gave says a lot about the way that many businesses think today, and it is a mindset that the public will inevitably get sick of, even if it appears they haven't yet. 'I knew it was wrong,' he said. 'I knew that what I was doing was misleading. But I didn’t think it was illegal. I thought: That’s how the game is played. You have a complex set of rules, and the objective is to use the rules to your advantage. And that was the mistake I made.'

He relays a parable he told his son who asked why he had been jailed if he'd had approval. 'Suppose when you’re 16 you go to a party using the car and the one rule is you don’t drink alcohol,' he said. 'The first thing is someone offers you a beer, and you say no, because the one rule is no alcohol. But what if you have a really clever friend, who pulls out a chewable tablet. This is a beer tablet, you can chew it and it’s the same as drinking a beer but you wouldn’t be breaking the rules. I asked my son would he do it? And he looked at me like I’m an idiot and said ‘of course not, because that wasn’t the point’. I said I’m in prison because I was the beer-tablet pusher. Every way I could find ways to follow the rule technically but undermine the principle of the rule, I did it. And because I did that, it caused a lot of harm and that’s why I should be in prison.'

We also need to understand what motivates people to be honest. Machiavelli once observed that 'Men seldom rise from low condition to high rank without employing either force or fraud.' This seems to be an attitude embraced by many, with shows like The Apprentice popularizing the idea that you have to do whatever it takes to get to the top. However, we are also taught from childhood that cheaters never prosper, that society runs on rules or it fails. There is no reason this should go by the wayside in business. Economists, ethicists, and business sages have also persuaded us that honesty is the most fundamental value a business can have and that it will pay off in the end, even if it may seem that cutting a corner will yield the best results. These results will be short term, we're told, they will be found out.

There are two ways of looking at honesty. The first is that it is really a product of self-interest. Reputation is an exceptionally powerful economic force. If we are honest, we are trusted, and people will do business with us or buy our products. Economists and game theorists tell us that this means trust is enforced in the marketplace through retaliation and reputation. If you violate a trust, your victim will seek to retaliate by ending the business relationship and look to someone with a reputation for honesty, whether this is a customer or supply chain partner. This is a cynical vision of humanity as fundamentally selfish creatures, but the end result is still honesty. The problem is, however, that if you do not fear revenge, if your misdeeds are not financially punished, people won't bother to act in an honest way. They will lie, cheat and steal, knowing that even if they are found out, the rewards will like have exceeded the losses.

The other way of looking at it is that people are intrinsically honest, that their default setting is to be moral. Trust based on morality as opposed to self-interest sounds naive, but if we turn the statistic that one in seven large orgs commit fraud on its head, six in seven don't. And there is evidence that supports this view of humanity. In a recent TED talk, economist Dr. Alexander Wagner discussed an experiment he conducted to test the honesty of a group of individuals in Switzerland. Participants were asked to flip a coin four times, unsupervised. They were then to report their findings anonymously. They would be paid according to the data they reported, irrespective of how that report related to actual coin flip results, with every tail earning $5. About one-third of the people were dishonest in their reporting, while the other two-thirds of those taking part in the experiment did the right thing, despite nobody watching over them.

The truth, though, is that people are complex. Some will lie and some will act honestly, and they will likely not do either all of the time. External factors often dictate our capacity for honesty, and they dictate our capacity to tolerate it in others. It is simply impossible to exclusively deal with companies who abide by our own moral codes, either as consumers or partners, even if you can't trust them at all as a result of your knowledge about them. You just have to invest extra effort to make sure that every risk is covered. This is why it is so important to regulate markets. It is always best to assume that others are trustworthy, at least in their initial intentions, as chances are they will be. Mistrust can also a self-fulfilling prophecy. At the same time, always be prepared for the worst. Cheaters don't always prosper, but enough do that there will always be those who think they can get away with it.

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