Behavioral Economics

Over the past few months, we have been exploring the field of behavior economics and how it applies to corporate governance, risk management, compliance, internal control and ethics. 

There are a number of fascinating people driving this field. One of my current favorites is Dan Ariely and his recent-ish book Predictably Irrational which has been translated into at least 10 languages. In it, Dan summarizes some of his research into why people behave irrationally -- or at least the conditions under which average people behave irrationally. Some of his original research papers can be found on his blog.

Our Leadership Council recently spoke with Dan on a conference call to discuss the implications of his research -- especially as it applies to corporate misconduct. Here are some thoughts from Dan:

Just after the Enron scandal in 2001, I started wondering what made these people cheat and how pervasive is this tendency. To look into this, we created a series of experiments in which we tempted people to cheat and examined how much money they stole from us and what caused them to cheat more or less.

We found that when people are tempted to cheat, a majority of them do, but only by a “little bit.”

Interestingly, and in opposition to the way we usually think of dishonesty, their cheating doesn’t seem to be related to the amount of money they stand to gain or to the probability of being caught. What does influences the extent to which they cheat?  Being asked to recite the Ten Commandments or sign an honor code eliminates cheating altogether, while getting paid in non-monetary currency (tokens that become money a few seconds later) increase cheating dramatically. These finding show that cheating is a function of our conscience at the moment and not a cost-benefit analysis, and that cheating just a little bit allows us to get the benefits of cheating but at the same time consider ourselves honest upright citizens.

I personally find the finding that once we paid people in non-monetary currency they doubled their cheating to be very very worrisome since this is what stock options are, and where society is heading.

We also took the honor code experiment and replicated it with a large insurance company.  This company mails their clients a form asking them to report how much they drove in the last year.  Some of the customers were mailed a form that asked them to sign the declaration before they filled their mileage and some people were asked to first fill their mileage and only then sign.  We expected that the people who sign first will be more honest and will report higher driving mileage, and indeed this is what we found.  People who signed at the top "drove" about 20% more.  

In my mind if we start to truly understand what causes people to be honest and not honest, we can better create mechanisms that will curb dishonesty.

This is a 6 minute excerpt of a discussion about his book that he gave at a bookstore earlier this year. The full 45 minute discussion is available here.

My perspective on applying these ideas to your work:

1. Recognize that your work is not about "good guys" versus "bad guys." In the end, good people can and will do sub-optimal things given the wrong incentives and structures around them.
   
2. Work more on analyzing the "structure" of your business processes and organization versus "finding and fixing problems" after the fact. In the end, average people will "cheat a little" if the incorrect structures are in place. Some of this cheating will be non-material in the instant -- but massive in the aggregate (take the number of cab rides times the number of "average people" who may have "cheated a little" on the amount of the fare or even the ride altogether).
   
3. Avoid and/or carefully monitor non-monetary compensation plans as it may increase noncompliance and cheating.
   
4. Have people sign certifications PRIOR to filling out the form rather than after.
   
5. Recognize that training a person months before a potential ethical issue will have little if any effect on the ultimate decision that is made. What is more powerful is a simple reminder IMMEDIATELY BEFORE the decision.

In this sense, the role of the chief ethics and compliance officer may be more about being the chief "removing attractive nuisances" officer or chief "remind as many people as possible right before the ethical decision will be made" officer.

Keep your eye on Dan Ariely. He already is and will continue to be a star in this field. His ideas will help you and your organization Drive Principled Performance.

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