Once upon a time you could go to your local bank branch and get investment proposals, that had a realistic chance of generating a positive return. You could pay several decades into your life insurance policy knowing, that the risks were very low and you would achieve a nice capital gain. And when you bought products from big corporations, you could be confident, that they would not cheat you outright.

Admittedly, not everything was perfect in the past, but the good times are certainly over. Nowadays, business ethics have been corrupted by misguided shareholder value thinking and lack of oversight. 


Reasons for declining business ethics

In the past top management of a company had to deliver satisfactory earnings at the end of the year and a clear vision, on how to grow profitably in the future. Nowadays investors expect excellent quarterly results and follow stock prices on a daily basis. This change has mostly been brought about by the shareholder value concept which stipulates, that the primary goal of a company is to increase the wealth of its shareholders. Though in general correct, the application of this approach has gone too far.

Despite of what is written in elaborate mission statements and fancy PR announcements, top management is nowadays pushed by shareholders to ignore and suppress the rights of customers and employees, to increase shareholder value. Focus has also shifted from creating long-term corporate success, to securing immediate increases in the stock price. As many shareholders are only interested in quick gains, they support risky and increasingly unethical management behavior, as long as they benefit from it. They take the view, that they can sell their shares just in time, in case something goes wrong.

The shareholder value approach is also evident in management incentives. In the old days, managers were paid a decent base salary and some bonus usually based on sales growth and profit. Nowadays the importance of the fixed salary has decreased. Instead bonuses related to growth in Earnings per Share (EPS), and stock options, whose value increases with the stock price, are the main driver for compensation. This has generated a strong incentive for executives to have the company borrow large amounts of money to buy back own shares. Even if net earnings of a company stay flat, a reduction in the number of shares causes EPS to go up, which usually results in a rising stock price. This is great for top managers, who benefit from higher bonuses and a higher value of their stock options. But it is unfavorable to the company, as it causes higher interest payments and higher risks. In case of an elevated debt-to-equity ratio, the long-term survival of the company can be stake.

Apart from the negative effects of misguided shareholder value thinking, lack of oversight is another aspect that has contributed to declining business ethics. Executives used to face a jail sentence if they did something wrong. This risk has diminished substantially in the last 20 years. Today there is not only “too big to fail” but also “too big to jail”.

In the U.S. a reduction in government oversight started in 1999, when a memorandum of then Deputy Attorney General Holder requested, that collateral consequences from prosecutions such as corporate instability or collapse should be considered, before prosecuting a financial institution. This has not only led to less prosecutions, but also to the Justice Department seeking settlements instead of prison sentences. Whereas in the savings-and-loan scandal of the 1980s over 800 managers were convicted, only one Wall Street executive was sent to jail following the Great Financial Crisis, which was certainly a magnitude larger. And this one executive was not even the managing director of a big corporation, but only a senior trader at Credit Suisse. The situation in the U.S. might be special, but political pressure will probably also prevent the CEO of a big company in Germany, the U.K., Australia or Canada from being prosecuted.

A lack of oversight is also seen in the work of audit firms. All big companies claim, that their financial statements have been audited. Though this is true, they don’t mention that they themselves select and pay the auditor. The many scandals involving “reputable” audit companies show, that a positive audit report can’t be trusted anymore.

The latest case came to light in June 2020, when German payment provider Wirecard filed for bankruptcy after admitting, that EUR 1.9 billion of audited cash probably never existed. It later became known, that auditor Ernst & Young (EY) failed for at least three years, to request respective account information from a bank in Singapore, which should have been a standard procedure. In the same period EY also ignored detailed complaints by short-sellers about Wirecard’s accounting and business practices.

The Wirecard scandal also exposed massive failure of Germany’s financial markets watchdog BaFin. The agency not only neglected to investigate Wirecard. It even suspended short-selling of Wirecard shares and filed a criminal complaint against two journalists of the Financial Times, accusing them of being involved in market manipulation. If you think that large-scale corporate fraud can only occur in Banana Republics, you should add Germany to the respective list.

Rating agencies have equally been accused of questionable behavior. Their failure to provide accurate ratings for Mortgage Backed Securities (MBS) and Collateralized Debt Obligations (CDO) was one of the main contributing factors to the Great Financial Crisis of 2007-09. Wall Street firms, that wanted to sell the above-mentioned products, had to get a rating first and paid credit rating agencies large amounts of money for it. In the years leading up to the crisis, the big rating agencies Moody’s and Standard & Poor’s assessed thousands of MBS and CDO and gave them the highest possible AAA rating, as anything below would have put them out of business. When many high-risk loans started to default in 2006, the agencies maintained the AAA ranking and it was only much later, that the ratings were lowered. 90% of AAA ratings given to subprime MBS securities were eventually downgraded to junk status.

Nobody would accept criminals choosing and paying their judges. But nobody complains, that companies can select and compensate their audit firms and rating agencies. Please keep that in mind the next time you hear from your financial advisor, that  “Everything has been properly audited” or “This is a triple A rated security”.

Today top managers face a big asymmetry between risk and reward. If they do something unlawful to increase their bonus and it goes wrong, the company faces the losses and might have to pay a (comparatively) small fine to the authorities. But if the offense is not detected, the reward will be huge. Losses go to the shareholders or other stakeholders, while profits go to the top management. You could not describe a moral hazard situation better.


Examples of corporate misbehavior

There is enough material available to write a book (or rather a series of books) about unethical and unlawful behavior of big corporations. Especially banks, that claim to be fully trustworthy as bastions of lawfulness and solidity, are often at the center of scandals as the following examples show.

Let’s start with the Great Financial Crisis (GFC), that was caused by a combination of deregulation, failed regulation, ill-conceived central bank policies, weak or even fraudulent underwriting standards, undisclosed conflicts of interests, high risk taking and outright fraud. At the heart of the market collapse were the above mentioned Mortgage Backed Securities (MBS) and Collateralized Debt Obligations (CDO). The latter were complex financial products that hardly anyone fully understood.

All the big banks were eager to sell MBS and CDO to their customers, even though they were aware that something was wrong with the products. Some banks went even further and shorted them while continuing to sell them to their clients. A report by the U.S. Senate Permanent Subcommittee on Investigations mentions one particular example involving (in)famous investment bank Goldman Sachs. It states: “In the case of Hudson 1, Goldman took 100% of the short side of the $2 billion CDO, betting against the assets referenced in the CDO, and sold the Hudson securities to investors without disclosing its short position. When the securities lost value, Goldman made a $1.7 billion gain at the direct expense of the clients to whom it had sold the securities.”

The U.S. Justice Department issued more than USD 100 billion in fines to banks for their role in relation to the GFS. All big players were affected such as Bank of America, JP Morgan Chase, Citigroup, Deutsche Bank, Wells Fargo, RBS, BNP Paribas, Credit Suisse, Morgan Stanley, Goldman Sachs and UBS. However, as already stated above, all those fines represented out-of-court settlements. None of the banks were officially charged and except for one mid-level executive no senior banker went to jail.

Banks have also been very active in rigging interest rates. One popular target was the London Inter-Bank Offered Rate (LIBOR), which is considered to be one of the most crucial interest rates in finance, as it affects the price of approximately USD 350 trillion in derivatives. In 2012 it was discovered, that banks had for many years colluded in manipulating the LIBOR, in order to profit at the expense of their clients and other market participants, who lost billions of dollars. Involved in the scandal was the “Who’s Who” of the banking industry, such as Deutsche Bank, Barclays, UBS, Rabobank, HSBC, Bank of America, Citigroup, JP Morgan Chase, the Bank of Tokyo Mitsubishi, Credit Suisse, Lloyds, West LB, and RBS. About USD 9 billion in fines were levied, which is peanuts compared to the damage caused. This time several traders were convicted, but again no senior banker ended up in jail.

Money laundering is another highly lucrative business that banks tend to be involved in. Normal citizens have to complete preposterous Know-Your-Customer (KYC) forms, are intensely questioned for larger cash deposits and withdrawals, and might even have their accounts frozen following a small international transfer to a bank in an emerging country. For big customers different rules apply, not just in America but also in Europe. In 2017 it emerged, that approximately EUR 200 billion of illegal money from Russia and other former Soviet states had been laundered through the Estonian branch of Denmark’s Danske Bank. Other European banks have also been caught facilitating money laundering. Research by anti-money laundering expert Fortytwo Data shows, that 18 out of the 20 biggest banks in Europe have been fined for respective offences.

Banks have breached the trust of their customers in many other ways. Wells Fargo is a good case in point. In 2017 the bank admitted, that its employees had opened 3.5 million savings and credit card accounts for customers, without their knowledge and consent. Main reasons for this fraud were very high sales incentives as well as strong pressure from higher-level management. The bank was fined USD 185 million by three government organizations, among them the U.S. Consumer Financial Protection Bureau. In the same year Wells Fargo had to admit, that it charged 750,000 customers for auto insurance they did not ask for. The case was later settled with a USD 385 million fine. In 2018 Wells Fargo agreed to pay a $2.09 billion fine for issuing mortgage loans, it knew contained incorrect income information. And in the same year the bank filed a report with the U.S. Securities and Exchange Commission (SEC), in which it disclosed that a software coding error resulted in 625 customers being incorrectly denied a mortgage, for which they were qualified. About 400 of these customers lost their homes. The list of scandals involving Wells Fargo can easily be extended. But the biggest scandal is, that after all the transgressions committed by the bank, it is still able to find customers who are willing to deposit money with it. 

Cheating and deceiving is for sure not confined to the financial industry. Despite their repeated claim to be good “corporate citizens”, companies in other business sectors are also willing to compromise ethics and contravene existing laws to obtain financial benefits.  

The Volkswagen “Dieselgate” scandal is a good example. Between 2009 and 2015 Volkswagen installed software in its diesel engines, which could detect when the car underwent emission testing. This “defeat device” was then able to reduce the emissions, helping the engine to pass the tests. Volkswagen admitted that around 11 million cars worldwide had been equipped with the software. The company had to pay several billion EUR in fines and also spent billions on car recalls.

Most companies don’t care about your privacy and the protection of your personal data despite what is written in their increasingly lengthy and incomprehensible privacy statements. One example is Facebook, which has a long track record of complete disregard for the privacy of its customers. The biggest scandal emerged in 2018 when it was found out, that personal data of 87 million Facebook users had leaked to the political consultancy Cambridge Analytica. Facebook alleged knew that Cambridge Analytica was siphoning off data, but did nothing about it. In July 2019 Facebook agreed to pay $5 billion to resolve a U.S. Federal Trade Commission investigation of privacy violations.

Theranos is another example of a Silicon Valley company with a highly questionable business model. It claimed to have developed a revolutionary technology for blood testing, raised USD 700 million from investors, and was at its peak valued at USD 9 billion. In 2018 Theranos was charged by the U.S. Securities and Exchange Commission (SEC) with massive fraud, by lying about the extent and quality of its testing technology, revenue, regulatory approval and clinical trials. The firm has since been liquidated. As a delicate side note it needs to be pointed out, that the Theranos Board of Directors included two famous former U.S. Secretaries of State, two former U.S. Senators and two former CEOs of big corporations.

Reckless management behavior even puts human lives at risk as the Boeing 737 MAX fiasco shows. In March 2019 aviation regulators around the world grounded the Boeing 737 MAX after two fatal crashes in Indonesia and Ethiopia, that killed a total of 346 people. Subsequent investigations uncovered, that Boeing was willing to cut corners in order to compete with Airbus in an upcoming American Airlines tender. Instead of developing a completely new aircraft, it opted to equip the outdated fuselage of the 737 with much bigger engines then it was originally designed for. To deal with the resulting aerodynamic instability, Boeing hastily developed a flawed Maneuvering Characteristics Augmentation System (MCAS), that was at the core of the two crashes. It later emerged that Boeing management disregarded internal safety improvement proposals to keep costs down, and put tremendous pressure on its development team, to speed up work and circumvent necessary but costly design changes. Instead of using available funds to increase safety, senior management preferred to invest in stock buybacks to boost their bonuses.

During the investigation it became known, that the U.S. Federal Aviation Administration (FAA) completely failed in its task, to properly certify the new aircraft type. Their inspectors were not only insufficiently trained, but also handed over most of the certification work to Boeing. Regarding the fatal MCAS system, which relied on a single sensor instead of at least two, it turned out, that regulators had never independently assessed the system. It is certainly useful to have a cozy relationship with your regulator.

The above examples are only the tip of the iceberg. Most unethical or illegal behavior doesn’t even make it to the news. Nonetheless, you increasingly find it everywhere. Companies make inaccurate statements about their products and pay ghostwriters to disseminate false information on the internet. Sales people give incorrect assurances to their customers to get commission (and avoid being fired for not hitting their “stretched” sales targets). Enterprises don’t adhere to business contracts in the hope, that the other party will not file a lawsuit to avoid high cost and risk. Subscription businesses reject cancellations or intentionally extend the cancellation process, to get a few additional payments. Enterprises employ subcontractors using child or slave labor. Construction companies and producers install substandard materials. Internet firms harvest your data without you even knowing it. The list can be extended almost indefinitely.


In summary, today’s executives are more likely to cook the books, cheat customers or commit other crimes. The reason is that they face high rewards if everything goes as planned, and have a low risk if someone finds out. This has led to an adverse selection process. Candidates for top positions who are law-abiding and ethical, are disadvantaged as they “underperform”. Instead candidates with no scruple and a strong desire to maximize their own bank account balance are selected. Consequently, it is not surprising that there are many sociopaths running large corporations today. And as a fish rots from the head down, this has a big impact on the whole organization. Middle managers with low moral standards are appointed to apply strong pressure on lower management and staff. Bad behavior is spreading like a virus from big corporations to medium and even small companies. Decent companies find it very difficult to compete and are increasingly forced out of the market.

We live in a time when you can only trust yourself and (hopefully) your family and close friends. Please consider this the next time you talk to your financial adviser, insurance broker, real estate agent or lawyer.

Disclaimer: The above is for informational purposes only. It is not an offer or advice to buy or sell any products or services. LBB and its owner do not provide investment, tax, legal, or accounting advice. Neither the company nor the author is responsible, directly or indirectly, for any damage or loss caused or alleged to be caused by or in connection with the use of or reliance on any content, goods or services mentioned in this article.


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