What's wrong with unethical companies?

Some examples of corporate rule-breaking – and some of the consequences.

Judging by newspaper headlines, corporations routinely break the rules. Walmart, Siemens, SNC-Lavalin and others have been accused of bribing foreign officials. Goldman Sachs and JP Morgan paid huge fines for deceiving clients and/or the government. Apple, RIM and other technology companies were found to have backdated employee stock options. If you were a shareholder in any of these companies, it might be worth stepping back and asking why you would, or would not, object to such behaviour.

One objection to wrongdoing is simply that it is wrong. If a corporation engages in acts contrary to your ethical standards, you are free not to invest in that company (although it's harder to prevent a pension plan or mutual fund from doing so on your behalf). As an activist shareholder you can work to change governance standards, elect new directors and otherwise fight behaviour you object to. However in business, economic arguments generally have more persuasive power than purely ethical ones. That is why people arguing for more gender balance on boards of directors cite studies showing that companies with more women directors achieve higher return on equity.

The economic arguments raised against corporate rule-breaking are the potential fines and loss of reputation that result from getting caught. The fines are getting larger — JP Morgan agreed to pay the US Justice Department a breathtaking US$13 billion. But a rational decision-maker without the benefit of hindsight could argue that the likelihood of having to pay a large fine in any particular instance is small. Unless there are adverse economic events that cause the investment to go bad, and unless the company (among many others engaging in the same behaviour) is the one to get caught, entering into illegal or unethical transactions, on a risk-adjusted basis, could be good business. As the Huffington Post pointed out, JP Morgan has already earned back the US$13 billion for its shareholders in its increased stock price.

One can also argue that the potential loss of reputation may be worth the risk. If the company gets caught, it can argue that "everyone was doing it." As a result, the loss of reputation may be industry wide rather than specific to that company, even if it was the worst offender.

I believe there is a more persuasive argument against breaking the rules that applies whether or not you get caught. It is based on the adverse consequences of a corporate culture that justifies every kind of deception and rule-breaking in order to win.

Corporations that break rules need the participation of many employees to do so. Those employees are not motivated by undying loyalty to the company, although a sense of team spirit may contribute. Their jobs, promotions, status, bonuses, popularity with colleagues, and many other inducements are at stake. Once they participate in or observe rules being broken, they may accept this behaviour as the norm. And they are unlikely to see a difference between cheating the clients and/ or regulators and cheating their employer. The next logical step for them may be to find "creative" ways to earn raises, bonuses, promotions or other incentives for themselves.

JP Morgan lost more than US$6 billion from the so-called London Whale rogue trading. SNC-Lavalin has announced writedowns on legacy fixed price contracts that turned out to be money losers. Is it far-fetched to think the employees who made those trades and wrote those contracts (and presumably earned bonuses) were aware of the rules the company had broken, and therefore felt entitled to enter into transactions that were bad for the company, but good for them?

Once you unleash a culture of winning at all costs, it's hard to stay in control.