J’accuse…!

We know from the underground economy that enforcement by itself can’t stop cheating. You need to change the culture.

The underground economy is not very far underground. From the contractor who gives you a cash price to the pot dealer on the next block to the operator of a site for pirated movies, they’re pretty open about their activities. The lawyers setting up corporations in Panama may have been less visible to the general public, but not to the people looking for that service. What they all have in common are willing buyers and sellers. Authorities may want to regulate, outlaw or tax the activities, but the fact that so many people are involved makes this difficult. Sometimes they become so ubiquitous and blatant that a consensus is reached that they should be allowed, provided they agree to regulation. This usually results in legitimate businesses making a lot of money (think Uber, or marijuana).

In the prelegalization phase, the underground activities are a great demonstration of how we rationalize our actions. We point out that many people are doing the same thing. If I stop, it will not have any material impact because everyone else will continue. If anyone is hurt, it’s a big entity (the government, large corporations) that no one really cares about. The rules/ laws are stupid. And everybody knows that this stuff is going on — surely if it was really harmful, someone would stop it. All those rationalizations mask the key point — the underground economy exists because it benefits the participants.

If we get indignant about the underground economy, it’s directed at an aspect that causes us economic harm. People in high tax brackets fume about all those little guys avoiding tax. The little guys are incensed by the rich people with high-priced tax advisers and offshore corporations. Large fashion houses are furious at all the knock-offs, but the buyers justify their purchases by pointing out that they could never afford the high prices of the originals.

Large corporations have their own underground economies that operate in much the same “let’s pretend it isn’t happening” manner. Take Wells Fargo, for example. Bank employees were incented based on the number of accounts and credit cards each customer had. So they started to create accounts even if the customer didn’t ask for them. The employees no doubt used the usual rationalizations. The cost to each customer was very small. Any customer who really paid attention could ask for the accounts to be deleted, so it was their own fault if they didn’t notice. Everyone is doing this and the managers know about it. Clearly, the reward system was designed to encourage this behaviour, so it must be OK.

This corporate underground is not unique to financial services. There are many participants: mechanics at car repair shops who fix problems that didn’t exist, manufacturers who overlook quality problems to meet production quotas, contractors who pay bribes and consulting firms that charge for hours they didn’t spend on the client. The employees can be faulted for their unethical behaviour, but I blame senior management and the board of directors, who are the ones looking the other way.

It all starts with pressure to beat the competition and increase earnings per share and share price. Boards and CEOs develop a strategy to do that, involving sensible things such as growing the number of services to existing customers, increasing revenue per transaction, becoming more productive or winning large contracts. Employee incentive plans are designed to drive the behaviour to accomplish this. Employees and their managers quickly learn how to game the system. Eventually, something comes to light, the CEO claims he or she didn’t know what was going on, some lower-level employees get fired and the CEO keeps the bonuses that were aligned with the strategy that gave rise to the whole thing.

Colleagues I talk to about Wells Fargo ask, “Where were the internal auditors?” But we know from the underground economy that enforcement by itself can’t stop cheating. You need to change the culture, so that people are proud to provide value to customers and grow earnings per share by being better than the other guys at what they do. It’s simple to say and fiendishly difficult to execute.

About the Author

Karen Wensley


Karen Wensley, MBA, is a lecturer in professional ethics at the University of Waterloo and a retired partner of EY.

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