If crime is rewarded, how can financial fraud be deterred?
In recent years, financial misconduct has been in the spotlight, and market regulators have increased the scope and severity of their interventions. We show that the economic benefits of illicit financial activities may outweigh the costs of litigation. We illustrate our argument using data from the U.S. Securities and Exchange Commission and examples of investment misconduct. From the paradigm of neoclassical economics, which follows utilitarian thinking, it is rational to engage in illegal activities. Nevertheless, the majority of professionals refrain from cheating and prioritize economic rewards. We suggest that financial activities may be reconsidered in light of intrinsic and prosocial motivations. The framework of virtue ethics can also be applied, linking economic behavior to the pursuit of moral excellence and shared prosperity.
Klimczak, KM, Sison, AJG, Prats, M. et al. How to deter financial misconduct when crime is rewarded? J Bus Ethics (2021). https://doi.org/10.1007/s10551-021-04817-0
Commentary
According to this paper, evidence was provided to prove that crime pays on a "net present value" (NPV) basis. It found that after asking why many financial professionals don't engage in financial fraud, it sketches another way to deter financial fraud, given that it's under the general assumption that it's "rational" and that crime pays. It examined the utilitarian and self-serving rationality embedded not only in neoclassical economic explanations of financial behavior, but also in the legal and ethical measures employed to prevent fraud. We were able to explain this through the similarities between economic utility and extrinsic motivation shown by psychology, and in a representative example, we showed that regulatory measures that rely solely on utility considerations and extrinsic motivation are ineffective under these conditions.
That said, the fact that the U.S. financial system is persuaded proves that not everyone behaves as this model of rationality describes, and certainly does not utilize a favorable calculus. This leads us to believe that there is a need for changes in the underlying framework of the regulatory system that can better explain actual financial behavior and better shape future deterrence efforts.
Researchers are considering two options, one based on a motivational approach and the second based on virtue theory.
The motivational approach suggests that there are motivations other than utility and self-interest at work, and that intrinsic and altruistic motivations may be at work in the economic and financial behavior of both individuals and organizations.
That is, intrinsically motivated and altruistically motivated financial actors are less likely to engage in illegal activities.
And insofar as motivation provides not only an explanation of behavior, as it does, but also a descriptive and normative account of the agent, it tones virtue ethics, and virtue has linked individual behavior to both individual moral excellence and the quest for the common good of thriving within a community.
In this way, virtue combines intrinsic and altruistic motivations. Virtue ethics emphasizes the instrumental value of financial assets with respect to the end goal of flourishing, and McIntyre's virtue ethics specifically requires that financial activities constitute "practices," that these "practices" be embedded in the individual lives of practitioners who play complex roles, and that "practices" and "practitioners" be embodied in a tradition It contributes to the flourishing of the community.
From all this, the researchers drew three conclusions.
The first concerns the very limited effectiveness of deterrent measures based solely on utility and extrinsic motivation, as dictated by neoclassical economic theory and its extension to law and ethics.
The second suggests that it would be better to reconfigure financial market behavior to include, for example, intrinsic and altruistic motives.
The third sought to show how virtue ethics integrates the best of legalistic and punitive approaches with inputs from motivational theory within a broader framework.
In summary, the current financial system may never stop cheating because the benefits to be gained are greater than the benefits of cheating, and these conclusions were presented as an opportunity to deter future cheating.
