Ethics and Derivatives Ethical and Financial Risks

Ethics and Derivatives Ethical and Financial Risks of Derivatives This paper examines the ethical and financial risks of derivatives. The paper discusses moral philosophies, how white collar crime differs from blue collar crime, and reviews the role of corporate culture and banking industry leaders in the banking industry meltdown that contributed to the worst recession in U.S. history. The moral philosophy most applicable to understanding the banking industry meltdown is teleology.

Teleological ethics holds that an action is right or wrong in terms of the consequences that result from it. From the perspective of the banking industry, this consequentialist approach defines their ethics in terms of whether an act produces a desired result. Given that their desired results were the advancement of self-interest and the accumulation of wealth, any action that produced these results would be considered ethical.

The single-minded pursuit of profit to the disregard of all other considerations, including risk to stakeholder value, is deeply ingrained in the corporate cultures of the financial industry. As the case study indicates, derivatives have had a long history of troubled transactions. In spite of this record, managers and traders were never compensated in a way that penalized them for fraudulent or deceptive practices; instead they were rewarded based on short-term results.

The fact that those results were obtained as a consequence of manipulation and excessive risk-taking did not constitute a moral problem for many within the banking industry. Their egoist philosophy allowed them to take advantage of market opportunities without considering any consequences beyond maximizing their own self-interest. White collar crime (WCC) does not differ from blue collar crime in that there are still victims who are seriously or fatally damaged, but WCC does differ in the way that the destruction is caused.

The most obvious difference is the level of physical violence involved, WCC seldom involves murder, rape, arson, burglary or assault. By contrast, WCC is frequently committed in a business or professional setting. Where the victim is an individual, WCC tends to involve establishing a relationship of trust with the victim. Also, more and more often, WCC is enabled by advances in technology and communication. Significantly, the case study notes that WCC do more damage in monetary and emotional loss than do crimes of the street.

It is interesting to note that the way in which WCC is punished can be seen as resulting from two different philosophical schools, Kantian vs. utilitarian methods. The Kantian position holds that WCC is as bad as blue collar crime and needs to be punished on similar levels. According to Kant's argument, people who perpetrate WCC are acting rationally and should therefore suffer the consequences of their actions.

The utilitarian method, however, argues that it is in the interest of the greater good to accept plea bargains where criminals turn state's witnesses, in which case punishment is doled out according to the final value utility created (White, 2010). Corporate culture played a significant role in the banking industry meltdown. There can be little doubt that many firms both encouraged and rewarded unethical, risk-taking behavior in the run up to the meltdown.

Just as corporate culture shapes a business' success and failure, an organization's culture also influences whether employees behave with ethics and integrity. The ethical framework that Sethia and Von Glinow propose, as cited in chapter 7 of the textbook, focus on only two basic dimensions of corporate culture, concern for people and concern for performance. Interestingly, this particular framework suffers from the same shortcoming as does the typical firm in the banking industry: there is no attempt to account for concerns for stakeholders who are not employees.

As a result, there is general consensus that the culture of banking is broken. Examples include the "mad rush into derivatives and other risky investment vehicles, obscene bonuses paid to bankers, the endless search for acquisition targets in order to expand scope and scale, the lack of focus on customer service, the retreat from lending, and the obsessive focus on internal profits" (Childress, 2011).

Childress further points out how internal business processes in banks and financial institutions have changed over the past 40 years from a focus on credit risk assessment and stewardship of other people's money to a focus on profit maximization, deal making and asset securitization. Because leaders influence corporate culture, banking industry leaders could have averted an industry meltdown, or certainly reduced its impact significantly. One of the tools at their disposal was the use of reward power.

Banking executives routinely used reward power to influence the behavior of their employees by offering extravagant bonuses. As might be expected, bankers focused on the sales of risky and complex financial instruments because of the financial incentives. It would have been simple enough to create compensation packages that incentivized appropriate, responsible, and ethical behavior while at the same time penalizing risky behavior. By failing to exercise reward power to change their bankers' behaviors, banking leaders shaped an ethically challenged corporate culture.

Implicit in any restructuring of compensation is the recognition that this approach needed to be taken on an industry-wide basis for it to be effective. If only one or two firms had revised their compensation, then their employees would have quit and gone to work at other better-paying jobs. Rather, the entire banking industry needed to revise their approach to compensation for this policy to have been effective. There are recent indications that the banking industry is moving in the direction of correcting this problem. According to a survey by.