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After Milken, Keating, Madoff, Kerviel... New paths to ethical practice in the Finance industry

Peter G. Szilagyi , Professor
Aziza Laguecir , Professor
Fabian Bernhard , Associate Professor

Almost every week, a new financial scandal or echoes of an old one hit the news. Whether in the private or the public sector, these constant stories of financial market abuse - insider trading or…

Reading time :
17 Jan 2022

Almost every week, a new financial scandal or echoes of an old one hit the news. Whether in the private or the public sector, these constant stories of financial market abuse - insider trading or market manipulation - have harmed the image of financial institutions and professionals. Though some research shows that media coverage of bad behaviour can, surprisingly, enhance the business of the banks involved (1), the strong consensus is that bad behavior must be prevented because it undermines the integrity of the finance industry as a whole.

Since the 2008 Global Financial Crisis, numerous new regulations designed to prevent and discourage market abuse have been put in place on different levels. Yet, recent research by EDHEC Business School economists and their co-authors demonstrates that finance is far from being in the clear. The corrective measures introduced tend to miss the key problem: financial misconduct always starts with an individual decision, within a fluctuating but specific “money culture” (2). What do we see when we examine the finance industry’s structural deficiencies that are in contradiction with the decisions, biases, and moral values of individuals? How can we change people’s attitudes to making money? Could bankers, traders, controllers, or risk managers lead the way to a more ethical sector?

Why laws, procedures and controls aren’t enough

Following the proposals of the G20 Washington and London Summits right after the 2008 crisis, banking and financial regulations designed to improve market discipline were introduced at three levels: national laws and regulations, industry-level codes of conduct (national and international), and institutional self-regulation. “Though these new laws and guidelines are going in the right direction, this top-down approach of imposing new rules is clearly missing something” says Peter G. Szilagyi, Professor of Finance at EDHEC. “In financial institutions and in financial markets, illegal and unethical behavior keeps happening.”

Why? Consider, for example, the division of duties in the finance industry, designed to separate bankers and traders from their controllers. The solution seems to have become the problem: “The distance, which might lead to objectivity, works as a smoke screen” says Aziza Laguecir, Professor of Management Control at EDHEC, following her recently published research paper (Ref. A.). “The geographical, technical and social – including payroll-level – gaps between controllers and traders are undermining the efficiency of the control systems. One might even think that these systems have been devised in order not to work fully” she says.

Many researchers advise that public and private decision-makers narrow their approach in order to reach “ethical efficiencies”, because the way individuals observe each other and see themselves is key: “To me, illegal and unethical market behavior is fueled by behavioral biases at the individual level that a top-down approach to enforce market discipline cannot prevent” Szilagyi states in his latest research paper (Ref. B.). “Examples of behavioural biases observed but tolerated inside financial institutions include overconfidence, frame dependence, loss aversion, and regret minimization. These are often tolerated due to in-group biases such as loyalty and tribalism.” To him, the behavioural issue is critical: “These biases will not disappear with the imposition of rule-based codes and deterrents designed to ensure compliance with those codes. An inside trader may not feel guilty if his colleagues are forgiving or even egg him on. A whistleblower may not blow the whistle if she then has to change careers because her colleagues shut her out and no-one else will hire her.”

The importance of management and corporate culture

“It would be a mistake to analyze finance professionals as being homogeneous in their beliefs, expectations and goals” says Fabian Bernhard, Associate Professor of Management at EDHEC, and author of a recent research paper (Ref. C.) on this issue. “Bankers differ in the way they think and feel about previous scandals in the finance industry. The people I have interviewed can be categorized according to the degree to which they identify as members of the profession” he says. “Many finance professionals reported not feeling guilty about the unethical conduct of their fellow bankers. Most importantly, those who did not identify themselves as bankers and could be doing something else, recognized little accountability. At the other extreme, the group of ‘hard-core’ bankers who would fight tooth and nail for their image and status also experienced little guilt. It was those between these extremes, those who somewhat identified with, yet maintained a critical distance to their profession, who were most likely to accept accountability and urge for change.”

In a way, for institutions that are used to implementing rationalized decisions and now want to curb ethical violations, forcing cultural change could be promising. “I do believe that the idea of solving these issues with data analytics, computer tracking and even Artificial Intelligence is somehow a dead end” says Laguecir. “Finance professionals should not hide behind their hands on the issue of industry culture” says Szilagyi, “We all know how money can change people’s attitudes and put their personal ethics under pressure. Organizational culture should not tolerate ‘unless you get caught’ unethical behavior.”

Could understanding and improving behavioural patterns be the key?

For Laguecir, some recent improvements to the control of trading operations might provide answers: “We need to come back from the segregation of duties and make sure that the key individuals – those who are most in a position to commit legal and ethical misconduct – are monitored closely by their peers. Not by distant management, not by software: by people.”
Much like a Russian nesting doll, moving towards a more ethical finance industry requires that rules and codes of conduct are acknowledged, understood, implemented and monitored at every level, but especially at the individual level: “It seems clear to me that ‘hard-core’ bankers need to be addressed in small steps, by confronting them with repeated information on the negative aspects of financial misconduct” says Bernhard. “Behavioural science has shown that if someone is convinced of something, you can reason with them all you want, and they will still ‘rationalize away’ your arguments to maintain their own point of view – a process called motivated reasoning. Through both internal communication and management, motivated reasoners must be confronted with strong, credible, and frequent negative information on past malpractices. Only then does change become possible”.

Ethical principles should be embedded in the immediate culture of both individuals and institutions, such that action is filtered through the lenses of both duty and consequence. Szilagyi says that this is a long process that begins at home and in the classroom. “The behavioural finance literature has shown that the classroom setting can help develop individual moral judgement (3). Techniques include discussing theories of ethics, peer learning, and moral discourse.” To him, academics can contribute by asking the right set of questions, rooted in their understanding of the industry, of human behaviour, and of the complementarity between different actions: “How do we and those around us make individual decisions, considering social performance and peer pressure for instance? Which motivations and which biases might explain certain behaviour and choices? How do we act ethically, in the interest of the common good? This inclusive, bottom-up approach starting with the individual can go a long way in complementing the rule and incentive-based environments of modern financial institutions to prevent illegal and unethical conduct.”

(1) Thomas Roulet, “Sins for some, virtues for others: Media coverage of investment banks’ misconduct and adherence to professional norms during the financial crisis”, Human Relations, 2018. (2)The title of a 2011 highly-renowned book by Michael Lewis about the “folly that fueled the 1980s” in the financial market. (3) “Mapping Ethics Education in Accounting Research: A Bibliometric Analysis”, Tamara Poje et Maya Zaman Groff, Journal of Business Ethics (2021)


A. Organized decoupling of management control systems: An exploratory study of traders’ unethical behavior (2021) – Journal of Business Ethics. Aziza Laguecir (EDHEC Business School), Bernard Leca (ESSEC Business School). https://doi.org/10.1007/s10551-021-04741-3

B. Financial Market Manipulation, Whistleblowing, and the Common Good: Evidence from the LIBOR Scandal (2021) – Abacus, A Journal of Accounting, Finance and Business Studies. Jonathan A. Batten (RMIT University), Igor Lončarski (School of Economics and Business, University of Ljubljana), Peter G. Szilagyi (EDHEC Business School). https://doi.org/10.1111/abac.12245

C. When Bankers feel Guilty – Employees’ Vicarious Guilt and the Support of Moral Business Practices (2021) - European Management Journal. Fabian Bernhard (EDHEC Business School). https://doi.org/10.1016/j.emj.2021.08.001

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