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Memo to Gordon Gekko: Ethics, not greed, boost profits

United States Sen. Elizabeth Warren questions Wells Fargo CEO John Stumpf, foreground, during congressional hearings into allegations that bank employees opened millions of unauthorized accounts to meet aggressive sales targets. (AP Photo/Susan Walsh)

Memo to Gordon Gekko: Ethics, not greed, boost profits

Stories involving business ethics appear regularly in the news. Some report good deeds, but most allege scandalous corporate behaviour. While these may seem like examples of businesses choosing money over morals, that’s a false choice. Unethical behaviour is not only embarrassing from a public relations standpoint, it can also be unprofitable for firms and their investors.

One ongoing scandal, both in Canada and the United States, involves banks selling unwanted financial services to their customers. The story began south of the border with Wells Fargo. The bank admitted in September 2016 that thousands of its employees had created more than two million accounts without customer permission.

The problem arose after management set overly aggressive sales targets. Employees felt pressured to open accounts regardless of customer need. Some ex-employees claim they were fired for refusing to play along.

Regulators fined Wells Fargo US$185 million and its CEO resigned, but the fallout continues. The bank cancelled executive bonuses and demoted several managers. A customer lawsuit is seeking compensation of US$142 million. Lawyers speculate that employees may have created 3.5 million unauthorized accounts.

Canada’s banks face similar allegations

In March, CBC News began reporting an eerily similar Canadian story. Hundreds of TD Bank employees complained about unrealistic sales targets. They too felt pressured to sell needless services. Similar stories emerged from other banks and even credit unions. A parliamentary committee is set to investigate this month.

Creditors took over the Trump hotel in downtown Toronto. (The Canadian Press/Graeme Roy)

Dubious ethics are not limited to banking. Investors in Trump Hotel in Toronto won a lawsuit last fall against its developer, Talon International, and its manager (a Donald Trump company). The investors claimed they had been deceived. Instead of earning handsome profits, they had suffered losses. The hotel went into receivership, and creditors took it over in March.

Trump “University” in the U.S. also faced allegations of deception. Its seminars promised real estate investment “secrets” from Trump “experts”. Its students sued because the seminars apparently involved neither secrets nor experts. New York’s attorney general called it “straight-up fraud” and sued too. Trump eventually agreed to reimburse US$25 million. A judge approved the settlement in March.

Greed is good? Not really

Other recent scandals involve mortgage applications at Home Capital in Canada and tuna price-fixing in the United States.

These businesses seemingly followed Gordon Gekko’s “greed is good” mantra from the film Wall Street. They’re doing what’s profitable rather than what’s right. In this context, investors might think they have no choice but to tolerate bad behaviour to get good returns.

However, unethical behaviour does not merely disgust the public and result in bad customer service. A study here at the Goodman School of Business revealed that it also harms companies and investors. Brock University’s Institute for International Issues in Accounting funded the study.

The probe examined 541 multinational corporations over a three-year period. It compared their financial performance, stock market returns and ethical reputations, including how companies treat their employees, customers and communities.

Perhaps surprisingly, the research revealed that investors by default expected decent, though not perfect, corporate ethics. Perhaps tellingly, investors held lower expectations of American firms than of firms elsewhere.

Share prices rise when ethics in play

More importantly, companies with improving ethics tended to have clearer financial reports and better financial performance. Conversely, transparency and profitability suffered when reputations fell.

Those reputational changes also affected investors. Share prices rose an average of 1.1 per cent within just three days after ethical ratings improved. Conversely, they fell 1.6 per cent when reputations dropped.

Put simply, when corporations paid attention to ethics, their finances improved. When investors paid attention to corporate ethics, their returns improved.

Consider some concrete examples. TD’s stock fell 5.5 per cent the day after news broke about the bank’s aggressive sales tactics. That cost shareholders about $7.2 billion.

At Wells Fargo, share prices slid for weeks, dropping 13 per cent over the month of September. That’s more than $30 billion lost by investors. Another month passed before the stock began to recover.

Bad ethics isn’t always due to sales targets and Gordon Gekko-ish bosses. Sometimes a company’s operating practices encourage it.

Analytics should benefit customers

For example, consider banking software that statistically analyzes customer data. It can prompt employees about financial services to offer each customer. If the only goal is to boost bank fees, then such data analysis becomes a “weapon of math destruction” against customers.

However, data analytics is not inherently evil. It can be mutually beneficial.

Operations researchers recently helped redesign a Turkish bank’s investment sales software. Now the computer only suggests new products that increase customers’ investment returns or reduce their portfolio risks. This win-win approach benefits both the bank and its customers.

Our school’s research also suggests a new priority for regulators. Investors at least sometimes reward ethical firms and punish unethical ones. So let’s require companies to report more about their ethics-related practices. How are they treating employees, suppliers and customers? Are they respecting their communities and the environment?

Publicize these business practices, whether admirable or deplorable. Shine a little light into the corporate shadows. More information will enable investors and other stakeholders to make informed choices, and express those choices in terms that businesses understand: money.

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