Ethical Systems Design: Bringing Behavioral Science Into Corporate Life

JULIA TAYLOR KENNEDY: You're listening to Impact from the Carnegie Council. I'm Julia Taylor Kennedy.

Each episode, we explore a topic in global business ethics. This time it's behavioral science and its growing role in the workplace.

Have you ever noticed how often bank CEOs are throwing around words like culture and values? Here's Juergen Fitschen, co-CEO of Deutsche Bank, at a press conference in 2013:

JURGEN FITSCHEN: We have laid the foundations for longer-term cultural change at Deutsche Bank. We have also laid the foundations for profound behavioral change throughout the entire bank.

And Antony Jenkins, CEO of Barclays, speaking at the Carnegie Council in 2014:

ANTONY JENKINS: I believe that values-driven leadership is good for business in the long term, but getting there is not without its challenges in the short term.

JULIA TAYLOR KENNEDY: JPMorgan Chase, Citigroup, and Wells Fargo CEOs have also talked about culture change. Suddenly, it seems like all of the big investment bankers are blaming a lack of values and morals at work for the risky behavior that caused the global financial crisis a few years ago.

Historically, scandals have been blamed on scapegoats. A single executive would take the fall for orchestrating an unethical practice. But bank CEOs today seem to blame a corporate culture that incentivizes short-term returns. Instead of a high-profile public firing, they talk about instituting a system of values and behaviors that encourage employees to raise ethical concerns and to make decisions differently.

So, how did "culture change" come to replace "fall guy" as the go-to response to an ethical breach? Well, consumers have lost a lot of faith in financial institutions as a whole and that played an important part in the shift.

But there's another shift that's been in the works over the past 20 years in academia. Thanks to the rise of a new interdisciplinary school of thought that draws on psychology, economics, and management disciplines, we now understand the dynamics at play in organizations in a much more nuanced way.

This is the first of a series of three podcasts where we'll consider how scholars, corporate leaders, and government regulators are beginning to better understand what makes people act in accord with their values or against them. And these leaders are experimenting with ways to create a society that most encourages citizens to act according to the better angels of their nature—in other words, to design an ethical system within our thriving economic one.

We are producing this podcast mini-series in collaboration with EthicalSystems.org. It's a free online site connecting corporate leaders with the latest academic research on ethical workplaces.

ANN TENBRUNSEL: I simply became interested in the topic of how is it that really good people can make bad decisions.

My name is Ann Tenbrunsel, and I'm a professor of ethics at the University of Notre Dame in the Mendoza College of Business.

JULIA TAYLOR KENNEDY: Twenty-five years ago, Tenbrunsel was a pioneer of the young field of behavioral ethics.

ANN TENBRUNSEL: I wasn't the only one, but there weren't very many of us.

Behavioral ethics is really the study of individuals who make decisions that go against their values and don't realize that in fact they're doing so.

JULIA TAYLOR KENNEDY: This approach represents a pretty revolutionary shift in ethical thought. Instead of assuming people who make bad decisions are either unethical or weren't taught the right values in their childhood, behavioral ethics looks at why good people sometimes behave badly.

ANN TENBRUNSEL: What we know is that we're not very good predictors of our behavior.

JULIA TAYLOR KENNEDY: Tenbrunsel has looked all kinds of experiments to prove it.

Take this one from 2002: Two researchers asked female college students to imagine a 32-year-old man is interviewing them for a job.

ANN TENBRUNSEL: . . . and to imagine that he asked you some sexually harassing questions, such as, "Do you have a boyfriend? Do people find you desirable? Do you think it's important for women to wear bras to work?" When they asked these women, "How would you behave?", a majority of them said they would refuse to answer the question.

JULIA TAYLOR KENNEDY: After all, those are pretty inappropriate questions.

ANN TENBRUNSEL: But when they actually put females in that situation, no one refused to answer the question.

JULIA TAYLOR KENNEDY: Zero percent. It's a dramatic finding: While more than 50 percent of the female students predicted they would refuse to answer sexually harassing questions, all of them answered those types of questions when they were asked.

Why? Well, Tenbrunsel breaks down our decision-making behavior into three phases.

The first one is the prediction phase.

ANN TENBRUNSEL: Some are very abstract, kind of value-based level of thinking.

JULIA TAYLOR KENNEDY: The second one is the action phase.

ANN TENBRUNSEL: So prediction at the forest level, and action—I'm kind of at the tree or the bark level. What drives my decisions at that time is a much more concrete, detailed line of thinking that really focuses on what makes sense for me in this moment at this time.

JULIA TAYLOR KENNEDY: Finally, we enter the recollection phase, or what I think of as the "rose-colored glasses" phase.

ANN TENBRUNSEL: Then later after we have made this unethical choice, it turns out our brain can also engage in a whole lot of processes to make that look better than it actually was. What that means is that your unethical behavior is really hidden in between the prediction that you would behave ethically, the recollection that you did behave ethically.

As a result, we never really learn or think we need to learn how to make better decisions because, in fact,we've convinced ourselves that we are or did make good decisions.

JULIA TAYLOR KENNEDY: Tenbrunsel says we all have ethical blind spots—and Blind Spots is the name of a book she's written about this phenomenon with Harvard Business School professor Max Bazerman. They make the point that we often don't even realize when we're acting against our values, since we're driven by all kinds of forces shaping our immediate behavior.

ANN TENBRUNSEL: The world would be pretty complicated if every time I was making a decision I had to draw up all considerations of all types of decisions and see whether or not they were relevant.

Rather what happens is our brain simplifies it for us and we say: "Is this a legal decision?" If the answer is yes, then it draws up all the considerations that are relevant to making a legal decision, weights them and comes up with the best answer; or if it's a finance decision, we weight the finance consideration.

What we worry about is the extent to which ethics isn't going to be part of those considerations. The extent to which it is classified as a decision, if that decision doesn't include ethical implications, you can have all the training in the world, all the desire to be ethical, but if you actually aren't seeing the ethics in the decision, you're simply not going to consider those considerations or implications. That's really what we mean by ethical fading, is when those don't enter into the decision.

JULIA TAYLOR KENNEDY: So, as individuals, we can't always be trusted to take ethics into account when we're making decisions. And ethical slips, even when they're small, can really add up.

ANN TENBRUNSEL: Let's say it's over-billing by 10 percent. That's kind of the easiest one to think about. So over-billing by 10 percent one week

JULIA TAYLOR KENNEDY: And then maybe a month later, another 10 percent,

ANN TENBRUNSEL: And then a week later, another 10 percent,

JULIA TAYLOR KENNEDY: And three months later, another 10 percent.

ANN TENBRUNSEL: Several months later, going from 0 percent over-billing to 40 percent over-billing.

JULIA TAYLOR KENNEDY: It's much easier to incrementally over-bill by 10 percent here, 10 percent there, than to over-bill by 40 percent from the get-go. It's almost a trick our brain can play on us. Ten percent is much easier to rationalize, and we don't even realize we're doing it.

ANN TENBRUNSEL: Just saying to an individual, "You need to do better, you need to behave ethically," hasn't worked. Most people want to behave in line with their values—why is it that we don't? That's just not an individual answer. That's got to be a collective, organizational-level intervention, but one that doesn't put it all into one group.

JULIA TAYLOR KENNEDY: Tenbrunsel has come up with all kinds of ways companies can uncover their employees' ethical blind spots and help them keep an ethical frame on all decision-making.

Number one: a moral performance review, comparing a manager's self-assessment with an assessment from his colleagues.

ANN TENBRUNSEL: Let's say, for example, how ethical the boss thinks that they are and how ethical those above him or below him think that they are.

JULIA TAYLOR KENNEDY: Number two: ensure employees have enough energy to make thoughtful decisions.

ANN TENBRUNSEL: I also find I'm more likely to behave unethically the more resource-depleted I am, so the more tired I am, the more stressed that I am.

JULIA TAYLOR KENNEDY: Number three: connect compensation and rewards to ethical behavior.

ANN TENBRUNSEL: What we know about human nature is, of course, I am really good, as are you, and everyone else is at paying attention to that which you reward me for. And I am equally good at not paying attention to that which you do not reward me for.

JULIA TAYLOR KENNEDY: Number four: lower the retaliation risks if colleagues call out the unethical behavior of others.

ANN TENBRUNSEL: So I simply turn a blind eye and maybe do it subconsciously because it's—I'm not rewarded. In fact, I might be punished for noticing that bad behavior.

JULIA TAYLOR KENNEDY: Number five: cut out the euphemisms.

ANN TENBRUNSEL: Do you say "cooking the books" or do you say "creative accounting"? Do you use the phrase "judgment call"? If you think about when we use the phrase "judgment call"—we use it when we are uncomfortable with the decision that we reached. We'll refer to it as "Oh, that was a judgment call."

JULIA TAYLOR KENNEDY: To recap: one, a moral performance review; two, ensure employees have enough energy to make thoughtful decisions; three, connect compensation and rewards to ethical behavior; four, lower the retaliation risk of calling out colleagues and bosses for their unethical behavior; five, cut out the euphemisms.

These are pretty concrete recommendations. And they're really far from the rational actor we're used to hearing about from economists. This pragmatic behavioral approach—assuming humans aren't rational, assuming certain flaws—wasn't always popular with the financial crowd.

MARK OLSON: I was in on some of the first discussions at the Fed where the whole discussion of behavioral economics was introduced and tested.

I'm Mark Olson and I am the chairman of Treliant Risk Advisors. I was a member of the board of governors of the Federal Reserve Board from 2001 to 2006.

JULIA TAYLOR KENNEDY: And, about 10 years ago, just as behavioral economics started getting recognition, Olson sat through a presentation at the Federal Reserve board.

MARK OLSON: The Fed invited people in who had started to look at the whole subject of behavioral economics. For example, looking at things like will people be more apt to make decisions if they look at three choices of products or if they look at 400 choices of products? Or will people be more apt to make decisions on products if they are presented a certain way?

Behavioral issues clearly were driving financial decisions. I think that that was a subject matter that was new to some of the classic [economists], especially the macroeconomists.

JULIA TAYLOR KENNEDY: Behavioral economics was being considered for the first time. And it wasn't that popular.

MARK OLSON: There were some of the classic economists that were not so sure that that was the direction they wanted to go, in spite of the overwhelming evidence that behavioral issues affect decisions that are made.

JULIA TAYLOR KENNEDY: So, at first, despite Chairman Alan Greenspan's attempts to introduce a new approach to economics to the top economists in the country, it fell on resistant ears.

But financial regulators are a key piece of the economy. And despite Ann Tenbrunsel's recommendations for individual companies, these organizational approaches may not be enough to move us all to a more ethical way of doing business.

JONATHAN HAIDT: What we really need to do is teach future leaders how to design an ethical system when they have the power and authority to make such decisions.

JULIA TAYLOR KENNEDY: That voice belongs to Jonathan Haidt, business professor at New York University, psychologist, and author of a book called The Righteous Mind, among many other publications. He's also founder of EthicalSystems.org, the organization we're collaborating with for this podcast series. [For more from Haidt, don't miss this Carnegie Thought Leaders interview and his 2012 Carnegie talk on The Righteous Mind.]

But back to what Jonathan Haidt was saying about ethical systems: He sees a regulatory body like the Fed as key to the design of an ethical system. The Fed has to buy into behavioral economics and ethics. As Haidt sees it, that ethical system has three levels.

First, at the individual level, nudges can prompt different behaviors.

Then comes the company culture level.

JONATHAN HAIDT: Everybody knows, "Well, you actually need to do more than those nudges. You need to actually change the culture."

Okay, but how do you do that and, in particular, why would a company spend a lot of time and money to hire all of these consultants to do that?

JULIA TAYLOR KENNEDY: But then, what too many of these conversations about ethical corporate culture gloss over is the regulatory level.

JONATHAN HAIDT: That's where this third level comes in: the higher level of the legal and regulatory environment.

The reason why there are all of these consultants out there, especially in the financial industry, is because the Federal Sentencing Guidelines, going back to the 1990s, but especially more recently, the Federal Sentencing Guidelines say, at least, that the Feds will give a big break to companies that have a good ethics and compliance program. But nobody really knows how to do that for sure.

My point is just that if we can get the Feds, the Justice Department, and SEC [U.S. Securities and Exchange Commission], get them working with ethics compliance officers and consultants and business leaders, that we can all come to understand what exactly do we really need to do here? What's the best way to incentivize that without leaving the measures opened to being gamed?

If you get consonance between the regulatory level, the intermediate organizational level, and the lower level, which is individual behavior, that's when you are really talking about ethical systems design.

JULIA TAYLOR KENNEDY: All of this rhetoric about corporate culture from the banks starts to make sense. It sounds like a great ideal to work towards, one where ethics is designed to be an integrated part of every level of societal decision-making. But it can be hard to tell how serious bank CEOs are when they talk about culture since bottom-line pressures can still push them to make short-term decisions.

JACK EWING: Culture is kind of a squishy topic to begin with and changing a corporate culture is not very easy to do.

JULIA TAYLOR KENNEDY: That's Jack Ewing, European economics correspondent for the International New York Times.

Part of Ewing's beat is to cover Deutsche Bank, which has gotten hit with a number of fines due to ethics violations—from the firm's sale of mortgage-backed securities, to suspicions it colluded to manipulate the LIBOR rate affecting the interest rate for home mortgages to accusations that top executives coordinated court testimonies. These ethical legal problems have already cost the company billions of dollars in fines. And Deutsche Bank has become one of the most vocal of the investment banks about cleaning up its culture.

You heard a soundbite just a few minutes ago from one of their firms' CEOs, Juergen Fitchen, talking about culture. Although Deutsche Bank declined to be interviewed for this podcast, Ewing has followed the story since 2012.

JACK EWING: Anshu Jain, who is the other co-chief executive, has been very vocal in acknowledging that there was a culture problem—that there wasn't enough focus on customers, and shareholders, and the general public; that the culture was too oriented to the short-term interests of bank executives trying to increase their own bonuses and their own compensation. He's vowed to change that.

JULIA TAYLOR KENNEDY: And unlike other bank CEOs, he's still talking about culture change.

Deutsche Bank's website also talks about how the company worked with all its employees to define a common set of values, strengthened internal controls to catch ethical violations, and embedded values-based evaluations into its performance reviews.

The firm also runs internal communications campaigns to encourage employees to act ethically. One internal video leaked to the Financial Times took a scolding tone, threatening all communications are monitored, and those with vulgarities or those that discuss ethical violations will have serious repercussions.

JACK EWING: If there's one difference perhaps at Deutsche Bank, compared to some of the other investment banks that I'm aware of, it is that they were very vocal about it. To that extent, Anshu Jain has kind of staked his reputation on affecting some kind of change.

But, of course, doing that is something else. If Deutsche Bank manages to get through a period of time without any big problems then we'll know it has worked.

JULIA TAYLOR KENNEDY: The firm is under great pressure from regulators to clean up its act. But one of the toughest elements of designing an ethical system is the global nature of the big banks.

Deutsche Bank, which is based in Germany, has to answer to the European Central Bank and to the Federal Reserve, as well as supervisory bodies in many other countries around the world. And while that can be onerous on Deutsche Bank's compliance department, the loopholes that vary country to country can also frustrate regulatory arms like the Federal Reserve Bank of New York.

SARAH DAHLGREN: Some of the largest organizations have well over 200,000 employees, are active in over 75 or 100 jurisdictions, are regulated by over 200 to 300 different regulatory agencies across the globe.

Sarah Dahlgren, executive vice president at the Federal Reserve Bank of New York, and head of the Financial Institution Supervision Group.

JULIA TAYLOR KENNEDY: Traditionally, the Fed's supervision group has reviewed companies' ethics and compliance programs to make sure they have the capacity to comply with regulations.

SARAH DAHLGREN: It's also an engagement with the firms to identify whether they're operating the right way, whether they have the right risk management processes, whether they have the right staffing, whether they have the right different pieces within the organization to run an organization in a safe and sound manner.

JULIA TAYLOR KENNEDY: The Fed sends teams to work on-site at big banks. These powerful organizations can try to win favor with the Fed employees sent to watch over them.

Recent news reports accuse the Fed of this kind of regulatory capture, but Dahlgren is adamant that she promotes the most ethical conduct on her teams. She rotates colleagues regularly from bank to bank so that they maintain objectivity. She encourages employees to flag and report any improper behavior. And she reminds them of the public service mission they signed up for when they took a job at the Federal Reserve.

When it comes to enforcing ethical behavior among banks, Dahlgren has a battery of tools at her disposal.

SARAH DAHLGREN: . . . one of which is the bully pulpit speeches and other ways of communicating more broadly. More directly, though, the work that we do in supervision is through direct engagement with institutions, particularly at the board of directors level, at the C-suite level, by engaging in dialogue, asking questions, sharing our observations both about what we see within the firms that we supervise, but also sharing observations about what we see at other firms.

JULIA TAYLOR KENNEDY: If a member of Dahlgren's team does observe a culture that could lead to misconduct, they send an official letter to notify the firm's leaders.

SARAH DAHLGREN: It's a weakness that could lead to other things. It's a weakness in your risk management system. It's a weakness in your compliance control area. I mean, it could be in any number of the areas that would be reviewed within a firm.

JULIA TAYLOR KENNEDY: Dahlgren is also getting more and more involved in looking at the way companies are building their ethical cultures—by doing more than just tying compensation to values-based performance reviews, but also by providing ongoing education, having the firm's top leaders talk about the importance of ethics, and using other strategies.

The New York Fed's CEO is also talking about "culture change" and he was ranked number one in the 2014 Ethisphere Institute's list of the "100 Most Influential People in Business Ethics."

But, as we hinted earlier, even though she's made traction on "ethical culture supervision" in the United States, Dahlgren still gets frustrated by the limited view she has of global organizations that only have some of their operations under her jurisdiction.

SARAH DAHLGREN: At any given point in time, we can only see so much. Each of the supervisors and regulators around the world is in the same place. They have responsibility largely for what's in their jurisdiction, and so they're only seeing a piece of the organization. What they can't tell is what they see or what they find within that jurisdiction—are there similar issues in other places in the world?

We, as a consolidated supervisor for the U.S. firms, have a much broader perspective. We try to help to bring that together, but we do rely on the other supervisors for what they are seeing where they are.

JULIA TAYLOR KENNEDY: As Dahlgren and the Fed further emphasize ethical culture and behavioral approaches, they can't control how other countries approach these issues—uncovering yet another difficulty in designing an ethical system.

And as behavioral ethicist Ann Tenbrunsel would say, sometimes the rules on the books simply can't impact day-to-day practices.

ANN TENBRUNSEL: We do find that when you look at the formal systems, which I think of as that Band-Aid-fix code of conduct ombudsman training, and you compare it to what we call the informal systems, the pressure that you feel from your peers or from your supervisors, that those informal systems explain nine times the amount of observed misconduct in comparison to the presence or absence of the more formal systems, the codes of conduct, the training.

JULIA TAYLOR KENNEDY: Even so, Tenbrunsel is hugely encouraged at the way companies are experimenting with their ideas.

Remember how the Fed's board of governors were skeptical of the tactics that behavioral economists employ? Here's a really tangible nudge that Tenbrunsel says has gotten serious traction. It has to do with the way we fill out forms. Usually, we fill in all the information, and then swear that it's true at the end of the form with our signature.

ANN TENBRUNSEL: By putting that first, saying all the information I'm about to give you is true, it led to more honest reporting.

To me, it's a cute example of what we're talking about more fundamentally here, and that is the ethics may not have been primed or may have been baited when I was filling out the form because I haven't looked at the end question yet. But by priming the ethics first, ethical fading was not occurring when I was filling out that form. That then led my values to, in some sense, kick in.

JULIA TAYLOR KENNEDY: Interesting. We are sometimes such habitual, predictable creatures.

ANN TENBRUNSEL: We are. Somebody said, "Does this just mean we're doomed?" and I said, "No, there's been so much interest in this work by the corporate world that I actually have more hope than I did 23 years ago when I was asked what I was going to do when this was no longer a fad."

JULIA TAYLOR KENNEDY: Thanks for listening to Impact from the Carnegie Council. As I mentioned earlier, this podcast was produced in collaboration with all of the fine folks at EthicalSystems.org where you can learn more about topics in behavioral ethics from top academics in the field.

A special thanks to our production team, Mel Sebastiani, Terence Hurley, Deborah Carroll, Amber Kiwan, and Chris Green. And thanks to the team at Ethical Systems—especially to Jonathan Haidt and Jeremy Willinger. This collaboration wouldn't have been possible without Bryan Turner, who recently passed away, and who is often in our thoughts. I'm Julia Taylor Kennedy.

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