The Value of Financial Ethics, Part II


By: Judy Zhu


I Introduction

Philosophical commentator, Alan R. Malachowski once made the remark that finance nowadays seems to be playing an ‘ethically-enervating role’, as the rise of the doctrines of ‘The New Finance’[1], including the Agency Theory, the Irrelevance Theorem, the Efficient Market Hypothesis (EMH), the Capital Asset Pricing Model (CAPM) and the Option Pricing Theory, threaten to create an ‘ethically incommensurable world’ where matters of finance dominate everyday life, and all recognisable notions of ethics seem to evaporate.[2] Whilst it is not the purpose of this inquiry to address the truth or untruth of every aspect of Malachowski’s claim, the central premise of this research note can be stated in the following terms: if it is true that matters of finance indeed ‘dominate everyday life’, then such a pervasive role should also be an ethical one.

To arrive at this conclusion, this research note firstly provides an account of how the role of finance has evolved from the simple perception of a ‘black box’, to a process of ‘financialisation’ through which financial logics increasingly encroach upon everyday social interaction. Secondly, the notion of an ethical role for finance is consistent with the popular concern over the ethicality of financial activity as well as the development of financial ethics as an academic discipline. Thirdly, a concise account of the types of ethical problems encountered in finance is provided, which raises questions of what is the optimal way to regulate finance by ethics. Finally, it is argued that despite the difficulties inherent within ethical regulation of finance, it does not follow that governmental regulation in the form of legal obligations is sufficient, thereby vindicating the central premise that an ethical role for finance is not only desirable, but also inevitable.

II Beyond The ‘Black Box’

Traditionally speaking, the role of finance can be visualised as a black box with input and output functions. Disposable income in the form of existing savings resources are placed into the box as input and are directed to the needs of investment, which become the output.[3] However, since the 1970s, the finance industry has undergone a major paradigm shift due to the expansion of the role of finance, both in terms of the size of capital movement as well as the mode through which financial transactions are carried out.[4] At the international level, the ‘securitisation’ of financial markets meant that the monopoly of traditional bank lending instruments gradually acceded primacy to market traded assets and this has resulted in exponential growth in market trade volumes.[5] However, this has also given rise to substantial increase in the trading of off balance-sheet products and derivatives as well as increasing anonymity in the identity of market participants.[6] Finance no longer serves its customary ‘representational role’ whereby a financial ‘snapshot’ of a current state of affairs, like a company’s share price or an individual’s level of credit, is a reliable indicator of whether the underlying ‘fundamentals’ of an economic actor are sound.[7] Therefore, the inherent volatility of the parameters of economic life and the complexity of market transactions mean that the primary goal of modern finance is to ensure these fluctuations do not cause harm to economic actors,[8] through the development of adequate financial instruments to manage the increasing role of international institutional investors, as well as processes of risk diversification and reinsurance.[9] It then follows that modern finance plays an instrumental role in ensuring competitiveness through investment, at the micro level, as well as in serving as a kind of ‘red light’ for the economic policies set by a country, at the macro level.[10]

It is of no surprise then, that philosophical commentator, Elizabeth Vallance, once remarked that, ‘[w]ithout finance, there is no business, or at least there is no possibility of acquisition of tangible assets such as plant and machinery, no development of technological innovation, no training of employees and increase in the knowledge base, no growing of the market.’[11] However, underlying this statement is the assumption that, at best, finance is one of the activities which make up business, and it is an assumption which corresponds with the traditional academic classification of finance as a sub-discipline of business.[12] Notwithstanding, some commentators argue the impact of finance reaches beyond mere engagement with money; it is now ubiquitous and pervades all aspects of daily life.[13] The increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of domestic and international economics means that the ‘financialisation’ of our society brings with it a certain kind of logic which is gradually becoming intertwined with everyday social interactions.[14] One commentator goes as far as saying that no project is ‘immune to financial interference unless it promises supernumerary financial gain itself’.[15]

III The Case For An Ethical Role For Finance

It is reasonable to argue that the discussions above justify, prima facie, why the general public, and not just the finance profession, has an interest in knowing the underlying agenda of finance and in ensuring that financial activities should be subject to ethical norms and expectations. From the very beginning of rudimentary financial activity, people have raised concerns as to what is fair in markets, and what are the rights and obligations of market participants.[16] As financial activities grow in size and complexity, ethical concerns about fairness, rights and duties have arisen about their operation, as reflected, amongst other places, in the business press.[17] As the media carries stories about the unethical activities of Enron, WorldCom and more recently, JPMorgan Chase and HSBC, the general public takes this as representative of financial ethics, or of the need for it.[18]

However, in terms of academic disciplines, some have also argued that there are inevitable interconnections between finance and ethics which warrant the need for ethics in finance. Given its origin in moral philosophy, economics as a discipline has had an extensive, and often conflicted, relationship to ethics. It then follows that the integration of finance into a sub-field of microeconomics has not only resulted in the adoption of the assumptions and methodologies of economics, but has also led to increasing academic interest in the underlying agenda of economics.[19] The financialisation of everyday social interactions, as discussed above, parallels the extension of applied economic methodologies and assumptions into other academic disciplines, including ethics.[20] However, the persistence of massive financial scandals has foregrounded the failure of these standard models to properly account for human psychology and market behaviour in such high-profile cases.[21] The introduction of market imperfections, in particular the impact of imperfect information, challenges the utility of neoclassical models of perfectly competitive markets, as such paradigms, which still reflect the ‘black box’ view of finance, fail to account for the fact that economic actors are now endowed with new capacities for behaviour.[22] Consequently, and correspondingly, the study of ethics has also expanded aggressively into other areas, including finance and economics, primarily through applied ethics and, more specifically, business ethics.[23] As financial logic encroaches more and more upon the spheres of human activity, the role of ethics in financial theory has also evolved in tandem with the field of financial economics itself.[24]

IV Problems With Ethical Regulation Of Finance

As we have established, there seems to be an almost proportionate relationship between, on the one hand, the extent to which financial activities impinge upon everyday life, and on the other hand, the need for finance to play an ethical role in an economy. However, when considering how finance should be governed by ethical norms, one needs to return to the questions of what finance actually encompasses, as a profession or an industry, and what kinds of ethical problems arise at various levels of this entity. Firstly, some commentators draw similarities between finance and the likes of medicine, law, engineering and accounting because they all involve a highly technical knowledge and training. Viewed in this light, some may argue that finance is an occupation or profession.[25] However, unlike medical practitioners, lawyers, engineers or accountants, who provide much of the same service in almost every setting, people who are trained in finance engage in a much wider range of activities which are not susceptible to uniform description.[26] Therefore, even if finance practitioners can be collectively called an occupation or profession, it is not one where its boundaries can be clearly demarcated. It then follows that it would be impractical for the finance ‘profession’ to be governed by a single code of ethics given the diversity of the ethical problems that a finance practitioner may encounter in his or her career.

Alternatively, as demonstrated by Vallance’s remark, if one takes a functional, rather than occupational, viewpoint in examining finance as an entity, it soon becomes apparent that finance is also an indispensable function in every business enterprise and in many not-for-profit organisations and government agencies.[27] From a corporate perspective, financial managers’ responsibilities range from decisions about the preservation and growth of capital through investment, to the orchestration of mergers and acquisitions. Contrastingly, public finance administrators are primarily responsible for the raising and distribution of funds used for governmental purposes. Whilst these functions give rise to ethical dilemmas of personal conduct, primarily in the form of conflicts of interest or misperceptions of responsibility,[28] they also raise broad questions of public policy, as corporate and public financial decision-making both contribute to the financialisation of society. Financial ethics is not solely concerned with ethical problems encountered by individual economic actors, it also deals, at a broader level, with problems which arise in financial markets, financial institutions in the operation of domestic and international economies.
Nevertheless, as John R. Boatright rightly comments, ‘the level of ethics in finance depends on a complex interplay of the personal integrity of individuals, ethical leadership by people in positions of responsibility, and an understanding of the ethical issues that arise in finance’.[29] Arguably, the starting point for ethical regulation of finance is still at the level of the individual; but even assuming the finance profession is able to promulgate the most comprehensive code of conduct as a condition to gain and retain membership in the profession, a number of problems still stand in the way. Firstly, one commentator has argued that these codes encourage mechanical reasoning and stultify judgement.[30] Regardless of the level of specificity at which the codes are generated, there will still be judgemental factors involved. However, in modern day mass-produced education systems, there are great pressures for generating expert systems of technical knowledge, but very little room is left for personal and cognitive development which enhances these judgemental factors.[31] Furthermore, given that values are fragmented and decisions are single, whatever the outcome of the decision, there will always be important values not given their due.[32] Secondly, the promulgation of comprehensive codes can generate conflicts of interest between the finance profession and society as a whole. It has been argued that the profession will only take into account societal interest only if these are beneficial for the group itself. The corollary of this argument is that unethical behaviour is likely to be tolerated up to the point where the existence of the profession might be jeopardised by public outrage and governmental regulation, therefore adherence to ethical codes in such circumstances have been dismissed as merely mechanical, and less than participative.[33]

V Insufficiency Of Legal Regulation

As demonstrated by the previous section, there are myriad problems and complexities associated with the promulgation and enforcement of ethical norms. Perhaps such difficulties in implementing ethical regulation of finance has led some people to conclude that government regulation in the form of legal sanctions is the best way to govern conduct in finance. However, whilst conceding that the discussions in the previous section raise more questions than answers, it is argued that mere adherence to legal obligations does not fulfil the standards of conduct that society expects of financial actors. According to Boatright, the ubiquity of law and governmental regulation in finance has had two effects. Firstly, whilst it may be true that in advance economics, much of what is unethical is also illegal, if ethical issues in finance are perceived as merely legal or regulatory matters, the role that ethics has played in the development of law is obscured.[34] Secondly, whilst ethical issues are typically conceptualised within finance theory as side constraints, externalities and the like, the effect of such conceptualisation is to dismiss these issues as problems to be addressed by law or by public policy, and not matters within the field of finance.[35] Therefore, even though branding an illegal activity as being ‘unethical’ may not add to its descriptive utility, it does not follow that being ethical can be subsumed under the heading of simply obeying the law.[36] A financial actor will normally comply with legal obligations as a bare minimum response in a dilemma; but above that, it is also expected to consider its obligations to other parties who might be affected by its actions, and whose interests will be reflected in its values.[37]

A counterargument that is sometimes posed is that, if the interaction between business and society is left to the political process, not only would this simplify the task of management, but doing otherwise would undermine the foundation of our free society.[38] However, whilst the law generally approves and reinforces what is generally accepted as moral social behaviour, there is no exact correspondence between law and accepted morality.[39] It then follows that a society that leaves no room for an individual’s own sense of morality would no longer be a free society. In the words of Sir Gordon Borrie:

Just as modern conditions require moral standards to be increasingly backed by law, so the effectiveness of the law needs to be backed by an ability on the part of the community and in particular that section of the community most affected … to recognise what is moral or immoral.[40]

Therefore, if it is accepted that finance and business, like most other spheres of human endeavour, presuppose a background of morality and would be impossible without it, then it is inevitable that finance is expected to play an ethical role in society.

VI The Value of Financial Ethics

This research note has been an attempt at addressing the hypothesis that, if the role of finance is such that it dominates everyday life, then such a role should be conditioned by ethical norms and expectations. To canvass this central premise, this note has firstly provided an account of the evolution of the role of finance, from the simplistic ‘black box’ mechanism to the process of ‘financialisation’ which has pervaded everyday social interactions. It then follows that the pervasive nature of modern finance justifies the need for it to play an ethical role in society. However, it has been conceded that the implementation of ethical regulation of financial activities is not without its inherent difficulties, but ultimately, it does not follow that mere adherence to legal obligations satisfy the ethical standards that society expects of financial actors. Contrary to the opinion expressed by some, a free society requires the presence, but not the absence, of a set of ethical norms which is separate from the law; that finance should be governed by such norms is but an inevitable reality.



[1] See John R Boatright, Ethics in Finance (Blackwell, 1999).

[2] Alan R Malachowski, ‘Some Ethical Considerations on the Recent Revolution in Finance’, in Alan R Malachowski (ed), Business Ethics: Some Critical Perspectives on Business and Management (Routledge, 2001) 132, 139.

[3] Wilhelm Hankel, ‘The Role of Finance in the Market Economy: Lessons for Economic Growth and Development’ (1994) 14 SAIS Review 47, 50.

[4] Antoine de Satins, ‘Does Finance Have a Soul?’ (1998) 19 Review of Business 18, 18–19.

[5] A B M Soppe, Finance as an Instrument to a Sustainable Company (Dissertation, Erasmus University Rotterdam, 2006) 36.

[6] Ibid.

[7] Malachowski, above n 2.

[8] de Satins, above n 4, 19.

[9] Soppe, above n 5.

[10] de Satins, above n 4, 19.

[11] Elizabeth Vallance, Business Ethics at Work (Cambridge University Press, 1995) 78.

[12] George A Aragon, Financial Ethics: A Positivistic Analysis (Oxford University Press, 2011) 4.

[13] See, e.g. Armin Beverungen, Stephen Dunne and Casper Hoedemaekers, ‘The Financialisation of Business Ethics’ (2013) 22 Business Ethics: A European Review 102; Malachowski, above n 2.

[14] Armin Beverungen, Stephen Dunne & Casper Hoedemaekers, ‘The Financialisation of Business Ethics’ (2013) 22 Business Ethics: A European Review 102, 107.

[15] Malachowski, above n 2.

[16] John R Boatright, ‘Ethics in Finance’, in John R Boatright (ed), Finance Ethics: Critical Issues in Theory and Practice (John Wiley & Sons, 2010) 3, 4.

[17] Ibid.

[18] Aragon, above n 12.

[19] Ibid 12.

[20] Ibid.

[21] Ibid 13.

[22] Ibid 16.

[23] Ibid 13.

[24] Ibid 16.

[25] Boatright, above n 1, 4.

[26] Ibid.

[27] Ibid.

[28] Vallance, above n 11, 79.

[29] Boatright, above n 1, 26.

[30] Bimal Prodhan, ‘Ethics, Finance and Society’, in Andreas R Prindl and Bimal Prodhan (eds), Ethical Conflicts in Finance (Blackwell, 1994) 3, 17.

[31] Ibid.

[32] Ibid 22.

[33] Ibid 17.

[34] Boatright, above n 16.

[35] Ibid.

[36] Vallance, above n 11, 15.

[37] Ibid 16.

[38] Sir Adrian Cadbury, ‘Ethical Managers Make Their Own Rules’, in Andreas R Prindl and Bimal Prodhan (eds), Ethical Conflicts in Finance (Blackwell, 1994) 31, 33.

[39] Sir Gordon Borrie, ‘Law and Morality in the Marketplace’, in Andreas R Prindl and Bimal Prodhan (eds), Ethical Conflicts in Finance (Blackwell, 1994) 45, 46.

[40] Ibid 60.