The Value of Financial Ethics, Part I

By: Judy


The term, ‘ethics’, can mean three things. Firstly, it denotes the ethical outlook of an entity, whether implied by its behaviour or explicitly stated. Secondly, it may refer to the set of normative principles and reasons which govern conduct, whether at the individual or collective level. Thirdly and most commonly, it is defined as an area of philosophical enquiry devoted to grasping the principles constituting ‘ethics’ in its second sense explained above.[1] It then follows that the term, ‘financial ethics’, refers to the philosophical endeavours which seek to postulate the set of principles which govern individual and collective conduct in the field of finance, as well as more general enquiries into the justifications, both moral and amoral, which purport to guide conduct in a financial environment. However, despite the fact the examination of such issues and norms is long standing because they underline much of the popular concern with regulating financial activity, financial ethics as an academic discipline is relatively new.[2] This is due to a lack of recognition of ethics in finance, which reflects not only the perception of many people in and out of the business world, but also the way many would like to continue to perceive business and finance.[3] Until the mid-1990s, the norm in business schools has been to concentrate on the ‘hard’ disciplines such as economics, finance and accounting, which can purportedly boast ‘objective’ quantitative methodologies. On the other hand, ethics was, and still is, to a certain extent, dismissed as subjective, relativistic and undeserving of a place in finance.[4] Therefore, this article aims to defend the importance of financial ethics by examining the normativity of finance theory, the necessity of moral thinking in real life decision-making and the ethical foundation upon which financial markets operate.


I. Normativity of Finance Theory

A. An Objective Science?

Finance theory is regarded by its advocates to be ethically neutral.[5] However, the finance discipline has borrowed, almost in toto,from economics various value assumptions which depend for their certainty on an account of the world where ‘ceteris’ are always ‘paribus’.[6] It then follows that finance theory only offers a limited paradigm which stands in stark contrast against a world of imperfect information and unpredictable human behaviour.[7] Furthermore, the main assumptions of finance theory, such as rational or self-interested behaviour, and the models that have been developed pursuant to the acceptance of those assumptions, such as the capital asset pricing model or the efficient market hypothesis, potentially lead to conclusions about how people ought to behave and how corporations ought to be organised and operated.[8] It only takes a short intellectual leap from ‘assuming that individuals are self-interested’ to ‘a rational actor is self-interested’ to ‘one ought to act as to maximise self-interest’.[9] These assumptions may well lack normative import when first introduced to the world of finance, but a critical transition takes place when those ideas are advocated as guides for conduct. [10] In the words of Robert W Kolb,

… there is a tendency for characterizations of human psychology that are consciously adopted as methodological fictions to harden into descriptions of the ways that people actually think and behave, and eventually to become even a prescription for how people ought to think and behave.[11]

Therefore, it is not surprising that many, like Kolb, argue that even though the finance discipline often attempts to present itself as an objective, ethically neutral science, not dissimilar to other natural sciences, it is in fact ‘essentially prescriptive and normative’.[12]


B. Challenges to Assumptions

The traditional assumptions adopted by finance theory have been challenged on two broad fronts. Firstly, a growing body of empirical and experimental evidence has challenged the simplified view of society and human psychology discussed briefly above. Secondly, and somewhat linked to the first ground for objection, it is argued that the descriptive accuracy of economic rationality is inseparable from its prescriptive desirability.[13] Relying on the fact that human behaviour is fundamentally malleable and suggestible, scholars have found that actors in the marketplace actually change their behaviour when confronted with role models, or assumptions about how other actors conduct themselves.[14] Furthermore, even in strictly financial environments, human psychology has proven to be far more ‘complex, multifaceted and unpredictable’ than that characterised by the traditional assumptions.[15] Therefore, these assumptions and models retain their place in the finance discipline not because of their purported descriptive accuracy which befits an ‘objective science’, but rather their latent normative power which transforms ‘is’ into ‘ought’. It is unsurprising one scholar has made the following criticism:

[such] methodologies perhaps give their practitioners delusions of grandeur, the belief that their application can solve real problems, when they are often more akin to the technique of the drunk looking for a dropped coin underneath a lamp-post, not because that is where it fell but because that is the only place there is any light.[16]

In the face of such criticism, virtually all finance theorists readily concede that the traditional assumptions about human behaviour are not realistic.[17] However, the finance discipline as a whole seeks to justify those assumptions upon two grounds. Firstly, its narrow view of rationality and reduction of human values to monetary terms are perceived to be methodological simplifications of reality that make it possible to proceed with financial investigations. The making of such assumptions have been likened to the unrealistic assumptions that have proven to be useful in physics, such as the assumption that a feather falls in a vacuum. Finance theorists hope that similarly, the simplification of the paradigm of human psychology will prove to be elucidating and facilitative for the field of finance.[18] Secondly, defenders of finance theory argue that finance does not stand itself on the pedestal of scientific realism, but rather an instrumental approach is taken in which the value of the discipline should not be judged by how well its theories correspond to the full complexity of reality, but how they are able to develop a useful heuristic which facilitates the prediction of economic behaviour and explains observed market prices.[19] This Keynesian line of argument suggests the correspondence of the predictions made by finance with subsequent realities justifies the reasonableness of its simplifying assumptions.[20] However, whilst the utility and reasonableness of such assumptions might be accepted, it does not follow that the finance discipline can present itself as an ‘objective science’ devoid of any normative import.


II. Moral Reasoning in Financial Decision-Making

Just as how finance theory is essentially normative and prescriptive, few financial decisions can be made solely on the basis of financial arithmetic, as a degree of ethical judgement is almost always involved.[21] As finance professionals are involved in processes of allocation across time, products, markets and people, value judgements are necessarily involved in the identification and quantification of variables and in the evaluation of consequences.[22] Therefore, financial ethics is crucial to finance as it presents valuable tools for the systematisation of such moral reasoning in real life decision-making. However, this proposition is met with the objection the business entity is not structured to handle questions of values and ethics, and managers are usually not trained in business schools to do so.[23] Such practical concerns are not unfounded, as it is simpler to deal with dollars and cents than to deal with value judgements, more comfortable to discuss a problem in terms of a bottom line in the form of profit or loss, and easier for those outside business to judge a corporation by its financial status or products.[24]

However, such objections are grounded upon the place of philosophy in our society. According to some, philosophy has turned itself into a highly specialised and even esoteric discipline which is solely within the province of the universities; its methods and style have led to its complete retreat from the public arena.[25] It then follows that philosophy is ignored by business people because it is too difficult to comprehend in its contemporary form, and philosophers who clearly possess deep understanding of business and finance only utilise such knowledge as a source of interesting problems and a context for argumentation within the academia, rather than for the purpose of communicating with those who are concerned with the ethics of finance.[26] However, one cannot help but notice the exaggerations of this argument. The objectors clearly disregard the fact that finance professionals themselves publish in academic journals of ethics, many business schools now offer courses in ethics, and the fact that business people are almost always included in conferences and meetings pertaining to the ethics of business and finance.[27]

A somewhat related objection is also mounted by those in the business world against moral philosophy. Such objectors argue the methodologies of philosophy are ill-suited to answer the ethical questions which arise from the day-to-day, practical and contextually-rich exigencies in a business environment.[28] Such objections arise from the perception that there exists an almost dichotomous relationship between philosophy and reality, but the gap between these two concepts may not be as great as the objector implies. It seems reasonable to say that when faced with a moral problem, most people do stop to think, and when they do so, they are seeking to provide some kind of universal justification for the course of action they eventually choose. Therefore, people do engage in moral reasoning and philosophy on a daily basis. Furthermore, it is only a short intellectual leap to recognise our everyday moral thinking has its roots in those very traditions that lie behind contemporary moral theory, found in the works of Plato, Aristotle and other worthy philosophers.[29] Whilst one may concede philosophy can be abstract, in that it consists in the articulation of rather general principles which require much interpretation if they are to be used as guides for everyday conduct, one must also accept that philosophy can be of utility in suggesting lines of reasoning, opening up new logical possibilities and extending one’s imagination, whether the context is business or otherwise.[30] To sum up, in the words of Robert Crisp:

… it might be the case that any apparent stand-off that exists between contemporary business ethics and business itself is at least as much the fault of the majority of businesspeople, who do not take the trouble to discover even the basics of philosophical business ethics, as it is over-technical philosophers.[31]

If it is inevitable finance professionals will encounter some ethical issue in some stage of their career, and if it is accepted the gap between philosophy and real life is not unsurmountable, then it is reasonable to argue that it is only beneficial if finance professionals make full use of the tools offered by financial ethics when dealing with such issues.


III. Ethical Foundations of Finance

John R Boatright once said, ‘Despite the popular cynical view that there is no ethics in finance, a moment’s reflection reveals that finance could not exist without it’.[32] If it is true that actors in finance are not expected to behave in accordance with ethical rules and they are merely expected to do whatever is necessary to maximise self-interest, then financial scandals would not be met with indignation, shock or uproar from the rest of society. Whilst it may be accepted that freedom is necessary to the free-enterprise approach which is characteristic of many contemporary economies, such freedom always exists within the limits imposed by a political framework.[33] Without an assumption of fairness, equal opportunity and the observation of basic rights and duties, nobody would make exchanges in a market or entrust their assets with financial service providers.[34] Therefore, legitimate businesses, including those in the financial sector, need a ‘societal foundation of ethical values in order to operate efficiently and effectively’.[35]

However, opponents to this view seem to overemphasise the effects of competition, which is a requisite element for any market economy. By relying upon the notion of the ‘unseen hand’ postulated by Adam Smith, which also produces Pangloss’ ‘best of all possible worlds’, protagonists of a competitive market regard the system as one where self-interest is maximised without anyone caring for anyone else.[36] However, such a characterisation is but a myth. According to Bimal Prodhan, the market ‘is simply the imaginary place where the exigencies of the material and social conditions of production are imposed’.[37] It then follows the ‘unseen hand’ of the market is not a gift of nature, but a politically chosen set of property rights which depend upon some minimum of self-constraint. Furthermore, even the concept of efficiency, which is popularly seen as the virtue of the market system and a product of competitive economic life, is a value category because it can be perceived as a function of available opportunities, which are shaped by property rights.[38] As property rights determine which effects of A’s action on B are costs that must be considered by A, and which are costs to others, social efficiency requires some general measure of value reflecting group choices in a political system. That general measure of value, it is argued, takes the form of ethical choices. Therefore, to make rational financial operations possible, there must be an assumption of general adherence to ethical values.[39]


IV. Conclusion

This note is an attempt to defend the value of financial ethics. It seeks to achieve this purpose by (1) examining the latent normativity of finance theory under the guise of an ‘objective science’; (2) canvassing the debate which surrounds the almost dichotomous relationship between philosophy and real life and its implications for application of moral reasoning in financial decision-making; and (3) arguing that finance, like any other sphere of human activity, cannot exist without an ethical foundation which reflects group choices in a political system.




[1] Robert Crisp, ‘A Defence of Philosophical Business Ethics’ in Christopher Cowton and Roger Crisp (eds), Business Ethics: Perspectives on the Practice of Theory (Oxford University press, 1998) 9, 9.

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

[3] Richard T De George, Business Ethics (Pearson, 6th ed, 2006) 6.

[4] Elizabeth Vallance, Business Ethics at Work (Cambridge University Press, 1995) 12.

[5] Boatright, above n 2, 5.

[6] Vallance, above n 4.

[7] Ibid.

[8] Boatright, above n 2, 5.

[9] Robert W Kolb, ‘Ethical Implications of Finance’ in John R Boatright (ed), Financial Ethics: Critical Issues in Theory and Practice (John Wiley and Sons, 2010) 23, 23.

[10] Boatright, above n 2, 5.

[11] Kolb, above n 9.

[12] Ibid.

[13] John Dobson, ‘Behavioral Assumptions of Finance’ in John R Boatright (ed), Financial Ethics: Critical Issues in Theory and Practice (John Wiley and Sons, 2010) 45, 50.

[14] Ibid.

[15] Ibid 51.

[16] Vallance, above n 4.

[17] Kolb, above n 9, 25.

[18] Ibid.

[19] Ibid.

[20] Ibid 26.

[21] Sir Adrian Cadbury, ‘Ethical Managers Make Their Own Rules’ in Andreas R Prindl and Bimal Prodhan (eds), Ethical Conflicts in Finance (Blackwell, 1994) 31, 34.

[22] Bimal Prodhan, ‘Ethics, Finance and Society’ in Andreas R Prindl and Bimal Prodhan (eds), Ethical Conflicts in Finance (Blackwell, 1994) 3, 21.

[23] De George, above n 3, 7.

[24] Ibid 6.

[25] Crisp, above n 1, 14.

[26] Ibid 16.

[27] Ibid.

[28] Ibid 13.

[29] Ibid.

[30] Ibid 14.

[31] Ibid 16–17.

[32] Boatright, above n 2, 4.

[33] De George, above n 3, 8–9.

[34] Boatright, above n 2, 4.

[35] John M Kline, Ethics for International Business: Decision Making in a Global Political Economy (Routledge, 2nd ed, 2010) 8.

[36] Prodhan, above n 22, 8.

[37] Ibid.

[38] Ibid 9.

[39] Kline, above n 35.