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Human Ethical Decisions Good People Doing Bad Things Leslie Caldwell, formerly lead prosecutor on the Enron/Andersen case remarked that most corporate criminals are not bad people. Rather, they succumb to pressures (and/or to ego) and begin a slide down a slippery slope. Conscious….? Subtle and Unconscious? Both? How We Think - Group Dependent Common blind spots in our behavior -Our Focus of Attention. -Diverting our Attention. Ethical Behavior – Our Blind Spots Ethical Behavior – Blind Spots Human and Ethical Behavior “Consistent with decades of research in social psychology, each of these three conditions (of the Codes of Conduct (e.g., objectivity, integrity and independence) makes independence a farce.”[Bazerman, Gino, 2015] Bending Our Ethical Compass – External Factors Colors Accountability Smells Our Group Framing Bending the Moral Compass – Primal Emotions Shame Disgust Uncertainty Happiness Time & Stress Primal Emotions – Time • Time. •Two types of individuals with •two perspectives. Are you • Present; or • Furutre-oriented? • Think about 3 significant events in your past. •Were they positive or negative events? Marshmallows Primal Emotions – Time • Marshmallow test is really an evaluation of whether a person is “present-oriented” or “futureoriented” • Future-oriented (those who waited to eat the marshmallow) individuals seem to move to Stage 2 thinking faster. • When interviewed as 18-year-olds, • the kids who had waited had developed a range of superior emotional and social competencies • better able to deal with adversity and stress; • self-confident, diligent, self-reliant; • seemingly higher intellectual ability [proven to be twice as good a predictor of SAT scores as IQ]. Self-Adjustments to our Ethical Compass Framing •How we describe an issue or problem can influence our decisions. Framing Our Choices Anchoring (Internal Priming)2 • We can get help from others in “anchoring” on a decision. • Fraud percentages for auditors. • Writing a known number (like our SS number). • Similarly, we have internal biases that anchor us to an expected result/solution. • “Experienced” auditors have been shown to bias their decision by selectively relying on only those available facts and observations that tend to support prior experiences. Framing – Accountant’s Bias & Halo • Accountants were asked to review information about a proposed complex merger involving their client. They were asked to assess the information and advise the client. • Biased Judgment: A review of the accountant’s assessment showed that they • unconsciously biased their evaluation of the information in favor of their client and • ignored (e.g. failed to assimilate) information about the target that was relevant but inconsistent with their client’s interest. • The accountant’s were unable to adjust their thinking even after monetary rewards were included that should have adjusted their analysis.[Bazerman, Loewenstein, Moore, 2002] Fraud and Financial Reporting Fraud and Financial Reporting • Corporate fraud is nearly always accompanied by a change in auditor. Among fraudulent companies, • 60% change their auditor while the fraud is occurring. • 40% switch auditors in the quarter before the fraud begins. • Fraudulent firms • increase investment and employment during the fraud period, and then • shed assets and labor after fraud revelation. [Kedia and Phillipon (RFS, 2009)] Fraud and Financial Reporting2 • International auditing standards now encourage auditors to consider “organizational attitudes” toward fraud when making their fraud assessment. • EU now has regulatory guidance requiring auditors to address bribery mitigation, detection, and disclosure. • Considerable evidence that Corruption can be offset through • Extensive disclosure requirements; • Auditor “incentives” to identify & disclose corruption • Lower the burden of proof in litigation vs auditors. Fraud and Financial Reporting3 PCAOB • PCAOB report - auditors fail to effectively modify their standard audit procedures in response to fraud risk. • Nearly 1/3 of SEC enforcement actions cite auditor failure to consider a client’s fraud potential. Allegations include failure to • • • • Gather sufficient competent audit evidence (73%); Exercise due professional care (67%); Exhibit adequate level of professional skepticism (60%); Obtain adequate evidence related to management representations (54%); • Express an appropriate audit opinion (47%). Fraud and Financial Reporting4 • Use of a logit (vs. fraud) checklist achieved more accurate fraud risk assessments than any other fraud aid. • Group (Brainstorming) Thinking works: • identify more ways fraud could occur; • design better procedures in response to fraud risk. • Internal auditors made better fraud risk assessments • With “formal” training vs • Self-study (e.g. do a lot of reading about fraud). • Experience proved to be of no use to internal auditors. Groups The magnet near our moral compass Moral Accounting – Groups • We really want to be part of a group –so we’ll find any minimal reason to join. • Clothing (such as T-shirt); • We’ll behave more ethically if the actor is not part of the “group”. • • • • Similar name; Common confusion; Same birthday; Same culture or mindset. • We depend on our group to set our ethical consensus. • Excuse unethical behavior if it benefits the group. • Sync our primal emotions to the group. • Pain; • Embarrassment; • Joy. Corporate Governance – Internal Controls • Strong internal controls without • Training and • Emphasis on proper behavior; • Results in encouraging managerial self-interested behavior. • How controls are presented (e.g., framed) make a difference to potential fraud. • if framed as a • coordinating effort (e.g., suppliers, company, etc), stronger controls result in more fraudulent reporting whereas • monitoring control, stronger controls result in less fraudulent reporting. Corporate Governance – Board Structure • Stock option grants increase financial restatements potential. • Active outside directors and audit committees make fraudulent financial reporting less likely. • use of an audit committee does not of itself seem to impact the chances of financial statement fraud. Corporate Governance - Board Structure Corporate Governance - Women • New data support a relationship between the number of women on a board of directors or as CEO and • higher returns; • share price; • greater governance controls and accountability. • statistically-significant decrease in the chance of financial restatements.