No full-text available
To read the full-text of this research,
you can request a copy directly from the authors.
Can Ethics be Taught? Evidence from Securities Exams and Investment Adviser Misconduct
Abstract
We study the consequences of a 2010 change in the investment adviser qualification exam that reallocated coverage from the rules and ethics section to the technical material section. Comparing advisers with the same employer in the same location and year, we find those passing the exam with more rules and ethics coverage are one-fourth less likely to commit misconduct. The exam change appears to affect advisers’ perception of acceptable conduct and not just their awareness of specific rules or selection into the qualification. Those passing the rules and ethics-focused exam are more likely to depart employers experiencing scandals. Such departures also predict future scandals. Our paper offers the first archival evidence on how rules and ethics training affects conduct and labor market activity in the financial sector.
... To the extent that the GFC represents financial shocks to advisers, our results suggest that the probability of adviser misconduct increases during financial pressure. Kowaleski, Sutherland and Vetter (2020) focus on the effectiveness of professional conduct training. They find that investment advisers passing the qualification exam with fewer rules and ethics coverage are more likely to commit misconduct. ...
... (3) We include the exam count in the misconduct equation following Kowaleski et al. (2020), who show the critical role of qualification exams in predicting adviser misconduct. We also include the exam count in the detection equation because regulators conduct these exams to screen advisers. ...
... In addition, advisers who pass fewer industry exams, work in a more "toxic" office (high office misconduct rate), and have more nonmisconduct-related disclosure count are more likely to involve in misconduct. Consistently, Kowaleski et al. (2020) Table 8 provides a sense of the magnitudes of the effects and their relative importance. ...
We find that approximately 30% of financial advisers in the United States are involved in misconduct, yet only about one-third of those are detected and reprimanded by regulators. Advisers involved in misconduct tend to be male, work in a "toxic" environment, change firms more often, pass fewer industry exams, and have less experience. The firms they work for tend to be larger and are more likely to charge fees per hour or based
on assets under management (AUM). Adviser misconduct is pervasive across years while increasing during the GFC, suggesting a rationale for why the public distrusts the finance
industry.
... To the extent that the GFC represents financial shocks to advisers, our results suggest that the probability of adviser misconduct increases during financial pressure. Kowaleski, Sutherland and Vetter (2020) focus on the effectiveness of professional conduct training. They find that investment advisers passing the qualification exam with fewer rules and ethics coverage are more likely to commit misconduct. ...
... (3) We include the exam count in the misconduct equation following Kowaleski et al. (2020), who show the critical role of qualification exams in predicting adviser misconduct. We also include the exam count in the detection equation because regulators conduct these exams to screen advisers. ...
... In addition, advisers who pass fewer industry exams, work in a more "toxic" office (high office misconduct rate), and have more nonmisconduct-related disclosure count are more likely to involve in misconduct. Consistently, Kowaleski et al. (2020) Table 8 provides a sense of the magnitudes of the effects and their relative importance. ...
We find that approximately 30% of financial advisers in the United States are involved in misconduct, yet only about one-third of those are detected. Advisers involved in misconduct tend to be male, work in a "toxic" environment, change firms more often, pass fewer industry exams, and have less experience. The firms they work for tend to be larger and are more likely to charge fees per hour or based on assets under management (AUM). Adviser misconduct is pervasive across years while increasing during the GFC, suggesting a rationale for why the public distrust the finance industry.
... The inclusion of RiskGov i allows to control for any potential selection bias arising from the effect of common unobserved characteristics between the group of FIs with strong risk governance, compared to those with weak risk governance. This approach helps to neutralize endogeneity concerns and is inspired by various studies from different strands of literature (Michaely et al. 2016;Adra et al. 2020;Kowaleski et al. 2020). X i,k,t represents a vector of relevant control variables. ...
This study investigates the relationship between board risk oversight practices at financial institutions in the EU and systemic risk during the sovereign debt crisis. More specifically, we examine whether European banks and insurance companies that had strong board-level risk oversight in place before the onset of the sovereign debt crisis fared better during the crisis. We construct a risk oversight index based on publicly available, hand-collected data, which captures the strength of the institutions’ board-level risk governance practices. We find that financial institutions with stronger board risk oversight prior to the crisis were less vulnerable to the sovereign debt crisis, after controlling for other factors. The results are consistent and economically relevant for SRISK, probability of default, and Delta-CoVaR, three measures of systemic risk that are commonly used in the context of financial institutions.
Research background: The processes of globalization contributed to the unification of accounting principles through their standardization and harmonization. However, there is rapid and frequent permeation of innovative and complex transactions and as a result, the area and scale of implementation of creative and aggressive accounting practices are increasing. There is also a new issue of forensic audit, whose task is to prevent economic crime by mainly detecting financial crime and fraud. A research field that requires deepening is the analysis of the perception, understanding, and propensity of accountants to adopt creative and aggressive accounting solutions and their attitude toward forensic audit.
Purpose of the article: The main purpose is to analyze the degree of knowledge and adoption of internationally known creative and aggressive accounting solutions and to investigate the propensity of people involved in accounting to commit fraud.
Methods: The article employed survey methods and techniques (within an accounting students’ group and among accounting professionals) as well as literature analysis, synthesis, and inference.
Findings & Value added: The results indicate that the degree of knowledge of creative accounting is the highest among the issues considered. The most important factors influencing the propensity to commit fraud are pressures caused by third parties (in particular superiors), financial benefits, and the fear of losing a job. Knowledge of the issues of forensic audit is low. It is necessary to conduct promotional activities to increase awareness of the issues studied and to shape appropriate ethical attitudes among accounting professionals.
This paper develops a unified framework to synthesize the growing stream of positive research on the role of individual decision makers in shaping observed accounting phenomena. This line of research recognizes two central ideas in behavioral economics. First, individual behavior depends not only on economic incentives and accessible information but also on individual preferences, ability, experiences, and other characteristics. Second, the constraints that structure human interactions encompass both formal institutions (e.g., rules, laws, constitutions) and informal institutions (e.g., norms, conventions, rituals). Our review covers a broad set of individuals that are of interest in accounting research: managers, directors, audit partners, analysts, standard setters, politicians, judges, journalists, loan officers, financial advisors, and investors. We aim to understand the systematic effects of individual characteristics on a wide spectrum of accounting phenomena, including financial reporting, disclosure, tax planning, auditing, and corporate social responsibility. We highlight the importance of personal characteristics not only for an individual's own behavior but also for others’ perceptions. Our review mainly focuses on archival research in accounting and provides some thoughts about opportunities for archival empiricists going forward. We also, when feasible, highlight opportunities for future field, survey, and experimental research. A central takeaway from our review is that individual-level factors significantly improve our ability to explain and predict accounting phenomena beyond firm-, industry-, and market-level factors.
This article is protected by copyright. All rights reserved.
We show that social capital has a strong mitigating effect on financial adviser misconduct in the United States. Moreover, advisers who have committed misconduct are also more likely to relocate to counties with a relatively lower level of social capital than that of his previously residing county. These findings provide support for both the deterrence and displacement effects of social capital on financial adviser misconduct, and are robust to tests that address potential endogeneity concerns. Our results shed new light on social capital as an informal governing and monitoring mechanism against individual unethical behavior.
Manuscript Type
Empirical
Research Question/Issue
Using regulatory qualification requirements for being an independent director in China, we examine the effect of explicit norms of reciprocity between uncertificated independent directors (UIDs), who are not qualified at the beginning of their appointment, and insiders.
Research Findings/Insights
We find that UIDs are less likely to cast dissenting votes after their appointment, especially after they are qualified, and that firms with UIDs exhibit more expropriation and information opacity. Our main results are robust to alternative explanations and endogeneity tests.
Theoretical/Academic Implications
Our study contributes to the literature on reciprocity theory by presenting a new reciprocity norm under the rules of ID qualification and documenting that independent directors who highly value board appointment reciprocate with less independence.
Practitioner/Policy Implications
This study offers insights to policy makers regarding how to effectively establish and enhance regulations for qualification for independent directors throughout the world.
This paper provides evidence that disclosing corporate bond investors' transaction costs (markups) affects the size of the markups. Until recently, markups were embedded in the reported transaction price and not explicitly disclosed. Without explicit disclosure, investors can estimate their markups using executed transaction prices. However, estimating markups imposes information processing costs on investors, potentially creating information asymmetry between unsophisticated investors and bond‐market professionals. We explore changes in markups after bond‐market professionals were required to explicitly disclose the markup on certain retail trade confirmations. We find that markups decline for trades that are subject to the disclosure requirement relative to those that are not. The findings are pronounced when constraints on investors' information processing capacity limit their ability to be informed about their markups without explicit disclosure.
This review addresses, from a unified perspective, the important role of conflicts of interest in various facets of asset management and advising, including managing individual portfolios, institutional asset management, and order routing. I use an agency framework to highlight the sources of the underlying incentive conflicts, the nature of efficient solutions, the role of the structure of compensation in mitigating (or creating) the agency problem, and the use of benchmarks as a solution. I also highlight several contemporary contexts in which conflicts of interest are important.
Expected final online publication date for the Annual Review of Financial Economics, Volume 12 is November 2, 2020. Please see http://www.annualreviews.org/page/journal/pubdates for revised estimates.
We study the role of reputation in auditor-client matching. Using 1.2 million employment records from US broker-dealers, we find that broker-dealer clients of the same auditor have similar financial adviser misconduct profiles. Our estimates indicate that variation in client misconduct behavior is nearly half as important as variation in client size in explaining matches. Auditors adjust their portfolios when presented with new information about client behavior, and those with the most significant reputation concerns are least likely to deal with high misconduct clients. Finally, we find that an auditor’s reputation for accepting high misconduct clients predicts their new clients’ future misconduct. Together, our results present new evidence on how reputation affects audit relationships, and the consequences of auditors’ reputation concerns for client behavior. Our results also indicate an unintended consequence of audit mandates: non-discerning auditors emerge to serve clients with low endogenous demand for auditing.
The Dodd-Frank Act shifted regulatory jurisdiction over “ midsize” investment advisers from the SEC to state-securities regulators. Client complaints against midsize advisers increased relative to those continuing under SEC oversight by 30 to 40 percent of the unconditional probability. Complaints increasingly cited fiduciary violations and rose more where state regulators had fewer resources. Advisers responding more to weaker oversight had past complaints, were located farther from regulators, faced less competition, had more conflicts of interest, and served primarily less-sophisticated clients. Our results inform optimal regulatory design in markets with informational asymmetries and search frictions. (JEL G24, G28, K22, L51, L84)
We study the role of client reputation in auditor-client matching. Using 1.2 million employment records from US broker-dealers, we find that broker-dealer clients of the same auditor have very similar financial adviser misconduct profiles. Misconduct is approximately half as important as client size in explaining auditor-client matches, and misconduct unrelated to misreporting or fraud risk is relevant to this matching. We link these matching patterns to auditors' heterogeneous preferences for client reputation. An auditor's track record for accepting high misconduct clients predicts future client misconduct, even after controlling for the client's misconduct record and characteristics. Additional results reveal that auditor-client reputation matching is widespread and generalizable to firms outside the investment industry. We interpret our results within a positive assortative matching framework, and conclude that auditors' differential reputation concerns relate to their client acceptance and continuance decisions.
We study the role of reputation in auditor-client matching. Using 1.2 million employment records from US broker-dealers, we find that broker-dealer clients of the same auditor have similar financial adviser misconduct profiles. Our estimates indicate that variation in client misconduct behavior is nearly half as important as variation in client size in explaining matches. Auditors adjust their portfolios when presented with new information about client behavior, and those with the most significant reputation concerns are least likely to deal with high misconduct clients. Finally, we find that an auditor’s reputation for accepting high misconduct clients predicts their new clients’ future misconduct. Together, our results present new evidence on how reputation affects audit relationships, and the consequences of auditors’ reputation concerns for client behavior. Our results also indicate an unintended consequence of audit mandates: non-discerning auditors emerge to serve clients with low endogenous demand for auditing.
In an effort to motivate firms to more rapidly detect potential misconduct, legislators, regulators, and enforcement agencies incentivize firms to have integrity or “whistleblowing” hotlines. These hotlines provide individuals an opportunity to report alleged misconduct and seek guidance about how to appropriately respond. Beyond some isolated examples, little is known about the responsiveness of hotlines to actual claims of alleged misconduct. I undertake a field study to investigate how hotlines function in practice by making four different inquiries involving alleged misconduct to nearly 250 firms. I find that one‐fifth of firms have impediments (e.g., phone line disconnected, e‐mail bounce back, direct to incorrect website) that hinder reporting and approximately ten percent of firms do not respond in a timely manner. Overall, this investigation illuminates several differences between integrity hotlines “on paper” and how they actually perform in practice.
This article is protected by copyright. All rights reserved
We document the economywide extent of misconduct among financial advisers and the associated labor market consequences. Seven percent of advisers have misconduct records, and this share reaches more than 15 percent at some of the largest firms. Roughly one-third of advisers with misconduct are repeat offenders. Approximately half of advisers lose their jobs after misconduct. The labor market partially undoes firm-level discipline by rehiring such advisers. Firms that persistently engage in misconduct coexist with firms that have clean records. We show that this phenomenon may be explained by some firms “specializing” in misconduct and catering to unsophisticated consumers.
We study the importance of trust in the investment advisory industry by exploiting the geographic dispersion of victims of the Madoff Ponzi scheme. Residents of communities that were exposed to the fraud subsequently withdrew assets from investment advisers and increased deposits at banks. Additionally, exposed advisers were more likely to close. Advisers who provided services that can build trust, such as financial planning advice, experienced fewer withdrawals. Our evidence suggests that the trust shock was transmitted through social networks. Taken together, our results show that trust plays a critical role in the financial intermediation industry.
Received April 18, 2016; editorial decision March 8, 2017 by Editor Robin Greenwood.
Financial misconduct (FM) rates differ widely between major U.S. cities, up to a factor of three. Although spatial differences in enforcement and firm characteristics do not account for these patterns, city‐level norms appear to be very important. For example, FM rates are strongly related to other unethical behavior, involving politicians, doctors, and (potentially unfaithful) spouses, in the city.
This article is protected by copyright. All rights reserved
Using a novel data set of U.S. financial advisors that includes individuals' employment histories and misconduct records, we show that co-workers influence an individual's propensity to commit financial misconduct. We identify co-workers' effect on misconduct using changes in co-workers caused by mergers of financial advisory firms. The tests include merger-firm fixed effects to exploit the variation in changes to co-workers across branches of the same firm. The probability of an advisor committing misconduct increases if his new co-workers, encountered in the merger, have a history of misconduct. This effect is stronger between demographically similar co-workers.
Are regulatory interventions delayed reactions to market failures or can regulators proactively pre-empt corporate misbehavior? From a public interest view, we would expect “effective” regulation to ex ante mitigate agency conflicts between corporate insiders and outsiders, and prevent corporate misbehavior from occurring or quickly rectify transgressions. However, regulators are also self-interested and may be captured, uninformed, or ideological, and become less effective as a result. In this registered report, we develop a historical time series of corporate (accounting) scandals and (accounting) regulations for a panel of 26 countries from 1800 to 2015. An analysis of the lead-lag relations at both the global and individual country level yields the following insights: (i) Corporate scandals are an antecedent to regulation over long stretches of time, suggesting that regulators are typically less flexible and informed than firms. (ii) Regulation is positively related to the incidence of future scandals, suggesting that regulators are not fully effective, that explicit rules are required to identify scandalous corporate actions, or that new regulations have unintended consequences. (iii) There exist systematic differences in these lead-lag relations across countries and over time suggesting that the effectiveness of regulation is shaped by fundamental country characteristics like market development and legal tradition.
This paper undertakes an assessment of a rapidly growing body of economic research on financial literacy. We start with an overview of theoretical research which casts financial knowledge as a form of investment in human capital. Endogenizing financial knowledge has important implications for welfare as well as policies intended to enhance levels of financial knowledge in the larger population. Next, we draw on recent surveys to establish how much (or how little) people know and identify the least financially savvy population subgroups. This is followed by an examination of the impact of financial literacy on economic decision-making in the United States and elsewhere. While the literature is still young, conclusions may be drawn about the effects and consequences of financial illiteracy and what works to remedy these gaps. A final section offers thoughts on what remains to be learned if researchers are to better inform theoretical and empirical models as well as public policy.
Conceptual priming has become an increasingly popular tool in economics. Here, we review the literature that uses priming in incentivized experiments to study economic questions. We mainly focus on the role of social identity, culture, and norms in shaping preferences and behavior. We also discuss recently raised objections to priming research and conclude with promising avenues for future research.
Academics' view of the benefits of finance vastly exceeds societal perception. This dissonance is at least partly explained by an underappreciation by academia of how, without proper rules, finance can easily degenerate into a rent-seeking activity. I outline what finance academics can do, from a research point of view and from an educational point of view, to promote good finance and minimize the bad.
U.S. Organizational Sentencing Guidelines provide firms with incentives to develop formal ethics programs to promote ethical organizational cultures and thereby decrease corporate offenses. Yet critics argue such programs are cosmetic. Here we studied bank employees before and after the introduction of formal ethics training—an important component of formal ethics programs—to examine the effects of training on ethical organizational culture. Two years after a single training session, we find sustained, positive effects on indicators of an ethical organizational culture (observed unethical behavior, intentions to behave ethically, perceptions of organizational efficacy in managing ethics, and the firm’s normative structure). While espoused organizational values also rose in importance post-training, the boost dissipated after the second year which suggests perceptions of values are not driving sustained behavioral improvements. This finding conflicts with past theory which asserts that enduring behavioral improvements arise from the inculcation of organizational values. Implications for future research are discussed.
To date the teaching of business ethics has been examined from the descriptive, prescriptive, and analytical perspectives. The descriptive perspective has reviewed the existence of ethics courses (e.g., Schoenfeldtet al., 1991; Bassiry, 1990; Mahoney, 1990; Singh, 1989), their historical development (e.g., Sims and Sims, 1991), and the format and syllabi of ethics courses (e.g., Hoffman and Moore, 1982). Alternatively, the prescriptive literature has centred on the pedagogical issues of teaching ethics (e.g., Hunt and Bullis, 1991; Strong and Hoffman, 1990; Reeves, 1990; Castro, 1989; George, 1987; Golenet al., 1985) and in providing recommendations for teachers of business ethics (e.g., Nappi, 1990; Hosmer and Steneck, 1989). From the analytical perspective judgments have been made as to whether courses in ethics are in fact effective in achieving value and attitudinal modifications in students (e.g., Loeb, 1991; Weber, 1990; Wynd and Mager, 1989; Pamental, 1989; Martin, 1982; Purcell, 1977). The evidence to date suggests that courses can be a means of achieving ethical awareness and sensitivity in students although it should be recognized that significant objections to the teaching of business ethics do exist and greatly inhibit their successful introduction. This paper addresses a number of the common objections to the teaching of business ethics that must be overcome if ethical programs are to continue in the future, and concludes with recommendations to facilitate the establishment of ethical training in an academic context.
I show that stock market shocks have important and lasting effects on the careers of MBAs. Stock market conditions while MBA students are in school have a large effect on whether they go directly to Wall Street upon graduation. Further, starting on Wall Street immediately upon graduation causes a person to be more likely to work there later and to earn, on average, substantially more money. The empirical results suggest that investment bankers are largely "made" by circumstance rather than "born" to work on Wall Street. Copyright (c) 2008 The American Finance Association.
The study of the regulation of occupations has a long and distinguished tradition in economics. In this paper, I present the central arguments and unresolved issues involving the costs and benefits of occupational licensing. The main benefits that are suggested for occupational licensing involve improving quality for those persons receiving the service. In contrast, the costs attributed to this labor market institution are that it restricts the supply of labor to the occupation and thereby drives up the price of labor as well as of services rendered. Alternative public policies for this institution are identified.
Crime and punishment: an economic approach
- G S Becker
The economic way of looking at life. Unpublished working paper
- G S Becker
Executives’ “off-the-job” behavior, corporate culture, and financial reporting risk
- R Davidson
- A Dey
- A Smith
Predicting fraud by investment managers
- S G Dimmock
- W C Gerken
What is business ethics?Public Interest63
- P F Drucker
Consumer financial protection
- J Y Campbell
- H E Jackson
- B C Madrian
- P Tufano
Executive networks and firm policies: evidence from the random assignment of MBA peers
- K Shue
When Harry fired Sally: the double standard in punishing misconduct
- M Egan
- G Matvos
- A Seru
Trusting the stock market
- L Guiso
- P Sapienza
- L Zingales