Chapter | Moral Markets: The Critical Role of Values in the Economy | 2008

Corporate Honesty and Business Education: A Behavioral Model

by Rakesh Khurana and Herbert Gintis

Abstract

Since the mid-1970s neoclassical economic theory has dominated business school thinking and teaching in dealing with the nature of human motivation. However valuable in understanding competitive product and financial markets, neoclassical economic theory employs an incorrect, Homo economicus, model of human behavior that treats managers as selfish maximizers of personal wealth and power. The Homo economicus model implies that a firm's board of directors can best further stockholders' interests by (a) selecting managerial personnel who are focused virtually exclusively on personal financial gain, and (b) inducing them to act as agents of the stockholders by devising incentives that minimize the difference between the financial returns to stockholders and the firm's leading managers. Moreover, while neoclassical financial theory, in the form of the efficient markets hypothesis, is a generally insightful portrayal of financial markets, this theory implies that a firm's stock price is the best overall measure of the firm's long-term value. This implies that managerial incentives should be tied to stock market performance, since this will best align the interests of managers and stockholders. However, this implication is invalid when managers can manipulate information flows that influence short-term stock price movements. Neoclassical economic theory thus fosters a corporate culture that ignores the personal rewards and social responsibilities associated with managing a modern enterprise, and encourages an ethic of greedy materialism in which managers are expected to care only about personal financial reward, and in which such human character virtues as honesty and decency are honored only when they contribute to personal material reward. However, a wide range of experiments based on behavioral game theory contradicts the Homo economicus model. In complex environments where complete contracts cannot be written or enforced, honesty, integrity, intrinsic job satisfaction, and peer recognition are powerful motivators, leading to better results for contracting parties than reliance on financial incentives alone. In particular, many individuals place high value on such character virtues as honesty and integrity for their own sake and are more than willing to sacrifice material gain to maintain these virtues. We suggest that business schools develop and teach a professional code of ethics similar to those promoted in law, education, science, and medicine, that the staffing of managerial positions be guided by considerations of moral character and ethical performance, and that a corporate culture based on character virtues, together with stockholder-managerial relationships predicated in part on reciprocity and mutual regard, could improve both the moral character of business and the profitability of corporate enterprise.

Keywords: Business Education; Ethics; Managerial Roles; Corporate Social Responsibility and Impact; Organizational Culture; Business and Shareholder Relations; Mathematical Methods; Behavior;

Citation:

Khurana, Rakesh, and Herbert Gintis. "Corporate Honesty and Business Education: A Behavioral Model." In Moral Markets: The Critical Role of Values in the Economy, edited by Paul J. Zak. Princeton University Press, 2008.