Saturday, April 26, 2008

money and corporate social responsibility

The cynical and sad musical Cabaret has it that “money makes the world go round.” If so, then money must bear an awful responsibility for all the wrongdoing and misfortune that overtake humanity again and again.

On the other hand, St Paul wrote that “love of money is the root of all evil”, implicating not money but ourselves as the proper agent of wrongfulness in the world.

Similarly, Adam Smith proposed that seeking to make money need not be sheer malevolence when he said: “Man is never so innocently engaged as when he is making money.”

Advocates for more corporate social responsibility, however, often point to profit – acquiring cash money – as the driving force behind business negligence, abuse of market power, and willful omission to correct harmful externalities. Greed, it is more often inferred than said outright, biases judgment when greed is energized and encouraged by the availability of money.

Non monetized societies, as a rule, do not enjoy much in the way of business activity or capitalism. At the same time, they are more prone to poverty than wealth with all the conceptual opportunity costs that come with living in poverty.

If we want the fruits of wealth, which are many, but we fear the effects of greed and avarice, what role should we tolerate for money? Can we ever reach a positive moral assessment of those who strive for money?

Powerful ideas for thinking about money were given by Georg Simmel in his book The Philosophy of Money, written in 1900.

His first proposition is to accept the subjective theory of value. According to this understanding of human dispositions towards reality, the value of a thing is entirely determined by what we make of it. Value arises from our emotions and thoughts. Value, like beauty, is in the eye of the beholder not in the flower or the painting. From this perspective, there are no absolute values to be imposed on us, only the partial and relative values that we impose on ourselves and, may from time to time, attempt to impose on others.

Consciousness, said Simmel, endows objects with significance, not the other way around. No object has intrinsic significance.

Accordingly, it is our natural right to value or not value money just as we may or may not value a cowrie shell, an emu, or The Rollling Stones.

When two or more minds converge on a single evaluation, then we have a common value. What has been subjective now becomes more objective in that it has acquired a post-individualistic meaning with social characteristics and implications. Any such valuation in common takes on tangible form and public appearance, gains resilience in the presence of time and space, and acquires an aura of respect, even prestige.

Simmel pointed out that a primary function of money is to facilitate the process whereby people can reach common valuations. When they agree on a monetary amount to fix on an object, or a promise, they have achieved something social, something more objective than their individual preferences. When many people with different subjective concerns all come to agreement on a monetary price, then a market price enters social reality and conditions subsequent behaviors.

Without money, it is more difficult to find easily expressed and sustainable equivalences. With money, agreements can be more easily reached, kept and memorialized and transactions can be undertaken with far greater confidence in their having real advantages. The philosophical role of money, therefore, is to convert the intangible and the merely subjective biases and prejudices of the individual into social truth.

To probe further into the dark side of human dynamics around money, we need to consider the complex mental process of valuation.

Abraham Maslow proposed a hierarchy of human needs where prior and more immediate needs were associated with preservation of the self – responding to fears and threats, seeking food and shelter, etc..- were first attended to. Only after such necessities, as it were, were fully and satisfactorily attended to, would a person be likely to appreciate more abstract goals such as friendships, art, religious insight.

We can infer from Maslow’s notion of a hierarchy that money associates itself with goods on the lower levels of the hierarchy. Food, shelter etc. are most easily obtained with money. For most of us they are market goods which must be purchased from others.

Sigmund Freud associated money with his conception of an anal personality – someone fixated on retention and holding in. Anal personalities tend to be tight with money and stingy. They are also more comfortable as controlling personalities in their relationships with other people. Money for Freud took on a bad connotation of assisting anal personalities in their search for dominance over others.

Freud did not elaborate on the point at all but there is indeed an easily observed very strong link between money and having power. Since others need money to meet their own needs, we can use money to win their submission on a transaction basis. If we give them access to what they want, we can demand and receive in return some “price” paid by them for the goods or services we have at hand. That “price” could be money, but it could also be submission, labor, respect and public praise, help on a project, intimacy or some form of friendship.

I f our goal is indeed power, seeking money is a reasonable means to that end. What drives us, however, is not the money but the need for power.

Money, which through exchange can bring us into conditions of social objectivity, can also be conducive to the removal of the personal element from relationships. In this way money can contribute to our distancing ourselves from others and in so doing to protect ourselves from them. Money is indifferent and objective; with it we can be aloof from the desires and manipulations of others. Money can bring about reassuring feelings of inner independence and individual self-sufficiency.

Money has the amazing capacity to make possible relationships between people but at the same time leaves them personally undisturbed. It balances out respect for different dimensions of human dignity by leaving people alone in their own subjective majesty while permitting them to respond to the values and preferences of others.

And a need for power can be insatiable. When power is sought to make up for inadequacies, to fill a spiritual void of low self-confidence, to hold off fears of the infinite and the unknown, to make up for feelings of personal sinfulness and guilt or shame, then we can never enjoy enough power.

Correspondingly, such needy people can never have too much money. They are always on the hunt for what will make them feel more secure and less threatened.

At times, their approach to business can be to “cry havoc and let slip the dogs of war”. It is dominance that they seek and power that they need at almost any cost. The premises of Social Darwinism, Herbert Spencer’s theory of life and private freedom as constant rivalry and competition, fits comfortably with their understanding of who they are and what they need. Such strivers press for unconstrained competition and glory in making short term profits that they can appropriate personally not because they need the money, but because they would feel victimized without having the power that money can bring.

Avarice, as opposed to simple greed, is the will to power expressed through money where the power represented by money is experienced as the absolutely satisfying value.

Psychologists have studied motivations by using the “Ultimatum Game” where one player divides a pot of money between himself and another. The second player then gets to whether to accept the division or not. If the second player rejects the division, neither player gets any money. In this game, a stingy offer by player one to player two will usually be rejected – even though it will give player two some money. (The offers that get rejected are usually offer player two less than ¼ of the total pot.) Thus, game results imply that money in and of itself is not always a goal for human interaction. Other considerations come into play as well. The further implication is that people strive for relative, not absolute, prosperity, believing that it’s not the money but the share that counts.

In one series of Ultimatum Games played among men only, men with high levels of testosterone were more likely to reject offers with low proceeds for themselves.

Higher up on Maslow’s hierarchy of needs is having status in the eyes of others. Such status too confers a form of social protection, so it meets one’s need for power. But it has, apparently, other attractions as well.

Adam Smith noticed this quite some years ago. In his 1759 book on human moral capacities, The Theory of the Moral Sentiments, Smith wrote: “… yet we cannot live long in the world without perceiving that the respect of our equals, our credit and our rank in the society we live in, depend very much upon the degree in which we possess, or are supposed to possess, ‘the advantages of external fortune’. The desire of becoming the proper objects of this respect, of deserving and obtaining this credit and rank among our equals, is, perhaps, the strongest of all our desires, and out anxiety to obtain the advantages of fortune is accordingly much more excited and irritated by this desire, than by that of supplying all the necessities and “conveniences’ of the body, which are always easily supplied.” (p. 213)

In another recent experiment, volunteers were asked to take sips of what they were told were five different wines priced between US$5 and US$90 per bottle. But actually only three wines were used; two of them were served twice. Volunteers were monitored for brain functions. As they drank what they thought were more expensive wines, activity in their medial orbitofrontal cortices increased in tandem. What were thought to be more expensive wines triggered more engaged mental activity.

What costs more money is, pro-forma, most likely to be more exclusive, more rare, and more prestigious. Fewer people will have access to it. Participation in exclusivity generation perceptions of value; it is the reward that comes to wealth and status and most of us like it.

A dynamic money culture can indeed spawn cynicism and a blasé attitude in the face of tragedy and human need. This results, says Simmel, when the concrete values of life are reduced by our choices to the mediating value of money. What should be highly valued, is reduced to the lowest instrumental value, one completely relative at that.

Money is a servant of our desires. If abusive desires merit our concern, we might be wiser to tackle the problem directly by confronting the desires rather than indirectly by reducing the means to assuage what will still be an active command center in our psyches.

We are come to an ancient point of view: tranquilization of the passions should be uppermost in our minds. Character to govern desire removes the “love” that would and does turn money from a boon into an evil. Aristotle taught this as did Cicero and Marcus Aurelius and Confucius. In our time, an eloquent teacher of this perspective on business is the Dalai Lama.

Money in and of itself enters the world as a useful good. It is we who abuse it, as we abuse many other things in the physical world. It is a useful tool; it is an institution through which the individual concentrates his or her activity and possessions in order to attain goals that he or she could not attain directly says Simmel. Like any tool money is inert; it has no purpose of its own and functions impartially to all humanity.

Money is demonstrative of the truth that humans are the “tool-making animal”, which infers, of course, that they are “purposive” animals with goals and desires. The tool incorporates the aspirations of the human will.

Money reveals its indifferent and empty character, says Simmel, very clearly where the valuation process putting it to work is exclusively upon consumption. When desires are superficial, money facilitates the triumph of superficiality.

Simmel wrote that “the psychological structure of demand is such that in most cases it is focused upon the satisfaction itself and the object becomes a matter of indifference so long as it satisfies the need.” If what we seek are status and power, and money is not available, will we not find other means to achieve our ends? And, the alternatives may be even more cruel or vindictive than making money.

Simmel notes perceptively that exchange – the transactions facilitated by money – are the highest form of interactions between people in that they are win – win, or non-zero. In a true exchange, which is voluntary and non-coerced by power or excessive need – each party is offered more than what he or she had before. So, the social work of exchanges is to increase the sum of value that is tangible.

Exchange presumes the scarcity of goods – that the goods available are not public goods made freely accessible to all upon use or demand. Exchange uses subjective valuation of that which is limited to respond constructively to scarcity and generate positive social enhancement embracing the parties to the exchange.

As Adam Smith said in The Wealth of Nations, the butcher and the baker look to their subjective needs to supply us with meat and bread for our dinner and we look to our needs to supply them with money, which they value as a means to meet their needs. Their values and our values are both vindicated- simultaneously and separately. It is an alchemy that turns selfish reflections into social good.

Furthermore in making an exchange and paying for it with money, one is subordinated to an objective norm. We are socialized in the process and become less the wild beast or the despoiler of the innocent.

Where there is pure subjectivity and no exchange, we might have either robbery and theft or compassion and gifts.

Simmel warns that exchange with money reconciles opposites: relativism and society. Money perpetuates a relativistic world view where each can live with his or her own subjectivities. But at the same time through exchange, money permits individual relative things, as valued by individuals, to become something of social consequence and so to enter into history as objective phenomena.

Money as the expression of a concept of objective economic value brings forth, says Simmel, an interpretation of existence. Money can be philosophy too.

Money is no more than way stations on an endless series of cognitions. Cognition – valuation – is a free-floating process where elements determine their positions reciprocally and relative to one another. Truth here is relative like weight or price. Truth is an aesthetic more than a command. It works through induction far more surely that with deduction. A culture of flux and change is engendered by money. Money has no respect for any eternal verities other that the process by which it is assigned to prices reflecting our values. As Simmel wrote, money corresponds to the “many-sidedness of our being and the onesidedness of any conceptual expression.”

The ultimate principles of such a culture proposed Simmel become realized not in the form of mutual exclusion (I-It over I-Thou to borrow from Martin Buber) but in the form of mutual dependence, mutual evocation, and mutual complementation – just like in an exchange. The philosophical significance of money, then for Simmel, is that it is the clearest embodiment of the formula of all being, according to which things receive their meaning through each other, and have their being determined by their mutual relations.

It interweaves all singularities and so creates reality. Money could, Simmel affirms, thus play the role of God for a weak minded humanity.

Monday, April 14, 2008

Moral Hazard: A Necessary Price to Pay for Stakeholder Responsibility

The current liquidity crisis centered in the American financial system but which has extended its cancerous tentacles as well out to global financial institutions has led to knowledgeable commentators reflecting on the problem of “moral hazard”.

Is it wise, some ask, to provide relief from the consequences of their actions for those who created too much risk?

Recently, the case of Bear Sterns, the New York investment bank at the center of the sub-prime/CDO bubble – brought concerns for creating “moral hazard” to the fore.

To prevent the bankruptcy of Bear Sterns and defaults on its many borrowings and guarantees, which would have spread losses to many other financial institutions, the US Federal Reserve System with support from the US Treasury arranged easy terms for Bear Sterns to be purchased by another concern so that Bear Sterns’ business and obligations could go forward in some form of a going concern basis.

The Federal Reserve System – the American lender of last resort – took bad assets from Bear Sterns in exchange for a loan to buy the firm. If the Bear assets prove to be worth something in the future, the cost to the public for this intervention will not be so much.

The owners of Bear Sterns were paid at first US$2 and then US$10 per share for equity worth $80 per share in book value. They were so forced to absorb great capital loss as a result of their company’s imprudent business activities.

Nonetheless, the reformatting of Bear Sterns’ business set a precedent that, in the future, incautious investment banking practices will again be coddled by the government and not given a market death sentence as was the case with Enron. This act of public interference with market discipline, it is said, creates “moral hazard” – the hazard that business decision-making will be more “immoral” or irresponsible than otherwise because the decision-makers will have less fear of the consequences of their actions.

Creating moral hazard implies that businesses will be careless about the risks they create or assume.

Coming as part of the sub-prime mortgage meltdown where the mortgage loans of many sub-prime borrowers will be foreclosed and the borrowers will lose their homes, the government’s financial support for the well-to-do on Wall Street while providing no help for the poor was not well-received in many parts of society. The financial elite was indulged with tolerance of moral hazard while the poor were left to bear all on their own the consequences of their imprudent borrowing.

Market discipline is good enough for some but too tough for others it appears.

Under Treasury Secretary Paulsen’s proposal for revised regulation of American financial markets, investment banks will be invited to use the lending capacity of the Federal Reserve System. This will give the originators of the most sophisticated and most sought-after financial instruments deep pocket support in times of crisis – crises no doubt brought about by the very practices of creating investment vehicles now to be given a kind of fiscal insurance by the government.

Why should the government, that is the people, reward mistakes in judgment with indulgence and protection against extreme outcomes? This will only encourage weak character in senior business leaders who will be more likely as a result to let their greed take the reins of business strategy, to lower quality standards, and to become more childishly naïve about risk. Moral hazard promotes infantile fixation on the short term where adult maturity should have pride of place in decision-making.

The free market, with its powers of creative destruction, its weeding out of the weak, the overly greedy, the stupid, and the careless, has its own high standards of morality. Failure is punished harshly and there are few second acts for companies that can’t make the grade. Why not let the market dish out the consequences in all cases? All should get to sleep in the beds they make.

The justification for indulging in moral hazard is to eliminate contagion in financial systems. Financial systems turn on trust; credit is a gossamer thing, easily broken and lost. The so-called real economy of production and distribution is more tangible, with hard assets to support restructuring of ownership and creditor interests when things go badly. With financial services, however, protecting the intangible assets of trust and confidence keeps liquidity flowing so that industry and commerce can have their necessary flows of credit and cash on a daily basis.

Contagion in the financial system is a danger to all in a way that is not implicated so much when an individual home owner defaults on a mortgage or when an Enron or a WorldCom goes bankrupt.

The logic at work here in justifying indulgence in moral hazard is stakeholder thinking, akin to the ethical rational for corporate social responsibility.

When stakeholder interests are taken into account, good decision-making moves beyond pure market rationality narrowly defined in only micro-economic terms. When stakeholders are included in business decision-making, assets of a more intangible nature are added on to tangible ones in the calculation of risk and return.

Adding stakeholder considerations to the decision-making matrix moves more towards a system theory understanding of the economy, where tangible and intangible feed-back loops intertwine and crisscross one with another.

Thus, it would be very appropriate in the case of a Bear Sterns market failure to worry about contagion – the impact of one firm’s demise on many who have interests in the play of market forces.

It is only another example of the problem of externalities – who should pay the cost of consequences that are external to the firm’s profit and loss statement and its balance sheet?

In most cases, it is society that pays in one way or another – for environmental damage, for health problems of consumers or employees, for unemployment compensation when companies close down, etc.

So it would seem consistent with wider practices to have society, in the form of the Federal Reserve System that passes its costs on to all in the economy, step up and attempt to minimize the harm flowing from bad decisions on Wall Street.

The problem of moral hazard arises whenever we insure against the negative consequences of our conduct. When we spread the cost of our externalities widely through insurance policies, we create moral hazard by reducing the full measure of punishment on those whose actions produce the loss or harm.

By removing the onus of paying the “last full measure” of careful consideration from their shoulders, we encourage people through insurance programs to feel that they are less at risk themselves, So they may conveniently take greater risk with respect to the lives and fortunes of others.

Insurance, externalities, and moral hazard combine to form a rather intricate puzzle for optimizing market outcomes.

To reduce negative externalities, we want to bring the consequences of actions back on the actors. But they may not be in a position to make good on the harm they have created, so we need insurance to protect the interests of stakeholders who have no say in the decisions that affect them. But with such insurance, we open the doors to moral hazard.

In any case, society seems consistently to take the stakeholder perspective into account through its laws and regulatory practices and so runs the risk of allowing too much moral hazard.

The point would seem to be that markets turn on more than the stand-alone profit and loss accounts of firms and individuals, but are forced willy-nilly by the powers that create and sustain them to take account of intangible stakeholder concerns even at the cost of indulging in moral hazard.