Rivista di etica e scienze sociali / Journal of Ethics & Social Sciences


Rowman & Littlefield, Lanham and Oxford, 1997, pp. 159, plus notes and index.
ISBN 0-8476-8401-6 (cloth) 0-8402-4 (paper)

It would be an understatement to say that the discipline of finance has not been strongly associated with ethics; if anything, the two areas have been opposed to each other as mutually exclusive. Even where such an opposition is not maintained, it remains true that the ethics of finance is underdeveloped compared to the fields of business ethics or professional ethics. Most financiers have not had a strong ethical formation, whereas ethicists lack an understanding of the technicalities of financial management, and thus the situation perpetuates itself. In recent years, however, following a series of stockmarket crashes, bank scandals and the present general financial instability, there is a renewed interest in the interface between ethics and finance. Within the field of Catholic Social teaching, an important step was taken in 1994 with the publication of the booklet Modern Financial Systems and the Ethical Imperatives of Christianity (original in French), written by two members of the French Treasury. Its publication followed on a series of meetings between top financiers under the auspices of the Pontifical Council for Justice and Peace. The Financial Monitoring Centre, set up in Geneva, is another important development, which, while not openly confessional is clearly influenced in its approach and thinking by Catholic social thought. Perhaps most significant of all is the recent launch of the new journal, Finance and the Common Good (bilingual French and English). If this new journal can establish itself, it will show that the field of financial ethics has become a discipline in its own right, with its own academic and professional identity.

Finance Ethics has thus arrived at an auspicious time, and it merits the attention that it should get as a result. Its central aim is to show that finance theory, with its assumption of self-interested opportunism and maximisation of wealth on the part of every agent, cannot explain what really happens in financial systems. Further, taught in a fundamentalist and uncritical way in business schools, the ideology behind finance theory leads to the distortion of agents' behaviour in practice, and the undermining of the proper functioning of a healthy financial system. Dobson maintains that a proper theoretical understanding of finance requires a necessary foundation in some set of ethical assumptions that go beyond the technical financial sphere. In other words, an ethical basis to the operation of finance is not a constraint or limitation on financial agents, but rather the condition that the financial system can exist at all. The first six chapters of the book are spent in establishing this first stage of his argument. In the remaining four chapters, comprising part III, Dobson argues that the best way to conceive this ethical basis, and the most useful basis from a practical point of view, is that of "virtue ethics," and that other approaches, such as Kant's "categorical imperative" are deficient in comparison. In this short book of 150+ pages, Dobson gives a rounded critique and counterproposal to the ideology behind the finance theory. This is all the more important when one knows that Dobson is a professor of finance himself, teaching in one of the major business schools of the US, Caltech.

Crucial to the book's thesis is Dobson's characterisation of what he calls the "finance paradigm," He explains what he means by this at the opening of chapter 1:

In his Essay on the Application of Mathematics to the Moral Sciences, published originally in 1881, F.Y.Edgeworth declares that "the first principle of Economics is that every agent is actuated only by self-interest." Within our century, this "first principle" has been further honed by the discipline of financial economics. Within this discipline 'self-interest' has come to be defined in very narrow, and very specific, terms: "individuals always prefer more wealth to less" and act "with, if necessary, guile and deceit." This concept characterizes self-interest as the narrowly individualistic and opportunistic pursuit of material wealth, to the exclusion of all other motivations. I label this behavioral concept the 'finance paradigm.' (p.1)

Using this term, Dobson wants to make use of the idea of a paradigm as a whole way of thinking that resists strongly any attempt to be challenged, in the

way that Kuhn using the term in The Structure of Scientific Revolutions. The force of this paradigm is so strong and so entrenched that it continues to be maintained in the face of considerable evidence that it is self-contradictory. Opportunistic agents try to maximise their wealth, at the expense of others if necessary. Since to maximise wealth, agents may act with "guile and deceit,", no agent can trust any other in the market. This leads, for instance, to lenders charging higher rates of interest on their loans because they cannot trust borrowers to invest fully in the most profitable projects. The result is at best a second-best equilibrium, one that maximises no-one's wealth. On this point, Dobson quotes the business ethicist, Norman Bowie: "The conscious pursuit of self-interest by all members of society has the collective result of undermining the interests of all."

This "finance paradox" identified by Dobson in his first chapter is expanded in chapters 2 and 3, where he deals with two particularly important aspects of finance: contracts and reputation effects. In the globalised world of finance today, where businesses are dealing with each other often without any personal contact, the need for enforceable contracts is crucial if the whole system is not to fail. Furthermore, the problem of enforcing contracts is not purely external to the business. Dobson discusses the now prevalent view of the firm as a "nexus of contracts," containing within it people with very different and sometimes conflicting objectives. When one takes this view of the corporation, it begins to look much more like a structured market, structured so as to minimise costs and maximise efficiency. The problem of enforcing contracts is not therefore merely one of the firm's interactions with other entities, but enters right into the heart of the firm itself. Explicit contracts can be enforced (at a cost) through the courts, but implicit contracts require trust and mutual good will for their enforcement. It would seem, then, given the importance of contracts for the functioning of the financial system that building trust would be a central ethical requirement. Unfortunately, the finance paradigm has already judged pursuing trust for more than merely materialistic, opportunistic ends as irrational. As Dobson says:

But for trust to work, agents must be intrinsically trustworthy. They cannot merely act in a trustworthy manner when it suits their material ends. What is required is trust for trust's sake. But clearly. . . "trust for trust's sake" is irrational within the finance paradigm. . .an individual who forgoes material gain in order to honor some trust-based agreement would be as irrational as an individual who forgoes material gain because the moon happened to be full. . .Within the finance paradigm, the act of honoring trust in and of itself has absolutely no value. (p.14; italics in the original)

Firms try to create confidence in what they are doing by sending out "signals" which may or may not convince the market that they are trustworthy. "Good" firms need to send out "signals" that cannot be mimicked by "bad" firms if they are to be effective. If giving such a signal is not too costly, the good firm that gives it creates a "separating equilibrium" in which it is clear who is who to outside agents. However, such signals do have some cost, and this reduces the efficiency of the good firm. Again, at best we can have a "second-best" outcome, with a "residual loss" due to the contractual enforcement problem between agents. It is important to realise here that we are not dealing with a redistribution of income from principal to agent, but with an absolute loss from which no-one gains. Dobson gives much attention to possible ways of enforcing contracts, so as to test out whether it is possible to find a way of doing it that does not require real trust. Lack of information, or "information asymmetry" can make it difficult for principals to know in advance whether they can trust agents, and "moral hazard" describes the situation where it is unsure whether agents will honour or abuse the trust put in them. In both cases, proponents of finance theory would argue that firms could build a "reputation" for being trustworthy, consistent with the opportunistic and maximising assumptions of the finance paradigm. Dobson devotes his third chapter to showing that this, too, does not work.


Reputation is not well defined in the finance literature, and Dobson derives a definition by extrapolating from the annual Fortune survey to rank companies by their reputation and a number of other sources:

A reputation is a behavioral trait. A firm builds a reputation by demonstrating a consistent mode of behavior through a series of contractual situations. Once built, a reputation increases the value of the implicit claims sold by the firm to stakeholders. Thus, a firm's desire to earn future profits by maintaining its reputation may act as an implicit contractual enforcement mechanism.

Yet, we still hear of financial scandals, even among the most respectable banks and financial agencies. Furthermore, firms like Salomon brothers that were the subject of a serious fraud soon seem to bounce back into action after a short period of re-organisation and "knocking heads together." From the point of view of the finance paradigm, the fundamental flaw is the one to which Dobson has already referred: opportunistic agents cannot be trusted. After this extensive treatment of the possible resources within the finance paradigm for enforcing contracts, and the demonstration that they are wanting, Dobson is ready to spend the next three chapter in "Challenging the Finance Paradigm" (the title of part II). 

The first challenge Dobson offers to the finance paradigm comes from the way financial markets operate themselves. After Salomon brothers were involved in stitching up the market for US Treasury bonds, an expert on the incident, Clifford Smith, claimed that Salomon was punished for its unethical behaviour by the financial markets. This implies that there was some moral basis to the "punishment", which took the form of economic costs incurred by Salomon brothers as a result of the scandal. However, as Dobson points out, to see whether there was a moral basis to this censure and not purely a financial one, the underlying motivation for the censure needs to be established. In an indirect way, this information was forthcoming through the approbation that the new chief executive,Warren Buffett, received when he stated: "If I hear of an employee losing the company money, I'll be understanding. However, if I hear of any employee losing Salomon one shred of reputation I'll be ruthless!" This statement is important because it separates the loss of reputation from the loss of money, with the implication being that reputation is not purely an instrument used towards the maximisation of wealth. In other words, an employee who makes a technical error, losing money for Salomon Brothers, will be treated with understanding, but an employee who sets out to exploit other agents in the market, gaining money for Salomon Brothers but tarnishing the reputation of the firm for honesty will be treated severely. This is clearly openly contrary to the tenets of the finance paradigm.

This discussion still leaves open the motivation that a particular employee might have for not tarnishing the company's reputation. After all, many would maintain, what matters is what the person does, not why they do it. As Dobson points out, however, this "practical" argument has a fatal weakness: "an agent who is not motivated to act ethically will sooner or later act unethically." The last ditch stand of the finance paradigm against this thinking is the "Confidence School" position: scandals undermine confidence in financial markets, which could reduce the number of participants in the market and lower the efficiency of the market. Therefore, since it maintains confidence in the market, ethical behaviour is important. As Dobson points out, this justification of ethics only supports the position that unethical behaviour is unacceptable if it undermines confidence in the market. The obvious implication is that if it can be done in such a way that it does not undermine such confidence, then it is acceptable behaviour, as long as it maximises wealth. Dobson then takes a look at the possibility of using deontological ethical theories as a basis for the operation of a financial system, but decides that they are too controverted to be taken as a communally-shared basis for ethical behaviour in finance. Two chapters follow in which Dobson extends his discussion of the need for ethics in finance and also considers possible approaches to the incorporation of ethics in financial activity, such as through corporate codes. In only one tradition can he find an approach that can both cope with the diversity of culture and market that financial agents face today without falling into the trap of subjectivism: the virtue tradition. Dobson is particularly interested in this tradition as it is proposed by Alasdair MacIntyre's re-reading of Aristotle. Dobson's focus on MacIntyre is particularly interesting because MacIntyre himself is extremely sceptical that the modern business manager can in any way practise a life of virtue. In fact, MacIntyre uses the image of the business manager to show how far our modern, market dominated society has come from one in which the practice of virtue would be really possible. Dobson in many ways agrees with MacIntyre, but instead thinks that we must try to find a way to rethink finance so that it is compatible with a life of virtue. At the same time, Dobson has to convince the financial community that to be virtuous is also to be rational. The last part of Dobson's book is thus focussed on laying out the "rationality of virtue", under the general title of "Beyond the Finance Paradigm."

In chapter 7, Dobson extends his discussion of the appropriateness of virtue theory to the operation of finance. Since virtue theory is based on the growth of persons, on their character development, is can take much better account of the vastly different situations around the globe that financial managers face than a system based on following particular, universally applied rules or "categorical imperatives." This will be very familiar to the ethicists, but to the financial managers reading this text, it could well be a revelation. Dobson outlines four key components of a virtue ethics approach: a strong emphasis on particular forms of character development, such an fairness, good judgement, perseverance and consistency, which are classically called "virtues;" recognition of the vital role of the community in the formulation, nurturing and passing on of these virtues; the central role of sound judgement rather than relying on fixed rules and guidelines; the importance of role models, people who can be held up as examples of ways in which to live the virtuous life, in the particular circumstances of their lives. Dobson then interestingly links this thinking to the idea of the "metaphysics of quality," developed by Robert Pirsig, which is likely to be more accessible to the average financial manager than the language of the virtue tradition. According to Pirsig, in all our actions we must aim to pursue quality, both at the physical level, and at the higher social and spiritual levels. Pursuit of excellence or "quality" at the spiritual level equates with MacIntyre's idea of the pursuit of the "internal" goods as the goal of virtue, or with Aristotle's idea of eudaimonia. Dobson thus usefully connects what may well seem a very distant ethical tradition and language to the quality literature, with which all business people are familiar in the post-Japanese technological era. Dobson closes this chapter by trying to show that earlier in the industrial revolution, traditions of business survived which maintained a more virtue-based approach, and only later were these eclipsed by the forms with which we are today more familiar. Chapter 8 is an application of MacIntyre's idea of a "practice" and of "practical rationality" to the functioning of finance, including a model in which Dobson shows that agents basing their activities on virtue ethics can compete efficiently in a financial market, even one that contains opportunistic agents, and furthermore, that, in fact markets cannot operate without such virtuous agents.

Probably the weakest point in the book is chapter 9, "Some gender implications," in which Dobson rather uncritically uses the work of Gilligan and others, on the supposedly different way in which women reason ethically. Despite the dubious attribution of this way of thinking particularly to women, the chapter does point out the connections between the communally-based virtue tradition and the "ethics of care," focussed on the idea of a "connected" self rather than a "separated" self. Whether this way of thinking is characteristic of women as opposed to men, as Gilligan and others suggest and about which I have my doubts, is a secondary point. Dobson does point out that some of the literature on so-called "feminist business" approaches can be weak when it comes to the aspect of competition and the need for efficiency in the firm. I would agree that this can be the case, but I am not convinced that such a lack is due to a particularly "feminine" way of thinking about business. However, these points are secondary to the main argument and do not detract from its value.

The final chapter, "Towards a New Finance Paradigm," focusses appropriately first on the "new agent" and secondly on the "new firm", the new "polis," in which we can learn what virtues need to be developed and how to develop them. The "new agent" pursues internal goods so as to reach his "true end." In doing so, he uses external goods competently and sophisticatedly, such as his financial resources and techniques, and thus acts in the way of a true professional. What the "good life" actually is cannot be defined further than what a virtuous person would strive for or choose as their goal; in order to take things further, one would need to call on a religious tradition, which is beyond the scope of this book. The "firm as polis" gives the necessary infrastructure for the pursuit of our ultimate good, providing the community environment in which we can grow in virtue, This implies growing in technical excellence, in the development of the internal goods of our profession, and in our own characters. Thus, "the theory of the firm is a moral theory because the firm is a moral organization" (p.148).

Dobson's short book is an excellent contribution to the development of this nascent field of financial ethics. He ends by showing the potential that the development of this field could have today, and the fact that so far we have failed to develop it.

When Aristotle described life's ideal as one of 'intellectual pursuit' or 'contemplative enquiry,' he accepted that the material wealth of his society was sufficient for only a fraction of its inhabitants to realize this ideal. The triumph of our age is that the wealth generated by the firm through the market system has freed the majority of humanity from the fetters of material servitude. But the victory has been Pyrrhic. As virtue disappears from our cultural milieu, the fetters of material servitude are merely being replaced by those of moral ignorance. The tragedy of contemporary corporate culture is thus the tragedy of King Midas. In creating the means for unlimited material acquisition, we have prevented ourselves from acquiring that which we should most desire.

Dobson's book is an important step forward in dealing with the opportunities and problems of our present-day financial system for the good of the whole human family.

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