In October 2011, three years into the wake of the 2008 US financial crisis, federal agents in Manhattan arrested Rajat Gupta on charges of insider trading. Gupta had been a towering figure in the U.S. management consulting and investment banking industries. Most famously, Gupta was the first foreign-born employee to become the Managing Director of Big 3 consultancy McKinsey & Company.
Gupta had been elected as the executive of McKinsey three times in the 1990’s, leading the firm to more than double its number of employees, expand to offices in 44 countries, and grow its annual revenues from $1.4B to $3.4B by the end of his tenure. Gupta also served on the boards of corporate giants Procter & Gamble and Goldman Sachs, and co-founded the Indian School of Business in 1997.
What brought this major player down from such lofty heights was his close relationship with Raj Rajaratnam, who had been the head of the Galleon Group hedge fund management firm, and with whom Gupta had secretly given privileged information that led Rajaratnam to make trades worth millions of dollars. An FBI investigation led by US Attorney Preet Bharara produced wiretaps of conversations that revealed that Gupta would call Rajaratnam within minutes of learning sensitive investment information at board meetings at companies like Goldman Sachs.
Another player in the Galleon scandal was Anil Kumar, who was a former protégé of Rajat Gupta during his reign at McKinsey, co-founded the Indian School of Business with Gupta, and who was also charged with providing Rajaratnam with insider information that led to millions in illicit trading profits.
These three men each had relatively unique backgrounds and career paths, but one experience they all shared was having obtained an MBA at one of America’s elite business schools. Raj Rajaratnam and Anil Kumar both graduated with Wharton MBAs in 1983, and Rajat Gupta graduated in 1973 with an MBA from Harvard Business School.
A Criminal Track Record
Gupta, Rajaratnam, and Kumar aren’t the only convicted fraudsters on HBS and Wharton’s lists of infamous alumni. The notorious former-CEO of Enron and convicted inside trader Jeffrey Skilling is a 1979 HBS MBA graduate, and Michael Milken, who was convicted of securities fraud and fined $1.1 billion in 1990, has a Wharton MBA.
In all fairness, these men’s crimes could potentially be chalked up to having cut their professional teeth in the wild west of 1980’s corporate America, where junk bonds, hostile takeovers, and corporate raiding ruled the day. Ethics certainly weren’t the first thing on anyone’s agenda. For professors teaching at schools like Wharton and HBS in the late 70’s and early 80’s, Gordon Gekko’s “Greed is Good” speech may not have been as salient as it is today with the 2008 financial crisis in the rear view mirror, and the teaching of business ethics was likely an afterthought.
However, more recent scandals in upper echelons of business suggest that, while many more ethics courses may be being taught at elite business institutions in the U.S. today, their message still might not be getting through to some graduates. In 2013, Wharton MBA graduate Courtney Dupree was convicted in an $18M bank fraud case. In 2017, Cornell MBA John Afriyie used his mother as a shell investor in an insider trading scheme, and in 2018, former Goldman Sachs VP and Wharton Grad Woojae Jung pled guilty to insider trading charges. Even more recently, in August 2019, Bill Tsai, a 2018 NYU Stern bachelor’s graduate, was arrested on charges of insider trading while working as an Analyst at RBC Capital Markets. Graduates of America’s most elite business schools feature prominently in many of the great white collar criminal cases, from the late 70’s to present.
Where’s the Focus on Ethics?
How did the top business schools in the U.S., who are supposed to shape and train the best and brightest business minds, end up producing graduates who try to cheat the system? A quick look at the core curriculum for HBS and Wharton could provide a clue. The word ‘ethics’ is only mentioned once in the online descriptions of HBS’s core curriculum, and at Wharton, the word also only appears once, in the description of an optional core course. Alternatively, the words ‘leadership,’ ‘finance,’ and ‘value’ appear at least five times more frequently in these core course descriptions. While the number of times that the concept of business ethics is mentioned on a webpage certainly doesn’t mean that these two elite programs aren’t teaching units on business ethics in individual courses, the conspicuous absence of a focus on ethics does invite skepticism as to whether it is an important value that HBS and Wharton are looking for in potential applicants.
If these elite business programs have consistently produced graduates who end up becoming the focus of criminal investigations and scandal after graduation, why doesn’t a focus on business ethics seem to be at the forefront of these schools’ marketing? The answer may lie in longstanding debate between two theories of business ethics, theories that have shaped the way business ethics is taught (and not taught), and that have influenced the actions of executives in many American corporations.
In 1970, Nobel prize-winning economist Milton Friedman wrote an editorial in the New York Times entitled, ‘The Social Responsibility of Business is to Increase its Profits.’ In the article, Friedman argues for a normative understanding of business ethics wherein a company’s only responsibility is to make as much profit as possible. Freidman went even further, stating that any efforts spent by a company or employees of a company to work towards anything indirectly related to maximizing profits are actually doing something socially irresponsible, or in other words, unethical. In Friedman’s theory, the most optimal outcomes for an economy will be realized only when every company is only looking out for its own interests.
This idea of profit maximization being the sole ethical objective of a company came to be known as ‘Shareholder Theory’, referring to the fact that the shareholders of a company, either its stockholders or the individual owners of a company, hire employees with the overarching understanding that those employees will be working to make a profit for those shareholders. In Shareholder Theory, any energy spent by an employee on something unrelated to profit-making (think volunteer days, interoffice fundraising competitions, community service on company time) is actually unethical.
Friedman was laying out this stark, zero sum theory in a particularly turbulent period of American economic history. In 1970, the United States was undergoing severe economic and social transformations. The cultural upheavals of the 1960’s had produced a mass movement of people who were questioning traditional norms in all spheres, including sexuality, demographics, family life, and work. Women were demanding equality and more representation in the workplace through the Equal Rights Amendment, and ethnic and racial minorities were expanding the fights of the civil rights movement to the workplace through affirmative action legislation. Coupled with these demands, President Nixon was fighting a war in Vietnam and faced an inflation crisis that was spinning out of control. Because of this turmoil, many academics began to question the sustainability of the American free-market economic system. This open criticism of capitalism, the likes of which hadn’t been seen since the Great Depression, likely led to a reaction from free-market purists such as Friedman, and to his publishing and defense of Shareholder Theory.
Friedman taught the principles of his Shareholder Theory as a professor of economics at the University of Chicago until his retirement in 1977, and his doctoral students went on to teach in the economics departments of the United States’ most prestigious universities, including Yale, Stanford, Johns Hopkins, and MIT.
According to a 2017 Harvard Business Review article by HBS professors of management Joseph L. Bower and Lynn S. Paine, Shareholder Theory is, “now pervasive in the financial community and much of the business world,” and guides the majority of decision-making processes in terms of compensation, governance, and corporate social responsibility. Bower and Paine go on to directly link the principles of Shareholder Theory to the criminal decisions that led to the 2001 Enron scandal. Additionally, Bower and Paine cite a 2007 Aspen Institute survey of MBA students (including Wharton, CBS, Ross, and Fuqua students), that shows the majority of these future business leaders consider maximizing shareholder value to be their most important priority.
The Consequences of Shareholder Theory
According to Bower and Paine, companies that dogmatically adhere to Shareholder Theory, making every decision based upon the short-term benefits or losses to their shareholders, can make decisions that can eventually be harmful to the long-term prospects or even survival of the company. They cite several examples of companies that decided to cut cost-heavy research and development functions to boost stock prices in the short-term, but in the long-term suffered an overall stock price loss due to not being able to compete with more innovative rivals.
How did Shareholders influence the unethical decisions of the financial criminals we highlighted in the beginning of this article? As mentioned earlier, Bower and Paine attribute Shareholder Theory-driven decisions to Jeffrey Skilling’s cooking of Enron’s books. However, many of the insider trading convictions that we outlined at the beginning of this article were for pure personal gain, not for the benefit of shareholders.
Milton Friedman was an adherent of what is known as Neoclassical Economics, the most prevalent branch of economics taught in universities, and one that stresses the importance of individual rational decision making in economic life and which advocates against government intervention in business and the market. This focus on the primacy of the individual and their self-interested choices in the economy could help to explain why these financial criminals made the decisions that landed them in hot water. In business school, these traders and analysts were likely taught by professors that advocated Shareholder Theory, believing that realizing profit was the only goal of a businessperson, and that government intervention in the economy was ultimately detrimental. It’s not hard to imagine how these individual traders and analysts could then take the next step, convincing themselves that executing an insider trade that skirted government-mandated investing regulations was the most reasonable and individually profit-maximizing thing for them to do.
Enter Stakeholder Theory
In 1984, in an era of deregulation in the United States inspired by the proponents of Classical Economics and Shareholder Theory, Professor Ed Freeman published Strategic Management: A Stakeholder Approach. In this work, he outlined what has come to be known as the most influential competitor to Friedman’s Shareholder Theory. Freeman’s Stakeholder Theory eschews the idea that the sole objective of a business is to realize profit for its shareholders, and instead offers a more complex theory. In Stakeholder Theory, a business is obligated to look out for the interests of its shareholders, but also the interests of every entity that is affected by the actions and operations of that business. This includes employees, the communities in which businesses are located, the environments in which businesses operate, the suppliers of goods to these businesses operations, and so on.
To Freeman, an economy that operates according to the principles of Stakeholder theory is one where businesses and their stakeholders mutually benefit each other in the long-term. This could include private corporations investing in public schools for the children of their employees, building sports facilities in their communities, and funding arts organizations. All of these actions cost money that could have gone to shareholders in the short-term, but Stakeholder Theory posits that these are investments in making the lives of their employees and communities better, which in turn will lead to a happier, more productive, and innovative workforce.
Ed Freeman has been teaching stakeholder theory at the University of Virginia’s Darden School of Business since 1986, and his alternative to Friedman’s zero sum Shareholder Theory has sparked a heated debate in the study of business ethics. Critics of Stakeholder theory argue that its definition of ‘stakeholders’ is too broad to be scientifically analyzed, and therefore isn’t something that can be integrated into the quantitative profit and loss formulas that inform businesses decision-making processes.
A New Era of Business Ethics?
From the mid 1980’s to the year 2000, an approach to business ethics that was informed by Milton Friedman’s Shareholder Theory seemed to be validated by unprecedented amounts of economic growth and prosperity in the United States. However, the bursting of the dot com bubble in the year 2000, China’s entry to the World Trade Organization, the subsequent offshoring of millions of American manufacturing jobs, and the global economic crisis of 2008 have led many business ethics scholars to advocate for an institutional shift away from the Shareholder Theory model and towards a more holistic Stakeholder Theory approach. Some professors teaching at America’s elite business schools, such as Freeman, Bower, and Paine, argue that private businesses can maintain profitability and play a bigger part in supporting the communities in which they operate, and in fact must do so in order to thrive in the long-term.
The global COVID-19 pandemic may well prove the validity of this argument. However, the price of poor ethics was already becoming apparent. Pharmaceutical companies like Purdue have been overwhelmed with lawsuits stemming from their unethical sales practices that led to the opioid epidemic plaguing many American communities. The settlements for these lawsuits will reach into the multiple billions, and may lead to the folding of several major corporations. In addition to the traditional media coverage of these trials, hundreds of articles can be found online excoriating the CEOs and leaders of these companies, and dozens of hours of podcasts have been recorded that dive deep into the backgrounds of the people responsible for these companies’ decisions. As social media and online journalism make the actions of financial criminals (and the names of their alma maters) more public, there may be a strong incentive for business schools to take another look at the emphasis their programs are placing on the teaching of business ethics, and whether the underlying principles of those ethics need to be reconsidered.