James Montier: What Corporate Governance Can Learn From Behavioral Finance
Following our recent tradition of providing you with the best of James Montier, here is his paper on applying behavioral finance to improve corporate governance.
Article Introduction (Via DKWR)
Bad apples or bad barrels? It is tempting to believe bad behaviour is the result of a few rotten individuals. However, the overwhelming psychological evidence suggests that if you put good people into bad situations they usually turn bad. Corporate malfeasance and the events in Iraqi prisons are examined and the lessons explored.
Article Excerpts (Via DKWR)
“We all tend to assume that our own actions are the results of a careful analysis of the situation we find ourselves in. However, we also assume that everybody else’s actions are the result of their inherent attitudes. This is called the fundamental attribution error. It means that we shouldn’t be so fast to judge others, since we can’t be sure that we would act differently if we found ourselves in their shoes.”
“Both experiments are classic evidence for the importance of understanding context on predicting behaviour The factors that lead to increased risk of turning bad are explored inside.”
People have a bad habit of believing others act according to their disposition, whilst simultaneously believing we act according to our circumstances. It is tempting to believe that bad behaviour is the result of a few bad apples. However, the bulk of evidence argues that in general, a situational perspective is much closer to the truth. That is to say, good people will go bad in the wrong situation. It isn’t a particularly comforting view of humanity.
From a corporate governance point of view, the situational perspective tells us that we must always be on our guard for situations that could give rise to bad behaviour. The men now standing trial for misbehaviour during the bubble years are unlikely to be the last corporate wrong doers.