Richard H. Thaler won the Nobel Prize in Economics yesterday. Binyamin Appelbaum, reporting in a New York Times (NYT) a piece entitled, “Nobel in Economics Is Awarded to Richard Thaler”, wrote that “Thaler, whose work has persuaded many economists to pay more attention to human behavior, and many governments to pay more attention to economics, was awarded the Nobel Memorial Prize in Economic Sciences on Monday. Professor Thaler is the rare economist to win a measure of fame before winning the prize. He is an author of a best-selling book, “Nudge”, about helping people to make better decisions. He also appeared in the 2015 film “The Big Short”, delivering what is surely one of the most widely viewed tutorials in the history of economics, on the causes of the 2008 financial crisis.”
Thaler’s true insight was to remind us all that economics has a human component. Thaler was quoted at a news conference after the announcement, that “In order to do good economics, you have to keep in mind that people are human.” This simple insight has significant implications for the compliance profession and anti-corruption compliance programs. Thaler also recognized “the importance of fairness. He showed that people will penalize unfair behavior even if they do not benefit from doing so.” Yet this is also a theoretical basis for the Fair Process Doctrine, which is so critical in compliance.
One thesis of Nudge, written with Harvard Law School Professor Cass R. Sunstein, is choice architecture, which is the manner through which decisions are influenced by how the choices are presented. People can be “nudged” by arranging the choice architecture in a certain way without taking away the individual’s freedom of choice that how choices are presented can impact the final selection by a person. This concept has application to the compliance profession in the following but simple example. By moving the signature on an employee expense reimbursement form to the top, at the start of the process, can actually improve compliance. When employees certify the information they will be reporting is true and correct, they tend to provide more truthful information in the information they record. This straight-forward example demonstrates how a prevent control can be modified to become more effective at little or no cost.
Appelbaum wrote Thaler’s “career was shaped by his discovery of the work of Professor Kahneman and his longtime collaborator, Amos Tversky, who were advancing the idea that economics needed to grapple with actual human behavior. Professor Thaler became their collaborator and played a central role in bringing the work into the economic mainstream.” Kahneman won the Nobel Prize for Economics in 2002, Tversky having passed away in 1996. These two men were instrumental in the field of behavioral economics.
They were profiled in Michael Lewis’ The Undoing Project, A Friendship that Changed Our Minds. It was the story of two Israeli academicians who authored a series of papers on humans’ decision making process. Lewis, a well-known author of such works as Liar’s Poker and The Big Short first heard of the two psychologists after publishing his book Moneyball. Indeed, it was another paper in response to Moneyball which directly led to The Undoing Project.
The main thesis for Moneyball was that baseball was inefficient because judgers and raters of baseball talent misjudge that talent due to their mind’s biases. However, this thesis was developed by the two Israeli psychologists, Kahneman and Tversky almost 30 years ago. They were so well known in the academic community that the one still living, Kahneman, won a Noble Prize in Economics. The book was a great read and should be studied by every compliance professional for its insights into how the human mind works, or in some cases fails to work, when forming judgments and making decisions. In short, people do not always make rational decisions.
The implications for anti-corruption compliance programs under the Foreign Corrupt Practices Act (FCPA) or UK Bribery Act are numerous. Often one hears legal types advocating simple rules and regulations as a compliance program. They opine a compliance professional only has to understand the law and then communicate that understanding to employees in a corporation to create an effective compliance program. In short, the rational mind will always make the rational and rules based decision.
Lewis’ book explains the research and publications of Kahneman and Tversky that destroy and debunk this myth. There are wide variety of other factors which go into an employee’s decision making process, least of which could be summarized as ‘What’s in it for me?’ The work of Kahneman and Tversky also explain not only why you must have a compliance program but why a company must actually do compliance for the rules and regulations to gain and hold effectiveness.
Thaler reintroduces the human element into compliance programs. His theories go a long way to helping the compliance practitioner understand how important non-financial incentives can be towards influencing behavior. Every compliance practitioner is well-aware of the role of financial incentives in compliance. I write about this topic on a regular basis. Todd Haugh, an assistant professor of business law and ethics at Indiana University’s Kelley School of Business, takes the incentives discussion in a different direction, suggesting there are non-monetary incentives which could positively impact compliance. As posited in a MIT Sloan Management Review article, entitled “The Trouble With Corporate Compliance Programs”, he noted that companies should “use incentives to influence behavior in the right direction” by understanding how rationalizations come into play. Most interestingly Haugh believes that employee “praise and expressions of gratitude motivate more than money”. Think of the cost of a good word now and then or a pat on the back. But more than a pat on the back, such an approach emphasizes that good compliance is seen as the “governing ethos” of the company where the goal is “to build a corporate culture that incentivizes the rejection of rationalizations through the creation of shared values.”
No compliance program will always eliminate bad employee behavior. However, the research pioneered by Thaler gives the compliance practitioner new insights into how to motivate employees and make compliance more effective in an organization. Further, many of the ideas in Nudge and in the works of Kahneman and Tversky will help the compliance practitioner to more fully operationalize your compliance program as specified by the Department of Justice (DOJ) in the Evaluation of Corporate Compliance Programs (Evaluation). Finally, the use of behavioral economic techniques can add a powerful tool to the compliance practitioner in more fully integrating compliance into the fabric of an organization.
Richard Thaler demonstrated the behavioral economics can inform a best practices compliance program.Click to tweet
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© Thomas R. Fox, 2017