Why motives matter less than results, microfinance questioned and why political connections do not always pay

Outcome bias

A house buyer moves into his new home and immediately renovates the basement. A few months later, there is a flash flood and his recent remodelled room is ruined. The house seller knew all along that the basement was susceptible to water damage, but declined to tell the buyer.

Now picture the same, but with a drought rather than a flood. Sellers in both situations are guilty of an ethical breach, but people are more likely to condemn the former.

Using a series of similar vignettes, this paper analyses reactions to ethically questionable behaviour; what academics term “outcome bias”. The researchers consistently find that the weight of blame ascribed by participants to an unethical act depends on the result of that act.

If a toy company sells a product from China that ends up killing six children, then its decision to source offshore is suddenly held in question. People presume that the company in question must have had private “inside knowledge” that would indicate such a risk.

The implications for companies are profound. As the studies show, decision-makers should anticipate being judged not so much on the ethics of their actions but on the consequences of those actions. However ethical your decision, do not expect customers to treat you rationally if things go wrong. From an internal perspective, the findings also help explain why colleagues are slow in reporting unethical behaviour: it seems they are waiting for the ramifications before making a final judgment.

Of course, sometimes bad things happen when good people are unlucky, and sometimes scoundrels get away clean. Judging decisions on their outcomes will wind up condemning too many unlucky people and acquitting too many scoundrels.

“No harm, no foul: The outcome bias in ethical judgments” by Francesca Gino and Don Moore of Tepper Business School and Max Bazerman of Harvard Business School, Working Paper, February 2008.

Micro-clients first

Microfinance has staggering potential to promote economic self-sufficiency and cut world poverty. But first it needs to work. For all the attention Grameen Bank and knock-on schemes have been gaining of late, microfinance is not without its critics as a poverty-alleviation tool. Stable jobs in large industries, not risk-laden entrepreneurial activities, lift people out of indigence.

This (first) paper seeks to cut through the controversy by returning to basics. What are lenders hoping microfinance will achieve, and how can they get there? The first answer is straightforward. Microfinance is primarily about alleviating poverty. The second, less so. Lenders have tended to think that the bigger the loan, the greater the impact. Think again.

The vast majority of the world’s 100 million microfinance clients have no prior business or banking experience and little formal education. It might be better for lenders to help clients build successful enterprises. Such “client-centred” microfinance requires more than just a cheque book. In addition to financial products and services, clients require financial education, management training, value chain support, and social services.

Too often, “institution-focused” microfinance lenders judges success on revenue and payback rates. The approach presumes poverty-alleviation will follow. As going concerns themselves, it is natural for microfinance institutions to focus on the balance sheet. The danger is that microfinance becomes tainted with the brush of profiteering, as this second paper finds.

This is precisely what happened last year in Mexico when the microfinance institution Banco Compartamos issued shares in a secondary offering IPO. Existing shares were sold at 12 times their book value, leading to accusations that poor people were being sacrificed for rich investors.

“In Microfinance, Clients Must Come First” by Srikant Datar, Marc Epstein and Kristi Yuthas, Stanford Social Innovation Review, Winter 2008.

“Ethical Issues of NGO Principals in Sustainability, Outreach and Impact of Microfinance” by Matthew Bush and Arvind Ashta, Burgundy School of Business, Working Paper, February 2008.

Cronyism put crudely

The shady world of corporate agreements with developing world governments rarely finds its way onto the balance sheet. But does such high-level deal-making pay off? This original paper takes the ethics out of cronyism and asks if political connections harm or help a company’s competitiveness.

Cronyism, the evidence indicates, certainly lowers the fixed costs of doing business. Administrative hurdles and regulatory obstacles have a habit of diminishing, if not disappearing. At the same time, it raises a politicised company’s variable costs by tying the extent of extra employment to the level of capital invested. As well as carrying bloated payrolls, companies with political connections are found to invest and innovate less. So not such a good deal after all.

“Do Politically Connected Firms Undermine Their Own Competitiveness? Evidence from Developing Countries” by Raj Desai and Anders Olofsgård, Georgetown University, Brookings Working Paper, January 2008.