This is the third of the 5-part essay that attempts to answer the question: Is it good for society if the financial services sector is motivated by greed?. (READ: Greed is Good, Greed and Society), This post discusses some of the theories that provide the framework for different arguments for or against greed. Specifically, I discuss the concepts of the invisible hand theory, egoism, and to a certain extent the shareholder theory as support for the argument that it is beneficial for society if the financial services sector is motivated by greed. On the other hand, the stakeholder theory supports the other view.
Greed is Good
Greed as an incentive provides one of the strongest arguments that support the idea that greed is good. No society can advance without incentives. The standard economic assumption of egoism holds that “individuals seek to maximize their own perceived self-interest” (Boatright, Theoretical Perspectives in Finance, 2008). Thus, productivity is maximized when talented people are offered great rewards to fulfil selfish objectives. In economics, the invisible hand theory is used to explain how the motivation of greed and economic self-interest can promote the general welfare.
In The Theory of Moral Sentiments, Adam Smith coined the term invisible hand, which was created by the conjunction of forces of self-interest, competition, and supply and demand. This, he noted, was capable of efficiently allocating resources in society. Smith argues that self-interest drives actors to beneficial behaviour. For instance, efficient methods of production are adopted to maximize profits; low prices are charged to gain market share and ultimately maximize revenues; investors invest in industry that can maximize their returns and withdraw capital from firms that are less efficient in creating value (Wikipedia). The principle of the invisible hand has been further elaborated since Smith’s time. Leon Walras, for example, developed a general equilibrium model that concludes that individual self-interest operating in a competitive market place produces the conditions under which society’s total utility is maximized (Wikipedia).
…or is it?
While the invisible hand principle provides strong argument in justifying greed as good for society, Carson (2003) argues that the view that self-interested individuals in a capitalist society tend to promote general welfare is mistaken. Adam Smith’s model, he elaborated, presupposes that businesses are managed by their owners. “In Smith’s model, the business person who promotes the general welfare by means of self-interested action owns the business he manages and does not act as an agent for others. Modern capitalism involves a sharp divorce between the ownership and management of business” (Carson, 2003). This highlights the problems encountered in a principal-agent relationship. Carson (2003) further emphasizes that the diffusion of ownership in the modern corporation gives considerable scope for executives to enrich themselves at the expense of shareholders and everyone else, i.e. be motivated by greed and taking more than one’s fair share. However, Boatright (2008) suggests several ways to minimize agency problems. In addition to monitoring and providing appropriate incentive schemes to align interests of agents with principals, it is also important to balance controls with trust, promotion of professionalism, code of ethics and standards of ethical practices.
To the extent that the interests of principals and agents are aligned, the shareholder’s theory is consistent with the invisible hand and egoism principles. Under the shareholder theory, managers primarily have the duty to maximize shareholders’ returns. The “self-interest” concept then can be applied as looking after the interest of the shareholders. Carson (2003) quotes Milton Friedman’s version of the shareholder theory, “…there is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it…engages in open and free competition without deception or fraud.”
However, while Friedman appears to agree with the invisible hand theory, Carson (2003) holds that Friedman does not entirely support Smith’s crude version. Self-interested actions tend to promote the general welfare only when businesses engage in free and open competition free from fraud and deception, in addition to appropriate laws. In this sense, Friedman recognizes the limitations of the invisible hand theory. Greed, as an incentive may be good, but it has been recognized that markets need to be free from fraud and manipulation as well.
Thus, we come to the view that greed is not consistent with the need for ethics in the financial markets. The most basic of moral rules and expectations are concerned with fairness, which is often expressed as a level playing field (Boatright, Financial Ethics: An Overview, 2008). Clearly, being greedy and being fair are two conflicting views since greed involves taking more than one’s fair share. It is my view that because of the special role that financial services industry plays, being motivated by greed in this industry can be harmful to society, if not properly reigned in.
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