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E-MailDonald Langevoort is a Professor of Law at the Georgetown University Law Center. This post relates to Professor Langevoort’s new book.
Most existing work in the fields of corporate governance and investor protection assumes that corporate managers (and bankers, analysts, brokers and the like) are smart—and selfish—utility maximizers, while many investors are not. That follows naturally from the assumption that the former got to where they are via success in competitive crucibles that reward rationality, and survive and thrive by continuing their savvy ways. Many of the legal strategies designed to discourage opportunism and promote honesty and fiduciary responsibility take that assessment of human nature for granted.
But what if that assessment is overly simple, or wrong? In a new book—Selling Hope, Selling Risk: Corporations, Wall Street and the Dilemmas of Investor Protection—I explore what it means for securities regulation if we take seriously ways that cultural and cognitive biases affect the behavior of more than just ordinary investors. A rapidly growing body of research in financial economics, psychology, and sociology paints a richer picture of how these biases, especially egocentric ones, can actually be survival traits in the Darwinian world of business and finance. Phenomena like overconfidence, excessive optimism, competitive arousal, self-serving inference and many others offer explanations for why illusions sometimes produce marketplace success, not prevent it.
The book asks the reader to imagine being the Chair of the SEC, buffeted not only by the contemporary politics of the job but frustrations about how much wrongdoing there appears to be notwithstanding concentrated efforts to promote honesty and integrity. To be sure, much of the frustration comes from inadequate regulatory resources and an excess of partisanship, matters I explore. But cognition and culture get their due. When commands of honesty and law-abidingness are filtered through self-serving lenses, they are diluted. Asking a person or a firm to tell the truth doesn’t mean much when their reality is distorted. So, deterrence fails short of expectation. The distortions come from tropes that are success-inducing, as well as from hopes and fears.
To say this is provocative, but what’s the evidence? My book is the first sustained effort to link the key initiatives of securities regulation with our burgeoning awareness in the social sciences of how people and organizations—managers, securities professionals and investors–think and behave in economic settings. Chapter 1 introduces this research, as well as the basic points of contention about the goals of investor protection, the role of market efficiency, the value (and limits) of disclosure, and the like. The remaining chapters then put these ideas to work to understand law and policy. Chapter 2 asks why there is apparently so much corporate fraud, and why the hoped-for sources of deterrence predictably fail. Chapter 3 is about insider trading, why people do it, and why we make such an effort to prevent it. Chapter 4 is a critical analysis of the disclosure apparatus after Enron and Sarbanes-Oxley—the behavior of executives, directors, securities analysts and auditors from a behavioral perspective. That takes us quickly to current debates about short-termism, social responsibility and the freedom (or not) the exit the world of publicness. Chapter 5 is about the selling of securities—investment bankers, brokers, analysts, spam artists and others gifted in the arts of salesmanship, and how technology is altering the sellers’ craft. Chapter 6 brings all this together in a close look at what brought on the global financial crisis. That is an opportunity, among many other things, to ask the “Lehman Sisters” question: if so many of the sources of wrongdoing are cognitive and cultural, how much would change in a more diverse world with less male domination in business and finance?
The conclusion—invoking the vivid image of chasing a greased pig—returns to the frustrations of regulation, turning the behavioral lens back on those charged with regulating a financial world that is increasingly sophisticated yet deeply human and thus incurably flawed. Regulation has a persistent greased pig problem, in that the impulses that drive aggressive financial behavior are very hard to get hold of, and you can look very bad trying to do so. The book shows why, and what has to change to do better.
