PRACTICE AND POLICY LECTURE SERIES, MAY 2013 - BUSINESS ETHICS IN A REGULATORY ENVIRONMENT

No Audio: Daniel T. Ostas, University of Oklahoma

(applause)

Dr. Daniel T. Ostas: I feel that was overly kind, but thank you very much. I'm very happy to be here today. I have a handy dandy timer here I'm going to set for myself. I'm going to talk to you about business ethics in a regulatory environment. I happen to have a PhD in economics and I have a law degree and I've taught both micro and macro theory which is why I'm in a business school and several different law courses. But these days I'm teaching business ethics. 

And in particular I have a course called Business Ethics in a Regulatory Environment and I really enjoy the class. I teach it down in Norman to the MBA students. I also teach it to the executive MBAs in Oklahoma City and I do a lot of executive education with some of this material as well. 

I want to share with you some of the more, hopefully interesting, ideas from what I do in my classroom. I'll give you kind of an overview of the topic at first and then take you through our extended case study. The topic of business ethics in a regulatory environment, to me, is a sub-set of corporate social responsibility. Corporate social responsibility of course talks about the, what are the responsibilities of a corporation and the business executives that run those organizations? Too, with regard to social requirements, what are their responsibilities to make the world a better place? 

Academically speaking, that topic dates back to the Great Depression. In the Great Depression the natural question would be, is there anything that business leaders could do to try and alleviate some of the catastrophes that they saw outside their windows? And there was a debate in the law reviews and economic journals and particularly an influential book written by a couple of fellows by the name of Berle and Means. 

They were, one was a lawyer and one was an economist. And it was called, "Private Property and the Modern Corporation." Which they ask the question, does a corporate executive have the moral and the legal authority to go outside of their mandate to maximize shareholder wealth to try to engage in some form of philanthropy or, alternatively, some sort of social engagement that may very well not maximize profit for the shareholders? That was essentially the question and economists would call that an "agency question." To what extent do you have a moral obligation only to shareholders and to what extent does it go beyond? 

What they determined was that the responsibilities both in law and in social custom was that there has to be fidelity to shareholder desires and presumably shareholders desire wealth. But there's also some good news. And the good news is that shareholders cannot authorize executives to engage in illegal activities. So it is maximize shareholder wealth subject to law. Nor can they authorize them morally to engage in unethical conduct. So if you don't have the moral authority to authorize your executive or your agent to engage in immoral activities then those agents, although they're maximizing shareholder returns, must do them subject to law and ethical custom. 

The next person that really wrote on corporate social responsibility with any note, was a fellow by the name of Howard Bowen. He wrote a very influential book in 1953 and, if you read the management literature, Bowen is always cited as the founding voice or seminal writer in the area of corporate social responsibility. And Bowen writing in 1954 emphasized that we have come out of the Great Depression and after the Great Depression what we have is the first wave of regulatory bodies. 

So in the, prior to the Great Depression we're essentially a laissez faire society. There's an Interstate Commerce Commission and a couple of other minor regulatory agencies out there, but there isn't much of note. It's pretty amazing just how small the government is in 1929. But by the time you get to 1954, we not only have had World War II, but the Great Depression gave birth to about a dozen major regulatory bodies on the federal level, including the Securities and Exchange Commission, the Food and Drug Administration, the National Labor Relations Board and they're all... all these regulatory agencies are essentially regulating the interface between business and some kind of constituency or stakeholder group. 

Now in that context what Bowen argued was that the primary responsibility of a corporate executive with regard to social responsibilities is to cooperate with the creation, implementation and reform of big business regulations. So the idea there was that you don't have to go out and engage in philanthropy, but if you're going to make a car, you're going to make a tire, if you're going to make a battery, whatever it is that your manufacturing process does, you do that in a way that cooperates with the regulatory apparatus that you find, okay? 

So in terms of formation, obviously regulators need information from their constituencies and from the business groups. That information should be forthcoming, full, creative and ideas generated in a cooperative way. Once the regulations are on the books, you don't exploit legal loopholes, you don't look to do end-runs around them, you don't try to engage and take advantages of vagaries in law, but rather you comply. You put in compliance programs as well as cooperate with the spirit that underlies the regulation. And finally, if you discover that there are problems with the regulation, work with the regulators to reform those regulations. And essentially that was Bowen's definition of corporate social responsibility circa 1953 or '54, which really wasn't that different from what Berle and Means had said it was just more expanded. 

The next speaker that is sort of in this list of academics that have written on this topic that is also well known is a fellow by the name of Keith Davis. He was a professor out in California. And he penned this thing in 1960. He called it the "Iron Law of Responsibility." And he said, "You know, I think that Bowen is being a little optimistic to think that business people can be that cooperative because they're going to be seduced by huge opportunities to make money. They are going to have all sorts of rationalizations at their fingertips and unless somebody is going to really be looking over their shoulders, I'm not so sure that voluntarily cooperating with the regulatory process isn't a little bit of, pollyannish thinking." 

So he came up with this argument and the argument was, if you don't cooperate in business we have social expectations and you will get more regulations. And of course in the '60s and early '70s he becomes prescient because during the '60s and '70s we get everything else regulated. So half the stuff is regulated by 1954. By the time you get to 1974, everything is regulated. There isn't any aspect of the business interface, if there is these days that isn't subject to regulation. 

There are 23 major federal regulatory agencies out there and every single interface is regulated. There's the Environmental Protection Agency, the Food and Drug Administration, the Securities and Exchange Commission, SarbanesûOxley Act, Interstate Commerce Commission, Occupational and Safety Health Act, Equal Employment Opportunity Commission. Most of that stuff is responding to some sort of a scandal. So you have the Cuyahoga River is on fire you get Environmental Protection Agency. You wind up having the Corvair or the Pinto unsafe at any speed and you wind up getting National Product Safety Commission. 

So but to, ultimately what you have now you have some kind of civil rights act that's not being cooperated with, you'll wind up getting Equal Employment Opportunity Commission. So by the time you get to mid '70s, there really isn't anything left to regulate. Everything is regulated. Alright? 

So if everything is regulated then what is social responsibility? What are the ethics in that regulatory environment? Well, we're sort of back to the proposition - let's cooperate with the regulations rather than fight them. Now there was another voice in 1972 named Milton Freedman, a very thoughtful fellow, - he's passed away recently, but he's a Nobel Prize winner, economist from Chicago, a very well-known fellow. A libertarian; wrote a great book on liberty if not more, more than one perhaps. And he also addressed corporate social responsibility in a little essay that he put in the New York Times Magazine, which was, I think, designed to maximize his exposure. And it certainly has gotten a lot of exposure. 

And essentially if you read Freedman, what Freedman's article says is something that is pretty uncontroversial. He just says that if you're an executive for an organization, for a corporation, then your moral and legal obligations are exclusively to shareholders. I'm not so sure anybody disagrees with that. I don't disagree with that. Bowen didn't disagree with that. Keith Davis didn't disagree with it. But this other part of Freedman's formula: "subject to law and ethical custom," and if ethical custom includes a robust obligation to cooperate and not exploit legal ambiguities and loopholes, then you get a pretty robust call for corporate social responsibility, even out of Milton Freedman. 

Now pardon me, I'm an academic. I'm going to give you one more academic source and that is in 1975 we get another book written, this is by Preston and Post, Lee Preston and James Post. And it's called, "Private Property and Public Management," in which they sort of explain the entire interface between corporations and public policy. How you can manage the corporate liaisons and compliance programs and so forth. How you can responsibly coordinate with the regulatory environment. 

To me Preston and Post basically writing in '75 or '74, whatever it was, is really the last word on the topic. And if you go through all five of those folks you get pretty much harmony. There's really most, basically the proposition is maximize profit, yeah, but you've got to maximize profit legally and maximize profit ethically. And if you maximize profit those two ways then you're behaving in socially responsible ways. 

I think oftentimes social responsibility is presented as if there's a debate. I think that that's wrong. I don't think that there is a debate. I think that it's... there are some things that you can get some consensus on. Course the devil's in the details and you could ask, "Well, what exactly does it mean to cooperate with the public policy process?" Trying to get at some of the details, let me... 

I want to address four topics that are related to this social responsibilities or ethical responsibilities in regulatory process. The first is to talk a little bit about why people obey law. Secondly I want you to reflect upon what is it meant for a law to have a loophole. What do those loopholes mean? And then ask is there anything wrong with taking advantage of a legal loophole? Third I would like to talk about what is an underenforced law? What does it mean for a regulation law to be underenforced? And is there anything ethically wrong with taking advantage of an underenforced law? And then finally reflect a little bit on civil disobedience. Ask yourself if you're in the business context, can you pick and choose amongst regulations as to which ones you might comply with, which ones you might cooperate with and which ones you might evade based on some kind of a hierarchy of a particular law in question? 

Okay. I'm going to give you some thoughts on each one of those questions as we go along. If you have any questions I'm going to try to leave ten minutes at the end. So you might jot a question down and you might ask later and I will sort of end this the last 15 or 20 minutes or so with an extended case study so we can pull this all together. But I'm going to start with a little bit of an overview with regard to each one of these four topics.

Let me start with why people obey law. Okay there was a book written in 2003 by a fellow by the name of Tom Tyler and the title of the book was "Why Do People Obey Law?" What the book was, was a collection of a reporting on empirical studies that have asked that question. So Tyler went to about 200, and I think it was more like 350, empirical studies on, why do people obey law? Sociologists, criminologists, economists, a lot of its behavioral type of experimentation as well as statistical analysis. 

And he came up with the proposition there are two basic reasons why people obey law. One's called normative and the other one's called instrumental. These are the words that he used. Okay? Normative. Normative stands for the proposition that people obey law because they think they ought to. They just feel a social obligation to obey law. Hopefully it's ingrained in their habits because they just think, "Hey it's law; I ought to obey law." And if you ask... And that's sort of the baseline proposition. Sort of the baseline normative proposition. You obey law simply because it's law and it deserves respect. 

If you go to philosophy and political philosophy and you ask what are the reasons people obey law? There's almost complete widespread support for the proposition that law ought to be obeyed. There are a few philosophical anarchists who don't believe that law deserves respect at all. But they're pretty minor and in philosophy you're going to have dissent somewhere. Right? But most virtually everybody is on the proposition that at least as an a priori, first step we ought to obey law just because law is law. 

You can justify that on some kind of social contract theory. You can justify that on utilitarian analysis. You can base it on some ontological reasoning like John Rawls might that there's a presumption that we ought to all support reasonably just social institutions. But regardless of how you... or virtue. But there's all different ways that you can support the duty to obey law, but it's pretty, thank goodness, it's pretty widespread that people think, "Well law deserves respect." Therefore one reason I obey law is simply because it's law and I'm in the habit and I think people ought to obey the law. 

Now beyond that there is also the notion of that there are different laws deserve more or less respect based on their pedigree. So if you have a law that you find morally repulsive, you might even engage in some civil disobedience. Other laws that you think are extremely important you're going to be very willing to cooperate and even, you know, do whatever you can to improve that law. 

Then there are laws that you know, you respect, but they're kind of in the middle. Perhaps you're more complying with, but there's this notion that there are pedigrees to law. Again, this is coming out of the empirical work. Alright? Now in terms of pedigrees. Pedigrees take two forms. 

One is there are procedural pedigrees and there are substantive pedigrees. What a procedural pedigree refers to is, does the person that's considering the regulation and their attitude towards that regulation respect the process that generated the regulation? Was the process open? Was the process well thought out? Did they have an opportunity to come in and contribute to the process? Was it legitimate? And to the extent that it seemed legitimate then it has a higher pedigree. 

On the other hand, there are some regulations where you may, as a business person, feel as though some other competitor who you have is well-positioned and they're using the regulation as a weapon. To stick a regulation that's more costly on you than on them so as to create a competitive advantage. 

Now if you are involved in, and that's called the capture theory, and if you brought in most economists or political scientists to speak capture theory is pretty widely adopted. At least in political theory as to how regulations are actually made through the legislative process. But if you are in a situation where you don't respect the process that generated the regulation, then it has a lower procedural pedigree. 

There's also substantive pedigree, substantive pedigrees has to do with, how important is the regulation? For example let's say you have an environmental regulation that says you have to reduce the output of a certain compound, let's make it compound "Z". Putting out a compound Z and compound Z you have to reduce it from 25 parts per million down to ten parts per million. That's sort of costly to you. The question is well, how much substantive pedigree does this regulation have? If that regulation is designed to prevent human birth defects and it makes sense that it will actually reduce human birth defects, I think that has a very high substantive pedigree. You're most likely going to cooperate with that one. 

By contrast if you had a regulation that is trying to protect migratory bird habitat, okay I'm going to comply with migratory bird habitat because it's got a baseline pedigree and it's legitimate, but I'm not going to be as excited about trying to cooperate with protecting migratory bird habitat as I am in trying to protect unborn children. It just doesn't have as much substantive pedigree. Okay? 

So again, this is not me speaking, this is the literature. This is Tom Tyler collecting 350 empirical studies as to why people obey law and the argument is that there's a baseline motivation and there's also a pedigree motivation. Both of which feed in to the normative aspects of why we obey the law. Okay. 

Now, in addition, there's also instrumental logic. Instrumental logic is sort of the crass calculation of cost benefit, like an economist might do. You just say to yourself, "Okay what is the chances of getting caught? What are the penalties? How much money can I make if I break this law?" Okay? And if to the extent that it's enforced and there are penalties, you go to jail if you don't do it. Then you're highly motivated to obey the law. 

Think in terms of driving on the highway. Driving on the highway, you're going from Oklahoma City to Tulsa. The speed limit on the turnpike is 75, I believe. Okay? If I'm not in too big of a hurry, I'm going to probably go 75. Okay? On the other hand, if I have some really important thing to do when I get there and I'm running a little late, I personally might push it up to 81 or 82. 

Why wouldn't I push it up to 95? I'm afraid of getting the ticket. Okay? So somehow it has something to do with you have both. I recognize that this is a legitimate law. I know it's important to be safe. On the other hand, it's sunny and there's not a whole lot of cars around here and I'm doing these calculations and I'm bringing in both my moral obligations as well as my instrumental calculus. 

Now most of the time, in terms of laws, fortunately, instrumentally, you have to obey them otherwise you're going to get hit with a penalty, so you have strong instrumental reasons to do so. Plus, you hopefully agree with it, and it has a very strong moral and procedural pedigree and you're a law-abiding citizen. And you have no real tension or any confusion as to what you're going to do. You're just going to obey law. But where it becomes interesting to think about what's going on is when there are splits between the instrumental logic as well as splits between the normative motivations that the person might indeed have. 

The second question I want you to think about -  again we will come to a case study where we can revisit these topics -  is... I'm sorry. Is the topic of a legal loophole. Okay I want to... there's a lot of words up here and I'm going to read them to you, but then I'll summarize it. Okay? The words say, "What is a legal loophole?" 

A legal loophole is an imperfection in the linguistic formulation of a legal text, a legal text is like a regulation. So it's an imperfection in the way... the wording of a regulation... whereby a literal interpretation of that regulation conflicts with a definitive interpretation dictated by the good faith application of formal legal reasoning techniques. 

There's a... legal reasoning techniques you have for reading legislation. It includes balancing literal with purpose of the regulation. And if you have some sort of a good faith interpretation of that regulation and it conflicts with the literal interpretation, then that conflict between that literal interpretation and purposeful interpretation is called a loophole. Okay? 

Or if more simply the letter and the spirit of the law conflict. Which is when people usually think about it. But I'm just... I'm giving it a little more technical definition. You're taking a regulation, you're reading the regulation, and you find a way to violate its intent, but live to its letter. That's a loophole. 

Now this can happen in one of two ways: either the language is too narrow or the language is too broad. Let me give you an example of narrow language first. I'll call it "compound XY." Okay we're back to our regulatory apparatus, you're generating manufacturing process or mining process, you're generating emissions. Environmental Protection Agency comes through and lists certain emissions that you have to reduce their output. 

If you don't take any kind of scrubbers or do anything to try to get rid of these emissions, you're going to produce 25 parts per million. Environmental Protection Agency says you have to reduce compounds X, Y and Z to ten parts per million. If you don't, then you have to pay a significant fine. Okay? That's the regulation. 

Alright, a clever engineer comes to you, you're the executive and says, "Hey Mr. or Mrs. Executive I have an idea. I know it costs a lot to get X and Y down to ten parts per million, but I got a way to combine X and Y into XY, it's almost costless and it's not on the regulation." 

And then you ask - I don't know if you write this down, you might shred the documents if you do - but then you ask, "Well, does it have the same effect on the environment as X or Y staying alone?" And the environmental engineer says, "Yes it does, but it's not on the list." Okay so now you do a calculation... That's a loophole. That's a situation in which the letter of the law... the spirit of the law is obvious, well not obvious, the purpose behind an environmental regulation... 

By the way, you know what the purpose behind an environmental regulation is? Purpose behind environmental regulation, the first reaction that you'll say is, "protecting the environment." Okay. That's not the purpose. The purpose is to draw a balance between the need for a pristine environment and the need for a productive economy. 

So all regulations already have balances built into them. I mean if you want to completely protect the environment, you just stop all automobiles. Well, we don't want to stop all automobiles. We think productivity is good. Wages are good. Therefore we have some kind of a balance built into it. 

Okay so with regard to XY, what's happening is if you do the balance calculation in your heart of hearts, you say to yourself, "I need to go down to... I don't' need... I shouldn't be putting out XY. In fact what I probably ought to do..." what should you really do? Maybe go to the regulators and say there's a gap here. But you have an economic opportunity to exploit the gap or the ambiguity or in this case the too narrowly draft language and put out XY. 

Okay now in my example here, what's going to happen is my executive is going to go with XY to make money. And then what happens is the EPA discovers it and they file a violation anyway; hit them with a fine. And now the lawyers are walking in trying to argue that, "Hey wait a minute. We just lived to the letter of the regulation, what's wrong with that? And if there was a gap in it that's not our fault, it's the fault of the regulators. It didn't have XY in it. It didn't say we couldn't transmute X and Y to XY, and nowhere were we under an affirmatively explicit obligation to come forward with these particular activities?" 

The EPA walks in and says, "Now wait a minute. The only reason you went to XY is to try and circumvent the regulation. You know the purpose of the regulation is to protect the environment or at least to strike a balance. And that balance said X and Y should be reduced. It was produced through proper procedures, you were fully aware of it and you should be cooperating. Not trying to circumvent that regulation." 

Now my question for you is, "Who wins that argument?" If you have that argument in front of an environmental judge... some kind of administrative judge, who winds up winning that argument? How many people think the company wins the literal argument? How many people think that the EPA wins the purposeful argument? Okay, and most of you didn't vote. 

(laughter)

Dr. Ostas (continues): I actually... I agree with the people that didn't vote. 

(laughter)

Dr. Ostas (continues): Because I don't know who wins this argument. Sometimes the literal argument wins. Sometimes the purposeful argument wins. As a lawyer what I would say to you is I would need more information. And in particular what I would need to know is some things like for example, is this regulation harming migratory bird habitat? If so maybe the company wins. But if it's harming unborn children, the EPA wins. So one question I would have is what is the purpose that underlies the regulation? The other thing I would ask is who's the judge? Who appointed him? Is this judge somebody that's there to protect business? Because I'm a little bit critical too on the side. Or is this judge a knee-jerk liberal that loves the environment and loves birds? And if you know the identity of your judge, you know the moral saliency of the law, you know, some other things like who's got deeper pockets in the argument then you can sort of predict who wins. 

Now the question is, if you're a lawyer, you have to walk in and represent either the EPA or your business. So there's no question you're an advocate. So if you're an advocate you argue literal if it serves your client and you argue purposeful if it serves your client. But the interesting question is from the point of view of the executive. Now the executive isn't an advocate. In fact, they're doing public policy analysis on the front end for compliance. 

Somebody has come to that executive with this and are they going to live to an extreme interpretation of the regulation just because it wins or are they going to restrain themselves? That's one of the questions that's incumbent in legal loopholes. To what extent are you to live to a balanced interpretation and to what extent do you do you live to a more extreme interpretation? 

The other example I have here for you is the example of a broad-based language. The language with regard to X and Y is too narrow. There was a gap in it. You were able to circumvent it. But it's also possible to have language too broad. And a good example is the Americans with Disabilities Act. Americans with Disabilities Act was enacted in roughly '91 or '92. 

Believe it or not I think that it got 98 or 99 votes in the U.S Senate which today seems almost impossible. That was Clinton era and it wasn't a great love of Clinton either, but it seems like everybody knows somebody who has a disability, you know it was kind of hard to be against Americans with Disability Act. But one way in which the legislation got through was it has all sorts of very broad language in it. It says things like, "major life impairment." It has things like "undue hardship." It has things like "reasonable accommodation," and none of those terms were well defined in the act. That's how you get 99 votes. 

And it was sort of punted to the EEOC through regulations to try and figure this out and to the courts as they went along. A second example of an imperfection of law, of legal language, is when language is very broad and requires interpretation. Now if you are an executive and somebody comes to you and says we've had a request for reasonable accommodation for someone who has an impairment of a major life function, at least allegedly, but it's kind of a gray area case. I'm not sure whether this would be undue hardship on the business or not. 

If you are oriented toward advocacy then you'll just say, "Well what can we get away with? You know, do... can we... do we have to give this person this or not?" On the other hand if you're more responsible then perhaps what you'll say is, "What is the purpose that underlies the act? Perhaps we should cooperate with it and come up with a balanced argument rather than an extreme argument." So again its sort of the ethics of legal interpretation. 

No Audio: Underenforced Law û Cost effective to evade: too few police, too easy to hide, penalties to low. Wrong to take advantage?

Underenforced law. What does it mean for law to be underenforced? Law is underenforced in situations in which it's cost effective to evade it. You do an economic calculation, you're driving your car, you say, "Well should I go 92? Should I go 82? Should I go 85?" And you're trying to figure out, what is the likelihood of the penalty? That's in part how many police there are out here. If there are very few policemen around then it's more cost effective to evade. Can you hide? Can you pollute at night? Can you shred documents? Can you put your money in a Swiss bank account and entangle it in a web of corporate interlocking directorates? Are there ways to somehow circumvent the law because it's easy to hide? 

Or is it possible the penalties are simply low? And if the penalties are very low, you do a calculation and you say, "Well, what the heck? The chances of me getting caught are kind of low and even if I do get caught, I ain't going to prison for this and the fines are not really enough to really dissuade me." That's what I would call a underenforced law. 

The classic example of the underenforced law in the law reviews these days is the hiring of undocumented workers. There's 11 million undocumented workers in the country today. And 2003 was the ebb. There were like 23 prosecutions of employers nationally. Twenty-three when there's 11 million workers. Now it has gone up since then and it's not quite as dramatic. 

But if you ask, how are all of these undocumented workers finding jobs? And it's because the employer finds that the law is underenforced. It's underenforced in part because the fines are so low. When you read the regulation, the third offense it's a little stiffer, but the first offense is $250 per worker. Second offense is $500 per worker. Third offense is like $2,000 per worker plus you could actually go to jail for a little bit of time. 

But if you haven't... you're an employer and you're knowingly hiring an illegal worker, undocumented worker. If you have zero offenses, and you calculate $250 and you say the likelihood of me being caught - you might do a cost benefit analysis and say well this would cost me $2.50 - or how much do I make by hiring this person? I make more money. I pay them less, and less benefits and so forth, and there's a lot of economic incentives to hire the... they're hard workers, they show up, they don't complain and there's a lot of reasons they do work that Americans don't really oftentimes want to do. So you do this kind of calculation and you wind up finding that the law is underenforced. 

Another classic example of underenforced law is the income tax. Right now there is a federal income tax revenues are about $1.3 trillion a year. Okay? The IRS estimates that there is $300 billion worth of tax evasion per year. That comes in two sources primarily. One is the use of illegal tax shelters overseas. That's about half of it. The other half of it is under-reporting of self-employment income. So you're getting paid in cash, you'll get a tip or alternatively you're doing yard work and you're getting paid in cash, and you under-report that income. 

But that would be an example of law where you do a calculation and you say, "Hey, if I don't report this I'm going to make, you know, 100% and if I do report it I'm going to make, you know, 80% on the dollar and so I have a strong incentive not to report this." And it's kind of tempting if you look around at social norms to say, "Okay I'm not going to report all my tips," or whatever it might be. But that's an example of underenforced law either because it's too easy to hide or it's too easy to take advantage. 

Another good one, just looking at my notes, is insider trading. Insider trading is very, very difficult to ferret out and to prove and if you do a calculation on insider trading it's probably pretty hard to resist the temptations presented in that particular context. 

Okay, finally with regard to these four questions is... I want you to think about whether it's ever justified to evade a legal rule. One way of thinking about this is in the talk of civil disobedience. Civil disobedience has a long history. You go back to the Bible and you find history... the way that the Pharaoh said the first born Hebrew child had to be massacred and the Hebrew midwives smuggled Moses away in a basket to save his life. That was civil disobedience. Civil disobedience of an unjust law of the Pharaoh. 

You go up to Greek tragedies, Sophocles wrote Antigone. Antigone... Creon, the King, tells Antigone that she is not allowed to bury her brother, Polyneices. She finds that abhorrent so she winds up burying Polyneices at night, gets captured, there's a trial, 353 B.C. They're discussing, who do you have more obligation to? Sophocles wants to think about, is it to God and natural law or is it to man-made law and Creon? And ultimately the protagonist in the story is Antigone, not Creon. And although Antigone dies via this tragedy, everyone dies in Greek tragedies. But it is at least an exploration of the topic of, is it okay to evade a regulation you find abhorrent? 

Maybe more recently you have violence combined with the Boston Tea Party, the patriots in Boston Harbor who engage in civil disobedience. Harriett Tubman obviously is a hero, not a villain, as is Mahatma Gandhi resisting British rule or Martin Luther King, Jr. more recently. But all those folks are portrayed as heroes.

Now the question is, is in... if you were talking about a business context, does a business person, an executive or a sole proprietor or a shareholder have the authority to engage in civil disobedience? Now in trying to find examples of civil disobedience in a business context, you typically do not find regulations that are emotionally charged. 

You know, it's not turnover run away enslaved people. It is not give up the first born child or to be slaughtered. It's something more where the law is not so much unjust as it is inane. There's some kind of a regulation out there and the business person looks at it and they say, "You know, this regulation is not unjust, but it's really silly. It's just wasteful. And by the way, if I didn't waste money filling this dumb regulatory obligation, you know what I was going to do with the money I would have made? I was going to reduce illiteracy in downtown Philadelphia. Well, I guess those people just won't ever learn how to read will they? So I can follow your regulation." 

Okay now the question is if you have an inane regulation, is it okay to violate it? Particularly if you find it has a gap in it like a loophole, or an ambiguity in it that you could argue both ways, and perhaps you do a calculation where it looks like because it has a gap and an ambiguity, if you do get challenged with this you can always plea bargain or something because you have an argument. So it looks like it might even be underenforced. And what are the temptations to look at regulations you consider to be inane and to at best comply, but certainly not cooperate and possibly even evade. 

Now I'll give you a couple of examples. One example... both of these I got out of executive education settings. So somebody in the audience gave an example of an inane regulation when I asked for one. Both of them will remain anonymous because they very well may have violated those regulations for all I know. 

But the first one is the sprinkler story. And the sprinkler story was, there was a sprinkler system regulations from the fire marshal that specifies that you have to have a sprinkler in your manufacturing plant based on number of people and square footage. Okay? This particular plant was making wire, it had a concrete floor and a metal apparatus around their structure. The executive felt as though it was really overkill putting in a sprinkler. 

Now the question is if you're in that situation do you fight it? Or not fight it? The second example is the Oklahoma burying beetle. This executive heads typically oil and gas industry. You'll hear about, you run into an Indian arrow head or alternatively a burying beetle you have to shut down production on the oil site while you get permission from the EPA to move the darn beetle. Well that can be pretty costly. 

You might consider it inane. I think I might consider it inane. But in any event the oil and gas company might say, "I'm not really that fond of Oklahoma burying beetles, and if you want... now I know there's an obligation because law is law and I know it has a legitimate pedigree. But I also recognize that this pedigree is not as salient as protecting unborn children." And that perhaps there's at least an incentive to try to evade inane regulations. 

So this proposition that we ought to all cooperate, well at least business people ought to cooperate, with the creation, implementation and reform of business regulations, and those business regulations aren't pervasive and all encompassing, although that may be fairly unambiguous, maybe even get some consensus on that. 

There's some devil in the details and some specific things that are probably worth thinking more about. To try to flesh that out a little bit more let me tell you, going to give you a case study. I'm going to call it "exploring the rules of the game". Okay. I have a quote here. This quote is... I got it out of the newspaper. We got it out of the Norman Transcript actually about three years ago. It was an AP story. 

And it was a quote from a NASCAR Crew Chief. His name happens to be Todd Barrier. And he was Crew Chief for Tom Harvick's NASCAR car. Okay. And he was responding to an AP reporter's question and the answer says, "If I had it to do over again, I'd still play it to get away with it, because I know how I got caught. I could tell you several ways I'd have gotten away with it." Okay this guy got caught cheating and his response was, "Next time I'll do it better so I won't get caught." That was his answer. Okay?
 
Well because I talk about these things I'm reading this thing and think, ôWow, that's really an aggressive response.ö What rule did he violate? Well there is a regulation in NASCAR that says when you're qualifying for the race at your time trials you have to operate your vehicle with a full gas tank. Okay? What this Crew Chief did was he put a balloon in the gas tank so it dispelled the water, or the gasoline rather, or fuel, and when you open the can, the tank it looked full, but it was mostly air. 

Now why would the guy do that? He did that because it reduced the weight of the car and when you're talking about just infinitesimal speeds can make a difference between getting the pole and not getting the pole, it gave him an edge. Okay, now when regulators discovered it, and instead of saying, "Oh I'm sorry, how embarrassing," he said, defiantly, "You morons! I could get away with this if I wanted to." Well throw out the word moron, but it was essentially his attitude. 

Okay now my question, and oh by the way he suffered a penalty. The penalty was he got fined $25,000, the owner of the car got fined $25,000 and the Crew Chief got suspended for four races which is probably a significant amount of money. I think he got suspended without pay. 
And in addition the car driver and the owner of the car got docked some points in the national standings. So there were some penalties associated with it, but he was still defiant. Now my question for you folks is, why was this guy so defiant? 

Audience Member: (inaudible)

Dr. Ostas (continues): Because why?

Audience Member: Because everybody else does it. 

Dr. Ostas (continues): Well maybe it's because he thinks that everybody else does it and does everyone else do it? And the answer that I'm looking for has something to do with culture. What is the culture of NASCAR?

Audience Member: (inaudible)

Dr. Ostas (continues): It's fairly aggressive right? So if this guy is cheating maybe the other guy is cheating, too. Where does NASCAR grow out of? Bootleggers. How much respect for the law do bootleggers have? The whole point of being a bootlegger is you have no respect for the law. If you're a bootlegger you... what is it? Smokey and the Bandit? The guy that is chasing away from the police and that's the culture that you come from. 

Now if you're coming from a culture that has a very aggressive attitude toward regulations, then it's easier to be able to be defiant afterwards. Now, in terms of why does this guy obey law or not obey law, how much normative respect does he give to the regulations of NASCAR? None. Zero. Zip. At least with regard to gas tanks. Can you think of some regulation that he might have some respect for? Safety. 

Now if it has something to do with the safety of himself or the other drivers maybe he restrains himself. But when it comes to qualifying speeds - no holds barred. It is whatever you can get away with. And this guy is over here doing an instrumental calculation. 

He's trying to figure out how much better can I improve the speed of the car? How many dollars is that worth? What's the likelihood that I'll get caught? What are the fines and suspensions and he just does a purely instrumental logic. And if it's enforced, then he obeys it. And if it's not enforced or likely to be enforced, then he doesn't obey it. 

Now in terms of economic incentives this guy has, do you think he's more likely to get a job in the future being a NASCAR Crew Chief if he's defiant? Or if he comes and goes, "Oh I'm so sorry. I would never do that again." I would argue that maybe he gets a job in the future if he's defiant. 

I mean if I'm a car owner in NASCAR, I might want to hire a guy that's willing to take a chance. I want him to be smarter than this guy and I may want to restrain him if he's ultimately doing something that's dangerous. But if it's just winning the race, this is NASCAR guys. So that's our culture. That's the argument. 

Now did he actually do something wrong? Yeah he did because when he signed on to those regulations, he swore to abide by them. That's perjury. That's some kind of... that's lying. And in addition if he cheats, he's clearly cheating, and not only did he cheat and lie, but he wound up stealing. So thou shalt not steal, thou shalt not bear false witness, at least that's two commandments this guy violated, right? But he's arguing that within that context, "Yeah but it's depending on culture and in this culture we are aggressive." Okay? 

Now what he essentially has done here is he has said that the regulations from NASCAR are a price rather than a prohibition. He's done a calculation, an economic calculation on instrumental logic and he has decided that what I'm going to do is if I can get away with it, I want to violate the regulation and if I can't get away with it, then I'll abide by it. The law to Mr. Barrier is strictly a price. There is no moral component to it. There's no normative side to it. 

Now the question is in various cultures of other games, are the rules prices or are they prohibitions? Price or Prohibition? Okay price again means if you can get away with it, it's okay to violate it. Prohibition means even if you can get away with it you shouldn't do it. It's just in and of itself wrong to do it, that's prohibition. Okay. 

Now let's try the first one, committing pass interference to stop a touchdown? Okay. Let me give you the context. We're all in Oklahoma so this will be familiar. So what basically happened is that... your defensive back, you're supposed to be behind the wide receiver, but the wide receiver has gotten behind you, the ball is in the air and it looks like it's going to be a touchdown. You got two choices: you can grab the guy, called pass interference, and maybe get a fifteen yard penalty. Alternatively, you could not do that because the rules say you're not supposed to grab him and he scores a touchdown. 

Now what is the defensive back going to do? He's going to grab the guy right? When he grabs the guy what's going to happen? Is the announcer on television going to condemn his ethics? No, he's going to say, "Don't let him behind you next time, but good thing you grabbed him." Right? In terms of the coaches, if the coaches went to the defensive backs and said, "Look, I'm trying... you are young men here at OU or OSU or wherever you are, and I'm going to try to not only instill good strong work ethic, but also some ethics towards rules and we will not voluntarily commit violations of the rules. Okay? Therefore I do not want you grabbing guys when they get behind you. Just let him get the touchdown." 

How long is that guy going to keep his job? He immediately gets... it's outrageous. I mean it would be all over the ESPN and so forth, just what a ridiculous statement because everyone is going to perceive this as a price not as prohibition. So you're allowed to do the calculation. Now notice, however, how slippery the calculation becomes. Because once you start saying rules are prices not prohibitions, that it's purely instrumental and there's no normative basis to rule obedience, then notice... well, what about hiding when you commit the penalty? 

You push the guy when you're going up for a shot so you push his hip a little bit to throw his shot off because you figure the referees won't call that. Or when you hold, you hold when you know they can't see it. Or you're playing golf and nobody's watching you, you improve your lie. You know, these are various situations in which the referee is not looking. And if you're going to do a calculation as a price, is it a price where you voluntarily take the fifteen yards? Or is it a price where you calculate the chances I could probably get away with it because no one will see it? 

And I would argue that in sports it's probably typically the latter. Because typically the coaches are teaching you how to hold without getting called for it. That you are engaged in this subterfuge so if you are going to commit the penalty, it's not an open penalty, it's a penalty that's hidden and you conceal it more cleverly. And what about the third one. 

The third one has to do with flopping. You know in the NBA just now... sadly we don't have any NBA basketball around here anymore. But we won't go there. At least not till next year. In the NBA now it used to be that there would be floppers. I happen to come from Indiana so I'm a big basketball fan. I love Reggie Miller. Reggie Miller was a flopper - he would throw out his legs and fall over. 

And Vlade Divac when he used to play against Shaq used to flop with Shaq when he started. He tried to fool the regulators into calling a foul. It's rampant in soccer. Try to watch World Cup soccer; they're just flopping constantly. Now in soccer the... actually the referee is empowered to try to figure out whether this was a flop or not a flop. And if they think you're flopping, the foul is on you and not on the other guy. But it's a tough call. 

But the idea is that when people do flop, typically on television, the announcer will say, "Good acting. Give the guy an Oscar." And I'll go... although you don't really like when the other team flops, when Reggie flopped I loved it. So it kind of depends on whose ox is being bored, but this idea that it's a price is slippery. Because it's a price that not only may be a little too low for fifteen yards but also can be hidden, you can also try to fool the referees in these examples. 

Okay now all of this has to do with games. Now the question now is, however, is what is the ethic or the culture of business? Are we talking NASCAR or just how aggressive is it? I'm going to give you another long quote. This quote is by two people by the name of Fischel and Easterbrook. Forgive me I'm going to read it but I'll explain what it means. It's in quotes. 

It comes out of the Michigan Law Review. It was written in 1982. Okay. It says managers or executives do not have an ethic - do not - have an ethical duty to obey economic regulatory laws just because the laws exist. Now notice they're talking about economic regulatory laws, saying managers don't have a duty to obey economic regulatory laws just because they exist. There is no baseline presumption for an economic regulatory law. 

What is an economic regulatory law? Well, inside trading is probably an economic regulatory law. Anti-trust is definitely an economic regulatory law. Trade embargo is probably an economic regulatory law. But let's stick with anti-trust. Basically what they're saying is anti-trust says you can't collude and you can't abuse monopoly power. That's an economic regulatory law. 

But you don't have to obey it just because it exists, according to these two folks. There's no presumption that you're going to try to obey economic regulatory laws. The managers must determine the importance of the laws. And the penalties Congress names for disobedience are a measure of how much it wants firms to sacrifice to adhere by the rules. Okay are these folks saying that law is a price, or law is a prohibition? Price. They're saying you can figure out the price and how important it is based on the penalty. And managers not only may, but also should violate the rules when it is profitable to do so. 

So these folks writing in the Michigan Law Review are saying you do economic calculation and if you can make money violating the law then you are unethical if you obey the law. You have to violate the law. Now if I seem a little outraged, I find this outrageous. I find it even more outrageous when I know who Easterbrook and Fischel are. 

Who is Fischel? That's Daniel Fischel. He was the Dean of the University of Chicago Law School when he wrote this. Who is Frank Easterbrook? He currently serves as the Chief Judge on the Seventh Circuit Court of Appeals. You know it's the United States Supreme Court and there are thirteen federal circuit courts. It's the second highest court in the land. This guy is the Chief Judge. He's saying when it comes to economic regulatory laws, if you can make money violating them, you ought to violate them. 

Now I have an excuse as to why they said this. Because I think it's a minority opinion. And thank goodness. But the, it is... I have a reason as to why they said it. It has something to do with the year. What year did I say it was? 1982. What's going on in society in 1982? Deregulation is all the rage. Okay? Ronald Reagan has come in as President, he wants to deregulate he's denounced snail guarders. He thinks government is the problem not the solution and we have disrespect for economic regulatory laws and beyond that, we love free markets. Okay? 

I got my start for the first 15, 20 years of my academic career doing law and economic analysis Chicago style, and that's all about doing economic analysis to understand law. I still do some of that although now more ethics stuff. But it's in that era, 1982, in which this is written in a law review. Now it was never a popular view. Just because it's up here doesn't mean it is the view, but it is something to think about. You know we have a judge and we have a Dean of a law school saying that it's okay to violate - and not only okay but that you ought to violate economic regulatory laws if you can make a profit doing it. 

You never can ask them, well what if you can hide? What if you can fool? Or do you have to volunteer so that price you have to pay is recognized in the statute. But is it? Or is it really the kind of prediction what's going to happen to you? Okay. In summary then, what I've tried to do is to take you through several questions associated with this, with these issues of legal compliance. 

And let me finish with one kind of last thought that might somewhat summarize this. Again I got this from an academic source. It's 2002, Lindsharp-Payne published this article in a journal of legal studies education. To which she was talking about the relationship between the law and economics. I'm sorry, between law and ethics. And she started, she described two different views. One is called the separate realms view, the second is called the interdependent view. 

With the separate realms view, the relationship between law and ethics says, is that law is one thing and ethics is another. That's the separate realms view. So you have legal questions and ethical questions. Then she went on and she said that, "You know, and when it comes to the two and you're a business executive, the legal questions are hard the ethics are kind of soft." 

Legal is objective, ethics is subjective. Legal is rigorous, law is intuitive. Legal is obligatory. Ethics is optional. Law is determinate. Ethics is vague. Law is factual. Ethics, opinion. Law, important. Ethics, less important. When I'm reading this I'm kind of nodding. Maybe that's because I am a lawyer and an economist. That's kind of the way I see the world. And then she did something that rocked my world. I look at the world now differently after reading her article. 

And what she said was, "But you know, if you're an ethicist, the roles are reversed." If you think about this in a proper context, the most fundamental obligations we have are ethical. And the only real reason that you obey law is because it's the ethical thing to do. You don't obey law simply because it's enforced. You obey law because you have an ethical obligation to obey law and to cooperate with law. 

It's actually ethics that's hard. When you're a lawyer you realize law is kind of soft. Ethics is objective. Law is sort of subjective; you can argue it either way. Ethics is much more rigorous. Law is more intuitive, you argue different ways. Ethics is obligatory, if you're talking to the pearly gates you better be pure ethically. Law is sort of optional. Ethics is determinate. Law is more vague. Certainly law is opinion. And ethics may very well be more factual. And I would argue that ethics is probably more important than law. 

There is also this interdependent view, because it's really true that there is a mix between law and ethics. That in part ethics is a function of law because we have an ethical obligation to obey law. But it is also true that law is a function of ethics because laws typically have some kind of moral component to them. So it's a little bit more complicated. 

But I guess what I'm inviting, what I invite my MBA students and you as well to do is to just think about these things, take it seriously. And if I can get my MBA students to go out in the world and take their regulatory obligations seriously and don't perceive it as something you can just find loopholes in and make end-runs around, I think I have earned my pay for the day. Okay that's my presentation. 

(Applause)

Dr. Ostas (continues): I think I have a few minutes if you have a question or two. Do I? Five? 

Audience Member: It's one but people may stay for the questions. I'm curious about what people might have to say.  But there's a (inaudible) stuff we can talk about now with the IRS. But when you're talking about the ethics and the law and the (inaudible)... What about the health care law where they went, "No pass the law.  We don't know what's in it yet, but pass it anyway." Isn't that kind of opposite of what you were saying?

Dr. Ostas (continues): I guess what I am really trying to invite people to do is to adopt a certain attitude. And the attitude has to come both from the regulated and the regulator. And it's hopefully it's a cooperative attitude. I can tell you that I did this presentation last year in Stillwater. One week I gave it to a bunch of oil and gas executives. And the next week I did it to a bunch of government regulators. It was pretty amazing the different responses I got from two different groups. 

(laughter) 

Dr. Ostas (continues): Business people all think it's all the fault of the regulators and the regulators think it's all the fault of the oil and gas folks. And I didn't see any cooperation. I was glad to be in my ivory tower where I could think about cooperation and not have to actually implement it. 

But to the extent we can budge people into thinking that regulators are not bad guys, then that would be a good thing. And to the extent that we can get regulators to think that the regulated entities are not bad guys, I think that would be a good thing, too. 

Audience Member: You mentioned the slippery slope when you were giving your sports examples. Where would you characterize us on the slippery slope in regard to the business ethics and probably specifically regarding the presentations you made in Stillwater? 

Dr. Ostas: Where do I see the slippery slope? 

Audience Member: Where do you see us on the slippery slope?

Dr. Ostas: Oh. You're asking me just how cynical am I, perhaps. It's hard to read the Wall Street Journal or even the Norman Transcript business page on a daily basis. - actually that's why I subscribe to USA Today business page - on a daily basis without getting cynical. It strikes me in particular that I sort of... 

I was reading a diatribe by Jim Hightower the other day in Frosty Troy's. I like Frosty Troy's publication that he puts out about local politics. And as Jim Hightower railing on Wall Street and I just think... 

I wrote a paper one time, this is an article that actually won an award. And it was called When Fraud Pays. And it documents, the beginning of that article, it documents that there is about $1 trillion worth of fraud in the American economy every year. Now we have a $13 trillion economy so it's only 8-9%, but still $1 trillion is a lot. And it just seems to me that the reason we have so much fraud is because fraud pays. 

And in particular if you're looking at some of the shenanigans that go on in big banks and so forth and on Wall Street and you look at how seldom there's any repercussions in terms of going to prison for the executives that are making this huge amounts of money, I think that it's hard not to be somewhat cynical. I don't exactly know what the solution is because it's hard to ferret out fraud and these people are fairly clever. I have some political ideas of my own, but perhaps I'll keep them to my own. 

(laughter)

(applause)

Dr. Ostas (continues): I think I set this for 60 minutes...

Connie Schlittler: Oh, it's at 55, yeah. I like to see you guys. We're going to try to do a special event in July if you're interested in working better with private foundations. (Inaudible) ...the summer but we're planning on having kind of a follow-up to Charise Johnson about, how can government and private foundations work better together to solve social problems? So be watching for that in your email and then you guys have received our schedule for the fall and I hope to see you in August as we start again. Thank you so much for being here. Very good. I really enjoyed that. Excellent. Excellent.