Overview of the ethical problems facing Goldman Sachs
|Topics:||Business Ethics, Ethics, Investments, 💵 Finance|
Table of Contents
Matt, a management level executive of Goldman Sachs, is on the verge of making a decision on how to reimburse the agreed upon magnanimous payment packages to the group of eight highly salaried traders who had made between $1.5 billion to $3 billion for Goldman Sachs during the years 2008 and 2009. In this context, the main problem that Matt is facing is that owing to the financial recession, there was a widespread criticism and demand for reform in the pay structures across the global financial industry. The extensive criticism is directed to the practice of paying hefty bonuses to the traders by the financial institutes in case their risky investment succeeds. On the contrary, the traders are not subjected to any sort of penalty during instances when their hazardous investments fail. Instead, the bailout amount is paid out from the pockets of the taxpayers if in case the failure of the huge perilous investments leads to a crisis scenario like the subprime crisis (Martin & Scotto, “Bailouts and Bonuses on Wall Street”).
Hence, it can be observed that in both the scenarios the financial executives and traders have nothing to lose. Furthermore, the lack of disincentive or a negative consequence and the enormous amount of bonuses involved in the process facilitate and encourage the traders as well as the financial institutes on the whole to pursue making exceedingly risky investments.
The fact that Citigroup had paid a similar large amount of compensation to one of its traders, who had earned $2 billion for the company, had created much criticism amongst the public. In this scenario, the major problem that Matt would have to encounter is that if Goldman Sachs does not pay the concerned eight traders their due bonus of $125 million as per the contract, they might depart for other organizations, obtaining the clients with them as well. Besides, Goldman Sachs had obtained in excess of $10 billion in the form of taxpayer assistance from a federal bailout. Furthermore, the concerned group of eight traders had also played a significant part in the financial depression owing to their association with Financial Products group of AIG (Martin & Scotto, “Bailouts and Bonuses on Wall Street”).
Justification of the Analysis of the Ethical Problems of Goldman Sachs
As already cited in the assessment of the ethical problems encountering Goldman Sachs, there are numbers of moral hazard issues in this context. The first instance of ethical hazard is the fact that the traders are paid cash bonus for making risky investments. There are no downside risks for such traders because even if the investments made by them became unprofitable in the future, they had nothing to lose. Similarly, the mortgage companies had provided loan to doubtful homeowners without proper due diligence, accumulated their share of commission and passed the hazardous and unsafe mortgages to other banks. Since the mortgage companies did not have to bear any negative outcomes related to the inclusion of risky loans, they had no inducement to ascertain that the mortgage loans they initiated were safe. Above all, the most significant instance of ethical hazard is when banks are provided with federal bailouts as in such occasions their positions became unprofitable. This is because while the banks could earn huge amount of earnings as a result of their exceedingly risky positions, they were considerably protected from the negative outcomes of their investment position owing to the government support. These instances raise major ethical difficulties for Goldman Sachs (Martin, “Bailouts and Bonuses on Wall Street: Teaching Note for BRI-1007”).
Recommendations for Goldman Sachs
Prior to the assessment of the options available to Matt and Goldman Sachs in order to respond to the demands created by the ethical issues already discussed, one needs to understand, who are the parties that Matt should take into account and whom does he and the company have responsibility to. Goldman Sachs is expected to pay the traders their bonus amount, as per the contract between them. Goldman Sachs could have postponed the bonus payment worth $125 million to the traders, provided the financial performance of the company was not reasonable. However, it can be validated from the profit margin figures of Goldman Sachs that the profit margin of the company has been much higher than that of other companies like JP Morgan Chase, Morgan Stanley and Bank of America (Martin & Scotto, “Bailouts and Bonuses on Wall Street”). Hence, considering the relatively reasonable financial performance of Goldman Sachs, the non-payment of the bonus amount to the traders would lead to the breach of contract between the traders and the company. Moreover, if Goldman Sachs does not pay the bonus amount to the traders there is a probability that the traders would leave for some other organization. As a result, Goldman Sachs would not only lose a few of its best traders and also a certain percentage of their clients, since it is likely that the traders would take along some of the client with them. Furthermore, the payment to the traders for their superior past performances would be in alignment with the industry standards. Additionally, if Goldman Sachs holds back the bonus amount payable to its traders with the consideration of economic condition, other financial institutes would also be under pressure to respond correspondingly.
Being a responsible financial organization, Goldman Sachs has certain obligation to the government and the taxpayers as well. However, it should be noted that though the company had received Troubled Asset Relief Program (TARP) funds from the federal government during the financial crash, it had paid back the amount to the government with interest.
It should however be noted that though it is true that Goldman Sachs has obligation towards the Government and the society as a whole, its primary obligation as a financial institute is to conduct business, provide loans, and offer consultations in financial strategies to its clients. Moreover, as an employer it is the responsibility of Goldman Sachs to compensate its employees, i.e. the traders in this case, on the basis of their performance. However, in order to fulfil its social responsibility, Goldman Sachs in association with other financial institutes should consider revising the upcoming bonus structures for their employees. Additionally, these organizations should hold their executives accountable to an extent for any failure of their deals, just as they are paid munificently for the deal’s success. Hence, it is recommended that Goldman Sachs pays its traders the due amount and subsequently considers revising the pay structure and the involved moral hazards in the near future.
Justification of the Recommendations
The two most common approaches in the process of ethical decision making are the utilitarianism theory and the deontological theory. The utilitarianism theory also known as the ‘consequentialism’ was formulated by Jeremy Bentham and John Stuart Mill. This theory characterizes the ethical goodness of acts by their outcomes (Smart, J. J. C. & Williams, B., “Utilitarianism; For And Against”). The utilitarianism theory differentiates between good and bad acts on the basis of the contentment produced by the outcomes of the acts. According to this theory, those acts are considered to be correct that generate maximum contentment for the utmost number of people. Thus, the utilitarianism theory prescribes that, once in a while, personal interests of certain individuals can be forgone for the overall good of larger number of people.
The deontological theory is often referred to as the theory of duties and was formulated by Immanuel Kant. This theory differentiates between right and wrong by accentuating on the observance of duty as the chief indicator of moral rightness (Frankena, W. K., “Ethics”). The actions and behaviours are considered to be right or wrong on the basis of the intentions behind those actions and not by the end results. Thus, as opposed to exploring the outcomes of actions as in the case of utilitarianism theory, as per the deontological theory the selection of the act is examined. Hence, the recommended strategy of paying the due amount of bonus to the traders is in line with the deontological theory because as an ethical employer, it is the duty of Goldman Sachs to pay the promised bonus as per the contract. Whereas, the recommendation to hold the traders accountable for the success or failure of the investments made by them and the strategy to revise the pay structure of the employees in future, are aligned with the utilitarianism theory.
- Frankena, William K. Ethics Prentice- Hall, 1973.
- Martin, Kirsten. “Bailouts and Bonuses on Wall Street: Teaching Note for BRI-1007”. Business Roundtable Institute for Corporate Ethics. (2010).
- Martin, Kirsten. & Scotto, Michael. “Bailouts and Bonuses on Wall Street”. Business Roundtable Institute for Corporate Ethics. (2010).
- Smart, John Jamieson Carswell & Williams, Bernard. Utilitarianism; For and Against Cambridge University Press, 1973.