Vol 10, No 4 - Financial Planning Association of Malaysia

of a financial adviser is dependent upon
the perceived ethical standards of the
adviser. Although good intentions are
necessary for ethical behaviour, they
are not sufficient. Cognitive limitations
and biases, including the self-serving
bias, can lead to unethical behaviour
even when the intention is to be ethical.
Many people accidentally blunder into
unethical behaviour (Prentice, 2007). A
complicating issue is the tendency for
people to be overconfident about their
ethical standards. The self-enhancement
bias not only leads people to believe
that they are above average in their
abilities, but also that they are above
average in the maintenance of ethical
standards (Jennings 2005). If people
are overconfident about their ethical
standards, they may be less inclined to
critically examine their behaviour; “I am a
good person, so what I do must be ethical.”
Often people will rationalise unethical
behaviour in order to preserve a selfimage
of being ethical. Rationalisation is
alternatively known as self-justification.
Anand, Ashforth and Joshi (2005)
described some types of rationalisation.
They included denial of responsibility;
e.g. “It is not my choice, it is the way the
business operates,” or “The client makes
the final decision,” or “The law allows it, so
it is the fault of the government.”
Another rationalisation is denial of injury;
e.g. “I know the fund charges are high, but
the good fund management will more
than compensate.”
There is denial of victim; e.g. “The
client does not pay the commission,
the life assurance company pays it,” or
“Customers are clever, they are not fooled.”
There is appeal to higher loyalties; e.g. “I
have a family to keep.”
Another form of rationalisation is the
metaphor of the ledger; e.g. “The value of
my advice is greater than the value of the
commission.”
Colleagues and authority can undermine
someone’s ethical standards without the
person being aware of the process. There
is a conformity bias whereby people
conform to the values and behaviours of
those around them, including colleagues.
A person could unconsciously adopt the
unethical behaviour of others. Obedience
to authority figures, such as employers
and managers, can be a strong tendency.
Even when explicit instructions are not
given they may be inferred (Tetlock 1991).
Strong emphasis on sales targets could
be taken as implying that sales volume is
more important than other factors such as
business ethics.
The conformity bias can result in groupthink
(Janis 1982, Sims 1992). Groupthink entails
a uniformity of thought and values within
a group. In business settings, bonding
activities such as awaydays reinforce
groupthink. If the thinking of the group
were unethical, a new member would
tend to adopt the unethical thinking. The
concurrence of other group members in a
set of values could lead to the belief that
those values are ethical. Risky shift is the
tendency for a group to take bigger risks
than individuals within the group (Coffee
1981). Group action dilutes an individual’s
feelings of responsibility (Schneyer 1991).
The increased risks include increased
ethical risks. Clients might be advised to
make risky investments.
A tendency to advise clients to take more
risk than is appropriate could be reinforced
by the optimism bias. This can manifest
itself in an understatement of risk (Smits
and Hoorens 2005) and an exaggeration
of profit potential. The optimism reflects
genuinely held beliefs on the part of the
financial adviser. Corporate insiders may
provide over-optimistic forecasts because
they really believe them, rather than
because they intend to deceive investors
(Langevoort 1997). The same may be true
of investment analysts (Prentice 2007) and
financial advisers.
MacCoun (2000) suggested that the
chances of removing cognitive biases
from people’s thinking are very low.
One implication is that regulation, to
protect consumers from cognitively
biased advisers, is necessary. If regulation
improves client trust, everyone could
benefit, but regulators must also be aware
of behavioural biases.
The principles of behavioural finance
throw light on the effectiveness of specific
regulatory measures. For example, in
Britain financial advisers are required to
tell clients how much commission the
advisers expect to receive. Laboratory
studies have indicated that clients follow
the advice of advisers to nearly the same
extent as they would in the absence of
knowing about the conflict of interest.
Also, advisers seem to feel less compelled
to be impartial when the conflict of
interest has been revealed. The presumed
increased scepticism on the part of the
client is seen as reducing the need to be
impartial (Bazerman and Malhotra 2005;
Cain, Loewenstein and Moore 2005).
“There is a
conformity bias
whereby people
conform to
the values and
behaviours of
those around
them, including
colleagues.
Conclusion
Financial advisers would improve
their service to clients if they correct
biases arising from the psychology of
perception (perceived information), the
psychology of cognition (information
processing), and the psychology of
motivation (activation).
Keith Redhead is principal lecturer in
finance at Coventry University in the
United Kingdom. He has published nine
books including, Personal Finance and
Investments: A Behavioural Finance
Perspective (Routledge, 2008). He teaches
courses on behavioural finance, financial
services, and institutional investments.
12 The 4E Journal