Chasing the greased pig down wall street: A gatekeeper's guide to the psychology, culture, and ethics of financial risk taking

Cornell Law Review

Volumn 96, Issue 5, 2011, Pages 1209-1246

  Langevoort, Donald C ^a  

^a GEORGETOWN UNIVERSITY LAW CENTER   (United States)

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[No Author keywords available]

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EID: 80054101130     PISSN: 00108847     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (147)

1. Various commentators provide helpful overviews of the crisis and its institutional and regulatory context. See generally Markus K. Brunnermeier, Deciphering the Liquidity and Credit Crunch 2007-2008, 23 J. ECON. PERSP. 77, 82-98 (2009) (providing an event logbook of the 2007-2008 financial crisis and discussing the amplifying mechanisms that can turn shocks into financial meltdowns);
2. Gary Gorton, The Subprime Panic, 15 EUR. FIN. MGMT. 10, 12-37 (2009) (describing the intricate chain of risk distribution that lead to the financial panic);
3. Charles K. Whitehead, Reframing Financial Regulation, 90 B. U. L. Rev. 1, 16-36 (2010) (tracing the evolution and regulation of financial markets and explaining how such changes led to riskier behavior by financial intermediaries).
4. See MARTIN NEIL BAILY ET AL., BROOKINGS INST., THE ORIGINS OF THE FINANCIAL CRISIS 8-9(2008), available at http://www.brookings.edu/~/media/Files/ rc/papers/2008/11-origins-crisis-baily-litan/11-origins-crisis-baily-litan.pdf. For an explanation of the structure of these mortgages and the aggressive sales practices at origination
5. see Oren Bar-Gill, The Law, Economics and Psychology of Subprime Mortgage Contracts, 94 CORNELL L. REV. 1073, 1096-1107, 1129-32 (2009).
6. See Steven L. Schwarcz, Regulating Complexity in Financial Markets, 87 WASH. U. L. REV. 211, 241 (2009) ("In the subprime crisis, for example, underwriters customarily purchased some portion of the subordinated 'equity' tranches of ABS CDO securities to demonstrate their belief in the securities being sold.").
7. Cf. John P. Harding & Stephen L. Ross, Regulation of Large Financial Institutions: Lessons from Corporate Finance Theory, 16 CONN. INS. L. J. 243, 250 (2009) ("While most large investment banks and bank holding company subsidiaries that originated subprime mortgages operated with the intent to pool and sell mortgage-backed securities as soon as a sufficient number of loans had been originated, at any given time, they nevertheless had significant exposure to subprime loans because they were holding mortgages as inventory awaiting future sales or holding securities as part of their underwriting and trading operations.").
8. For a good discussion of the facts available to investors and analysts that might suggest the foreseeability of the subprime meltdown, see Kristopher Gerardi et al., Making Sense of the Subprime Crisis, BROOKINGS PAPERS ON ECON. ACTIVITY, Fall 2008, at 69, 127-42. On the residual uncertainty that may have made this investment a rational response to rapid financial innovation while learning evolved by trial and error (with an unfortunate paucity of error until too late in the game)
9. see Alessio M. Pacces, Uncertainty and the Financial Crisis, 29 J. FIN. TRANSFORMATION 79, 82-87 (2010). This latter view is hard to accept today given the massive losses those portfolios have suffered, but that difficulty may just be the hindsight bias at work. Events always seem to have been much more foreseeable at the time after we know what later came to pass.
10. See Jeffrey J. Rachlinski, A Positive Psychological Theory of Judging in Hindsight, 65 U. CHI. L. REV. 571, 571-81 (1998). (Pubitemid 128443620)
11. See RICHARD A. POSNER, A FAILURE OF CAPITALISM: THE CRISIS OF '08 AND THE DESCENT INTO DEPRESSION 106-08, 114-15 (2009) (discussing rational profit-maximizing behavior and the need for government regulation to control the negative externalities of this behavior);
12. see also Richard A. Posner, Shorting Reason, NEW REPUBLIC, Apr. 15, 2009, at 30, 31-32 (reviewing AKERLOF & SHILLER, infra note 54, and criticizing the conflation of being right and being rational in investment decisions).
13. See Charles W. Calomiris, The Subprime Turmoil: What's Old, What's New, and What's Next, J. STRUCTURED FIN., Spring 2009, at 6, 12-13.
14. See Kathleen C. Engel & Patricia A. McCoy, Turning a Blind Eye: Wall Street Finance of Predatory Lending, 75 FORDHAM L. REV. 2039, 2049-50 (2007) (discussing information asymmetry between lenders and investors as to riskiness of subprime loans and potential for exploitation);
15. Vikas Bajaj & Jenny Anderson, Inquiry Focuses on Withholding of Data on Loans, N. Y. TIMES, Jan. 12, 2008, at A1 (discussing New York's investigation as to "whether Wall Street banks withheld crucial information about the risks posed by investments linked to subprime loans" from rating agencies and investors).
16. See Claire A. Hill, Who Were the Villains in the Subprime Crisis, and Why It Matters, 4 ENTREPRENEURIAL BUS. L. J. 323, 345 (2010). Some notable examples include John Paulson, whose involvement in constructing Goldman Sachs' Abacus deal came under scrutiny in the suit that the Securities and Exchange Commission (SEC) filed against the investment bank
17. see Louise Story & Gretchen Morgenson, S. E. C. Accuses Goldman of Fraud in Housing Deal, N. Y. TIMES, Apr. 17, 2010, at A1, and Jeff Greene, whose profits in betting against the housing market became a political liability in his failed Senate bid
18. see Jeff Ostrowski, Feud Simmers over Greene's Subprime Bet, PALM BEACH POST, July 11, 2010, at 1A.
19. See JOHN C. COFFEE JR., GATEKEEPERS: THE PROFESSIONS AND CORPORATE GOVERNANCE 2 (2006) (defining gatekeepers).
20. See Robert J. Rhee, The Madoff Scandal, Market Regulatory Failure and the Business Education of Lawyers, 35 J. CORP. L. 363, 365 (2009) ("Among the many leitmotifs of the financial crisis is the failure of lawyers as regulators and gatekeepers.").
21. See Deborah R. Meshulam & Grayson D. Stratton, Lessons from the Credit Crisis: Can Market Participants Bear the Risk?, BUS. L. TODAY 2-4 (Aug. 2, 2010), http://www.abanet.org/buslaw/blt/content/articles/2010/08/mt0001.pdf (providing examples of alleged inadequacies in disclosure during the financial crisis and the lawsuits they engendered).
22. See id. at 216-23. See generally Roger C. Cramton et al., Legal and Ethical Duties of Lawyers After Sarbanes-Oxley, 49 VILL. L. REV. 725 (2004) (providing an overview of duties imposed on lawyers by Sarbanes-Oxley and relevant rules).
23. Most recently, the SEC revised its corporate governance disclosure rules to require a description of the board's role in risk oversight. See Proxy Disclosure Enhancements, 74 Fed. Reg. 68, 334, 68, 344-45, 68, 364-65 (Dec. 23, 2009)
24. (to be codified at 17 C. F. R. § 229. 407 (h)) (revising item 407 of Reg. S-K).
25. Dennis K. Berman, Tourre: A Hero in Villain's Garb?, WALL ST. J., Apr. 27, 2010, at C1 (quoting Professor Adam Galinsky of Northwestern University's Kellogg School of Business).
26. Eugene Volokh, The Mechanisms of the Slippery Slope, 116 HARV. L. REV. 1026, 1105 (2003) ("If a frog is dropped into hot water, it supposedly jumps out. But if a frog is put into cold water that is then heated, the frog doesn't notice the gradual temperature change, and eventually dies.... The frog doesn't notice the [temperature] increase because of a sensory failure; it senses not absolute temperature but changes in temperature.").
27. See John M. Darley, The Cognitive and Social Psychology of Contagious Organizational Corruption, 70 BROOK. L. REV. 1177, 1179-85 (2005).
28. See Donald C. Langevoort, Behavioral Theories of Judgment and Decision Making in Legal Scholarship: A Literature Review, 51 VAND. L. REV. 1499, 1500-02 (1998). (Pubitemid 128443468)
29. See generally LARS UDEHN, METHODOLOGICAL INDIVIDUALISM: BACKGROUND, HISTORY AND MEANING 1-6 (2001) (reviewing the debate over methodological individualism). Psychologists may disagree, of course. For commentary
30. see, for example, Martin Kilduff & David Krackhardt, Bringing the Individual Back In: Structural Analysis of the Internal Market for Reputation in Organizations, 37 ACAD. MGMT. J. 87, 87-88, 105-06 (1994) (summarizing structuralism's rejection of individualism, arguing for the integration of "psychology and the role of individuals... [into] social network analysis", and "challeng[ing] the claimed incommensurability of individualism and structuralism by pointing to the influence on structural analysis of the psychology it has purported to reject"); (Pubitemid 24763430)
31. Barry M. Staw & Robert I. Sutton, Macro Organizational Psychology, in SOCIAL PSYCHOLOGY IN ORGANIZATIONS: ADVANCES IN THEORY AND RESEARCH 350, 352-67 (J. Keith Murnighan ed., 1993) (reviewing individualist and collectivist perspectives of psychology and sociology, respectively, and providing a rationale for macro-organizational psychology, which employs psychology to explain organizational behavior).
32. See Geoffrey Ingham, Some Recent Changes in the Relationship Between Economics and Sociology, 20 CAMBRIDGE J. ECON. 243, 251-52 (1996) ("[T]here is widespread agreement amongst sociologists that functionalism of the most flawed kind pervades a great deal of economic analysis....").
33. For an extensive analysis of the application of behavioral economics and the firm, see Colin F. Camerer & Ulrike Malmendier, Behavioral Economics of Organizations, in BEHAVIORAL ECONOMICS AND ITS APPLICATIONS 235, at 235-73 (Peter Diamond & Hannu Vartiainen eds., 2007).
34. See, e.g., PAUL MILGROM & JOHN ROBERTS, ECONOMICS, ORGANIZATION AND MANAGEMENT (1992) 185-88 (analyzing monitoring and incentive contracts as solutions for controlling moral hazards in the field of organizational economics).
35. See George A. Akerlof & Rachel E. Kranton, Identity and the Economics of Organizations, 19 J. ECON. PERSP. 9, 9-16, 27-29 (2005).
36. See Donald C. Langevoort, Opening the Black Box of "Corporate Culture" in Law and Economics, 162 J. INSTITUTIONAL & THEORETICAL ECON. 80, 86 (2006). For a thoughtful exploration of cultural effects on lawyers' decision making
37. see generally Milton C. Regan, Jr., Moral Intuitions and Organizational Culture, 51 ST. LOUIS U. L. J. 941 (2007).
38. For a classic exposition, see John W. Meyer & Brian Rowan, Institutionalized Organizations: Formal Structure as Myth and Ceremony, 83 AM. J. SOC. 340, 343-48 (1977).
39. For an illuminating study of the psychology and culture of risk taking by traders at London investment banks that is sensitive to these competitive constraints, see MARK FENTON-O'CREEVY ET AL., TRADERS: RISKS, DECISIONS, AND MANAGEMENT IN FINANCIAL MARKETS 74-145 (2005).
40. On the economics of corporate culture from a variety of perspectives, see, for example, Benjamin E. Hermalin, Economics and Corporate Culture, in THE INTERNATIONAL HANDBOOK OF ORGANIZATIONAL CULTURE AND CLIMATE 217, 218-42 (Cary L. Cooper et al. eds., 2001) (summarizing and assessing economists' previous studies and writings on corporate culture);
41. Eric Van den Steen, On the Origin of Shared Beliefs (and Corporate Culture), 41 RAND J. ECON. 617, 619-21, 638-40 (2010) (reviewing economics literature on corporate culture and conceiving of corporate culture as shared values and beliefs).
42. See generally David M. Kreps, Corporate Culture and Economic Theory, in PERSPECTIVES ON POSITIVE POLITICAL ECONOMY 90, 90-141 (James E. Alt & Kenneth A. Shepsle eds., 1990) (exploring corporate culture from the perspective of economic theory). Krebs's model is discussed at length in Hermalin, supra, at 218-30.
43. See Daniel Denison, Organizational Culture: Can It Be a Key Lever for Driving Organizational Change?, in THE INTERNATIONAL HANDBOOK OF ORGANIZATIONAL CULTURE AND CLIMATE, supra note 37, at 347, 356 ("Organizations that are strong in adaptability usually experience sales growth and increased market share.").
44. See Richard R. Nelson, Recent Evolutionary Theorizing About Economic Change, 33 J. ECON. LITERATURE 48, 78-79 (1995) (discussing some sociologists' organizational ecology models and noting that "the set of things a firm can do well at any time is quite limited", and despite their ability to "learn to do new things, these learning capabilities also are limited");
45. cf. Bo Hedberg & Christian Maravelias, Organizational Culture and Imaginary Organizations, in THE INTERNATIONAL HANDBOOK OF ORGANIZATIONAL CULTURE & CLIMATE, supra note 37, at 587, 594 (noting that "[a] distinct and strong culture" in an organization "might improve its capability to handle specific environmental circumstances" but may hamper that organization's "capabilities to adapt to changing environments").
46. For such an argument, see Malcolm Gladwell, Cocksure: Banks, Battles, and the Psychology of Overconfidence, NEW YORKER, July 27, 2009, at 24, 26-28.
47. Shelley E. Taylor & Jonathon D. Brown, Illusion and Well-Being: A Social Psychological Perspective on Mental Health, 103 PSYCHOL. BULL. 193, 199 (1988) ("[R]esearch evidence indicates that self-enhancement, exaggerated beliefs in control, and unrealistic optimism can be associated with higher motivation, greater persistence, more effective performance, and ultimately, greater success.").
48. See Donald C. Langevoort, Resetting the Corporate Thermostat: Lessons from the Recent Financial Scandals About Self-Deception, Deceiving Others and the Design of Internal Controls, 93 GEO. L. J. 285, 299-300 (2004).
49. See, e.g., Simon Gervais & Itay Goldstein, The Positive Effects of Biased Self-Perceptions in Firms, 11 REV. FIN. 453, 479-81 (2007) (concluding that worker overconfidence encourages harder work, reduces free-riding, and ultimately increases firm productivity);
50. Anand M. Goel & Anjan V. Thakor, Overconfidence, CEO Selection, and Corporate Governance, 63 J. FIN. 2737, 2737-41, 2769-72 (2008) (discussing the effects of managerial overconfidence on internal promotion and CEO overconfidence on firm value);
51. cf. Eric Van den Steen, Rational Overoptimism (and Other Biases), 94 AM. ECON. REV. 1141, 1141-43 (2004) (discussing the "'choice-driven overoptimism' mechanism" that results in an agent's positive bias "about the consequences of his own actions, relative to others").
52. For empirical evidence of overconfidence, see, for example, Ulrike Malmendier & Geoffrey Tate, CEO Overconfidence and Corporate Investment, 60 J. FIN. 2661, 2667-79 (2005) (constructing "three measures of overconfidence... based on the personal portfolio decisions of CEOs" and providing evidence of such behaviors).
53. See Donald C. Langevoort, Organized Illusions: A Behavioral Theory of Why Corporations Mislead Stock Market Investors (and Cause Other Social Harms), 146 U. PA. L. REV. 101, 154-56 (1997). (Pubitemid 127445825)
54. See Catherine M. Schrand & Sarah L. C. Zechman, Executive Overconfidence and the Slippery Slope to Fraud 9-35, (Sept. 2010) (unpublished manuscript), available at http://ssrn. com/abstract=1265631. I developed a similar argument in Langevoort, supra note 48, at 121-26, 135-41. See also Langevoort, supra note 46, at 307-08 (positing that as the threat to incumbency grows, overconfident CEOs will embark on a slippery slope of obfuscation, concealment, and greater risk taking to retain office).
55. See GERD GIGERENZER ET AL., SIMPLE HEURISTICS THAT MAKE US SMART 14-24, 30-31 (1999).
56. See Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006);
57. In re Caremark Int'l Inc. Derivative Litig., 698 A.2d 959, 969-70 (Del. Ch. 1996).
58. This is an important theme in a number of books, perhaps the best known of which is GEORGE A. AKERLOF & ROBERT J. SHILLER, ANIMAL SPIRITS: HOW HUMAN PSYCHOLOGY DRIVES THE ECONOMY, AND WHY IT MATTERS FOR GLOBAL CAPITALISM (2009) 5-7, 11-56, 86-96, 169-71.
59. See also, e.g., Emilios Avgouleas, The Global Financial Crisis, Behavioural Finance and Financial Regulation: In Search of a New Orthodoxy, 9 J. CORP. L. STUD. 23, 34-45 (2009)
60. Hersh Shefrin, How Psychological Pitfalls Generated the Global Financial Crisis, in INSIGHTS INTO THE GLOBAL FINANCIAL CRISIS 224, 224-32, 250-54 (Laurence B. Siegel ed., 2009) (positing that "specific psychological reactions", such as overconfidence and risk-seeking, to external economic factors "took the global financial system to the brink of collapse", instead of those economic factors themselves).
61. See CARMEN M. REINHART & KENNETH S. ROGOFF, THIS TIME IS DIFFERENT: EIGHT CENTURIES OF FINANCIAL FOLLY 207-15 (2009).
62. See Joe Nocera, Risk Mismanagement, N. Y. TIMES, Jan. 4, 2009, § 6 (Magazine), at 24, 46 ("VaR [Value at Risk model] didn't see the risk [of AAA-rated mortgage-backed securities] because it generally relied on a two-year data history.");
63. See Geoffrey P. Miller & Gerald Rosenfeld, Intellectual Hazard: How Conceptual Biases in Complex Organizations Contributed to the Crisis of 2008, 33 HARV. J. L. & PUB. POL'Y 807, 818 (2010);
64. Michiyo Nakamoto & David Wighton, Bullish Citigroup is 'Still Dancing' to the Beat of the Buy-Out Boom, FIN. TIMES (London), July 10, 2007, at 1-1.
65. GILLIAN TETT, FOOL'S GOLD: HOW THE BOLD
66. DREAM OF A SMALL TRIBE AT J. P. MORGAN WAS CORRUPTED BY WALL STREET GREED AND UNLEASHED A CATASTROPHE 148 (2009);
67. Dealbook, Citi Chief on Buyouts: 'We're Still Dancing', NYTIMES. COM (July 10, 2007, 10:54 AM), http://dealbook.nytimes.com/2007/07/10/citichief-on- buyout-loans-were-still-dancing;
68. Steven Pearlstein, The Art of Managing Risk, WASH. POST, Nov. 28, 2007, at D1.
69. In testimony before the Financial Crisis Inquiry Commission, Prince explained that the reference was to the "leveraged lending business" of private equity financing and had nothing to do with subprime. See Cyrus Sanati, Prince Finally Explains His Dancing Comment, NYTIMES. COM (Apr. 8, 2010, 2:04 PM), http://dealbook.blogs.nytimes.com/2010/04/08/prince-finally-explains- his-dancing-comment.
70. See Peter Bossaerts, What Decision Neuroscience Teaches Us About Financial Decision Making, 1 ANN. REV. FIN. ECON. 383, 394-95 (2009).
71. Andrew W. Lo, Hedge Funds, Systemic Risk, and the Financial Crisis of 2007-2008, Written Testimony Prepared for the U. S. House of Representatives Committee on Oversight and Government Reform Hearing on Hedge Funds 12-13 (Nov. 13, 2008) (internal footnote omitted), available at http://papers.ssrn. com/sol3/papers.cfm?abstract-id= 1301217. For some of Lo's work in financial neuroscience
72. see Andrew W. Lo & Dmitry V. Repin, The Psychophysiology of Real-Time Financial Risk Processing, 14 J. COGNITIVE NEUROSCIENCE 323, 332-33 (2002) (studying physiological responses of professional securities traders and finding "that emotional responses are a significant factor in the real-time processing of financial risks").
73. For a more general discussion relating to the financial crisis, see Gary Stix, The Science of Bubbles and Busts, SCI. AM., July 2009, at 78, 80-85.
74. See William J. Bernstein, Of Laws, Lending, and Limbic Systems, 66 FIN. ANALYSTS J., Jan.-Feb. 2010, at 17, 19 (noting that the nucleus accumbens "respond[s] most intensely to the anticipation of reward" and labeling it the "greed center").
75. See id. (noting that the amygdala "activate[s] in reaction to revulsion, fear, and financial loss", labeling it "the financial market's horsemen of the apocalypse"). While fear reduces the tendency toward risk-taking, anger does the opposite. See Jennifer S. Lerner & Dacher Keltner, Fear, Anger, and Risk, 81 J. PERSONALITY & SOC. PSYCHOL. 146, 146-47, 154-56 (2001).
76. Karen Ho, Disciplining Investment Bankers, Disciplining the Economy: Wall Street's Institutional Culture of Crisis and the Downsizing of "Corporate America", 111 AM. ANTHROPOLOGIST 177 (2009).
77. For a more extended discussion, see generally KAREN HO, LIQUIDATED: AN ETHNOGRAPHY OF WALL STREET (2009).
78. See Rick Bookstaber, Conversations with the Trading Desk, RICKBOOKSTABER. COM (Dec. 2, 2007), http://rick.bookstaber.com/2007/12/conversations-with- trading-desk.html. Bookstaber, now an SEC official, elaborated on this and the market becoming more vulnerable to crisis before the meltdown.
79. See RICK BOOKSTABER, A DEMON OF OUR OWN DESIGN: MARKETS, HEDGE FUNDS, AND THE PERILS OF FINANCIAL INNOVATION 5-6, 255-60 (2007).
80. See supra note 57 and accompanying text. See also Erik F. Gerding, Code, Crash, and Open Source: The Outsourcing of Financial Regulation to Risk Models and the Global Financial Crisis, 84 WASH. L. REV. 127, 139-43, 170-74 (2009).
81. See also Kimberly D. Krawiec, The Return of the Rogue, 51 ARIZ. L. REV. 127, 151-52 (2009) (discussing data deficiencies in operational risk models).
82. See Sara Kiesler & Lee Sproull, Managerial Response to Changing Environments: Perspectives on Problem Sensing from Social Cognition, 27 ADMIN. SCI. Q. 548, 564 (1982);
83. The sunk-cost fallacy refers to the economic behavior of tending "to continue an endeavor once an investment in money, effort, or time has been made." Hal R. Arkes & Peter Ayton, The Sunk Cost and Concorde Effects: Are Humans Less Rational Than Lower Animals?, 125 PSYCHOL. BULL. 591, 591 (1999).
84. See, e.g., Gillian Ku et al., Towards a Competitive Arousal Model of Decision-Making: A Study of Auction Fever in Live and Internet Auctions, 96 ORGANIZATIONAL BEHAV. & HUM. DECISION PROCESSES 89, 99-100 (2005) (finding in laboratory auction experiment that "[r]ivalry and sunk costs increased the likelihood of overbidding");
85. Deepak Malhotra, The Desire to Win: The Effects of Competitive Arousal on Motivation and Behavior, 111 ORGANIZATIONAL BEHAV. & HUM. DECISION PROCESSES 139, 139 (2010) (discussing studies showing that "the desire to beat rival bidders can lead auction participants to pay more than an item is worth to them").
86. see Deepak Malhotra et al., When Winning Is Everything, HARV. BUS. REV., May 2008, at 78, 80-83. Interestingly, the authors note that competitive arousal seems more likely when lawyers are involved in the process.
87. see also Bernard S. Black, Bidder Overpayment in Takeovers, 41 STAN. L. REV. 597, 625-27 (1989) (discussing winner's curse theory in the context of overpayment in corporate takeovers).
88. See Stephen M. Garcia et al., Ranks and Rivals: A Theory of Competition, 32 PERSONALITY & SOC. PSYCHOL. BULL. 970, 970-72, 980-81 (2006).
89. Michael J. Zyphur et al., Testosterone-Status Mismatch Lowers Collective Efficacy in Groups: Evidence from a Slope-as-Predictor Multilevel Structural Equation Model, 110 ORGANIZATIONAL BEHAV. & HUM. DECISION PROCESSES 70, 71 (2009);
90. see also Maurice Levi et al., Deal or No Deal: Hormones and the Mergers and Acquisitions Game, 56 MGMT. SCI. 1462, 1463, 1476 (2010) (using CEO age as a proxy for hormone levels and discussing the impact of testosterone on acquisition activity, in particular withdrawn bids and tender offers). Although there is a perception that this hormonal effect is largely found in males, evidence shows that "alpha"-like behavior is found fairly equally between genders, based on relative testosterone levels within gender. See Zyphur et al., supra, at 71 (noting that despite its greater presence in men, testosterone "has been shown to have an equivalent impact on social dominance in both males and females after controlling for the difference" in gender-associated testosterone levels). That said, evidence of male cultural domination on Wall Street is disturbingly substantial.
91. See Christine Sgarlata Chung, From Lily Bart to the Boom-Boom Room: How Wall Street's Social and Cultural Response to Women Has Shaped Securities Regulation, 33 HARV. J. L. GENDER 175, 177-81 (2010).
92. See Coren L. Apicella et al., Testosterone and Financial Risk Preferences, 29 EVOLUTION & HUM. BEHAV. 384, 387-89 (2008);
93. J. M. Coates & J. Herbert, Endogenous Steroids and Financial Risk Taking on a London Trading Floor, 105 PROC. NAT'L ACAD. SCI. 6167, 6170-71 (2008).
94. Maurice E. Schweitzer et al., Goal Setting as a Motivator of Unethical Behavior, 47 ACAD. MGMT. J. 422, 423-24, 429-30 (2004) (studying the impact of goal setting in motivating unethical behavior when individuals fail to attain such goals).
95. See Scott Rick & George Loewenstein, Hypermotivation, 45 J. MARKETING RES. 45, 45-46 (2008) (discussing hypermotivation, "a visceral state that leads a person to take actions he or she would normally deem to be unacceptable", and how it arises in response to loss aversion and perhaps in response to unattainable or overly ambitious goals);
96. see also Langevoort, supra note 46, at 306-08 (discussing the "slippery slope" that leads to unethical behavior in CEOs who fall short of expectations and fear termination). Especially for prominent firms, a period of high performance may ratchet up expectations so high that improper behavior becomes the only way of avoiding falling short. See Yuri Mishina et al., Why "Good" Firms Do Bad Things: The Effects of High Aspirations, High Expectations, and Prominence on the Incidence of Corporate Illegality, 53 ACAD. MGMT. J. 701, 703-06, 715-18 (2010).
97. See Claire Hill & Richard Painter, Berle's Vision Beyond Shareholder Interests: Why Investment Bankers Should Have (Some) Personal Liability, 33 SEATTLE U. L. REV. 1173, 1177-78 (2010).
98. See e.g., Malcolm Baker & Jeffrey Wurgler, Investor Sentiment in the Stock Market, 21 J. ECON. PERSP. 129, 131-35 (2007) (discussing investor sentiment, mispricing of hard-to-arbitrage stocks, and reaction to mispricing by corporate insiders).
99. See, e.g., Malcolm Baker et al., Behavioral Corporate Finance, in 1 HANDBOOK OF CORPORATE FINANCE: EMPIRICAL CORPORATE FINANCE 147-48 (B. Espen Eckbo ed., 2007) (distinguishing research based on the "irrational investors approach" from the "irrational managers approach").
100. William W. Bratton & Michael L. Wachter, The Case Against Shareholder Empowerment, 158 U. PA. L. REV. 653, 720 (2010).
101. see also Edward B. Rock & Michael L. Wachter, Islands of Conscious Power: Law, Norms, and the Self-Governing Corporation, 149 U. PA. L. REV. 1619, 1640-63, 1697-99 (2001) (describing the extent to which this view is widely held among business people and also describing the effects on corporate governance).
102. See Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 NW. U. L. REV. 547, 563-64 (2003);
103. See Richard E. Kihlstrom & Michael L. Wachter, Corporate Policy and the Coherence of Delaware Takeover Law, 152 U. PA. L. REV. 523, 523-30, 556-75 (2003) (arguing that in regard to takeover defenses, Delaware courts employ a management-discretion model that provides "managers with the freedom to ignore financial market valuations when setting corporate policy");
104. John Arlidge, Inside the Goldmine, TIMES (London), Aug. 11, 2009, (Magazine), at 12.
105. Complaint at 1-3, 11-17, SEC v. Goldman Sachs & Co., No. 10-CV-3229 (S. D. N. Y. Apr. 16, 2010), available at http://www.sec.gov/litigation/ complaints/2010/comp21489.pdf.
106. Goldman settled with the SEC a few months later by agreeing to a record-setting payment of $550 million. See SEC Litig. Release No. 21592 (July 15, 2010), available at http://www.sec.gov/litigation/litreleases/2010/ lr21592.htm. The thrust of the claim was that both IKB and ACA were misled by not being informed that Paulson & Co., the initiating party that was taking the short side of the deal, had negotiated to include in the reference portfolio securities that it deemed particularly susceptible to the looming subprime risk. Complaint, supra, at 11-19.
107. See Julie Creswell, Goldman Was Regulators' First Prize, and It May Be the Last, N. Y. TIMES, July 17, 2010, at B4;
108. John E. Morris, The SEC Tests Goldman's Teflon, THE SOURCE, (Apr. 19, 2010, 10:18 AM), http://blogs.wsj.com/source/2010/04/19/the-sec-testsgoldmans- teflon.
109. See Andrew Ross Sorkin, A Crowd with Pity for Goldman, N. Y. TIMES, Apr. 27, 2010, at B1.
110. See Zachary A. Goldfarb and Tomoeh Murakami Tse, Goldman Says Its Clients Knew the Product, WASH. POST, Apr. 21, 2010, at A12.
111. See Zachary A. Goldfarb, SEC Confident on IKB Part of Goldman Suit, WASH. POST, Apr. 24, 2010, at A8 ("Much of the criticism of the SEC case... is that IKB and ACA were sophisticated investors who knew what they were doing.");
112. see also Fareed Zakaria, Cross of Gold, NEWSWEEK, May 3, 2010, at 24 (noting that IKB was "a large German bank that had whole departments devoted to analyzing just these products" and that it "surely knew that someone was betting against them" who thought they "were garbage").
113. See C. Edward Fletcher, III, Sophisticated Investors Under the Federal Securities Laws, 1988 DUKE L. J. 1081, 1086-94.
114. See Carrick Mollenkamp & Laura Stevens, German Bank: Victim or a Contributor?, WALL ST. J., Apr. 22, 2010, at C2;
115. Nathaniel Popper, Main St. Paid for Wall St. Maneuvers, L. A. TIMES, Apr. 29, 2010, at B1.
116. See supra Part I. B. This is true in terms of ethics as well. See Francesca Gino & Max H. Bazerman, When Misconduct Goes Unnoticed: The Acceptability of Gradual Erosion in Others' Unethical Behavior, 45 J. EXPERIMENTAL SOC. PSYCHOL. 708, 709 (2009).
117. See Gretchen Morgenson & Louise Story, Banks Bundled Debt, Bet Against It and Won, N. Y. TIMES, Dec. 24, 2009, at A1.
118. For a short overview of F. A. Hayek's views of the marketplace and spontaneous ordering, see Kevin T. Jackson, The Scandal Beneath the Financial Crisis: Getting a View from a Moral-Cultural Mental Model, HARV. J. L. & PUB. POL'Y 735, 771-73 (2010).
119. See Charlie Rose: Lloyd Blankfein, Chief Excecutive Officer and Chairman of Goldman Sachs (PBS television broadcast Apr. 30, 2010), available at http://www.charlierose.com/view/interview/10989. Goldman Sachs executives defended the firm's actions similarly before the Senate Subcommittee on Investigations.
120. See Matthew Goldstein, Goldman's More Than a Wall Street Toll Collector, REUTERS (Apr. 28, 2010), http://www.reuters.com/article/2010/04/28/us-goldman- maker-analysis-idUSTRE63R5JA20100428.
121. For more information on these rationalization processes as they pertain to financial self-interest and wealth-based inequity, see Francesca Gino & Lamar Pierce, Dishonesty in the Name of Equity, 20 PSYCHOL. SCI. 1153, 1153-54, 1159 (2009).
122. See Eric Lichtblau & Edward Wyatt, Pro-Business Lobbying Blitz Takes on Obama's Plan for Wall Street Overhaul, N. Y. TIMES, March 28, 2010, at A19 ("In the last decade, the financial sector has spent more money than any other industry to influence Washington policy-more than $3.9 billion, according to the Center for Responsive Politics.").
123. Cf. Wall Street's New Shape: Rearranging the Towers of Gold, ECONOMIST, Sept. 10, 2009, at 75, 76 (noting that despite Goldman's claims about being a market-maker and its simultaneous roles as principal and agent, its huge profits in the first six months of 2009 "have turned the media as well as the mob against it").
124. For a summary of the most troubling of the Tourre e-mails released by Goldman Sachs, see Steve Eder and Karey Wutkowski, Goldman's 'Fabulous' Fab's Conflicted Love Letters, REUTERS (Apr. 25, 2010), http://www.reuters.com/ article/2010/04/26/goldman-emailsidUSN2516585020100426.
125. The full text of the Goldman Sachs e-mails-including some of those sent by Tourre-can be found at Goldman Sachs and the Financial Crisis, NYTIMES. COM, http://documents.nytimes.com/goldman-sachs-internal-emails (last visited Feb. 1, 2011).
126. See BETHANY MCLEAN & PETER ELKIND, THE SMARTEST GUYS IN THE ROOM: THE AMAZING RISE AND SCANDALOUS FALL OF ENRON 73-84 (2003);
127. see also Donald C. Langevoort, Technological Evolution and the Devolution of Corporate Financial Reporting, 46 WM. & MARY L. REV. 1, 2 (2004) (noting Enron's transition to an "energy-based investment bank... [from] a traditional supplier of natural resources").
128. Cf. Nicole L. Mead et al., Too Tired to Tell the Truth: Self-Control Resource Depletion and Dishonesty, 45 J. EXPERIMENTAL SOC. PSYCHOL. 594, 596-97 (2009) (finding that "[w]hen people's self-control resources have been taxed by a prior act of self-control, cheating increases" and discussing possible explanations).
129. See Francesca Gino & Lamar Pierce, The Abundance Effect: Unethical Behaviors in the Presence of Wealth, 109 ORGANIZATIONAL BEHAV. & HUM. DECISION PROCESSES 142, 152 (2009) (concluding that unethical behavior increases among laboratory subjects when wealth is proximately displayed);
130. see also Kathleen D. Vohs et al., The Psychological Consequences of Money, 314 SCIENCE 1154, 1156 (2006) (finding that money promotes self sufficiency and interpersonal disharmony).
131. See ROBERT JACKALL, MORAL MAZES: THE WORLD OF CORPORATE MANAGERS 203 (1988) ("Only those with an inexhaustible capacity for self- rationalization, fueled by boundless ambition, can escape the discomfort such [ethical] compromises produce.").
132. For a discussion of the impact of "negative activities" in the promotion process, see Kong-Pin Chen, Sabotage in Promotion Tournaments, 319 J. L. ECON. & ORG. 119, 120-34, 137-38 (2003).
133. See Joris Lammers et al., Power Increases Hypocrisy: Moralizing in Reasoning, Immorality in Behavior, 21 PSYCHOL. SCI. 737, 738, 742 (2010). For a useful overview of moral hypocrisy and the self-deception strategies that enable it
134. see C. Daniel Batson et al., Moral Hypocrisy: Appearing Moral to Oneself Without Being So, 77 J. PERSONALITY & SOC. PSYCHOL. 525, 525-27, 534-36 (1999). Interesting research is emerging on the connections among moral decision making, utilitarian rationalization, and testosterone.
135. See Dana R. Carney & Malia F. Mason, Decision Making and Testosterone: When the Ends Justify the Means, 46 J. EXPERIMENTAL SOC. PSYCHOL. 668, 670 (2010).
136. There is a substantial literature on the psychology of CEO's and its influence on corporate decision making and performance. See, e.g., Arijit Chatterjee & Donald C. Hambrick, It's All About Me: Narcissistic Chief Executive Officers and Their Effects on Company Strategy and Performance, 52 ADMIN. SCI. Q. 351, 375-78 (2007) (studying CEO narcissism in the computer hardware/software industry and "find[ing] that narcissistic CEOs favor bold actions that attract attention, resulting in big wins and big losses, as well as wide swings between these extreme outcomes").
137. See Michael Lewis, The Man Who Crashed the World, VANITY FAIR, Aug. 2009, at 98, 137-39. An insider account of the failure of Lehman proceeds along similar lines, suggesting arrogance and incompetence at the senior executive level that walled itself off from groups within the firm that were, allegedly, trying to highlight the excessive subprime risk.
138. See LAWRENCE G. MCDONALD & PATRICK ROBINSON, A COLOSSAL FAILURE OF COMMON SENSE: THE INSIDE STORY OF THE COLLAPSE OF LEHMAN BROTHERS 124-30, 201-02, 223-25, 233-36 (2009). If so, this emphasizes two important points. First, there will never be one single set of cultural perceptions in any large firm: there will potentially be many subcultures. Second, culture interacts with the economics of information and power dynamics: CEOs may surround themselves with those tied to some aspects of the culture and not others. There is an important litigation point here as well. Showing awareness of problems in one unit of an organization does not as a practical matter demonstrate contemporaneous awareness of risk elsewhere. On this interaction and the legal standards for attribution of knowledge, see Langevoort, supra note 48, at 157-63. In other words, the fact that some Lehman or Goldman Sachs traders were predicting and betting on a subprime downturn while others in the firm were aggressively selling products that would be valuable only in the absence of a downturn does not necessarily suggest intentionally wrongful behavior.
139. See Arnoud W. A. Boot & Jonathan R. Macey, Monitoring Corporate Performance: The Role of Objectivity, Proximity, and Adaptability in Corporate Governance, 89 CORNELL L. REV. 356, 374-77 (2004) (noting reputational stigma monitors acquire from intervention);
140. Claire A. Hill & Erin Ann O'Hara, A Cognitive Theory of Trust, 84 WASH. U. L. REV. 1717, 1792 (2006) ("If monitoring causes officers to believe that they are strongly distrusted by the directors, the officers might decide to live up (or more precisely, down) to that view when they are not being monitored.");
141. Donald C. Langevoort, Monitoring: The Behavioral Economics of Corporate Compliance with Law, 2002 COLUM. BUS. L. REV. 371, 96-100 (discussing possible negative effects of overly aggressive monitoring, including mistrust, cynicism, and decreases in motivation, morale, and compliance).
142. See Michelle M. Harner, Ignoring the Writing on the Wall: The Role of Enterprise Risk Management in the Economic Crisis, 5 J. BUS. & TECH. L. 45, 48-49 (2010).
143. See Max H. Bazerman et al., The Impossibility of Auditor Independence, SLOAN MGMT. REV., Summer 1997, at 89, 91-93.
144. See, e.g., Gerald J. Lobo & Jian Zhou, Did Conservatism in Financial Reporting Increase After the Sarbanes-Oxley Act? Initial Evidence, 20 ACCT. HORIZONS 57, 71 (2006). (providing evidence of increased conservatism in accounting judgments and financial reporting after Sarbanes-Oxley).
145. See MILTON C. REGAN, JR., EAT WHAT YOU KILL: THE FALL OF A WALL STREET LAWYER 31-41 (2004);
146. see also Stephen M. Bainbridge, The Tournament at the Intersection of Business and Legal Ethics, 1 U. ST. THOMAS L. J. 909, 915-22 (2004) (describing tournament theory as applied to law firms and corporate lawyers and examining the efficacy of Sarbanes-Oxley § 307 in light of such dynamics).
147. See, e.g., Marcel Kahan & Edward Rock, Embattled CEOs, 88 TEX. L. REV. 987, 1029-32 (2010) (discussing the emergence of outside directors "as a power center independent of CEOs", the declining tenure of CEOs, and the greater willingness of boards to replace CEOs).