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Business Schools and the Financial Crisis

By Dr. Hassan Shirvani—Business schools have been widely criticized for causing the recent financial crisis by teaching deeply flawed financial models and by failing to instill in their students an adequate appreciation of socially responsible behavior.  As a result, many of their graduates, armed with their defective financial models and lacking in ethical standards, are accused of having directly contributed to the recent chaos on Wall Street.  To redress the situation, many critics have been demanding a significant revision of the business school curricula, with greater emphasis placed on offering both more relevant behavioral financial models and more effective instruction of business ethics.

Justified Blame

There is no question that business schools share some blame for the financial excesses on Wall Street before the crisis.  Being the products of a business environment deeply steeped in the free market ideology and its distrust of government regulation, many business schools simply met the perceived needs of their corporate clients by offering the financial models that relied heavily on the so-called efficient markets model.  This model is based on the assumptions that financial markets are informationally efficient and also can largely self-regulate.  In addition, the standard financial models also assumed that the security returns were normally distributed, an unwarranted assumption that tended to minimize the likelihood of any severe financial crisis by design.  (For example, according to this normality assumption, a 7 percent daily change in the stock market should happen once every three hundred thousand years, while in fact we have had more than 50 of such movements in the 20th century alone).  Given the difficulty of modelling the increasingly complex financial system, business schools should have warned their students about the tenuous nature of many of their financial models and their underlying special assumptions.  In particular, they should have taught that many of their models, while working relatively adequately during more normal times, were hardly capable of handling the so-called “black swan” events, as exemplified by the recent housing bubble crash.  At such times, where historical values of risk and correlation among different asset classes break down, many standard financial models will simply fail to deliver, rendering any financial decisions based on them misguided and potentially dangerous.

Having said all this, however,the standard behavioral criticism of these models that they failed because they wrongly assumed rational investor behavior in an irrational world, is largely misplaced.  Seemingly irrational behavior, such as herding, is often a rational response to the situations characterized by a lack of sufficient information. Being in the dark about the future, many investors simply follow the herd, or other rules of thumb, by trusting the collective judgment of the market.  At any rate, it is highly unlikely that the psychological glitches that have long plagued market participants should have suddenly become such an exceptionally potent force to have caused one of the worst global financial crises in history.  Far more likely, it was a combination of the reckless financial deregulation and excessive leverage and risk-taking on the part of the captains of the financial industry that did the damage.

On the other hand, business schools should have done a better job of emphasizing the importance of the interests of other corporate stakeholders, such as their employees, creditors, suppliers, and the public at large, in addition to those of their shareholders.  Furthermore, and to the extent that many business school professors routinely engaged in corporate consulting activities, business schools should have paid more attention to the issue of potential conflicts of interest that such activities might have posed.  This was of particular concern when many financial academicians with corporate ties also served as the congressional witnesses to advocate greater liberalization of the financial system. Apparently, many business schools were comfortable with letting their values be drowned in a sea of corporate donations.

Teaching Ethics

As to the need for more ethics instruction, many business schools have indeed been offering ethics courses on corporate social responsibility at least since the technology bubble crash of 2000.  Indeed, some elite business schools started this process as early as the 1970s.  In this light, the unethical conduct of many money managers during the recent financial crisis should raise serious doubts about the efficacy of such ethical instruction in promoting more responsible business behavior.  This is simply because many ethical lessons supposedly learned in the ethics courses are soon forgotten when students decide to head to Wall Street in search of lucrative financial careers.

Faced with fierce pressure for performance, many graduates simply succumb to the temptations for unethical, and occasionally illegal, short cuts.  What these graduates therefore need is seemingly less instruction on the distinction between right and wrong, a la Plato, and more training to develop better ethical habits, a la Aristotle. Put differently, many on Wall Street commit ethically questionable acts not because they do not know any better, but because they fail to resist their baser human instincts.  Thus, a more effective business program should underline the importance of good ethical conduct early and in all its courses, instead of offering a late and insulated ethics course with its endless philosophical discussions about the meanings of various ethical concepts and models.  In addition, students should be taught that their unethical actions can sometimes have real and severe consequences for many innocent bystanders who through no faults of their own may end up losing much of their possessions and livelihoods, as many did during the recent crisis.  At the same time, as future corporate leaders, students need to be taught to safeguard the interests of all their stakeholders, rather than merely those of their owners. Thus, it is quite disheartening to learn that, a decade after the financial crisis, the overwhelming bulk (83 percent) of the recent President Trump massive corporate tax cut has been used by many corporations to further enrich their shareholders through various share-buyback and dividend-payout schemes.  Other corporate stakeholders have seemingly benefited very little from such governmental largesse.  In the meantime, and while business schools are still busy putting their acts together, there seems to be a need for a much stronger enforcement of financial laws and regulations.


To sum up, while business schools did undoubtedly contribute to the recent global financial crisis, they should not be held accountable as the main culprits.  More important were the roles played by the financial and banking interests who managed to sell their governments the need for major financial deregulations.  The result, as we have seen, was the emergence of a global financial system characterized by recklessly high levels of debt and risk taking, with disastrous consequences. To avoid the recurrence of such calamities in the future, governments must therefore act as more effective watchdogs of their financial systems.


Hassan Shirvani, Ph.D.
Professor Cullen Foundation Chair in Economics

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