Michael L. Michael
Senior Fellow, Mossavar-Rahmani Center for Business and Government
John F. Kennedy School of Government, Harvard University
March 2006 ⎪ Working Paper No. 19
A Working Paper of the:
Corporate Social Responsibility Initiative
A Cooperative Project among:
The Mossavar-Rahmani Center for Business and Government
The Center for Public Leadership
The Hauser Center for Nonprofit Organizations
The Joan Shorenstein Center on the Press, Politics and Public Policy
Business Ethics
The Law of Rules
Citation
This paper may be cited as: Michael, Michael L. 2006. “Business Ethics: The Law of
Rules.” Corporate Social Responsibility Initiative Working Paper No. 19. Cambridge,
MA: John F. Kennedy School of Government, Harvard University. Comments may be
directed to the author.
A version of this paper is forthcoming in 16-4 Business
Ethics Quarterly (Oct. 2006).
Corporate Social Responsibility Initiative
The Corporate Social Responsibility Initiative at the Harvard Kennedy School of
Government is a multi-disciplinary and multi-stakeholder program that seeks to study and
enhance the public contributions of private enterprise. It explores the intersection of
corporate responsibility, corporate governance and strategy, public policy, and the media.
It bridges theory and practice, builds leadership skills, and supports constructive dialogue
and collaboration among different sectors. It was founded in 2004 with the support of
Walter H. Shorenstein, Chevron Corporation, The Coca-Cola Company, and General
Motors.
The views expressed in this paper are those of the author and do not imply endorsement
by the Corporate Social Responsibility Initiative, the John F. Kennedy School of
Government, or Harvard University.
For Further Information
Further information on the Corporate Social Responsibility Initiative can be obtained
from the Program Coordinator, Corporate Social Responsibility Initiative, Harvard
Kennedy School, 79 JFK Street, Mailbox 82, Cambridge, MA 02138, telephone (617)
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BUSINESS ETHICS: THE LAW OF RULES*
Abstract
Despite the recent rash of corporate scandals and the resulting rush to address the problem by
adding more laws and regulations, seemingly little attention has been paid to how the nature (not
the substance) of rules may or may not affect ethical decision-making. Drawing on work in the
law, ethics, management, psychology, and other social sciences, this article explores how several
characteristics of rules may interfere with the process of reaching and implementing ethical
decisions. Such a relationship would have practical implications for regulatory policy and
managers of organizations, and the article concludes by suggesting how regulations and
corporate ethics programs should be able to improve the ethical culture of business and enhance
the ethical decision-making skills of employees.
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“One might suppose that where law is largely absent, behavior is pretty bad. Yet it turns out to be
nearly the other way around. The two areas where law is arguably the largest presence in ordinary
life – driving cars and paying taxes – are probably the two areas where there is the largest amount
of self-conscious cheating.”1
“NASA’s culture of bureaucratic accountability emphasized chain of command, procedure,
following the rules, and going by the book. While rules and procedures were essential for
coordination, they had an unintended but negative effect. Allegiance to hierarchy and procedure
had replaced deference to NASA engineers’ technical expertise.”2
INTRODUCTION
Lower Manhattan, March 2, 2004: Martha Stewart, WorldCom’s Scott Sullivan, Tyco’s Dennis
Kozlowski and Mark Swartz and Adelphia’s John Rigas were being prosecuted, all within two blocks of
one another, when Attorney General John Ashcroft appeared at Foley Square to announce the indictment of
Bernard Ebbers, Chief Executive of WorldCom.3 While perhaps lacking the same dramatic simultaneity
and proximity, many other officials have been indicted by state and federal authorities, and still more have
been named in civil enforcement actions, arising from the corporate scandals of the past several years.
* The author is grateful to colleagues at the Mossavar-Rahmani Center for Business and Government at
Harvard University’s John F. Kennedy School of Government (particularly Professor Cary Coglianese), as
well as to Professors George Brenkert, Joshua Margolis, Frederick Schauer and Linda Treviño, for their
insights and suggestions during the research for and preparation of this article. Thanks are due also to the
editor of BUSINESS ETHICS QUARTERLY and the three anonymous reviewers for comments that helped to
strengthen the article.
1 William J. Stuntz, Christian Legal Theory, 116 HARV. L. REV. 1701, 1747 (2003) (reviewing CHRISTIAN
PERSPECTIVES ON LEGAL THOUGHT (Michael W. McConnell et al. eds.) (2001)).
2 1 NAT’L AERONAUTICS & SPACE ADMIN., REPORT OF THE COLUMBIA ACCIDENT INVESTIGATION BOARD
200 (2003), available at http://anon.nasa-global.speedera.net/anon.nasa-
global/CAIB/CAIB_lowres_full.pdf.
3 See Robert Frank, The Gang’s All Here:‘90s Highfliers Bring Day of Chaos to Courts, WALL ST. J., Mar.
3, 2004, at A1.
These facts make it difficult to argue that law enforcement lacked an arsenal of statutes and regulations
with which to charge companies and individuals for corporate misconduct.4 Moreover, the many guilty
pleas and settlements suggest that defendants and respondents either were aware of applicable regulations
and the difference between right and wrong, and that they were doing the wrong thing, or that they had
concluded (on the basis of their own assessment or that of their lawyers) that the likelihood of persuading a
jury or other fact-finder to the contrary was slight.
This should not be a surprise. Wall Street scandals arose in one of the most intensely regulated
industries. Other corporate scandals – Enron and WorldCom to name only the most widely known –
involved issues of finance and accounting, which are largely rule-based disciplines. This misconduct did
not occur in a corporate “wild West” where lawlessness required that one make it up as one went along.5
Despite the many existing rules, prosecutions, and settlements, the response to the corporate
scandals has been primarily rule-based.6 Congress passed the Sarbanes-Oxley Act of 2002.7 The
Securities and Exchange Commission and other agencies have promulgated numerous regulations
implementing Sarbanes-Oxley and addressing other corporate governance issues. The New York Stock
Exchange and the National Association of Securities Dealers have adopted new listing standards and other
governance rules.8 Business continues to develop new procedures, appoint governance officers, and train
employees on their legal and regulatory obligations.
These regulatory developments arguably have been accompanied by a greater focus on ethics.
Ethics consulting has increased in the wake of Sarbanes-Oxley;9 membership in the Ethics and Compliance
4 Donald C. Langevoort, The Regulators and the Financial Scandals, in RESTORING TRUST IN AMERICAN
BUSINESS 63, 68 (Jay W. Lorsch et al. eds., 2005) (hereinafter “Lorsch”) (“[W]hat many people have said
in the aftermath of the scandals is true: everything that was seriously wrong violated existing rules or
principles, so that the problem was not that the disclosure regime was filled with large holes.”).
5 Rules must still be applied to particular situations, of course, which entails judgment and discretion. As
discussed in this article, however, rules affect how these decisions are made and implemented.
6 ”Rule,” when used in this article, refers to statutes, regulations, and other prescriptions promulgated by
governing bodies applicable to everyone subject to their authority. Excluded are “rules of nature,” “rules of
thumb,” and ad hoc directives to fewer than all similarly-situated individuals.
7 Sarbanes Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (codified in scattered sections of the
United States Code, principally Title 15) (hereinafter “Sarbanes-Oxley”).
8 See NAT’L ASS’N OF SECURITIES DEALERS, MANUAL Rule 4350 (2003); NEW YORK STOCK EXCHANGE,
LISTED COMPANY MANUAL § 303A (2003).
9 See Kris Maher, Sarbanes-Oxley Is Boon for Slew of Consultants, WALL ST. J., Aug. 19, 2003, at B1.
2
Officer Association has increased steadily and remains at an all-time high;10 and the recently-amended
Federal Sentencing Guidelines now refer explicitly to ethics.11 A closer examination, however, reveals that
even these ethics developments have been largely rule-based. First, while some consultants focus on
values, much of ethics consulting tends still to entail implementing statutory requirements or developing
training programs on the legal obligations of employees. Second, the “ethics officer” and “compliance
officer” titles are often interchangeable, and the role involves supporting regulatory compliance by the
business and its employees. A report by the court-appointed corporate monitor of WorldCom, Inc. (viewed
by many as a blue-print for governance generally), for example, describes the ideal ethics officer as
someone with legal, regulatory, and law enforcement experience, who would report to the company’s
General Counsel.12 Yet, such a structure, whether the Ethics (or Compliance) Officer is a lawyer or a non-
lawyer supervised by a lawyer, tends to influence the approach taken to ethics.13 Third, despite references
to promoting ethical conduct, the Sentencing Guidelines actually define a “compliance and ethics program”
as one “designed to prevent and detect criminal conduct”14 and would seem narrowly satisfied by a
program limited to criminal activity rather than also to ethical or even civil law issues.
This post-scandal preoccupation with rules could have been predicted. In deciding how to behave
in a situation, our inquiry often starts – and stops – with rules. Rules have become proxies for the “right”
thing when the distinction between obeying the rule and acting ethically becomes blurred, when we hear “If
10 Telephone Interview with Edward S. Petry, Executive Director, Ethics and Compliance Officer Ass’n
(Sept. 6, 2004).
11 See U.S. SENTENCING GUIDELINES MANUAL § 8B2.1(a)(2) (2005), available at
http://www.ussc.gov/2005guid/gl2005.pdf. In U.S. v. Booker, 543 U.S. 220 (2005), the Supreme Court
invalidated a statute that permitted judges to depart from sentencing ranges on the basis of facts not pled to
or found by a jury. Whereas the Court’s concern was with aggravating circumstances (id. at 244), a
“compliance and ethics program” is a mitigating factor. Moreover, the Guidelines, while no longer
mandatory, do have an advisory function (id. at 246). A “compliance and ethics program,” therefore,
remains relevant for both judges and business managers.
12 See RICHARD C. BREEDEN, RESTORING TRUST: REPORT TO THE HON. JED S. RAKOFF ON CORPORATE
GOVERNANCE FOR THE FUTURE OF MCI 110 (2003), available at http://www.nysd.uscourts.gov/rulings/
02cv4963_ 082603.pdf.
13 See Linda Klebe Treviño et al., Managing Ethics and Legal Compliance: What Works and What Hurts,
41 CAL. MGMT. REV. 131, 146 (1999). See also Scott J. Reynolds & Norman E. Bowie, A Kantian
Perspective on the Characteristics of Ethics Programs, 14 BUS. ETHICS Q. 275, 286 (2004) (hereinafter
“Reynolds & Bowie”).
14 See U.S. SENTENCING GUIDELINES MANUAL § 8B2.1(a)(2) cmt n.1 (2005), available at
http://www.ussc.gov/2005guid/gl2005.pdf. The point here is not that the Sentencing Guidelines should
extend to legal-but-unethical conduct, but simply that regulatory references to ethics remain largely limited
to legal rather than ethical considerations.
3
it’s legal, it’s ethical,”15 or “As long as it’s not illegal, it’s okay.”16 Rules have also triumphed over ethics
when they become the ceiling rather than the floor for desired conduct – as when companies opt not to go
beyond the minimum requirements of the code-of-ethics provisions of Sarbanes-Oxley, or when research
analysts participated in sales calls in Europe when then-recent regulatory changes technically applied only
to such meetings in the United States.17
Rules have significant limitations, however.18 Many of these limitations are well-known and have
been widely considered. Some involve scope – rules are reactions to yesterday’s disaster and cannot be
developed to address crises that we cannot anticipate.19 Others involve content – rules can require acts
that are morally reprehensible, such as those on which racial or religious discrimination is based. And still
other limitations involve language and currency – the number, age, complexity, and clarity of rules affect
whether rules will (or will not) succeed in controlling behavior.20
But what if the inherent nature of rules also makes it more difficult to decide and do the right
thing? What if the tendency to focus on the letter of the rule rather than its spirit, or to interpret rules
technically and narrowly, or to push the envelope is due, at least in part, to characteristics of the rules
themselves? The pages that follow consider just such a possibility, namely that rules might actually (albeit
ironically and unintentionally) undermine ethical decision-making.
The debate over whether conduct is more effectively regulated by principles (standards) or rules,
while not unrelated to this issue, need not be addressed here. First, although rules and principles are
distinct, the distinction is not between law and morality: moral dictates can be as detailed as legal rules
(e.g., “children should give their seats to elderly people who board a bus”), and legal/regulatory
requirements can be as broad as ethical principles (e.g., due process; “fairly present in all material
15 See Lynn Sharp Paine, Managing for Organizational Integrity, HARV. BUS. R, Mar.-Apr. 1994, at 106,
109 (hereinafter “Paine”) (“‘If it’s legal, it’s ethical,’ is a frequently heard slogan. But conduct that is
lawful may be highly problematic from an ethical point of view.”). See also William H. Widen, Enron at
the Margin, 58 BUS. LAW. 961, 999 (2003).
16 See Blake E. Ashforth & Vikas Anand, The Normalization of Corruption in Organizations, 25 RESEARCH
IN ORG. BEHAVIOR 1, 18 (2003) (citation omitted).
17 See Erik Portanger, Banned on Wall Street, But All Right Abroad?, WALL ST. J., June 6, 2003, at C1.
18 See, e.g., Rakesh Khurana et al., Management as a Profession, in Lorsch, supra note 4, at 43, 44.
19 EUGENE BARDACH & ROBERT A. KAGAN, GOING BY THE BOOK: THE PROBLEM OF REGULATORY
UNREASONABLENESS 100 (2d ed. 2002) (hereinafter “BARDACH & KAGAN”).
20 See Diane Vaughan, Toward Understanding Unlawful Organizational Behavior, 80 MICH. L. REV. 1377,
1398-99 (1982).
4
respects”). 21 The limitations of rules that are discussed below apply to both moral and legal rules. Second,
the way that rules or principles are applied (whether their content is legal or ethical in nature) tends to cause
them to converge:
When authorised to act in accordance with rules, rule-subjects will tend to convert rules into
standards by employing a battery of rule-avoiding devices that serve to soften the hard edges of
rules. . . . Conversely the adaptive behaviour of rule-subjects when given a standard goes in the
opposite direction. These rule-subjects, when given few rules in the rules-standards sense, will
make them themselves, and apply them to their own allegedly discretionary behaviour, thus
limiting significantly the case-sensitive discretion that it was the intention of the rule-maker to
grant.22
If rules and principles are two ends of a continuum,23 then precisely where on the continuum a particular
prescription is located may not be crucial; it will eventually tend toward the middle.24
To be clear: the point here is not that the ethical lapses involved in corporate scandals stemmed
directly and primarily from rules. Surely other factors (including compensation structure, management’s
preoccupation with short-term results rather than long-term sustainability, conflicts between business lines,
greed, and a feeling of being “above the law”) played a role. Nor is the point that rules should be
abolished; they will – and should – continue to be essential guides for conduct. Indeed, one should not
overlook the ways that rules make certain freedoms possible and influence morality positively; statutes
prohibiting racial discrimination, for example, required people to interact and, over time, some racial
