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Psychology and Fraud

Psychology has profound effects on decision making. Within the business world, psychology can explain the processes through which organizations and individuals develop fraudulent and unethical behavior. Through analysis of the psychology behind the decision making and considering examples of corruption within the corporate world, precautions may be made to prevent similar fraudulent practices from occurring within the medical field.

Over a period of many years, concluding with the bankruptcy of Enron in 2001, corporate and individual corruption and fraud cost shareholders millions of dollars (paraphrased, Einstein Law, 2008). “All of this debt was concealed from shareholders through partnerships with other companies, fraudulent accounting, and illegal loans” (Einstein Law, 2008). Because of the fraudulent business deals and special ghost companies that were created to hide the company’s debt, investors kept pouring more and more money into the stock. The artificial inflation of the stock price kept the executives rich, fed with outlandish bonuses. Enron trussed up its corporate structure with hidden debt instruments, supported by the belief that reward could be divorced from risk (Steffy, 2008).”

Decision Making – Halo Effect

Enron was ranked as one of the top companies in the world. The corporate culture was both fun and challenging, and was viewed as the business model of the future (paraphrased, Ivanovich, 2004). Everything that Enron did appeared to be the best. “Fortune magazine named Enron the nation’s most innovative company five years running and, a year before Skilling’s resignation, ranked Enron among its ‘10 Stocks to Last the Decade’” (Ivanovich, 2004). The business was associated with its people, all of whom were top-notch. “The company also was obsessed with recruiting brilliant, aggressive people” (Ivanovich, 2004). In almost a hero-worship fashion, the brilliance of the executives carried over to the brilliance of the company. Everything looked perfect from the outside. The books looked great, and no one challenged the incredible profits that were being reported.

In retrospect, it is likely that stockholders and analysts should have been more cautious, scrutinizing the reports and actions of the company. I think that the primary reason that people did not investigate deeper into Enron was because of the halo effect. The people reacted to Enron because of the context-dependant stimulus (paraphrased, Plous, 1993). By seeing the executives as highly intelligent, brilliant and successful, fun and creative, the halo effect lead stakeholders to believe that they were also fair and ethical people, and that the business was run in a moral and ethical manner. Because of the halo effect, assumptions were made, based on the context of all the wonderfully positive things being said about the management; these assumptions eventually left employees and stockholders taking a major loss, facing long-term suffering.

Descriptive Models – Satisficing

Enron executives did not make the best decisions for the long-term good of the company or the collective. They did not even make the best long-term decisions for themselves, especially considering the lasting effects of their law-breaking on themselves and their families. However, I think that they chose their course of action by using the satisficing decision making model. “To satisfice is to choose a path that satisfies your most important needs, even though the choice may not be ideal or optimal” (Plous, 1993, p. 95). The executives committed fraud to fulfill their immediate need (or greed, in this case) for money. By fraudulently producing deceiving reports, they were able to keep a continuous flow of money into their own pockets. I imagine that the millions that they illegally gained helped to meet all their immediate needs, and to give the illusion of security. By choosing to address only their most primitive and narrow needs, without considering other all the other options that would be ideal or even optimal, the fraud committed is an example of satisficing.

Heuristics and Fallacy

Using the representativeness heuristic, people often judge probabilities by how much one thing appears to resemble another thing (paraphrased, Plous, 1993). However, this heuristic can cause problems when people fall into the “conjunction fallacy”, meaning that they assume that because there are more details, something is more likely to happen (paraphrased, Plous, 1993). In the case of Enron, I think that the executives used the conjunction fallacy of the representativeness heuristic to deceive the investors. With each additional factor, the probability is reduced (paraphrased, Plous, 1993); however many people feel that the more details the more likely something is. In the example of Enron, it created false companies to help hide its losses and substantial debt. By providing highly specific scenarios and ghost companies, many people did not question, but fell into the conjunction fallacy; assuming that, since there were so many details regarding the false companies, the lies must be truth. Fake companies, such as Chewco, JEDI, and Southampton (Einstein Law, 2008), helped to hide the billions of dollars of debt. By falsifying details such as the company names, stakeholders fell into the conjunction fallacy, and the executives were free to act as unethically as they wanted.

Another reason that I think Enron executives were able to execute such a grandiose fraud was because of their advantage using the availability heuristic. “People often use heuristics (or shortcuts) that reduce complex problem solving to more simple judgmental operations” (Schwarz, 1997). Using the availability heuristic, people judge probability on the frequency or prevalence of memory associated with a similar event (paraphrased, Plous, 1993). “The Enron mystique is due, in part, to the fact it was first in the recent wave of corporate scandals” (Ivanovich, 2004). Since there was yet to be a precedence of corporate fraud on such a massive level, no one suspected it. In fact, the company established such a reputation that its crash from on high was of tragedy proportions. Investors and watchdogs using the availability heuristic would not have perceived that such a massive fraud could take place, since there was no previous and readily available example of such events.

Overconfidence and Behavioral Traps

Enron seems to have achieved primacy because it has all the earmarks of classic tragic drama, in which hubris causes the fall of the mighty” (Ivanovich, 2004). The mighty Enron, powerhouse and a sort of prince among large companies, became overconfident. The executives assumed that they would not be caught, that their deceiving and fraudulent tactics would continue without recompense. “No problem in judgment and decision making is more prevalent and more potentially catastrophic than overconfidence” (Plous, 1993, p. 217). Because the executives became overconfident in their own brilliance, they took risks that reasonable people would never enter into, particularly the defrauding of their investors, employees, and the general public.

Another major behavioral trap that the Enron executives fell into was the time delay trap. “When Kinder left and Skilling took over the presidency,” Strong said, “I started feeling that people were not looking at the longer-term perspective” (Fowler, 2004). Similar to saticficing, time delay serves only the short term, most immediate needs, without searching out the most ideal long-term decision. In this scenario, they fulfilled their immediate greed, but destroyed their futures, some by serving jail terms, another through desperation, shame and suicide (Einstein Law, 2008).

I would argue that a third behavioral trap that played a major role in this fraud was the investment trap. After completing the first fraud, they had little additional to lose to complete the second, the third, and so forth. Once the line was crossed into fraudulent and illegal behavior, it did not greatly affect the situation if they continued to behave in this way. Essentially, they had already invested too much, and could not withdraw from their immoral actions without even greater loss. Hence, it was easier for them to continue on the path than to withdraw and return to ethical business practices.

Yet another trap would be the collective trap. This small group of people benefitted greatly, but at a huge loss to the collective; costing not only the business entity, but the persons involved to suffer extensively. Lost jobs, lost wages, lost investments; stakeholders of all sorts were impacted by the selfish greed of this élite group. This trap seems to be especially cruel, since it shows a premeditated choice to injure so many other individuals. The evidence of the collective trap shows that the group of executives felt themselves above the rest, with a morally and ethically superior value.

The Social Side – Groupthink

I think that it is obvious that this group of executives fell victim to groupthink (Plous, 1993). Some of the most common symptoms that were demonstrated by the Enron group were: the illusion of vulnerability, collective efforts to rationalize warnings, and unquestioned morality (paraphrased, Plous, 1993).

Conclusions

There is no doubt that the Enron executives were brilliant, and that they used many theories and fallacies of common decision makers to extort and defraud millions of dollars from stakeholders. By utilizing their knowledge of the processes of decision making, they were able to mislead and manipulate the situation. They took advantage of the halo effect to make themselves look better than they were. They were satisficing; serving only their immediate needs. By exploiting the heuristics used by stockholders, they were able to continue to increase stock prices while the actual business portfolio plummeted. Their eventual downfall was a direct result of their overconfidence.

While it is embarrassing that such an event happened, it is important to understand how and why so that there is not a repeated scenario. Investors and the general public need to be aware of how immoral people can manipulate the situations, thereby controlling the cash flow. Awareness and knowledge are the best defense against such fraudulent behavior. These same concepts need to be applied to all aspects of healthcare; no department or field is beyond the possibility of flawed decision making.

References

Einstein Law. (2008). Enron fraud, the history of Enron, the Enron investigation. Retrieved 8 March 2009 from: http://www.lawyershop.com/practice-areas/criminal-law/white-collar-crimes/securities-fraud/lawsuits/enron/

Fowler, T. (2004). Enron’s implosion was anything but sudden. Retrieved 8 March 2009 from: http://www.chron.com/disp/story.mpl/special/enron/2655409.html

Ivanovich, D. (2004). Everybody knows Enron’s name. Retrieved 8 March 2009 from: http://www.chron.com/disp/story.mpl/special/enron/2655424.html

Plous, S. (1993). The psychology of judgment & decision making. New York, McGraw Hill.

Schwarz, S. (1997). SFB 504 glossary: heuristics. Retrieved 28 February 2009 from: http://www.sfb504.uni-mannheim.de/glossary/heurist.htm

Steffy, L. (2008). Meltdown highlights our own failings. Retrieved 8 March 2009 from: http://www.chron.com/disp/story.mpl/business/steffy/6038997.html

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