Legitimized Unethicality

Financial markets, where companies are characterized by a separation of ownership from control and interactions are opaque to a large majority of uninformed investors provide a fertile ground for executives to conduct practices that push the ethical boundaries of accepted and expected behavior. Furthermore, some practices such as tunneling of funds in business groups and backdating of executive's stock option grants exhibit remarkable proliferation among many disparate actors, ones who will argue for the merits of these practices even after they are exposed. In this dissertation I examine the antecedents of widely practiced financial frauds, processes that lead to what I call "legitimized unethicality"- unethical behavior that gains credence among perpetrators while remaining clearly illegal to outsiders. In chapter 1 I look at skewed investments of mutual funds in affiliated companies when these go public, highlighting how shared ownership over financial and non financial companies can lead mutual funds to transfer funds from savers who's portfolios they manage to the business group to which they belong. In chapter 2 I examine the diffusion pattern of stock option backdating among executives in the United States, where co-location (both spatial and temporal) creates clusters of bad behavior among clients of audit firms. I isolate a key "agent of diffusion" that gives credence to the practice of stock option backdating- the local office of the companies' auditor and show, using multiple methods, that this geographical concentration of backdating is the result of heterogeneous acceptance of backdating among local auditors and is dependent on the level of competition among the local offices of these auditors. In the third chapter I turn to look at the social characteristics that promote adoption of stock option backdating and show that this practice is adopted by those executives who experience a gap between their realized compensation and the expected compensation level when comparing to their peers. Backdating is therefore one form of catching up to perceived "fair" levels of compensation. Together these papers demonstrate that some unethical practices can gain legitimacy by perpetrators, and spread widely among them, while remaining clearly unethical to outsiders until exposed.