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Moral Neutralization in Pakistan's Capital Markets: a Study of Market Abuse

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Moral Neutralization in Pakistan's Capital Markets: a Study of Market Abuse University of Pennsylvania ScholarlyCommons Wharton Research Scholars Wharton Undergraduate Research 2017 Moral Neutralization In Pakistan's Capital Markets: A Study Of Market Abuse Syed Irtaza Ali University of Pennsylvania Follow this and additional works at: https://repository.upenn.edu/wharton_research_scholars Part of the Business Commons Ali, Syed Irtaza, "Moral Neutralization In Pakistan's Capital Markets: A Study Of Market Abuse" (2017). Wharton Research Scholars. 154. https://repository.upenn.edu/wharton_research_scholars/154 This paper is posted at ScholarlyCommons. https://repository.upenn.edu/wharton_research_scholars/154 For more information, please contact [email protected]. Moral Neutralization In Pakistan's Capital Markets: A Study Of Market Abuse Abstract This paper attempts to answer the question: why do brokers in Pakistan’s capital markets engage in corrupt behavior? It makes use of theories of moral neutralization and ethical decision making to understand what rationalizations or justifications individuals come up with ot justify or explain away their corruption. From analyzing what might motivate corruption on an individual level, this paper then looks at whether deeply embedded norms of corruption exist within brokerage organizations and across the brokerage industry. These theories are tested against insights gained from interviews with active market participants in Pakistan. The paper’s findings are: 1) evidence of partial degree of institutionalized corruption in broker organizations 2) brokers neutralize ethical concerns over their corruption by i) not seeing their actions as illegal and by ii) questioning the credibility and competence of the Securities and Exchange Commission of Pakistan as their rightful regulator, and 3) a relationship based culture amongst brokers motivates corrupt behavior within the industry. Keywords Neutralization, rationalization, corruption, Pakistan, brokers Disciplines Business This thesis or dissertation is available at ScholarlyCommons: https://repository.upenn.edu/ wharton_research_scholars/154 MORAL NEUTRALIZATION IN PAKISTAN’S CAPITAL MARKETS: A STUDY OF MARKET ABUSE By Syed Irtaza Ali1 An Undergraduate Thesis submitted in partial fulfillment of the requirements for the WHARTON RESEARCH SCHOLARS Faculty Advisor: Philip Nichols Joseph Kolodny Professor of Social Responsibility in Business Legal Studies and Business Ethics Department THE WHARTON SCHOOL, UNIVERSITY OF PENNSYLVANIA MAY 2017 1 I would like to express my immense gratitude to Professor Philip Nichols for his guidance, mentorship, and tremendous generosity during the year it took to write this thesis. He taught me how to become a better researcher and instilled in me an essential sense of clarity that I will take forward into my future research. I would also like to thank Dr. Utsav Schurmans for teaching me the tools to engage in scholarly research through the Wharton Research Scholars seminar, as well as his constant support and words of encouragement throughout the writing process. Finally, I would like to thank the interview participants who helped in bringing this paper to life and the Securities and Exchange Commission of Pakistan for giving me access to critically important data. 1 ABSTRACT This paper attempts to answer the question: why do brokers in Pakistan’s capital markets engage in corrupt behavior? It makes use of theories of moral neutralization and ethical decision making to understand what rationalizations or justifications individuals come up with to justify or explain away their corruption. From analyzing what might motivate corruption on an individual level, this paper then looks at whether deeply embedded norms of corruption exist within brokerage organizations and across the brokerage industry in Pakistan. These theories are tested against insights gained from interviews with active market participants in Pakistan. The paper’s findings are: 1) evidence of partial degree of institutionalized corruption in broker organizations 2) brokers neutralize ethical concerns over their corruption by i) not seeing their actions as illegal and by ii) questioning the credibility and competence of the Securities and Exchange Commission of Pakistan as their rightful regulator, and 3) a relationship based culture amongst brokers motivates corrupt behavior within the industry. KEYWORDS: Neutralization, rationalization, corruption, Pakistan, brokers 2 ABBREVIATIONS Pakistan Stock Exchange PSX Securities and Exchange Commission of Pakistan SECP Karachi Stock Exchange KSE Pakistani Rupee PKR United States Dollar USD Islamabad Stock Exchange ISE Lahore Stock Exchange LSE Corporatization, Demutualization, and Integration Act, 2012 Demutualization Act Corporate Law Authority CLA Asian Development Bank ADB International Monetary Fund IMF Non-Banking Finance Companies NBFCs Central Depository Company CDC National Clearing Company of Pakistan Limited NCCPL Carry over transactions COT Initial Public Offering IPO Oil and Gas Development Corporation OGDC National Investment Trust NIT Competition Commission of Pakistan CCP Morgan Stanley Capital International Index MSCI 3 1. INTRODUCTION The Pakistan Stock Exchange (‘PSX’) forms an essential component of the Pakistani capital markets. As of the end of March 2016, there were a total of 560 companies listed on the PSX with a book value of PKR 1,288.78 billion (USD 12.31 billion), a market capitalization of PKR 6,915.69 billion (USD 66.03 billion), and a market capitalization to Gross Domestic Product (‘GDP’) ratio of thirty percent.2 3 This market has experienced three major crises in the last two decades. Theses crises have been marked by allegations of market abuse, broker and investor default, and serious mismanagement on the part of the capital market regulator, the Securities and Exchange Commission of Pakistan (‘SECP’). Market abuses have included various price manipulation tactics and misuse of trade financing products by broker dealers who serve as intermediaries to investors. Given that these abuses have taken place frequently, and few, if any market participants have been held accountable for allegations of misconduct, an important question arises: why do broker dealers engage in these illegal market activities? This paper, therefore, tries to understand what possible reasons there might be for brokers engaging in corrupt behavior. It is important that this question be answered because persistent corrupt behavior inhibits the growth of a country’s capital market by eroding trust in its institutions, and in the process, discourages investment. This prevents or inhibits private sector companies from being able to access much needed capital for their business objectives and households from allocating their savings to the stock market. This paper will make use of theories of moral neutralization and ethical decision making, to understand why brokers would engage in corrupt behavior. Techniques of moral neutralization are essentially cognitive measures taken by individuals to explain away or justify their corrupt behavior. In this paper, these techniques of moral neutralization have been situated in a larger theory about the normalization of corruption in business organizations as purported by Blake E. Ashforth and Vikas Anand. These scholars argue that there is a multi-faceted and interactive process through which corruption becomes deeply embedded in organizations. The pillars of normalization are institutionalization, rationalization (a subset of neutralization), and socialization. This paper will focus on the former two, to see what, if any, evidence of institutionalization and rationalization exists in Pakistan, and how this explains the prevalence of market abuse. The other theory of ethical decision making at the individual level being used is posited by Xiao-Xiao Liu, George I. Christopoulos, and Ying-yi Hong. They argue that when an individual decides to give a bribe, the individual considers three interactive decision frames: ethical, economic, and relational. This paper extends this model to other forms of broker corruption, and attempts to explain how these decision frames are employed by brokers to justify corrupt acts. These theories will be tested against insights gained from interviews conducted with active market participants in Pakistan. These interviews provide a fascinating portrayal of Pakistan’s capital markets and the respective positions of the PSX and SECP within it. The interview findings 2 Government of Pakistan Ministry of Finance. “Capital Markets,” in Pakistan Economic Survey 2015-16, 99. Note: The dollar amounts were calculated using historical US/PKR FX rate from March 31, 2016 of $1=104.7299 rupees 3 Nadeem Naqvi. “Divestment of 40 percent strategic stake in Pakistan Stock Exchange,” Business Recorder, January 20, 2017, accessed April 25, 2017. http://epaper.brecorder.com/2017/01/20/13-page/841381-news.html. 4 are a unique contribution to the field of research on this industry. The findings of these interviews resulted in six key tropes about the markets: 1. The SECP’s main functions are to regulate and develop but it can be heavy handed in its policing of the market without giving due attention to the developmental aspect of its mandate 2. Market participants maintain that the SECP has serious human resource constraints which handicap its enforcement capabilities 3. A perception exists that the SECP is not entirely independent since it is susceptible to undue political influence and broker exploitation which could
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