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Predicting Fund Manager Integrity and Profitability - a Theoretical Analysis with First Steps Towards an Empirically Based Assessment

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Predicting Fund Manager Integrity and Profitability - a Theoretical Analysis with First Steps Towards an Empirically Based Assessment Predicting Fund Manager Integrity and Profitability - A Theoretical Analysis with First Steps Towards an Empirically based Assessment DISSERTATION of the University of S. Gallen Graduate School of Business Administration, Economics, Law and Social Sciences (HSG) to obtain the title of Doctor Oeconomiae submitted by Jon Michael Ebersole from The United States of America Approved on the application of Prof. Dr. Martin Hilb and Prof. Dr. Dres. h.c. Rolf Dubs Dissertation no. 3720 Difo-Druck, Bamberg, Germany Predicting Fund Manager Integrity and Profitability The University of St. Gallen, Graduate School of Business Administration, Economics, Law and Social Sciences (HSG) hereby consents to the printing of the present dissertation, withouthereby expressing any opinion on the views herein expressed. St. Gallen, November 23, 2009 The President: Prof. Ernst Mohr, PhD - 2 - Predicting Fund Manager Integrity and Profitability Copyright © Jon Ebersole 2009 All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means without prior permission from the author. - 3 - Predicting Fund Manager Integrity and Profitability Abstract The goal of this dissertation was to test whether assessment scores measuring socio-emotional maturity and ethical judgment ability correlate with the financial returns of fund managers. The basic research questions are: (1) Will fund manager scores in ethical judgment, measured by the Moral Judgment Interview (MJI) or Defining Issues Test (DIT), show a correlation with market returns? (2) Will fund manager scores in emotional maturity, measured in the “Subject-Object Interview” (SOI), show a correlation with market returns? Positive correlation would provide a measure of the link between these assessments of mental processes and effective behavior. Further, if fund manager maturity and ethics scores were found to correlate with profitability the finding could enable an augmentation of existing fund manager recruitment models, influence educational curricula in the finance sector, and raise significant issues for investors. Thirty financial institutions were contacted with a research proposal detailing the above, and all thirty declined to participate. Four banks were contacted with a simplified request for single interviews of a general nature, resulting in five interviews that were scored for their socio-emotional content. The result of the study are: (a) the hypothesis that, given a fair market, equal conditions and equal qualifications, fund managers with higher levels of socio- emotional maturity and ethical judgment ability will achieve greater profitability; and (b) a model for how this hypothesis could be scientifically tested. November 2009 Jon Michael Ebersole - 4 - Predicting Fund Manager Integrity and Profitability Zusammenfassung Ziel dieses Dissertation war herauszufinden, ob Personaleinschätzungen, welche die sozio-emotionale Reife und ethischen Urteilsfähigkeit messen mit der finanziellen Renditen von Fondsmanager korrelieren. Die grundlegende Forschungsfragen sind: (1) Werden die Ergebnisse betreffend die ethische Urteilsfähigkeit von Fonds Managern, welche durch Moral Judgment Interviews (MJI) oder Defining Issues Tests (DIT) eruiert wird, mit deren Marktergebnissen korrelieren? (2) Werden die Punktzahl der emotionalen Reife von Fondsmanagern, welche mittels “Subject-Object Interviews” (SOI) gemessen wird, mit ihrer Marktergebnissen korrelieren? Eine positive Korrelation würde ein Mass der Verbindung zwischen diesen Bewertungen von mentalen Prozessen und effektivem Verhalten ergeben. Wenn sich darüber hinaus ein Zusammenhang zwischen Reife- und Ethikergebnisse von Fond Managern und Rentabilität als eine deutliche Einfluss für Gewinn zeigen würde, könnte das Resultat zum vermehrten Einsatz von bestehenden Personalevaluierungsmodellen für Fund Manager führen. Dies dürfte wiederum die Lehrpläne für die Finanzbranche beeinflussen und könnte zu einem Thema für Investoren werden. Dazu wurden dreissig Finanzfirmen mit dem vorliegenden Forschungsvorschlag kontaktiert. Alle dreissig haben die Teilnahme abgewiesen. Daraufhin wurden vier Banken mit einem vereinfachten Vorschlag für Individualinterviews allgemeiner Natur angefragt. Das hat zu fünf Interviews geführt, welche sozial-emotional bewertet wurden. Die Ergebnisse der Studie sind (a) die Hypothese, dass angesichts eines fairen Marktes, gleicher Bedingungen und gleicher Qualifikation Fondsmanager mit einem höheren Niveau an sozio-emotionaler Reife und ethischer Urteilsfähigkeit eine höhere Rentabilität erzielen und (b) ein Modell, wie diese Hypothese wissenschaftlich belegt werden kann. - 5 - Predicting Fund Manager Integrity and Profitability This dissertation is dedicated to the least fortunate on this earth. Acknowledgments This dissertation was carried out in the context of a doctoral program at the University of St. Gallen. My sincere thanks are extended to the numerous persons who encouraged and assisted me in this endeavor. Special thanks are due to Prof. Dr. Martin Hilb, and Prof. Dr. Dres h.c. Rolf Dubs for the support they lent to this study. A deep sense of gratitude is offered to my parents, Myron and Geraldine Ebersole, without whose support this study would have never been possible, and to my daughters Stella and Helena Ebersole, who give me hope for the future. Appreciation is due to persons who provided intellectual inspiration and encouragement, including Claude Baumann, Anne Colby, Eckhard Freimann, Prabhu Guptara, Otto Laske, Prasad Oswal, Julia Indera Ramlogan, Michael Sanson, Jeannette Schläpfer, Florian Schulz and Zoltan Zolcer. My sincere appreciation is extended to the many persons in the finance industry who helped to arrange the interviews that were possible, the interviewees themselves, and to those who took the time to consider, and some to encourage, the research project in institutions who decided not to participate. Since the research became somewhat controversial, I have decided to keep their names confidential. Thanks are also due to the University of St. Gallen administration as well as the library, cafeteria and household staff who provided a friendly environment for study. Any shortcomings are, of course, my own. - 6 - Predicting Fund Manager Integrity and Profitability Table of Contents Abstract 4 Acknowledgements 6 List of Figures and List of Tables 9 Abbreviations and Key Words 10 Preface 11 1 Introductory Section: 14 1.1 Problem Analysis: The Evolution of Swiss Banking 15 1.1.1 Origins of Banking 16 1.1.2 Historical Phases of Swiss Banking 18 1.1.3 The Context of Globalization 25 1.1.4 The Digitalization of Finance 28 1.1.5 The Sub-Prime Crisis: Collective Failure and System Meltdown 32 1.1.6 The Ratings Agencies 36 1.1.7 Major Fraud Cases 41 1.1.8 The Role of Regulators 45 1.1.9 Ethics as a Financial Issue 47 1.1.10 Switzerland in the Global Context 48 1.1.11 Personnel Competencies for Swiss Banking in the Global Context 49 1.2 Goals for the Study 53 1.3 Procedure 59 1.4 Definitions 60 2 General Theoretical Section: The Human Side of Banking 63 2.1 Assessing Fund Managers 63 2.2 The Role of the Fund Manager 70 2.3 The Decision Making Context 72 2.3.1 Criminogenic Environments 74 2.3.2 The Nature of Fraud in Fund Management 75 2.3.3 Fraud as Manipulation 77 2.3.4 Regulatory Mechanisms 80 2.3.5 The Search for Ethical Leadership Capability 81 2.4 Defining the Competencies of Successful Bankers and Fund Managers 82 2.4.1 Behavioral Finance 83 2.4.2 Psychoanalytic and Developmental Approaches 84 2.4.3 Defining Competencies 87 2.5 Assessments Based On Developmental Psychology 90 2.5.1 The Genesis of Developmental Psychology 90 2.5.2 Measuring Ethical Judgment 92 2.5.3 Measuring Socio-emotional Maturity 105 2.5.4 Measuring Cognitive Capability 122 2.6 Organizational Frameworks using Developmental Assessments 125 - 7 - Predicting Fund Manager Integrity and Profitability 3 Specific Empirical Section 126 3.1 Empirical Objective 126 3.2 Empirical Targeted Participants 127 3.3 Empirical Methodology 128 3.4 Limits of the Empirical Study 132 3.5 Empirical Results 135 4 Concluding Section 139 4.1 Recommendations for Further Research 140 4.2 Contributions to Theory 141 4.3 Recommendations for Practice 141 4.3.1 For Human Resources and Coaching 141 4.3.2 For the Finance Industry 142 4.3.3 For Swiss Banking 143 5 References and Appendix 146 5.1 References and Additional Resources 146 5.2 List of Interviews 163 5.3 Final Certificate from the Interdevelopmental Institute 164 5.4 Long Letter Requesting Research Cooperation 165 5.5 Short Letter Requesting Research Cooperation 172 5.6 Banks and Investment Companies Contacted 173 5.7 Curriculum Vitae of Author 175 - 8 - Predicting Fund Manager Integrity and Profitability List of Figures Fig. 1. Structure of the Dissertation 10 Fig. 2. House Mortgaged with a Subprime Loan 35 Fig. 3. The Decision Making Context 73 Fig. 4. A Schematic of Habermas' Speech Acts 79 Fig. 5. DeSeCo’s overarching conceptual frame of reference 89 Fig. 6. Stages of Socio-Emotional Development by Robert Kegan 107 Fig. 7. Stages of Socio-Emotional Development 109 Fig. 8. Stages of Socio-Emotional Development with Sub-Stages 114 List of Tables Table 1: Methods of approach to change patterns in trading. 85 Table 2. Stages in the application of rules by children 94 Table 3. Four Psychological Component Determining Moral Behavior 98 Table 4. Twelve Component Model of Moral Action 98 Table 5. Different Groups on the DIT P Score 101 Table 6. The Heinz Dilemma 102 Table
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