Ethical standards and cultural assimilation in financial services
We study a hierarchical firm run by a profit-maximising principal whose employees account for ethical concerns when they make decisions. The employees can adopt a profitable new working practice that may harm their customers; their decision reflects their compensation contract, what they learn from their peers, and their ethical willpower. Organizational culture is an equilibrium phenomenon when employees have similar ethical values; when employees differ sufficiently, the principal opts not to create an organizational culture. Our model explains observed patterns of malpractice, and it explains the ways in which training budgets and regulation can affect culture and, hence, misconduct.