Cheating as a concept has long fascinated me, as has the general notion of what could be called delusional behaviour within humans. The interesting thing about cheating is that it seems to have moved from being an individually directed activity to a group activity. The activity of the group not only encourages the cheater but actively moves to protect them.
I want to look at endemic cheating within two parallel fields, sport and investment. I first want to look at the case of Alberto Contador, winner of the Tour de France. In 2010, Contador tested positive for the drug clenbuterol. Clenbuterol in a synthetic beta 2 agonist that acts as a bronchodilator, that is it opens up the lungs allowing a greater intake of air. Traditionally used in those that suffer from breathing disorders such as asthma it is on the banned list of substances for cyclists. These tests were met with the usual range of excuses that athletes put forward when they are caught cheating. Contador defence was that it was part of tainted food he ingested along with the rest of his team. The problem for Contador was that none of his team members tested positive. Traditionally the penalty for a positive test is a two-year ban and it is at this point that things become interesting and some fascinating group dynamics emerge.
Almost from the moment he tested positive, the group set up to investigate Contador displayed a lack of impartiality. In fact, the President of the Spanish Cycling Federation hoped that he would be found to be innocent. In addition to this, the Spanish Prime Minister said there was no legal basis for any sanction. The sanction initially offered to Contador was a proposed sanction – that is they effectively suggested to him would he like to be banned from the sport to which he said no and they said fair enough. At which point the committee set up to investigate the incident find him not guilty and say no worries off you go.
I have no doubt nor does anybody else that based upon the evidence that Contador was guilty of doping – this is no brainer since probably every modern Tour winner has used performance-enhancing drugs. What is interesting is the system has now set itself up to protect those who cheat.
This is a classic case of cheating; Contador assessed the risk of being caught (minimal), the size of the possible sanction (minimal to none) and the payoff for not being caught (huge). This is the traditional payoff matrix, that all cheaters go though when assessing whether to cheat or not. Experimentally it has been found that changes to the payoff matrix do not induce more people to cheat. That is if the pay off goes up a lot then the level of cheating does not go up much. It is an insensitive metric and it is not what traditional rational economic theory would predict. The notional is that the economically rational individual would respond instantly to an increase in the payoff by increasing the level of cheating.
However, the rate of cheating within groups is not as constant as initially appears. There is a within groups a personal threshold of cheating, that is people want to be able to sleep at night without undoing the image they have of themselves as honest individuals. This threshold is a little bit elastic in that it enables people to cheat a little without undermining their sense of self. However, this threshold can be dramatically altered if individuals have a perception that the entire group cheats. If there is a social element to the cheating then both the rate and scale of cheating goes up.
Now apply this paradigm to financial markets most notably during the GFC when you had massive corporate frauds perpetrated particularly in the US. These frauds undoubtedly had a myriad of causes that range from lax regulation to a catastrophic misunderstanding of the products involved. At the heart of the matter though, is the personal threshold of cheating. If the payoff for cheating is raised from a $1 million bonus to a $100 million bonus, the risk of being caught stays the same, and everyone around you is doing it then financial thievery is inevitable.