When business promotes honesty

In this article from The Independent Institute, Dwight R. Lee argues that businessmen are more honest (or less dishonest) in their dealings than preachers, politicians, and professors:

Jean-Leon Gerôme: “Diogenes, Having Failed in his Search for an Honest Man, Finds Some Stoic Dogs”

Notwithstanding regular reports of dishonest businessmen in the daily news, businessmen deserve more respect for their honesty than they receive.  Granted, businessmen are not always as honest as we would like them to be, and some of them are simply crooked.  The business community would certainly be a strange place for Diogenes to search for a completely honest man.  But would his search prove more successful elsewhere?  In considering the honesty of businessmen in our imperfect world, the relevant question is, compared to whom?  My case for businessmen’s relative honesty is not that they are more virtuous than preachers, politicians, and professors.  Instead, the argument is based on the constraints on those under consideration who might seek to profit from dishonesty.

In our experience, the business case for honesty (the moral case is another discussion) can often be based on the fact that many businesses rely on repeat business.  So although dishonesty may improve the profit or advantage in a single transaction it would result in less success over the long term.

Will Harrell, founding partner of Capco Asset Management in Tampa, has guest blogged for us before (on the subject of inflation), and we found this to be another thought-provoking subject on which to ask him to opine:

This is a terrific issue, and one I agree with in general although perhaps not across-the-board.  The upside from being perceived as a reliable, consistent, trustworthy, &etc. vendor of certain kinds of goods and services is simply huge.  Costco’s CEO has a line I love: “No easy hits on the customer.”  Honesty is just a sub-category of this thesis, which in many cases has more to do with product quality or user experience than honesty per se:  McDonald’s consistency, the taste of a Hershey bar, etc.  It’s also not limited to customers – similar considerations apply to suppliers, capital sources, and employees.

We once wrote on this subject in a quarterly letter, On Being a Good Partner: “But however great or small a company’s advantages, it is our observation that their durability is usually directly related to how good a partner the company is to those with whom it does business.”

It may strike some as corny and simple, yet is exactly what game theory predicts will transpire between participants in repetitive transactions.  What’s surprising is that the effect is not more dominant, and that trustworthy players don’t completely squeeze out untrustworthy ones.

It’s harder to explain the successful (for a time) sleazes like Bernie Madoff or ENRON than the good guys.  There ought to be a Darwinian element to it: where trust or consistency matters, the “good” should attract all the business from the “bad.”  Like bad genes, bad practices should be competed away.

However – bad pennies have a habit of always turning up, and in some cases, thriving.  Perhaps the particular transaction is not repetitive enough, like a car or home purchase; or perhaps customers attach insufficient value to character or are buying a credence good, one whose quality they lack the expertise to judge for themselves even after experiencing it.  (Like most professional services, including mine.)  Of course, some customers rely too heavily on price alone:  the repairman who intends to rip you off can rationally charge less than the honest one who intends to actually do the work and needs to price accordingly.

It’s a fascinating question, with huge implications.  It would be a real political plus for capitalism if more people understood it.

We agree with Mr. Harrell (as well as Mr. Lee).  BPV often backs the same entrepreneurs in more than one business, and we view honesty and consistency as critical to sustaining long term relationships for long term growth as opposed to trying to squeeze maximum value from a single transaction.  We also put a premium on transparency, as it’s easier to remember the importance of being honest when everyone involved in a business relationship can observe how decisions are being made.  In fact, we think that the victims of both Madoff and Enron could have avoided a great deal of misery if they had demanded a level of transparency that would have made both of those schemes unworkable.

From “Why Businessmen Are More Honest than Preachers, Politicians, and Professors“:

Businessmen interested in long-run survival are more honest in their professional dealings than are many other groups in society—not because they are more virtuous, but because they face more effective constraints. Their customers can usually detect and avoid deception more easily than can a politician’s constituents, a professor’s students, and a preacher’s congregants.  …It turns out that, because most businesses are profitable only by earning the patronage of returning customers, they have stronger incentives to be truthful than do preachers (“no one can ‘test drive’ a preacher’s most important promise,” Lee observes), politicians (for whom elections are sporadic and often predetermined by gerrymandering and other devices), or professors (whose customers, the students, “often do not care much about the honesty of the professors’ claims”)…

Yet as long as people continue to embrace beliefs out of comfort or convenience, opportunities will exist for someone to profit by making claims that are intentionally misleading – that is, by acting dishonestly.  Such dishonesty will arise in business, religion, politics, and academics, as some practitioners in those areas yield to the temptation to take advantage of the possible profits.  From this observation, I have made three arguments:

1. First, the costs and benefits of determining the accuracy of claims being made differ in the four occupational areas considered.

2. Second, in business the costs of determining honesty are smaller and the benefits greater than in the other three areas.

3. Third, the lower the costs and the greater the benefits of determining honesty, the more restricted are the opportunities to profit from dishonesty – and the less dishonesty will surface.

Base on these arguments, my conclusion is that, as a rule, businessmen are more honest than preachers, politicians, and professors when making claims about their products.