A Better Approach to Avoiding Misconduct: Use nudges to complement traditional methods of risk management

Despite substantial regulatory reform following the 2008 financial crisis, financial firms are still suffering from fraud and other forms of ethical misconduct. As a result, they have collectively paid out more than $400 billion in fines over the past 12 years. A 2019 Harvard Business School study found that among a sample of Fortune 500 companies, more than two instances of internally substantiated misconduct occur each week, on average. It’s becoming increasingly clear that the traditional approach to financial regulation—imposing formal rules and investing in a strong compliance function to ensure that institutions, managers, and employees comply with those rules—cannot protect firms against excessive risk-taking and financial misconduct. The authors of this article draw on their experience advising some of Europe’s largest financial institutions to present an alternative approach to compliance that is based on the principles and discoveries of behavioral psychology. It involves understanding the contextual drivers of human behaviors and introducing small changes, or “nudges,” to eliminate misconduct at the source.