To find ways to deter this recklessness, we’ve studied the mindset of financiers and others who take ‘moral hazard’ decisions
In the aftermath of the 2008 financial debacle, a term that was once confined to economic textbooks found its way into the public discourse: ‘moral hazard’. The term describes the inclination toward risky decision-making in circumstances where someone else – not the decision-maker – bears most of the costs. In the case of the financial crash, taxpayers ended up involuntarily bankrolling a bailout of the institutions whose reckless gambles precipitated the catastrophe. It’s been argued that these corporations, deemed ‘too big to fail’, effectively danced on the edge of risk, comforted by the safety net provided by public funds.
Some have suggested that the collapse of Silicon Valley Bank in 2023 set a more recent moral-hazard precedent. After the bank failed, the US government stepped in to protect depositors; this might encourage other bankers to engage in risky lending practices, confident that someone else will handle any fallout. Another example of moral hazard would be when the head of an organisation makes self-interested decisions (which could include increasing the size of their ‘golden parachute’) that put their subordinates and the future of the organisation at risk, but not them, if things go wrong. Moral hazard can also happen at a more individual scale, such as when someone who is infected with a virus decides not to take precautions like staying at home or wearing a mask, thereby putting those in their vicinity at risk without incurring any additional cost themselves.
Given the far-reaching consequences of moral hazard, we need a better understanding of the psychological and structural factors that encourage these kinds of risky decisions. Surprisingly, to date, there has been little such research. An important exception comes from work that delves into decision-makers’ psyches, suggesting that those who wield power, or are imbued with a sense of empowerment, are more likely to make self-serving decisions in situations involving moral hazard. These findings highlight the importance of the leaders’ role in understanding this problem.
However, we know that not all leaders act out of self-interest, especially when their actions can harm others. Many leaders view power not just as a means to personal gain, but also as a responsibility to serve others. Furthermore, even individuals without a leadership position can make decisions that put others at risk. So, the question becomes: why do some, but not all, decision-makers make these risky decisions?
Are dominant individuals more likely to make moral-hazard decisions that put others at risk?
To help us answer this question, we turned to a dual framework of social influence that has been used in previous research. This framework describes contrasting ways in which people attain and maintain influence over others. It broadly categorises individuals as having one of two orientations: ‘prestige’ or ‘dominance’. By examining how a person influences others, rather than just how powerful that person is, the framework allows us to explore which types of decision-makers or leaders are more prone to take decisions that put others at risk.
Individuals with a prestige orientation are valued for their skills and their tendency to share their knowledge or expertise with others. As a result, they are granted respect and admiration. This is the kind of person who invests time in helping and teaching those who work under them, who is empathetic and open to suggestions, and whom employees feel comfortable reaching out to for advice.
In contrast, dominant individuals are assertive and controlling in their interactions with others. By speaking first and more often, they command attention. Dominant individuals often use their authority and assertiveness to induce compliance. They exert influence by creating a sense of intimidation. Someone with a strong dominance orientation can be a tough taskmaster, cultivating a high-pressure performance environment.
Given dominant people’s tendency to be more controlling, agentic and self-focused – and to appropriate resources for themselves – we recently hypothesised (with our colleague Niro Sivanathan) that such individuals are more likely to make moral-hazard decisions that put others at risk. We tested this in a series of 13 studies that covered a variety of relevant contexts, including financial, environmental, public investment and public health scenarios.
In one notable study, we recruited seasoned finance professionals with experience investing in financial markets. These professionals first provided information on their own levels of dominance and prestige, using a set of scales. To capture dominance, the scale asks a participant to rate, for example, how much they enjoy having control over others, or getting their way regardless of what others want, and their willingness to use aggressive tactics. The scale for prestige asks someone, for example, how much they are sought for advice and how much they are respected and admired.
They were more willing to jeopardise their clients’ money to maximise their own potential gains
After getting these ratings, we presented the participants with various hypothetical scenarios in which they could invest a client’s money. In these scenarios, our investors could choose either an option with a guaranteed return or an option involving moral hazard, where their client could get a better return with a higher risk – meaning a greater commission for the investor. However, in the case of loss, the investor would be protected from any liability; only the client would bear the loss.
We found that the more dominant the investor was, the more likely they were to go for the moral-hazard option. That is, they were more willing to jeopardise their clients’ money to maximise their own potential gains. We did not find any consistent relationship between prestige and moral hazard.
We replicated these results across multiple studies with different groups of participants and contexts. For example, there was a scenario in which a leader could risk the health and safety of others by using substandard waste-disposal systems in pursuit of profits, and one in which signing a lucrative contract would lead to environmentally destructive fishing practices. Importantly, our analyses provided evidence that dominance itself – and not merely selfishness or a preference for risk-taking – is a distinct factor driving moral-hazard decisions.
What explains this behaviour in dominant individuals, and what can be done to mitigate it? To inform our theorising about this, we drew on previous research on accountability preferences. This work suggests that, when someone is pursuing a goal, they might hold themselves accountable either to the outcome of their efforts or to the process undertaken to achieve it. In other words, individuals can focus either on the ends or on the means. If the goal is to increase a company’s sales, a leader could just instruct employees to focus on the end goal – to find a way to increase sales, with little concern for how this goal is achieved. Alternatively, the leader could instruct employees to look at current sales practices and see where they can make improvements to them. In this scenario, the focus is more on the process that affects the company’s sales.
One ought to be more careful about trusting dominant individuals who have decision-making roles
We posited that dominant individuals would be more inclined to focus on outcomes over process. If that were the case, it could help inform ways to curtail the problem of moral hazard.
To explore this possibility, we asked study participants to imagine either that they were a dominant leader or that they were a prestige-oriented leader. In the scenarios we gave them, we also sought to influence whether they would feel more accountable to an outcome or to a process. Participants in the process-accountability condition were told that, when making their decision, it was important that they evaluate themselves on the procedures and means to obtain their desired goals, and not so much on the bottom line. In contrast, those in the outcome-focused condition were told that it was important that they evaluate themselves on obtaining the desired results rather than on how they attained them.
Then we presented all the participants with a series of moral-hazard scenarios. In support of our predictions, we found that the ones who took on the role of a dominant leader made more moral-hazard decisions than those who took the role of a prestige-oriented leader. However, this tendency among dominant leaders was significantly reduced when participants were held accountable to the process, rather than the outcome.
This study suggests a practical way that organisations might seek to prevent dominant people from making decisions that put others at risk. For instance, instead of rewarding hedge fund managers disproportionately when a risky bet pays out, a company could judge their performance based on whether they followed the necessary steps before investing a client’s money in risky assets. Was the client’s approval obtained for such transactions? Were they notified that such an investment could potentially wipe out their money? Even when an investment hasn’t proven very financially successful, was the due diligence exemplary? Emphasising such considerations might reduce the impact that outcomes have in driving risky decisions.
The temptation to prioritise self-interest while risking others’ wellbeing is timeless. Our research offers a more nuanced understanding of who is especially prone to put others at risk in pursuit of their own goals. A possible implication of these findings is that one ought to be more careful about trusting dominant individuals who have decision-making roles – such as bosses, team leaders, financial advisors or others – especially when one’s interests might be at odds with the decision-maker’s aspirations.
Our work also highlights the importance of awareness about individual differences in how people pursue goals, and the need to prioritise the means by which goals are pursued, rather than just the ends. By implementing structural changes that encourage such a focus, organisations and teams can effectively mitigate the risks associated with moral hazard – even when dominant people are the ones with decision-making power.
