Cheating business minds: How to break the cycle

July 20, 2012, 3:42 PM UTC

FORTUNE — In certain situations – when the rewards are high and the risks are low — our brains tell us that it’s okay to cheat. We figure out a way to rationalize behavior that may not otherwise align with our values.

Given that business leaders, especially at banks, have lately been in the news for their poor choices, Fortune took a look at what goes on in the mind of a cheater. There are powerful psychological forces behind rule-breaking for financial gain. But the next step — harnessing those powerful reward pathways in the brain to encourage ethical behavior — is incredibly difficult.

“Unfortunately, we know a lot of these rationalization behaviors that people engage in. We’re not quite as good yet about figuring interventions,” says David Mayer, a management professor at the University of Michigan’s Ross School of Business. Still, there are some ways to avoid or fight the temptation to cheat.

The best way to handle a high-pressure, unethical situation is to never get involved in one at all. That’s easier said than done, but leaders can work on the front-end to communicate solid business values to employees and shareholders. “If you advertise that you are trying to be ethical, you’re going to wind up hiring more ethical people. It’s kind of that field of dreams thing: if you build it, they will come,” says Mark Frame, a psychology professor at Middle Tennessee State University who specializes in workplace psychology.

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Companies often think they have communicated their values when, in fact, they remain unclear to the rank and file. None of the banks in court now have mission statements that say they want to cut corners for quick cash. Yet the short-term responsibility to shareholders, promotions based on money earned fast, and the cutthroat work environment in the run up to and during the financial crisis set up a competing reward system that stood in contrast to the businesses’ stated moral code.

The first step to getting people on board with good business ethics is to state the right thing, clearly, then reward it.

“There are still gray areas of business between ethics and profit,” says Barry Staw, a professor of leadership and communication at the University of California, Berkeley. Traders, for example, engage in activities that can look plenty like gambling with other people’s money. “I’m not sure that we will successfully, at least for a long time, be able to get rid of the market pressure,” says Staw. Given that, “people need to know where the boundary is,” and it should go beyond prohibiting illegal behavior. “Companies need to say, okay, you might not get arrested for this, but it is over the line.”

Strict internal policies could do some damage control. Leaders ought to work on sanctioning unethical behavior before it gets to a level that regulators would flag. “There would have to be a message within companies, not just that ‘if we’re caught by regulators, you’re going to fry,’” says Staw. “It’s that ‘if you are going over the line legally, as soon as we find out about it, you will immediately lose your job and we will decide whether or not to report you to various authorities.’”

This isn’t a very fun reward pathway; it’s more about instilling fear of personal punishment than rewarding people for making money.

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For leaders to establish those policies, they’re going to have to fear the consequences themselves. To that end, some of the recent high-profile resignations at banks — CEO Bob Diamond at Barclays (BCS) and head of compliance David Bagley at HSBC — could serve as examples to other finance executives that someone at the top will take the fall for systemic problems. That could force those top execs to adhere to their stated ethical code, Staw suggests.

In a high-pressure and close-knit work environment, it’s easy to get tangled in a tight circle of people behaving a certain way, says Frame. Certain choices may seem right within the group, but the outside world will view them differently. “Executives really need to start thinking about, not what it is they are doing, but how is it that they are being judged. They don’t always understand how it is going to come out in the court of public opinion,” says Frame.

Taking a step back, we might have a more ethical corporate environment if we trained people better before they get in a moral crucible at a big company. Ethics training might be due for a revise, starting at the business school level — especially since business school students might view ethics a little differently than others. In a 2006 paper published in the Journal of Business Ethics, researchers surveyed 268 students in various fields about cheating. While business students didn’t report cheating more often than others, they had significantly more relaxed standards about what it meant to cheat.

The idea that our ethics are hard-wired is a fallacy, Mayer says. “I think a lot of it comes from this idea that who you are is determined early on — did you have good parenting, did you have good friends? In reality, that’s a piece of the puzzle, for sure, but we de-emphasize our environment and the environment that we create.”

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By paying attention to how the environment affects our choices, people can begin to treat their ethics as a skill to develop and continue developing, even as students graduate, enter the workforce, and become executives.

“If we can understand some of these processes, then we can do a better job of developing … intervention,” Mayer says, and that is in business professionals’ best interest. “You really want people to be able to act in line with their values. People feel good when they do that, so how do you provide tools to help people do that?”

As a kind of ethical tool, Mayer tells his students that, when asking themselves if they did the right thing, “If the moral conclusion you come to is exactly what would be in your own self-interest, it’s worth checking again.” It’s a simple but elegant thought.