Generation mechanism of behavioral risk for organizational decision-makers in financial institutions: organizational and human errors

The paper addresses growing misconduct risk in financial institutions, particularly since the 2008 global financial crisis and amid recent increases in regulatory penalties (e.g., in 2023, Chinese financial institutions received 8,139 fines totaling 2.751 billion yuan). Regulators and scholars emphasize understanding the causes, mechanisms, and transmission paths of misconduct to improve governance. Existing work often focuses on organizational errors or complexity but lacks clarity on why and when organizational decision-makers make inappropriate decisions and how human and organizational errors interact. This study asks: Why do organizational decision-makers make inappropriate decisions? Under what conditions? What roles do human error and organizational error play? The study constructs a behavior risk analysis model for organizational decision-makers in financial institutions, grounded in the general mechanism of organizational decision-making, integrating organizational and human error theories with behavioral decision theory, to inform supervision and governance of misconduct risk.

The review covers two streams. (1) Organizational and human error: Reason (1995) conceptualized organizational errors as latent, systemic threats; subsequent work (Goodman & Ramanujam, Van Dyck & Frese, Ruchlin & Dubbs, Glavas, Grabowski & Roberts) highlights management/decision failures, system defects, culture, and resource fragility as roots of individual errors. Human error is framed as information-processing failure influenced by work environment and personal skills; evidence links employees’ knowledge, attitudes, and attention to error incidence. Organizational errors are key causes of human errors; in finance, governance and control deficiencies are primary organizational errors that precipitate human decision errors. (2) Behavioral decision theory: Beyond rational choice, bounded rationality, uncertainty, heuristic bias (Tversky & Kahneman), and preference heterogeneity shape decisions. In finance, managers’ optimistic biases can drive excess risk-taking. Decision processes depend on psychological behavior and risk attitudes; prospect framing affects attention and preferences. While behavioral decision theory is applied in financial consumption/investment, there is limited application to organizational decision-making and to misconduct risk generation integrating organizational and human error perspectives. The review motivates a systemic, behaviorally-informed model of misconduct risk for financial institutions.

The study develops a conceptual-analytical framework and model. Research framework: Using organizational and human error theories with behavioral decision-making theory, the authors (i) articulate a general mechanism of organizational decision-making behavior in financial institutions; (ii) analyze organizational and human factor errors within that process; (iii) specify necessary conditions for conduct risk; (iv) construct a risk analysis model including decision-maker utility and cost functions; and (v) analyze behavioral adjustment under different states of self-assessed capability versus expected utility, complemented by a case study (China Everbright Group, CEG) for reflection. General mechanism: Organizational decision-making behavior is influenced by individual psychological factors (cognition, stress, emotions, values), knowledge/experience/skills, and organizational context (governance, culture, standardized processes, performance allocation/assessment, internal control compliance, external supervision/regulation). A key safeguard is an organizational decision audit mechanism serving as a third line of defense. Elements include: (1) decision-makers’ capability and authority to propose plans/options; (2) consideration of conduct risks, costs, and responsibilities; (3) dynamic adjustment after implementation. Error analysis: Human errors arise from knowledge gaps, poor risk perception/forecasting, biases, emotions, and self-interest. Organizational errors include weak communication/coordination, inadequate decision audits, unclear rights-responsibilities, and internal control shortcomings. Conditions for conduct risk: (1) Conflicts between decision-makers’ and organizational interests; (2) Ineffective organizational constraints (internal/external); (3) Absent/ineffective decision auditing and feedback mechanisms post-proposal. Model construction: Two risk sources—adverse selection and moral hazard—are tied to decision-makers’ interests. Assumptions: (A1) Owners expect decision-makers to maximize organizational interests, while decision-makers maximize their own utility. (A2) Organizational constraints and audits are imperfect and selectively implemented. (A3) Marginal utilities of benefits—performance incentives/rewards (p), decision-making power (r), rank promotion (j)—decline; marginal costs to obtain each are equal. Notation: For a chosen decision D, P{D} is firm profit; U{D} is decision-maker utility; T(C) is cost to the decision-maker of self-serving actions detrimental to the firm; R(a) is the decision-maker’s self-assessed ability; U(p,r,j) is the utility function over benefits. Analysis steps: Step 1 (drivers): Misalignment between Max P{D} and Max U{D} creates inherent conflicts. Step 2 (selection function): T(C) = ΔU (AU). Improper behavior occurs when AU > T(C). Stronger governance, oversight, and decision auditing increase T(C), lowering the likelihood of misconduct; culture and incentive design can reduce AU by aligning interests. Step 3 (motivation intensity): S ≥ ΔU − T(C); S>0 indicates sufficient motivation for misconduct. The model defines U(p,r,j) conditioned by R(a). States and behavioral adjustments are analyzed by comparing R(a) and U(p,r,j). Case approach: The CEG case is examined against the model’s three conditions and adjustment scenarios to illustrate mechanisms and policy implications.

- Necessary conditions for conduct risk among organizational decision-makers: (1) conflicts between organizational and decision-maker interests (human error); (2) failure of internal/external organizational constraints (organizational errors); (3) lack of effective decision auditing and feedback mechanisms post-proposal (organizational errors). - Decision-maker behavior is governed by a trade-off between incremental utility from self-serving actions (AU) and behavioral costs (T(C)). Misconduct occurs when AU > T(C); increasing the effectiveness of governance, external oversight, and decision auditing raises T(C) and reduces misconduct likelihood. - Utility framework: Decision-maker utility U depends on performance incentives/rewards (p), decision-making power (r), and rank promotion (j), moderated by self-assessed ability R(a). Three states: • State 1: R(a) ≤ U(p,r,j) and equal marginal utilities dU/dp = dU/dr = dU/dj constitute a balanced Nash-like equilibrium; misconduct motivation is low. • State 2: R(a) > U(p,r,j) (self-assessed ability exceeds expected benefits). If marginal utilities are unequal, decision-makers adjust their pursuit across p, r, j to raise overall utility, potentially via misconduct (e.g., bribery to gain power; falsifying performance for promotion; misuse of authority for personal rewards). Six adjustment scenarios are identified depending on the ranking of marginal utilities across p, r, j. • State 3: R(a) < U(p,r,j) (benefits exceed contributions). Decision-makers may (a) invest to raise ability for a positive rebalance or (b) settle into a distorted balance expecting more compensation; institutions should use performance allocation, assessment, and supervision to steer toward positive balance. - Overestimation of ability relative to expected benefits increases the likelihood of inappropriate decision behaviors. - Case evidence (CEG): The misconduct episodes reflect the three conditions—interest conflict, weak organizational constraints, and absent/ineffective decision auditing—manifesting as secrecy, information asymmetry, concentration of power, and exploitation of internal control loopholes. These illustrate adjustment scenarios where high decision power coincided with heightened pursuit of rewards, leading to fraud/misappropriation. - Policy implications: Aligning interests to reduce AU and strengthening governance/audit to raise T(C) mitigate conduct risk. Dynamic rebalancing of incentives (p), power (r), and promotion (j) can reduce motivation for misconduct while supporting organizational objectives.

The findings address why and when decision-makers engage in inappropriate decisions by linking misconduct to measurable drivers—conflicts of interest, imperfect constraints, and insufficient auditing—and to a utility-cost calculus (AU versus T(C)) shaped by governance design. The model integrates organizational and human error theories with behavioral decision-making, showing that organizational errors often precede and enable human errors. The three-state framework (R(a) vs U(p,r,j)) explains how misalignment between perceived capabilities and expected benefits catalyzes misconduct and predicts the forms of behavioral adjustment. In practice, this implies that strengthening organizational context (governance, culture, internal control, external oversight) and installing robust decision-audit mechanisms can raise behavioral costs and reduce misconduct. Simultaneously, incentive architectures that harmonize organizational and personal utilities (calibrating p, r, j) reduce the incremental gains from misconduct. The CEG case illustrates these mechanisms in a real institutional setting, demonstrating how concentrated decision power, information asymmetry, and audit blind spots amplify conduct risk and how targeted reforms could mitigate it. These insights are relevant to financial regulators and institutions seeking more precise supervision and governance of misconduct risk.

The study concludes that conduct risk among organizational decision-makers in financial institutions has a dual origin in organizational errors and human errors. Triggers include conflicts between organizational and personal interests and imbalances between self-assessed ability and provided benefits/utility. By decreasing organizational errors—improving governance, culture, internal controls, and decision auditing—institutions can increase the behavioral costs of misconduct and lower its likelihood. The proposed model contributes by (i) defining selection and motivation intensity functions for misconduct (AU and S with T(C)); (ii) formalizing decision-maker utility U(p,r,j) conditioned on ability R(a); and (iii) mapping behavioral adjustments across three states and six scenarios. Practical measures include optimizing incentive allocation and assessment, cultivating a people-oriented culture, reinforcing internal control and decision auditing (raising T(C) and lowering AU), and dynamically balancing p, r, j to align organizational and individual interests. Future research should incorporate richer organizational context variables and analyze the utility game between institutions and decision-makers to refine the mechanism of misconduct risk generation and inform targeted supervision and governance.

The model focuses on decision-makers’ behavioral motivation, self-ability evaluation, and utility acquisition, implying a singular research object and limited scope. Functional constructions abstract from detailed organizational context variables and interactive utility games between institutions and decision-makers. There is no quantitative empirical testing or statistical validation; the case analysis (CEG) serves illustrative purposes. Future work should integrate internal and external organizational factors into the functions, model strategic interactions between organizations and decision-makers, and pursue empirical validation.