The old saw is that character is what you do when nobody's watching.

Well, thanks to the stock option backdating scandal currently roiling some companies, we're finding out exactly what sort of character certain executives have.

Beginning in the 1980's, and taking off in the 90's, executives of public companies started seeing more and more of their compensation take the form of stock options. Options represent the right (but not the obligation) to buy the stock of the company at some future date for a predetermined price (the "strike price"). If the stock is worth more than the strike price, then the options are worth something, and sometimes quite a lot. If the stock is worth less than the strike price, then the option has very little value (it is "underwater").

So, if the stock goes up, then the CEO gets paid very well. If the stock goes down, the CEO just gets his normal salary and bonus.

In theory, and as required by current tax and accounting rules, the strike price is supposed to be set at the market price of the stock on the day the option is granted (this wasn't always the case, by the way). If the company grants stock options which have a strike price below the market price of the stock (that is, they are "in the money"), then the value of those options needs to be treated as an expense and the executive needs to pay taxes.

With me so far? Good.

The problem is that granting stock options isn't like giving someone a puppy. There's a lot of paperwork involved, it takes time to process, and it could be many months before the option grant is disclosed in a company's SEC filings. So unless a company has careful internal controls, it is very easy for someone to, well, fudge a little on the exact date the options were granted.

If you happen to be given stock options on a day when the stock price was lower, then the strike price on the options will be lower, and the options will be worth more. And who's going to notice a few days difference on the paperwork?

The Scandal
A few months ago, the Wall Street Journal ran an article about a fascinating analysis they did on the stock option grants of a number of public companies. And what they found was that top executives at several public companies had the most amazing luck: they happened to be granted stock options on the exact day that would give them the best strike price. Year after year after year. In one particular case (United Health Group), this amazing bit of good fortune increased the value of the stock options by over $200 million over the course of several years.

There are two explanations for this. One is that the CEOs of these companies have the incredible ability to pick the exact bottom of their company's stock price every single time without fail. If this is true, then these men (and they are all men) are probably actually underpaid for their remarkable ability to predict the future, since the odds of choosing the right date every time for all the different companies is something like a quadrillion to one against.

The other explanation is that a lot of public company executives are cheating, consistently and repeatedly.

Of course the executives all deny any wrongdoing, even the ones who have been fired. Some blame clerical errors--and to be fair, there is no evidence that the executives themselves ordered or even knew about the backdating. It is entirely plausible that the dirty deeds were done by overzealous underlings trying to curry favor by quietly lining the boss' pockets.

But whoever actually forged the paperwork to backdate stock options, it is the corporate executives who ultimately benefited, and who are responsible for setting the moral tone of a company. So they need to take the blame.

Who Loses?
Some people might argue that there are no real victims in this scheme, but that's not true. In fact, every dollar in ill-gotten gains from improperly priced options is a dollar straight out of the treasury of the company. That's because when the owner of the stock option exercises the option, he buys the stock directly from the company at the strike price.

If the CEO was given a million stock options priced at $20 per share which should have been $25 per share, then when he exercises the options he will buy the stock for a total of $20 million instead of $25 million. That's $5 million that he has effectively stolen from the company treasury.

Character
If the Wall Street Journal article is correct (and I have no reason to doubt it), then this has been going on for years at some companies. And we're learning the true character of some who have been viewed as corporate "good guys." Competent, hardworking, successful executives who have been quietly transferring money from their corporate treasuries to their personal bank accounts for years. Some of these people I knew personally (though not closely) from my days as a stock analyst.

I met Lou Tomasetta and Gene Hovanec from Vitesse Semiconductor (both now fired) on many occasions, and had nothing but respect for them at the time. They ran a tight ship and managed in the interests of the shareholders. Except for that little paperwork problem that happened to move several million dollars from Vitesse's bank account to theirs.

Kobi Alexander and David Kreinberg of Comverse Technologies are two other executives I personally knew who have been fired for backdating options, though I didn't have quite as much respect for them as I did for Tomasetta and Hovanec. I always thought the Comverse crew were a little too gung-ho about promoting their stock price instead of focusing on running their business as the telecom sector melted down in 2000 and 2001. But still--Alexander in particular was one of the founders of Comverse and was already extremely wealthy. Why did he feel the need to pick the shareholders' pockets for a few million more?

And here in Minnesota, we have our hometown hero William McGuire of United Health Group, who is also embroiled in this fiasco. I don't know him personally, but the man is worth well over a billion dollars and has a squeaky-clean reputation. Plus he's from Minnesota. He, too, has a dark side.

I feel that the best executives are the ones who are acutely aware that they are not working for themselves but for the shareholders. They have a sense of fiduciary duty towards the people who (in theory at least) hired them.

Unfortunately, in most companies there are few strong checks and balances to make sure the CEO is doing his job properly. The CEO serves at the pleasure of the board of directors, and while the board is in theory elected by the shareholders, in practice board members are actually chosen by management and ratified by the shareholders. Very few board members are ever voted out. So there isn't much to stop the CEO from arranging things to work out in his personal favor instead of the company's favor, especially when nobody's watching.

There've been a number of angry articles recently about PayPal censoring bloggers who use its donation system. In a nutshell, a handful of bloggers have received notices that they would be cut off from PayPal. PayPal has clearly gone too far down the road of trying to control who uses its service and for what purposes, but I do have some sympathy for them, since the first few steps on this path were not of their choosing.

First a little history: PayPal legally can't offer its payment services for certain types of businesses, particularly online gambling. Gambling used to be a significant business for PayPal (about 6% of revenue), but then they were forced to cut off all gambling customers. Congress, in its infinite wisdom, decided that if interstate gambling was to be illegal in the U.S., then banking services which support gambling would also be illegal. For better or for worse, this effectively makes every bank an extension of law enforcement when it comes to illegal gambling.

As a result, any bank which knowingly offers a credit card merchant account to a gambling organization can get in big trouble. PayPal, as a "payment service," ran afoul of this law, and was forced to start policing its customers to make sure they weren't running online casinos.

There are other services which financial institutions are prohibited from offering (for example, money laundering, sending money to terrorists, and large untraceable fund transfers), and as long as PayPal had to start policing their customers for gambling, they probably figured it was a good idea to make sure they weren't being used as a vehicle for other illegal transactions.

This is about where they probably should have stopped. Nobody suggests that PayPal should be breaking the law, though I suspect few understand just how restricted banks are in who they can deal with.

From Following the Law to Censorship
PayPal has a right to decide who they will and won't do business with (within limits--for example, they probably would not be permitted to discriminate on the basis of race or gender). As long as they were forced to purge their customers of gamblers, terrorists, and money launderers, they probably made the decision to avoid doing business with any person or company which might bring a taint of scandal. I'm sure there are PayPal executives whose nightmare is seeing a front-page "expose" about how PayPal is a major funding channel for some scandalous-but-not-illegal venture, such as online pornography or hosting beheading videos.

In other words, better to play it safe. This decision was probably made easier now that PayPal is owned by eBay, which has never been shy about enforcing its version of community values on its member base (and to be fair, eBay also has to be careful to avoid becoming a marketplace for illegal or morally distasteful products).

Gone Too Far
I can entirely understand PayPal's point of view (by the way, my company is a heavy user of PayPal's payment services, since they're far and away the most efficient way to make thousands of small online payments). There's a lot more business to be done in the "squeaky-clean" arena than in the shady backwaters, and very little upside to exposing oneself to potential scandal.

The problem is that PayPal is a de-facto monopoly. There are other payment services out there, but none with the size and reach of PayPal. Critically for my company, there are also no other services which offer the ability to crank out thousands of tiny payments to individuals for pennies each.

In other words, if you don't like PayPal's policies, you might not have the option of taking your business elsewhere.

Monopolies have, in my opinion, a special ethical responsibility to not abuse that position. That means they have to deal with everyone fairly, not leverage their monopoly into other monopolies, and not arbitrarily refuse to do business with certain customers. In this respect, PayPal is failing to live up to its ethical responsibility as a de-facto monopoly.

More Competition, Please
For this article, I've ignored many of the other problems at PayPal, particular their customer service (which sets new heights for the term "sucks"), and their very un-bank-like attitude towards their customers' money (such as their practice of completely freezing accounts when there's a dispute, cutting the customer off from his/her money). I would like nothing more than to see a credible competitor to PayPal, especially one with better service and more of an attitude of fiduciary responsibility. That might actually force PayPal to consider some of its business practices in terms of customer's ability to take their money elsewhere. Until then, we're stuck with what we've got.

A series of three essays about what it means to be both ethical and a practicing capitalist:

Is Ethical Capitalism Possible?

To Whom Does an Ethical Business Owe a Responsibility?

How Does a Business Behave Ethically?

In my last article , I showed that a business owes an ethical responsibility towards its employees, customers, community, and shareholders, in roughly that order. This was based on a practical consideration of which people and groups are most responsible for a company's success, or can cause it to fail. In other words, you want to behave nicely towards people who can help you.

The final question is, what actions does a business have to take (or not take) to behave ethically towards its employees, customers, community, and shareholders?

My guiding principle here is the golden rule: ethical businesses should treat others the way they would want to be treated in a similar situation. More specifically, an ethical business should behave:

1. Honestly
Behaving honestly means that a business does not attempt to deceive others. This covers a lot of ground, from accounting fraud, to claiming that a product does something which it was never designed to do.

Hardly anyone would disagree that dealing with employees, customers, etc., honestly is required of an ethical company. But the number of times companies deal with others dishonestly is astonishing. For example:

Accounting gimmicks: Many public companies, especially in technology (where the pressure to grow every single quarter is immense) play games like trying to convince customers to buy a bit more at the end of the quarter to make a target, or capitalizing what might otherwise be expensed. There is an ethical grey area here: it is OK to push hard to make a sales goal, but it is not OK to take it to the point where it distorts the underlying health of the company.

Overpromising: Salespeople are notorious for promising customers the moon, and probably everyone has had the experience of buying something only to discover that it couldn't do what you wanted it to. Software is particularly bad in this regard, as companies often try to inflate feature lists by including things which don't work, or are so marginal as to be useless.

2. Openly
Openness is a subset of honesty. It means that a business keep others informed about what it is doing and why. This does not mean giving away proprietary information, or tipping off competitors as to strategy, but simply letting others feel like they are in the loop.

Stated another way, behaving openly means not concealing information which someone might reasonably want to know, and which wouldn't harm the business to release. It also means not concealing information which might lead an employee, customer, community member, or shareholder to behave differently towards the company.

Some examples of information which is often inappropriately concealed: Known product defects; sudden adverse changes in the business environment; and the fact that different customers pay different prices (though it is reasonable to not release the exact prices others pay).

3. Consistently
Behaving consistently means not changing what a company does over time without reason. For example, if a customer calls MegaBank to check his account balance, that customer should be treated the same way every time. He should not get prompt service on one call, then a brush-off on the next, and be assessed a $2 fee on the third.

Or, if an employee keeps losing his keycard, he shouldn't be fined $10 one time, not charged at all another time, ignored the third time, reprimanded the fourth time, and fined $5 the fifth time.

Inconsistency is often the result of a company not caring enough about a person or group of people to take the time to provide a measured response to some request or action on the part of an employee, customer, community member, or shareholder; and it sends a strong message of not caring to the person being dealt with inconsistently.

Consistency is important, though, because it helps people understand how a business will interact with them. Without consistency, a person doesn't know what to expect, or how to go about getting what he or she wants.

4. Fairly
Fairness is the flip side of consistency, and means treating all members of a group in the same way. Fairness does not mean that everyone gets identical treatment, but that when the treatment is different, it is for reasons which are the same for everyone.

In practice, fairness is hard to enforce. People are always trying to gain some unfair advantage, and some are more persistent about it than others. It is tempting to give in to the salesperson who demands to stay in a four-star hotel when everyone else is staying at the Holiday Inn, especially if the salesperson is a top performer.

When such favors are discovered by others, as they almost always are, it breeds considerable resentment among those who did not receive the special favors. In the long run, this is usually more damaging than holding one's ground against the requests for unfair treatment.

5. In The Best Interests of Others
Probably the hardest part of behaving ethically is working in the best interests of others. This means that an ethical business needs to actively promote the interests of its employees, customers, community, and shareholders. Merely not getting in the way is not enough.

This does not mean that an ethical business should liquidate its assets and give them all to the starving hordes in Africa. Everyone is nearly always better off when the company is operating successfully, generating jobs and economic value, and actively contributing to the vitality of the community.

What it does mean is that an ethical business should work to make its employees, customers, community, and shareholders prosper. This is also in the best interest of the company itself: remember that these are the groups which contribute to the company's success, and when they all prosper, the business will prosper, too.

The hard part comes in figuring out what actions are truly in the best interests of others (as opposed to short-term gain with long-term damage); and how to balance competing interests of different groups.

For example, shareholders nearly always want a company to do everything possible to boost its stock price. While this may be to the short-term benefit of particular shareholders, it doesn't really help shareholders who don't actually sell the stock while it is high, and it actively harms future shareholders who bought while the stock was high, since it limits their gains. In the long run, it is nearly always better for the shareholders for the company to provide a good return over the long-term, either through dividends, or consistent growth; and to work to ensure that the stock price is reasonably consistent with the underlying value of the business.

In addition, since many of the actions companies take to boost their short-term stock price also harm customers, employees, or the community, a company can fail to meet its ethical obligations by focusing too much on the demands of one group.

So Why Is This So Hard?
I don't think it is necessarily hard to be an ethical business, but it requires being able to work with the big picture and the long-term view.

In the past few decades, companies in the United States have become focused on keeping shareholders happy to the almost complete exclusion of all else. A lot of good has come of this--for example, working to improve inefficient operations--but it has also been taken to an extreme in some cases.

The key is to focus on what is in the long-term best interest for everyone involved. In the short-term, employees, customers, the community, and shareholders often have competing interest. In the long-term, however, everyone's best interests are aligned in having a successful, prosperous enterprise which treats everyone honestly, openly, consistently, and fairly.

In my prior essay on ethics and capitalism , I argued that Ethical Capitalism is not inherently impossible. Now that I've established that it is possible--and even in a company's best interest--to behave ethically, I'm going to examine where a business owes its ethical responsibilities. A common myth today is that a company owes its primary, and possibly sole, responsibility to its shareholders. I will argue that an ethical company's true responsibilities lie with many different groups of people, both for practical and for ethical reasons.

No person or organization can hope to take care of everyone and everything which might need help. So, the first step is to figure out who a company is ethically obligated to worry about. We need to have a working criterion for deciding who a business owes its ethical responsibilities:

A Company Owes an Ethical Responsibility To Those Individuals and Groups Who Are Responsible for Its Success.

I chose this for both an ethical reason, and a practical one. The ethical reason is one of mutuality: if a business has been helped by the actions of a third party, there is an obligation to recognize that. The practical reason is that if someone helped a business succeed, the same person or group could possibly cause it to fail, should the company misbehave and invite retribution.

Four groups of people are generally responsible for the success of a business: Employees, customers, the community, and shareholders. Ethical companies need to balance their responsibilities to these groups, especially when they conflict. Of these four, the shareholders are generally the least important, especially for public companies, even though the "responsibility to the shareholders" is often cited as a company's reason for taking a particular action vs. another.

Employees
Employees are the group most responsible for a company's success, since a business is essentially nothing more than a collection of individuals gathered together for a common purpose and with a certain amount of infrastructure and capital. Without employees (and I include management in this category), a business literally could not exist. Profitable companies do not spontaneously form out of piles of equipment, software, and money.

An important caveat, however. Companies owe an ethical responsibility to employees only insofar as the employees contribute to the success of the company. It is not unethical to fire an underperforming employee. It is also important to keep in mind that changing industry or economic conditions may force a company to do things (like lay people off) which hurt employees, but are necessary to the survival of the business.

Customers
Nearly as important as employees are customers. No company can be profitable without them, and the customers provide purpose and direction (and money) to a company.

Just as with employees, however, not all customers contribute to the success of a company. Some customers are too demanding, abusive to employees, or insist on doing business in a way which is unprofitable. When this happens, a company will normally be better off in the long run by politely refusing to do business with the problem customer. Of course, if the problem customer is, for example, Wal-Mart, this may be easier said than done. Management has to keep in mind that it cannot afford to ignore the needs of the profitable customers in order to satisfy the demands of the problem customer.

Community
By "community" I mean the cities, states, and countries in which a business operates. It isn't as obvious as with employees and customers, but the community is vitally important to the success or failure of a business. A healthy community provides many things which a business needs to function:

* A pool of potential employees with the necessary skills and experience.

* Customers who want or need what the business produces.

* Infrastructure, including things like roads, power, water, phone, Internet, and other necessary services.

* Food, shelter, education, a safe environment, and other elements needed for people to focus on the business, rather than basic needs of themselves or their families.

* Social and cultural opportunities which keep people stimulated and productive.

* Mechanisms for resolving disputes (laws, courts, regulations, etc.) in a fair, predictable, and reasonable fashion.

Most of these things are invisible when present, and we tend to take them for granted. Nevertheless, the communities a company operates in are important to its success: just look at how hard it is to do business in a war zone, or in a country where the laws are uncertain.

As a result, companies bear an important ethical responsibility to improve their communities. When successful, this benefits the company by giving it a better environment to operate in.

Shareholders
Even though shareholders "own" a company in a legal sense, in most public companies they contribute little to the success or failure of the business. Unless shareholders are active in the business (for example, company founders, or employees/management with significant holdings of company stock), shareholders contribute only money to a company's success. Money is the most fungible commodity that it exists: there is no difference between $1.00 from a hedge fund in New York and $1.00 from a grandmother in Toledo.

This is not to say that a company owes no ethical responsibilities to its shareholders, but that other duties are generally more important. Unfortunately, the bias recently has been to pay attention to the shareholders before the other groups. Shareholders, however, generally have the option of selling their stock at any time for market value at little cost, and bear no risk beyond the value of the shares themselves. Employees, customers, and the community have a much harder time disengaging themselves from a business; and can be hurt very badly by a company's misdeeds.

Ethical Responsibilities of a Business
Most companies are obligated to behave ethically towards their employees, customers, community, and shareholders, in roughly that order. Next, I will examine what those duties are, and how a business can fulfill them.

There is a meme, particularly fashionable since, oh, 1995 or so, that it is impossible to be both ethical and a practicing capitalist. This idea has become even more popular since the corporate scandals of the past few years. As an entrepreneur, CEO, and (I believe) and ethical person, I argue that it is not only possible for a company or businessperson to behave ethically, it is imperative. This is the first of a series of essays in which I will lay out what it means to be ethical in business, and how to behave ethically.

There are really two reasons typically given that ethical capitalism is impossible. First, that the corporation (and any similar legal structure) has no inherent ethical compass; and second, that the profit motive prevents people from behaving ethically.

Corporations Have No Ethical Compass
The argument that corporations inherently have no ethics is based on the idea that it is easier for one person to misbehave when he can cast the blame on a group he belongs to, rather than when he must bear full responsibility for his actions. This is clearly true, and is one of the things which allows mobs of people to do things which no individual in the group would normally do.

Corporations (and similar legal structures like partnerships, LLC's, etc.) are essentially groups of people, gathered together for a common purpose. But the dynamics of most corporations are much different than those of a rioting mob or a group like the KKK. Perhaps most importantly, business do hold individual employees accountable for their actions. In many companies, this is a formalized review process, but even when no formal process is in place, employees are expected to behave in a manner consistent with what the company expects.

The real question is, what kind of behavior does the company expect from its employees? Does it expect employees to behave in a way consistent with core values; or is lying, cheating, and stealing acceptable as long as employees bring in revenue? When an employee steps over the line of acceptable behavior, any of a range of things typically happen, from a mild correction by a peer, all the way to a formal reprimand or even firing.

A corporation's values come from its leadership, and are institutionalized by longtime employees. People within the company notice what kinds of behavior are tolerated by management, what gets people into trouble, what gets someone promoted, and what gets someone fired. Rather than saying that corporations have no ethical compass, it is more correct to say that corporations magnify the ethics of their leaders. The corporation as a whole will care about those things which its leadership cares about, and encourage the behavior its leaders encourage. As a result, unethical behavior by corporations is not inherent in the corporate structure, but the result of leadership which doesn't care about ethics.

The Profit Motive Prevents Ethical Behavior
But why should leaders care about ethics, when it is so much easier to make a buck by being unethical?

It is true that there are a number of shortcuts one can take in business which are both unethical and more profitable than doing things right, but these shortcuts tend to hurt in the long run. The reason is that a company does not exist in an ethical vacuum: it must be responsive to the concerns of its customers, employees, and community--however broadly those groups are defined.

A company which behaves in ways inconsistent with the values of its customers, employees, or community will find itself being corrected in any number of ways, ranging from losing individual customers or employees, to formal boycotts, to legal action. Trying to increase profitability by ignoring ethical concerns will eventually wind up costing the company money, negating any short-term benefit.

This is particularly true today, when information can spread rapidly through the Internet, and both customers and employees have an enormous range of options. It is difficult to try to sell a new car for $2,000 over the sticker price when the customer knows both the sticker price, the invoice price, and has two other offers from different dealers. The customer will decide what an acceptable level of profit is, and the dealer has to work to justify its margins.

Sometimes, behaving ethically may require a company to take a longer view, and sacrifice some profit today for the sake of building goodwill and a strong reputation. This, however, is entirely consistent with capitalism. Capitalism means working to make a profit; it does not require sacrificing all else for the maximum possible profit at every moment in time. Investing in goodwill for the future (after your unethical competitors have disappeared) is a completely rational business strategy.

Or, stated another way, nobody worries about competing against Enron anymore.

Ethical Capitalism Is Possible
Neither of the two arguments against ethical capitalism hold up under scrutiny. It is possible to behave ethically, while working to earn a profit in a corporate structure. In fact, ethical behavior makes sense as a business strategy, since it tends to create goodwill among customers, employees, and the community.

The next question is, what exactly does it mean for a business to be ethical ? What are the ethical responsibilities of a company?

Google's AdSense program (the program which is serving ads on this site) presents a twisted version of the agency problem, where Google is acting as an agent for parties (advertisers and content providers), but has an incentive to act against the best interests of the parties it represents.

An agent is a person or organization hired to represent some other person or company, and carry out certain activities on behalf of the represented person. A classical agency problem arises when the financial incentives of the agent run counter to the best interests of the person the agent represents. For example, a stockbroker with trading discretion (the right to make trades on behalf of a client) is supposed to act in the client's best interest, but gets paid on commission when trades are made. The all-too-common result is that the broker makes unnecessary trades in the client's account, racking up commissions but doing little good for the client.

AdSense presents this problem with a twist. Now there are three parties involved: the advertiser, Google, and the content provider. Google is acting as an agent for both the advertiser and the content provider, and keeps some fraction of the advertising fees the content providers pay. I don't know what the fraction is, because Google decides, but I'm guessing it is half or more. The problem arises in that Google can make more money by shortchanging either the advertiser or the content provider (or both).

Google can act against the interests of the advertiser by presenting inflated click-through rates, or by charging more per click than the market rate. Inflated click-throughs are relatively easy to audit and detect, since the advertiser knows how many surfers arrived through a particular ad, and can measure the quality of the clicks fairly easily by tracking the conversion rate (i.e. what fraction of click-throughs resulted in a sale). A sudden jump in clicks, combined with a drop in conversion rate, is a strong indicator of someone monkeying with the ad. In fact, my own company stopped advertising through a particular online company a couple years ago when we suspected the company of inflating the click-through rate, and they wouldn't provide us with the data to audit their numbers.

Charging more than market rate for a click is harder to detect, however. Google's ad programs work by essentially auctioning off ad slots to the highest bidder. Advertisers specify a maximum cost-per-click they're willing to pay, and Google is supposed to charge a fair market price based on advertisers' bids for a given slot. If there is only one advertiser for a slot, the click goes for a nickel. The potential for abuse arises because no advertiser knows what anyone else bid for a given click, or even what ads filled the other slots. In theory, no advertiser should pay more than a penny above the second-highest bid for a slot, but there's no way to know. Google could easily be using a bid increment of a nickel, or even thirty-seven cents, and none would be the wiser.

Google also gets to choose the percentage paid to the content providers. Since this percentage is never disclosed (and could be different from site to site, day to day, or even slot to slot), there's no way to know if the percentage is going up or down with time. If Google, as a newly-public company, ever needs to boost its profit a bit, they could drop the payout from, say, 50% to 45%, and few would notice the difference.

Right now, smaller content providers have no real options other than AdSense, but in the long-term, competition is the only way to keep this abuse in check. Since switching from Google to a competitor would be simple (if such a competitor existed), content providers would quickly go wherever they could make the most money. Many would probably even use both, and allocate ads based on who's payout was highest last week.

The really interesting agency dilemma has to do with fraudulent clicks from content providers. A content provider using AdSense owes no agency duty to the advertiser: the content provider is acting in his best interest only. So what is to prevent a content provider from clicking on every ad in sight to make more money?

Google has to prevent this fraud (by its duty to the advertiser), even though Google makes more money if the fraud continues. Fraud is controlled by kicking off content providers who appear to be inflating their clicks, though Google also owes a duty to the content providers to avoid falsely accusing them of fraudulent click-throughs.

Earlier in the AdSense program, several content providers complained about being inappropriately kicked out of the program, without explanation or recourse (and often, without the money they felt they had legitimately earned). This is where Google's twisted agency problem really gets ugly.

How, exactly, is Google supposed to reliably detect click-through fraud and eliminate cheaters without violating its duty to either the advertisers or the content providers?

Google can never release details of its Fraud Detection Algorithm, because that would tell would-be fraudsters how to get around the safeguards in the system. A side-effect of this is that content providers kicked out of AdSense can never be told why, which means they never get the opportunity to defend themselves. Furthermore, no Fraud Detection Algorithm can be perfect, so some false accusations are inevitable.

For example, the most obvious thing to look for is a sudden spike in impressions and clicks for a given site. But, as any webmaster knows, spikes in traffic of several orders of magnitude are common. When this blog was slashdotted a few months ago, we went from a few visits per day to 20,000 visits in 24 hours, and back again.

Other obvious warning signs, such as an unusually high click-through rate, can be just as innocuous. The click-through rate might jump because Google started serving a more relevant ad, or because the traffic mix to the site changed.

What it comes down to in the end is trust. Advertisers need to trust Google to police the content providers and price ads fairly, and content providers need to trust Google to give them a fair cut and not be arbitrary in their decisions to label someone suspect.

As Google becomes a public company--and all the quarterly financial pressure that implies--the incentives to violate the trust of both advertisers and content providers will only grow. It will be interesting to see how Google deals with this position.

Our woes with Protection One continue, with many letters exchanged so far, but no resolution. Protection One is claiming that we have only a short window once a year in which we can cancel the contract, otherwise it becomes irrevocable for another year. I see no such language in the contract, nor was that my understanding of the meaning of the contract at the time it was signed.

This has led me to wonder: have we now entered an age when fair and reasonable business practices--and even consumer protection laws--have become circumvented by one-sided consumer contracts? To obtain almost any kind of service these days, from a credit card to a mobile phone to an airline ticket, requires signing or agreeing to a densely-worded contract which very few people can even understand, and which nobody actually gets the opportunity to negotiate.

A few examples:

1. Nearly all commercial software now comes with a "shrink-wrap" agreement of dubious enforceability. These agreements, which you supposedly agree to by opening or installing software, or clicking an "Agree" button during the use of the software, have been known to contain all kinds of weird provisions, like agreeing to be spammed, or giving the software company the right to delete data from your computer. Very few software companies allow you to inspect the agreement before buying the software, and once you open the package, it is often unreturnable--meaning that if you don't accept the agreement, you have no recourse for the money you spent. These contracts are often very long, and very few people actually read them to the end, much less comprehend all the nuances.

2. Airline tickets are governed by extremely complicated tariff provisions, which are (in theory) available to anyone to inspect upon request. These documents, however, are generally hard to find, and (I am told) excruciatingly long and complicated. For example, Northwest's website contains several references to something called "Domestic General Rule Tariff No. DGR-1" which is "available upon request" but not on their website. A call to Northwest's toll-free number yielded a confused agent who didn't know what I was talking about.

3. Credit card agreements are often running 8-10 pages of very small print in a pamphlet, and while readability has improved over the past several years, the legalese is still generally incomprehensible. Such important terms as termination charges, dispute resolution, and so forth, are often hidden, and few consumers have the legal savvy to understand exactly what rights they're giving up. Many credit card agreements now contain "mandatory binding arbitration" clauses which limit or even eliminate your ability to take the company to court. My Discover Card recently added a clause which required Discover's consent before I can join a class-action lawsuit against them. Imagine that! I need their consent to sue them!

Even more amazing, in many cases, the companies don't even care what their own contracts say, unless there's an actual lawsuit--which almost never happens, because the dollar amounts at stake are too small. My company is doing a contest where we're asking for customer service horror stories, and we've gotten quite a few entries relating events where companies would unilaterally extend the length of a contract, impose fees, and so forth, against the terms of their own contracts. These situations can be very hard to fix, since most customer service reps are trained to believe whatever the computer tells them. Until there's a lawsuit, and the company is forced to document its actions, there's little the consumer can do other than refuse to pay the bill--which then gets sent to a collection agency.

Furthermore, a common clause in many consumer contracts is one which allows the company to unilaterally change the terms of the agreement with little opportunity for the consumer to refuse, short of canceling the contract altogether.

This raises a huge issue of business ethics. It is not ethical for a company to impose a contract upon its customers without a reasonable expectation that most customers will (a) fully understand the contract before signing it, (b) have a reasonable opportunity to refuse to the terms of the contract, and (c) have a reasonable chance to review the contract before agreeing to it.

As contract law is classically understood, those points are required for a contract to be binding. Unfortunately, we have somehow morphed into a system where, if the customer didn't understand the contract, it is considered the customer's fault, no matter how opaque the language or absurd the provision. $200 cancellation fee? Too bad, it was in the contract. Want to keep your data private? Sorry, you signed away that right. Not our fault if you didn't read the whole contract.

Amazingly, there doesn't seem to be any good reason for companies to behave this way. With a very small number of exceptions, most big companies are upfront and straightforward about their daily business practices (the exceptions are typically companies which are overtly playing games of "gotcha!" with their customers. Most companies don't do this, because word gets around). Most of these dense, impenetrable contracts could be boiled down to a half-page or less of "Terms and Conditions," and the cost of making these T&C's available (on a website, or a package box) would be minimal.

I would argue, in fact, that probably 95% of the bulk of these consumer contracts is legal language inserted to protect the company against extremely unlikely or unusual events.

Lawyers love to dream up extremely improbably but potentially disastrous scenarios, and then insist on contract language to protect against those events. I know this firsthand, having been through these discussions with our corporate counsel during contract negotiations. Most 57-page contracts can be boiled down to a page of plain-English terms, and the caveat that "If something unexpected happens, use your common sense."

This same dynamic plays into consumer contracts, but with an insidious twist. Because the company gets to essentially dictate the terms of the contract, the lawyers put in pages and pages of conditions. Why does every software shrink-wrap agreement state that the software is licensed "as-is"? Because companies are deathly afraid that they'll get sued for bugs under consumer protection laws (actually, maybe not such a bad idea....). The actual business practices of most software companies, though, is to issue patches and bug-fixes, which implies that they're not really selling the software "as-is."

But, once you get up to several pages of impenetrable legalese, it gets very easy for unethical companies to insert "gotcha" clauses. This is where the credit card company states that "payments are due by 4 AM local time on the due date printed on the statement" (actual term in a credit card agreement), effectively making the real due date the day before the date printed on the statement, since the mail doesn't arrive at the processing center until 11 AM.

I would argue that the only ethical way for a consumer-oriented company to treat its customers is to:

1) Make any customer contract or agreement available ahead of time, preferably online, in its complete form.

2) Write all customer contracts in plain English, one page or less of 12-point type, with any unusual terms clearly highlighted.

3) Eliminate any terms allowing the company to change the contract without the express consent of the customer.

For most reputable companies, point 1 should be a no-brainer, and some already do this (sadly, not enough). Some companies even do reasonably well on point 2, though I've yet to see a consumer contract which I truly consider readable and understandable for the average consumer (maybe I can make a project of rewriting some contracts as examples). Point 3 is where most consumer companies will scream: few companies, I suspect, would be willing to give up the right to make contract changes unilaterally (would you?). But most changes I've observed are either (a) new fees--which shouldn't be buried in a 15-page contract anyway; or (b) adding terms to protect against unlikely events.

There are also certain terms which simply have no place in consumer contracts, and should be outlawed. Things like giving up the right to sue in court, disclaiming various warranty and other consumer protections, and giving up other rights a consumer would normally have.