ETHICS IN FINANCE Doing the right thing is the best thing. Senior Seminar in Finance

Ethics in Finance Ethics Integrity A set of principles of right conduct Integrity Doing the right thing according to your ethical standards Senior Seminar in Finance

Ethics in Finance Ethical issues permeate most financial activities Ethical behavior is everybody’s concern Senior Seminar in Finance

Ethics in Finance Vulnerable person One typical path to problems Job stress and/or insecurity No prior consideration of ethical issues Existing conflicts of interest Failure to consider implications of situations and their consequences Failure to be aware of organization’s ethics policies and practice; haven’t identified the person to “talk to” if problems arise Senior Seminar in Finance

One typical path to problems Ethics in Finance One typical path to problems Vulnerable organization No real ethics code or practice in place Poor risk management controls Culture of aggressive growth in sales and profits Very high short term pay incentives linked to stock price, sales, or profits High levels of debt Market downturns reveal “cracks” Senior Seminar in Finance

Ethics in Finance The “slippery slope” One typical path to problems Vulnerable people or organizations encounter a cascade of unanticipated problems requiring the handling of bad news. In a world of grey, decisions are made to “bend” the rules to eliminate or minimize the bad news. This decision is made to “get by” until circumstances change to make current situation better. Senior Seminar in Finance

Ethics in Finance Consider this question: One typical path to problems Consider this question: If faced with the following options, which would you choose? a sure gain of $2,500 a 25% chance of gaining $10,000, but a 75% chance of no gain Senior Seminar in Finance

Ethics in Finance Now consider this question: One typical path to problems Now consider this question: If faced with the following options, which would you choose? a sure loss of $7,500 a 75% chance of a $10,000 loss, but a 25% chance of losing nothing Senior Seminar in Finance

Ethics in Finance The “slippery slope” One typical path to problems The resulting situation either gets better or worse. If the situation improves, then the breach may go undetected (until problems arise again). If the situation deteriorates, another round of decisions is required: do we continue to “bend”? Senior Seminar in Finance

Ethics in Finance The “slippery slope” One typical path to problems At some point, the “bending” of rules becomes clear violations of standards and a “lie”. At some point, the situation is detected by management or the public, requiring a response. Once public, a decision is required: lie/spin or tell the truth? Senior Seminar in Finance

Ethics in Finance The “slippery slope” One typical path to problems Once lying is detected, consequences usually occur: loss of confidence in person or organization loss of employment; career damage legal or regulatory sanctions Senior Seminar in Finance

Ethics in Finance Creates sustainable business Why be ethical? Creates sustainable business Creates trust in individual and organization Builds teams and leadership Builds reputation, career, conscience Senior Seminar in Finance

Ethics in Finance Ethical decisions consider long term consequences over the short term Emphasis on short term financial goals may create problems in the longer term Proper management pay and incentives can help address this problem Senior Seminar in Finance

Ethics in Finance Ethical decisions consider financial risk taken Financial leverage can enhance shareholder returns and competitiveness Tendency is to “leverage up” with debt during expansionary periods, making firm too risky when market downturns occur Proper financial policies can help prevent undue risk to be taken Senior Seminar in Finance

Ethics in Finance Who is affected by a business decision? Ethical decisions consider all stakeholders Who is affected by a business decision? Shareholders, lenders, and management Employees Community Suppliers Customers How will actions and decisions affect each group? What are the consequences? Senior Seminar in Finance

Ethics in Finance The “triple bottom line” versus focus only on profit Emerging “social” ethics in Finance The “triple bottom line” versus focus only on profit Maximizing firm value focuses on creating a long term, sustainable enterprise through focus on: Environmental issues (“planet”) Social issues (“people”) Economic results (“profit”) Senior Seminar in Finance

Ethics in Finance Improper revenue recognition Typical financial/accounting problem areas Improper revenue recognition Mis-classing expenses or accruals Hiding debt Greatly overestimating expected revenue Greatly underestimated expected expenses Senior Seminar in Finance

Ethics in Finance Investment related A list of ethical issues in Finance Investment related “Churning” “Front running” trades Insider trading Socially responsible investing (SRI) Senior Seminar in Finance

Ethics in Finance Labor Deceptive sales practices Lending A list of ethical issues in Finance Labor Outsourcing, workplace safety, worker rights Deceptive sales practices Lending Overcharging, discrimination International Kickbacks, bribes Senior Seminar in Finance

Ethics in Finance Executive compensation A list of ethical issues in Finance Executive compensation Compensation levels Short term incentives versus long term performance Backdating stock incentive options Golden parachutes Senior Seminar in Finance