1. Ethics and the Conduct of Business
Eighth edition
Chapter 13
Governance, Accountability, and Compliance
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2. Modules 13.1: Corporate Governance 13.2: Corporate Accountability
13.3: Corporate Compliance
Conclusion: Governance, Accountability, and Compliance
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3. Learning Objectives
13.1: Identify the moral arguments and legal rules for shareholders’ control of publicly held corporations, and the additional considerations for protecting the interests of other stakeholders
13.2: Critique how financial reporting, corporate management roles, and the law function to prevent fraud and other kinds of corporate misconduct, and the flaws in the system that have allowed major scandals
13.3: Evaluate the components of corporate ethics programs, the federal guidelines designed to punish and prevent misconduct, and how adopting a code of ethics benefits companies
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4. Introduction: Governance, Accountability, and Compliance
Fraud at WorldCom
Creative accounting
Unraveling of the scheme
Points to consider
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5. 13.1: Corporate Governance (1 of 2)
Objective: Identify the moral arguments and legal rules for shareholders’ control of publicly held corporations, and the additional considerations for protecting the interests of other stakeholders
13.1.1: Shareholder Control
Overview
Justifying control
Public policy
Incentives
The market
13.1.2: The Shareholders' Contract
Residual risk bearer
Solutions
13.1.1: Shareholder Control
Point 1- Overview
Many publicly held for-profit organizations
Shares bought and sold by public in public organizations
Shares owned by the founder in private organizations
Initial public offering
Point 2- Justifying control
Shareholders have right to make major decisions
Objective of for-profit organizations is shareholder profit maximization
Doctrine of shareholder primacy
Justification of shareholder primacy has two sources
Significance of the two sources of support
Point 3- Public policy
Corporate governance guided by two concepts
Separation of ownership
Shareholders assigned day-to-day control to managers
Shareholders relieved themselves from legal responsibilities
Shareholders are providers of equity capital
Point 4- Incentives
Investors of equity capital have strongest incentives to achieve efficiency
Groups with less incentive for risk
Two features considered from the point of public policy
Point 5- The market
Shareholders provide capital and get profit in return
Shareholders have certain control rights on the firm
Nexus-of-contracts view of a firm
Corporate governance a contract between firm and shareholders
Shareholders as residual risk bearer
13.1.2: The Shareholders' Contract
Point 1- Residual risk bearer
Creates contracting problems for shareholders
Fixed claims are easy to be assured in contracts
Profit of the firm cannot be mandated in the contract
Point 2- Solutions
To accept role of risk bearer in conditions they have control over
Without control, the cost of capital would be much higher
Shareholders ask managers to put in their best effort to be profitable
Imposing fiduciary duty on managers
Shareholders more economical in bearing the cost of residual risk
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6. 13.1: Corporate Governance (2 of 2)
Objective: Identify the moral arguments and legal rules for shareholders’ control of publicly held corporations, and the additional considerations for protecting the interests of other stakeholders
13.1.3: Shareholders and Stakeholders
Overview
Stakeholder theory
Protecting stakeholders
Return to stakeholders
13.1.3: Shareholders and Stakeholders
Point 1- Overview
Employees, customers, suppliers, community members, shareholders as a group are stakeholders
Groups vital to success of corporations
Effective management of stakeholders important for success
Point 2- Stakeholder theory
Descriptive
Instrumental
Normative
Point 3- Protecting stakeholders
Conducting thought experiments
Two reasons why each group would prefer shareholder model
Point 4- Return to stakeholders
Fairness in distribution
Decision on distribution should be made by the government
Contracts and legal rules best protect each group’s return
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7. Figure 13.1: Measures for Corporation Accountability
American system for corporate accountability
Financial reporting
Corporate management
Criminal law
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8. 13.2: Corporate Accountability (1 of 2)
Objective: Critique how financial reporting, corporate management roles, and the law function to prevent fraud and other kinds of corporate misconduct, and the flaws in the system that have allowed major scandals
13.2.1: Financial Reporting
Overview
Accounting and auditing
Job pressure
Conflict of interest
Confidentiality and expectations gap
13.2.1: Financial Reporting
Point 1- Overview
Company financials first line of defense
Serve as an important check on management
Tempting vehicles for committing fraud
Point 2- Accounting and auditing
Accounting is recording and presentation of financial transactions
Must keep track of revenues and expenditures
Auditing is inspection of accounting records
Could easily spot wrongdoings and fraud
Point 3- Job pressure
To achieve financial picture that top executives want
To meet earning expectations
May be pressured to go along with inaccurate financial treatments
Point 4- Conflict of interest
CPA firms have many interests
May have a financial relationship with the company they audit
May have clients who are competitors of the company being audited
Conflicts arise when CPA firm provide auditing and consulting services to a client
Conflicts result from dual loyalty of auditors
Point 5- Confidentiality and expectations gap
Accountants have a strict duty of confidentiality
Should file a report with the SEC
Any information about suspected wrongdoing should not be disclosed
Gap exists between what public expects from auditors and what auditors actually do
Gap can be closed if auditors are made more effective in detecting fraud
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9. 13.2: Corporate Accountability (2 of 2)
Objective: Critique how financial reporting, corporate management roles, and the law function to prevent fraud and other kinds of corporate misconduct, and the flaws in the system that have allowed major scandals
13.2.2: Executives and Directors
Role of CEO
Role of directors
13.2.3: Criminal Prosecution
Overview
Theoretical problems
Practical problems
13.2.2: Executives and Directors
Point 1- Role of CEO
Makes most important decisions
Has the greatest amount of knowledge
Influence selection and retention of board members
Creating right incentives can be achieved by four main means
Point 2- Role of directors
Directors elected by shareholders
Directors select and monitor CEOs
Board exercises control through various committees
Due to structural features, boards fail to prevent wrongdoing
Board members should have control systems capable of detecting misconduct
13.2.3: Criminal Prosecution
Point 1- Overview
Fraud and conspiracy to commit fraud are criminal offenses
Criminal offense involves harm to the state
Civil offenses arise due to violation of some regulations
Criminal prosecutions are state actions
Civil suits brought by either state or private individuals
Point 2- Theoretical problems
Corporations lack the two essential elements of criminal liability
Corporation lacks a body that can be punished
Difficult to determine when employees act on behalf of corporation or on their own
Point 3- Practical problems
Prosecutors face great difficulty in building a case
New cooperative approach is the result of two developments
If corporations cooperate with investigators, they are less likely to be criminally prosecuted
Company executives faced with a choice
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10. 13.3: Corporate Compliance (1 of 3)
Objective: Evaluate the components of corporate ethics programs, the federal guidelines designed to punish and prevent misconduct, and how adopting a code of ethics benefits companies
13.3.1: Program Components
Overview
Components
Integrity strategy
13.3.2: Program Benefits
Main benefit
Other benefits
13.3.1: Program Components
Point 1- Overview
Ethics program consists of rules and policies
Rules and policies include culture and value
Compliance with rules and policies are secured with various procedures and systems
Procedures and systems are essential functions
Point 2- Components
Code of ethics
Ethics training for employees
Means of communication
Reporting mechanism
Audit system and a system of conducting investigation
Point 3- Integrity strategy
Fostering right conduct
Motivates employees by appealing to their values and ideals
13.3.2: Program Benefits
Point 1- Main benefit 
To prevent ethical misconduct
Main loss from employee misconduct has been company’s reputation
Point 2- Other benefits 
Provides a managerial tool for adapting organization to rapid change
Helps organizations manage relations with external constituencies
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11. 13.3: Corporate Compliance (2 of 3)
Objective: Evaluate the components of corporate ethics programs, the federal guidelines designed to punish and prevent misconduct, and how adopting a code of ethics benefits companies
13.3.3: Federal Sentencing Guidelines
Overview
How do guidelines work
Effective ethics programs
13.3.3: Federal Sentencing Guidelines
Point 1- Overview
Adoption of effective ethics program
Imposing a just sentence on any convicted organization
Influencing the conduct of all organizations
Achieved through formulating guidelines
Guidelines provide fines to punish an organization and compensation to the victims
Point 2- How do guidelines work
Determining a base fine
Culpability score
Point 3- Effective ethics programs
Prevent or detect every instance of wrongdoing
Must practice due diligence
Steps to be followed in due diligence
No solid reason that ethics programs are more effective
Corporations may create window dressings programs
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12. Table 13.1: Determining a Culpability Score
Points added to 5
Points subtracted from 5
+ 5 points if high-level personnel were involved in the wrongdoing
– 1 to 5 points for:
reporting an offense
+ 3 points if the organization obstructed the investigation or prosecution of the crime
cooperating with the investigation
+ 2 points if similar misconduct had occurred before
accepting full responsibility
Ranges from 1 to 10
Starting with 5 points and adding and subtracting 5 points for certain factors
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13. 13.3: Corporate Compliance (3 of 3)
Objective: Evaluate the components of corporate ethics programs, the federal guidelines designed to punish and prevent misconduct, and how adopting a code of ethics benefits companies
13.3.4: Codes of Ethics
Overview
Types of codes
Reasons for adoption
13.3.4: Codes of Ethics
Point 1- Overview
First step in developing ethical program
Recent phenomenon
Point 2- Types of codes
Codes of conduct
Mission statement
Corporate philosophies
Point 3- Reasons for adoption
To clarify standards
Effective means for disseminating standards
Enables employees to do what they believe to be right
Even well-written codes of ethics have limitations
Everyone in the company should have ownership of the code
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14. Conclusion: Governance, Accountability, and Compliance
Corporations should be legally structured
Corporations must be held accountable
There must be a control environment within the corporation
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