Ethics in Business and Accounting: Lessons We Are Learning

Prepared by Dr. L. Murphy SmithDill Distinguished Professor of Accounting

Murray State University

For permission to use or adapt this presentation, please contact Dr. Smith,

msmith93@murraystate.edu

Why are ethics so important? Business operations require trust.

Consider the millions of business transactions that take place daily that require mutual trust. Would you go to a job if you didn’t trust your employer to compensate you? How many people would shop on the Web if they didn’t trust that their financial information would be secure?

The classical economists such as Adam Smith considered economics a branch of ethics. Business activity would grind to a halt without trust, fair dealings, and

honest communication.

In his 1995 book, Trust: The Social Virtues and the Creation of Prosperity, Francis Fukuyama writes: "One of the most important lessons we can learn from an examination of economic life is that a nation’s well being as well as its ability to compete, is conditioned by a single, pervasive cultural characteristic: the level of trust inherent in the society."

When evaluating one’s goals and objectives, a vital question must be asked: What is your highest aspiration?

A. WealthB. Fame C. KnowledgeD. PopularityE. Integrity

If integrity is second to any of the

alternatives, then it is subject to sacrifice in situations where a

choice must be made. Such

situations will inevitably occur in every person’s life.

About how many high school students do you think cheat on exams?

a. 10%

b. 25%

c. 50%

d. 75%

e. 100%

In a recent Wall Street Journal

article, Psychology professor Steven Davis says that

cheating by high school students has increased from about 20 percent in the 1940’s to 75 percent

today.

“Students say cheating in high school is for grades, cheating

in college is for a career.”

If students lack ethics in high school and college, then there should be little surprise that

they lack ethics in their careers. Greed and over-reaching

ambition often end in disastrous personal consequences.

Convicted inside trader, Dennis Levine, in a Fortune magazine

article wrote:“I have painful memories of Sarah learning to walk in a prison visiting room, and of Adam pleading with a guard

who wouldn’t let him bring in a Mickey Mouse coloring

book.”

For what reason do people most often sacrifice their integrity and act unethically?

a. Need for popularity

b. Greed for money

c. Desire for power

d. Ambition to be famous

e. Something else

Money can be dangerous!?It is the most often cited cause of unethical behavior.

“Whoever loves money never has money enough; whoever loves wealth is never satisfied with his income.” (Eccl 5:10)

“For what will it profit a man, if he gains the whole world and forfeits his life?” (Matthew 16:26a)

“For the love of money is a root of all kinds of evil.” (I Timothy 6:10a)

Rembrandt’s Parable of the Rich Man, 1627.

Academic Institutions have established ethics codes for their students, e.g. the U.S. Air Force Academy Honor Code:“We Will Not Lie, Steal Or Cheat,

Nor Tolerate Among Us Anyone Who Does."

What do you think is the harder part?a. Line 1b. Line 2

Ethics codes: Accounting and BusinessAccounting and business organizations have established ethics codes. The code of ethics of the Institute of Internal Auditors includes the following principles: 1. Integrity

The integrity of internal auditors establishes trust and thus provides the basis for reliance on their judgment.

2. ObjectivityInternal auditors exhibit the highest level of professional objectivity in gathering, evaluating, and communicating information about the activity or process being examined. Internal auditors make a balanced assessment of all the relevant circumstances and are not unduly influenced by their own interests or by others in forming judgments

3. ConfidentialityInternal auditors respect the value and ownership of information they receive and do not disclose information without appropriate authority unless there is a legal or professional obligation to do so.

4. CompetencyInternal auditors apply the knowledge, skills, and experience needed in the performance of internal audit services.

Corporations, e.g. Halliburton, have established ethics codes to guide their employees.

Founded in 1919, Halliburton is one of the world's largest providers of products and services to the oil and gas industries. Halliburton employs more than 100,000 people in over 120 countries working in five major operating groups:

Source: http://www.halliburton.com/, 1/16/06.

Company policy requires Directors, employees and agents to observe high standards of business and personal ethics in the conduct of their duties and responsibilities.

Directors and employees must practice fair dealing, honesty and integrity in every aspect of dealing with other Company employees, the public, the business community, shareholders, customers, suppliers, competitors and government authorities.

No Director or employee should be misguided by any sense of loyalty to the Company or a desire for profitability that might cause him or her to disobey any applicable law or Company policy. Violation of Company policy will constitute grounds for disciplinary action, including, when appropriate, termination of employment.

http://www.halliburton.com/policies/ethical_business.jsp, 1/16/06.

Halliburton’s Code of Business Conduct: Ethical Business Practices

Prior research shows that students are affected in a positive manner by classes that include ethics education. Teddy Roosevelt

said, “To educate a person in mind and not in morals is to educate a menace to society.”

Can ethics be taught?

What is ethics?

Ethics: a branch of philosophy which is the systematic studyof reflective choice (decision problems), of the standards of right and wrong (moral principles) by which it is to be guided, and of the good or bad (consequences) toward which it mayultimately be directed.

An ethical problem occurs when you must make a choiceamong alternative actions and the right choice is notabsolutely clear. Often that choice affects the well-being ofother persons.

Philosophical Principles in Ethics

Imperative Principle: Do what is right. Act according to absolutemoral rules (e.g. lying is wrong). Ethics is a function of moralrules and principles and does not involve a situation-specific calculation of consequences.

Utilitarian Principle: Do what produces the greatest good.

Generalization Argument: This is a combination of the imperativeprinciple and the utilitarian principle. Make the decision by considering the consequences if everyone made the same choiceunder similar circumstances. That is, what would happen if everyone acted in this way?

Steps in Ethical Decision-Making1. Define all the facts and circumstances: e.g. Who, what, where, when, and how?

2. Identify the people (stakeholders) affected by the situation; What are the stakeholders rights and obligations?

3. Identify the alternative decisions and consequences.

4. Make the decision.

Financial ScandalsEthics and corporate governance play key roles in the capital

markets. Financial scandals often lead to new regulations.1930s - Corporate financial scandals led to U.S. securities acts.1980s - Savings and loan debacles led to FDIC Improvements

Act of 1991.Late 1990s and early 2000s - Corporate financial scandals led

to SOX of 2002, creation of PCAOB and more than 20 SEC rules.

2008 - Financial crisis led to Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. This law includes reforms of the financial regulatory system and a number of corporate governance provisions affecting public companies.

Short Cases: EnronEnron Corporation is considered by many to be the most infamous financial scandal in U.S. history. The Enron scandal caused people to question the reliability of the financial reporting practices of publicly traded corporations. Enron was a key event leading the U.S. Congress to pass a new federal securities law, the Sarbanes-Oxley Act of 2002, often referred to as SOX.

Before its collapse in late 2001, Enron was a highly regarded energy company located in Houston, Texas. The company’s bankruptcy, which was the largest in U.S. history at the time, resulted in 20,000 employees losing their jobs. Many of them also lost their life savings, which were tied up in Enron stock. As explained in the 2005 documentary film Enron: The Smartest Guys in the Room, a great number of the company’s assets and profits were overstated or in some cases completely fraudulent and nonexistent.

Short Cases: WorldComWorldCom began in 1983 as Long Distance Discount Services, Inc. (LDDS). It was located in the U.S. in a middle-sized town, Hattiesburg, Mississippi. Bernard Ebbers became the company’s CEO in 1985. In subsequent years, the company name was changed to LDDS WorldCom and later just WorldCom. From 1999 to 2002, the company manipulated earnings by using fraudulent accounting methods, thereby presenting a false image of economic growth and prosperity. As a result, the company’s stock price continued to climb, when in reality it should have been falling.

Two techniques were used to cook the books. The first was underreporting “line costs” by recording them as assets on the balance sheet instead of correctly expensing them on the income statement. The second technique was overstating revenues through recording fraudulent transactions regarding “corporate unallocated revenue accounts.” During 2002, a small group of internal auditors at WorldCom worked together, frequently in the evening and in secret, to explore and reveal $3.8 billion in fraud.

Short Cases: ParmalatParmalat is an Italian-based multinational corporation specializing in dairy and food products. In the late 1990s, Parmalat entered into world financial markets in a significant way, financing several international acquisitions, especially in the Western Hemisphere, with debt. However, by 2001, a number of the new operations were losing money. As a result, the company began extensively using derivatives for financing. This facilitated efforts to disguise the extent of the company’s financial liabilities and losses. Parmalat cooked its books by purchasing its own credit-lined notes and thereby creating an asset, but an asset that in reality was meaningless.

By 2003, the company was no longer able to pay off debts and make bond payments: a 14 billion euro shortfall led to the company’s collapse, which became Europe's biggest bankruptcy. Prior to Parmalat’s collapse, the company’s former CEO, Calisto Tanzi, had become a symbol of great economic success and a business hero of sorts. Italians were amazed how a once powerful company could suddenly disintegrate.

“A democracy cannot exist as a permanent form of government… The average age of the world’s greatest civilizations has been 200 years. These nations have progressed through this sequence: From bondage to spiritual faith, to great courage, to abundance, to selfishness, to complacency, to apathy, to dependency, and back again to bondage.”

More than 200 years ago, Professor Alexander Tyler wrote of the Athenian Republic, which had fallen 2,000 years earlier:

Ethical standards are essential to a free society

Ethics is essential to the functioning of a free society: 2nd U.S. President John Adams observed: “We have no government armed with power capable of contending with human passions unbridled by morality and religion. Our Constitution was made only for a moral and religious people. It is wholly inadequate to the government of any other.”

Where Do We Start?

Upon What Can We Agree?

People learn about ethics from various sources. Upon what do you base your personal code of ethics?

a. Study of history

and literature

b. USAF Honor Code

c. Personal experiences

and observations

d. Religious beliefs

e. Something else

Whether we derive a code

of ethics from

religious beliefs, a study of

history and literature, or

personal experience

and observation: We can all agree upon some basic

values.

In an issue of Management Accounting, James Brackner stated: The universities are

responding with an increased emphasis on ethical training for decision making. For the most part, however, they ignore the

teaching of values. For moral or ethical education to have meaning there must be

agreement on the values that are considered “right.”

Be sure you are right, then go ahead.

David Crockett

1786-1836

A nation or a culture cannot endure for long unless it is undergirded by common values such as valor, public spiritedness, respect for others and for the law; It cannot stand unless it is populated by people who will act on the motives superior to their own immediate interest.

Chuck Colson, Against the Night

When the situation needs improvement, Gandhi offers guidance: “You must be the change you wish to see in the world.”

Michael Josephson, in Chapter 1 of Ethical Issues in the Practice of Accounting,

describes the “Ten Universal Values: “Honesty, integrity, promise keeping, fidelity,

fairness, caring, respect for others, responsible citizenship,

pursuit of excellence, and accountability.”

Are there legal concerns? Is it right? (If you know it’s wrong, don’t do it!) Does it comply with company values? Does it comply with the principles of your profession (for

accountants, GAAP)? Would you be embarrassed by your decision if others knew

about it? Who else is affected by this (others in the company,

customers, etc.)?

Questions to Consider for Ethical

Decision Making

Questions to Consider for Ethical

Decision Making

Are you willing to take sole responsibility for this decision?

Is there another course of action that does not create an ethical dilemma?

How will it look in the newspaper? Do you think a reasonable person would agree with your

decision? (Ask an appropriate person.)

Can you make a

difference?

How can an honest person

succeed?

If societal values are deteriorating, maintaining high ethical standards in accounting and business grows increasingly difficult. People will undoubtedly ask, if everyone else is dishonest, then how can an ethical person possibly succeed? Nevertheless, the real question is, how does one measure success?

Why is it often so hard to do what’s right? “To sin by silence when they should protest makes cowards of men.” - Abraham Lincoln

Do you think this relates to line 2 of the USAF Honor Code?

‘The right way is not always the popular and easy way. Standing for right when it is unpopular is a true test of moral character.’- Margaret Chase Smith, first woman elected to both houses of Congress

‘You cannot make yourself feel

something you do not feel, but you

can make yourself do right in spite of

your feelings’– Pearl S. Buck,author, Nobel

Laureate

“To see what is right and not to do it is want of courage.” - Confucius

The reputation of a thousand years may be determined by the conduct of one hour.

Japanese proverb

At a Congressional Hearing on Accounting and Business Ethics in July 2002, Truett Cathy, the Founder of Chick-Fil-A quoted Proverbs 22:1 – "A good name is more desirable than great riches; to be esteemed is better than silver or gold." The truth is that fame and fortune are nothing compared to personal honor.

“Honor is

better than

honors.”

Abraham

Lincoln

Take-Away Points • Important: Ethics is a major concern to people in every

walk of life. While academic concepts and technical skills are important, at the heart of all business and social activity is a foundation of ethical values.

• Ethics can be taught: Research shows that ethics education has a positive impact on people’s ethical perspectives and behavior.

• Deep Truths: While economics, history, sociology, and financial reporting are important academic topics, the issue of ethics addresses deeper truths about doing business and living life in general.

• ‘A nation or a culture cannot endure for long unless it is under-girded by common values such as valor, public spiritedness, respect for others and for the law; It cannot stand unless it is populated by people who will act on the motives superior to their own immediate interest.’ -- Chuck Colson, Against the Night.