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What are the Ethical Issues in Business Finance?

Nov 3, 2021 4:13 AM 5 min read

Are you aware that you cannot trade in stocks of a company if you have knowledge of unpublished documents? If you do so, you can be penalised.

What if a firm terminates the pension plan on your retirement and gives a lump sum check instead of a pension check for life? Is it legal to do that? Window dressing is the strategy used by fund managers in which they sell the stocks bearing large losses and buy high-flying stocks near the year-end to improve the portfolio’s appearance before presenting it to clients. What can an investor do but read it and believe it?

Let’s take a look back at how ethical concerns were raised in the past and how the foundation was laid.

Ethical Practices in Business

The history of ethics in business goes as far as the earliest bartering system which involved the exchange of equals. Back in the time, instead of following a code of ethics, people centuries ago used ethical guidelines like the religious Ten Commandments or Aristotle’s economic philosophies. 

The modern concept of business ethics dates back to the 1970s in the United States which was also the era of civil rights movement and the formation of environmentalist groups. During the Vietnam war, Americans became hypercritical of governments involvement and ongoing business operations. After World War II the United States was the only large power that did not suffer serious devastation and as a result, American businesses flourished and developed a worldwide reach. With the enormous growth of the chemical - petroleum industries, pollution became a large-scale problem and Environmental groups sought to attack the business. Another group of activists who saw extending global reach of American businesses as exploitative added their voices to the critics of big business. Introduction of courses in social issue management and corporate social responsibility in business schools lacked a cohesive basis and with all these criticisms in the 1960-70s the academia field of business ethics arose.


Corporate Scandals

The scandals about bribery, insider trading, money laundering and false schemes constitute the failure of businesses/corporations to act ethically. One of the cases of insider trading that shook wall street was of Jeffrey Skilling CEO of Enron, he was involved in multiple white-collar crimes but insider trading was the most egregious. He duped the investing public by hiding companies' financial problems and dumped his stocks worth $60 million before he quit the company and soon after which it got bankrupt. Enron’s downfall was shocking and it also destroyed Arthur Andersen, one of the largest audit firms in the world.

Another scam story of Bernie Madoff the wall street financier who ran the largest Ponzi scheme in history had victims from every stratum of society from the poorest to the high and mighty. Pretending to be trading securities, he promised steady, double-digit returns to his customers while he was using money from the new investors to pay to the older customers. He was able to sustain the fraud for several years like the recession in 1990s, the global financial crisis in 1998 and also the 9/11 attacks, it was finally the crash of 2008 which unravelled the Ponzi scheme. The court sentenced him to 150 years of prison and estimated a scam of approx $65 billion. With hundreds of such cases popping up this led to the formation of the branch of corporate finance.


What is Corporate Finance?

Corporate Finance is a department that deals with how businesses/corporations address their funding sources, take care of accounting, capital structuring, and investments decisions. They are concerned with maximizing shareholders' value through financial planning, distributing dividends, and various strategies. They are also in charge of capital investments and taxation.

As managing corporate finance, dealing with the financial resources of a firm involves a lot of decision-making and risks, there can be a lot of incentives to choose unethical procedures. Regulatory reforms by governments and regulators are not enough to be sure that a firm is fully ethical, that’s why firms need a developed set of principles to analyse decisions and check potential conduct from an ethical perspective. 


Ethical Rules

One of the most important ethical considerations in recent years is maintaining consumer privacy while companies mine user information for valuable marketing data. Basic ethics in financial management quoted by governing organizations include professionalism that is complying with all applicable laws, no misinterpretation or misconduct. All dealings/ transactions should be well informed and integrity is maintained. In case of conflicts of interest financial managers must act in favour of their clients and employers. Another role is to guard yours and your employer’s reputation. Some believe that the risk of scandal and loss of reputation is sufficient to discourage financial managers from acting unethically. Industry analysts say tighter regulation is necessary because ethics in finance can't withstand temptation. 


Targets Over Ethics

One problem with living up to a code of ethics in finance is that the system sometimes rewards unethical behaviour. If an organization rewards financial managers for making decisions that benefit the company, not the clients, some financial managers will stumble. For example, In the banking industry, mis-selling to customers is a serious breach of ethics. If the rewards system prioritizes targets over ethics, it's too tempting for some to pass up.


The Role of Investors

Investors want to make sure that their invested capital is secured and that the company is ethical. Additionally, the investor doesn’t just want to make sure that the company is an ethical one, they want to be sure that the professional investor can be trusted and doesn’t put his interests ahead of his clients. Investors can analyse firms by identifying the tone of their code of ethics and comparing it with other organizations. Many companies write a very complicated code of ethics which is difficult to understand. This may be because the company has something to hide. This can be perceived as? Investors can also look out for firms whether they came clean when investigated by regulatory bodies.


The Bottom Line

History has shown us how important ethical behaviour is in the financial world. The consequences of unethical behaviour are too immense to let a financial crisis happen again. The government and regulators have implemented new rules, which companies have to follow to do their business. New processes have been made to prevent employees from acting unethically. And to be 100% sure that a company is ethical the investor should do his research about a company, by analysing and reading the code of ethics.


Written by Pradyumn Bagry


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