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The Crisis of Confidence in Business W. Steve Albrecht, Associate Dean Marriott School of Management Brigham Young University Presentation at the University of Montana November, 2004 Let’s start with a story—who committed fraud in this case? Rich Man--three friends Lawyer Accountant

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the crisis of confidence in business

The Crisis of Confidence in Business

W. Steve Albrecht, Associate Dean

Marriott School of Management

Brigham Young University

Presentation at the University of Montana

November, 2004

let s start with a story who committed fraud in this case
Let’s start with a story—who committed fraud in this case?
  • Rich Man--three friends
    • Lawyer
    • Accountant
    • Minister

1/1/02

Rich Friend

50,000

Fifty Thousand and no/100---------------

I M Smarter than U

the accountant s check
The Accountant’s Check

Eternity

My Rich Friend

50,000

Fifty Thousand Dollars and no/100--------------------------------------

I. M . Smarter Than U.

Honor Commitment

crisis of confidence
Crisis of Confidence
  • In recent years there has been a crisis of confidence in the business world
  • The market value of international stock exchanges plummeted in early 2000
  • Terrorists acts such as “9/11” were a contributing factor
  • BUT unethical behavior destroyed more wealth than all terrorist acts combined!
slide6
391%

78%

9/11

5049

5000

4000

3000

2000

1114

1000

The NASDAQ “Bubble”

1996

1997

1998

1999

2000

2001

2002

2003

2004

slide7
Other markets looked very similar

Total market loss worldwide…

$15 trillion

why the crash what happened
Why the Crash—What Happened?

Misstated financial statements: Quest, Enron, Global Crossing, HeathSouth, WorldCom, Xerox, Rite-Aid, Harris Scarfe, HIH, etc.

Executive loans and corporate looting: John Rigas (Adelphia), Dennis Kozlowski Bernie Ebbers (WorldCom)

Insider trading scandals: Martha Stewart, Sam Waksal, One.Tel, etc.

IPO favoritism, incl. spinning and laddering: Bernie Ebbers, etc.

Massive fraud by employees

why the crash what happened9
Why the Crash—What Happened?

Excessive CEO retirement perks: Delta, PepsiCo, AOL Time Warner, Ford, GE, IBM (consulting contracts, use of corporate planes, executive apartments, maids, etc.)

Exorbitant stock options for executives

Loans for trading fees and other quid pro quo transactions: Citibank, Chase, etc.

Bankruptcies and excessive debt

Mutual Fund Frauds: Late trading and market timing to benefit insiders and favored customers

consequences of these problems
Consequences of These Problems
  • Lost confidence in capital markets
  • Lawsuits—one company has over 3,000
  • Going out of business/bankruptcies
  • Lost reputation and bad press
  • Longer and more expensive audits, special inquiries
  • Fines & investigations
  • Damaged employees & reputations
  • Lost retirement and pension funds
  • Directors with personal liability, forced resignations
  • Losses from fraud
  • Significant legislative activity
how costly is financial statement fraud
How Costly is Financial Statement Fraud?
  • Financial statement fraud causes a decrease in the market value of a stock of approximately 500 to 1,000 times the amount of the fraud.

$2 billion drop in

stock value

$7 million fraud

example martha stewart
Example: Martha Stewart
  • Martha Stewart gained ~$46,000 by using inside information
  • Martha Stewart Living Omnimedia shareholders lost ~$750,000,000 after Martha’s arrest and ensuing publicity!
fraud against organizations a costly business problem
Fraud Against OrganizationsA Costly Business Problem
  • Large Fraud of $2.6 Billion over 9 years
    • Year 1 $600K
    • Year 3 $4 million
    • Year 5 $80 million
    • Year 7 $600 million
    • Year 9 $2.6 billion
  • In years 8 and 9, four of the world’s largest banks were involved and lost over $500 million

Some of the organizations involved: Merrill Lynch, J.P. Morgan Chase,

Union Bank of Switzerland, Credit Lyonnaise, Sumitomo, and others.

why fraud against organizations is a costly business problem
Fraud Losses Reduce Net Income $ for $

If Profit Margin is 10%, Revenues Must Increase by 10 times Losses to Recover Affect on Net Income

Losses……. $100 Million

Revenue…...$1 Billion

Fraud Robs Income

Why Fraud Against Organizations is a Costly Business Problem

Revenues $100 100%

Expenses 90 90%

Net Income $ 10 10%

Fraud 1

Remaining $ 9

To restore the $1 of lost income, need $10 more dollars of revenue.

why fraud against organizations is a costly business problem18
General Motors

$436 Million Fraud

Profit Margin = 10%

$4.36 Billion in Revenues Needed

At $20,000 per Car, 218,000 Cars

Bank

$100 Million Fraud

Profit Margin = 10 %

$1 Billion in Revenues Needed

At $100 per year per Checking Account, 10 Million New Accounts

Why Fraud Against Organizations is a Costly Business Problem
fraud internationally transparency international
1. Finland

2. Iceland

3. Denmark

3.New Zealand

5.Singapore

5. Sweden

7. Netherlands

8.Australia

8. Norway

8. Switzerland

11. Canada

18. United States

21. Japan

23. France

54. Brazil

56. Mexico

66. China

86. Russia

132. Nigeria

133. Bangladesh

Fraud InternationallyTransparency International
why did so many financial statement frauds occur
Why Did So Many Financial Statement Frauds Occur?
  • Good economy was masking many problems
  • Moral decay in society
  • Misplaced executive incentives
  • Unachievable Wall Street expectations—rewards for short-term behavior
  • Large amounts of debt and other leverage
  • Nature of accounting rules
  • Behavior of auditing firms
  • Greed by executives, investment banks, commercial banks, and investors
  • Educator failures

"The Perfect Storm"

1 good economy masked problems
1. Good Economy Masked Problems
  • With increasing stock prices, increasing profits and increasing wealth for everyone, no one worried about potential problems.
  • People were making nonsensical investment decisions—“irrational exuberance”
  • How to value a dot.com company:
    • Take their loss for the year
    • Multiply the result by negative 1 to make it positive
    • Multiply that number by at least 100
    • If stock price is less than the result…buy
    • If not, buy anyway!
2 moral decay
2. Moral Decay
  • Attendees at the April, 1998 Business Week Forum of Chief Financial Officers:
    • 67% of CFOs said they had fought off other executives’ requests to “misrepresent corporate results”
    • 12% of CFOs admitted they had “yielded to the requests” while 55% said they had “fought off requests” to misrepresent corporate results
  • Honesty studies
    • People are becoming less honest
    • Less modeling and labeling of good ethical behavior
has there really been moral decay data from the u s
Dishonesty Is Increasing

12% in 1961

31% in 1986

Retail Losses

30% customers

70% employees

$400 billion annually

$9 per employee per day (2002 Study)

Organizations lose between 1% and 6% of revenues to fraud

Insurance fraud in 2000 was $120 billion

General Motors had $436 million fraud

Large bank in recent year

6200 customer frauds

2100 employee frauds

3600 lawsuits

Has There Really Been “Moral Decay”?Data from the U.S.

We All Pay for Fraud!

the transformation of arthur andersen
The Transformation of Arthur Andersen
  • Early days of Andersen
    • Leonard Spacek—epitome of ethics
    • DuPont lost to a competitor because Anderson would not agree with accounting method
  • Recent years
    • Waste Management case
    • Anderson turns a blind eye to abuses to keep account
3 executive incentives
3. Executive Incentives

Meeting Wall Street’s Expectations

  • Stock prices are tied to Wall Street’s earnings forecasts
    • Focus is on short-term (quarterly) performance only
    • Price is heavily punished for not meeting forecasts
  • Compensation is based on earnings & stock price
    • Bonuses tied to stock price
    • Stock options—often far in excess of salary
4 wall street s expectations
Firm A

Firm B

4. Wall Street’s Expectations
  • Investors want decreased risk and growing returns.
  • Risk is reduced when variability of earnings is decreased.
  • Rewards are increased when income continuously improves.

Which firm will have the higher stock price?

actual complaint in 2 8 billion financial statement fraud case
Actual Complaint in $2.8 Billion Financial Statement Fraud Case

“The goal of this scheme was to ensure that (the company) always met Wall Street’s growing earnings expectations for the company. (The company’s) management knew that meeting or exceeding these estimates was a key factor for the stock price of all publicly traded companies and therefore set out to ensure that the company met Wall Street’s targets every quarter regardless of the company’s actual earnings. During the period 1998 to 1999 alone, management improperly inflated the company’s operating income by more than $500 million before taxes, which represents more than one-third of the total operating income reported by (the company.)”

actual complaint in 2 8 billion financial statement fraud case29
Actual Complaint in $2.8 Billion Financial Statement Fraud Case

“The participants in the illegal scheme included virtually the entire senior management of (the company), including but not limited to its former chairman and chief executive officer, its former president, two former chief financial officers and various other senior accounting personnel. In total, there were over 20 individuals involved in the earnings overstatement schemes.”

meeting ws projections
Meeting WS Projections

Firm1st Qtr 2nd Qtr3rd Qtr

Morgan Stanley $ 0.17 $0.23

Smith Barney 0.17 $0.21 0.23

Robertson Stephens 0.17 0.25 0.24

Cowen & Co. 0.18 0.21

Alex Brown 0.18 0.25

Paine Webber 0.21 0.28

Goldman Sachs 0.17

Furman Selz 0.17 0.21 0.23

Hambrecht & Quist 0.17 0.21 0.23

Actual Earnings $0.08 $0.13 $0.16

Fraud 0.09 0.09 0.07

Reported EPS 0.17 0.22 0.23

Fraud (Millions) $62 M $61M $71M

Wall Street expectations were especially high for certain industries such as the telecom industry (e.g. Global Crossing, ATT, WorldCom, Quest)

how people got involved
How People Got Involved
  • The CFO instructed the chief accountant to increase earnings by $105 million. The chief accountant was skeptical about the purpose of these instructions but he did not challenge them. The mechanics were left to the chief accountant to carry out. The chief accountant created a spreadsheet containing seven pages of improper journal entries, 105 in total, that he determined were necessary to carry out the CFO’s instructions. Over 20 people were involved in making or instructing to make similar entries.
5 high amounts of debt other leverage
5. High Amounts of Debt & Other Leverage
  • During 2000, Enron’s derivates-related liabilities increased from $1.8 B to $10.5 B
  • By 2001 Enron hid $25 B in off-balance sheet (SPE) debt while on-balance sheet debt was $13 B
  • WorldCom had nearly $100 B in debt
    • Not only did Bernie Ebbers borrow $100 billion for WorldCom but he also racked up over $1.3 billion in personal debt while CEO of WorldCom
  • Every company that committed financial statement fraud had huge amounts of debt

In U.S. 186 public companies with $368 billion in debt filed for bankruptcy in 2002—includes WorldCom, Conseco, Global Crossing, United Airlines

6 nature of accounting rules
6. Nature of Accounting Rules
  • In the U.S., accounting standards are “rules-based” instead of “principles based.”
    • Allows companies and auditors to be extremely creative when not specifically prohibited by standards.
    • Examples are SPEs and other types of off-balance sheet financing, revenue recognition approaches, merger reserves, pension accounting, and other accounting schemes.
    • When the client pushes, without specific rules in every situation, there is no room for the auditors to say, “You can’t do this…because it isn’t GAAP…”
    • It is impossible to makes rules for every situation
7 behavior of auditing firms
7. Behavior of Auditing Firms
  • Failed to accept responsibility for fraud detection (SEC, Supreme Court, public expects them to detect fraud) If auditors aren’t the watchdogs, then who is?
  • Became greedy--$500,000 per year per partner compensation wasn’t enough; saw everyone else getting rich (Andersen’s partners were jealous of Accenture partner’s income)
  • Audit became a loss leader
    • Easier to sell lucrative consulting services from the inside
    • Became largest consulting firms in the U.S. very quickly (Andersen Consulting grew to compete with Accenture)
  • A few auditors got too close to their clients
  • Entire industry, especially Arthur Andersen, was punished for actions of a few
8 greed by all parties
8. Greed by All Parties
  • Jeff Skilling, onetime CEO of Enron: “All that matters is money.”
  • One large investment bank issued $2 billion of Enron debt it internally considered “legal but sleazy.” It received huge fees for this issue.
  • Example: Jack Grubman, CitiBank, and the million dollar preschool
9 educator failures
9. Educator Failures
  • Haven’t taught “ethics” enough in the classroom
  • Need to teach students about fraud—“Most students wouldn’t recognize a fraud if it hit them between the eyes!”
  • Need to teach students how to think—more analytical skills; less memorization
  • Need to teach ethicalcourage and ethicalleadership
how did we teach
How did we teach?

Professors

Lecture

Professionals

find similar

examples

and copy

(last year’s

work

papers

Assign Problems

at end of chapters

Students can’t

work problems

What did we teach? We taught our students how to copy!

Students

graduate and

get assignments

(e.g. perform audit)

Find similar

examples in the

chapters and

copy

Never really learn

or think analytically

the fraud triangle
Opportunity

Pressure

Fraud

Triangle

Rationalization

The Fraud Triangle
  • Good economy masked problems
  • Lack of controls from board, auditors
  • Nature of accounting rules
  • Educator failures
  • Behavior of CPA firms
  • Executive incentives
  • Wall Street expectations—rewards for short-term behavior
  • Large amounts of debt and leverage
  • Greed by investment banks, commercial banks, investors and executives

Moral Decay in Society

enron a case of complexity
Enron: A Case of Complexity
  • WorldCom was a $9 billion fraud but a simple one
    • Capitalized expenses that should have been expensed
  • Enron involved many complex transactions and accounting issues
  • “What we are looking at here is an example of superbly complex financial reports. They didn’t have to lie. All they had to do was to obfuscate it with sheer complexity—although they probably lied too.” Senator John Dingell
enron s history
Enron’s History
  • Born from merger of two pipeline companies in 1985.
  • Incurred massive debt and no longer had exclusive rights to its pipelines.
  • Needed new and innovative business strategy
  • Kenneth Lay, CEO, hired McKinsey & Company to assist in developing business strategy—consultant Jeffrey Skilling.
    • Background in banking and asset and liability management.
    • Recommendation: create a “Gas Bank”—buy and sell natural gas
  • Feb. 2001-- Fortune magazine names Enron “The Most Innovative Company in America”--company worth $60B
  • Dec. 2001 – Enron files the biggest bankruptcy in U.S. history (now exceeded by WorldCom)
slide42
Enron

Kenneth Lay –

Founding and last CEO

Jeff Skilling –

CEO from 2/2001

to 8/2001

Andrew Fastow –

CFO

Michael Kopper –

Assistant to Fastow

Andersen

David Duncan –

Audit Partner

Michael Odom –

Risk Mgt Partner

Nancy Temple –

Firm Attorney

enron s changing business
Producer

Utility

Industrial User

4”Extras”

2Wholesale

3Retail

1Transportation and Distribution

Enron’s Changing Business
aggressive nature of enron
Aggressive Nature of Enron
  • Enron believed it was leading a revolution
    • Pushed the rules
    • Employees attempted to crush not just outsiders but each other. “Enron was built to maximize value by maximizing the individual parts.
    • Enron traders were afraid to go to the bathroom because the guy sitting next to them might use information off their screen to trade against them.”

Enron took more risk than others—

”it swung for the fences.”

the motivation
The Motivation
  • Enron delivered smoothly growing earnings (but not cash flows)
  • Wall Street took Enron on its word but didn’t understand its financial statements
  • It was all about the price of the stock. Enron was a trading company and Wall Street normally doesn’t reward volatile earnings of trading companies.
    • Goldman Sachs, a trading company, had P/E of 20
    • Enron’s P/E was 70 times earnings
  • In its last 5 years, Enron reported 20 straight quarters of increasing income
enron s arrogance
Enron’s Arrogance

“Those whom the Gods would destroy they first make proud.”

Enron’s banner in lobby: Changed from “The World’s Leading Energy Company” to “THE WORLD’S LEADING COMPANY”

“Older, stodgier companies will topple over from their own weight…” Skilling

Conference of Utility Executives in 2000: “We’re going to eat your lunch”….Jeff Skilling

special purpose entities spes enron s principal method of financial statement fraud
Special Purpose Entities (SPEs)Enron’s principal method of financial statement fraud
  • Originally had a good business purpose
  • The SPE is really a joint venture between sponsoring company and a group of outside investors
  • To help finance large international projects (e.g. a gas pipeline in Central Asia)
  • Investors want risk and reward exposure limited to the pipeline, not the overall risks and rewards of the associated company
  • Pipeline is to be a self-supported, independent entity with no fear that the company will take over
  • Outsiders must own >3% to qualify for off balance sheet
manipulating numbers between entities
Hide Everything

Bad

Bring in

Everything Good

Manipulating numbers between entities

Off-Balance Sheet SPE

Enron

Going back and forth: Debt, cash flows, earnings,

Related party-transactions, investments, etc.

enron s use of special purpose entities spes
Enron’s Use of Special Purpose Entities (SPEs)
  • To hide bad investments and poor-performing assets (Rhythms NetConnections). Declines in value of assets would not be recognized by Enron (Mark to Market.)
  • Earnings management—Blockbuster Video deal--$111 million gain (Bravehart, LJM1 and Chewco)
  • Quick execution of related-party transactions at desired prices. (LJM1 and LJM2)
  • To report over $1 billion of false income
  • To hide debt (Borrowed money and not put on financial statements of Enron)
  • To manipulate cash flows, especially in 4th quarters
  • Many SPE transactions were timed (or illegally back-dated) just near end of quarters so that income could be booked just in time and in amounts needed, to meet investor expectations
slide50
LJM1 SPE

One Enron Example (the “Rhythms” transaction):

  • Enron held Internet stock in company called Rhythms NetConnections
  • Stock was restricted (couldn’t be sold for a certain period of time)
  • Enron didn’t want exposure to risk of a price drop
  • The solution was simple! Find someone else who believes the Rhythms stock price would rise and was willing to sell a contract (a put option) to buy the stock in the future at a set price (a hedge!)
  • The problem was that Enron couldn’t find anyone willing to “do the deal”
  • Another simple solution! Start a company (a Special Purpose Entity or SPE) to take the other side of the transaction (Enron called it LJM1)
  • Where did the financing come from?
    • 97% from bank loan  Guaranteed with Enron stock
    • 3% from entity other than Enron Andrew Fastow and others!
  • Enron gave $168 million in Enron shares to LJM1 (LJM1’s primary asset)
  • LJM1 gave Enron a note for $64 million and a put option valued at $104 million
  • When everything “settled out,” Fastow received $15 million for his $1 million investment
  • Enron got to “hedge” (i.e., not report) a $103 million market loss on its stock investment
clue 1 warnings about enron
Clue #1: Warnings about Enron
  • In early 2001, Jim Chanos, who runs Kynikos Associates, a highly regarded firm specializing in short selling said publicly that “no one could explain how Enron actually made money.” He noted that Enron had completed transactions with related parties that “were run by a senior officer of Enron” and assumed it was a conflict of interest. (Enron wouldn’t answer questions about LJM and other partnerships.)
clue 2 fortune article march 5 2001
Clue #2: Fortune Article…March 5, 2001
  • “To skeptics, the lack of clarity raises a red flag about Enron’s pricey stock…the inability to get behind the numbers combined with ever higher expectations for the company may increase the chance of a nasty surprise. Enron is an earnings-at-risk story…”
  • “At the least, these sorts of hard-to-predict earnings are usually assigned a lower multiple...In 1999 its cash flow from operations fell from $1.6 billion the previous year to $1.2 billion. In the first nine months of 2000, the company generated just $100 million in cash. (In fact, cash flow would have been negative if not for the $410 million in tax breaks it received from employees’ exercising their options.”
clue 3 executives abandon enron
Clue # 3: Executives Abandon Enron
  • Rebecca Mark-Jusbasche, formerly CEO of Azurix, Enron’s troubled water-services company left in August, 2000
  • Joseph Sutton, Vice Chairman of Enron, left in November, 2000.
  • Jay Clifford Baxter, Vice Chairman of Enron committed suicide in May, 2001
  • Thomas White, Jr., Vice Chairman, left in May, 2001.
  • Lou Pai, Chairman of Enron Accelerator, departed in May 2001.
  • Kenneth Rice, CEO of Enron’s Broadband services, departed in August 2001.
  • Jeffrey Skilling, Enron CEO, left on August 14, 2001
enron s cash flows
Enron’s Cash Flows
  • Enron’s cash flows bore little relationship to earnings (a lot due to mark-to-market). On balance sheet debt climbed from $3.5 billion in 1996 to $13 billion in 2001.
  • Key Ratio

Net Income (from Operations*) – Cash Flow (from Operations**)Net Income (from Operations*)

  • Would expect to be about zero or slightly negative over time

*From the Income Statement

**From the Statement of Cash Flows

enron s cash flow ratio
Enron’s Cash Flow Ratio

Negative Cash Flows: 1st three quarters in 1999, 1st three quarters in 2000,

1st two quarters in 2001.

role of investment commercial banks
Role of Investment & Commercial Banks
  • Companies like CitiBank & JP Morgan Chase made millions in loan interest and fees but hundreds of millions in investment banking business
  • Enron paid several hundred million in fees, including fees for derivatives transactions.
  • None of these firms’ analysts alerted investors about derivatives problems at Enron.
  • In October, 2001, 16 of 17 security analysts covering Enron still rated it a “strong buy” or “buy.”
  • Example: One capital management firm purchased 7,583,900 shares of Enron for a state retirement fund, much of it in September and October, 2001
role of law firms
Role of Law Firms
  • Enron’s outside law firm was paid substantial fees and had previously employed Enron’s general counsel
  • Failed to correct or disclose problems related to derivatives and special purpose entities
  • Helped draft the legal documentation for the special purpose entities
role of credit rating agencies
Role of Credit Rating Agencies
  • The three major credit rating agencies—Moody’s, Standard & Poor’s and Fitch/IBCA—received substantial fees from Enron
  • Weeks prior to Enron’s bankruptcy filing—stock traded at $3 per share—all three agencies gave investment grade ratings to Enron’s debt
  • These firms enjoy protection from outside competition and liability under U.S. securities laws
  • Being rated as “investment grade” was necessary to make SPEs work
part ii what was done
Opportunity

Pressure

Fraud

Triangle

Rationalization

Part IIWhat Was Done?
what was done
Opportunity

Pressure

Fraud

Triangle

Rationalization

What Was Done?

I. Passed New Laws and Listing Requirements

what the laws guidelines attempt to accomplish
Restore

Public Confidence

What the Laws/Guidelines Attempt to Accomplish

Align Directors

More Towards

Shareholders

Improve

Quality of

Financial

Information

Encourage

Ethical & Legal

Behavior

in Management

and Boards

legislation in u s sarbanes oxley
Legislation in U.S.—Sarbanes Oxley

On July 30, 2002 President Bush signed into law the Sarbanes-Oxley Act of 2002.

  • Bolster public confidence
  • Impose new duties and significant penalties for non-compliance on public companies
    • Management
    • Boards of directors
    • Auditors
    • Attorneys
    • Securities industry
summary of sarbanes oxley act
Summary of Sarbanes-Oxley Act

Title I: Public Company Accounting Oversight Board

Title II: Auditor Independence

Title III: Corporate Responsibility

Title IV: Enhanced Financial Disclosures

Title V: Analyst Conflicts of Interest

Title VI: Commission Resources and Authority

Title VII: Studies and Reports

Title VIII: Corporate and Criminal Fraud Accountability

Title IX: White Collar Crime Penalty Enhancements

Title X: Corporate Tax Returns

Title XI: Corporate Fraud Accountability

what can be done
Opportunity

Pressure

Fraud

Triangle

Rationalization

What Can Be Done?

II. Reducing the Pressure

pressure comes from
Pressure Comes from…
  • Focus almost exclusively on
    • Stock price
    • Earnings
  • High levels of debt and other leverage
    • Corporate
    • Personal
  • “Tone at the top”
  • Peer pressure
example enron s compensation model
Example: Enron’s Compensation Model
  • Skilling— “Stock price is the only measure the company should be concerned with.”
  • Main reward: stock options
    • Accelerated vesting if earnings growth >15%
  • Cash bonus if stock price > index of tech stocks
  • Employees rewarded for present value of sales—regardless of cost of providing service
what organizations should do
What Organizations Should Do
  • Reduce compensation from stock options
  • Reduce leverage from financial and operating sources
  • Focus on long-term measures: growth, customer service, core business retention, etc., rather than on single, myopic measures like earnings alone
set the tone at the top
Set the “Tone at the Top”
  • Talk often about long-term goals and measures of performance
  • Include long-term measures in compensation system
  • Stress ethics over performance
  • Build a culture of ethics within the company
slide69
Example: Warren Buffett
  • No quarterly statements
  • Wants only long-term investors
  • Invests in people
  • Once said to his CEO’s:

“We can afford to lose money, even a lot of money.”

“We can’t afford to lose reputation—not even a shred of it.”

management education must help
Management Education Must Help
  • Finance courses often claim stock price is only valid measure
    • Corollary—that earnings is most meaningful accounting number
  • Must develop other more comprehensive measures meaningful performance for employees and firms
what can be done71
Opportunity

Pressure

Fraud

Triangle

Rationalization

What Can Be Done?

III. Improving our Ethical Strength

Bad News

Good News

questionable state of ethics
Questionable State of Ethics

Did You Cheat to Get Into Graduate School?

“Yes”

  • 43% Liberal Arts
  • 52% Education
  • 63% Law and Medicine
  • 75% Business

Source: Rutgers University survey of students

questionable state of ethics73
Questionable State of Ethics

MBAs

  • 76% were willing to understate expenses that cut into their companies’ profits
  • Nearly all believe shareholder value is more important than customer service
  • Convicts in 11 minimum security prisons had higher scores on an ethical dilemma exam than MBAs
questionable ethics at work
Questionable Ethics at Work
  • 76% of employees observed a high level of illegal or unethical conduct at work in the past 12 months
  • 49% of employees observed misconduct that, if revealed, would cause their firms to “significantly lose public trust”

KPMG 2000 Organizational Integrity Survey

deterioration in ethical values
Deterioration in Ethical Values

YearYear

College students who cheated in H.S. 1940 (20%) 2002 (75-98%)

Self-reported cheating 1983 (11%) 1993 (49%)

Believe cheating is common 1940 (20%) 1997 (88%)

Used cheat sheets 1969 (34%) 1989 (68%)

Let others copy work 1969 (58%) 1989 (98%)

Willing to lie to get job 2000 (28%) 2002 (39%)

Students who had stolen 2000 (35%) 2002 (38%)

(Based on several different ethics studies)

survey of employees
Survey of Employees
  • Most (65%) don’t report ethical problems they observe
  • 96% feared being accused of not being a team player
  • 81% feared corrective action would not be taken anyway
  • 68% feared retribution from their supervisors

Source: Society of Human Resource Management

will our ethics improve survey of high school students
Will Our Ethics Improve?Survey of High School Students

2002 2001

  • 74% (71%) cheated on an exam in the last year; 45% (45%) said they did it at least twice in the last year
  • 93% (92%) lied to their parents in the past year; 79% (79%) say they lied twice
  • 78% (78%) have lied to their teachers
  • 37% (27%) said they would lie to get a job
  • 38% (35%) took something from a store in the last year

Josephson (2002)(2001)

why is dishonesty increasing
Why is Dishonesty Increasing?

Modeling Labeling

Honesty

why is dishonesty increasing79
Bad Modeling/Lack of Good Modeling

Makes up our news— more explicit than ever

Focus of TV/movies

Dishonest “leaders”

Sports, business, entertainment “heroes”

Good models are rare

Lack of Positive Labeling

Home….average family spends 10 hours less time together a week than 20 years ago

Vocabulary of kindergarten children

Schools

Churches

Why Is Dishonesty Increasing?
who commits fraud
Who Commits Fraud?

Bank Robbers

Normal Citizens

Fraud Perpetrators

Sample

Sample

Sample

Major Differences

No Significant Differences

While people who commit rape, murder, bank robbery and other

property offenses have distinguishing characteristics, fraud

perpetrators look more like more citizens than criminals!

who commits fraud demographics
Who Commits Fraud? Demographics
  • Married
  • Active church members
  • Children
  • Good education
  • First-time offenders
  • Good employees
  • Don’t abuse alcohol
who commits fraud psychological characteristics
Who Commits Fraud?Psychological Characteristics
  • Optimistic
  • High self-esteem
  • Achieving
  • Family harmony
  • Socially conforming
  • Self control
  • Kind
  • Sympathetic

Conclusion: Fraud Perpetrators Look Exactly Like Us!

slide83
Who Commits Fraud?Length of Time With Company
  • Less Than 3 Years…………………....26 Percent
  • 3-5 Years……………………………..14 Percent
  • 5-10 Years……………………………30 Percent
  • 10-20 Years…………………………..20 Percent
  • Over 20 Years………………………...10 Percent

Moral: Just because someone has been honest in the

past doesn’t mean they will be honest in the future.

slide84
Who Commits Fraud?Perpetrators’ Ages
  • Under 26 Years Old……………...…14 Percent
  • 26-35 Years Old…………………….28 Percent
  • 36-45 Years Old…………………….36 Percent
  • 46-55 Years Old………………….…12 Percent
  • Over 55 Years Old………………….10 Percent
can ethical values be taught level 1 the foundation
Can Ethical Values be Taught?Level 1: The Foundation

Personal Ethical Understanding

Right/wrong, Fairness, Honesty, Personal Integrity, Respect for Others

level 2 application to business
Level 2: Application to Business

Application of Ethics to Business Situations

Fraudulent Practices, Misleading Advertising, Unfairness

Personal Ethical Understanding

Right/wrong, Fairness, Honesty, Personal Integrity, Respect for Others

can ethical values be taught
Can Ethical Values be Taught?

Ethical Courage

Willingness to Pay the Price for Ethics

Application of Ethics to Business Situations

Fraudulent Practices, Misleading Advertising, Unfairness

Personal Ethical Understanding

Right/wrong, Fairness, Honesty, Personal Integrity, Respect for Others

can ethical values be taught88
Can Ethical Values be Taught?

Ethical Leadership

Helping Others to be Ethical

Ethical Courage

Willingness to Pay the Price for Ethics

Application of Ethics to Business Situations

Fraudulent Practices, Misleading Advertising, Unfairness

Personal Ethical Understanding

Right/wrong, Fairness, Honesty, Personal Integrity, Respect for Others

walmart s view
WalMart’s View

Swing Group

Could Go Either Way

Honest Employees

Will be Honest Always

Dishonest Employees

Policies Won’t Help Much

Ethical Leadership will significantly impact an organization since the vast majority, in this view, can be influenced to behave ethically.

is there a universal ethical standard
Is There a Universal Ethical Standard?

Yes—In Principle

Categorical Imperative: How would you want to be treated?

Are you comfortable with a world with your standards?

Christian principle: The Golden Rule

Do unto others as you would have them do unto you. Luke 6:29-38

Thou shalt love thy neighbor as thyself. Luke 10:27

taught in all cultures
Taught in All Cultures

Confucius: What you do not want done to yourself, do not do to others.

Aristotle: We should behave to our friends as we wish our friends to behave to us.

Judaism: What you hate, do not do to anyone.

Islam: No one of you is a believer until he loves for his brother what he loves for himself.

Hinduism: Do nothing to thy neighbor which thou wouldst not have him do to thee.

Sikhism: Treat others as you would be treated yourself.

Buddhism: Hurt not others with that which pains thyself.

Plato: May I do to others as I would that they should do unto me.

TREAT PEOPLE THE WAY

YOU WANT THEM TO TREAT YOU

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