Ethics in Business and Accounting: Lessons We Are Learning

1. Ethics in Business and Accounting: Lessons We Are Learning Prepared by Dr. L. Murphy Smith Dill Distinguished Professor of Accounting Murray State University For permission to use or adapt this presentation, please contact Dr. Smith, msmith93@murraystate.edu

2. 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?

3. 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."

4. When evaluating one’s goals and objectives, a vital question must be asked: What is your highest aspiration? A. Wealth B. Fame C. Knowledge D. Popularity E. Integrity

5. 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.

6. About how many high school students do you think cheat on exams? a. 10% b. 25% c. 50% d. 75% e. 100%

7. 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.”

8. 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.”

9. 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

10. 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.

11. 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 1 b. Line 2

12. Ethics codes: Accounting and Business • Accounting 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. Objectivity • Internal 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. Confidentiality • Internal 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. Competency • Internal auditors apply the knowledge, skills, and experience needed in the performance of internal audit services.

13. 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.

14. Halliburton’s Code of Business Conduct: Ethical Business Practices 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.

15. Can ethics be taught? 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.”

16. What is ethics? Ethics: a branch of philosophy which is the systematic study of 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 may ultimately be directed. An ethical problem occurs when you must make a choice among alternative actions and the right choice is not absolutely clear. Often that choice affects the well-being of other persons.

17. Philosophical Principles in Ethics Imperative Principle: Do what is right. Act according to absolute moral rules (e.g. lying is wrong). Ethics is a function of moral rules 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 imperative principle and the utilitarian principle. Make the decision by considering the consequences if everyone made the same choice under similar circumstances. That is, what would happen if everyone acted in this way?

18. Steps in Ethical Decision-Making • Define all the facts and circumstances: • e.g. Who, what, where, when, and how? • Identify the people (stakeholders) affected by the situation; • What are the stakeholders rights and obligations? • Identify the alternative decisions and consequences. • 4. Make the decision.

19. Financial Scandals Ethics 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.

20. Short Cases: Enron • Enron 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.

21. Short Cases: WorldCom • WorldCom 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.

22. Short Cases: Parmalat • Parmalat 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, CalistoTanzi, 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.

23. Ethical standards are essential to a free society More than 200 years ago, Professor Alexander Tyler wrote of the Athenian Republic, which had fallen 2,000 years earlier: “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.”

24. 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.”

25. Where Do We Start? Upon What Can We Agree?

26. 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

27. 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.

28. 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.”

29. Be sure you are right, then go ahead. David Crockett 1786-1836

30. 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

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

32. 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.”

33. Questions to Consider for Ethical Decision Making • 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.)?

34. 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.)

35. Can you make a difference?

36. 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?

37. 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?

38. ‘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

39. ‘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

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

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

42. 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.

43. “Honor is better than honors.” Abraham Lincoln

44. 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.