How to Lose and Restore Confidence in Business - Research Paper Example

Financial Crisis and the Dilemma of Business Ethics 1. Introduction This paper seeks to discuss the link between the recent financial crisis and the dilemma of business ethics by focusing on the element of trust in business as a relationship link. Understanding this ethical problem created by the crisis could give an insight that can help in possibly preventing or solving another problem of the same kind in the future. The paper will discuss the dynamics of the problem of lost trust using as illustration some transactions of Lehman Brothers which are imbued with ethical choices. The paper will attempt to discuss some practical ways of contributing to restoration of lost trust by principally business ethics in financial reporting. 2.0 Lost trust is the ethical problem created by financial crisis and its consequences. The effects of financial crisis could be observed in the extended unemployment cases until time caused by the slowdown in the economy as there are less business economic activities than expected. In particular, the US financial crisis of 2007- 2009 manifested itself in the having extended recessions also that could result to economic depression if not solved (Slavin & Slavin, 2010; Arnold, 2008; Baumol & Blinder, 2008). In fact said financial crisis became a global financial crisis, and although recent statistic figures indicated positive economic growths, the high unemployment levels in the US and UK continue. Governments around world have been making economic stimulus as a way on increasing government spending and encourage business activities from an economic point of view. By admitting limitations of pure economic approaches to solving the problems caused by the crisis, business ethics theory could offer a very relevant solution to the element of trust that got lost with the financial crisis. Going back to how business activities including of the existence of governments started one cannot deny the requirement for trust by those affected before institutions could actually function. This paper believes that trust on the power of the market, on the reliability of institution must have suffered a great decline or a loss. 2. The need to have trust restored as result of financial crisis Without restoring the trust, there is no way to bring back investors to decide to invest again in corporations which will produce the badly needed goods and services and at the same time generate the need employment to ease high unemployment level as those in the US and the UK. Market capitalism did have its excesses as in the case of corporations having become powerful as they went beyond their borders operating globally (Schaffer, 2002). The governments of these countries where these corporations operate will have to get their acts together also if they have to prevent the excesses committed by the companies especially the banks. The rules of the game in on country may have to differ if the companies which are just covered by the local rules will bring the game outside that country. In other words, local problems would need local solutions but international problems would need international solutions. The international financial system must be adjusted with the needs of the times (Kenen, P. & Swoboda, 2000; Isard, 2005; Kunt, 2011). With companies becoming extraordinarily bigger because of the globalization, their chief executive officers and other managers are given abnormally high incentives that would sound to match their big responsibilities in managing others money and resources. Would sky be the limit for all these perks and incentive to get the best CEO for each of the companies because the shareholders happen to be looking for the best returns of their investments? If indeed the shareholders would not be restrained by their desire to get more wealth in capitalistic society (Brigham, and Houston, 2002), common sense could dictate that there are limit to things. It is a basic finance theory that the higher the return, the higher would be the risk (Brigham and Houston, 2002). How far then should investors go to get their best returns for their investments even to the extent of hiring the best managers that could deliver what they would believe as maximum return? What could happen is that a country may have it is local rule that there should be a limit to what CEO could get as salary or perks from his function in relation to what the company could achieve in terms of financial performance of the companies they manage. However as capitalism becomes global, the CEO who gets restrained with that they can get from their country because of certain rules, may have to creatively find ways to expand outside their own country of operation. Now governments actually support globalization as seen in the present business realities as they solve, of course, social and economic problems. The rules in the global economy therefore become different and to get the act of these governments together, they have to cooperate with one another and at attempt to harmonize rules of the game. One area of harmonization is in the reporting standards used by the countries which happened to influenced by their unique cultures. Another aspect that is worth looking into under the new international business rules is the need to make managerial incentives schemes more transparent with the aim to discourage executives of companies from possible abuses. The idea of preventing abuse by disclosure can be taken from the premise that the salaries if these main officers of the corporate are known to the public, they could be subjected to different standards just like other companies. A responsible CEO whose salary is made known to public may more probably behave better than when there is no transparency. Transparency by disclosure could be way of seeing the value that were actually created by these managers in relation of their worth as measured in terms of salaries and perks paid to them. To put these transparency requirements for managerial incentives the accounting rules necessarily must complement or supplement the need. Thus these accounting rules must not be awkward or stubborn as to allow fake transparency in terms of window-dressing the financial information. They should properly cause the provision of accounting information to the have the quality of being relevant and objective and the same time (Kieso, et al, 2007; Helfert, 2001; Meigs, Meigs, & Meigs, 1995; Johnson, et al, 2003). The idea of restoring trust by the enactment and enforcing rules that would produce relevant and objective information is not an easy task. It is decision that must be coupled with good faith from those involved in its preparation for use by the decision makers. This would be discussed more latter on the ethics of financial reporting. To restore trust in business is to have a balance of looking at the short-term view and long-term view with more focus on the latter. The principle could be best appreciated by asking the question: How should humans live? Should they live at the present only and forget the future? Or should they rather plan for the future and live today with the idea that they will still have the future to live? An affirmative answer for the second question would be better as nobody really live to the fullest today and forget tomorrow without regretting afterwards. Companies too need to plan for the future while they exist today to attain their plans for the future. The investors in corporations or business organization do not normally put their money today and after few days they would get back their money with big returns. They normally expect a number of years for their returns or wealth to grow overtime. This is the same argument fort companies’ need to plan with long-term view that would discourage excessive risk taking. The path to prosperity has no short-cuts but it is the latter that attracts many decision makers to forget their long-term view. In such a situation where a long-term view is assumed for business to realize their full potential, business ethics can really come into play by the enactment of rules that would lead toward attainment of long-term objectives for corporations. For such a span to time, a time to contemplate these corporations would deliberately prepare the long-journey. That they will exist not only for today but in many years to come would be easier to believe. If one reverses this premise of ethical business, what one gets would be the cases of Enron and WorldCom (Fernando, 2009; Kitchen, 2006). Their officers were motivated by chance to get wealth the fastest way. These officers were thinking that tomorrow can be forgotten as today they can now become rich. The situations of these companies can be likened to thieves who may become millionaires or billionaires so fast but they forgot the natural order of things that it takes time to get wealthy in the same way that it takes time to grow. The economy could not be expected to have a 100% GDP. That would be almost impossible. To double income in so short a time would be miracle when it comes to stocks. The role of business ethics therefore becomes significant and inseparable from the business. It is business ethics that supports the enactment of codes or rules that would help companies to have transparency, reliability, objectivity, honesty and prudence. With these values, trust, which is very important in the conduct of business, will be generated. Without trust the market cannot operate as investors would be again suspicious whether their money or resources would be lost again in the process. To have well-functioning markets and societies, there must be trust. A household can only be encouraged to place its savings in a bank and it is the same trust that will allow business entities to enter into transactions of business in deciding whether to invest resources, produce goods and services, and employ people and to grow in assets with the related risks. This trust appears to have been lost in the recent financial crisis as the stock markets and investors are not taking risks as before the crisis. The more immediate effects can be seen in the still very high unemployment levels in the US, UK and other European countries. Lost trust needs to be restored by building a more health regulatory framework. Business organizations and the stakeholders therein should be convinced that globalization is reliable. Countries should therefore cooperate among themselves if they have to regulate the globalized nature of business. Thus the need for sound international rules and regulators become obvious. High ethical standards should also be created as they share with corresponding rights and responsibilities. International organizations could help in promoting sound and reliable agreed principles and standards for business ethics. 2.2 Lehman Brother’s collapse, an illustration of the lost trust Lehman Brothers Holdings Inc. (or “Lehman”) was a global financial services firm, headquartered in New York City until it declared bankruptcy in 2008. In operating under three major segments that include Investment Banking, Capital Market, and Investment Management, the company was enabled legally into transactions that may involve conflict on interests. The legal and economic environment therefore virtually the company allowed to have unethical chances and possibilities. Even as a primary dealer in the U.S. Treasury securities market with various subsidiaries, a time just came when things become irreversible and the company has no choice but to file for Chapter 11 bankruptcy protection on September 15, 2008. Such decision was understandable the effect of the mass departure of its clients, devaluation of its assets by credit rating agencies and radical losses in its stock and (Mitchell & Wilmarth, 2010; Stowell, 2010). Banks are the most affected in the financial crisis and domino effects on business are simply unavoidable. Banks’ critical role in the payment system the provision of credit, the maintenance of financial stability as well the transmission of monetary policy by central banks of the different countries (Bikker, et al, 2009) would make them multipliers of problems when they themselves are sick. The fall of Lehman Brothers as financial services company just was followed by news of other collapses that eventually led to the earlier financial crisis in the US than the rest of the world. Understanding how trust in the banking systems evolved starting from with fall of Lehman Brothers may make more meaningful the need to appreciate ethics in business. By critically assessing the immediate and long-term causes of Lehman Brothers collapse in relation to financial crisis could point out how lost trust played a role in its demise and the resulting crisis. 2.2.1 The nature of Lehman’s business in relation to the collapse The nature of Lehman’s business includes dealings with by complex derivatives and under conceived or finance terms as a result. A collateralized debt obligation (“CDO”) transaction could uses as an example as this would entail the purchase by a special purpose entity (SPE) of a diversified portfolio of securities and/or loans that would be managed by independent asset manager. With Lehman’s role in the CDO as structuring and placement agent (Carl Levin, n.d.), one can just imagine how complex its business to others who may not have a deep background in finance. The complexity is fertile ground for much possible confusion and to entrust everything to analysts who may not have actually understood the matters but all the same they came with recommendations to investors. With investors attracted to the promise of big returns without minding or understanding the corresponding risks including the uncertainty of the basis of the decision due to ignorance of lack of good information, what else could be expected? In addition to being a structuring and placement agent, Lehman was also a market maker (Rezaee, 2011; Jackson - 2010). This conflict of interest cannot be easily perceived for those who were looking for above average return and which again goes back to the problem of doing business that may not have been objectively evaluated in the first place because of the motivation to close the related transaction by selling or buying itself the part of portfolio of security or loan. Since Lehman dealt with credit default swaps (CDSs) (Skeel & Cohan, 2010) through which it made a market by buying and selling credit protection on portfolios of credit exposures, the increased credit could always be there. This kind of transaction neither sounds easy. As such they could be hostile to even highly educated investors. The consequence was the seeming problem of lack of familiarity was no longer evaluated. To understand the effect of the same in the financial statements and in stock prices could not even be reduced by professional accountants because of the counter cost and benefits associated with the transaction. The great chance then was to have the complexity of its business not really understood by decision makers and the related consequences as many were misinformed and some were misled with increasing prices. It may be good to ask about the possible consequences of having this complicated nature of business to the practice of business ethics. When things appear too complicated, many untoward things could happen. The information cannot be therefore clear for some investors that would cause them to behave under a herd mentality. They could not trust their analysis of the risks associated with making their investments and they would rather what the so called “experts” would tell them to do. But a greater problem is created when the these so called experts are acting exclusively acting for their own-self-interests with the taking advantages the lack of knowledge on investors on the rules of the game. This is unethical. 2.2.2. Credit ratings effect on its business viability Lehman, just like any other companies, makes disclosures in its reports to the Securities and Exchange Commission (SEC). It has disclosed that its borrowings costs and access to the debt capital markets to be relevantly connected in its credit ratings (MSN, 2011). The company essentially declared to be living based on trust as it has to be based largely on perceptions by credit rating agencies. Credit agencies are essentially conveying whether companies can be trusted by their credit ratings Perception and evaluation from credit agencies significantly influence decision making concerning Lehman. Imagine a company that has consistently shown positive bottom line for the past five years or more as revealed by it financial reports filed to the SEC and made known to the public and all of a sudden, the company has no more value or was filing for bankruptcy. If this has happened to a very big company like Lehman Brothers, who is going to trust now the financial reports of many other companies in the world? Are all the financial values in paper only then? From this point, the principles of ethics could not be separated from the operations of Lehman brother because of the need for the trust. Investors with Lehman and the rest of the companies in the world must trust that their money would be safe, secure and would provide them the sufficient return in relation to risk associated with the investment. How could one company be able to establish that trust? Does it have the honesty and integrity in its financial transactions? Does it provide complete, fair and accurate information whenever it is expected to help assure about the integrity of the system? Does its board of directors practice due diligence in the managing the business? Since Lehman Brother is part of banking or the financial services system, it would be interesting to ask whether it was subjected to regulation through effective monitoring by authorities or governments. If government who has interest in banking in keeping stability failed to prevent the collapse of Lehman, what is the assurance that it would be able not to repeat the same mistakes? Trust in inevitable in business. 2.2.3 past unethical practices in the company due to conflict of Interest In 2003, Lehman was part of the ten companies about a settlement concerning penalties amounting to millions of dollars against due to undue influence over each firm’s research analyst by investment banking divisions with the US Securities and Exchange Commission (SEC) (Bolland, 2010). In relation to this, it is interesting to get an insight about the nature of combined business of investment banking and investment management. Lehman Brothers may be operating business segments imbued with functions which inherently possess conflict of interests so that Lehman may necessarily be recommending decisions to clients, which may not be completely unbiased from a professional point of view. Some would argue that it is all greed implying that nothing could be done. However from a deeper analysis of the case, it would appear that rules of the game were not fair. It would appear that regulation failed and it has not even attempted to check the inherent conflicting functions under the elementary elements of good internal control. It is possible that Lehman may be acting out of self-interest but what about the interest of the investors? Was the latter just misplaced? By having preventing Lehman Brothers and the perpetrators from its own violations, ethics would be at work to restore trust to the system. If it was a problem to make laws that would have addressed the situation, ignorance could not a valid ethical defense as it would mean callousness to consequences in not helpless to be ethical. 2.2.4 Excessive aggressiveness for speculation by management. Lehman was accused of engaging in short selling which contributed to its demise but also that of Bear Stearns (Gregoriou, 2011; Brown, 2009; Sinn, 2010; Taulli, 2011). Short selling allows selling securities without having first acquired ownership (Brigham & Ehrhardt, 2010; DePamphilis. D (2011). This in effect would show in the meantime revenue transaction of the company. How revenue was this recorded in the books may have to deal with the issue whether reporting standards are fair or stubborn. Bear Stearns and Lehman can be branded as great merchants of bubble economy because of this practice of short-selling. Not all kinds of short selling are illegal as there are those that could it illegally. The charge for Lehman was serious or has gone out what was legal based on their very high leveraged situations which made its collapse to be very vulnerable (Taulli, 2011). 2.2.5 Ignorance of decisions makers as excuse Some quarters may attribute the demise on ignorance than greed as the failure of analysts to make their mathematical computations in balance the correct amount of return for the right amount of risk. The premise of the argument is that with wrong recommendations given by analyst to decisions makers, the latter who were the investors simply failed to realize what should have been the proper returns of their investments from their wrong choices. An argument of ignorance as excuse still cannot pass the ethical requirement in business. Ethics presupposes responsibility for the consequences. To do business without knowledge of its consequences is just like arguing that manufacturing a produce without knowing its consequences that it could kill in case of wrong prescription. Ethics presupposes a choice from alternative course of actions that tries to balance self-interest and interest of the community. 3. Improving corporate governance starting with the ethics of financial reporting Ethics in business that would argue for transparency can be appreciated in the need to have accountability for results and transparency. Financial reporting in such situation must be occupying a very important aspect if ethics in business need to be promoted. Ethics of financial reporting presupposes rightness or wrongness of acts by those who should provide the financial information for decision-making. The value of information provided to decision makers must therefore be very important. The rest of section seeks to discuss such ethics in financial reporting including its theoretical underpinning on the need for such ethics. This would also explain how ethics in financial reporting could be best practiced by those involved in it process of financial reporting. Knowing who are involved in financial reporting may illumine the path to better understanding. There are three important parties involved as far the as ethics of financial reporting is concerned. They are the management, the audit committee, and the external auditor. The role of each is discussed and analyzed next on how each would help accomplish in putting well-functioning capital markets. Management as represented by the board of directors acting through its officers is the preparer of a company’s financial statement. Management responsibility for financial statements as agent for the stockholders and in-charge of the stewardship of business under a principal-agent relationship is assumed. The stockholders as in effects agents of the corporation in being responsible for the total assets of the business, based on share ownership by the stockholders and the creditors. Management responsibility as required by law requires publication of its financial statements and the same extends to information disclosed. All estimates and assumptions used in getting to the final numbers or figures in financial statements are included. Management can improve reliability and relevance of accounting information through accounting policies based on acceptable accounting standards, which company accountants must use in preparing the financial statements. Management responsibility about the reporting process extends to reliability and effectiveness of internal control. Integrated with this responsibility is the need to understand, assess and implement policies to mitigate risk in managing the business. The creation of audit committee within the organization headed by non-executive or independent directors becomes a requirement. In the course of time, management responsibility has to evolve towards accomplishing its purpose as a respond to financial outrages of the past. Thus management responsibilities under Sarbanes-Oxley Act of 2002 (SOX) made after Enron and WorldCom fiasco now requires chief executive officers (CEOs) and chief finance officers (CFOs) of US public companies to afford three assurance (Lasher, 2010). They must personally certify the accuracy of the company’s quarter and annual filings. They must also to certify that there are effective disclosure controls and procedures in place. They must also provide an assessment of the internal control that was applied about the practice of financial reporting in the company (Anand, 2011; Ramos, 2008). Audit committee is as an extension of the management, should be separate and independent from the executive function. Internal auditors should not fear to find fault of the CEO and CFO under the present requirement of the SOX. To establish their strong independence from management, audit committee’s responsibility includes the appointment, compensation and oversight of the external and internal auditors of the company. The internal auditors should not be confused with external auditors as the latter are employees of the company but not under the President or CEO. The external auditor is professional whose function is to express and opinion as the fairness of the financial statements in accordance with generally accepted accounting standards or financial reporting standards like US GAAP or IFRS (Moeller , 2011; Gleim & Flesher, 1996; Parker, 200). 4. Conclusion   Business ethics is an indispensable part of business. Financial crisis cannot be detached from the problem of business ethics as the latter consider business activities choices by decision makers that would have an effect on society whether it is favorable or unfavorable. Because of the inherent self-interest in capitalism to maximize one’s take or profit in very transaction, the practice of good ethics would serve as balancing force. Indeed wealth maximization objectives are pursued given the requirement of unabated self-interest under capitalism and some argue that what is ethical to one is not ethical to others. Virtue ethics however exists which appears as more logical foundation of better law and ethical requirement for business. When decision makers are honest, fair and considerate about the life of others and society while balancing their own-self-interest, would not a better world for business exist. That greed is a direct cause of financial crisis cannot be discounted or easily rebutted but as to whether the same greed would have been reduced if decision makers were more ethical, the answer should be in the affirmative. Ethics may not completely have prevented the financial crisis but it could at least have moderated the effects. 5. References Anand (2011). Essentials of Sarbanes-Oxley. John Wiley and Sons Arnold, R. (2008). Economics. Cengage Learning Baumol, W. and A. Blinder (2008) Economics: Principles and Policy. Cengage Learning Bikker et al (2009). The Panzar-Rosse Revenue Test: To Scale or not to Scale. Retrieved from 20 October 2011 from Bolland, J. (2010). Writing Securities Research: A Best Practice Guide. John Wiley and Sons Brigham, E & M. Ehrhardt (2010). Financial Management Theory and Practice. -Cengage Learning, 2010 Brigham, E. and Houston, J. 2002, Fundamentals of Financial Management, London: Thomson South-Western Brown, P. (2009). 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