Ethics

As we saw last week in this module, regarding the legal profession, the American Bar Association has promulgated the Model Rules of Professional Conduct which addresses many ethics rules that govern the legal profession, including the client-lawyer relationship, advertising, and maintaining the integrity of the profession.

For the purpose of this lesson, we will focus on the ethics governing the business environment, also called “business ethics”.

Business Ethics refers to organizational standards, principles, values, and norms that govern the actions and behavior of individuals and corporate entities in the business environment.

In a broader view, business ethics encompasses relationships that result in potential controversial issues involving all the corporate stakeholders, including the company, its employees, shareholders, suppliers, customers, neighbors etc.

Most of these controversial issues revolve around a profit-maximizing behavior of the companies’ high management.

Traditionally, only individuals could have responsibilities in the corporate environment. However, the modern view has changed and today, in most countries, corporate entities are legally treated as persons in some respects – e.g., they can hold title to property, sue and be sued, and are subject to taxation.

Therefore, corporate entities also have independent ethical responsibilities.

It was only in the 2000s, in response to accounting scandals that occurred in the U.S. which strongly impacted the whole business world, that the concept of business ethics caught more attention of academics, the media, and business firms.

As a consequence, firms began to promote their commitment to non-economic values under headings such as ethics codes and social responsibility charters, possibly in an attempt to distance themselves from the business scandals.

The Accounting Scandals

The recent multi-billion dollar accounting scandals have helped to fuel a massive loss of confidence in the integrity of business corporations. They have brought ethical questions about business to the forefront in the media and public consciousness more than ever before.

There were numerous corporate accounting scandals in the U.S.– e.g., Enron, WorldCom, Tyco, Lehman Brothers, Bernie Madoff, Satyam etc. – and most of them used “creative accounting” tools to intentionally manipulate corporate financial statements.

The illegal mechanisms were adopted with the agreement of the companies’ executives and they included practices such as inflation of the company income and assets, stock price manipulation, expense deferrals, and hiding over loans disguised as sales.

Some of the reasons for the adoption of these illegal measures were:

• Bonuses: managers would reward themselves with higher bonuses if they achieved certain financial results.

• Dividends: the distribution of enormous amount of dividends would meet shareholder expectations who would keep investing in the company.

• Stock Price: by increasing the company earnings, the expectation from the investment community would be met.

• Competitors: good financial results would potentially increase the competitive advantage over other businesses.

After extensive investigation from the Security and Exchange Commission (SEC), sometimes tipped off by whistle-blowers, corporate scandals were uncovered and strong penalties were imposed on the lawbreakers: prison, multi-million (and sometimes multi-billion) restitutions, and charge with breach of trust, conspiracy, cheating and falsification of records etc.

Consequences

In response to the business ethics scandals, which mainly occurred between 2001 and 2004 in the U.S., the American Congress passed the Sarbanes–Oxley Act, commonly known as SOX, to introduce the most sweeping set of new business regulations mandatory to publicly-held companies. This set of laws also applied to other countries, making business regulations stronger worldwide.

Many small- and mid-sized companies also began to appointethics officers. Often reporting to the Chief Executive Officer (CEO), on one hand, they focus on preventing unethical actions by making recommendations on ethical policies and disseminating information to employees; on the other hand, they focus on uncovering unethical and illegal actions.

In addition to ethics officers, companies also began to designate a board committee to oversee ethics issues.

Finally, more and more companies have formulated internal policies pertaining to the ethical conduct of employees. These policies can be simple broad guidelines, with highly generalized language, or they can be more detailed, containing specific behavioral conducts. They can also be used both as the basis for operational requirements (things one must do) and operational prohibitions (things one must not do).

Typically called “corporate codes of ethics”, they are meant to identify the company’s expectations of workers and to offer guidance on handling some of the more common ethical problems that may arise while doing business.

It has been observed that companies are increasingly nurturing an ethical culture, forcing top management to be transparent and employees to be responsible for their acts.

All of the above measures are important elements of companies’ ethics and integrity which are at the core of sustainable long-term success.