Chapter 3

Ethical Decision Making in

Business
McGraw-Hill/Irwin

3-1

Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Capitalism is the astounding belief that the

most wickedest of men will do the most
wickedest of things for the greatest good
of everyone.
John Maynard Keynes

3-2

Capitalism as such is not evil; it is its wrong

use that is evil. Capitalism in some form or
other will always be needed.
Mahatma Gandhi (1869-1948)

3-3

Motivation of Decision Makers

Moral motivation is necessary ingredient
to ethical action
Decision maker must have integrity
Decision maker must have moral courage
to follow through with ethical choice

3-4

What is Business Ethics?

Core values and standards adopted to guide
decision making
John Maxwell: Golden Rule as the standard
for making ethical decisions
Consider the interests of stakeholders
Owners Stockholders
Creditors
Employees
Suppliers
Customers
Government Agencies
3-5

Ethical Issues in Business

Honesty and fairness

Conflicts of interest
Fraud
Discrimination
Information technology

3-6

Honesty
Obligation to be honest and trustworthy
Lincoln:
No man has a good enough memory to be a
successful liar.

3-7

Fairness
Treating others equally
Justice in ethical decision making
Objectivity in accounting and auditing
Transparent
Accurate
Reliable
Reflect full disclosure

Accordance with GAAP

Not be misleading
3-8

Conflict of Interests
Situation in which private interests or
personal considerations may affect or be
perceived to affect an employees
judgment
Affects objectivity and integrity
Disclosure as an element of honesty

3-9

Fraud
Activity is clandestine
Violates fiduciary duties to organization
Committed for purpose of direct or indirect
financial benefit to perpetrator
Costs the organization assets, revenue, or
reserves

3-10

Why Fraud can Happen

Lack of internal controls
Ineffective corporate governance

3-11

2006 Fraud Stats

Median dollar loss: $ 159,000.
Represents 5% of annual revenues
On a national scale, estimated to be
$652billion lost to fraud on $13.037 trillion
gross domestic product.

3-12

2006 Fraud Stats

Organizations:
Private companies 36.8%
Public companies 31.7%
Government organizations 17.6%
Not-for-profit organizations 13.9%

3-13

2006 Fraud Stats

Median loss:
100 > employees: $100,000
100 to 999 employees: $179,000
Employees > 999: $150,000

3-14

Pillars of Corporate Governance

Responsibility
Accountability
Fairness
Transparency

3-15

Good Governance
Dealing with
the ways in which the suppliers of finance to
corporations assure themselves of getting a
return on their investment

Typically includes the mechanisms to

ensure that the agent (management) runs
the firm for the benefit of one or more
principal with whom the firm conducts its
business.
3-16

Importance of Good Goverance

2001: 80% U.S. and European investors
say they would pay more for companies
with good governance
2003: 70% believe the perception of good
governance standards have a positive
impact on stock prices

3-17

Agency Theory
Corporate managers and directors are
agents
Shareholders are the principal
Construct rules and incentives to align the
behavior of agents with the desires of the
principals

3-18

Agency Problem
Desires and goals and agents and
principals may not be in accord
Difficult to verify the activities of the agents

3-19

Agency Costs
Agents likely to place personal goals
ahead of corporate goals
Results in conflict of interests between
agents and principals
Consistent with egoism
Information asymmetry

3-20

Overcoming Agency Problem

Executive compensation
Controlling management through Board of
Directors actions
Accounting system as a monitoring device
Internal control

Audited financial statements

3-21

Stakeholder Theory
Stakeholders other than shareholders
Employee governance
Employee share ownership
Employee representation on Board of
Directors
Employee involvement in governing
committees

3-22

Corporate Values

Ethical behavior/integrity
Commitment to customers
Commitment to employees
Teamwork and trust
Honesty/openness
Accountability
Corporate citizenship
3-23

Corporate Codes of Conduct

Formal statements that describe
the organizations expectations for
its employees

3-24

Credo
Aspirational statement that encourages
employees to internalize the values of the
company

3-25

Codes for CEOs and CFOs

SOX requires public companies to have a
code of ethics for its CEO and principal
financial officers
Separate from the companys code of
ethics

3-26

How Employees Views Ethics in

their Organization

Supervisors clearly set an ethical tone

Talking about the importance of ethics
Keeping promises and commitments
Supporting employees
Setting a good ethical example

3-27

Detecting Occupational Fraud

Tip 34%
Internal audit 20%
By accident 25%
Internal controls 19%
External audit 12%
Notified by police 4%

3-28

Ethical Decision Making

1.
2.
3.
4.
5.

Frame the ethical issue

Gather all the facts
Identify the stakeholders and obligations
List the relevant core values
Identify the operational issues

3-29

Ethical Decision Making

6. Identify the accounting issues
7. List all the possible alternative
8. Make an ethical analysis of the
alternatives
9. Decide on a course of action
10. Reflect on your decision

3-30

Examples of Decision Making

Tylenol Poisoning
Good ethics is good business
Put stakeholders first

Ford Pinto
Risk/benefit analysis in decision making
Act utilitarian reasoning
Ignores the rights of various stakeholders

3-31