W1 (28/07) - Introduction

Texts:
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TB:
o Ch1 and Ch2 (end at ethics of firms)
AFR Hurtling towards a moral conundrum
Ultimate bargaining game limits of rational behaviour
Saul Gellerman Why Good Managers make Bad Ethical Choices
Theory of Moral Sentiments Adam Smith (does not deal with disparity in wealth)

Cases
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Case 1.1 Merck Vioxx (slow withdrawal of drug that increased risk of heart attack)
Case 1.2 Toys R Us (buying competitors products) and Home Depot (wood selling
during hurricane period)

What is ethics in finance?

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It is the responsible and sustainable decision making in business and finance.

Moral/ethics describes whats right or wrong (ethics is the study and implementation
of morality p.23 of Sixth edition)
o Morality sociological phenomenon; existence of rules/standards; specific to
culture, time, place
o Ethics rules and norms of specific kinds of conduct (by group) or philosophical
study of morality; considers rights and justices of noneconomic values
o Moral dimension is usually supplanted by economic viewpoint of profit max and
efficiency
o Moral viewpoint usually underlies CSR
Ethics can be
o Descriptive empirical inquiry into actual rules/standards of a particular group,
or could consist of understanding the ethical reasoning process
o Normative justification and what we ought to do through moral
reasoning/argument

Moral reasoning
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MR requires willingness to seek out and act on reasons; be impartial

Consequentialist moral reasoning right thing is based on the consequences of our
actions. We locate morality in the consequences of an act (what is the state of reality
after such actions)
Categorical moral reasoning the intrinsic quality of an act (it is categorically
immoral)
Personal risk when familiarity with a situation becomes non-intuitive or counterintuitive; when a problem presents gray areas in decision making

Business decision making

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3 levels
o Individual self-discovery of dilemma, relies on own moral stds, judgments and
values to decide
o Organisation managerial level discovery, relies on procedure/policy to drive
decision

Business system industry wide discovery, relies on industry code of ethics,

peak body rules, gov regs, economic reforms to drive decision to solve systemic
issues (e.g. generally accepted business practices or economic problems
o Ethical displacement can occur where solution to problem is on different level to
where problem was discovered/occurred
2 distinguishing factors of business: business are economic relations in markets and
orgs
o Economic character (trading is hard bargaining); ethics prohibits questionable
selling practices; employment is a special rship; ethics of business is the ethics
of economic activity
o Business takes place in orgs; not the individual value system alone that is
crucial; hierarchical system of functionally defined positions; reconciling ethical
reasoning/private morals with commercial realities/business imperatives
We keep in clear distinction separate rules in different circumstances (social,
professional, etc)
o

Context of ethics in law, economics and management

Economic the firm as an economic unit of production/value adding in market seeking max
profits, but it is also a distinct entity
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Increase shareholders wealth given acceptable business practice

Economic choices driven by utility max (with limits on theft and fraud) economic
reasoning as an explanation for consumer/supplier behaviour can be seen as moral
reasoning in that economic actors ought to make utility-maximising choices (i.e. the
economic normative of maximising utility is predicated on moral grounds) Wealth of
Nations (though assumes ordered, civil society with high level of integrity and virtues)
Justification competitive free-market benefits society but only on condition of:
o Observance of minimal moral restraints
o Fully competitive markets (i.e. low barriers to entry/exit, minimal asymmetry in
info, prices reflect all costs of production including externalities)
Conditions overseen by gov
5 reasons econ perspective alone cannot serve as basis for DM
o 1. Market system per se has ethical justification
o 2. Ethics required by markets
o 3. Rules of game cannot be set by gov alone need for a culture, selfregulation/restraint
o 4. Ethics influences economic behaviour (e.g. people motivated in their
behaviour by perception of fairness hence limits profit seeking behaviour)
o 5. Public policy utilises non-economic values

Law conducting business within legal limits is enough

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Theory 1 legal rules apply to public life whereas ethics are a private matter; law
represents a minimal level of expected conduct that is imperative, whereas ethics is a
high-level and optional
Theory 2 law as a social control which embodies ethics of business with clear, detailed
and enforceable rules, thus providing a level playing field
Limitations law does not extend to everything (e.g. taking credit for others work,
unreasonable demand); law is slow and lags behind development as it is primarily
reactive; can be vague and open to interpretation such as reasonable, good faith,
fair dealing, due care (hence theres a business in litigation funding!); inconsistency
between jurisdictions; and can be inefficient.
o Courts of equity have existed in the Australian jurisdiction as well as many
Commonwealth jurisdictions, which seek to redress wrongdoings by equitable

remedies. E.g. contracts may be rescinded or rendered inoperative if there was a

reliance on some representation that was false.
Ethical mgmt. vs mgmt. ethics
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Ethical management doing right thing; however there is a distinction between

ordinary, private ethics and commercial ethics
Management of ethics acting effectively as a manager in recognising and resolving
ethical problems (e.g. mission statements, policies, procedures, rules); it includes
gaining acceptance of such policies through perceptions of fairness and commitment by
management
Managers operate both as business agents and leaders; thus they are required to have
a body of knowledge, high degree of organisation and self-regulation
o Cf high-level mgmt. who must develop and sustain an ethical culture inside the
company
Knowledge needs to be broad to overlook their area of responsibility and beyond
including: a) knowledge to recognise and resolve ethical issues, b) understand
motivation of individuals, c) knowledge of regs/law, d) ability to develop logical and
defensible ethical arguments to persuade others through moral imagination; all the
while maintain commercial viability

Roles of managers
Ethics in roles
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Each role has its set of relationships and accompanying rights and obligations, with a
set of unique responsibilities to various groups/interests
Well defined roles based on functions better cater to serving society (division of labour)
through increase in productivity (i.e. specialisation increases specificity of
responsibilities and obligations); going up the commercial peking order requires
subsuming increasing amount of roles which increases probability of conflicts of
interests, responsibilities and obligations between each role.

Various types of managerial roles

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Economic actors
o Primarily economic factors with underlying driver being success of end goals
(usually profitability)
o To weigh which risks to take and actively manage risks
o Ensure company survival, then maximise profits
Company leaders
o Entrusted with assets and to manage them prudently; expected to meet
legitimate expectations of all stakeholders
Community leaders
o Need to legitimise their exertion of enormous power
o Great clout over society as a whole (their constituencies extend out to the public
sphere due to externalities which are endemic to all companies)

Organisation theory
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DM in commercial setting is a collaborative experience which is subject to dynamic

forces that is not wholly understood/recognise by any one entity.
Collective actions are the combination of multiple individual actions (who is then
responsible for an inadvertent final outcome?)
Wrongdoing in orgs more likely due to inadequate oversight on particular policies,
procedures, etc

E.g. work environments that lack policies that provide guidance for behaviour or
deal with conflicting signals; there is an operational gap between what is
instructed by mgmt. and how/what is achieved.

Integrated approach to ethical viewpoints

Integration
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Utility cannot be simply the only yardstick in delineating moral actions

Do we, and how do we, assign weights to different goals?
Decisions must be economically satisfactory, fulfilling legal obligations while ethically
defensible

Bias, heuristics and rationalisations

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Rogue agents can:

o Make dangerous rationalisations (Gellerman)
Belief that activity is within reasonable ethical/legal limits (no real harm is
done)
Belief that activity is in individuals or Cs best interest
Expected to just do it or someone else would do it
Management usually distance themselves from subordinates
tactical decisions as preemptive of things going bad
Belief that activity is safe because it wont be found out (discovery)
Belief that activity helps the company, that C will condone it and protect
the actor
o Ambiguous, ill-defined situations are a hotbed for rationalising immoral
behaviour (what isnt labelled wrong should be okay)
o Make errors of judgment/cognitive biases
loss aversion bias/zero risk bias tend to weigh losses more heavily than
gains
framing effect how framing of choices affects decisions
confirmation bias tendency to seek out information which confirms
existing beliefs
cognitive dissonance tendency to dismiss information that would disrupt
existing beliefs
sunk costs resources are committed persist in that course of action
(inertia)
hindsight bias tendency to belief events more predictable than really are
(black swans)
causation bias and illusion of control find causal patterns in random
events leading to overestimating ability to control future
Overconfidence unduly confident of own knowledge/abilities
self-interest bias estimations of fairness skewed to favour onself
risk perception bias overestimating risks and discounting others (ignore
low-probability events and preference for certain seemingly certain
consequences)
blind-spot bias being unaware of our own bias in a situation
choice-supportive bias tendency to validate choices weve made to the
exclusion of all others
clustering illusion tendency to create patterns out of random events due
to repetition (e.g. red on roulette as its hot)
conservatism bias preference for existent or established evidence over
emerging/new evidence that proves to the contrary (e.g. earth is round);
challenges our beliefs system (need for certainty)

information bias tendency to find out information which leads to no

action
ostrich effect avoiding potentially negative consequences (e.g. people
check portfolios less when in recession)
outcome bias judging decision based on outcome rather than how
decision was made (won money at Casino, hence gambling is good)
bandwagon effect increase in probability to adopt a belief if others are
adopting it (if he buys that, it must be good)
placebo effect belief that there is an effect on something causes the
effect
recency tend to prefer latest information over older data
salience (vivid examples) tendency to focus on highly recognisable
features of a thing
selective perception allowing expectations to influence perception
stereotyping pre-qualifying objects with certain qualities without real
information
survivorship bias (e.g. SMB failures, and overestimating entrepreneurism)
preference to memorise surviving examples
Use heuristics (mental shortcuts)
anchoring and adjustment overreliance on information perceived
immediately and adjusting accordingly with additional information (hence
decision is affected by initial conditions)
availability tendency to rely on available information rather than seek
out new sources
representativeness utilise vivid/recent examples (similar to salience)
Contributors to mistakes
Decisions made over time and independently raise no alarms
Commitments are difficult to stop (inertia and bureaucracy); high burden
of proof to justify moving against it (e.g. Continental Illinois Bank loans
purchased from smaller banks on hopes of capitalising an oil future market
in contango; no need to wait for paperwork to assess the risk of each loan)
Diffusion of information
Fragmented responsibility
Paradox is, ultimate responsibility for a decision rests with top level
management however, this responsibility is limited by the depth
and breadth of knowledge of each point of DM below them (e.g.
CEO may not know the exact technical specifications of a chemical
compound but relies on the chemists engineering capabilities)
factors of influence
Obedience to authority
Conformity with others
Incremental engagement in unethical behaviour
Following group decisions
Responding to incentives

Other
o
o
o
o
o

Possible solutions:
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Managers should be looking at how results are obtained and use internal watchdogs to
identify misconduct early on
Gellerman prescribes increasing perceived probability of being caught
Top management need to exert a moral force
o GE case of shifting costs to budgets of miscellaneous projects to keep under cost
o Code of ethics was superfluous as wrongdoers admitted to knowing the
standards
Subject Cs control mechanisms to periodic, surprise audits

Ethics of markets
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Ethics that apply when conditions for perfect markets do not obtain can be categorised
as
o Observing arms length agreements/contracts
Breaches by non-performance or misrepresentation
Contracts have terms/conditions/warranties/exclusions which may be
vague or non-explicit due to need for flexibility, minimise
rigidity/complexity, avoid excessive legalism exposed to violation with
impunity
Lack remedies for breaches
o Avoiding force/fraud
Fraud (5 elements) material, misrepresentation, with intent to deceive,
causes representee to rely on it, to their detriment/harm
o Not inflicting wrongful harms
Despite no duty to other party-in-exhanges interest, obligation of basic
morality exists
Tort law deals with wrongful harms outside of commercial realm it
depends on what the parties consent to, and hence to uphold duties to
that consent; but also duties to uphold what is not consented to (e.g.
commission of negligence, omission when duty of care exists or avoid
intentional harms such as violation of rights which is a wrongful harm)
o Actigin responsibly in case of market failures
Justifications for markets
o Welfare enhancing (invisible hand)
Rights-based utilitarianism increase societys welfare through economic
efficiency which is possible through a market mechanism which promotes
the highest volume of exchanges
Benefit to society as a whole is due to the pursuit of self-interest rather
than regard for the well-being of others
o Secures rights and liberty (Hayek and Austrians) through spontaneous order
Opportunity/right to trade (as a right intrinsic to property ownership of
control/disposal/do as you please) is an exercise of liberty by advancing
self-interests
Cf planned economy which is primitive by comparison in terms of order
of complexity required to execute an economy that increases welfare
through free market exchanges (where everyone can participate and
contribute to the economy)
o Utilises all avail info (price discovery system)
As efficient economic decision making requires an inordinate amount of
information (that is dynamic) for frictionless exchanges, the market
system provides the best mechanisms through price discovery on a listed,
but regulated, market
Features of market system
o Private ownerships, voluntary (usually mutually advantageous) exchange, profit
motive to advance ones interests
Failures
o Imperfect markets lead to breaches of agreements/contract; fraudulent activity;
wrongful harms and irresponsible actors
Cf Gauthiers assertion that perfectly competitive markets are moral-free
zones (i.e. markets require consent and cooperation of others due to
dynamics of a successful transaction hence no moral wrongs possible)
o Reasons (4)
No perfect comp

Barriers to entry/exit
Non-existence of homogenous goods (substitutable) (i.e. strong
differentiation)
Information asymmetries
Transaction costs
No perfect rationality (bounded by resources to information gathering) and
utility is not maximised
Firms behave in a satisficing way (sacrifice and satisfy) to achieve
internal efficiency (rather than satisfy the external efficiency of the
marketplace)
Existence of externalities
Governments regulate externalities through various means: regs,
market mechanisms (e.g. carbon ETS)
Collective choice problem
Aggregating individual choices to find total societal choice requires
assumption that individual decisions are rational (maximise own
welfare/utility) prisoners dilemma is a paradox of this concept
taking advantage of anothers cooperation without paying a
premium; an assurance problem solvable by forced cooperation
(gov regulation) or by mutual knowledge of each others
trustworthiness
coercion, paradoxically, enables voluntary/consenting behaviour
o Public goods
Excludable and rival goods
Private goods (excludable and may be rival/non-rival) vs public goods
(non-excludable and may be rival/non-rival)
Free-riding problem
o Tragedy of the commons
Outcomes
o Return is a function of risk taken
o Nozick market outcomes are just, not matter how unequal, just to voluntary
transactions (the action of consenting is morally justified)
Rawls market needs adjustment if outcomes leads to unjust levels of inequality
of outcome

Fiduciaries (Ethics of roles and relationships)

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Assuming a role binds the person to a code of professional ethics; some professions
render the person a fiduciary or agent to another (e.g. lawyers or doctors)
o Removal of person from market and into the ethical realm of agency where selfinterest is subordinated to serving best interests of a beneficiary/principal
o Employ their skills for best interest of principal as if principal had those skills
themselves (i.e. agent becomes extension of the principal, in Ps shoes, with a
duty to use abilities for Ps benefit)
Elements
o Candour disclosure all info that B would consider relevant
o Care entrustment of assets require due care (reasonable, prudent person would
exercise)
o Loyalty act in interest of B and avoid personal conflicts of interest
Why professionals are usually prescribed fiduciary duties
o Specialised body of knowledge
o High degree of organisation/self regulation
o Commitment to public service in exchange for independence
Agency theory - problems

Views of the firm (economic vs sociological) (cf W1 Ethics of markets)

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Economic view
o Firm as a natural entity comprising a combination of markets relationships
o Economic production also takes place in firms (and not only markets) because of
hierarchical relationships yield greater efficiency (Coases concept of the firm)
o Business ethics conssits of both markets ethics (i.e. transactions) and ethics in
firm (roles and relationsips)
Sociological view
o Firm = organisation (as a unit of analysis)
o Community perspective common goal/purpose, structure of roles/rships and DM
process
o Elements
Distinct org ethical climates (i.e. culture) which influences recognising
moral DM process
Organisational justice decisions made must be accepted as just org wide
Organisational harms attribution of wrongs committed to whole of firm
(i.e. ethics of individuals is shaped by forces of the firm including culture,
procedures, systems)

Questions:
EDM

What is a capitalist economy?

What are problems that occur in imperfect markets?
o What can fix some of these problems?
What is the economic basis for free markets?
o Market systems and justifications
Fraud?

Other frameworks (p 40-1)

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Ethical reasoning requires ID ethical concepts and principles; willingness to seek out
and act on reasons; be impartial
Boatright framework involves ID principles of welfare, duty, rights, fairness, honest,
dignity, integrity
Markkula framework
o recognise ethical issue (what is being contested?);
o obtain facts (what relevant facts and what I dont know; who who has a stake?
Whos concern is more important?; how evaluate alternative actions/options
including least harm principle (utilitarian) or respect of rights (rights approach) or
equitable treatment (justice approach) or serves community as whole (common
good approach) or leads to actions which I value (virtue approach));
o make decision and test (which is the best option for situation, how would an
outsider view my actions?)
o act and reflect on outcome (how to implement decision with consideration paid
to all stakeholders, what was the outcome vs expectations)
Alan Meder framework (CFA uses it) requires
o High standards
o Professional training
o Assess integrity of group settings and individuals
o Act when integrity breaches are observed
Underlying themes
o Consider benefit/harm to all stakeholders
o Respect humanity of others
o Treat others with equality, fairness and justice
o Care of other persons in way to nurture that rship

Case studies:
Mercks Vioxx
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Facts:
o
o
o
o
o
o

Well respect company

Founder/CEO, Medicine is for the people. It is not for the profits.
Vioxx approved 1999 and bestseller
2 million users, $2.5bn annual revenue (11% of Cos revenue)
Competition from generics
VIGOR study questioned drugs efficacy in treating what it was advertised to
treat
o Vioxx on-label changed 2002 (indicated increased risk)
o V withdrawn in Sep 2004 due to unexpected risks
o Medication found to increase risk of heart attacks
o Merck claimed withdrew drugs in expedient manner, critics claimed otherwise
Lessons
o Culture of strong values
o Damage to reputation, trust and brand due to decision to keep V on market
despite studies showing risks
Challenge
o Pursue highest ethical standard while being competitive

Toys R Us
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Facts:
o TRU empees went undercover to mass buy Child World inventory that were
heavily discounted (near cost)
o Products were low margin goods which also provided gift certificates for purchase
o Tot turnover was $1.5m, $375k gift certificates

Home Depot
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Facts:
o Hurricane over Miami
o Home improvement store HD decided to sell high demand recovery supplies at
cost
o Good business decision from shareholders POV? Ethically sound?

Bogus Apple Juice

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Facts:
o Juice made from concentrate (no natural ingredients)
o Aggressive sales campaign overseas
o False advertising

KPMG
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Facts:
o Creative tax advice to high networth clients purpose to evade tax through
offshore shelters, phantom losses in offshore banks
o KPMG protected itself through signed statement
o Netted itself $110m in fees through $2.5bn in tax write offs

Facts:

HP

o
o

Cartridges with smart chips under a campaign for automated refill supply
(consumables represented over half revenue with profit margins of 50-60%
Class action led to settlement eCredits (essentially vouchers) for customers to
use for printing needs