Ethics in Finance Notes 2021 + CFA notes PDF

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Ethics in Finance NotesLecture 1Ethics in the World of BusinessMoral Principles for moral reasoning- Consequentialist moral reasoning o Right thing to do depends on the consequences from our action  5 live, 1 dies train theory  Killing 1 over 5 is the utilitarian view with consequential thinking o...

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Ethics in Finance Notes Lecture 1 Ethics in the World of Business Moral Principles for moral reasoning -

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Consequentialist moral reasoning o Right thing to do depends on the consequences from our action  5 live, 1 dies train theory  Killing 1 over 5 is the utilitarian view with consequential thinking o Links morality to the consequences of an act, focusing on what is best and what makes the world right. Categorical moral reasoning o Hesitating pushing fat man is simply wrong o Reasoning depends on intrinsic quality of act, some actions appear categorically wrong  Train theory but if you push someone of the bridge it will runover the 1 person (killing 2 people over 5). Philosophy challenges the familiar, not by new information, but by provoking a new way of looking at the world

The World of Business -

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Are there different sets of rules for: o Business o Social o Sport o Or should they be the same Conflicts of rights o Employers o Employees Who do we owe loyalty to? o Shareholders (fiduciary responsibility)  Anglo Saxon Model o Customers o Suppliers o Employers o Government o Society o Law says we owe loyalty to shareholders but our gut says society

Levels of Business Decision Making -

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Each level of decision making impacts on the ethical implication Individual o E.g. discover manager inflates expense account o Decision driven by individual o Relies on own moral standards, judgement & values Organisation o E.g. manager hears about harassment o Decision driven by organisational role o Relies on procedures and policies Business System o E.g. find evidence of conspiring amongst competitors o Systematic problems in industry & economic system o Relies on industry code of ethics, government regulation, economic reform

Behavioural Biases

The main heuristics people employ

Systemic problems require systemic solutions: -

Industry wide code of ethics (CFA standards of professional conduct) Regulation Better: reforms Ethical displacement (addressing the problem on a different level [individual to organisational level etc.])

Case 1.2b: Home Depot -

After the Miami hurricane (1992), home improvement store home depot decided to sell high demand goods at cost price Was it a good business decision? o Yes, impacted on short term profits it creates loyalty o Others says it was a ‘shrewd business decision’

Three Viewpoints Economic, Law, Moral

Economics -

Increases shareholders wealth given acceptable business practices Economic choices driven by utility maximisation ( with limits on theft & fraud) Justification: competitive free market benefits society Externalities: accident, defective products, pollution Conditions overseen by government

Law -

Conduct business within the law is enough o Law: rules applied to public life o Ethics: personal opinions applied to private life

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Law sets a minimum standard Things may be legal but not ethically

Law – Counterpoints -

Problems with: ‘if it’s legal, then its morally ok’ Law does not extend to all areas: o Taking credit for someone else’s work Law is slow & needs time to develop Laws can be vague (e.g. ‘in good faith’ or fiduciary duty) Inconsistent between countries Laws may be inefficient

Moral: Morality vs ethics -

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Morality o Sociological phenomenon o Existence of rules & standards in society o Specific to times, places & cultures Ethics o Philosophical study of morality being either descriptive or normative  Descriptive – describing  Normative – prescribing what we should do

We need an Integrated approach -

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What is the measure of success o Profit o GDP o Equality o Fairness o Happiness Decision making needs to be economically satisfactory, fulfilling legal obligations, and ethically defensible

Ethical Management -

Can ethics be taught to finance professionals? Knowledge Understand ethical issues (recognise and resolve problems) Understand motivation of individuals Knowledge of regulation (IP) Ability to develop logical ethical arguments to persuade others

Critical: Organizational Decision Making -

Four features that contribute to mistakes: o Decisions are made over time o Resulting commitments are difficult to stop o Diffusion of information o Fragmentation of responsibility o Behavioural bias & Heuristics

Ethical Decision Making -

HP Case 2.1: o SureSupply campaign o ‘Smart chips’ in ink cartridges o Argument that cartridge sent a low ink message while there was still ink left and would also shut down after a premature date. o Prompts for guiding to webpage o Cartridges represented half the revenue. o Law suits 50 – 60% o Law suits settled in 2010: eCredits of $2 - $6 per printer o What are duties and responsibilities? o What rules or principles apply? 

These questions can be addressed by studying business ethics in 2 steps:  Ethics of the market place  Relationships based on rules and principles roles of agents and firms in business.

The Market System -

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Three main features o Private ownership, voluntary exchange & profit motive o Rights-based Utilitarianism – increase welfare of society Adam Smith’s (1723 – 1790) ‘invisible hand’ argument, but 3 problems o Collective choice & public goods o The prisoner’s dilemma o Market failure

Ethics in Markets -

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Markets are based on consent exchanges But: wrongs can occur in actual markets Market ethics are rules that apply in imperfect market exchanges o Breaches of agreements or contracts o Avoid fraud o No wrongful harm o Act responsible Definition of fraud o Misrepresentation, material, intent to deceive, reliance, harm

Problem 1: Market Failures -

Four main reasons: o No perfect competition (monopolies etc.) o No perfect rationality (bounded rationality) o Existence of externalities (e.g. pollution) o Collective choice (prisoner dilemma)

Problem 2: Public Goods

Problem : Lack of Trust, Example: The Prisoner’s Dilemma

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Solved with communication Utilitarian theory is both to stay silent

Roles, Relationships, and Firms -

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Roles and relationships evolve out of market Obligations of professionals critically depend on roles: o Medical o Lawyers o Accounting Mangers professionals play many roles o Economic actor o Company leader o Community leader Two most important roles in business relationships o Agent (agency relationship with principal) o Fiduciary (act in interest of someone else)  Duty of candour  Care  Loyalty

Ethical Reasoning: Why do people do what they do? -

Ethical reasoning requires the identification of ethical concepts and principles It is the intellectual procedure for justifying ethical judgement Frameworks can help assess ethical dilemmas and guide ethical reasoning The sociological view Kohlberg’s stages

Kohlberg’s 6 Stages

Ethical Framework

Business Ethics, 7 simple questions

Ethical Reasoning: Framework -

Ethical reason requires identifying the relevant concepts and principles (not RULES) o Welfare  Greatest good for everyone o Duty  Obligation to do right o Rights  Entitlement, correlated with duties o Fairness  Ultimatum bargaining game o Honesty  Important for business, markets o Dignity  Respect for human beings o Integrity  A virtue, e.g. the quality of honesty

Four Ethical Justifications for an Integrated approach -

Considering the benefit and harm to all of the different parties involved Respecting the essential humanity of others Treating other with equality, fairness, and justice Caring for other persons in ways that nurture relationships

Ethical Theories Ethical Issues -

Ethical issues o Situations, problems, or dilemmas where a person or organization faces different decision alternatives to choose from. These have to be evaluated to be ethical or unethical

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Ethical theories o Employed to evaluate the alternatives

Four Groups of Ethical theories

Teleological theory -

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Utilitarianism o Practical method for evaluating alternatives, consequences and choose course of actions Decision making tool for public agency Basis for moral concepts right and justice Fits with economic principle and cost benefit analysis Utilitarianism = coherent basis for decision making

Teleological theory: Utilitarianism -

Telos (Greek) = end or goal Basis: decisions are determined by consequences Decision by highest utility

Utilitarianism -

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Ethical Decision o Develop list of alternatives o Select alternative with greatest benefit (least harm) to society/ shareholders o Impartial judgement o End justifies the means, sacrifice interests of minorities to achieve greatest good for majority Calculating Utility o Ranking is no problem  Problem: exactly defining how much pleasure something provides o Problems:  Information burden  Interpersonal comparison of utility (insoluble bit no insuperable)  Individual vs society Cost-benefit analysis o Monetary units o Adv: objective market values o Uses: product safety and environmental protection o Issues  Not all costs and benefits have determinable monetary values  Does not always correspond to opportunity cost

Deontological Theory: Kantian Ethics -

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Deon (Greek) = duty Basis: universal duties/principles (rules based) Examples: golden rule (do not do unto others as you would expect they should do unto you) o We don’t allow murder because you don’t want to be murdered Based on human dignity

Kantian Ethics -

Kant’s moral philosophy: o Denied that any consequence, such as pleasure can be good by itself o Instead: performing action because it is our duty

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Denies that consequences are relevant to determine what we ought to do Actions not based benefits to us or others, but because of nature of these actions or the rules from which they follow Lying is wrong, not because of consequences, but by its nature contradicting human nature, dignity, Golden Rule

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Universalizability o “Act only according to that maxim by which you can at the same time will that it should become a universal law” o How to identify these imperatives? o Example: taking out a loan o If an act is right for one person, it is right for others (given similar circumstances)

Virtue Ethics -

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Human pursuit of happiness through moral excellence Moral character emphasised (instead of right action) Comprehensive approach o address characteristics of decision maker’s personality, rather than particular action ‘What sort of person should I be?’ instead of ‘What should I do?’ or ‘What action is right? What are virtues? o Feelings (e.g., hunger) are not virtues. o Virtues are specifically those (acquired) traits that everyone needs for the good life, regardless of their specific situation. o For example, courage is a virtue because it enables anyone to get what he or she wants. o The virtues are integrally related to what Aristotle called practical wisdom, which is what a person needs in order to live well. Virtues: integrity, kindness, compassion, courage, courtesy, honesty, loyalty, tolerance ... Ethical role models cultivate virtues of society (Integrity of Warren Buffet) Response to a complex ethical dilemma: What do I feel comfortable with? What would my role model do? Limitation o Does not address conflict between rules  Honesty vs kindness

Rights and Justice -

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Rights o Important role in business ethics o All stakeholders have rights Nature of rights o Rights = entitlement o Different kinds of rights  1. legal and moral rights  2. specific and general rights  3. negative vs. positive rights o Thought to belong to all persons purely by virtue of being human o Two main features:  Universality  Unconditionality o John Locke  Right to property  Everyman has property of his own person

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Justice o What is fair? o Just = right, good  Better: Fair o E.g. taxes o E.g. crime punishment, compensate crime victims (righting of wrong) Nature and value of justice (aristotle distinguished) o Distributive justice o Compensatory justice o Retributive justice

Case 3.3: Snuff -

Union Tobacco, producer of snuff Was a product for old men in 1970s Rough tasting product Two new product lines, pouches with mint and cherry flavour 1-2million out of 7million users were 12-17 year old’s Users 50 times more likely to develop gum cancer etc. Would you join such a company? Which theory backs up joining and which does not?

Lecture 2 Whistle-Blowing -

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ENRON How does corporate failure and greed with a code of ethics? o It doesn’t matter how good your code of ethics is or how detailed it is, it only works if the higher management does abide by it. What are ethical companies? o Hard question.

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Whistle-blowing o Release of information by a member or former member of an organisation (internal) o Voluntary release of non-public information, as a moral protest, by a member or former member of an organisation to an appropriate audience outside the normal channels of communication regarding illegal and/or immoral conduct in the organisation that is opposed to the public interest.

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Case 4.1 (Time’s person of the year 2002) o Sherron Watkins (Enron) o Cynthia Cooper (WorldCom) o Colleen Rowley (FBI) Women are less likely to whistle-blow then men

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Ethically problematic – Conflict between: o Employee’s obligation (loyalty) to company o General obligation to public interest

Justification of Whistle-Blowing -

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Employee – Legal & contractual agent of employer o Duty of loyalty: protect confidential information & act in principal’s best interest. Limits: o Agent has obligation to obey only reasonable directives (cannot be required to do anything illegal or immoral) o Obligations of agent confined to the needs of the relationship (not obligated to do anything outside scope of employment) Are whistle-blowers simply disloyal employees? o Commitment to the true interests or goals of an organisation (rather than merely following of orders) o Expose wrongdoing in belief that they are doing their job and acting in the best interest & goals of the company o Supported by sociological evidence Three options of dissatisfied organisation members o Turn blind eye & follow orders o Leave organisation o Speak out (whistle-blowing)  Prevent things from getting worse

Conditions for justified whistle-blowing -

Is the situation of sufficient moral importance to justify whistle-blowing? Do you have all the facts and have you properly understood their significance Have all internal channels and steps short of whistle-blowing been exhausted What is the best way to blow the whistle What is my responsibility in view of my role within the organisation? What are the chances for success?

Arguments: Whistle-Blowing -

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Pros: o o o Cons: o o o o

Benefits society Moral right to blow whistle Employees ought to have right to act following their own’s conscience Open right to abuse Covering up incompetence Hurts cooperative spirit Infringes entrepreneurs’ rights to run company as they want to

Effective Whistle-Blowing Policy -

Incentive to address misconduct internally & avoid embarrassing public disclosure

Components of a whistle-blowing policy 1) 2) 3) 4) 5)

An effectively communicated statement of responsibility A clearly-defined procedure for reporting Trained personnel to receive and investigate reports A commitment to take appropriate action A guarantee against retaliation (e.g. Poor evaluations, transfers, blacklisting…)

Whistle-Blowing Gone Wrong

WB – Career Implications -

CFA Institute Magazine (Jan./Feb. 2011 issue)

Trade Secrets & Conflict of Interest -

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Trade Secret o Formula, Pattern, device or compilation of information used to give an advantage over competitors o Right not to have a secret misappropriated by others o Just because it’s not patentable does not mean it’s not a trade secret Examples of intellectual property: o Software o Chemical composition of product o Design of a machine o Details of a manufacturing process o Results of marketing surveys o Confidential business information (salaries) Is there an ethical obligation of current and former employees to protect information & not use it to their own advantage? o Legal obligation – Patents o Ethical obligations how to deal with problems making you the better company Is information protectable as a trade secret? o Information know outside the business o Info known inside the business o Measure taken to guard secrecy o Value of information for competitors o Effort to produce information in the first place o Can info easily be duplicated by others.

Three Main grounds for justifying trade secret protection Property Rights -

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Who owns the information? Inventor or employers? o Usually employer Wexler (Buckingham Wax Company) vs Greenberg o Information is protectable as a trade secret only if:  The information is a genuine trade secret  The user of the information has violated legal confidentiality obligation (theft, bribery, espionage) o Employee (Greenberg) worked on formulas at Buckingham then moved to another company and Buckingham sued for trade secrets. o Greenberg had an obligation of confidentiality not to disclose the formulas Utilitarian reasons for recognising IP rights – society benefits from willingness of companies to innovate (with legal protection)

Fair competition -

Employees have a right to seek new employment (freedom to choose their livelihood) and to compete with a former employer.

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Associated Press vs International News Service o Intellectual production becomes free for common use after voluntary communication to others o If a company has acquired something at substantial cost in order to earn a profit, a competitor has no right to misappropriate it for the purpose of his own profit

Non-competition Agreements -

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Signed at employment (for benefit for employment) o Time period specified o Geographical area involved o Kind of work that is excluded Serve to protect legitimate business interests Not be more restrictive than that what is required for the protection of these legitimate interests Not impose an undue hardship on the ability of an employee to secure employment Not be damaging to the public

Confidentiality -

Obligation of confidentiality continues after employee leaves one job for another Obligation of confidentiality when they enter into various relations with each other

Competitor Intelligence Gathering Unethical Competitor intelligence gathering: - Theft & receipt of unsolicited information o Employee or on outside - Misrepresentation o Gain information under false pretences (deception) - Improper influence o Employment relations – built on trust - Covert Surveillance o Violates a right to privacy

Conflict of Interest Conflict that occurs when a personal interest interferes with a person’s acting so as to promote the interes...