Financial Ethics in Corporations

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Introduction

Generally, ethics is concerned with the behavior of human beings that is deemed to be right and acceptable in society and that behavior that is deemed to be wrong and therefore not acceptable based on conventional morality. The ethical norms compose of such behaviors as respect for other people, truthfulness, fairness, justice, and honesty. These behaviors relate to the overall aspects of life; finance and business being among these aspects. Therefore, in considering financial ethics, it is found that this is a subset of the overall ethics. This paper is going to look at the financial ethics in corporations by considering a business ethical issue and particularly the issue of the agent-principal relationship.

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Financial Ethics in Corporations (Discussion)

The ethical norms are quite vital for bringing about and maintaining a stable and harmonious social life in which there is the interaction among people. Embracing the recognition of the needs of other people together with their aspirations and the supportive efforts to handle the common issues are features of social behavior that enable the realization of a stable social setup.

In the course of development in social life, people have build up not just a natural feeling to take care of themselves but a feeling to take care of others as well. Sometimes there arise conflicts between these two instincts and when such comes about there is a need for ethical norms to give guidance to human behavior. Demsey (1) puts it that ethics stand for the effort to get a solution to a conflict arising between being selfish and being selfless; the conflict that stands between the people’s material needs and their conscience.

The violations and dilemmas that are ethical in finances can be said to come about due to changeability in the theoretical framework of the contemporary financial-economic theory and the great utilization of a “principal-agent model” of financial transactions relationship. The theory (financial-economic) that lies beneath the contemporary capitalistic system is based on the “rational-maximizer paradigm” that holds that people are self-seeking and rationally conduct themselves when they strive to optimize the interests of their own (Ahrens 1).

The model of “principal-agent” is whereby there is an organization in which a single party that is playing a role as an agent of another party performs particular functions for the other. Arrangements like these are a fundamental portion of the contemporary economic as well as the financial system and it is hard for it to function in the absence of such arrangements (Frederick 155).

The contemporary financial-economic assumption which is based on conduct goes in opposition to the devotion, sincerity, and concerns for other people that lie beneath the usual relation of principal-agent. The usual concept of agency is based on moral values. But in the case where people are rational maximizers, the agency in the place of others in the usual sense can not be possible. Duska (61) puts it that doing something for another person in a way directed to realize the maximization of self-interest is not wise. A reply like this, however, outlines a contradiction at the core of the system, for a system that is guided by rules that require the agents to seek others and at the same time encourages people to seek for themselves, brings about the destruction of the practice of seeking for others. According to Bowie (19), seeking out for oneself is a motive that comes about naturally and is very strong, and requires very minimal reinforcement. If the theory (financial-economic theory) concurs with the idea that behavioral incentives apart from that of maximizing wealth are real and can be desired, then the problem of agency that the experts in the field of economics try to handle will cease to be a problem and turn out to be a non-problem. According to Dobson (60), the actual part played by ethics in the field of finance is to be traced in accepting of internal good where “good” here refers to “right” and not in the sense of the product that is physical. He further points out that the “internal good” was described by the philosophers as “virtue” implying that this is the internal good in whose direction all the people should direct their efforts towards. He agrees that if the getting of the internal goods were to turn out to be acceptable in general terms as the eventual goal of all efforts of human beings in terms of professional goals as well as personal goals, then there would be turning out of the financial markets to be ethical (60).

The dilemma that is ethically brought in by the problem of the clashing interests has been dealt with in particular financial areas like the corporate governance through the conversion of the agency relationship to an entirely contractual relationship that employs a “carrot-and-stick approach” to make sure there is the realization of ethical behavior by agents. In the area of corporate governance, the setback of the conflict between the management which serves as the agent, and the stockholders that serve as the principal is described as the agent problem. The experts in the field of economics have come up with an agency theory to handle this problem.

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The assumption made by the agency theory is that the agent, as well as the principal, has self-interest and their goal is to maximize their benefit in their relationship. An illustration that is not complex can be traced in the case where a manager of a store serves as an agent for the store owner. The manager demands the maximum pay possible for the minimal work possible. On the other hand, the owner of the store demands the maximum work possible from the manager for the minimal pay possible. Such a theory doesn’t judge whether the conduct where there is maximization is bad or not bad and doesn’t have a concern about what a recompense that is fair for the manager might be.

This theory does not consider and leaves out the ideas of loyalty and honesty from the relationship of agency due to their incongruity with the basic rational maximization assumption. According to DeGeorge (1992), the agency theory’s work is to assist in devising methods for giving a description of the conflict inbuilt in the relationship (agent-principal) and offering control to the situations for the agent that is acting from self-interest affects the interest of the principal negatively on the minimal level possible.

The agency theory makes the conversion of the usual agency relationship concept into a contractual relationship where there is the influence of the principal over the actions of the agents. This influence is through motivations, incentives as well as schemes of punishment. Loyalty from the agent is commanded by the principal by using rewards in terms of money, the punishments in the case where there is no acceptable behavior by the agents, and also by using the agency laws.

Many of the individuals’ needs for financial services are better handed over to other people since we do not have the capability as well as the time to undertake them most effectively. However, the corporate mechanism of agency relationship contractualization is very hard to apply to a great number of dealings in finances between the institution and individuals that occur daily in the financial market. Individual people aren’t as orderly as the stockholders and they are in most cases not aware of the agency problem. The absence of adequate information gives a limit to the capacity to carry out monitoring of the behavior of the agent. Thus, what is there in the contemporary economic system is a paradoxical situation. This implies that there is a constant increase in the need for getting tasks carried out on one part and the giving description to the nature of human beings that puts much emphasis on the self conduct on the other. This situation can explain many of the problems that are ethical and decreasing morality in the contemporary finance and business field (Anonymous 1).

According to Frederick (l57), the agency relations are prone to familiar hardships that come about as a result of the principals’ incapability to carrying out monitoring of the agents. Most of the problems that are ethical which may include stockbrokers churning the accounts of the customers, and the habit in which the manager wants to set up an empire among others, have their roots in the hardships intrinsic in the relations of the agency. Such problems can be dealt with by carrying out close monitoring and making adjustments in the structure of the relations. For instance, the motivation for brokers to churn can be brought down by considering compensation based much more on the portfolios of the performance of the customer and not very much on the level of trade in terms of the volume. More so, giving compensation to the executives with stock alternatives brings inline their interests with those interests of the shareholders and therefore enables the prevention in setting up of empires.

The solutions that are very much effective regarding the ethical problems in agency relations are dual. In the first place, there should exist a very powerful sense of professionalism that should move together with professional organizations with a system of morals. In the second place, there must be a high level of trust. In an industry such as the one that offers financial service, trust is greatly vital. It is because of this that in the case where a company violates the confidence of the public gets to pay a very heavy price.

According to Ang (2), in the current days where competition is very high, the corporations are faced with too much pressure from the shareholders to produce results regarding finances. The executives in finances encounter some temptations to take steps that might cause their corporations to look to be more profitable more than they are. However, most of these executives do withstand these temptations.

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Maximizing the wealth of shareholders is not just in line with the behavior that is ethical but it is as well an ethical right. Any manager who does not succeed in acting according to the interests of the shareholders is mostly acting in a way that is not ethical. According to Duska (25), being an agent in the field of business is being a professional. A person does not just do what he or she is told, a person has the expertise, and one carefully assesses and anticipates the principal’s interests and needs and carries out his duty for the good of the principal. The agents include the managers, accountants, sales representatives, financiers, and Ad executives. All of them should be committed to the good of their client.

Therefore those managers who are ethical are those that respect their responsibility to the shareholders in terms of acting to maximize the wealth of the shareholders. On the other hand, unethical managers are the managers who do not act in the interest of the shareholders but instead evade this duty through sluggishness, more than enough benefit consumption, or misrepresentation. According to Frederick (157), as fiduciaries and agents, the financial managers have the responsibility of carrying out the management of the assets cautiously and particularly to evade the utilization of assets for personal gain. Therefore managers who have a special right to use information are not supposed to take part in self-dealing. More so, these managers are called upon to come up with decisions that have impacts on different groups of people, and therefore they have the responsibility in their coming up with decisions to achieve a balance of the interests that are competing. Basing on the theory of finance, the main goal of any firm is to ensure the realization of the maximizing of the shareholder wealth. There is a reflection of this goal in the corporate law and according to this law, the managers of the corporation are the corporation’s agents and possess a fiduciary obligation to carry out the operation of the organization regarding the shareholders’ interests.

The expectation about the professionals is that they have to practice in a manner that goes in line with particular ethical standards that are prescribed. Being a professional is partly being committed to employing the knowledge and skills in a manner that is acceptable morally for society’s good. Managers need to have awareness, in case a conflict comes about, that their responsibility to the shareholder may be made ineffective by their responsibility to defend the professionals’ moral standards as the people who serve the society. Even if conflicts like these could precisely be visualized, their actual coming about is ameliorated by the reality that the financial markets tend to assign an actual economic value to moral corporate conduct.

According to Ang (3), Swanda notes that the value of the moral character of a firm can emanate from the firm’s market value that is bigger than the net assets of the firm. Swanda further notes that even within the shot run a person can present arguments that the firm having a great reputation regarding ethics can gain an exceptional economic advantage. He makes the characterization of the corporate virtue as being an asset as well as being an income source, a flow, and even a stock.

As on the one hand morality can’t be categorized among the tangible assets but on the other hand, it can be taken to be a greatly valuable asset but volatile, that is, the asset that gives a reflection of the community’s perception. In this regard, it will employ the resources’ outflows to set up a morality store to enhance the holding of the firm in trust by the public. A conflict traced between ethical issues and the profits that are perceived may be elusive. The moment there is the inclusion of the moral reputation’s economic gains in the evaluation of the finances then there is coming together of the ethics and profits. According to Ang (3), such coming together was in the recent times portrayed in the statement made by Warren Buffet regarding the value of the reputation of the corporations. Buffet who was just taking the position of the interim chairman of Salomon Brothers Inc. expressed that if he could hear of whoever employee losing the company the money, he would understand. He further noted that in case he could hear about whoever employee losing the company a single slice of reputation, then he could be callous. Such a stand defines reputation in a wider framework than the firmly economic context. Here there is the use of a concept that is more general of a reputation as composed of a moral element. Therefore, the professionals in the field of business like Buffet make the recognition of the inherent value of moral conduct over any narrow focus on the baseline.

Conclusion

Ethical financial managers are the managers who work towards maximizing the wealth of the shareholders confining in the moral boundaries of professionalism. The primary duty of the manager to the society as professionals, thus take priority over the basic duty to the shareholders among other duties to other stakeholders. The prospective conflicts that come in between the duty of the manager to the society as a professional and the duty to the shareholders as the agent are brought to the lowest level by the evidence giving an indication that corporations that uphold social requirements are rewarded in terms of finances.

According to Ferrell, Fraedrich, and Ferrell (21), there can be no nurturing and development of an ethical culture by a company without the achievement of satisfactory performance in finances in form of profits. The corporations with many resources, not considering the size of their staff have the mechanism to carry out social responsibility and at the same time offering service to their clients and attaching much value to its workers and more so, at the same time carrying out the efforts to win the trust from the public. Several studies have given out an indication that there is a positive correlation between the performance of a business and corporate social responsibility.

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Those corporations that have engaged in unethical conduct have realized a substantially low return to assets as well as on sales more than those companies that have engaged themselves in such. Therefore maintaining a stable agent-principal relationship plays a great role in contributing to the firm’s profits.

Works Cited

Ang, James. “On financial ethics – includes appendix – FM Forum – Panel Discussion. Financial Management (Financial Management Association).” CBS Interactive Inc. 2010. Web.

Anonymous. “Code of Ethics for Financial Executives.” Pinnacle West Capital Corporation,2004. Web.

Ahrens, Steve. “The Pursuit of A Reliable System.” SiMaMa, 2010. Web.

Bowie, Norman E. Challenging the Egoistic Paradigm. Business Ethics Quarterly. 1. 1-4. 1991

DeGeorge, Richard T. Agency Theory and the Ethics of Agency. In Norman E. Bowie and Edward R. Freeman, eds. Ethics and Agency Theory: An Introduction. New York: Oxford University Press, 1992.

Dempsey, Mike. An Agenda for Window-Dressing or for Radical Change? 1999.

Dobson, John. The Role of Ethics in Finance. Financial Analysis Journal. 1993.

Duska, Ronald R. Why Be a Loyal Agent? A Systematic Ethical Analysis. In Ethics and Agency Theory: An Introduction. Norman E. Bowie and Edward R. Freeman, eds., New York: Oxford University Press, 1992.

Ferrell O. C., Fraedrich John, and Ferrell Linda, Business Ethics: Ethical Decision Making and Cases. Cengage Learning, 2009. ISBN: 1439042810, 9781439042816

Frederick, Robert. A companion to business ethics. Wiley-Blackwell, 2002. ISBN: 1405101024, 9781405101028

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BusinessEssay. (2021, November 26). Financial Ethics in Corporations. Retrieved from https://business-essay.com/financial-ethics-in-corporations/

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BusinessEssay. 2021. "Financial Ethics in Corporations." November 26, 2021. https://business-essay.com/financial-ethics-in-corporations/.

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