CHAPTER 1: ETHICS EXPECTATION The Ethics Environment for Business: Battle for Credibility, Reputation & Competitive Advantage.

1. Introduction a. Increasing expectation that business exists to serve needs of shareholders and stakeholders. b. Support for business < credibility by stakeholders (corporate commitments, reputation and strength) < trust < values underlying corporate activities. c. Stakeholders expect co. activities will respect their values and interest d. Corporate directors are expected to govern ethically e. Corporations are expected to be accountable to stakeholders f. As a result, business & profession is now becoming more concerned with stakeholders interest and ethical matters. 2. F1: Environmental Concerns a. Initially, reactions by politicians were slow and arguments were raised on who was responsible. b. Corporations asserted that they did not have technical solutions to eliminate air and water pollution at reasonable cost and didnt do so to remain competitive. c. Once it grew more severe and public began to understand that, special interest groups began to pressure companies as well as the government to improve safety standards. 3. F2: Moral Sensitivity a. Significant increase in sensitivity to the lack of fairness and to discrepancies in society. b. Groups responsible: i. Feminist movement ii. Spokespeople for the mentally & physically challenged, for native people and for minorities c. Realization increased due to unfortunate events. d. Disposable incomes and leisure time have increased and this further led to focusing on issues above livelihood. e. Advances in satellite communications have allowed faster coverage of worldwide problems. f. Public pressure for fairness and equity has resulted in laws, regulations, compliance conditions in contracts and affirmative action programs. 4. F3: Bad Judgments & Activist Stakeholders a. Public do not approve of bad judgments. b. Two kinds of activists: i. Ethical consumers 1. Buying goods and products that were made ethically. ii. Ethical investors 1. Investments should not only make a reasonable return, but should do so in an ethical manner

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c. Business decisions are being judged against different standards than before. F4: Economic & Competitive Pressures a. During the period of no growth. b. Growing pressure from global competitors and the drive for improved, costly technology shrank profit margins. c. Led to downsizing to maintain overall profitability d. Resulted in many companies falsifying information e. This led to the reason of environmental or financial malfeasance F5: Financial Scandals: Expectation Gap & the Credibility Gap a. Due to many recent financial scandals/fiascos, public has become cynical about the financial integrity of corporations. b. The term expectation gap has been coined to describe the difference between what the public thinks it is getting in audited financial statements and what it is actually getting. c. This has led to tightened regulations, higher fines and investigations. d. On a broader basis, this has led to a crisis of confidence over corporate reporting and governance. e. This lack of credibility affected other non-financial activities and is known as credibility gap. f. Led to Sarbanes-Oxley Act of 2002 F6: Governance Failures & Risk Assessment a. Financial scandals had proven that current existing modes governing companies were not sufficient. b. Public were fed up and directors were not identifying, assessing and managing ethic risks in the same manner that they should. c. Sudden reversal of fortunes created by failure to govern ethics changed rusk management. d. Governance reform was perceived as necessary. F7: Increased Accountability & Transparency Desired a. Lack of trust spawned desire for increased accountability and transparency. b. Companies responded by publishing more info. on their websites and freestanding reports on their CSR. c. Trend is growing towards increased non-financial reporting to match publics growing expectations. Synergy among Factors & Institutional Reinforcement a. In aggregate, the result is a cumulative heightening of the publics awareness of the needs for controls on unethical corporate behavior. b. Publics awareness in turn, impacts politicians who form new laws or tighten regulations. c. The desire for global standards of corporate disclosure, auditing practices and for uniform ethical behavior by professional accountants generated the IASB and IFAC. d. Movement towards higher level of corporate accountability and ethical performance is no longer characterized only by leaders but it has become mainstream and international Outcomes a. Public expectations have changed to exhibit less tolerance, heightened moral consciousness, and higher expectations of business behaviors.

b. In response, organizations have emerged to watch the business-environment interface. c. Consultants are available to advise corporations and ethical investors. d. Mutual funds that specialize in ethical investments emerge. e. Lack of credibility has brought increased regulation, international standards, mainstream interest and changes in governance and management practices. New Expectations for Business 1. New Mandate for Business a. Business exists to serve society, not the other way round. b. 3 critical issues regarding Milton Friedmans position i. Deviation from a profit-only focus does not mean that profit will fall 1. Social and profit goals can mix profitably. 2. Max Clarkson above average social performance is positively correlated with profits. 3. Performances of some ethical mutual funds have surpassed NYSEs. ii. Profit is now recognized as an incomplete measure of corporate performance, therefore an inaccurate measure of resource allocation 1. Accuracy with which profit guides the allocation of resources to their best use for society. 2. Initially, when articulating profit-resource linkage, there was virtually no cost. 3. However, the costs increased and the profit-resource linkage became less and less effective. iii. Friedman expects that performance would be within law and ethical custom 1. Minimum framework of rules is essential. 2. Increased regulation. c. Those who focus on profit-only will make short-term opportunistic decisions that jeopardize sustainable long-term profits. d. Sustained profit is the consequence of providing high-quality goods and services, within the law and ethical norms in an efficient and effective manner. e. Profit-only mandate is evolving to one recognizing the interdependence of business and society. f. Mandate is shifting focus from a narrow shareholder-oriented view of what business is achieving to include what and how a broader stakeholder-oriented set of achievement is achieved. 2. New Governance & Accountability Frameworks a. Successful corporations are served best by governance and accountability mechanisms that focus on a different and broader set of fiduciary relationships than in the past. 3. Reinforced Fiduciary Role for Professional Accountants a. Professional accountants need to focus their loyalty on the public interest in order to meet publics expectations for trustworthy reports.

b. Need to adopt principles such as independence of judgment, objectivity and integrity that protect public interest. c. Can be misguided as they have proven to be self-interested that they become untrustworthy. d. Primary fiduciary responsibility should be to the public. e. Realization that loyalty to the public includes current and future investors and their interest needs to be protected. f. Reform of accounting profession is underway to reinforce the publics expectations. Responses & Developments 1. Emerging Governance & Stakeholder Accountability Models a. Trends developed as a result of economic and competitive pressures: i. Expanding legal liability ii. Management assertions to shareholders iii. A stated intention to manage risk and reputation iv. Delayering, employee empowerment, use of IT interfaces v. Increased reliance by management on non-financial performance indicators. b. As a result, corporations start to take greater interest I how ethical activities were, and how to ensure ethical problems do not rise. c. Initially, corporations reaction to a more demanding ethical environment was the desire to know how ethical their activities have been, then attempt to manage their employees actions by developing a code of ethics. d. Desire to know about the appropriateness of activities led corporations to undertake an inventory of significant impacts on various aspects of society. i. Could identify specific issues that were most problematic and take action. e. The inventory and fix approach led to a patched-up system for governing employee behavior. i. To reduce this vulnerability, corporations began to develop comprehensive codes of conduct/ethics. 2. Management Based on Values, Reputation, & Risks a. In order to incorporate interests, corporates have to understand the nature of stakeholders interest and the values that underpin them. b. Reputation and degree of support depends on this and the ability to manage risks. c. Hyper norms (values underlying stakeholder interests) i. Honesty iv. Fairness ii. Compassion v. Integrity iii. Predictability vi. responsibility d. The hyper norms should be built into corporations code of conduct, policies and etc. e. Determinants of reputation i. Credibility ii. Trustworthiness

iii. Reliability iv. Responsibility f. Should consider ethics risks the risk of failing to meet expectation of stakeholders. 3. Accountability a. Corporate reports frequently lack integrity and transparency. b. Desire for relevance has increased reports that are principally nonfinancial in nature and tailored to needs of specific stakeholders. 4. Ethical Behavior & Developments in Business Ethics a. Philosophical approach to ethical behavior i. Greek philosopher Aristotle 1. Goal of like is happiness, and happiness is achieved by lending a virtuous life in accordance with reasons. 2. Directors should demonstrate integrity, honor, loyalty, courage and forthrightness. ii. German philosopher Immanuel Kant 1. People are ethical when they do not use people opportunistically and when they do not act in a hypocritical manner. iii. English philosopher John Stuart Mill 1. Goal of life is to maximize happiness/minimize unhappiness and the goal of society is to maximize the net social benefits to all people. 2. Goal of business is to contribute to increasing the physical and psychological benefits of society. iv. American philosopher John Rawls 1. Society should be structured so that there is a fair distribution of rights and benefits and any inequalities should be to everyones advantage. 2. Businesses act in an ethical manner when they do not have discriminatory prices and hiring systems. b. Business ethics concepts & terms i. Stakeholder concept ii. Corporate social contract c. Approaches to ethical decision making i. Executives need to ensure that their decisions reflect their ethical values established for the corporation, and do not leave out of consideration any significant stakeholders rights. ii. This has led to development of ethical decision-making approaches that combine philosophical and practical techniques, such as stakeholder impact analysis. iii. Decision makers should understand three basic philosophical approaches: 1. Consequentialism good consequences 2. Deontology act depends on duty 3. Virtue ethics act must demonstrate virtues expected iv. Practical analytical approach: 1. Modified Five Question Approach

a. Challenging any proposed policy with 5 questions designed to rate proposals based on: i. Profitability ii. Legality iii. Fairness iv. Impact on shareholders v. Demonstration of virtues 2. Modified Moral Standards Approach a. Focus on 4 dimensions of the impact of proposed action: (whether) i. Provide net benefit ii. Fair to all stakeholders iii. Right iv. Demonstrates virtues expected b. Less company-centered and is better suited to evaluate decisions that has severe impact on stakeholders. 3. Modified Pastin Approach a. Taking specific account of culture within the corporation. b. Proposed decisions be evaluated: i. In comparison to the companys ground rules ii. Net benefit it produces iii. Whether it impinges rights of stakeholders iv. Whether it abuses rights of others The Ethics Environment for Professional Accountants 1. Role & Conduct a. Professional accountants own their primary loyalty to the public interest. b. There was a need for reforms and additional changes in the role and conduct of professional accountants. c. Professional accountants need to understand shift from just shareholders to involve stakeholders as well. d. Expectation gap will increase if accountants do not keep up with standards of ethical behavior. 2. Governance a. Movement to a globally harmonized set of generally accepted accounting and auditing principles to provide analytical efficiencies. b. IFAC has developed the Code of Ethics for Professional Accountants. c. Principles in the code are becoming the basis for future behavior and education of professional accountants. d. Developing global audit standards to serve their major clients. 3. Services Offered a. Services have been curtailed so that tighter conflict-of-interest expectations can be met.

Managing Ethics Risk & Opportunities 1. 2. 3. 4. Guidance is provided for the process of ethics risk identification Caution is advised against overreliance on external auditors Insights are offered for management and reporting of ethics risks. Effective strategies and mechanisms for influencing stakeholders are discussed with the aim of developing and maintaining their support. 5. Modern corporations should understand how their impacts are regarded as well as the sensitivities they arouse. 6. CSR and telling the companys story through CSR forms an important part of strategic planning. 7. Crisis management approaches have been developed to avoid suffering more damage to their prospects and reputation.