Corporate Finance in relation to Ethics
In today’s business world corporate finance is an essential part of a firm. It is responsible for the area of finance that deals with sources of funding. Furthermore, it controls the actions that managers take to increase the value of the firm to shareholders, without having selfish thoughts behind them. And lastly corporate finance provides tools and analysis to allocate financial resources. Due to the fact that these studies involve a lot of decision making and risks, there can be a lot of incentives to choose unethical procedures. Also, costs and benefits are allocated to different parties, which can create conflicts of interests. For this reason, ethics must be implemented in order to prevent such errors. A perfect example for unethical behavior in the financial industry was in 2008 when the financial crisis hit the markets. Before that crisis the knowledge and awareness of the ethical industry was not very well-known but the outcome of it changed the financial industry forever (Thompson, 2017).
What is ethics
Ethics is a set of moral principles of a particular person has. It is there to decide what is right and what is wrong. We can also call it rules of conduct, which people usually do not want to break. Ethics are there to help us and provide guidance for our behavior that affects others. Our morals, norms and values are a big part of ethics. If people stop following their own morals, they will act unethical, which as mentioned can lead to job loss, jail, huge fines or reputational damage. An example of unethical behavior in a company would be insider trading or fraud. To prevent this firms, have to make sure that their employees work honestly, fair and with respect. Even though governments and regulators combat misconduct through regulatory reform, it is still not enough to be sure a company is fully ethical, that is why firms have to develop a culture of integrity and an ethical framework. The firm will need a well-developed set of principles that will analyze decisions and potential conduct in an ethical perspective. Managers have a big influence in promoting ethical behavior, they are able to demonstrate how it should be done. This can inspire employee to behave ethical.
Importance of ethics
As mentioned above the financial crisis 2008 hurt many people financially. As a result, many investors are paying more attention to the companies which they have invested in. They want to make sure that their invested capital is secured and that the company is ethical. Additionally, the investor doesn’t just want to make sure that the company is an ethical one, they want to be sure that the professional investor can be trusted and doesn’t put his interests ahead of his clients.
To be sure that companies and professional investors have the right intentions, new regulations have been implemented. Companies nowadays have to go through a yearly due diligence control and need to record all the transactions they have made. The company needs to have open books and be able to explain how they earned their assets and why they have debts. Looking at the professional investor side, most investing companies obligate their employees to attend an ethical class, to teach them how to invest in an ethical way and show them the consequences of unethical behavior. Also, investors cannot just invest in everything they want anymore. There are new rules with different types of stocks. Before the financial crisis investors could invest in stocks without having the money to cover their investment. When the crisis exploded the investors couldn’t pay their debts anymore, which resulted in immense loss for banks and clients. For this reason, investments need to have a security. There are still stock types that have less restrictions, like hedge funds but these are only traded by a limited number of investors. At the moment the CFA Institute maintains and promotes the Code of ethics and standards of professional conducts in the financial industry.
If ethical behavior is not given in a company this can have further consequences as mentioned above. Investors might not want to invest or will demand a higher risk premium, because the risk of the investment is much higher. Also, it will reduce innovation and job creation, which will be bad for the company’s growth. In general, it can hurt the economy and society as a whole, because of the reduced capital the investors will make. (CFA, 2017)
Analyzing companies for ethical behavior
There are many ways to make sure that a company is ethical. Before investing in a company identify the tone of the organization’s code of ethics and analyze it clearly. By reviewing it you can get a feel for the company and its corporate culture. Also, by comparing the code of ethics with other companies you get a view of what is the current standard of ethical behavior. There are many companies who write a very complicated code of ethics, which is really hard to understand. This may be, because the company may have something to hide. Normally a code of ethics is written clearly and well-organized, so that people at every level understand it. After reading the code you should study the company’s mission and vision statement to determine if the code of ethics has been applied to it. (Sharrieff, 2018)
If you are still unsure about how ethical a company is, you can get information about the company on the internet or ask the company itself, what kind of programs they have to make sure their employees act ethical. Furthermore, professional investors in banks have a great knowledge about the companies they invest in. This is a must for them, as they are responsible for a huge amount of capital, they are investing for customers.
Summarized our history has shown us how important ethical behavior is in the financial world. The consequences of unethical behavior are too immense to let a financial crisis happen again. In order to prevent a crisis like that to happen again, the government and regulators have implemented new rules, which companies have to follow in order to do their business. But it’s not just the company itself that has new and stricter regulations, it is also their employees. New processes have been made to prevent employees to act unethically. And to be a 100% sure that a company is ethical the investor should do his own research about a company, by analyzing and reading the code of ethics.
CFA. (2017, October). www.cfapubs.org. Retrieved from https://www.cfapubs.org/doi/full/10.2469/ccb.v2017.n20.1
Sharrieff, M. (2018). www.smalbusiness.chron.com. Retrieved from https://smallbusiness.chron.com/analyze-code-ethics-organization-2726.html
Thompson, M. (2017, Feburary 22). www.business.com. Retrieved from https://www.business.com/articles/are-you-sending-clients-the-wrong-message-when-it-comes-to-ethics/