University of Technology
Sydney
25602 Ethics in Finance
Subject Coordinator:
Gerhard Hambusch, PhD, CFA
Ethics and the
Conduct of Business
Ethics in the World of Business
(Chapter 1)
1
Got Ethics?
This seminar is about principles for responsible and
sustainable decision making in Business in general,
and in Finance in particular
What does “Ethics” mean to you?
2
Moral principles for moral reasoning
1. Consequentialist moral reasoning
– Right thing to do depends on the consequences from our
action: 5 live, 1 dies
– Locates morality in the consequences of an act, in the
state of the world after acting
2. Categorical moral reasoning
– Hesitating pushing fat man is simply wrong
– Reasoning depends on intrinsic quality of act, some
actions appear categorically wrong
• Philosophy challenges the familiar. Not by new information,
but by provoking a new way of looking at the world.
Which camp do you belong to?
3
The World of Business
• Are there different sets of rules (honesty,
fairness, promise-keeping…) for?
– Business (economic character and takes place in
organizations)
– Social (friends & family)
– Sport (competition)
• Conflict of rights?
– Employers (termination, drug testing…)
– Employees (discrimination, safety, privacy…)
4
The World of Business
• Who do we owe loyalty to?
– Shareholders (fiduciary responsibility)
– Customers
– Suppliers
– Employers
– Government
– Society
• These are the stakeholders of a firm
Are you a stakeholder of any firm?
5
Levels of Business
Decision Making
• Individual
– E.g. discover manager’s inflated expense account
– Decision driven by individual
– Relies on own moral standards, judgments & values
• Organisation
– E.g. manager hears about harassment
– Decision driven by organisational role
– Relies on procedures and policies
• Business System
– E.g. find evidence of conspiring amongst competitors
– Systematic problems in industry & economic system
– Relies on industry code of ethics, government regulation,
economic reform
6
Behavioural Biases (source: Boatright, 11th edition, p. 16)
1. Loss Aversion Bias. People tend to weigh losses more heavily than gains and thus take greater risks to avoid
losing something they have than to gain something that they do not have.
2. Framing Effect. People's decisions depend on how the choices are presented or framed. Thus, the loss aversion
bias leads people to choose alternatives that are framed in terms of losses rather than gains.
3. Confirmation Bias. This is the tendency of people to seek and process information that confirms existing
attitudes and beliefs instead of seeking and processing information that poses challenges to their attitudes and
beliefs.
4. Cognitive Dissonance. Related to the confirmation bias, cognitive dissonance is the tendency of people to
dismiss information that would disrupt their existing attitudes and beliefs.
5. Commitment and Sunk Costs. Once commitments are made and resources expended, people tend to persist in a
course of action, even in the face of information that should lead them to reconsider their initial decision.
6. Hindsight Bias. People tend to believe that events are more predictable than they are, and consequently they
blame themselves for not anticipating events that occur.
7. Causation Bias and Illusion of Control. People often find causal patterns in random events, which leads to the
belief that they have a greater ability to control events than is warranted.
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9. Self-interest Bias. People tend to make judgments, especially about fairness, that favour themselves.
10.Risk Perception Bias. People make poor judgments about risk, overestimating some risk and discounting others,
often ignoring low-probability events and favouring certain over uncertain outcomes.
The main heuristics people employ (source: Boatright, 11th edition, pp. 16-17)
1. Anchoring and Adjustment Heuristic. People tend to form an initial choice
("anchor") early in the decision-making process and then adjust the choice in
response to additional information. Thus, the final decision is heavily
influenced by the initial choice, especially given that people often fail to make
adequate adjustments.
2. Representativeness Heuristic. This is the tendency of people to utilize recent
and vivid examples rather than objective statistical data. For example, a person
purchasing an automobile may rely on a friend's experience with one model
instead of reading test reports.
3. Availability Heuristic. People tend to make decisions based on the available
information at hand rather than seeking out new sources of information.
Information may be "available," for example, because it is more recent or vivid
or because it is easier or more comfortable to remember.
Levels of Business
Decision Making
Systemic problems require systemic solutions:
– Industry-wide code of ethics (for example CFA
Standards of Professional Conduct)
– Regulation
– Better: reforms
– Ethical displacement
(addressing the problem
on a different level than
it occurs)
7
Case 1.2b: Home Depot
•
•
•
•
After a Miami Hurricane (1992), home
improvement store Home Depot (like e.g.
Bunnings Warehouse in Australia) decided
to sell high demand goods (ply wood
sheets) at cost
Was that a good business decision?
Was it ethically sound?
If you had managed the stores, what had
your decision been?
8
Would you increase the price of toilet paper?
Three Viewpoints
Economic, Law, Moral
Economics
Integrated
Approach
Law
Ethics/Morality
9
Three Viewpoints
(1) Economics
• Increase shareholders’ wealth given acceptable
business practices
• Economic choices driven by utility maximisation
(with limits on theft & fraud)
• Justification: competitive free-market benefits
society
• Externalities: accidents, defective products,
pollution
• Conditions overseen by government
Should the CBA/Util.max. always be applied?
10
Three Viewpoints
(2) Law
• Conduct business within the law is enough
– Law: rules applied to public life
– Ethics: personal opinions applied to private life
11
Three Viewpoints
(2) Law - Counterpoints
Problems with: ‘If it’s legal, then it’s
morally OK’
• Law does not extend to all areas:
– Credit for someone’s work, unreasonable
demands at work …
• Law is slow & needs time to develop
• Laws can be vague (e.g. ‘in good faith’ or
‘fiduciary duty’)
• Inconsistency between countries
• Laws may be inefficient
Your view?
12
Three Viewpoints
(3) Moral: Morality versus Ethics
• Moral (from the Latin moralitas) and ethical (from
the Greek ethikos) have essentially the same
meaning: a description of human behavior as right
or wrong, good or bad that may be used
interchangeably
• subtle differences exist between morality and ethics
• Morality
– Sociological phenomenon
– Existence of rules & standards in society
– Specific to times, places & cultures
• Ethics
– Philosophical study of morality
13
We need an integrated approach
Integration of all three points of view, but how?
• What is the measure of success? Profit? GDP?
Equality? Fairness? Happiness? Which point of
view emphasizes what?
Your view?
• How to assign weights to the different goals?
• Decision making needs to be economically
satisfactory, fulfilling legal obligations, and ethically
defensible
• This is tricky not only at the national level, but
especially at the international level (topic 5)
14
Ethical Management
Can ethics be taught to finance professionals?
• Knowledge to understand ethical issues (recognise
& resolve the ethical dimensions of the situation)
• Understand motivation of individuals (e.g. whistleblowing)
• Knowledge of regulations (e.g. intellectual property)
• Ability to develop logical ethical arguments to
persuade others (not just feelings)
15
Critical: Organizational Decision Making
Four features that contribute to mistakes:
• Decisions are made over time
• Resulting commitments are difficult to stop
• Diffusion of information
• Fragmentation of responsibility
16
Ethics and the
Conduct of Business
Ethical Decision Making
(Chapter 2)
17
Ethical Decision Making (Chapter 2)
HP Case 2.1:
• “SureSupply” campaign
• “Smart chips” in ink cartridges
• Cartridges represented half of the revenue, profit
margin of 50-60%
• Sometimes would shut down cartridge
• Law suits 2005-2008
• Law suits settled in 2010: eCredits of $2-$6 per
printer
You work for HP. Would you
implement these technologies?
18
Ethical Decision Making
HP Case 2.1:
• What are duties and responsibilities?
• What rules or principles apply?
We can address these questions by studying
business ethics in two steps:
1. Ethics of the market place
2. Relationships based on rules and principles
Roles of agents and firms in business
19
The Market System
Three main features
• Private ownership, voluntary
exchange & profit motive
• Rights-based Utilitarianism – increase welfare of
society
• Adam Smith’s (1723-1790) ‘invisible hand’
Your view?
argument, but:
– Collective choice & public goods
– The Prisoner’s Dilemma
– Market failures
20
Ethics in Markets
• Markets are based on consent exchanges
• But: wrongs can occur in actual markets
• Market ethics are rules that apply in imperfect
market exchanges
–
–
–
–
Breaches of agreements or contracts
Avoid fraud
Your view?
No wrongful harm
Act responsibly
• Definition of fraud (p. 27-28)
– misrepresentation, material, intent to deceive, reliance,
harm
21
Market Failures
• Four main reasons:
– No perfect competition (monopolies etc.)
– No perfect rationality (bounded rationality)
– Existence of externalities (e.g., pollution)
– Collective Choice (see Prisoner’s dilemma)
22
What is a Public Good?
Source: Mankiw, Principles of Economics, 4th ed.
23
The Prisoner’s Dilemma
Prisoner B
stay silent
stay silent Prison time
Prisoner A
A = 6 months
betray Prison time
A = goes free
betray
Prison time
B = 6 months A = 10 years
B = goes free
Prison time
B = 10 years A = 5 years
B = 5 years
Imagine you are prisoner A:
• If B chooses to stay silent, both get 6 months
• But if B knows that you are going for the 6 months result, she is better
off betraying, then she is free and you get 10 years
• Collective best outcome for the two is staying silent but no one can
afford to go to prison for 10 years if other party breaks agreement
• But if you cannot trust the other prisoner, you play safe and you
betray in which case you get 5 years, which is better than 10 years
Roles, Relationships, and Firms
• Roles and relationships evolve out of markets
• Obligations of professionals critically depend on
roles:
– Medical
– Lawyers
– Accounting
• Managers professionals play many roles:
– Economic actor
– Company leader
– Community leader
24
Roles, Relationships, and Firms
• Two most important roles in business relationships (later
used to analyze conflicts of interest in business and
finance):
– Agent (agency relationship with principal)
– Fiduciary (act in interest of someone else)
• Duty of candor
• Care
• Loyalty
• Also: Professionals
25
Ethical Reasoning
•
•
•
Ethical Reasoning requires the identification of
ethical concepts and principles
It is the intellectual procedure for justifying ethical
judgment
Requires
•
•
•
•
•
Willingness to seek out and act on reasons
Be impartial (newspaper test)
Frameworks can help to assess ethical dilemmas
and guide ethical reasoning
The sociological view
Kohlberg’s stages
26
Source: Boatright, Ethics and the Conduct of Business
Ethical Reasoning: Kohlberg’s 6 Stages
“The aim of cognitive development should be to advance to successively higher
levels, which also represent morally superior modes of ethical reasoning.”
•
•
reasons
Be impartial (newspaper test)
27
We need a Framework to tackle ethical dilemmas!
1. AWARENESS: situation presents an ethical issue
How?
Consider: Is there a risk of harm done to anyone?
Is anybody being made worse off?
2. IDENTIFY THE ISSUE: collect facts, data
How?
Consider: What are the full range of consequences of actions?
Identify the relevant ethical concepts and principles!
3. RELEVANT CONCEPTS: which ones?
Consider seven concepts/principles on the next slide.
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I. AWARENESS (anybody harmed?)
II. IDENTIFY ISSUE (data, facts)
III. RELEVANT CONCEPTS (see next slide for details):
1. Welfare
2. Duty
3. Rights
4. Fairness
5. Honesty
6. Dignity
7. Integrity
2
Business Ethics in a Nutshell – Seven “Simple” Questions
1. Welfare – Who is affected by any proposed course of action?
Is anyone harmed, and if so, can the harm be justified?
2. Duty – What is my duty in this situation? In particular, are there any
special duties that belong to any role or relationship that I am in?
3. Rights – Are anyone’s rights being violated?
If so, can the violation be justified?
4. Fairness – Is any proposed course of action fair to all affected
parties?
5. Honesty – Am I being entirely honest in my decision?
6. Dignity – Am I showing respect for all persons involved?
7. Integrity – Is the decision one that would be made by a person of
integrity?
4
Ethical Decision Making
Seven concepts for the application in a simple model
(From Boatright, 7th ed., pp. 42-43)
I. AWARENESS (anybody harmed?)
II. IDENTIFY ISSUE (data, facts)
III. SEVEN RELEVANT CONCEPTS:
1. Welfare. We often use the overall impact on people’s welfare—“The greatest good for the
greatest number”—as a justification for making social improvements, and we consider the alleviation of suffering (after a natural disaster, for example) to be a moral imperative. Although the
promotion of welfare is a good, a person may have no duty or obligation to promote it in any
given instance, and some harm may result without anyone being responsible for it. In general, inflicting harm becomes a moral matter only when some wrong is committed, which was described
previously as a wrongful harm. Still, welfare is an important value in ethical reasoning: Welfare
should be promoted, and any infliction of harm requires some moral justification. In business,
the welfare principle requires that a manager take into account the impact that personnel decisions and policies have on employees, that products and services have on consumers, and that
corporate activities have on communities. Although layoffs, for example, are sometimes unavoidable, they should be done in ways that minimize the human cost and enable employees to seek
other employment. Manufacturers have an obligation to ensure that their products are reasonably free of defects that can cause serious injury or death. When companies engage in activities that
harm communities—as when banks were charged with refusing loans in poor areas, a now-illegal
practice known as “redlining”—they commit a moral wrong.
2. Duty. A duty or an obligation is a moral requirement to act in a certain way, something that we ought to do. Such a requirement may be one imposed on all persons, such as a
duty to tell the truth or to keep promises. Many duties in business arise from agreements or
contracts, which are kinds of promises, and from the assumption of specific roles and
relationships, as is done by agents and fiduciaries (who have an agency and a fiduciary duty,
respectively). Duties are especially associated with professionalism since professionals explicitly assume certain responsibilities that they have a duty to fulfill. A person who has a duty is
expected to fulfill it without regard for his or her own interest, which means that a person
with a duty, say a fiduciary, is expected to be diligent, to exercise care and loyalty, to not
engage in self-dealing, and to avoid conflicts of interest that would interfere with the performance of a duty.
3. Rights. A right is an entitlement whereby a person is due certain treatment from
others. Rights are often said to be correlated with duties such that if one person has a right,
then another person has a duty to treat others in a certain way. In business, certain rights are
generally recognized for employees, including the right to privacy, a right not be discriminated
against, and a right to a safe and healthy workplace. Other rights are commonly accorded to
consumers (consumer rights) and investors (the rights of bondholders and shareholders). One
of the most important rights in business is property rights, which are basic to markets (since a
transaction is a transfer of property rights) and important for profitability (without patent
rights, for example, innovation would be discouraged). Rights are also closely related to the
welfare principle inasmuch as many wrongful harms are wrong precisely because they involve
the violation of some right. For example, a person may be harmed when refused a job, but a
refusal to hire itself may not be a wrongful harm unless it involves a violation of a right, such as
the right not to be discriminated against.
42
Ethical Decision Making
4. Fairness. Fairness or justice—which means, very roughly, equal treatment or different
treatment according to some justified differences—is applied to a wide range of activities and
practices in business. We speak of fairness in market exchanges (with regard to committing fraud,
for example, taking unfair advantage of another or setting a fair price); of fair competition
(which rules out monopolies, anticompetitive sales practices, and price-fixing); of fair labor practices (treating employees fairly in hiring and promotion, offering fair wages, allowing collective
bargaining); of the fair sharing of burdens (not being a freeloader or a free-rider); and of fairness
to creditors and investors (treating them fairly in bankruptcy, for example, or in matters of
corporate governance). Fairness or justice is also closely related to rights inasmuch as unfair or
unjust treatment often involves violating someone’s rights. Thus, discrimination is unfair, but it is
also a violation of rights. In this case, applications of the concepts of fairness and rights may be
merely different ways of describing the same moral wrong.
5. Honesty. Although honesty may be regarded as a duty—a duty to tell the truth—it is
important enough in business to be considered a basic ethical principle. As previously noted,
markets require a certain amount of information, and fraud, which involves the misrepresentation of a material fact, is a prominent violation of market ethics. Furthermore, the business
system requires an abundance of accurate and reliable information. This is especially true of
financial information, which companies are required to disclose and which is subject to certified
audits. Accounting fraud is a particularly serious breach of honesty that causes a great deal of
harm. Honesty is a value that is lost when bribes are paid to public officials since such corrupting
payments deprive countries of the honest services of their officials. Honesty is also an important
element in developing the kind of trust, with employees, customers, and the public, that success
in business requires. It is integral to a company’s reputation.
6. Dignity. The concept of dignity expresses the fundamental ethical principle that all people
deserve respect as human beings. All moral systems regard persons as autonomous moral agents who
should be free to make their own decisions and pursue their aims in life. This view is expressed in
Immanuel Kant’s idea that everyone should be treated as ends in themselves and not as a means to be
used solely for the benefit of others. Human dignity is denied when people are subject to violence,
coercion, manipulation, degradation, or the risk of serious injury or death. Often, people’s dignity is
denied when their rights—especially fundamental human rights—are violated. The principle of
dignity is most commonly employed in business in operations in less-developed countries where
standards of acceptable business conduct may be lower or ineffectively enforced. In particular, environmental damage from mining and oil production and working conditions in garment factories
have been criticized as violating a principle of dignity or respect for persons.
7. Integrity. Integrity is an elastic term that denotes a person of character or virtue who
holds the right values and has the courage of his or her convictions.31 According to Robert
Solomon, “Integrity is not so much a virtue itself as it is a complex of virtues, the virtues working
together to form a coherent character, an identifiable and trustworthy personality.”32 The concept
is also widely adopted in business codes of conduct not only to describe an ideal for employees
but also to characterize the company itself. Motorola, for example, has adopted the slogan
“Uncompromising Integrity” as its guide for conduct worldwide. Lynn Paine also uses the term
“integrity strategy” to describe a value-based form of internal control, which she calls “moral
self-governance.”33 A person or an organization with integrity would be one that adheres to the
other six ethical principles described here.
43
Ethical Reasoning: Framework
The Boatright Framework (p. 40-41)
Ethical reasoning requires identifying the relevant
concepts and principles (not rules!):
• Welfare - Greatest good for everyone
• Duty - Obligation to do right
• Rights - entitlement, correlated with duties
Ultimatum Bargaining Game
• Fairness
• Honesty - important for business, markets
• Dignity - respect human beings
• Integrity - a virtue, e.g., the quality of honesty
28
Four Ethical Justifications
for an Integrated Approach
1) Considering the benefit and harm to all of
the different parties involved
2) Respecting the essential humanity of others
3) Treating others with equality, fairness, and
justice
4) Caring for other persons in ways that
nurture relationships
29
Ethics and the
Conduct of Business
Ethical Theories
(Chapter 3)
30
Ethical Issues
Throughout this seminar we will be dealing
with case studies that highlight ethical issues
in social, business, and financial settings.
Ethical issues are situations, problems, or
dilemmas where a person or organization
faces different decision alternatives to
choose from. These have to be evaluated
to be ethical (right) or unethical (wrong).
Ethical theories can be employed to
evaluate the alternatives.
31
Four Groups of Ethical Theories
Ethical Theories and Concepts
Teleological
Theories
Deontological
Theories
Virtue
Ethics
Utilitarianism:
Jeremy Bentham
John Stuart Mill
Kantian Ethics:
Immanuel Kant
“Living the good
Life”:
Aristotle
Robert Solomon
Rights and
Justice
Entitlements,
Justice, and
Fairness:
Aristotle
John Rawls
Robert Nozick
32
Teleological Theory
• Utilitarianism is a practical method for
evaluating alternatives, i.e. consequences
and choose course of actions
• Decision making tool for public policy
• Also serves as basis for moral concepts
right and justice
• Fits easily with economic concepts of value
which is the basis for market system and
cost benefit analysis
• Utilitarianism = coherent basis for
business ethics
33
Teleological theory: Utilitarianism
•
•
•
•
Greek telos = End or goal
Utilitarianism
Main contributor: John Stuart Mill
Basis: Rightness of decision determined by
consequences
• Investment decision – choose course of
action that results in highest utility
34
Utilitarianism
Ethical decision
• Develop list of alternatives
• Follow consequences into future
• Select alternative with greatest benefit
(minimum harm) to society / shareholders
• Impartial judgement
The end justifies the means – sacrifice
interests of minorities to achieve
greatest good for majority
6
35
Utilitarianism
Calculating Utility
• Ranking is no problem
• Problem: Exactly define how much pleasure
something provides
• Utility calculation for individual vs. for everyone
• Problems:
• Information burden
• Interpersonal comparison of utility (insoluable,
but not insuperable)
• Individual vs. society
7
36
Utilitarianism
Cost-benefit Analysis
• Monetary units – benefits & drawbacks of
alternatives in decision making
• Advantage: Objective market values
• Uses: Product safety & environmental
protection
• Issues
• Not all costs & benefits have determinable
monetary values
• Does not always correspond to
opportunity cost
8
37
Deontological Theory:
Kantian Ethics
• Deon = Greek word for duty
• Main contributor: Immanuel Kant (17241804)
• Basis: Universal duties / principles (rules
based)
• Examples: Golden Rule (Do not do unto
others as you would expect they should do
unto you)
• Based on human dignity
38
Kantian Ethics
Kant’s Moral Philosophy:
•“Groundwork of the Metaphysics of
Morals” (1785)
•Denied that any consequence, such as
pleasure, can be good by itself
•Instead: performing action because it is
our duty
10
39
Kantian Ethics
• 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
11
40
Kantian Ethics
Universalizability
• “Act only according to that maxim by which
you can at the same time will that it should
become a universal law”
• How to identify these imperatives?
• Example: Taking out a loan
• If an act is right for one person, it is right for
all others (given similar circumstances)
• “What if everyone did that?”
12
41
Virtue Ethics
• Main contributor: Aristotle
(384BC – 322BC)
• Human pursuit of happiness
through moral excellence
• Moral character emphasised (instead of right
action)
• Comprehensive approach – 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?
13
42
Virtue Ethics
What are virtues?
• Feelings (e.g., hunger) are not virtues.
• Virtues are specifically those (acquired)
traits that everyone needs for the good life,
regardless of their specific situation.
• For example, courage is a virtue because it
enables anyone to get what he or she wants.
• The virtues are integrally related to what
Aristotle called practical wisdom, which is
what a person needs in order to live well.
14
43
Virtue Ethics
• 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?
• Practical limitation: Does not address conflict
between rules
Do you have virtues?
15
44
Rights and Justice
Rights
• Important role in business ethics
• All stakeholders have rights
Nature of Rights
• Rights = entitlement
• Different kinds of rights
1. legal and moral rights
2. specific and general rights
3. negative vs. positive rights
16
45
Rights and Justice
Natural Rights
• Thought to belong to all persons purely by
virtue of being human
• Two main features:
• Universality
• Unconditionality
• John Locke (1633-1704)
• Right to property
• “Every man has property of his own person”
17
46
Rights and Justice
Justice
• Another important moral concept: What is fair?
• Just = right, good. Better: fair
• E.g. taxes
• E.g. crime punishment, compensate crime
victims (righting of wrong)
Nature and value of Justice
Aristotle distinguished:
1. Distributive justice
2. Compensatory justice
3. Retributive justice
18
47
Case 3.3: Snuff
•
•
•
•
•
•
•
•
Union Tobacco, producer of snuff
Was a product for old men in the 1970s
Rough tasting product
Two new product lines, pouches with mint and cherry
flavor
1-2 million out of 7 million users were 12-17 years old
Users 50 times more likely to develop gum cancer etc.
Would you join such a company?
Which theory backs up joining, which does not?
19
48