Ethics in FinanceEthics in Finance

PGDM-Session 7PGDM-Session 7

Characteristics of Characteristics of Management Prone to Management Prone to

FraudFraud Unduly aggressive financial TargetsUnduly aggressive financial Targets Domination by person or group without Domination by person or group without

controlscontrols Aggressive accounting practice to keep Aggressive accounting practice to keep

stock prices highstock prices high Pressure to reduce tax liabilitiesPressure to reduce tax liabilities Major performance related compensationMajor performance related compensation Non-Financial personnel involved in Non-Financial personnel involved in

accounting mattersaccounting matters

Ethical issues in FinanceEthical issues in Finance

Financial statementsFinancial statements

Hostile TakeoversHostile Takeovers

Financial MarketsFinancial Markets Insider TradingInsider Trading

Fraud in Financial Fraud in Financial StatementsStatements

Fictitious RevenuesFictitious Revenues Concealed Liabilities and ExpensesConcealed Liabilities and Expenses Fraudulent Asset ValuationsFraudulent Asset Valuations Improper or Fraudulent Disclosures Improper or Fraudulent Disclosures

or Omissionsor OmissionsCreative accounting – form of Creative accounting – form of fraudulent financial reporting so fraudulent financial reporting so as to provide misleading as to provide misleading information.information.

Duties of an AuditorDuties of an Auditor

To give an accurate statement to the To give an accurate statement to the members about the state of affairs of members about the state of affairs of a company a company

To meet the objectives of the To meet the objectives of the Companies Act 1985 and also the Companies Act 1985 and also the Articles of AssociationArticles of Association

To be reasonably skillful and careful To be reasonably skillful and careful in identifying the true nature of the in identifying the true nature of the accountsaccounts

Ethical AuditEthical Audit An audit that assess a business’s An audit that assess a business’s

structures, procedures, systems and structures, procedures, systems and policies.policies.

It measures the extent to which the It measures the extent to which the activities of a business comply with the activities of a business comply with the standards it has publicly declared to its standards it has publicly declared to its external customersexternal customers

It measures business conduct against It measures business conduct against varied moral standards of the community.varied moral standards of the community.

Objectives of Ethical Objectives of Ethical AuditAudit to provide a critical assessment of functioning of businessto provide a critical assessment of functioning of business

To investigate into acquisition or restructuring operationsTo investigate into acquisition or restructuring operations

To determine the type of training necessary for employeesTo determine the type of training necessary for employees

To establish ethical conduct of businessTo establish ethical conduct of business

To enhance, measure and promote the quality that To enhance, measure and promote the quality that increases business performance by assessing them increases business performance by assessing them against the ethical business objectiveagainst the ethical business objective

To improve the quality of governance by evaluating the To improve the quality of governance by evaluating the performance and ensuring that financial information is performance and ensuring that financial information is both available and reliableboth available and reliable

Ethical Issues in Ethical Issues in Financial MarketsFinancial Markets

Deception: act of misrepresenting Deception: act of misrepresenting relevant information relevant information

Churning: Excessive or inappropriate Churning: Excessive or inappropriate trading for clients account by a trading for clients account by a broker who has control over the broker who has control over the account with intent to generate account with intent to generate commissions rather than to benefit commissions rather than to benefit clientclient

Unsuitability Unsuitability Unfairness in MarketsUnfairness in Markets

Insider TradingInsider Trading

Refers to trading on price Refers to trading on price sensitive information by company sensitive information by company employees or individuals closely employees or individuals closely connected with the firmconnected with the firm

This information has not been This information has not been disclosed to other market disclosed to other market participantsparticipants

Ethics & Insider TradingEthics & Insider Trading

It violates equality of opportunityIt violates equality of opportunity Does not give a level playing field Does not give a level playing field

between insiders and outsidersbetween insiders and outsiders Might harm exchange as a whole Might harm exchange as a whole

because investors might not be willing because investors might not be willing to trade on exchange that does not to trade on exchange that does not give shareholders their rights.give shareholders their rights.

Hostile TakeoversHostile Takeovers

Are those that elicit opposition Are those that elicit opposition from the boards or employees of from the boards or employees of Target companyTarget company

Reasons for opposition are as Reasons for opposition are as follows: follows: Disagreements over priceDisagreements over price Protecting their own interestsProtecting their own interests

Anti-takeover defense Anti-takeover defense measuresmeasures

Poison PillsPoison Pills

Green mailGreen mail

Golden ParachuteGolden Parachute

People PillPeople Pill

Poison PillsPoison Pills An anti-takeover device used by An anti-takeover device used by

company’s management to make company’s management to make takeover prohibitively expensive for takeover prohibitively expensive for the biddersthe bidders

Company under target changes AOA Company under target changes AOA so that group of Shareholders have so that group of Shareholders have special rights to buy and sell special rights to buy and sell preferred stock at highly favorable preferred stock at highly favorable prices (At times below market price) prices (At times below market price)

Ethics & Poison PillsEthics & Poison Pills

Poison pills are prohibited in Britain Poison pills are prohibited in Britain by takeover code because they by takeover code because they prevent open competition between prevent open competition between bidders for sharesbidders for shares

Use of poison pills are ethical if they Use of poison pills are ethical if they are designed to protect the are designed to protect the management from unwanted management from unwanted takeover bids.takeover bids.

GreenmailGreenmail It occurs where a potential takeover agent It occurs where a potential takeover agent

purchases stock in a companypurchases stock in a company After the purchases have totaled five percent the After the purchases have totaled five percent the

agent must announce his intention to takeover agent must announce his intention to takeover the company, if that is the intentthe company, if that is the intent

Stock prices go up in anticipation of takeover Stock prices go up in anticipation of takeover battlebattle

Management of target company sends Management of target company sends greenmails to prevent a shareholder from taking greenmails to prevent a shareholder from taking over the companyover the company

Takeover agent ends up selling the shares back Takeover agent ends up selling the shares back to company at an increased or higher negotiated to company at an increased or higher negotiated price price

Ethics & GreenmailEthics & Greenmail

Target company may be forced Target company may be forced to incur debts to raise funds to to incur debts to raise funds to finance the buy back of shares at finance the buy back of shares at premium pricepremium price

Golden ParachuteGolden Parachute

A company gives lucrative A company gives lucrative benefits to its top executives benefits to its top executives such as stock options, bonuses, such as stock options, bonuses, etcetc

Presence of parachute allows Presence of parachute allows management to evaluate management to evaluate takeover bid more objectivelytakeover bid more objectively

People PillPeople Pill

Management threatens that in Management threatens that in event of a takeover the entire event of a takeover the entire management team will resignmanagement team will resign

If managers act in their own If managers act in their own interest rather than company’s interest rather than company’s long term value then they are long term value then they are acting unethicallyacting unethically

Management BuyoutManagement Buyout

It occurs when management It occurs when management decide to bid for the companydecide to bid for the company

They convert the company into a They convert the company into a private company and at a later private company and at a later date, bring it back to market to date, bring it back to market to make substantial profits.make substantial profits.

Ethics & Management Ethics & Management BuyoutBuyout

Shareholder believe that Shareholder believe that management may resort to unethical management may resort to unethical practices to bring down share prices practices to bring down share prices and buy out at cheaper rate and buy out at cheaper rate

Unethical activities can involve Unethical activities can involve leaking confidential information by leaking confidential information by managers for their benefit during managers for their benefit during buy outbuy out

Thank YouThank You