CHAPTER- 11 ETHICAL ISSUES IN FINANCE
Objectives of the Chapter
Importance of financial statements Ethical issues in Mergers and Acquisitions Insider Trading Money Laundering
Importance of Financial Statements
To run a business ethically, it is necessary to have trustworthy internal accounting systems. Companies usually maintained two sets of accounts. Financial accounts that are given to the shareholders and internal management accounts. Management accounts give details about the functioning of the different departments, the work they perform, the cost involved and the earning.
Importance of Financial Statements contd
The steps that a companys management should take into account for true, fair and reliable management accounts are: Determining the key elements of the business like the objectives of the firm and see how they are defined and measured. Making sure that the funds are allocated to different activities on the basis of their importance, Frame rules that have a positive effect on business activities.
Ethical issues in Mergers and Acquisitions
Mergers and acquisitions can help a company develop a competitive advantage and thereby increase shareholder values. At the same time mergers and acquisitions, buyouts and takeovers present several ethical challenges. They are said to destroy industries and increase unemployment.
Takeovers are said to harm the interest of stakeholders as they reduce employment and disrupt the organization's relationships with suppliers and customers. The changes brought about by takeovers and mergers should be handled in such a manner as to protect all the interests of stakeholders and shareholders of the organization.
Ethical issues in Mergers and Acquisitions contd
Ethical issues in Mergers and Acquisitions contd
One more charge that is levied is that takeovers involved breach of trust as they transfer wealth to shareholders by isolating implicit contract with other stakeholders. It implies that a supplier or an employee who expects security for their work can be ignored during takeovers.
Hostile Takeovers
Hostile Takeovers are those that elicit oppositions from the boards or employees of the target company. They are typically those takeovers to which managers of the target company are against. The reasons for the oppositions to the takeovers are: Protecting their own interest Disagreements over price
Hostile Takeovers contd
Some of the popular ways in which managements use to protect themselves from unruly predators are: Poison pills Greenmail Golden parachute People pill Sandbag
Poison Pills
Poison pill is an anti-takeover devices used by a companys management to make a takeover prohibitively expensive for the bidders. The company under target changes the Article of Associate so that a group of shareholders have special rights, which are evoked by a takeover.
Greenmail
Greenmail occurs where a potential takeover agent purchases stock in a company. After the purchase have totaled five percent, the agent must announce his intention to takeover the company, if that is the intent. The stock price goes up in anticipation of the takeover battles.
Greenmail contd
The takeover agent ends up selling the shares back to the company for this increased price or somewhat higher negotiated price, when the attacked company struggles to thwart the takeover. Greenmails are considered unethical because the target company may be forced to incur debts to raise funds to finance the buyback of the shares at a premium price.
Golden Parachute
When a company is taken over, many top executives are likely to lose their jobs. So to discourage an unwanted takeover attempt, a company gives lucrative benefits to its top executives- these benefits are awarded to those executives who lose their jobs after takeover. Benefits include stock options, bonuses, and severance pay, etc. Such Golden parachutes can run into millions of dollars and can cost the firm a lot of money.
People Pill
This is a defensive strategy for warding off a hostile takeover. In this case management threatens that, in the even of a take over, the entire management team will resign This is a very effective method if they are a good management team, in place, the loss of which would harm the company.
Sandbag
This is another tactic used by management to stop a takeover attempt. The company stalls the attempts in the hope that another more favorable company will try to take them over. Management should not waste too much of time in trying to find a more favorable company.
Insider Trading
Insider trading refers to trading on price sensitive information by company employees or individuals closely connected with the firm. This information has not been disclosed to other market participants. Insider dealing is considered unethical and blamed because it is though to violate equality of opportunity.
Money Laundering
Money laundering involves hiding, moving and investing the process of criminal transactions. Money laundering involves disguising assets so they can be used without detection of the illegal activity that produced them. Through money laundering, the criminal transforms the monetary proceeds derived from criminal activity into funds with a seemingly legal source.
Money Laundering
Even legal money can become illegal, if moving it violates a countrys foreignexchange control or other financial regulations. Laws governing money laundering originated in the US. In the US money laundering laws were enacted primarily to drugs and narcotics dealers who were legalizing the profits earned from their nefarious activities. A number of initiatives have been established for dealing with the problem at the international level. Eg. Financial Action Task Force
Summary of the Chapter
Importance of financial statements Ethical issues in Mergers and Acquisitions Insider Trading Money Laundering