Business ethics are very important part of financial strategic management. The chief executive officers and chief financial officers are held accountable for the ethics of a business. Violations of ethics are caused by misrepresenting financials, misleading the public, and other acts that give certain investors an advantage over others. Many firms in the past have used unethical accounting to show performance results that were untrue.
Companies such as Enron and WorldCom are two of the biggest accounting scandals in the world. The scandals have changed legislation and forced the SEC to pass the Sarbanes Oxley Act of 2002. Unethical reporting and transaction will decrease the investors’ confidence in the capital market systems. The regulators must enforce rules and observe the ethics of companies to ensure they are reporting accurate financial numbers. If the investor’s confidence decreases and the reforms do not work then the capital market systems will fail and companies will not have limited options to raise finance for expansion, new products, or innovation.
Enron was a major energy trading company. The company grew to becoming the largest company in the industry. The company continued to generate revenues and grow through transactions and acquisitions. The company always had strong financial statements that showed the company was financially strong. The problem with Enron is all the manipulation that was going behind the doors of the company. They had colluded with board members, the auditing firm, and banks to hide losses and show revenue growth.
The company manipulated the financial statements by changing historical values to market values to show financial strength. The forecast were optimistic and market values were reported much higher than assets were worth. Enron directors approved many transactions and reporting techniques that were unethical. The company was trading futures and marking down revenues from optimistic forecast before any funds were transferred. The company reported many revenues that had not taken place and were at risk to never take place. The expenses were marked down in quarters in the future that had profits to hide any losses the company would have shown. The company bribed their auditor, analysts, and creditors to sign off on the financial strength of the company by offering them stock options. The company was hiding losses in many places and inventing companies to show growth.
The company was also involved in limiting the power supply to areas in California to increase the price of their electric bills. Enron traders had power companies working at less than half capacity to invoke the blackouts in California to raise the price of electricity. Many stock options were given to the people involved in the scandal and many of them profited from the scandal whereas the public and employees lost everything they had. The company invented various types of accounting to hide losses and show profits even though the company was losing money.
WorldCom was a telecommunications company that was acquiring the competition. The company was showing revenue growth from acquisitions of companies. The company acquired rival MCI communications even though MCI was the larger company. The scandal WorldCom was involved in was accounting fraud. The majority of the company’s assets on the balance sheet were from goodwill. The reported goodwill was from optimistic values that allowed the company to acquire more long-term debt. The company was listing goodwill even if the acquisitions were losses or accumulated debt. The misrepresentation of goodwill allowed the company to portray that it was financial strong and have high credit ratings.
Another fraud the company was a part of is not reporting operating expenses. The company had operating expenses charged as capital expenditures, double revenue counting and undisclosed debt. This method hid expenses and showed lower operating costs that generated more profit. The company had to pay other telecommunication company for the use of their physical assets to provide services for their customers. The company was misleading investors and showing profits when the company was generating losses. An audit of the company found 3.8 billion dollars of undisclosed debt. The investigation that led to the company’s bankruptcy revealed more than 10 billion dollars of undisclosed debt. The company mislead the public and investors to show profitability when debt and losses were the real picture.
Business Ethics are defined as the standards of conduct or moral judgment of persons engaged in commerce. The directors and senior management are held accountable for any unethical behavior. If unethical behavior is discovered the officers and managers face severe penalties including fines and imprisonment. Ethics is an important factor in strategic financial management because the managers must know how to react to different scenarios. The key to every financial strategy should be to maximize shareholder wealth. Longevity and future cash flows are good ways of succeeding in this objective. A company that acts unethical can harm their reputation and the cost to repair it may be insurmountable. Keeping loyal customers cost a company less time and money than attracting new customers. Ethical behavior will allow customers and investors to have confidence in the company and their products to generate loyal relationships. A company faces many decisions during the financial planning stage and managers’ act ethically will reward the shareholders and stakeholders of that company.
Deception = Collapse
The examples of Enron and WorldCom show what happens when unethical behavior is involved in the operations of a company. The companies tried so hard to show investors profits and portray strong financial condition that many people involved were hurt. Employees and investors lost their life-savings and were subjected to lies and fraud. The people involved in the fraud were sentenced to jail and had to pay large sums of money back to creditors. No one benefited from the fraud when it was discovered. Ethics are an important factor for all stages of business and financial reporting and strategic management are no exception.