Kenneth Lay. Bernie Ebbers. Dennis Kozlowski. Bernie Madoff. The list of disgraced – and convicted – perpetrators of financial malfeasance has continued to grow since the dawn of the new millennium. A lack of ethical behavior has led to catastrophe for several companies. Beyond the legal consequences, there are financial implications that follow a decision to act unethically.
Accounting practices are at the heart of most financial scandals. This has led the American Institute of Certified Public Accountants (AICPA) to develop a professional code of conduct that licensed accountants should follow. Accounting provides the technical data and forecasting information that executives base their decisions upon. That is not to say that all financial scandals are committed by accountants, but the way in which finances are represented has led to the conviction of some of the worst offenders in history.
Corporate financial decisions are a result of a systemic process of analysis, discussion and election. Steps include generating alternatives, evaluating outcomes, verifying decisions and communicating the result. Because these deliberate steps are taken, trust is built; this trust leads to confidence in the company. If unethical behavior is discovered, that trust often erodes quickly.
So how does a lack of ethics impact a company’s operations? There are five key stakeholders that are typically affected when financial fraud is uncovered:
- Lenders – Institutional lenders increase risk assignment due to fraudulent activity. This leads to higher borrowing costs (if you can obtain financing).
- Investors – Confidence in the company’s performance takes a hit because investors cannot trust the financial reporting that is distributed.
- Peers – Partners will look elsewhere for business relationships if they cannot trust the company’s management; competitors take advantage of bad news in order to gain a stronger foothold in the market.
- Employees – Workers’ morale slips following an announcement of unethical behavior. Loss of quality employees can lead to further operational upheaval.
- Public – The company’s image will forever be tarnished, even if there is a turnaround under new management. Often a rebranding campaign must take place.
Some experts, including University of Washington’s Foster School of Business professor Jonathon Karpoff, have indicated that corporate financial fraud is being committed less often. “We have international evidence that points to the decline of business misconduct over time” he wrote in 2010 for the University website. Could there be an awakening to the longer term costs of making a short term gain by “cooking the books”? As we’ve seen, corporate fraud has led to bankruptcy filings of some powerful, otherwise healthy companies. Ethics matter when it comes to sustaining your business.
Karpoff notes that reputation is a primary inducement of ethical behavior. He writes “(reputation) is the penalty imposed by the people with whom a firm does business—its customers, suppliers, employees and investors. Such people may or may not intend to impose a penalty on cheating firms. Rather, acting in their own interests, they simply change the terms with which they are willing to do business with cheating companies.” He estimates that reputation losses, in financial terms, equate to several times the amounts for legal and regulatory penalties, including class action lawsuits.
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