Global business ethics lesson 10

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Ethics in Accounting and Finance

UNIT 1

UNIT V


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Ethics in Accounting and Finance

LESSON

10
ETHICS IN ACCOUNTING AND FINANCE
CONTENTS
10.0

Aims and Objectives

10.1

Introduction

10.2

Accountability and Acquisitions

10.3

Success

10.4

Trends

10.5

Fair Value

10.6

Finance and Ethics

10.7

Financial Markets
10.7.1

Equity and Efficiency

10.7.2

Unfairness in Markets

10.7.3

Fraud and Manipulation

10.7.4

Equal Bargaining Power

10.8

Financial Statements

10.9

Let us Sum up

10.10 Lesson End Activity
10.11 Keywords
10.12 Questions for Discussion
10.13 Suggested Readings

10.0 AIMS AND OBJECTIVES
After studying this lesson, you should be able to understand:
z

The accountability and acquisitions

z

The finance, ethics and excessive trading

z

The equity, efficiency and unfairness in markets

10.1 INTRODUCTION
What possible moral decisions are involved in preparing cash flow forecasts for a
firm, auditing a company's books or advising a business on how to cost its good or
services?
The apparent mathematical precision of accountant’s right cause the public to believe
that - at least in so far as they are engaged in accounting procedures, there is no scope
for making any kind of ethical decisions.
Accountants should present ‘a true and fair view.’ The picture the accountant paints
can be either enlightening or misleading, depending on how he or she chooses to


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deficit it. Even within the law, various maneuvers can be carried out by accountants
which are often regarded as being in ethically gray areas. The most common practice
of this kind is known as 'creative accounting'; a phrase which is popularly associated
with 'cooking the books' in a way which is legal although morally dubious.
The practice of creative accounting, however, is not necessarily unethical. Those who
express outrage at the apparent creativity of certain firms’ book keeping are often
those whose limits of accountancy are confined to their own personnel accounting and
perhaps to organising small scale events where monetary transactions are clear and
unambiguous. In the average company by contrast, things are seldom so clear.

10.2 ACCOUNTABILITY AND ACQUISITIONS
Accountability is a concept in ethics with several meanings. It is often used
synonymously with such concepts as answerability, enforcement, responsibility,

blameworthiness, liability and other terms associated with the expectation of accountgiving. As an aspect of governance, it has been central to discussions related to
problems in both the public and private (corporation) worlds.
Acquisition means the process of acquiring, with appropriated funds, by contract for
purchase or lease, property or services (including construction) that support the
mission and goals of an executive agency, from the point at which the requirements of
the executive agency and include:
z

the process of acquiring property or services that are already in existence, or that
must be created, developed, demonstrated, and evaluated;

z

the description of requirements to satisfy agency needs;

z

solicitation and selection of sources;

z

award of contracts;

z

contract performance;

z

contract financing;

Merger accounting techniques are much more effective for measuring the success of
acquisitions than are standard acquisition accounting methods. Merger accounting
produces accurate performance improvement records because it produces profit and
loss accounts that are comparable between years. Merger accounting is also better for
measuring acquisition success because it is less susceptible to manipulation that
current acquisition accounting methods.
Buying a business makes sense when the benefit exceeds the cost. This means to find
a seller who excepts too low a price, so that you can secure a benefit from acquisition
by improving the targets performance.
Buyers of course, run into problems with competition law when their plans to improve
a targets performance depends in the creation and use of monopoly power, they can
actually be said to create wealth They have to use the targets resources more
efficiently than the seller or they exploit opportunities for synergy with exists


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Target Performance

Target Performance

Target Resources

Target Resources

Firm X

Firm Y

Total Target Performance

Total Target Resources

X+Y

Figure 10.1: Total Target Performances/Resources

The principal argument for a free acquisitions market is that it should allow business
to gravitate towards the managers who can do the most with them. Buyer’s accounts
often do not reflect real success and failure. There is therefore a danger that businesses
will gravitate towards the most creative accountants than the best managers. The
prospects of creating value from an acquisition arises whenever a potential target is
poorly managed.
Two courses of action are open to a corporate buyer/buy out or buy in team.
The target is well positioned in a market with a good future, and then the buyer should
aim to turn the business round.
If the target is poorly positioned, perhaps in a stagnant market with poor products and
people it makes more sense to strip the target. Most buyers other than management
buy - out or buy-in teams have an existing business to which they can add an
acquisition target. This existing business provides a further opportunity for a buyer to
create from an acquisition through synergy (2+2=5). Two businesses can together
achieve what is beyond their individual capabilities.
If the targets management is poor, little is lost by taking over the running of acquired
business and forcing the pace on realizing synergy gains. Alternatively, if it is good,
such a takeover is likely to be damaging. The acquisition needs to be viewed as a
merger and two business needs to be fused more gently. Negotiating a deal so that the
extra value is not given away to the sellers also requires particular skill, where there
are rival buyers.

Example
In the course of our employment within a large firm, we are asked to organise a
meeting. How much does it cost to do so? (Managers who wish to call meetings are
obliged to cost them first, to ascertain whether or not they are justified).
It appears that a meeting costs nothing at all. If attendees are paid no overtime, no
rooms to be hired, no external consultants demanding fees, it could be argued that the
costs are zero.
It is likely that at least there were printed agendas that the telephone costs of calling
the meeting. The meeting cost can be calculated on the basis of:
The cost of materials and services which would have been incurred if no meeting had
been contemplated.
These methods of costing were naive, meetings are to be attended by people, since
attendees are present as part of their paid employment, a suitable proportion of
salaries should be attributed to the cost of holding the meeting, one could calculate the
average number of hours worked in the course of each members week and determine


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what proportion of one's time (one's salary) was attributable. A more conservative
approach might be to consider the costs of hiring part time staff at cheaper rates to
execute the heavy work load of attendees, while on the other end of the scale one
might consider the 'opportunity costs' cancelled by tying up employees time, after all
in most firms employees are worth more to the firm than they are paid (opportunity
costs are the costs of not doing alternative tasks; if a member of a sales department
can sell goods at a profit of say 500 pounds an hour, then the opportunity cost of
attending an hour long meeting is 500 pounds). Do we consider the marginal costs to
the firm for holding the meeting, or the proportion of total costs of rents, heating and
lighting? There is no clear or right answer to the question; different answers may well

suit the purposes of different firms. If holding the meeting means a reduction in
selling, then the firm might be well advised to include opportunity costs; if the
attenders are happy to work unpaid overtime, the more conservative methods of
costing may be appropriate.
Just as a poet and a civil engineer might describe the same landscape differently
(because of different purposes), so two accountants could present the accounts of the
same firm in two entirely different ways. This is not unethical, any more than civil
engineers are unethical for describing the physical environment in terms of its
potential use rather than for its inherent beauty like the poet. All accounting is to some
extent creative accounting because there is no clear inarguable answer as to whether
we regard, something as a cost, as a loss, as an expense, or whatever.
Example
A firm whose profits are modest in a given financial year may decide to sell off some
of its capital and treat the proceeds as profits.
Equity accounting is another technique of enhancing profits. In UK, if the firm owns
more than 20% of another firm, it may declare that proportion of the other firms
profits as its own (including losses).
Due to a problem of dropping sales, a firm might enhance its sales figures by allowing
the bank to 'buy' goods when in reality the goods are being appeared as security for a
loan. The company would buy back its stock at a later date and for a higher priceexactly the same monetary transaction as taking out a loan. The goods themselves do
not change position, remains in the warehouse, without any necessity for the company
to deliver them physically to the bank and back again?
There can actually be ambiguity about where a sale represents a profit or a loss. If a
firm has sold a consignment of product one would imagine that such a sale would be
reflected in the accounts. If the buyer has been given credit, not only is it possible for
the vendor to omit the sale figure in accounts during the period of credit but it is
possible for the vendor to consider the sale as a loss of goods without payment and
hence a debit. He may thus omit the sales figure in accounts during the period of
credit.
Another form of creative accounting involves placing a hypothetical monetary value

on 'intangibles'. Companies are often worth more than the physical assets. If a firm has
built up enough 'good will' amongst customers and suppliers then its name is surely
worth something e.g., Coca Cola, if sold to another firm be of substantial value, even
perhaps if that firm consisted of functional directors. Coca Cola has never tried to sell
it - no one has ever tried to buy the name. Any figure therefore that is placed on its
value must be a 'guesstimate' or may be even just a guess. Well known firms quite
typically include intangible assets in their annual accounts.
Creative accounting can be described in a variety of ways, not all ways are correct.
Some are certainly false (If there is a hill there is a valley similar to if there is a will,
there is a way), and some although not false, can be down right misleading (a student
attends the occasional evening class). The same is true of accounting e.g., legally one


may not claim under the heading of 'expenses' costs of entertaining one's colleagues to
dinner (unless they are from abroad) or keep two sets of account books, one for
personal use and the other for the auditors (Rama's account and Krishna's account).
For creative accounting, freedom is important, which is a fundamental human right.
Companies should enjoy the fundamental right of deciding how to organise their own
affairs, including how they decide to present their accounts. One system of accounting
may be particularly appropriate to one firm, but inappropriate to another. The law
recognises that small businesses are not necessarily run by those who excel in
accounting. Consequently a sole trader or partnership which has no limited liability is
not obliged to present accounts with the same degree of exactitude as a Public Limited
Company (PLC). The affairs of an educational establishment, a charity, a chain store,
and a multinational company are all very different. No standard accounting scheme
could be devised.
A company like an individual, has the right to enjoy the best possible advantage
within the law (like IT returns), a car sales firm to treat a part exchange as a reducedprice single sale, rather than two separate transactions in which the new car is sold for
the full price and the old car bought as a separate deal. Business executives have the
duty of securing for their shareholders the best possible return for their investment (of

course, within the law). Creative accounting is favoured by many since they seem to
be convincing.
When the creative accounting is so carefully controlled it is a relatively harmless
weapon.

10.3 SUCCESS
The successful turn around leads to bigger operating profits although turnover can go
up or down.
Asset strip means the end of operating profits and turnover as trading assets are
realised and liabilities are settled to generate a one of non operating profit.
In take over or merger, profit margins can be improved by a greater bargaining power,
rationalised overheads and better asset utilization turnover can be increased when the
buyers products are sold to the targets customers and vice versa.
Broad range of complementary products are sold to new customers who prefer 'one
stop shopping.'
It should be straight forward to translate the reasoning behind an acquisition into
projections of profits, margins and sales. In most organisations, this will be part of the
moral process of planning and budgeting and the reporting of achievements will form
the basis for determining the success of each acquisition and the effectiveness of
management.
Even if a target business remains a separate limited company, it is unlikely that its
statutory accounts will allow a reliable company to be made of performance before
and after an acquisition. Inter company charges and the effects of positive or negative
synergy on the other parts of the buyers group will conceal the real results of an
acquisition.
Investors must therefore rely on the consolidated acquisition of the buyer to judge the
success of an acquisition.

10.4 TRENDS
Under acquisition accounting the results of an acquired business are consolidated from

the date of acquisition. This make nonsense of trying to assess whether buying
management have achieved real improvements in profits and sales.

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By contrast, merger accounting requires a buyer to consolidate the results of a target
for the whole of the year of purchase and for any previous periods that are presented.
Only an underlying improvement in performance will generate an improving trend in
reported sales and profits. Management seem to take credit for results which were
achieved prior to their stewardship. Such accounting is therefore often only seen as
appropriate when two business and their managements really do 'merge'. A feature of
both acquisition and merger accounting is that all companies included in the
consolidated accounts should apply consent accounting policies.

10.5 FAIR VALUE
Fair Value is the estimated value of all assets and liabilities of an acquired company
used to consolidate the financial statements of both companies. In the futures market,
fair value is the equilibrium price for a futures contract. This is equal to the spot price
after taking into account compounded interest (and dividends lost because the investor
owns the futures contract rather than the physical stocks) over a certain period of time.
Merger accounting calls for the assets and liabilities of a target business to be brought
into the buyers consolidated accounts at their previous book values, subject only to
adjustments to achieve consistency with the buyers accounting policies.
Acquisition accounting is different and requires adjustments to ensure that the
consolidated balance sheet at the end of the acquisition reflects the fair values of the

targets separable assets and liabilities. The concept of fair value can be illustrated by
looking at fixed assets and provisions.
The fair value of a fixed asset is represented by the cost of replacing it with an asset
which would give the same service. Because of inflation, an assets fair value is
usually greater than to its net book value.
Check Your Progress 1
1. What is asset strip?
………………………………………………………………………………
………………………………………………………………………………
2. What do you understand by ‘fair value’?
………………………………………………………………………………
………………………………………………………………………………

10.6 FINANCE AND ETHICS
"Ethics in Finance comprehensively analyzes important ethical issues in the field of
finance both theory and application by focusing on key concepts and practices. In so
doing, he demonstrates the critical importance of ethics for this vital industry."
–Thomas W. Dunfee, The Wharton School, University of Pennsylvania
Investor responsibility is a concept with content, notably spreading more and more
widely, involving the Pension Fund. The ethical guidelines for the Pension Fund were
globally adopted unanimously by the Norwegian parliament.
Sustainable development is dependent on three main elements, the so-called “Threelegged stool” – with government, civil society and the business sector each
representing a leg.


Over the recent years, we have reached some important milestones regarding
involvement of the business community in a meaningful way as contributors to
sustainable development.
Many sectors of the business community may still regard ethical considerations as a
cost, or at least as not relevant for the company’s financial return. For those investors

with a long-term perspective, there is self interest in encouraging companies to
prioritize sustainability in all areas, also socially and environmentally.
If we think seriously, we are bound to say that finance would be impossible without
ethics. We are placing our assets in the hands of the others, most of the times with
unknown people which requires immense trust. Unknown people includes an
untrustworthy stock broker or an insurance agent, an untrustworthy physician or
attorney, finds few takers for his or her services. Financial scandals shock us precisely
because they involve people and institutions that we should be able to trust.
Innumerable number of organisations in India has cheated many highly ethical people
who trusted them and their companies. Hard earned money has been put by many
people in cash to seek their better living in the post retirement stage. The company
starting have booted money by cheating the public and had themselves without
address and no action has been taken on them neither by the concerned authorities nor
by the Government. Even if caught, no stringent actions have been taken on them.
This is more predominant in India. It is shameful on the part of the concerned who
cheat and those who doesn’t take action.
Finance covers a broad range of activities, but the two most visible aspects are
financial markets, such as stock exchanges and the financial services industry.

Figure 10.2: Most Visible Aspects in Finance

Ethical issues in finance are important because they bear on our financial well being.
Ethical misconduct as everyone knows, may be by individuals acting alone or by
financial institutions has the potential to rob people of their life savings. As huge
money is involved in financial dealings, there must be well-developed and effective
safeguards in place to ensure personal and organisational ethics. Though the law
governs much financial activity, strong emphasis must be placed on the integrity of
the finance professionals and on ethical leadership in our financial institutions. Certain
principles in finance ethics are common to the other aspects of business:
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Duties of fiduciaries (held in trust)

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Fairness in sales practices

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Securities markets

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Activities like insider trading and hostile takeover raise unique issues that require
special consideration.

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Financial Services
This industry operates largely through personal selling by:
z

Stock brokers

z

Insurance agents

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Financial planners

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Tax advisers

z

Other finance professionals

Personal selling creates innumerable opportunities for abuse though financial
professionals take pride in the level of the integrity in the industry, misconduct still
found. Customers are unhappy over failed investments or rejected insurance claims.
Hence they blame the seller of the product, sometimes with good reason.
Three objectionable practices in selling financial products to client:
1. Deception
2. Churning
3. Suitability
Deception
Deception is the act of deceiving. Sales people have to explain all the relevant
information truthfully in an understandable, non- misleading way. This should be the
ethical treatment provided to clients. Brokers, Insurance agents and other sales people
have developed a new vocabulary to obfuscate rather than reveals. Obfuscate is to
darken or to confuse. For example,
A Financial adviser will help you select an appropriate planning vehicle or offer a

sense of investment choices or options among which to allocate your money.
(Insurance agents) peddle such euphemisms as:
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Private retirement accounts,

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College savings plans,

z

Charitable remainder trusts.

Among other linguistic sleights of hand in common usage these days saying ‘Tax free'
when it is only Tax deferred' 'High yield' when it is only 'Down right risky'. Projected
returns' when it is more likely in your dreams.
Sales people avoid speaking of commissions even though they are the source of
compensation, Commissions on mutual funds are 'front end' or 'back end loads' and
insurance agents whose commissions can approach 100% of the first year's premium
are not legally required to disclose this fact and they rarely do.
The agents of one insurance company represented life insurance policies as 'retirement
plans' and referred to the premiums as 'deposits.'
Deception is often a matter of interpretation e.g., promotional material for a mutual
fund may be accurate but misleading if it emphasises only the strengths of a fund and
minimizing the weakness.
Deception aside, what information ought to be disclosed to a cheat? e.g., the issuer of
a security is to disclose all material information, which is defined as information about
which an average prudent investor ought reasonably to be informed or to which a
reasonable person would attach importance in determining a course of action in

transaction.
The analysis of deception by a financial service provider is similar to that provided for
deceptive advertising.


In general, a person is deceived when that person is unable to make a rational choice
as a result of holding a false belief that is created by some claim made by another. The
claim may be either a false or misleading statement or a statement that is incomplete.
Churning
Churning is the act of making butter in dictionary. Churning is defined here as
excessive or inappropriate trading for a clients account by a broker who has control
over the account with the intent to generate commissions rather than to benefit the
client. Though churning occurs, there is a disagreement on the frequency or the rate of
detection. Churning is a rare occurrence as per the brokerage industry's contention.
This can be easily detected by firms as well as clients. But there are no statistics kept
on churning. However, unauthorised trading and other abuses are rising sharply in the
recent years.
Churning is a breach of a fiduciary duty. Fiduciary is confident, held in trust. This is
to trade in ways that are not in a clients best interests. Churning as different from
unauthorised trading occurs only when a client turns over control of an account to a
broker. The latter in turn assumes a responsibility to serve the clients interests. He
only recommends a trade and is not acting on behalf of the client or customer.
He is more or less like a traditional seller.
Example
Table 10.1: Ethical Issues Involved (Examples)
Case 1: Brokerage firm buys a block of
stock, prior to issuing a research report.
•

This contains a buy recommendation to

ensure that enough shares are available to
fill customer orders

•

The customers are ignorant about buying
stocks from the firm's own holdings

•

Customers are charged for the customer’s
market place + Standard commission for
a trade.

Case 2: Broker assures a client than an initial
public offering (IPO) of a closed-end-fund is sold
without a commission and encourages quick
action by saying that the IPO is sold, subsequent
buyers have to pay a 7% commission
• Fact is that a 7% commission is built into the
price of IPO
• This
charge
is
revealed
in
the
prospectus but will not appear on the
settlement statement for the purchase
• A client might be induced to buy an IPO in

the mistaken belief that the purchase would
avoid a commission charge.

Ethical issue

Ethical issue

The client is buying the stock at the
current market price and paying a fee as
though the stock were purchased at the order
of the client. The circumstances of the
purchases are not explained to the client.
Does the broker have any obligation to do
so? Would this knowledge have any effect
on the client's decision?

•

Commission charge is disclosed in the
prospectus might ordinarily exonerate the
broker from a charge of deception except that
the false belief is created by the brokers
claim, which at best, skirts the edge of
honesty

•

The broker made the claim with an intent to
deceive, and a typical, prudent investor is apt
to feel that there was an attempt to deceive

Figure 10.3: Legal Definition of Churning (3 Elements)

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Excessive trading:
This depends on the character of the account.
1. A client who is more speculative investor, willing to assume higher risk for a
greater return, should expect a higher trading volume.
2. High volume is not the only factor; pointless trades might be considered churning
even if the volume is relatively low.
3. Churning might be indicated by a pattern of trading that consistently favours
trades that yield higher commissions.
4. High volume trading that loses money might still be defended as an intelligent but
unsuccessful investment strategy; Investments that represent no strategy beyond
generating commissions are objectionable, no matter the amount gained or lost.
Suitability
Brokers, Insurance agents and other sales people have to recommend only suitable
securities and financial products.

Figure 10.4: Common Causes for unsuitability

Unsuitable trading technique includes the use of margin or options. This can leverage
an account and create greater volatility and risk.
Unsuitable liquidity is limited partnerships e.g., not very marketable and hence

unsuitable for customers who would like to liquidate the investment.
Investments are most often deemed to be unsuitable since they involve excessive risk.
However, a few risky investments may be appropriate in a well-balanced, generally
conservative portfolio. Even an aggravate risk taking portfolio may include unsuitable
securities if the risk is not compensated by the expected return.
Assuming recommended security is suitable for a given investor involves many
factors, financial services industry personnel offer to put their specialised knowledge
and skills to help, much more than expected from other areas of personnel like
physicians, lawyers anti accountants. Finance professionals are expected to do much
more.

10.7 FINANCIAL MARKETS
The transaction typically takes place in organised markets like:
z

Commodity markets

z

Futures or option markets

z

Currency markets etc.

In these markets, one expects certain moral rules and expectations of moral behaviour.
Most fundamental is a prohibition against fraud and manipulation. Generally, the rules


and expectations for markets are concerned with fairness expressed as a level playing

field. But this gets tilted in financial markets by many factors like:
z

Unequal information

z

Bargaining power

z

Resources

Participants in markets, in addition to making one time economic exchanges, also
engage in financial contracting by entering into long term relations. Those involve the
assumption of fiduciary duties or obligations to act as agents and financial markets are
subject to unethical conduct when fiduciaries and agents fail in their duties. The terms
of a contract specify the conduct required of each party and the remedies for
noncompliance.
There is a little 'wiggle room' in a well drafted contract. Many contractual relations in
finance and other areas fall short of this ideal, because actual contracts are often
vague, ambitious, incomplete or problematic resulting in uncertainty and disagreement
about ethical (and legal) conduct.
We shall deal with the following topics in detail
z

Equity and efficiency

z

Unfairness in markets

z

Fraud and manipulation

z

Equal bargaining power

z

Resources

z

Processing ability

z

Vulnerability

z

Efficient pricing

10.7.1 Equity and Efficiency
Efficiency
Economists have a particular kind of efficiency in mind, called Pareto efficiency. It is
defined as follows:

z

A Pareto efficient outcome is one that cannot be changed so as to make someone
better off without also making someone else worse off as a natural corollary,

z

A Pareto improvement is a change that makes at least one person better off
without also making anyone else worse off. Any outcome that we can change to
yield a Pareto improvement is said to be Pareto inefficient.

When economists use the words efficient or inefficient alone, they mean Pareto
efficient or Pareto inefficient.
Equity
The term Equity is generally used when referring to the equity available from an asset,
in simple terms equity is the amount of money you have tied up in an asset.
Equity is the UK Trade Union representing professional performers and other creative
workers from across the spectrum of the entertainment, creative and cultural
industries. Here we find a wide range of information including rates of pay, how to
join Equity, contacts, careers advice and how you can get involved in helping theatres
and companies at risk.

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An economic situation is, in which there is a perceived trade-off between the equity

and efficiency of a given economy. This trade-off is commonly viewed within the
context of the production possibility frontier, where any additional gains in production
efficiency must be offset by a reduction in the economy's equity.
Within this equity and efficiency trade-off, equity refers to the economy's financial
capital, while efficiency refers to the future efficiency in the production of goods and
services. This theory asserts that, in order for a nation to become wealthier, it must
save its equity.
Main aim of financial market regulation is to ensure efficiency. Markets will be
efficient only when people have confidence in their fairness or equity.

Figure 10.5: Efficiency in Markets

People will participate in capital markets, only if the markets are perceived to be fair.
Fairness has value as a means to the end of efficiency
Society is generally better off when capital markets allocate the available capital to its
most productive use. We also value fairness as an end in itself since fairness can
conflict with efficiency; some choice or trade off between the two must often be made
known as equity/efficiency trade off.

Figure 10.6: Painful Choices

Fairness always contributes to the efficiency even these two conflicts.

10.7.2 Unfairness in Markets
What does this mean? Fairness is not a matter to prevent losses. Markets produce
winners and losers. Most of the cases, the gain of one may equal loss to other, though
market exchanges are advantageous to both the parties. Involvement in a stock market
is like playing a sport. The aim is not to prevent losses but to ensure that the game is
fair. The regulation of financial markets protects the general public apart from the
individual investors. The latter can be treated unfairly by the operations of financial

markets in many ways.
The main kinds of unfairness are:
z

Fraud and Manipulation

z

Equal Information

z

Equal bargaining power

z

Efficient pricing


10.7.3 Fraud and Manipulation

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Ethics in Accounting and Finance

The main purpose of security regulation is to prevent fraud and manipulation practices
in the sale of securities. Investors (buyers and sellers) are vulnerable to fraud because
the value of financial instruments depends almost entirely on information that is
difficult to verify. Important information lies mostly in the hands of the issuing firm.
Hence antifraud provisions in securities law place an obligation also on the issuing
firm in addition to buyers and sellers.

The company that fails to report proper information may be committing fraud, even
though the buyer of that company's stock buys it from a previous owner who may or
may not be aware of the news. Insider trading is prosecuted as a fraud on the grounds
that any material of nonpublic information ought to be revealed before trading.
Manipulation involves the buying or selling of securities in order to create a false or
misleading impression about the direction of their price so as to induce other investors
to buy or sell the securities.
Table 10.2
Fraud

Manipulation

Meaning

Fails to report proper
information
Insider
trading is also a fraud

Buying or selling of securities for
the purposes of creating a false
or misleading impression about
price (direction) to induce investors
to buy or sell

Designed to deceive others

Yes

Yes

Effect achieved by

False or misleading
representations

Creation of false or misleading
appearances

Addressed by mandatory
disclosure regulations and
penalties for false and
misleading state in any
information released by a firm

Yes

Yes

With easy access to reliable
information

Difficult to commit

Difficult to commit

Better informed investors

Will
make

more
rational investment

decisions at lower overall cost

Possession of unequal information is unfair (when the information has been
illegitimately acquired and its use violates some obligation to others) e.g. Insider
trading – Insider has not acquired the information legitimately but has stolen (or
misappropriated) information that rightly belongs to the firm.
Information asymmetries are objectionable to the extent that they reduce efficiency.
The notion of equal access (while defining equal information) is not absolute but
relative. What one person possesses information could be acquired by another with
enough time, effort and money. Everyone could make the same investment and gain
the same access or a person could simply buy the analyst's skilled services.
People should seek information available at the lowest cost. To force people to make
costly investments in information-or to suffer loss from inadequate information is a
loss to the economy, if the same information could be provided at little cost. Issue of
new securities to be accompanied by a detailed prospectus is needed to prevent fraud
through the concealment of facts and to make it easier for buyers to get certain kinds
of information, which benefits society.
Efficiency and fairness both support attempts to reduce information asymmetries in
financial markets. What fairness or justice requires is not easy to determine? e.g. A
geologist can buy a land where oil is found, without revealing what he knows.


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10.7.4 Equal Bargaining Power
The fairness of bargained agreements assumes that the parties have relatively equal

bargaining power. A trader who negotiates for a future contract those results in great
loss has only himself or herself to blame.
Unequal bargaining power can result from many sources (including unequal
information).
Other sources are:
z

Resources

z

Processing Ability

z

Vulnerabilities

Resources
Wealth has an advantage in all transactions. The rich as compared to the poor
negotiates better over almost all matters. Similarly, wealthier customers have more
options. Large investors have plenty of opportunities because they are better
diversified, bear greater risk and obtain higher leverage, volume trading will benefit
them, access to investment closed to small investors.
Processing Ability
Unsophisticated investors are ill-advised to play the stock market and invest in
markets that only professionals understand. Even with equal access to information,
people vary enormously in their ability to process information and to make informed
judgements. Securities firm and institutional investors overcome the problem of
people's limited processing ability by employing specialists marketwise and using
computers/programs.

Vulnerabilities
Investors are human and they have many weaknesses which can be exploited.
Regulation is designed to protect people from the exploitation of vulnerabilities.
Consumer protection legislation provides protection for them with a cooling off
period. At that time shoppers can cancel an impulsive purchase.
Prospectus of the company accompany offers of securities carefully serve to curb
impulsiveness. Investors have to read this carefully to discourage speculative
investment. This protects incautious investors from over extending themselves and to
protect the market from excess volatility. The brokers recommend only suitable
investments and warn adequately of the risk of any investment instrument providing a
further check on people’s greedy impulses. Success of financial market depends on
wide participation. If unequal bargaining power were permitted to drive all but the
most powerful from the market place, the efficiency of the financial markets gets
affected maximum.
Efficient Pricing
Fairness in financial markets includes efficient prices that reasonably reflect all
available information. Volatility results from a mismatch of buyers and sellers in
eventually self correcting. Meantime, great harm may result by inefficient pricing.
Individual investors are harmed by buying at too high a price or selling at too a high
price during periods of mispricing.
Volatility also affects the market by reducing investor’s confidence and driving them
away. The loss of confidence depresses stock prices.


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Check Your Progress 2
Fill in the blanks:
1.

Accountants should present _____________.

2.

Broad range of complementary products are sold to new customers who
prefer _____________.

10.8 FINANCIAL STATEMENTS
The definition of the accounting in any business book is the process by which any
business keeps track of its financial activities by recording its debits and credits and
balancing its accounts." This offers a system of rules and principles which govern the
format and content of financial statements. Accounting is a system of principles
applied to present the financial positions of a business and the results of its operations
and cash flows. Adherence to these principles will result in fair and accurate reporting
of this information.
Table 10.3

1. Responsibility

Accountant

Independent
accountant

Works for the company

Hired by the company as outsider
counsel

Salaried Employee

2. Nature of the
audit

May or may not work independently.
May be guided by the corporation
executives

certified

public

Individual comes in to perform an
audit for the benefit of the public,
the
shareholders and
the
government, in order to maintain
the public's confidence
More independent nature of the
audit

The ethical issues surrounding accounting practices are varied like:
z

Under reporting income

z

Falsifying documents

z

Allowing or taking questionable deductions

z

Illegally evading income taxes and otherwise engaging in fraud

To prevent accountants questioned in these types of conflicts:
American Institute of CPAs publishes their professional rules.
Financial Accounting Standards Board governs accounting practices and establishes
the Generally Accepted Accounting Principles (GAAP) that stipulate the methods by
which accountants gather and report information.
International Accounting Standards Committee is in the process of developing
standards that would allow foreign companies to sell securities in the US as long as
their accounting confirms to the International standards, though not comply with the
GAAP.
Accountants are also governed by the American Institute of Certified Public
Accountants (AICPA) which has a code of professional conduct. The code relies on
the judgement of accounting professionals in carrying out their duties rather than
stipulating a set of extremely specific rules.


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10.9 LET US SUM UP
The love of money is a healthy emotion as long as it is earned in the rightful way.

Everyone has a right to earn so as to live in comfort and happiness. Illegal Accounting
Principles and practices in amounting to fraudulent behaviour and conduct of
business. It should be treated as a heinous crime since it is equal to robbing the
livelihood of other people. Generally Accepted Accounting Principles and Practices
should be universally adopted and practiced if all of us have to live in equality, peace
and harmony.

10.10 LESSON END ACTIVITY
The practice of creative accounting, however, is not necessarily unethical. Explain the
statement.

10.11 KEYWORDS
Accounting: Discipline of measuring, communicating and interpreting financial
activity.
Ethics: Ethics is concerned with human behavior that is acceptable or "right".

10.12 QUESTIONS FOR DISCUSSION
1. The picture the accountant paints can be either enlightening or misleading,
depending on how he or she chooses to depict it'. Enlighten on this subject.
2. What is creative accounting? Explain.
3. What is acquisition? How it works?
4. What is acquisition accounting?
5. What is merger accounting?
6. Discuss on the ethical issues involved in finance.
7. 'Finance would be impossible without ethics'. Do you agree? Comment.
8. Which are the most visible aspects in finance? Explain each one of them.
9. Which are the principles found in finance ethics common with other aspects of
business? Explain.
10. Explain the three objectionable practices in selling financial products to clients.

Check Your Progress: Model Answers
CYP 1
1. Asset strip means the end of operating profits and turnover as trading assets
are realised and liabilities are settled to generate a one of non operating
profit.
2. The fair value of a fixed asset is represented by the cost of replacing it with
an asset which would give the same service. Because of inflation, an assets
fair value is usually greater than to its net book value.
CYP 2
1. 'a true and fair view.
2. 'one stop shopping.'


10.13 SUGGESTED READINGS
Manuel G. Velasquez, Business Ethics.
Laura P. Hart Man, Business Ethics.
John R. Boat Right, Ethics in Conduct of Business.
William A. Wines, Ethics Law and Business.

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