CHAPTER 5

Teaching Ethics in Corporate Finance Courses

Osaretin Kayode Omoregie

Lagos Business School

Introduction

This chapter is written in the strong belief that ethics should be taught both as a stand-alone subject and as an integral and embedded part of the various management disciplines, in this case corporate finance.¹ Both approaches are likely to be beneficial and mutually reinforcing.

It offers a guide on “how to teach ethics in finance” in a “practical and sensible way,”² rather than a discussion of the theories of teaching ethics in finance. I agree with Elegido³ when he states that “My experience is that there is nothing better calculated to kill for good the interest in ethics of the average business executive (or student whose main discipline is not ethics⁴) than a discussion of the “schools of thought.”

To this end, I offer the ARARD-V (Awareness, Recognition, Analysis, Reflection, Decision, and Values) framework, which I developed and have found very useful in teaching ethics to students within the corporate finance curriculum.

Ethics is a practical discipline.⁵ It is about how to act in pursuit of a given set of objectives in a manner that seeks to attain the best outcome for the collective good⁶ or as proposed by Immanuel Kant, to act in a manner that is morally sound and consistent with our moral duty to uphold that which is right.⁷ This is the so-called deontological moral theory that posits that the rightness or wrongness of an action is not dependent on the consequences but is dependent on whether or not they fulfill our moral duty.

The rest of the chapter makes a case for teaching ethics within corporate finance. It includes suggestions that teachers should find helpful in assisting learners become more aware of ethical issues in the initiation and execution of financial transactions, while developing capacity to resolve these issues in an ethically acceptable manner.

Why Teach Ethics in Finance?

One dominant view about corporate finance is that it deals with the maximization of value for shareholders through the sourcing and deployment of financial resources based on some risk-return trade-off criteria. Some modification to this view may be necessary, since it ignores the fact that there are other relevant stakeholders who may be adversely affected by our actions if we focus too narrowly on shareholders. Ethics is about acting in a way that ensures no deliberate or intentional harm is done to the counterparty. As far as is possible, we should act in a manner that achieves an outcome that portends the greater good for all likely to be affected by the decision. The decision maker is usually a fiduciary who is expected to act in the interest of the shareholder while being critically mindful of the impact of decisions and actions on other relevant stakeholders.

Opportunities thus exist for the decision maker to either act ethically in the interest of the shareholder, or in his own narrow interest. Extending this argument, the decision maker may be working within an organizational culture that overtly or covertly promotes the achievement of results as an end worthy of pursuit without regard to the means. This puts considerable pressure on the decision maker to act in an unethical manner in pursuit of corporate and personal goals, without regard to the harm caused to other stakeholders.

The growing number of corporate finance-related scandals lends further support to teaching ethics within corporate finance. In January 2016, Goldman Sachs agreed to a $2.385 billion civil penalty, $875 million cash payment and $1.8 billion in consumer relief in relation to its mortgage securities dealings, as a result of structuring, securitization, underwriting, and selling defective mortgage loans that it was aware, was doomed to default to unsuspecting home owners.⁸ Fresh in our memories is the 2012 Libor rigging scandal that led to estimated losses of $9 billion in fines (shareholders’ funds).

Also in 2012, a number of UK banks including Lloyds Banking Group, Barclays, Royal Bank of Scotland, HSBC, and Santander, were fined by the regulator and required to pay various sums to their customers to whom they had aggressively sold payment protection insurance (PPI) whether they required it or not. The estimated amount of PPI sold as at 2012 was about £34 billion against which the banks have had to make provisions of £9.4 billion following complaints by over 160,000 aggrieved customers. Analyst at JP Morgan estimates that the total cost will reach £15 billion. The Financial Times⁹ reported that the PPI¹⁰ was the most aggressively mis-sold retail product in UK banking history.

McWilliams and Nahavandi report that while business schools offering ethics in their curriculum are hoping for a positive impact on the behavior of managers, a lot still needs to be done, given the growing trend in ethical violations in business.¹¹

According to Blommestein,¹² ethics plays an insignificant role in modern economics and finance because economic and finance agents act in a “morally neutral” manner, believing that ethics is not a part of the core explanations of the efficiency and viability of financial markets. This, he argues, is due to the absence of robust analytical models for evaluating ethical issues (incentive problems) such as adverse selection, moral hazards, and principle–agent complications.

According to the GMAT Blog Hub, surveys of prospective employers suggested that 80 percent of employees planned to employ MBA graduates in 2014, while 44 percent planned to employ graduates of finance, up from 39 percent in 2013.¹³ Teaching ethics in finance should better prepare these future practitioners from going down the unethical path.

Finally, I am of the opinion that the delineation of business studies into finely defined bounded disciplines is an artificial creation that is perhaps a matter of research and pedagogical convenience, with little value or parallel in the real world. No business decision is purely a marketing, finance, or operations decision. All business decisions create transactions with potential economic, social, and environmental consequences, and thus must be contemplated with respect to the entire functional management skills at the disposal of the corporation and individuals undertaking these decisions.

The Samuel Curtis Johnson Graduate School of Management, Cornell University, perhaps persuaded by this logic, offers courses based on a blended curriculum and pedagogical tools such as multidisciplinary case studies, which recognize the multidisciplinary nature of business decisions. Some of these cases are taught by several faculties from different disciplines simultaneously (in the same class) to emphasize the very complex, multidisciplinary and integrated nature of business decisions.

The Meaning and Scope of Corporate Finance

Ross, Westerfield, and Jordan¹⁴ define corporate finance as a discipline concerned with the creation and maximization of the wealth of shareholders through the choice of long-term investments by the firm (risk-return preferences), the choice of a source of financing the investment (capital structure), and the management of the everyday financial activities of the firm (financial management).

Corporate finance is thus concerned with how firms allocate capital (“the capital budgeting or investment decision”) and how they obtain capital (“the financing decision”).¹⁵

Modern quantitative approach to finance is grounded in neoclassical economics, which assumes an idealized world in which market agents are rational and in which markets work smoothly and predictably without impediments such as transactions costs, taxes, and information asymmetry.¹⁶ The neoclassical general equilibrium framework makes little allowance for moral or ethical contemplation in analyzing financial markets since it regards the interactions of economic agents as based entirely on the price system, wherein prices conveys all relevant information.¹⁷

Blommestein¹⁸ suggests, however, that modifications of the neoclassical general equilibrium framework and New Institutional Economics (NIE) argues for the introduction of ethics and moral standards for the efficient functioning of financial markets through for example, the introduction of the modern theory of financial contracts, which suggests that ethical issues are incentive problems that can distort information among economic agents.

Like Blommestein,¹⁹ Robert J. Shiller’s argument (cited by Blommestein²⁰), suggests that ethics should be an integral part of the academic curriculum in business and finance because people are more than just economic agents seeking to maximize their utility and that moral standards play a key role in the efficient functioning of markets.

McHugh,²¹ while contending that there is as yet no cohesive theory for integrating finance ethics with mainstream economic and financial theory, agrees with Boatright²² and Tirole²³ that there is a need for incorporating ethics in the contemplation of finance theory and decisions.

The assumption about the rationality of economic agents and their quest for maximization of their utility has led to such theories as the efficient market hypothesis (EMH), which suggests that markets exploit all available information in setting the prices of securities, thus eliminating the opportunity for arbitrage.²⁴ This has resulted in a failure to verify the real value of underlying financial assets, thus leading to failure in detecting asset bubbles.²⁵

Ball however contends that these arguments are flawed because evidence, in fact, shows that most investment funds are actively managed, and the losses incurred by investment banks was as a result of trading strategies that were designed to exploit market mispricing in the first place.²⁶ In other words, the greed and unethical behavior (insider dealings, false representation, conflict of interest, etc.) of some finance practitioners in attempting to exploit “market inefficiencies,” and the “irrational exuberance”²⁷ of other investors in bidding up the prices of financial assets led to the creation of asset bubbles and the inevitable financial crisis.

Typical Ethical Issues in Corporate Finance

Our objective as instructors in teaching ethics within finance should be to assist our learners and decision makers develop strong ethical consciousness about their actions and its implications. At the risk of oversimplification, ethics is about the rightness or wrongness of our actions.

According to Solomon,²⁸ “the aim of ethics ... is not to teach the difference between right and wrong, but to make people comfortable facing the moral complexity.” This may not be entirely true. Yes, the teaching of ethics must clearly demonstrate the complexity of moral dilemmas involved. However, resolution of these dilemmas will be facilitated to a great extent if we can demonstrate the difference between what is morally and ethically right and wrong. To achieve this it might be helpful to simplify our approach by “building-in” ethical awareness as principles-based decision support processes, rather than “inspecting-in” ethical resolution mechanisms by the prescription of “universally” applicable rules and precepts. From the point of contemplating a corporate finance transaction, decision makers should be “conditioned” to ask questions about the potential ethical issues that each situation and transaction/ product presents and how these can be resolved across the stages of the transaction flow from conceptualization to design and execution, with a clear reference to what is right and what is wrong.

Potential ethical dilemmas within the corporate finance domain can be classified using the following criteria:

• Perpetrators of ethically questionable action

  • Individuals within firms for their own personal pecuniary and/or nonpecuniary benefits.

  • The firm having a corporate culture to advance its financial and competitive advantage over others, with the tacit acceptance of its board and employees.

• Victims of the consequences of unethical corporate finance decisions/activities

  • Counterparties in transaction

  • Clients, investors, and the society at large

  • Local/global financial markets

  • Governments.

• Impact/consequences

  • Economic and social harm, economic recessions.

  • Financial market volatility, uncertainty, increased risk, credit squeeze, and increased cost of funds.

• Domain within corporate finance

  • Investment decision/Returns evaluation

  • Financing/Risk assessment

  • Distribution—dividend, share repurchase.

• Objectives of the unethical practices

  • Asset mispricing

  • Risk underassessment and reporting

  • Returns overstatement

  • Unfair advantage—arbitrage/insider dealings.

Some examples of unethical practices dilemmas in corporate finance are as follows:

Investment/Capital Budgeting Decisions

A division of a major corporation has been underperforming for a number of years. Corporate head office is thinking of closing down the division. If this happens, the head of the division would lose his job along with a sizable number of employees who work in that division. A prospect exists for the division to pursue a market opportunity, which, if successful, would turnaround its fortunes. The decision criteria for evaluating the opportunity and required investment/return are the net present value (NPV) criteria. An initial assessment suggests that the NPV is negative. The division head, suggests to his financial analyst that there could be ways in which the NPV model and estimates of cash flows could be “adjusted” to achieve a “favorable outcome” with “room to spare.” The alternative is that “we all lose our jobs.”

Financing/Distribution Decisions

The share price of a company has been significantly underperforming it peers for some time now. Analysts are of the view that the company is losing market share irreversibly to its major competitors. To mask this loss of market share and drop in revenue and profit, the company had resorted to “channel stuffing” and reporting shipments to its distributors as revenue, while classifying some operating expenses as deferred assets/ prepayments. To create an appearance of corporate health, the company implements a plan for the leveraged repurchase of about 5 to10 percent of its outstanding shares over a period of time. The repurchase program improves the firm’s earning per share (EPS) and stimulated some interest in the shares of the firm. To support this interest, the company, through some of its senior executives, initiates a program for the proprietary trading in its shares. The compensation and bonuses of these executives is tied to the share price of the company.

Underlying Assumptions and Approach to Teaching Ethics in Finance

Corporate pressure for performance devoid of ethical values, coupled with individual greed, create an atmosphere within which unethical practices thrive in the world of corporate finance.²⁹ I am persuaded that a pragmatic and interest-grabbing approach, devoid of complex and abstract theoretical models is required to condition the minds of learners to the challenges of acting ethically in the context of business and finance.

The notion that acting ethically will result in long-term profit maximization of the corporation, and the actualization of the individual’s intrinsic need for self-actualization may be too simplistic an approach. Rather, this chapter argues for a more pragmatic approach which recognizes that taking the ethical high road may more often than not (at least in the short- to medium-term), create a “lone voice in the wilderness” and in some situations an existential challenge for the corporation and the individual responsible for taking these ethical decisions. But in the long run ethically sound decisions are ultimately the better path for the individual, the corporation, financial markets, and society at large.

Teaching Ethics in Finance Using the ARARD-V Framework

Boatright³⁰ and Cheng³¹ agree that the effectiveness of teaching ethics will be poor if the teachers and instructors do not have knowledge of ethics cases in specific business and management disciplines. Cheng³² advances this argument by stating: “The present research implies that if the ethics course of each academic department were taught by a lecturer who understands the specific industry case, the teaching effect would be improved.”

Cheng³³ finds from his empirical study that the intention of lecturers to teach ethics in their discipline will be enhanced and more effective “if the department heads enhance their teachers’ self-efficacy” by providing them with tools that can assist them teach ethics. The ARARD-V framework is my attempt to provide such a tool to assist lecturers in teaching ethics more effectively in corporate finance (Figure 5.1).

Figure 5.1  A Framework for teaching ethics in finance ARARD-V

A strong awareness of potential ethical challenges in any given situation would improve the capacity of the learner/decision maker in recognizing specific ethical dilemmas. This in turn should lead to better analysis and reflection on the ethical implications and consequences of the different options available to the decision maker, hopefully resulting in the right decision. The entire process should be driven by strong and healthy organizational culture rooted in strong ethical values; integrity, loyalty, trust, honesty, fairness, and so on.

The ARARD-V framework prescribes a set of questions that the decision maker should ask in any given situation and at different stages of the transaction process or financial product marketing, from conceptualization to design and execution and including postexecution evaluation of the impact of the decision (Table 5.1).

Table 5.1 A Framework for teaching ethics in finance ARARD-V

Transaction process flow/stages
Ethical sign posts	Conceptualize (Stop)	Design (Think)	Execute (Act/Reflect)
Awareness	Awareness is the starting point of ethical contemplation. It should cut across the transaction flowprocess from conceptualization to design and execution. It is a state of mind wherein all decision makers are actively conscious of the potential ethical implications of their actions in pursuit of their corporate financial goals. All financial transactions have potential ethical issues and decision makers must actively seek out these ethical dilemmas and deal with them in the design and execution of the transactions (including design and marketing of financial products in pursuit of their objectives). This mindset of awareness should act like an ethics compass or radar, which helps them spot potential areas of conflict of interest, possible harm to counterparties and other stakeholders, fairness, greatest good, and the creation and preservation of trust, and so on.
Recognition	What are the specific ethical issues that have arisen or are likely to arise as a result of this proposed transaction/ product?	How do I deal with these specific issues in the design/re-design of this transaction/ product to ensure that I am dealing adequately with the issues of insider abuse, conflict of interest, breach of fiduciary responsibilities, potential fraud, deliberate misrepresentation, harm to counter parties, and so on?	In the process of execution, can I reasonably say I have contemplated all possible ethical consequences of my actions? Am I motivated by my fiduciary responsibility to the shareholders consistent with a desire to achieve a beneficial outcome for the greater good, with a concern for balance between economic, social, and environmental outcomes? Am I satisfied that my desired outcome should not be profit maximization for its own stake, value maximization with a narrow focus on shareholder interest, or personal benefits at the risk of harm to others and breach of my fiduciary duties and other ethical and legal obligations?
Analysis/Reflection	Who are the critical counterparties/stakeholders that may be impacted by this decision? Am I fulfilling my responsibility as a fiduciary and am I likely to be in breach of my fiduciary responsibilities? Is this decision/ transaction likely to (deliberately) harm anyone? How? Can this harm we averted?	Have I put in place specific actions (including terminating the transaction/ product if that is what is required) to ensure the ethical dilemma is resolved without deliberate or avoidable harm to counterparties/ stakeholders?
Decision	Is this transaction/ product safe to execute/sell for all concerned? Is there adequate provision for a stop/ reset procedure in the event that it becomes clear in the course of execution that this decision may cause avoidable harm to counterparties/stakeholders?	Can this transaction pass the “look-in-the-mirror” test? In other words, can I stand behind my decision in all good conscience and not behind some legal loophole that seeks to validate my unethical actions on the basis of legality rather than moral and ethical values, remembering that not all that is legal is ethical?
Values From conception through to design and execution, am I driven by a corporate and personal culture, value and support system that promotes strong ethical awareness and a focus on outcomes that do the least harm and promote the greater long-term good rather than short-term corporate or personal gains at the expense of others? Does the corporate value and reward system within which I operate explicitly promote ethics as a goal worthy of pursuit for its own sake?

Teaching Ethics in Finance: Pedagogy, Tools, and Strategies

Our objective as teachers should be to ensure that sufficient and sustained level of interest is generated in the learners (and the instructor) and that real learning takes place at the level of comprehension, synthesis, and evaluation (Bloom’s taxonomy). Our goal with respect to the teaching of ethics in corporate finance should be to engage the students at the levels of cognition (awareness, knowledge, and contemplation of ethical issues in corporate finance), psychomotive (consistently acting in line with their knowledge), and emotive (an enduring and positive change in attitude toward ethical issues in corporate finance).

At the Lagos Business School (LBS), our primary pedagogy and learning tool is the case-study method and is rooted in the core philosophy and mission/vision of the school, which seeks to develop ethically minded and technically competent managers.³⁴ Cheng,³⁵ Eschenfelder,³⁶ and Overton³⁷ find an increasing trend in the use and effectiveness of case studies in teaching ethics across management disciplines.

I have however found it beneficial to use a mix of pedagogical tools including cases, role-play, group presentations, videos, and computer-based simulations. I also encourage the use of live ethics cases and videos, which involves current situations. McWilliams and Nahavandi report that this is a very effective method of teaching ethics because it involves current ethical violations, increases awareness of the complexity of ethical challenges, promotes immediate application and promotes personal emotional engagement with the case.³⁸

These videos are either downloaded files or streamed live in class from video media channels such as YouTube™. An example is the five-minute news reel from Sky News³⁹ relating to the Tesco profit misstatement and the Libor rate rigging scandals.⁴⁰

The quantitative nature of finance may lead students into believing that finance is morally and ethically neutral,⁴¹ and ethics (a subjective, relative, and unquantifiable variable) does not come into the analysis. They should be encouraged to expand their case analysis criteria to include a qualitative and quantitative ethical dimension. Sufficient time should be allowed for the discussion and “resolution” of identified ethical dilemmas and an incorporation of the results in moderating conclusions reached from a purely quantitative financial analysis. The resulting decision is an “ethics-adjusted” decision.

Let us illustrate this approach with a simple case scenario, the ABC Limited minicase, using the ARARD-V framework.

The case scenario is deliberately conceptual, qualitative, and simple to enable us focus on the points being illustrated. Where corporate finance is contemplated as being ethically neutral, the only decision rule that would matter is the choice of an option(s) that maximizes value for shareholders. That is the option that results in cash flows with the highest positive NPV. The ethical considerations in the decision are not a relevant cash flow and so are not reflected in the analysis.

Using the ARARD-V framework students are reminded that the creation, maximization, and distribution of value, the domain of corporate finance, cannot be complete if the process/decision results in deliberate or avoidable harm to some counterparties or related stakeholders. Values (“V” in the framework) such as integrity, trust, fairness, and so on, must underlie the problem analysis and decision. The decision maker must: (“A”) have a general awareness of potential ethical dilemmas; (“R”) recognize specific ethical issues in the context of the problem; (“A”) analyze and (“R”) reflect on the “ethics” and impact of a course of action on the counterparties, stakeholders and shareholders; and (“D”) evaluate the consequences of a decision choice on these constituencies.

In the case of ABC Limited, let us assume the NPV analysis suggests that outsourcing production to another region is the option with the highest positive NPV. In a nonethics neutral corporate finance class, we would evaluate the ABC Limited and moderate the results of our financial NPV analysis from an ethics perspective using the ARARD-V framework as follows (Table 5.2).

Table 5.2 Analysis of ethics in finance using the ARARD-V framework: The ABC limited case

Transaction process flow/stages Company ABC limited Problem: Declining operating performance and erosion of shareholder value due to high production/operating cost and increasing lower cost competition. Potential existential threat. Decision options: (1) Maintain status quo but seek opportunities for lowering production and operating costs; (2) Relocate production to identified region with lower labor and production cost; (3) Outsource production to identified producer with lower cost output.
Ethical sign posts	Conceptualize (Stop)	Design (Think)	Execute (Act/Reflect)
Awareness	At this stage, the decision maker is expected to have a general awareness that all decision options have potential qualitative (and perhaps quantitative) ethical issues that should be evaluated beyond the obvious quantitative financial issues. The decision maker should think and actively recognize that the scenario is not ethics neutral and so should stop to reflect on these issues, recognize/identify all the specific ethical dilemmas in the options available. Next, the decision maker should analyze and reflect on the relevant stakeholders and impact of each option on these stakeholders in terms of avoidance of harm, fairness, common good, trust/integrity, reputation, social responsibility, etc. This broad ethical awareness and consideration should moderate conclusions drawn from the quantitative financial analysis in reaching the final decision.
Recognition	If we chose to outsource production, what control do we have on the quality and safety of the production inputs? Who is likely to be harmed if the inputs are unsafe? In relocating production outsourcing, why is labor so cheap? Is child labor being employed? Are employees being treated fairly? Is the proposed production technology and method in the new region environmentally safe? In using the logistics/customs agents as consultants, are we breaking any laws, or are we also “outsourcing” an illegality? If we do continue in our home base, do we have enough time to consider and execute other options that can reverse the situation in the medium- to long term and prevent the business from going under in the short term?	In negotiating a potential outsourcing contract, I have insisted on the use of labor practices that are transparently fair and auditable. I have also insisted on the use of production inputs that are of reasonable quality consistent with my product representation to my customers and that are safe for use. I am sure that the production technique being used by the outsourcing contractor, or our production partner is environmentally safe and measures up to high safety standards, not minding the permissible/questionable safety standards in the region.	I have contemplated all possible ethical consequences of my decisions and proposed actions and I feel reasonably satisfied that my decision will not deliberately cause harm to any person and the outcome will be fair, socially and environmentally responsible without harming the company and its shareholders economically. I have moderated my financial analysis to the extent possible and reasonably required by the conclusions reached from my ethics analysis. My decision is purely motivated by my personal integrity and fiduciary responsibility to the shareholders, and is consistent with a desire to achieve a beneficial outcome for all concerned and for the greater good, with a concern for balance between economic, social, and environmental outcomes. I am not motivated by any desire for unfair personal gains, whether pecuniary or otherwise. I am satisfied that my desired outcome will not maximize profit for its own stake, based on a narrow focus on shareholder interest, or personal benefits at the risk of harm to others and breach of my fiduciary duties and other ethical and legal obligations. I defend my final decision legally, morally, ethically and on the basis of sound financial and economic benefit.
Analysis/Reflection	All critical counterparties and stakeholders for the various options available have been identified along with the ethical issues relating to each. For example, the staff of ABC Limited who will likely lose their jobs if the production relocation or outsourcing option is adopted will be treated as fairly as the circumstance allows. The potential harm to customers if poor quality or unsafe inputs are used in the production has been clearly identified and fully mitigated. I am accepting only those residual harms that it is fair to accept in the circumstances. My decision is not likely to be unfair or deliberately harmful to any stakeholder and is for the greater good. I have only accepted collateral harm to relevant stakeholders only to the extent that it is fair to accept this.	The costs, cash flow implications, and risks of putting ethical safe guides in the design of and execution of the various options available to me have been reasonably well estimated and reflected in my adjusted quantitative analysis. For example, new cash flow estimates and risk-adjusted cost of capital. How should these identified potential ethical challenges affect my estimation of relevant cash flows? The relevant cash flows being evaluated for all the options reflect the true and fair inflows and outflows that are reasonable expected to be realized and have not reflected unfairly realized favorable cash flows (e.g., illegally reduced import duty rates). I have put in place specific actions (including the possibility of terminating the transaction/product if that is what is required) to ensure the ethical dilemma is resolved without deliberate harm to counterparties/ stakeholders.
Decision	In my considered opinion, I have diligently evaluated all the possible ethical challenges in the various options and I have decided on an option that meets the highest possible ethical standard and is best to execute for all concerned. I have put in place adequate provisions for identifying and dealing with any previously unidentified ethical issues with the option finally decided upon and where possible the transaction can be stopped if the likely harm to stakeholders/counterparties and customers is unreasonably high.	This option will pass the “look-in-the-mirror” test. I can stand behind my decision in all good conscience and not behind some legal loophole that seeks to validate my unethical actions on the basis of legality rather than moral and ethical value (e.g., I have not chosen to outsource the logistics and customs duty contract to an agent who will illegally evade the payment of the correct duties).
Values I do not feel under undue pressure to compromise my values in taking this decision. From conception through to design and execution, I am driven by a culture and value system that promotes strong ethical awareness and a focus on outcomes that do the least harm and promote the greater long-term good rather than short-term corporate or personal gains at the expense of others. I have not been unduly motivated by a need to maximize my personal reward and bonuses by compromising on rigorous ethical standards.

The ARARD-V framework forces a rigorous consideration and resolution of the ethical challenges previously ignored by students, leading to a rethink of the decision previously taken from purely ethics-neutral financial analysis.

Another point worth noting and stressing to learners when teaching ethics in corporate finance is the reality that most ethical issues present themselves as dilemmas, tough choices between alternatives, each with some adverse or less than desirable consequences. Put simply, there is usually a cost to being ethical. The approach to resolving these dilemmas is to take the option that will do the least harm (or not deliberately cause harm/minimize collateral harm) to the counterparties, is reasonably fair to all parties as far as can be managed, and will work out for the greatest common good.⁴²

In the ABC Limited scenario, it can be reasonably speculated that continuing with the status quo may create the greatest existential threat to the company. However, assuming that with respect to the other options of either outsourcing production or relocating production, we can satisfactorily resolve the ethical issues around fair labor practices, safety and quality of inputs, environmentally sound production processes, and correct and legal duty payments, then while either of these options may secure the business as a going concern, a significant number of staff may lose their jobs. The question then becomes how do we disengage them fairly and not create the impression that we are preserving shareholders investment and wealth by sacrificing staff. In other words, we accept a level of collateral harm (staff disengagement) only to the extent that it is fair to accept this and managed in a humane manner.

It is also possible that a rigorous attempt to quantify and reflect in the cash flow analysis the cost and benefits of resolving the ethical challenges for the options to outsource or relocate production, may result in unfavorable NPV estimates, making the status quo option(with its existential threat) the better one on the basis of our “ethics-adjusted” NPV calculations. The apparent preliminary conclusion then reached is that we may be sacrificing the company on the altar of being ethical as a business. This of course does not consider the possibility of other innovative ways of improving the fortunes of the company, perhaps even selling the company to a willing competition, a decision that opens up a whole new set of ethical contemplations.

Obviously, there is no silver bullet for resolving ethical business problems. A more rigorous framework for resolving these challenges is outside the purview of this chapter. The chapter objective is to make the case that corporate finance decisions are not ethics-neutral. The ethical challenges can be complex and challenging. Students of finance who will become decision makers in the corporate finance domain of the business world must be attuned to these challenges.

Developing Versus Developed Country Perspective

The universality of ethical principles is well established. There is no developing country ethics that is different from developed world ethics.⁴³ However, there exist some significant differences between the developing world and the developed world as it relates to the context within which ethical dilemmas occur and how they may be resolved. It is the responsibility of the instructor to point out the likely contextual differences and suggest ways in which the decision maker will need to make adjustments in the decision process, without compromising on the ethical standards.

Some of these contextual differences, especially as it relates to decisions within the domain of corporate finance include: relative differences in legal systems, sophistication and regulation of financial markets, corporate governance structures, social expectations, and environmental concerns. These differences are summarized in Table 5.3 below.

Table 5.3 A contextual comparison of ethics in finance between a developing and developed country

Contextual criteria	Developed world	Developing world	Likely implications	Instructor teaching responsibility
Legal systems, protection of property rights, efficiency of the judiciary, and enforcement of the rule of law.	Strong	Weak	The incentive for corruption and unethical practices is higher in the developing world, simply because you are more likely to get away with it.	The instructor in corporate finance in a developing world context needs to emphasize that while conditions may create higher incentives for unethical behavior, less chance of being sanctioned and less social revulsion or public outrage for unethical acts, the guiding principle should be to avoid deliberate harm to others and accept only those collateral harm that is fair to accept given the facts at our disposal.
Strength and sophistication of financial markets and market participants.	Strong, more sophisticated, relatively better regulated.	Weaker, less sophisticated. Less effective regulation. (Amao and Amaeshi 2008).	Higher incentive in developing world for the unethical manipulation of financial systems and asset prices.
Corporate governance structure and institutional shareholder activism.	Stronger and better structured. (Black 1998).	Relatively weaker.	Institutional shareholder activism provides stronger oversight arrangement and is a deterrent to unethical behavior in developed countries compared to developing countries (Gillian and Starks 2007).
Social expectations	Less pressure on individuals to act unethically in other to attain some socially acceptable economic standard.	Social expectations are higher and exert more pressure on the individual to act unethically to attain social and economic advancement.	The absence of social welfare systems puts financial pressures on decision makers in developing countries.
Environmental concerns	More concern for the impact of corporate economic and financial decisions and activities on the environment.	Relatively less concern for the impact of corporate economic and financial decisions and activities on the environment.	Harm to the environment is not often viewed with an ethics frame in developing countries.

Conclusion

Ethics is about acting in a way that is consistent with our moral duty to others, which includes a concern to minimize harm to them, accepting only those collateral harm that is fair to accept, or where the likely harm is not unreasonably high.⁴⁴

The case was made that teaching ethics as an embedded part of corporate finance can yield positive results in getting students and decision makers to better appreciate the complexity of corporate finance ethical dilemmas and how to make better ethical judgment and decisions, which should go a long way in reducing the high incidence of corporate finance scandals.⁴⁵

Following Boatright⁴⁶ and Cheng,⁴⁷ I argue that teachers are better able to teach ethics in corporate finance if they are subject matter experts and if they are equipped with tools that can assist them in teaching ethics. I then offered some suggestions on how to teach ethics in corporate finance using traditional case studies⁴⁸ and live cases.⁴⁹

Finally, I demonstrated the ARARD-V framework, which I have found useful in teaching ethics in corporate finance.⁵⁰ It is hoped that the use of the framework and other suggested tools would make the teaching of ethics in corporate finance easier and rewarding for you as a teacher, and beneficial to your students.

Suggested Exercise

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¹ McWilliams and Nahavandi (2006).

² Ogunyemi (2015).

³ Elegido (1996, 3).

⁴ Comments in parenthesis are mine.

⁵ Elegido (1996).

⁶ Elegido (1996); Reynolds (2011).

⁷ Laudon and Laudon (2006).

⁸ www.marketwatch.com/story/goldman-sachs-reaches-deal-to-pay-238-billion-fine-over-mortgage-securities-2016-01-14

⁹ Financial Times, Monday, October29, 2012, page 3; PPI Scandal—“Scale of mis-selling furore shocks industry.”

¹⁰ PPI is supposed to be a simple consumer protection product designed to cover borrowers’ loan repayments if they fell ill or lost their jobs. Unfortunately, the PPI was packaged and sold to consumers such as students, self-employed and foreign nationals who were ineligible to make a claim, and at an add-on cost of as much as 20 percent on the cost of the personal loan being insured. Banks, riding on a defective pay incentive structure, and in a bid to remain competitive and profitable in the face of the global financial crisis, designed and “force fed” the product to its unsuspecting customers.

¹¹ McWilliams and Nahavandi (2006).

¹² Blommestein (2006).

¹³ www.mba.com/africa/the-gmat-blog-hub/the-official-gmat-blog/2014/may/employer-demand-for-mbas-high-in-2014.aspx

¹⁴ Ross, Westerfield, and Jordan (2000).

¹⁵ Constantinides, Harris, and Stulz (2003).

¹⁶ Constantinides, Harris, and Stulz (2003).

¹⁷ Blommestein (2006).

¹⁸ Blommestein (2006).

¹⁹ Blommestein (2006).

²⁰ Blommestein (2006).

²¹ McHugh (2006).

²² Boatright (1999).

²³ Tirole (2006).

²⁴ Ball (2009).

²⁵ Ball (2009).

²⁶ Ball (2009).

²⁷ A phrase credited to Alan Greenspan, Chairman of the U.S. Federal Reserve in 1996.

²⁸ Solomon (1992).

²⁹ As an example, see the PPI scandal discussed earlier in the chapter.

³⁰ Boatright (2008).

³¹ Cheng (2013).

³² Cheng (2013).

³³ Cheng (2013).

³⁴ Alos (2013).

³⁵ Cheng (2013).

³⁶ Eschenfelder (2011).

³⁷ Overton (2006).

³⁸ McWilliams and Nahavandi (2006).

³⁹ www.youtube.com/watch?v=TzA9gzbiRaM

⁴⁰ www.youtube.com/watch?v=l_UKGiaiTcc

⁴¹ Blommestein (2006).

⁴² Reynolds (2011).

⁴³ Elegido (1996, 3).

⁴⁴ Reynolds (2011); Laudon and Laudon (2006); Elegido (1996).

⁴⁵ McWilliams and Nahavandi (2006).

⁴⁶ Boatright (2008).

⁴⁷ Cheng (2013).

⁴⁸ Cheng (2013); Eschenfelder (2011); Overton (2006).

⁴⁹ McWilliams and Nahavandi (2006).

⁵⁰ Cheng (2013).

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