Financial accounting concepts and applications

Financial Accounting

The question is missing a clause. "…is more conducive to ethical behavior" than what? The word "more" invites comparison but there is nothing to compare the current environment to. Well, the current environment is not much different than any past environment. The regulatory environment does not dictate ethics, as ethics exist distinct from laws. Ethical behavior rests on how society itself defines ethics, and is only loosely related to the regulatory environment. So while there is definitely a tighter regulatory environment at least with the introduction of Sarbanes-Oxley and the PCAOB, these laws do not dictate ethics, just behavior (Lennox & Pittman, 2010). Indeed, an increasingly complex regulatory environment only serves to complicate the issue of individual ethics, and creates confusion among business practitioners between legal/illegal and right/wrong, the two operating entirely different conceptual spheres (Jennings, 2004).

The "business" environment is quite vague -- there are many facets to the business environment. Which facet are we working with here? There is nothing that indicates to me that there is any strong social control embedded in our society that would regulate business ethics. There is no defined set of ethics, and this leaves each company to determine its own ethical guidelines. Some are more specific and more strict than others, but society as whole does not contribute that much to these guidelines, and there is no real enforcement mechanism because most people do not make purchasing decisions based on a firm's perceived ethical behavior.

2. One of the cases of "ethical breach" that stands out is actually the Martha Stewart Omnimedia one. Stewart's breach was insider trading. She was convinced of charges relating to that incident, and it reflected negatively on her company's stock. The reason this is more interesting than a garden-variety criminal fraud case -- breaking the law is hardly a major ethical dilemma worthy of study -- is that it reflects the role of leadership. The Martha Stewart case involved her own personal activities, not those of her company. However, the market perceived that the CEO of Omnimedia was perhaps lacking in good ethics, and felt that there was the risk that such lack of ethics had been transmitted via Stewart to the culture of Omnimedia. Thus, the market punished the stock because of the risk of ethical violations. The issues we saw with the Tycos, Enrons and other fraud artists all involved the CEOs of those firms -- any CEO thought to lack an ethical compass could be in charge of an organization committing similar fraud. It turns out that was not the case -- there was no accounting fraud at Omnimedia -- but the perception that the company was vulnerable to accounting fraud alone did damage to the stock from which the company had to work hard to recover.

3.

In this case, the issue was uncovered via SEC investigation, as often happens. In a lot of cases, it takes a whistleblower, like Sherron Watkins at Enron, to trigger an SEC investigation. At Omnimedia, there was nothing to detect, but the link between leadership and ethics is the key to the case. The company had an ethical environment, but because of the leader's personal indiscretions it was felt that perhaps there was a lack of ethics at the company because normally that is how it works. In other cases, unethical managers worked with others in the organization to commit fraud, but in this case the unethical manager ran the company well anyway. The problem was that the market did not trust that.

4.

There are significant impacts to organizations that commit accounting fraud or other unethical behavior. In this case, the impact was to the stock price. This is something that cannot be underestimated, since the market value of the stock reflects the perceived value of the firm itself. Investors take the issue of accounting fraud very seriously. A company like Enron found itself all but wiped out by its fraud, and other companies lost most of their value or went into bankruptcy. With Omnimedia, there was the increased risk of accounting fraud and that alone hurt the company. Its reputation was damaged, the perceptions of its ethical behavior diminished and the stock price tumbled, just on actions that the CEO committed unrelated to the company. This highlights how important perceptions are with ethics -- it is necessary not just to be ethical but also to avoid the appearance that there is any risk at all of being unethical. The greater the consequences of fraud are in the market, the less likely people are to engage in it (Gerety & Lehn, 1997). Furthermore, there is the risk of litigation from shareholders or other stakeholders as well. Aggressive litigation has made it all the more important for the company to have specific procedures, training and programs in place to reduce the risk of fraud (Erickson, 2011).

5.

The big thing with ethical breaches is that they are not always the responsibility of the CFO. This is not about financial controls. It is about culture and leadership. The CFO must joint all members of the C-suite in providing ethical leadership for the organization. The company's ethical guidelines need to be written and communicated throughout the organization. The accounting department will need to have specific communication from the CFO about what is expected of them, since many ethical breaches to relate to financial accounting.