A Strategy for the Marriott School - SoBA

Report
The Crisis of Confidence in Business
W. Steve Albrecht, Associate Dean
Marriott School of Management
Brigham Young University
Presentation at the University of Montana
November, 2004
Let’s start with a story—who committed fraud in
this case?
• Rich Man--three friends
– Lawyer
– Accountant
– Minister
1/1/02
Rich Friend
50,000
Fifty Thousand and no/100--------------I M Smarter than U
The Accountant’s Check
Eternity
My Rich Friend
50,000
Fifty Thousand Dollars and no/100--------------------------------------
Honor Commitment
I. M . Smarter Than U.
Crisis of Confidence
• In recent years there has been a crisis of
confidence in the business world
• The market value of international stock exchanges
plummeted in early 2000
• Terrorists acts such as “9/11” were a contributing
factor
• BUT unethical behavior destroyed more wealth
than all terrorist acts combined!
5049
5000
4000
391%
3000
78%
2000
9/11
1000
1114
The NASDAQ “Bubble”
1996
1997
1998
1999
2000
2001
2002
2003
2004
Other markets looked very
similar
Total market loss worldwide…
$15 trillion
Why the Crash—What Happened?
Misstated financial statements: Quest, Enron,
Global Crossing, HeathSouth, WorldCom, Xerox,
Rite-Aid, Harris Scarfe, HIH, etc.
Executive loans and corporate looting: John Rigas
(Adelphia), Dennis Kozlowski Bernie Ebbers
(WorldCom)
Insider trading scandals: Martha Stewart, Sam
Waksal, One.Tel, etc.
IPO favoritism, incl. spinning and laddering:
Bernie Ebbers, etc.
Massive fraud by employees
Why the Crash—What Happened?
Excessive CEO retirement perks: Delta, PepsiCo,
AOL Time Warner, Ford, GE, IBM (consulting
contracts, use of corporate planes, executive
apartments, maids, etc.)
Exorbitant stock options for executives
Loans for trading fees and other quid pro quo
transactions: Citibank, Chase, etc.
Bankruptcies and excessive debt
Mutual Fund Frauds: Late trading and market timing
to benefit insiders and favored customers
Consequences of These Problems
•
•
•
•
•
•
•
•
•
•
•
Lost confidence in capital markets
Lawsuits—one company has over 3,000
Going out of business/bankruptcies
Lost reputation and bad press
Longer and more expensive audits, special inquiries
Fines & investigations
Damaged employees & reputations
Lost retirement and pension funds
Directors with personal liability, forced resignations
Losses from fraud
Significant legislative activity
Lost Reputation
The Cost of Bad Press
Largest Bankruptcy Filings
Company
Assets (Billions)
When Filed
1. WorldCom
2. Enron
3. Texaco
$101.9
$63.4
$35.9
July, 2002
Dec., 2001
April, 1987
4. Financial Corp of $33.9
America
5. Global Crossing $25.5
6. Adelphia
$24.4
Sept., 1988
7. United Airlines
8. PG&E
9. MCorp.
$22.7
$21.5
$20.2
Dec. 2002
June, 2002
March, 1989
10. Kmart
$17.0
Jan., 2002
Jan., 2002
June, 2002
How Costly is Financial Statement Fraud?
• Financial statement fraud causes a decrease
in the market value of a stock of
approximately 500 to 1,000 times the
amount of the fraud.
$2 billion drop in
$7 million fraud
stock value
Example: Martha Stewart
• Martha Stewart gained ~$46,000 by using
inside information
• Martha Stewart Living Omnimedia
shareholders lost ~$750,000,000 after
Martha’s arrest and ensuing publicity!
Fraud Against Organizations
A Costly Business Problem
• Large Fraud of $2.6 Billion
over 9 years
–
–
–
–
–
Year 1
Year 3
Year 5
Year 7
Year 9
$600K
$4 million
$80 million
$600 million
$2.6 billion
• In years 8 and 9, four of the
world’s largest banks were
involved and lost over $500
million
3,000,000,000
2,500,000,000
2,000,000,000
1,500,000,000
1,000,000,000
500,000,000
0
Year 1 Year 3 Year 5 Year 7 Year 9
Some of the organizations involved: Merrill Lynch, J.P. Morgan Chase,
Union Bank of Switzerland, Credit Lyonnaise, Sumitomo, and others.
Why Fraud Against Organizations is a
Costly Business Problem
• Fraud Losses Reduce Net
Income $ for $
• If Profit Margin is 10%,
Revenues Must Increase
by 10 times Losses to
Recover Affect on Net
Income
– Losses……. $100 Million
– Revenue…...$1 Billion
Fraud Robs Income
Revenues
Expenses
Net Income
Fraud
Remaining
$100
90
$ 10
1
$ 9
100%
90%
10%
To restore the $1 of lost
income, need $10 more
dollars of revenue.
Why Fraud Against Organizations is a
Costly Business Problem
• General Motors
– $436 Million Fraud
– Profit Margin = 10%
– $4.36 Billion in
Revenues Needed
– At $20,000 per Car,
218,000 Cars
• Bank
– $100 Million Fraud
– Profit Margin = 10 %
– $1 Billion in Revenues
Needed
– At $100 per year per
Checking Account,
10 Million New
Accounts
Fraud Internationally
Transparency International
1. Finland
2. Iceland
3. Denmark
3. New Zealand
5.Singapore
5. Sweden
7. Netherlands
8. Australia
8. Norway
8. Switzerland
11.
Canada
18. United States
21.
23.
54.
56.
66.
86.
132.
133.
Japan
France
Brazil
Mexico
China
Russia
Nigeria
Bangladesh
Why Did So Many Financial Statement
Frauds Occur?
1.
2.
3.
4.
5.
6.
7.
8.
9.
Good economy was masking many problems
Moral decay in society
Misplaced executive incentives
Unachievable Wall Street expectations—rewards for short-term
behavior
Large amounts of debt and other leverage
Nature of accounting rules
Behavior of auditing firms
Greed by executives, investment banks, commercial banks, and
investors
Educator failures
1. Good Economy Masked Problems
• With increasing stock prices, increasing profits and
increasing wealth for everyone, no one worried about
potential problems.
• People were making nonsensical investment
decisions—“irrational exuberance”
• How to value a dot.com company:
–
–
–
–
–
Take their loss for the year
Multiply the result by negative 1 to make it positive
Multiply that number by at least 100
If stock price is less than the result…buy
If not, buy anyway!
2. Moral Decay
• Attendees at the April, 1998 Business Week Forum
of Chief Financial Officers:
– 67% of CFOs said they had fought off other
executives’ requests to “misrepresent corporate
results”
– 12% of CFOs admitted they had “yielded to the
requests” while 55% said they had “fought off
requests” to misrepresent corporate results
• Honesty studies
– People are becoming less honest
– Less modeling and labeling of good ethical
behavior
Has There Really Been “Moral Decay”?
Data from the U.S.
• Dishonesty Is Increasing
– 12% in 1961
– 31% in 1986
• Organizations lose
between 1% and 6% of
revenues to fraud
• Insurance fraud in 2000
was $120 billion
• General Motors had $436
million fraud
• Large bank in recent year
We All Pay for
– 30% customers
Fraud!
– 70% employees
• Retail Losses
• $400 billion annually
• $9 per employee per day
(2002 Study)
– 6200 customer frauds
– 2100 employee frauds
– 3600 lawsuits
The Transformation of Arthur Andersen
• Early days of Andersen
– Leonard Spacek—epitome of ethics
– DuPont lost to a competitor because
Anderson would not agree with
accounting method
• Recent years
– Waste Management case
– Anderson turns a blind eye to abuses to
keep account
3. Executive Incentives
Meeting Wall Street’s Expectations
– Stock prices are tied to Wall Street’s
earnings forecasts
• Focus is on short-term (quarterly)
performance only
• Price is heavily punished for not meeting
forecasts
– Compensation is based on earnings &
stock price
• Bonuses tied to stock price
• Stock options—often far in excess of salary
Example: Bernie Ebbers, WorldCom
Million $
46.2
50
40
30
Salary
Options
20
10
0
0.935
Compensation 2000
4. Wall Street’s Expectations
• Investors want decreased risk and growing returns.
• Risk is reduced when variability of earnings is decreased.
• Rewards are increased when income continuously
improves.
Firm A
Firm B
Which firm will have the higher stock price?
Actual Complaint in $2.8 Billion
Financial Statement Fraud Case
“The goal of this scheme was to ensure that (the
company) always met Wall Street’s growing earnings
expectations for the company. (The company’s)
management knew that meeting or exceeding these
estimates was a key factor for the stock price of all
publicly traded companies and therefore set out to
ensure that the company met Wall Street’s targets
every quarter regardless of the company’s actual
earnings. During the period 1998 to 1999 alone,
management improperly inflated the company’s
operating income by more than $500 million before
taxes, which represents more than one-third of the total
operating income reported by (the company.)”
Actual Complaint in $2.8 Billion
Financial Statement Fraud Case
“The participants in the illegal scheme included
virtually the entire senior management of (the
company), including but not limited to its
former chairman and chief executive officer, its
former president, two former chief financial
officers and various other senior accounting
personnel. In total, there were over 20
individuals involved in the earnings
overstatement schemes.”
Meeting WS Projections
Firm
1st Qtr
Morgan Stanley
Smith Barney
Robertson Stephens
Cowen & Co.
Alex Brown
Paine Webber
Goldman Sachs
Furman Selz
Hambrecht & Quist
$ 0.17
0.17
0.17
0.18
0.18
0.21
0.17
0.17
0.17
Actual Earnings
Fraud
Reported EPS
Fraud (Millions)
$0.08
0.09
0.17
$62 M
2nd Qtr
$0.21
0.25
0.21
0.25
3rd Qtr
$0.23
0.23
0.24
0.28
0.21
0.21
0.23
0.23
$0.13
0.09
0.22
$61M
$0.16
0.07
0.23
$71M
Wall Street expectations were especially high for certain industries such as the
telecom industry (e.g. Global Crossing, ATT, WorldCom, Quest)
How People Got Involved
• The CFO instructed the chief accountant to
increase earnings by $105 million. The chief
accountant was skeptical about the purpose of
these instructions but he did not challenge
them. The mechanics were left to the chief
accountant to carry out. The chief accountant
created a spreadsheet containing seven pages of
improper journal entries, 105 in total, that he
determined were necessary to carry out the CFO’s
instructions. Over 20 people were involved in
making or instructing to make similar entries.
5. High Amounts of Debt & Other Leverage
• During 2000, Enron’s derivates-related liabilities
increased from $1.8 B to $10.5 B
• By 2001 Enron hid $25 B in off-balance sheet (SPE)
debt while on-balance sheet debt was $13 B
• WorldCom had nearly $100 B in debt
– Not only did Bernie Ebbers borrow $100 billion for
WorldCom but he also racked up over $1.3 billion in
personal debt while CEO of WorldCom
• Every company that committed financial statement
fraud had huge amounts of debt
In U.S. 186 public companies with $368 billion in debt filed
for bankruptcy in 2002—includes WorldCom, Conseco,
Global Crossing, United Airlines
6. Nature of Accounting Rules
• In the U.S., accounting standards are “rulesbased” instead of “principles based.”
– Allows companies and auditors to be extremely creative
when not specifically prohibited by standards.
– Examples are SPEs and other types of off-balance sheet
financing, revenue recognition approaches, merger
reserves, pension accounting, and other accounting
schemes.
– When the client pushes, without specific rules in every
situation, there is no room for the auditors to say, “You
can’t do this…because it isn’t GAAP…”
– It is impossible to makes rules for every situation
7. Behavior of Auditing Firms
• Failed to accept responsibility for fraud detection (SEC,
Supreme Court, public expects them to detect fraud) If
auditors aren’t the watchdogs, then who is?
• Became greedy--$500,000 per year per partner
compensation wasn’t enough; saw everyone else getting
rich (Andersen’s partners were jealous of Accenture
partner’s income)
• Audit became a loss leader
– Easier to sell lucrative consulting services from the inside
– Became largest consulting firms in the U.S. very quickly
(Andersen Consulting grew to compete with Accenture)
• A few auditors got too close to their clients
• Entire industry, especially Arthur Andersen, was punished
for actions of a few
8. Greed by All Parties
• Jeff Skilling, onetime CEO of Enron: “All that matters
is money.”
• One large investment bank issued $2 billion of Enron debt
it internally considered “legal but sleazy.” It received
huge fees for this issue.
• Example: Jack Grubman, CitiBank, and the million dollar
preschool
9. Educator Failures
• Haven’t taught “ethics” enough in the classroom
• Need to teach students about fraud—“Most students
wouldn’t recognize a fraud if it hit
them between the eyes!”
• Need to teach students
how to think—more
analytical skills; less
memorization
• Need to teach ethical
courage and ethical
leadership
How did we teach?
Professors
Lecture
Professionals
find similar
examples
and copy
(last year’s
work
papers
Assign Problems
at end of chapters
What did we teach? We
taught our students how
to copy!
Students
graduate and
get assignments
(e.g. perform audit)
Never really learn
or think analytically
Students can’t
work problems
Find similar
examples in the
chapters and
copy
The Fraud Triangle
1. Good economy
masked problems
2. Lack of controls
from board,
auditors
3. Nature of
accounting rules
4. Educator failures
5. Behavior of
CPA firms
Fraud
Triangle
Rationalization
Moral Decay in Society
1. Executive incentives
2. Wall Street
expectations—
rewards for shortterm behavior
3. Large amounts of
debt and leverage
4. Greed by investment
banks, commercial
banks, investors and
executives
Example of a Company
Gone Wrong
Enron: A Case of Complexity
• WorldCom was a $9 billion fraud but a simple one
– Capitalized expenses that should have been expensed
• Enron involved many complex transactions and
accounting issues
• “What we are looking at here is an example of
superbly complex financial reports. They didn’t
have to lie. All they had to do was to obfuscate it
with sheer complexity—although they probably lied
too.” Senator John Dingell
Enron’s History
• Born from merger of two pipeline companies in 1985.
• Incurred massive debt and no longer had exclusive
rights to its pipelines.
• Needed new and innovative business strategy
• Kenneth Lay, CEO, hired McKinsey & Company to
assist in developing business strategy—consultant
Jeffrey Skilling.
– Background in banking and asset and liability management.
– Recommendation: create a “Gas Bank”—buy and sell
natural gas
• Feb. 2001-- Fortune magazine names Enron “The Most
Innovative Company in America”--company worth $60B
• Dec. 2001 – Enron files the biggest bankruptcy in U.S.
history (now exceeded by WorldCom)
Enron
Andersen
Kenneth Lay –
Founding and last CEO
David Duncan –
Audit Partner
Jeff Skilling –
CEO from 2/2001
to 8/2001
Andrew Fastow –
Michael Odom –
Risk Mgt Partner
CFO
Nancy Temple –
Michael Kopper –
Assistant to Fastow
Firm Attorney
Enron’s Changing Business
Producer
Utility
2Wholesale
Industrial User
4”Extras”
3Retail
1Transportation
and Distribution
Total Revenues
Transportation
and Distribution
Wholesale
Services
Retail Energy Services
1998
$1,849B
$27,725B
$1,072B
1999
$2,032B
$36,287B
$1,807B
2000
$2,955B
$94,906B
$4,615B
Aggressive Nature of Enron
• Enron believed it was leading a revolution
– Pushed the rules
– Employees attempted to crush not just outsiders
but each other. “Enron was built to maximize
value by maximizing the individual parts.
– Enron traders were afraid to go to the
bathroom because the guy sitting next to
them might use information off their screen
to trade against them.”
Enron took more risk than others—
”it swung for the fences.”
The Motivation
• Enron delivered smoothly growing earnings (but
not cash flows)
• Wall Street took Enron on its word but didn’t
understand its financial statements
• It was all about the price of the stock. Enron was
a trading company and Wall Street normally
doesn’t reward volatile earnings of trading
companies.
– Goldman Sachs, a trading company, had P/E of 20
– Enron’s P/E was 70 times earnings
• In its last 5 years, Enron reported 20 straight
quarters of increasing income
Enron’s Arrogance
“Those whom the Gods would destroy they first make proud.”
Enron’s banner in lobby: Changed from “The World’s Leading
Energy Company” to “THE WORLD’S LEADING
COMPANY”
“Older, stodgier companies will topple over from their own
weight…” Skilling
Conference of Utility Executives in 2000: “We’re going to eat
your lunch”….Jeff Skilling
Special Purpose Entities (SPEs)
Enron’s principal method of financial statement fraud
• Originally had a good business purpose
• The SPE is really a joint venture between sponsoring company
and a group of outside investors
• To help finance large international projects (e.g. a gas pipeline
in Central Asia)
• Investors want risk and reward exposure limited to the
pipeline, not the overall risks and rewards of the associated
company
• Pipeline is to be a self-supported, independent entity with no
fear that the company will take over
• Outsiders must own >3% to qualify for off balance sheet
Manipulating numbers between entities
Hide Everything
Bad
Enron
Bring in
Everything Good
OffBalance
Sheet SPE
Going back and forth: Debt, cash flows, earnings,
Related party-transactions, investments, etc.
Enron’s Use of Special Purpose Entities (SPEs)
• To hide bad investments and poor-performing assets
(Rhythms NetConnections). Declines in value of assets
would not be recognized by Enron (Mark to Market.)
• Earnings management—Blockbuster Video deal--$111
million gain (Bravehart, LJM1 and Chewco)
• Quick execution of related-party transactions at desired
prices. (LJM1 and LJM2)
• To report over $1 billion of false income
• To hide debt (Borrowed money and not put on financial
statements of Enron)
• To manipulate cash flows, especially in 4th quarters
• Many SPE transactions were timed (or illegally backdated) just near end of quarters so that income could be
booked just in time and in amounts needed, to meet
investor expectations
LJM1 SPE
One Enron Example (the “Rhythms” transaction):
• Enron held Internet stock in company called Rhythms NetConnections
• Stock was restricted (couldn’t be sold for a certain period of time)
• Enron didn’t want exposure to risk of a price drop
• The solution was simple! Find someone else who believes the Rhythms stock price
would rise and was willing to sell a contract (a put option) to buy the stock in the future
at a set price (a hedge!)
• The problem was that Enron couldn’t find anyone willing to “do the deal”
• Another simple solution! Start a company (a Special Purpose Entity or SPE) to take the
other side of the transaction (Enron called it LJM1)
• Where did the financing come from?
– 97% from bank loan  Guaranteed with Enron stock
– 3% from entity other than Enron Andrew Fastow and others!
•
•
•
•
Enron gave $168 million in Enron shares to LJM1 (LJM1’s primary asset)
LJM1 gave Enron a note for $64 million and a put option valued at $104 million
When everything “settled out,” Fastow received $15 million for his $1 million investment
Enron got to “hedge” (i.e., not report) a $103 million market loss on its stock investment
Clue #1: Warnings about Enron
• In early 2001, Jim Chanos, who runs Kynikos
Associates, a highly regarded firm specializing in
short selling said publicly that “no one could
explain how Enron actually made money.” He
noted that Enron had completed transactions with
related parties that “were run by a senior officer of
Enron” and assumed it was a conflict of interest.
(Enron wouldn’t answer questions about LJM and
other partnerships.)
Clue #2: Fortune Article…March 5, 2001
• “To skeptics, the lack of clarity raises a red flag about
Enron’s pricey stock…the inability to get behind the
numbers combined with ever higher expectations for the
company may increase the chance of a nasty surprise.
Enron is an earnings-at-risk story…”
• “At the least, these sorts of hard-to-predict earnings are
usually assigned a lower multiple...In 1999 its cash flow
from operations fell from $1.6 billion the previous year to
$1.2 billion. In the first nine months of 2000, the company
generated just $100 million in cash. (In fact, cash flow
would have been negative if not for the $410 million in tax
breaks it received from employees’ exercising their
options.”
Clue # 3: Executives Abandon Enron
• Rebecca Mark-Jusbasche, formerly CEO of Azurix,
Enron’s troubled water-services company left in August,
2000
• Joseph Sutton, Vice Chairman of Enron, left in November,
2000.
• Jay Clifford Baxter, Vice Chairman of Enron committed
suicide in May, 2001
• Thomas White, Jr., Vice Chairman, left in May, 2001.
• Lou Pai, Chairman of Enron Accelerator, departed in May
2001.
• Kenneth Rice, CEO of Enron’s Broadband services,
departed in August 2001.
• Jeffrey Skilling, Enron CEO, left on August 14, 2001
Enron’s Cash Flows
• Enron’s cash flows bore little relationship to
earnings (a lot due to mark-to-market). On
balance sheet debt climbed from $3.5 billion in
1996 to $13 billion in 2001.
• Key Ratio
Net Income (from Operations*) – Cash Flow (from Operations**)
Net Income (from Operations*)
• Would expect to be about zero or slightly negative
over time
*From the Income Statement
**From the Statement of Cash Flows
Enron’s Cash Flow Ratio
4
3
2
1998
1999
2000
2001
1
0
-1
-2
3
6
9
months months months
Year
Negative Cash Flows: 1st three quarters in 1999, 1st three quarters in 2000,
1st two quarters in 2001.
Role of Investment & Commercial Banks
• Companies like CitiBank & JP Morgan Chase made
millions in loan interest and fees but hundreds of millions
in investment banking business
• Enron paid several hundred million in fees, including fees
for derivatives transactions.
• None of these firms’ analysts alerted investors about
derivatives problems at Enron.
• In October, 2001, 16 of 17 security analysts covering
Enron still rated it a “strong buy” or “buy.”
• Example: One capital management firm purchased
7,583,900 shares of Enron for a state retirement fund,
much of it in September and October, 2001
Role of Law Firms
• Enron’s outside law firm was paid
substantial fees and had previously
employed Enron’s general counsel
• Failed to correct or disclose problems
related to derivatives and special purpose
entities
• Helped draft the legal documentation for the
special purpose entities
Role of Credit Rating Agencies
• The three major credit rating agencies—Moody’s,
Standard & Poor’s and Fitch/IBCA—received
substantial fees from Enron
• Weeks prior to Enron’s bankruptcy filing—stock
traded at $3 per share—all three agencies gave
investment grade ratings to Enron’s debt
• These firms enjoy protection from outside
competition and liability under U.S. securities
laws
• Being rated as “investment grade” was necessary
to make SPEs work
Part II
What Was Done?
Fraud
Triangle
Rationalization
What Was Done?
I. Passed New Laws and Listing
Requirements
Fraud
Triangle
Rationalization
What the Laws/Guidelines
Attempt to Accomplish
Restore
Public Confidence
Align Directors
More Towards
Shareholders
Improve
Quality of
Financial
Information
Encourage
Ethical & Legal
Behavior
in Management
and Boards
Legislation in U.S.—Sarbanes Oxley
On July 30, 2002 President Bush signed into law the
Sarbanes-Oxley Act of 2002.
• Bolster public confidence
• Impose new duties and significant penalties for
non-compliance on public companies
•
•
•
•
•
Management
Boards of directors
Auditors
Attorneys
Securities industry
Summary of Sarbanes-Oxley Act
Title I: Public Company Accounting Oversight Board
Title II: Auditor Independence
Title III: Corporate Responsibility
Title IV: Enhanced Financial Disclosures
Title V: Analyst Conflicts of Interest
Title VI: Commission Resources and Authority
Title VII: Studies and Reports
Title VIII: Corporate and Criminal Fraud Accountability
Title IX: White Collar Crime Penalty Enhancements
Title X: Corporate Tax Returns
Title XI: Corporate Fraud Accountability
What Can Be Done?
II. Reducing the Pressure
Fraud
Triangle
Rationalization
Pressure Comes from…
• Focus almost exclusively on
– Stock price
– Earnings
• High levels of debt and other leverage
– Corporate
– Personal
• “Tone at the top”
• Peer pressure
Example: Enron’s Compensation Model
• Skilling— “Stock price is the only measure the
company should be concerned with.”
• Main reward: stock options
– Accelerated vesting if earnings growth >15%
• Cash bonus if stock price > index of tech stocks
• Employees rewarded for present value of sales—
regardless of cost of providing service
What Organizations Should Do
• Reduce compensation from stock options
• Reduce leverage from financial and
operating sources
• Focus on long-term measures: growth,
customer service, core business retention,
etc., rather than on single, myopic measures
like earnings alone
Set the “Tone at the Top”
• Talk often about long-term goals and
measures of performance
• Include long-term measures in
compensation system
• Stress ethics over performance
• Build a culture of ethics within the company
Example: Warren Buffett
 No quarterly statements
 Wants only long-term investors
 Invests in people
 Once said to his CEO’s:
“We can afford to lose money,
even a lot of money.”
“We can’t afford to lose
reputation—not even a shred of
it.”
Management Education Must Help
• Finance courses often claim stock price is
only valid measure
– Corollary—that earnings is most meaningful
accounting number
• Must develop other more comprehensive
measures meaningful performance for
employees and firms
What Can Be Done?
III. Improving our Ethical Strength
Fraud
Triangle
Rationalization
Questionable State of Ethics
Did You Cheat to Get Into Graduate School?
“Yes”
–
–
–
–
43% Liberal Arts
52% Education
63% Law and Medicine
75% Business
Source: Rutgers University survey of students
Questionable State of Ethics
MBAs
• 76% were willing to understate expenses that cut
into their companies’ profits
• Nearly all believe shareholder value is more
important than customer service
• Convicts in 11 minimum security prisons had
higher scores on an ethical dilemma exam than
MBAs
Questionable Ethics at Work
• 76% of employees observed a high level of
illegal or unethical conduct at work in the
past 12 months
• 49% of employees observed misconduct
that, if revealed, would cause their firms to
“significantly lose public trust”
KPMG 2000 Organizational Integrity Survey
Deterioration in Ethical Values
Year
College students who cheated in H.S.
Self-reported cheating
Believe cheating is common
Used cheat sheets
Let others copy work
Willing to lie to get job
Students who had stolen
1940 (20%)
1983 (11%)
1940 (20%)
1969 (34%)
1969 (58%)
2000 (28%)
2000 (35%)
Year
2002 (75-98%)
1993 (49%)
1997 (88%)
1989 (68%)
1989 (98%)
2002 (39%)
2002 (38%)
(Based on several different ethics studies)
Survey of Employees
• Most (65%) don’t report ethical problems
they observe
• 96% feared being accused of not being a
team player
• 81% feared corrective action would not be
taken anyway
• 68% feared retribution from their
supervisors
Source: Society of Human Resource Management
Will Our Ethics Improve?
Survey of High School Students
2002 2001
• 74% (71%) cheated on an exam in the last year;
45% (45%) said they did it at least twice in the last
year
• 93% (92%) lied to their parents in the past year;
79% (79%) say they lied twice
• 78% (78%) have lied to their teachers
• 37% (27%) said they would lie to get a job
• 38% (35%) took something from a store in the last
year
Josephson (2002)(2001)
Why is Dishonesty Increasing?
Modeling
Labeling
Honesty
Why Is Dishonesty Increasing?
• Bad Modeling/Lack of
Good Modeling
– Makes up our news—
more explicit than ever
– Focus of TV/movies
– Dishonest “leaders”
– Sports, business,
entertainment “heroes”
– Good models are rare
• Lack of Positive
Labeling
– Home….average
family spends 10 hours
less time together a
week than 20 years ago
– Vocabulary of
kindergarten children
– Schools
– Churches
Who Commits Fraud?
Normal Citizens
Fraud Perpetrators
Sample
No Significant Differences
Sample
Bank Robbers
Sample
Major Differences
While people who commit rape, murder, bank robbery and other
property offenses have distinguishing characteristics, fraud
perpetrators look more like more citizens than criminals!
Who Commits Fraud?
Demographics
•
•
•
•
•
•
•
Married
Active church members
Children
Good education
First-time offenders
Good employees
Don’t abuse alcohol
Who Commits Fraud?
Psychological Characteristics
•
•
•
•
•
•
•
•
Optimistic
High self-esteem
Achieving
Family harmony
Socially conforming
Self control
Kind
Sympathetic
Conclusion: Fraud Perpetrators Look Exactly Like Us!
Who Commits Fraud?
Length of Time With Company
•
•
•
•
•
Less Than 3 Years…………………....26 Percent
3-5 Years……………………………..14 Percent
5-10 Years……………………………30 Percent
10-20 Years…………………………..20 Percent
Over 20 Years………………………...10 Percent
Moral: Just because someone has been honest in the
past doesn’t mean they will be honest in the future.
Who Commits Fraud?
Perpetrators’ Ages
•
•
•
•
•
Under 26 Years Old……………...…14 Percent
26-35 Years Old…………………….28 Percent
36-45 Years Old…………………….36 Percent
46-55 Years Old………………….…12 Percent
Over 55 Years Old………………….10 Percent
Can Ethical Values be Taught?
Level 1: The Foundation
Personal Ethical Understanding
Right/wrong, Fairness, Honesty, Personal Integrity, Respect for Others
Level 2: Application to Business
Application of Ethics to Business Situations
Fraudulent Practices, Misleading Advertising, Unfairness
Personal Ethical Understanding
Right/wrong, Fairness, Honesty, Personal Integrity, Respect for Others
Can Ethical Values be Taught?
Ethical Courage
Willingness to Pay the Price for Ethics
Application of Ethics to Business Situations
Fraudulent Practices, Misleading Advertising, Unfairness
Personal Ethical Understanding
Right/wrong, Fairness, Honesty, Personal Integrity, Respect for Others
Can Ethical Values be Taught?
Ethical Leadership
Helping Others to be Ethical
Ethical Courage
Willingness to Pay the Price for Ethics
Application of Ethics to Business Situations
Fraudulent Practices, Misleading Advertising, Unfairness
Personal Ethical Understanding
Right/wrong, Fairness, Honesty, Personal Integrity, Respect for Others
WalMart’s View
Honest Employees
Will be Honest Always
Swing Group
Dishonest Employees
Policies Won’t Help Much
Could Go Either Way
Ethical Leadership will significantly impact an
organization since the vast majority, in this view,
can be influenced to behave ethically.
Is There a Universal Ethical Standard?
Yes—In Principle
Categorical Imperative: How would you want to
be treated?
Are you comfortable with a world with your
standards?
Christian principle: The Golden Rule
Do unto others as you would have them do unto you.
Luke 6:29-38
Thou shalt love thy neighbor as thyself. Luke 10:27
Taught in All Cultures
Confucius: What you do not want done to yourself, do not do to others.
Aristotle: We should behave to our friends as we wish our friends to behave to
us.
Judaism: What you hate, do not do to anyone.
Islam: No one of you is a believer until he loves for his brother what he loves
for himself.
Hinduism: Do nothing to thy neighbor which thou wouldst not have him do to
thee.
Sikhism: Treat others as you would be treated yourself.
Buddhism: Hurt not others with that which pains thyself.
Plato: May I do to others as I would that they should do unto me.
TREAT PEOPLE THE WAY
YOU WANT THEM TO TREAT YOU
Questions?

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