Corp Gov & Ethics Exam #2

Enron CEO

Jefferey Skilling

Enron Founder

Kenneth Lay

Fragmentation and Plausible Deniability - 5 Signs Your Organization Might Be Headed for an Ethics Scandal

When a corporate scandal occurs, it is common for leaders to deny any personal knowledge or responsibility. These hollow-sounding explanations could be true as well, but disingenuous. A leader doesn't need to personally sign off on a bribe payment to hold responsibility for how employees have been socialized into an organization and what type of behavior is rewarded. However, organizational complexity and a lack of clarity in roles can help justify conditions in which each decision is judged in isolation, so no one is held broadly accountable

Urgency and Fear - 5 Signs Your Organization Might Be Headed for an Ethics Scandal

When a corruption scandal occurs, leaders tend to describe events in terms of pressure, necessity, and what the company needed to do to "survive." This perception of external competitive threats is used to justify the creation and maintenance of toxic incentives within the company and this urgency will mask any efforts to raise concerns.

Investment Banks - Watchdogs who dropped the ball

two conflicting responsibilities: help a company raise funds through issuing stocks or bonds, and to provide independent investment advice to investors. The two parties they serve have different objectives. The companies want to keep their stock price as high as possible while investors want to buy stocks as cheaply as possible. To avoid this conflict of interest, investment banks are supposed to maintain a "Chinese Wall" between the banking and analyst divisions. The Enron case shows did not exist due to pressure on analysts to stay bullish. Since analyst compensation was directly tied to how much banking business they brought in or maintained, they were incentivized to fraudulently promote stocks with whom they maintained off-the-books partnerships. Banks made large profits by maintaining partnerships with companies like Enron, not only by pumping up Enron's buy ratings but also by underwriting fees.

Daily returns deviate from the customary "random walk" in efficient market - Asset Price Bubbles

"Random walk" is violated by high serial correlation in daily returns. In efficient market conditions, it should not be possible to predict tomorrow's return based on a trend analysis of recent returns in the past.

SOX Title II

Auditor Independence. -Creates standards for external auditor independence -Goal is to reduce conflicts of interest -Auditor approval, audit partner rotation, auditor reporting requirements

Incompetence description & remedy - Fighting Financial Crises Problems and Remedies

Bad management choice is not the sole cause-compounding of smaller bad decisions - Replacement of employees, coordination, a culture of high reliability

Runnable debt and maturity mismatch description & remedy - Fighting Financial Crises Problems and Remedies

Banks borrow short and lend long, which exposes them to the risk of a liquidity crisis when lenders choose to withdraw their funds simultaneously - Have adequate reserves against runs and losses

WorldCom CEO

Bernard John Ebbers

SOX Title III

Corporate Responsibility; topics include 1. Public company audit committees 2. Corporate responsibility for financial reports 3. Improper influence on conduct of audits 4. Forfeiture of certain bonuses and profits

From the documentary "Bigger than Enron," describe how the system of controls were eroded by conflicts of interest, as well as by congressional intervention. Be sure to address the other 2 specific cases in which Anderson auditors allowed misleading or fraudulent accounting practices.

Corporate watchdogs, the bankers, lawyers, regulators, politicians, and above all the accountants, failed to prevent Enron and other scandals from happening. Congress weakened the protections and tied the hands of regulators, making it easier for aggressive companies to push the envelope. Three political battles of the decade's accounting wars was the fight over stock options, the fight over tort reform, and separating accounting firm's auditing and consulting practices. 1. Sunbeam - used simple accounting tricks to paint a picture of turnaround in earnings that didn't exist. Dunlap stood to make more than 200$ million personally if they could keep Sunbeam's stock high. When they ran out of tricks, they declared bankruptcy. 2. Waste Management - the company had exaggerated its earnings by 1.7 billion. The SEC found a long running cover-up by both Waste Management as well as Anderson. While they paid a steep price in stockholder settlements, no one went to jail.

WorldCom whistleblower

Cynthia Cooper

Lehman Brothers CEO

Dick Fuld

Theranos CEO

Elizabeth Holmes

Analyze the role of Elizabeth Holmes' charismatic leadership in influencing Theranos' corporate governance and investor decisions. Discuss how such leadership can be both an asset and a liability for startups. -Theranos The Unicorn that Wasn't

Elizabeth Holmes' charismatic leadership played a pivotal role in success. ability to inspire, communicate a vision, and attract high-profile endorsements garnered significant attention and investment. However, such leadership can be a double-edged sword for startups. Charismatic leaders might suppress dissenting voices, create culture where challenging status quo is discouraged, or overshadow potential issues with their personal brand. Holmes' charisma may have blinded some investors and board members to the company's technological shortcomings. when a company's value and brand are deeply intertwined with its founder's reputation, it becomes vulnerable to negative revelations about founder, as concerns and criticisms grew, the valuation and trust decreased. For shareholders, this tie means that any scandals with founder can lead to financial losses. underscores importance of diversifying company's brand identity ensuring that value is based on results, rather than founder's persona.

SOX Title IV

Enhanced Financial Disclosures. -We must audit and report on internal controls -Off balance sheet transactions and stock transactions

Describe the similarities and differences between the corporate structure failures of Enron and WorldCom?

Enron and WorldCom engaged in financial and accounting fraud to inflate their bottom line, and ended up the same way: bankrupt. The differences lie in difficulty of execution. Enron developed an incredibly complexcorporate structure, with off-the-balance-sheet financing, special purpose entities to off-load debt, top executives as micromanagers These factors made it difficult to assess the company's true financial position. WorldCom's fraud was simpler, as they continuously decreased reserve accounts to cover liabilities of acquired companies and misclassified operating expenses as long-term investments.Both companies possessed a weakness of internal controls, which led to minimal transparency in their financial reporting In both, there was a failure in corporate governance and the board of directors to exercise appropriate oversight

Enron Scandal - The Sarbanes-Oxley Act Details and Evaluation

Enron, the energy company, became a large trading platform for derivatives in the energy market. Enron was not following standard accounting practices so that they could make the company appear financially healthy. Specifically, Enron used SPEs (Special Purpose Entities) to hide debt off of their balance sheet and used mark-to-market accounting so that they could overstate the expected value of their revenue pipeline. These practices were exposed, and Enron had to file for bankruptcy, losing investor confidence in the markets. In order to restore confidence, the SOX Act was developed to reform corporate governance and financial reporting.

Human Excesses and False Beliefs - "Understanding the Credit Crisis of 2007-2008."

Excess of individual self-interest, greed, unanchored optimism, and hubris were primary characteristics that affected numerous parties in the housing market and financial system and further drove the housing bubble. Home buyers, local banks, mortgage originators, securitizers, and investment banks were incentivized to engage in subprime borrowing and lending through the compensation structure, claiming that the designing of securitized products accounted for all downside risk without hard evidence to support such beliefs.

Analyze the ethical considerations explored in the movie "The Inside Job" regarding the behavior of financial executives and government advisers. What conflicts of interest are revealed, and how do they shed light on the systemic issues within the financial sector? : "Inside Job"

"The Inside Job" exposes several ethical breaches within the financial sector, particularly focusing on the behavior of executives and government advisers. It highlights conflicts of interest where executives took risks at the expense of the public and even their own companies for personal gain. Moreover, the documentary points out how high-level government advisers, economists, and academics were often paid consultants for financial firms, raising questions about their impartiality when shaping public policy or providing public analysis of the economy. For instance, it suggests that some influential economists who publicly advocated for deregulation also had significant financial relationships with the industry they were supposed to regulate. These conflicts point to systemic issues of accountability and transparency within the financial sector, where personal profit often took precedence over public good, contributing to reckless behaviors that led to the crisis.

Describe the roles and conflicts of interest faced by at least four stakeholders of Enron and how they contributed to the fall of Enron. How can we increase accountability for these stakeholders to avoid another such failure?

1. Auditors 2. Board of Directors 3. Investment Banks 4. Credit Rating Agencies

Then explain one instance where storytelling was a factor in another scandal we studied in this course (i.e., WorldCom, Enron, or the 2008 financial crisis).

1. Enron and WorldCom cooked the books in order to project an image innovation financial stability. drove a popular narrative of companies' prospect for immense growth . narrative was leveraged to attract investors and elevate stock artificially high. notably different from Theranos case because there was false evidence generated through accounting fraud to support story, rather than story acting in isolation. 2. In 2008, financial institutions utilized narratives of home ownership as a symbol for American dream, enticing individuals to take on mortgages that were not viable. stories masked risk and instability in mortgage market--and post-crisis analysis has revealed powerful role these deceptive promises were in recruiting borrowers by exploiting FOMO and suspension of belief. On the other side, the financial stability of the mortgage backed security market was girded by the narrative that the industry was "too-big-to-fail" and would be bailed out by the Fed if things went wr

Identify and explain 6 of the proposed explanations for the credit crisis in the late 2000s as described in the article "Understanding the Credit Crisis of 2007-2008."

1. Human Excesses and False Beliefs 2. Securitization and the Structure of Incentives 3. Financial Transparency and Misguided Ratings 4. Lax/Absent Regulations 5. Investment Banks 6. Big Picture Concerns

Drawing from the "Fighting Financial Crises: Making Policy" document from Darden, evaluate the response to the past financial crisis using the "four Rs" framework. In your answer, provide specific examples of policies or actions taken under each category, and discuss their intended effects on both the financial system and the broader economy.

1. Rescue 2. Relief 3.Recovery 4. Reform

Briefly discuss the 9 antecedents of a financial crisis and the remedies outlined in the article "Fighting Financial Crises Problems and Remedies."

1. Runnable debt and maturity mismatch 2. High and/or rising leverage & debt-deflation cycle 3. Financial Innovation 4. Complexity and information asymmetry 5. Tight coupling 6. System dynamics: contagion, correlation, self-reinforcing feedback loop 7. Cognitive biases 8. Incompetence 9. Ethical violations

Identify the five traits of organizational culture that correlate with ethical scandals. 5 Signs Your Organization Might Be Headed for an Ethics Scandal

1. Urgency and Fear 2. Isolation 3. Fragmentation and Plausible Deniability 4. Success and Impunity 5. In-Group Language

In SEC Chairman Arthur Levitt's 1998 address to the NYU law school, he discusses several of the issues that he saw with respect to financial accounting and reporting. (a) Name at least 3 of the 5 unfaithful 'earnings management' techniques that chairman Levitt describes. (b) Next, identify (1) earnings management technique that Enron employed (and Levitt foreshadowed) in their fraud.

1."Big Bath" Charges 2 .Creative Acquisition Accounting 3. Cookie Jar Reserves 4. Materiality 5. Revenue Recognition (EMPLOYED BY ENRON)

The article, "Corporate Reform Elements of the Dodd-Frank Act," discusses four main types of governance refinements that the Dodd-Frank Act included. Identify these types of governance refinements and provide examples of how these initiatives took place.

1.Role of Shareholders 2.Board Structure 3.Compensation Disclosure 4.Enforcement

In "Asset Price Bubbles" the author discusses the different signs to identify an asset bubble- Name 6 signs that suggest an asset price bubble is forming.

1.The market price of an asset exceed its fundamental value 2.Daily returns deviate from the customary "random walk" in efficient market 3.Investor sentiment swings sharply positive 4.Market conditions are "hot" 5.High leverage, aggressive financing 6.Positive economic trends provide the kernel of fact upon which investor expectations change significantly

In "Fighting Financial Crisis: Making Policy", the authors walk through 4 hurdles of policy making.

1.clash of ideologies 2. clashing interests and their related incentives 3.constraints of institutions 4.disruptions of innovation within a less nimble infrastructure

Financial Transparency and Misguided Ratings - "Understanding the Credit Crisis of 2007-2008."

A third critical issue was low transparency of assets and bank risk, increased by complex products, the lack of clarity regarding security ownership, and undermined efficient market pricing. Bank reports that lacked assessment of risks the bank held, poorly-communicated bank models for writing down assets, and institutions' lack of disclosing their risk-taking policies further eroded confidence in the value of their assets held as well ass increasing difficulty when evaluating counterparty risks. Credit rating agencies, profiting from the issuance of asset grades instead of their actual performance, generously applied favorable ratings to a wide variety of assets. This was also incentivized as rating agencies were paid by the issuers of the securities, instead of the purchasers.

Effectiveness of SOX - The Sarbanes-Oxley Act Details and Evaluation

Although many argue that the SOX Act was successful in increasing financial regulation of public companies, it is my opinion that SOX was not effective in creating a healthier environment for corporations. For one, SOX had large implementation costs because it increased the amount of capital that must be put towards accounting, auditing, and creating more extensive reports. Large public companies were able to meet these requirements, but smaller companies with fewer funds had difficulty implementing SOX. More importantly, though, SOX failed because it treated the symptoms of corporate scandals instead of preventing them. SOX was specifically tailored to stop events like Enron and WorldCom from happening again. Although this worked, it gave room to different types of fraud. Allowing other malpractice to occur outside the scope of SOX led to the financial crisis of 2008, and SOX failed to prevent this because of its reactive nature.

Market conditions are "hot" - Asset Price Bubbles

Although not every hot market features a bubble, casual observation suggests that bubbles coincide with hot markets. Such conditions include: abnormally high trading volume, significant media hype, entry into the market of naive, inexperienced and unsophisticated investors b. Jumbo deals (large corporate financial transactions) are another characteristic of hot markets. These jumbo deals change the competitive landscape and frame of reference for investors, meaning investor's perception of the market and how they evaluate it can be altered. They might change the metrics or benchmarks used for valuations, alter expectations on future earnings or market growth, or redefine what's considered a good or bad investment within that particular market.

Enron CFO

Andrew Fastow

constraints of institutions - "Fighting Financial Crisis: Making Policy"

Another constraint discussed is the limitations of legal institutions. The article explains that there is a recency bias in politics, and that various stakeholders promote "quick-fix" solutions that pass quickly, so that they can promote their actions in advance of elections. This dynamic, on top of the complications from working with 9 federal agencies and institutional ambiguities, are additional hurdles of policy making that are given.

Creative Acquisition Accounting - The Numbers Game - Arthur Levitt

Classify part of acquisition as "in process" R&D so that it is written off as a one time charge and not forecasted into future earnings .

Tight coupling description & remedy - Fighting Financial Crises Problems and Remedies

Closely linked systems leave little room for any margin of error as trouble in one component of the system hastens the spread to others. - Safety buffers, firewalls, circuit breakers

Materiality - The Numbers Game - Arthur Levitt

Companies would abuse the materiality principle of GAAP by recording values off of their true value. Companies were allowed to do this if the difference between the real and reported value was less than 6% of reported net income.

Revenue Recognition (EMPLOYED BY ENRON) - The Numbers Game - Arthur Levitt

Companies would recognize revenue before it was truly earned in order to increase current earnings. In Enron's case, they "marked to market" future revenue that should not have been considered earned.

Complexity and information asymmetry description & remedy - Fighting Financial Crises Problems and Remedies

Complex nature of the financial systems, coupled with the volatility of prices that requires instantaneous responses removes any possibility for rational decision-making - Simplification (linearization, modularization), greater transparency, monitoring, supervision, early warning systems

System dynamics: contagion, correlation, self-reinforcing feedback loop description & remedy - Fighting Financial Crises Problems and Remedies

Contagion and correlation: prompts herd-like behavior during crisis Feedback loops: Fisher's debt-deflation cycle - Intervention, circuit breakers, credible signaling

Role of Shareholders -"Corporate Reform Elements of the Dodd-Frank Act

Dodd-Frank required public companies to have a vote at least once every three years from the shareholders regarding the compensation of the executives in their proxy statement, known as the "Say on Pay" vote. There were also common compensation arrangements made by these advisory shareholder votes called "golden parachutes," which were payments to executives of an acquired company who lost their positions during the acquisition. These votes allowed the shareholders to have empowerment through the formal and structured voting process, while ensuring that companies align executive compensation with shareholder interests and corporate performance.

Enforcement -"Corporate Reform Elements of the Dodd-Frank Act

Dodd-Frank required the SEC to enforce listed companies to develop and implement policies to recover incentive-based compensation awarded on the basis of financial information that would later be discovered as incorrect due to a false financial statement. Unlike the SOX clawback provision, Dodd-Frank's change applied to all current and former executives of the company. The act also gave permission to the SEC to pay whistleblowers 10 to 30% of any amount over $1 million awarded resulting from the proceedings brought by the SEC on the basis of original information brought by the whistleblower

Evaluate the role and importance of due diligence in the investment process. How might investors have better identified the red flags presented by the company's claims? - Theranos The Unicorn that Wasn't

Due diligence is a critical aspect of the investment process, especially when evaluating startups that promise groundbreaking innovations. In the Theranos case, while the company's claims about its revolutionary blood-testing technology were enticing, a thorough due diligence process could have unearthed inconsistencies or lack of substantial scientific evidence backing those claims. Investors could have sought independent verification of the technology, consulted with third-party diagnostic experts, or demanded more transparency regarding the company's trials and results. By prioritizing rigorous evaluation over the allure of potential high returns, investors might have recognized the red flags earlier

Increased GAAP Requirements - The Sarbanes-Oxley Act Details and Evaluation

Finally, SOX required that companies disclose more material to investors. Companies now had to list their off-balance sheet transactions to prevent situations like Enron. Furthermore, companies had to provide two new reports with their 10-K filings: a management report on financial reporting effectiveness and an external financial reporting effectiveness report from an external auditor.

disruptions of innovation within a less nimble infrastructure - "Fighting Financial Crisis: Making Policy"

Finally, the article talks about the fact that regulation is often playing 'catch-up' with financial innovation. It explains that every major American financial crisis was associated with some innovation in the market, which added regulatory confusion and complexity. It explains that previous regulatory infrastructure was insufficient, and people are able to take advantage of these innovations. Side note - history repeats itself again. Same exact thing happened recently with SBF, FTX, and crypto regulation... very interesting.

Financial Innovation description & remedy - Fighting Financial Crises Problems and Remedies

Financial innovation prompts development of new debt instruments that increase leverage to risky levels. Prudential standards or often not existent in these nascent financial markets, which enables institutions to lever up without much difficulty. - New product review and certification

Isolation - 5 Signs Your Organization Might Be Headed for an Ethics Scandal

Groups and teams that are far from the headquarters of the company, whether that be through geography, access to information, or both, are vulnerable. When a team is isolated and comes under role by an authoritarian, the company has created the baseline conditions for corruption. People are far more influenced by their immediate surroundings than by a code of conduct that is set at the top by a leader.

"Big Bath" Charges - The Numbers Game - Arthur Levitt

In a year where a company is restructuring and already expected to underperform, managers could overestimate their losses in order to make future performance seem relatively better. "Chainsaw Al'' utilized this strategy at Sunbeam Corp to make it seem like the firm was growing quickly after he took charge.

In his 2016 article Theranos and the Dark Side of Storytelling, Jonathan Gottschall explores the impact of storytelling in the corporate context and its associated ethical considerations using Elizabeth Holmes and Theranos as a case study. Explain Gottschall's argument

In his 2016 article, Gottschall explores the interconnectedness of storytelling and corporate affairs, particularly in an ethical dimension. His argument details how storytelling, when harnessed effectively, can serve as a persuasive force that changes perceptions of a business and impacting the decisions of others as a result. He uses the case of Theranos to illustrate for a compelling narrative contributed to unprecedented (and ultimately baseless) valuations and a cult-like following. An entrancing narrative about a young visionary leader with the potential to revolutionize healthcare convinced not only investors, but the media and the public at large, despite any real evidence to support that belief. Gottschall explores how the human tendency to "suspend disbelief" is not totally a conscious bias--a convincing storyteller can win logical people over (this is in part how Holmes was able to assemble such an impressive board, in turn lending her story even more legitimacy).

Lax/Absent Regulations- "Understanding the Credit Crisis of 2007-2008."

Lack of regulation, through both the lax enforcement of the law and the nonexistence of appropriate rules, did not stop dangerous actions or provide a suitable framework of incentives and disincentives for lenders' actions. The lifting of several SEC regulations, including loosened capital requirements of investment banks in April 2004 and the rescinding of limits to short sales in July 2007 were also seen as partially responsible. A lack of understanding or remembering of historical major recessions (including the one in the 70s) coupled with the failure of self-regulation in the "shadow financial system" and bank compensation schemes were strategies that destabilized the financial system.

Which major corporate event(s) led to the development of the Sarbanes-Oxley Act (SOX)? List and describe three of the major changes initiated by the SOX Act. In your opinion, has the SOX Act been effective in creating a healthier environment for corporations? Provide evidence.

Major Events 1.Enron Scandal 2.WorldCom Scanda 3 Major Changes 1.Creation of PCAOB 2.Reduce Conflicts of Interest in Audit Firms 3.Increased GAAP Requirements

Government Intervention arguments for Bear Stearns - Fighting the Financial Crisis of 2008

Moody's downgraded Bear Stearns' mortgage backed securities to junk, insolvency fear = bank run. Bernanke, Paulson, and Geithner (Fed and Treasury) had concerns about Bear Stearns' being "too big to fail". Geithner noted bailout ensures crisis doesn't get out of control. Both Fed and Treasury attempted to convince CEOs of large institutions to takeover but Bear Stearns was too large too risky. Under exigent and unusual circumstances, the Federal Reserve has the ability to lend to banks through discount window lending, but Bear Stearns was ineligible to receive loans because it was not a member bank of the Fed system. JP Morgan offered to acquire Bear Stearns with some assistance from the Federal Reserve. Fed's willingness to go to great lengths to ensure the stability of Bear Stearns is a clear indication of their belief that this institution was too big to fail. Critics thought that this bailout created moral hazard and "rewarded failure" that institution considered "too big t

Intense Desire to Compete- Narcissistic Leaders: the Incredible Pros, the Inevitable Cons

Narcissistic leaders are driven by an intense desire to win, viewing every challenge as a test of their survival skills. This ruthless pursuit of victory creates a highly competitive internal environment within their organizations, marked by urgency and a constant sense of threat. They often adopt a paranoid perspective, seeing potential enemies even among their colleagues, which can lead to internal discord.

Distaste for Mentoring- Narcissistic Leaders: the Incredible Pros, the Inevitable Cons

Narcissistic leaders are generally uninterested in mentorship due to their lack of empathy and strong independence. They rarely mentor others, and when they do, they expect their protégés to mirror their characteristics. Even those like Jack Welch, who may appear as mentors, tend to prioritize instruction over coaching. They don't credit their own leadership development to mentoring or educational programs. Some narcissistic leaders may seek guidance but prefer mentors they can control, valuing distance in relationships to avoid emotional influence and maintain secrecy. Their intimacy issues make them less likely to engage in deeper mentoring relationships, preferring peer relationships focused on challenging authority and achieving results

Sensitive to Criticism- Narcissistic Leaders: the Incredible Pros, the Inevitable Cons

Narcissistic leaders have a pronounced sensitivity to criticism, a notable weakness in their leadership style. They distance themselves from emotions, constructing an emotional barrier that isolates them. This emotional fragility makes it difficult for them to acknowledge their feelings and handle negative feedback, which they view as a threat to their self-image and vision. Their thin-skinned nature leads them to avoid feedback unless it escalates, fostering resistance to dissenting opinions. In practice, they often prefer a team of unquestioning supporters, which can result in the departure of independent thinkers, creating succession challenges. This hypersensitivity to criticism curtails open dialogue and diverse perspectives, potentially impeding effective leadership

Poor Listeners- Narcissistic Leaders: the Incredible Pros, the Inevitable Cons

Narcissistic leaders often struggle with poor listening skills, stemming from their hypersensitivity to criticism. When they perceive threats or criticism, they tend to ignore or dismiss feedback, causing significant communication breakdowns. This deficiency can be exemplified by a CEO who refused to acknowledge his poor listening skills. Some narcissistic leaders even take pride in their disinterest in listening, considering it a virtue. However, this dismissive attitude can hinder their ability to benefit from their team's insights and perspectives, potentially missing valuable input and growth opportunities. Success should not justify neglecting the importance of active and open listening.

Scores of Followers- Narcissistic Leaders: the Incredible Pros, the Inevitable Cons

Narcissists are adept at gathering devoted followers, a vital aspect of effective leadership. They excel in captivating and inspiring people through charismatic speeches. However, this dynamic isn't one-sided; narcissistic leaders rely on their followers for affirmation, boosting their self-confidence. Yet, this charisma can lead to isolation as their confidence grows, making them impulsive and unreceptive to advice, which can result in risky decisions and potential catastrophes, as seen with Bill Clinton. While their skill in attracting followers is a leadership asset, it comes with risks when not balanced with diverse input.

Great Vision - Narcissistic Leaders: the Incredible Pros, the Inevitable Cons

Narcissists excel at envisioning and pursuing ambitious, transformative goals. Their visionary mindset challenges the status quo and encourages innovation, as they are unafraid to take risks that others might avoid. They can energize entire organizations and industries by pushing boundaries and striving for groundbreaking achievements, making them potent agents of change and progress, despite their potential drawbacks.

Cognitive biases description & remedy - Fighting Financial Crises Problems and Remedies

Overconfidence, optimism, adherence to sunk costs and goal momentum hinders rational decision-making - Checks and balances, a culture of vigilance

Positive economic trends provide the kernel of fact upon which investor expectations change significantly - Asset Price Bubbles

Positive economic trends can significantly alter investor expectations, driven by underlying factors like technological advancements or political regime shifts, which have historically fueled stock market run-ups. However, the presence of such characteristics doesn't definitively indicate an asset bubble as they could exist in a rational, non-bubble market. b. Professor Eugene Fama suggests that large fluctuations in stock prices are reactions to real economic activity changes, aligning with an efficient market hypothesis.

Lack of Empathy- Narcissistic Leaders: the Incredible Pros, the Inevitable Cons

Productive narcissistic leaders often struggle with empathy, which can be both a weakness and strength. They find it challenging to display empathy and may be seen as unlikable. However, in times of radical change, their ability to make tough decisions without emotional attachment can be an advantage. This trait can lead to poor interpersonal evaluations but is sometimes tolerated when strong leadership is required during turbulent times.

Compensation Disclosure -"Corporate Reform Elements of the Dodd-Frank Act

Public companies were required to disclose both the median annual total compensation of all employees as well as the ratio of the median amount to the total annual compensation of the CEO in order to publicly display the internal equity of the company based on compensation. Additionally, the SEC was directed to require listen companies to disclose whether any employee or director had the ability to purchase financial instruments designed to hedge the market value of the company's securities.

High and/or rising leverage & debt-deflation cycle description & remedy - Fighting Financial Crises Problems and Remedies

Rising leverage is risky as it exposes to greater downside when crisis arises: Debt Deflation cycle is a self-reinforcing loop-when asset values decline during an economic downturn, credit volume declines, asset prices tend to fall (less demand in assets), prompting lenders to demand more collateral, triggering borrowers to fire sales of assets, which further depresses asset prices, prompting lenders to call for even more collateral to ensure their debt. - Rationing by lenders and central banks

WorldCom CFO

Scott Sullivan

Enron Whistleblower

Sherron Watkins

Big Picture Concerns - "Understanding the Credit Crisis of 2007-2008."

Some lamented that the failed leadership of many bank CEOs created this environment. 21 Others pointed to the U.S. business environment and noted its significant flaws: an excessive focus on short- term measures of success and the ability of CEOs to make money when their companies lost money.22 Some directed attention to a faulty public and private policy framework in arguing that "our society does not understand, or know how to deal with, speculative bubbles.

The article "Narcissistic Leaders: the Incredible Pros, the Inevitable Cons" discusses the relative high prevalence of this personality type among many of the most well-known CEOs. Explain several of the most important/relevant strengths and weaknesses of narcissistic business leaders.

Strengths 1. Great Vision 2. Scores of Followers Weaknesses 1.Sensitive to Criticism 2.Poor Listeners 3. Lack of Empathy 4. Distaste for Mentoring 5.Intense Desire to Compete

Theranos COO

Sunny Balwani

Rescue - "Fighting Financial Crises: Making Policy

The 2008 crisis featured the bailout of major banks, with the U.S. government taking unprecedented steps to prevent the collapse of key financial institutions. The Troubled Asset Relief Program (TARP) facilitated the infusion of capital into banks, and the Federal Reserve provided emergency liquidity. This rescue effort was critical in stabilizing the financial system and restoring confidence in the markets

Recovery- "Fighting Financial Crises: Making Policy

The American Recovery and Reinvestment Act of 2009 sought to catalyze economic growth through a mixture of tax cuts, spending on infrastructure, education, health, and renewable energy, amounting to around $787 billion.

Board Structure-"Corporate Reform Elements of the Dodd-Frank Act

The Dodd-Frank Act placed an emphasis on having independent directors, as they mirrored a SOX provision by requiring national securities exchanges to prevent listing any company whose compensation committee did not consist exclusively of independent directors. eThey also required the SEC to define independence by considering account consulting, advisory, or other compensatory fees paid by the company to decrease the amount of conflict of interest.

Reform- "Fighting Financial Crises: Making Policy

The Dodd-Frank Wall Street Reform and Consumer Protection Act represented a comprehensive reform effort to address the systemic issues that led to the crisis, including increasing oversight and regulation of financial institutions.

Relief- "Fighting Financial Crises: Making Policy

The Federal Reserve's decision to slash interest rates to historic lows was a form of relief aimed at making borrowing cheaper, thus encouraging spending and investment. Alongside this, tax rebates and expansions of unemployment benefits under the Economic Stimulus Act of 2008 were implemented to directly aid those impacted by the downturn.

Describe the role of deregulation in the financial industry as presented in "The Inside Job." How did changes in government policy contribute to the conditions that led to the financial crisis of 2008? : "Inside Job"

The documentary highlights the way in which deregulation played a critical role in the financial industry, contributing to the 2008 crisis; it shows that over several decades, government policies gradually dismantled the regulatory framework that had been in place since the Great Depression. This started with the repeal of the Glass-Steagall Act under the Gramm-Leach-Bliley Act in 1999, which removed the separation between investment banking and commercial banking. The resulting environment allowed for increased risk-taking by financial institutions. The Securities and Exchange Commission (SEC) relaxed capital requirements, and derivative markets grew rapidly without oversight due to the Commodity Futures Modernization Act of 2000. Such deregulation led to financial products like mortgage-backed securities and collateralized debt obligations proliferating unchecked, which eventually became toxic assets that contributed to the collapse.

clashing interests and their related incentives - "Fighting Financial Crisis: Making Policy"

The article explains that different parties of course have different interests. It talks about wall street vs. main street, rich vs. poor, old vs. young, etc. In each of these cases, people are incentivized to root in their own best interests. These clashing dynamics are a large problem for policymakers - everyone cannot be happy!

Analyze how the composition of Theranos' board might have impacted the company's corporate governance, especially in its early stages. Consider the role that "celebrity" board members might play in influencing investor confidence and public perception. - Theranos The Unicorn that Wasn't

The composition of Theranos' board with prominent figures might have increased the company's credibility and legitimacy in its early stages. "Celebrity" board members can have a significant influence on investor confidence as they are often seen as endorsements of the company's viability. However, a board's primary responsibility is to provide oversight and direction. If board members lack expertise in the company's core business (in this case, medical technology), they might not effectively challenge or scrutinize the company's operations, leading to weak corporate governance.

Investor sentiment swings sharply positive - Asset Price Bubbles

The infamous phrase "it is different this time around" can suggest overconfidence in investor sentiment. Sentiment reflets cognitive biases that figure prominently in the lore of bubbles and includes overoptimism, representativeness bias and herding. b. Robust research literature attributes some of this variation to changes in investor sentiment. Sentiment can be gauged by surveys of investor confidence and measures of risk aversion

Credit Rating Agencies - Watchdogs who dropped the ball

They are tasked with publishing research and expert opinions on the creditworthiness of institutions that issue securities. These ratings also determine the interest rates at which the issuer pays its debts. Conflicts of interest arise since companies applying for a rating are also paying rating agencies. This motivates agencies to provide those companies with a high rating. Like auditors, rating agencies contend that they resist this conflict of interest since their reputations are at stake. Yet, these rating agencies had ranked Enron as an "investment grade" five days before they filed for bankruptcy. Credit rating companies also contend that these ratings are just "opinions" and have not been held liable by the courts for publishing misleading reports leading to a gross lack of accountability. An increase in accountability for credit rating agencies and disclosure of how they rate companies may help us avoid future accounting scandals.

The market price of an asset exceed its fundamental value - Asset Price Bubbles

The price of the asset is expected to eventually lose its air with a dramatic decline or "pop" b. Fundamental value cannot be observed only estimated, can be done by using tools such as DCF models or market multiples

Securitization and the Structure of Incentives - "Understanding the Credit Crisis of 2007-2008."

The process of securitization spread in the 90s was believed to enhance risk allocation and portfolio diversification, with some complex derivatives like mortgage-backed securities (MBS) holding a diversified base, to the point where it "engineered [risk] away." Without the need to hold assets capable of supporting loans, securitization encouraged more banks to engage in lending relationships, with originators taking the profit at the start of the transaction through volume-based fees and reducing incentives to monitor loan obligors while driving the need to overstate their quality and complexity. Intended to disperse risk among many parties to limit systematic risk to the financial system, securitization instead resulted in parties that lacked any or substantial "skin in the game," investment banks that had compensation packages encouraging employees to purchase risky assets.

Board of Directors - Watchdogs who dropped the ball

They are representatives of a company's shareholders and their interests. They act as independent guardians of shareholders' interests. Recently, executive compensation has included stock options which was supposed to increase their stake in overall company performance but has led to their increased sensitivity to short-term company performance. In the Enron case, we found the directors to be "asleep at the wheel", simply conforming to the goals of management for a payout rather than being objective judges of management decision-making. This conflict of interest can be avoided with the inclusion of more independent directors who have no ties to the company and by restricting compensation solely to director fees.

clash of ideologies - "Fighting Financial Crisis: Making Policy"

This hurdle relates to politics. Conservatives lean towards less regulation after crises, lower taxes, and they have greater resilience for capitalism. More progressive parties lean the opposite way. Each political party is very polarized as well, which makes policy production even harder.

Creation of PCAOB - The Sarbanes-Oxley Act Details and Evaluation

Title 1 of the SOX Act created the Public Company Accounting Oversight Board. This board was created to increase the oversight of auditing firms that had contributed to the collapse of Enron and WorldCom because they had failed to alert the public to bad accounting practices. The PCAOB set auditing standards and oversaw accountants and auditors.

Reduce Conflicts of Interest in Audit Firms - The Sarbanes-Oxley Act Details and Evaluation

Title 2 of the Act limits audit firms to giving non-audit services to their clients. It also required that the main audit partner for a client be rotated every 5 years to prevent the same person from exhibiting faulty behavior. Finally, it prevented the client's CEO, CFO, controller, and chief accounting officer from having come from the auditing firm before the audit. These restrictions were meant to prevent auditing conflicts of interest.

In-Group Language - 5 Signs Your Organization Might Be Headed for an Ethics Scandal

To hide and rationalize unethical behavior, humans typically widespreadly use in-group jokes and euphemisms. A terminology is then created to describe bribes, from "gifts" and "commissions" and the funds Enron put aside to "educate Indians." Metaphors of war and sport, common in this context, help to shift the frame away from that of individual choice.

Success and Impunity - 5 Signs Your Organization Might Be Headed for an Ethics Scandal

Typically, we as people have a tendency not to question success. If a team clearly outperforms its peers, it develops a mystique that serves to block the scrutiny of the basis of this success. The reputations of other teams suffer as they appear, in comparison, to underachieve. If the high-achieving team's success has been achieved by unethical means, a company has created a slippery slope by which conditions in one subculture spread to others.

Ethical violations description & remedy - Fighting Financial Crises Problems and Remedies

Unethical, illegal behavior of decision-makers - Monitoring, incentives and penalties, codes of behavior

High leverage, aggressive financing - Asset Price Bubbles

Use of debt and financing in order to fund transactions can often signal a highly speculative market which can lead to asset bubbles. Growing use of debt might be due to stimulative monetary and fiscal policies by the government, or movement of "hot money" flows of capital across borders

Investment Banks - "Understanding the Credit Crisis of 2007-2008."

With high leverage, bad risk management, overreliance on faulty internal models, and the rise of proprietary risk-taking, banks are also seen as contributors to the crisis. Independent financial vehicles, including SIVs, allowed banks to hide assets outside their balance sheets and created fees by selling these to off-balance sheet entities. Though separate legal entities, these were still reputationally connected to the banks and problems with these possibly affected the deep selling of such financial stocks. Pervasive balance sheet contagion through financial intermediaries also led to international exposure to the crisis.

WorldCom Scandal - The Sarbanes-Oxley Act Details and Evaluation

WorldCom was a telecom company that went bankrupt in 2002. Similarly to Enron, WorldCom was "cooking their books" through accounting malpractice. In this case, WorldCom made the company appear more profitable by booking typical operational expenses as capital expenses so that net income would be inflated. When these methods were revealed, WorldCom had to file for the largest bankruptcy in history. The combination of the WorldCom and Enron scandal created an environment of distrust between public companies and investors. The SOX Act attempted to restore this confidence by strengthening financial disclosure.

"The Social Cost of Fraud and Bankruptcy" discusses the implications of the U.S. bankruptcy system effectively improving corporations like Worldcom for competitors who practice effective corporate governance and ethics. Compare the social costs of Sarbanes-Oxley and the Dodd-Frank Act as regulatory responses.

accounting fraud scandals began with managers taking advantage of accounting to financial SOX rigor and compliance . new standards came with reporting expenses, demands for administration. risk became expensive 4 aggressive managers because caught and expensive if guilty. DF imposed regulations for institutions to deter risk taking with greater compliance costs, tighter regulations for lending and investment activities, and increased oversight. Changes to board structures, roles for shareholders, and enforcement incentivized a swing back to conservative operations. SOX and DF were different, the social costs were similar. In both , the compliance costs hurt smaller companies to comply with rules designed unethical managers of their massive competition. larger companies gained advantages over small firms. support given unethical corporations like WorldCom Lehman Brothers negative for competition in respective industries. amplify failures if market consolidation leads more control

Government Intervention arguments for Lehman Brothers - Fighting the Financial Crisis of 2008

aggressive growth strategy and taking on an incredibly levered position in mortgage backed securities, Lehman unable to access an adequate level of credit after major asset write-downs. led to rapid deleveraging and a liquidity squeeze. This prompted CEO Dick Fuld to embark on an effort to find a buyer for the firm. Barclays emerged as a potential acquirer, but later reneged on its offer, all while Fuld asserted that the firm was solvent and worth more than offered. in light of Bear Stearns' rescue, the Government remained steadfast in their refrain from bailing out Lehman Brothers. The difference between these two scenarios was reported quality of Lehman's assets. John Bernanke, the Chair of the Fed, stated that although Dick Fuld claimed Lehman was solvent, the firm's capital figures were based on the firm's inflated asset valuations. In the end, the Fed was not legally authorized to lend to Lehman given that they "were not reasonably sure" it could be repaid.

Auditors - Watchdogs who dropped the ball

auditing firms are paid by the companies that they audit causing a conflict of interest. reluctant to criticize management over fear of losing client. Auditing firms argue that this conflict of interest may not matter since the reputation of the auditing firm is at risk if their reports are not truthful. Yet, throughout the 1990s, as revenues from auditing fees declined, firms started providing consulting services to companies which led to the loss of their independence. A further conflict of interest is the fact that the auditing industry is self-policing and standards are set by the FASB which is funded in part by the industry. The collapse of Enron highlighted a third issue known as the "revolving door" or the tendency for auditors to take jobs with the companies they audit, motivating auditors to give potential employers a good report. One way to avoid a conflict of interest is to separate auditing and consulting services within an auditing firm.

Cookie Jar Reserves - The Numbers Game - Arthur Levitt

capitalize gains (or create unrealistic losses) during good times that they can turn into revenue in periods where they would otherwise miss wall street expectations

SOX Title 1

established PCAOB

What does Catherine Bromilow mention in the video "Combating Financial Fraud," about how managers can take steps to avoid financial fraud?

most devastating fraud is financial reporting fraud. number of things that happen when a firm is accused of financial reporting fraud, often leading to a cascade effect. starts with class-action lawsuits, and punished stock price. Distraction of management as well as reputation hit and over-focus of resources on fraud are consequences of fraud. Three key steps that board members and managers should take to avoid fraud. 1. Be skeptical - Look red flags: for instance, is company experiencing significant operational issues, yet making its numbers? 2. Understanding environment - Are factors there that make companies likely to face fraud? Examples wall street putting pressure on companies for earnings expectations. Another could be compensation policies and whether incentives based on certain targets. 3. Make sure you are comfortable with tone at top - Expectations of management throughout company. For instance, looking at companies and management deal with those who work the gray

What types of people were complicit in these failures of Enron and WorldCom?

not contain men of high integrity or character. Enron's management, including CEO Jeffrey Skilling and Founder/Chairman Ken Lay, promoting a culture of recklessness greed. Skilling and Lay known domineering aggressive personalities, short-term profits over long-term sustainability. described WorldCom CEO Bernard Ebbers as charismatic, flaunting wealth and injecting confidence in shareholders. We have classified these leaders as narcissists. Skilling known influential, of fear, exhibited unwavering confidence in own abilities, led to believe that company's risky ventures were justified. Skilling wanted to maximize wealth and company's stock. faced with criticism, Skilling was quick to defend actions. refused to accept responsibility for problems. Ebbers known for authoritarian leadership style, expected loyalty. authoritarian approach allowed to maintain control over company and take risks in pursuit of growth. Ebbers resistant to criticism and not entertain doubts about company.