Business Ethics Chapter 10

True or false: Scholar Eugene White believes that markets are effective in resolving conflicts of interest in the financial world.

False Reason: Scholar Eugene White believes that markets are relatively ineffective in resolving conflicts of interest in the financial world and that the only possible answer is additional regulation.

True or false: One's professional gatekeeper duties should take precedence over one's responsibilities toward one's employer.

True Reason: Because professional gatekeeper duties are necessary conditions for the fair and effective functioning of economic markets, one's professional gatekeeper duties should take precedence over one's responsibilities toward one's employer.

A(n) _____________ ______________ ______________ exists where a person holds a position of trust that requires that she or he exercise judgment on behalf of others, but where her or his personal interests and/or obligations conflict with those of others.

conflict of interest

A ________ exists where a person holds a position of trust that requires that he exercise judgment on behalf of others, but where his personal concerns are in dispute with those of others.

conflict of interest Explanation: The most basic ethical issue facing professional gatekeepers and intermediaries in business contexts involves conflicts of interest. A conflict of interest exists where a person holds a position of trust that requires that she or he exercise judgment on behalf of others, but where her or his personal interests and/or obligations conflict with those of others.

The Committee of Sponsoring Organizations (COSO) describes "__________" as encompassing "those elements of an organization that, taken together, support people in the achievement of the organization's objectives."

control

In an organization, ____________ ______________ refers to cultural issues such as integrity, ethical values, competence, philosophy, and operating style.

control environment

Which of the following elements of the Committee of Sponsoring Organizations refers to policies and procedures that support the cultural issues such as integrity, ethical values, competence, philosophy, and operating style? -risk assessment -control environment -information and communications -ongoing monitoring

control environment Explanation: Control environment of COSO deals with policies and procedures that support the control environment. The control environment refers to cultural issues such as integrity, ethical values, competence, philosophy, and operating style.

Identify the specifics offered to boards of firms by the Federal Sentencing Guidelines (FSG) for mitigating eventual fines and sentences in carrying out their legal duties by keeping ethics and compliance in mind. (Check all that apply.) -Boards must be truly knowledgeable about the operation and content of ethics programs. -Boards must work with executives to evaluate the incentives for ethical behavior by every employee. -Boards must be critical in their inquiries about corporate vulnerabilities. -Boards should exercise "reasonable oversight" regarding the implementation and effectiveness of ethics/compliance programs. -Boards should understand where their companies are heading and whether it is realistic that they will get there.

-Boards must be truly knowledgeable about the operation and content of ethics programs. -Boards must work with executives to evaluate the incentives for ethical behavior by every employee. -Boards should exercise "reasonable oversight" regarding the implementation and effectiveness of ethics/compliance programs.

According to the Federal Sentencing Guidelines (FSG), which of the following are the guidelines that should be followed by boards of firms to assess their success when mitigating eventual fines and sentences in carrying out their legal duties? (Check all that apply.) -Boards should ignore even the most basic questions such as how a firm actually makes its money. -Boards should analyze their position descriptions and governance structure. -Boards should determine whether customers and clients truly do pay for products and services. -Boards should analyze their employee development and training materials.

-Boards should analyze their position descriptions and governance structure. -Boards should analyze their employee development and training materials.

Identify the causes for conflicts in the financial markets recognized by scholar Kevin Bahr. (Check all that apply.) -Conflicts between the services offered by public accounting firms -Compensation schemes for security analysts -The presence of excessive shareholder activism -The lack of self-regulation of the accounting profession

-Conflicts between the services offered by public accounting firms -Compensation schemes for security analysts

In the context of the legal duties imposed on board members by U.S. law, which of the following are required by the duty of loyalty? (Check all that apply.) -Directors should be disinterested and reasonably informed and rationally believe the decisions made are in the firm's best interest. -Conflicts of interest should always be resolved in favor of the corporation. -Directors may rely on information and opinions only if they are prepared or presented by corporate officers, employees, or a board committee. -Board members may never use information obtained through their positions as board members for personal gain.

-Conflicts of interest should always be resolved in favor of the corporation. -Board members may never use information obtained through their positions as board members for personal gain.

Which of the following are the causes for conflicts in the financial markets identified by scholar Kevin Bahr? (Check all that apply.) -The complete autonomy granted to audit committees -Short-term shareholder wealth versus long-term executive greed -Executive compensation schemes -The financial relationship between public accounting firms and their audit clients

-Executive compensation schemes -The financial relationship between public accounting firms and their audit clients

In the context of governance, which of the following are the reasons why excessive executive compensation suggests evidence of a failure of corporate boards to fulfill their fiduciary duties? (Check all that apply.) -Board members often hand-select senior executives. -Executives being evaluated and paid often serve as chair of the board of directors. -The compensation received by board members is determined by the chief executive officer, which creates a conflict of interest. -Executives usually have a strong incentive to focus on long-term corporate interests rather than short-term stock value.

-Executives being evaluated and paid often serve as chair of the board of directors. -The compensation received by board members is determined by the chief executive officer, which creates a conflict of interest.

Identify the elements that comprise the control structure described by the Committee of Sponsoring Organizations (COSO). (Check all that apply.) -Information and communications -Control activities -Risk assessment -Ongoing monitoring -Affirmative action -Control environment -Insider trading

-Information and communications -Control activities -Risk assessment -Ongoing monitoring -Control environment

Identify the true statements about the European Union 8th Directive. (Check all that apply.) -It requires similar reporting to shareholders and has more detailed requirements compared to section 404 of the Sarbanes-Oxley Act. -It provides for cooperation with regulators outside the European Union regulatory infrastructure. -It contains a whistle-blower protection section like the Sarbanes-Oxley Act. -It mandates external quality assurances through audit committee requirements and increased auditing transparency.

-It provides for cooperation with regulators outside the European Union regulatory infrastructure. -It mandates external quality assurances through audit committee requirements and increased auditing transparency.

Which of the following are true of the Sarbanes-Oxley Act of 2002? (Check all that apply.) -It was enacted very shortly after and directly in response to the Enron scandals of 2001. -It was enacted in 1985 by the Committee of Sponsoring Organizations (COSO). -It works to improve financial reporting through a combination of controls and governance standards called the Internal Control. -It applies to more than 15,000 public corporations in the United States and some foreign issuers.

-It was enacted very shortly after and directly in response to the Enron scandals of 2001. -It applies to more than 15,000 public corporations in the United States and some foreign issuers.

Identify the features of the Committee of Sponsoring Organizations (COSO). (Check all that apply.) -It was established originally to study fraudulent financial reporting and later to develop standards for publicly held companies. -It has become one of the most broadly accepted audit systems for internal controls. -It was established by two of the major professional accounting and finance associations in 2002. -It has tried to apply the provisions of the Sarbanes-Oxley Act to companies traded on European Union exchanges.

-It was established originally to study fraudulent financial reporting and later to develop standards for publicly held companies. -It has become one of the most broadly accepted audit systems for internal controls.

In the context of the legal duties imposed on board members by U.S. law, which of the following are true of the guidelines specified by the legal duty of care? (Check all that apply.) -A board member may never use information obtained through her or his position as a board member for personal gain. -The director is expected to be disinterested and reasonably informed and to rationally believe the decisions made are in the company's best interest. -Board members are not permitted to act in a way that is inconsistent with the central goals of the organization. -Board members are directed to use their "business judgment as prudent caretakers."

-The director is expected to be disinterested and reasonably informed and to rationally believe the decisions made are in the company's best interest. -Board members are directed to use their "business judgment as prudent caretakers."

In the context of governance, identify the reasons why excessive executive compensation suggests evidence of a failure of corporate boards to fulfill their fiduciary duties. (Check all that apply.) -There is little evidence that excessive executive compensation is actually needed as an incentive for performance. -There is little evidence of the disincentives that high compensation packages, and in particular the heavy reliance on stock options, provide. -In many cases, there is a lack of correlation between executive compensation and performance. -In many cases, there is no evidence of a diminishing rate of return on incentives for executives beyond a certain level.

-There is little evidence that excessive executive compensation is actually needed as an incentive for performance. -In many cases, there is a lack of correlation between executive compensation and performance.

According to Fortune journalists Ram Charan and Julie Schlosser, which of the following should the board members of a firm do to better fulfill their ethical responsibilities? (Check all that apply.) -They should be critical in their examination of corporate vulnerabilities. -They should be aware of how the firm actually makes its money and whether customers and clients actually pay for products and services. -They should be aware of the hierarchical structure of the firm and the responsibilities that each role entails. -They should understand where the firm is heading and whether it will realistically get there. -They should work with executives to evaluate the incentives for ethical behavior of most employees.

-They should be critical in their examination of corporate vulnerabilities. -They should be aware of how the firm actually makes its money and whether customers and clients actually pay for products and services. -They should understand where the firm is heading and whether it will realistically get there.

In which of the following situations can a conflict of interest arise? (Check all that apply.) -When a person works to ensure that those who enter into the marketplace are conforming to the rules of the market -When a person has a legal duty to act on behalf of or in the interests of another -When a person's personal interests clash with the duty she or he agreed to accept on behalf of someone else -When a person's ethical obligations in her or his professional duties clash with personal interests

-When a person's personal interests clash with the duty she or he agreed to accept on behalf of someone else -When a person's ethical obligations in her or his professional duties clash with personal interests

Identify the factors that make it difficult for individuals to fulfill their professional gatekeeper duties. (Check all that apply.) -When they are being paid by the businesses over which they keep watch -Having institutions that minimize conflicts of interest -Their self-interest -When they are hired by the board of directors rather than the management of a firm

-When they are being paid by the businesses over which they keep watch -Their self-interest

In the context of ethical theory, match the functions of lofty compensation packages with the situations in which they serve these functions.

A utilitarian function: When the packages act as incentives for executives to produce overall improvements An ethical principle: When the packages compensate people based on what they have earned and deserve

_____, by its very nature, is a system of principles applied to present the financial position of a business and the results of its operations and cash flows.

Accounting

Match the gatekeepers of the economic system with their roles.

Auditors: They verify a company's financial statements so that investors' decisions are devoid of fraud and deception. Analysts: They evaluate a company's financial prospects or creditworthiness to help banks and investors make informed decisions. Attorneys: They ensure that business decisions and transactions comply with the law.

______________ _________________ refers to the structure by which corporations are managed, directed, and controlled toward the objectives of fairness, accountability, and transparency.

Corporate governance

The ____________ of _______________ _______________ (COSO) is a voluntary collaboration of professional audit and accounting organizations that seeks to improve financial reporting through a combination of controls and governance standards called the Internal Control-Integrated Framework.

Committee of Sponsoring Organizations

_____________ ____________ is one of the five elements that comprise the control structure described by the Committee of Sponsoring Organizations (COSO), and it "sets the tone of an organization, influencing the control consciousness of its people."

Control environment

________ refers to situations in which economic winners and losers are determined by collusion between business and government officials.

Crony capitalism Explanation: Crony capitalism refers to situations in which economic winners and losers are determined by collusion between business and government officials. Crony capitalism can occur on many levels, ranging from systemic to individual corruption.

The _______________ ______________ _____________ _____________ covers many of the same issues as the Sarbanes-Oxley Act but applies these requirements and restrictions to companies traded on European Union exchanges.

European Union 8th Directive

Identify a view of scholar Eugene White on the resolution of conflicts of interest in the financial world.

He believes that the conflicts cannot be eliminated.

_______________ ______________ refers to a process effected by an entity's board of directors, management, and other personnel that is designed to provide reasonable assurance regarding the achievement of objectives in the effectiveness and efficiency of operations, reliability of financial reporting, and compliance with applicable laws and regulations.

Internal control

Which of the following statements is true of Section 201 of the Sarbanes-Oxley Act? -It provides the codes of ethics for senior financial officers. -It requires a company's management to file an internal control report with its annual report each year. -It mandates that members of public company audit committees should be independents with a total absence of current or prior business relationships. -It prohibits various forms of professional services that are determined to be consulting rather than auditing.

It prohibits various forms of professional services that are determined to be consulting rather than auditing. Explanation: Section 201 of the Sarbanes-Oxley Act prohibits services outside the scope of auditors—it prohibits various forms of professional services that are determined to be consulting rather than auditing.

Which of the following is true of the American Institute of CPAs? -It stipulates the methods by which accountants gather and report information. -It publishes professional rules to prevent accountants from being put in conflicts of interest. -It established generally accepted accounting principles (GAAP). -It established the Code of Professional Conduct that governs accountants.

It publishes professional rules to prevent accountants from being put in conflicts of interest.

Which of the following is the best approach that should be used by the board of a firm if it is aware of a practice that it deems unethical but not illegal? -It should allow the practice as long as it is not strictly illegal. -It should prohibit the practice to protect the long-term sustainability of the firm. -It should allow the practice as long as it is financially profitable. -It should advise the firm to be discreet while undertaking the practice.

It should prohibit the practice to protect the long-term sustainability of the firm.

Identify a factor on which insider trading is most likely based.

On a claim of unethical misappropriation of proprietary knowledge

Match the types of accounting activities with their responsibilities.

Public accounting activities: To audit and certify information Accounting activities conducted by investment banks and securities analysts: To provide guidance on the future prospects of a venture

The __________________-__________________ _________________, or the Public Accounting Reform and Investor Protection Act of 2002, was implemented on July 30, 2002, and administered by the Securities and Exchange Commission to regulate financial reporting and auditing of publicly traded companies in the United States.

Sarbanes-Oxley Act

Match the significant provisions of the Sarbanes-Oxley Act with their features.

Section 201: It prohibits various forms of professional financial services that are found to be consulting and not auditing. Section 301: It requires public company audit committees to be independent and mandates total absence of current or prior business relationships. Section 307: It establishes rules of professional responsibility for attorneys.

Match the important provisions of the Sarbanes-Oxley Act that have significant impact on corporate governance and boards with their features.

Section 404: It requires that management file an internal control report each year along with its annual report. Section 406: It requires codes of ethics for senior financial officers. Section 407: It requires audit committees to have a financial expert.

Match the organizations that govern accounting practices in the United States with their features.

The American Institute of Certified Public Accountants: It established a Code of Professional Conduct that relies on accounting professionals' judgment in carrying out their duties. The Financial Accounting Standards Board: It established generally accepted accounting principles (GAAP).

Match the justifications for lofty compensation packages with the purposes that the packages are believed to serve.

The consequentialist justification: They incentivize executive performance. The deontological justification: They reward accomplishments.

True or false: Insider trading is considered patently unethical and unfair because it prevents fair pricing based on equal access to public information.

True Reason: Insider trading is considered patently unethical and unfair because it prevents fair pricing based on equal access to public information. If market participants are aware that one party may have an advantage over another through information that is not available to all players, pure price competition will be impossible and the faith upon which the market is based will be lost.

Identify the gatekeepers who function as intermediaries between a company's stockholders and its executives.

board of directors Explanation: Boards function as intermediaries between a company's stockholders and its executives and should guarantee that executives act on behalf of the stockholders' interests.

The legal ____________ ______________ ___________ ___________ involves the exercise of reasonable care by a board member to ensure that the corporate executives with whom she or he works carry out their management responsibilities and comply with the law in the best interests of the corporation.

duty of care

In the context of the legal duties imposed on board members by U.S. law, the _____ does not permit board members to act in a way that is inconsistent with the central goals of the organization.

duty of good faith

Identify the duty of obedience according to which board members should strive toward corporate objectives and are not permitted to act in a way that is inconsistent with the central goals of an organization.

duty of good faith Explanation: The duty of good faith is one of obedience, which requires board members to be faithful to the organization's mission. In other words, they are not permitted to act in a way that is inconsistent with the central goals of the organization.

In the context of the legal duties imposed on board members by U.S. law, the ________ ________ ___________ requires faithfulness; a board member must give undivided allegiance when making decisions affecting the organization.

duty of loyalty

Professionals such as financial planners are said to have ______________ _____________—professional and ethical obligations—to their clients, duties rooted in trust that override their own personal interests.

fiduciary duties

A professional is said to have ________ if he has a professional and ethical obligation to clients rooted in trust that overrides his personal interests.

fiduciary duties Explanation: Conflicts of interest can arise when a person's ethical obligations in her or his professional duties clash with personal interests. Such professionals are said to have fiduciary duties—a professional and ethical obligation—to their clients, duties that override their own personal interests.

A legal duty to act on behalf of or in the interests of another is called a(n) _________ _________.

fiduciary duty

Some professionals, such as accountants, who act as "watchdogs" in that their role is to ensure that those who enter into the marketplace are playing by the rules and conforming to the conditions that ensure the market functions as it is supposed to function are called _____________.

gatekeepers

In the context of the legal duties imposed on board members by U.S. law, the duty of ______________ _____________ is one of obedience, which requires board members to be faithful to the organization's mission.

good faith

According to the Securities and Exchange Commission, ___________ ___________ generally refers to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of nonpublic information about the security.

insider trading

Trading by shareholders who hold private inside information that would materially impact the value of a stock and that allows them to benefit from buying or selling stock is known as __________ __________.

insider trading

Processes established internally, by boards and management, to ensure compliance with financial reporting laws and regulations are called _____________ ______________ mechanisms.

internal control

Which of the following scenarios gives rise to conflicts of interests in corporate governance? -board members hand-selecting employees in their company -the absence of cross-fertilization of boards -a CEO not chairing the board of directors -senior executives determining the compensation received by board members

senior executives determining the compensation received by board members Explanation: Excessive executive compensation can involve a variety of conflicts of interests and cronyism. The board's duties should include ensuring that executives are fairly and not excessively paid. However, all too often, the executive being evaluated and paid also serves as chair of the board of directors. The board is often comprised of members hand-selected by the senior executives. In addition, the compensation board members receive is determined by the chief executive officer, creating yet another conflict of interest. One of the larger concerns to have arisen in recent years has been the cross-fertilization of boards.

The function of auditors as gatekeepers is to

verify a company's financial statements so that investors' decisions are free from fraud and deception. Explanation: Auditors verify a company's financial statements so that investors' decisions are free from fraud and deception.

Corporate governance structures usually determine _____.

the relationship between the board of directors, the shareholders, and the executives of a firm

According to the Federal Sentencing Guidelines (FSG) for boards, a board must

work with executives to analyze the incentives for ethical behavior. Explanation: According to The Federal Sentencing Guidelines (FSG), a board must work with executives to analyze the incentives for ethical behavior. It must also be truly knowledgeable about the content and operation of the ethics program rather than simply the mere contents of a training session. The board should exercise "reasonable oversight" with respect to the implementation and effectiveness of the ethics/compliance program. In order to assess their success, boards should evaluate their governance structure and position descriptions, all board policies, procedures, and processes, including a code of conduct and conflicts policies.