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ETHICS AND MANAGEMENT OBJECTIVES

We have suggested that managers should try to maximize market value. But some idealists say that managers should not be obliged to act in the selfish interests of their stockholders. Some realists argue that, regardless of what managers ought to do, they in fact look after themselves rather than their shareholders.

Let us respond to the idealists first. Does a focus on value mean that managers must act as greedy mercenaries riding roughshod over the weak and helpless? Most of this book is devoted to financial policies that increase firm value. None of these policies require gallops over the weak and helpless. In most instances there is little conflict between doing well (maximizing value) and doing good.

The first step in doing well is doing good by your customers. Here is how Adam Smith put the case in 1776: It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.10

By striving to enrich themselves and their shareholders, businesspeople have to provide their customers with the products and services they truly desire.

Of course ethical issues do arise in business as in other walks of life. So when we say that the objective of the firm is to maximize shareholder wealth, we do not mean that anything goes.

In part, the law deters managers from blatantly illegal action. But when the stakes are high, competition is intense, and a deadline is looming, it`s easy to blunder, and not to inquire as deeply as they should about the legality or morality of their actions. Written rules and laws can help only so much. In business, as in other day-to-day affairs, there are also unwritten rules of behavior. These work because everyone knows that such rules are in the general interest. But they are reinforced because good managers know that their firm`s reputation is one of its most important assets and therefore playing fair and keeping one`s word are simply good business practices. Thus huge financial deals are regularly completed on a handshake and each side knows that the other will not renege later if things turn sour.11

Reputation is particularly important in financial management. If you buy a well-known brand in a store, you can be fairly sure what you are getting. But in financial transactions the other party often has more information than you and it is less easy to be sure of the quality of what you are buying. This opens up plenty of opportunities for sharp practice and outright fraud, and, because the activities of rogues are more entertaining than those of honest people, bookshelves are packed with accounts of financial fraudsters.

The reaction of honest financial firms is to build long-term relationships with their customers and establish a name for fair dealing and financial integrity. Major banks and securities firms know that their most valuable asset is their reputation and they emphasize their long history and their responsible behavior when seeking new customers. When something happens to undermine that reputation the costs can be enormous. Consider the case of the Salomon Brothers bidding scandal in 1991.12 A Salomon trader tried to evade rules limiting its participation in auctions of U.S. Treasury bonds by submitting bids in the names of the company`s customers without the customers` knowledge. When this was discovered, Salomon settled the case by paying almost $200 million in fines and establishing a $100 million fund for payments of claims from civil lawsuits. Yet the value of Salomon Brothers stock fell by far more than $300 million. In fact, the price dropped by about a third, representing a $1.5 billion decline in market value.

Why did the value of the firm drop so dramatically? Largely because investors were worried that Salomon would lose business from customers that now distrusted the company. The damage to Salomon`s reputation was far greater than the explicit costs of the scandal, and hundreds or thousands of times as costly as the potential gains it could have reaped from the illegal trades.

It is not always easy to know what is ethical behavior and there can be many gray areas. For example, should the firm be prepared to do business with a corrupt or repressive government? Should it employ child labor in countries where that is the norm? The nearby box presents several simple situations that call for an ethically based decision, along with survey responses to the proper course of action in each circumstance. Compare your decisions with those of the general public.