Monitoring and Social Conduct

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Monitoring and Social Conduct

• Ethics, Accounting and Finance

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Background

• Co-operative Bank in UK
• Only investing/lending in/to ethical companies
• Policy change to include social and ecological
  responsibility to develop social economy
• Is there a role for banks in influencing ethical
  behaviour?

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The Players

• Who are the players that can influence the
  development of a social economy?

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An Illustrative Case

• Enron
• Bank
• Two years before Enron's 2001 collapse, Citibank
  loaned the company 2.4 billion
• Citibank wanted to keep Enron afloat to help
  conceal its prior involvement in Enron's fraud
• Auditor
• Arthur Andersen covered up dubious accounting
  practices to keep Enron afloat to ensure
  continued revenue from consulting
• Corporation
• Enrons excessive creative and highly complex
  accounting systems

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Key Ethical Issues
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Lessons Banks

• Lack of social responsibility
• Drawing revenue from clients with unethical
  practices
• Self interest
• Uncertainty in sustainability of unethical
  clients could cause deception of stakeholders
• Eg. Citibank created dubious venture (Yosemite)
  in the case of Enron
• Fear of loss of business revenue
• Unethical investments are high risk
• Ethical investments balance risk and return

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Supporting Ethical Investments
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Supporting Ethical Investments
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Lessons - Auditors

• Conflict of Interest
• Auditing / Consulting
• Although different divisions its still the same
  firm
• Eg. Enron was Arthur Andersens 2nd largest
  client and revenue was predominantly from
  consulting services
• Relational Interests
• Eg. Senior Managers at Enron were ex-Andersen
  employees
• Vested Interests
• Eg. Andersen was also the auditor for many of the
  energy trading firms which had relationships with
  Enron
• Failure of Regulatory Monitoring
• Lack of clarity in the regulations
• SEC monitoring of independence of auditors

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Types of Contracts between Enron and Arthur
Andersen
Implicit Relational Contracts E.g. Andersen
obligated to act according to Enrons interests
rather than those of the SECs to ensure
sustained revenue
Specific Investment by parties (Time and Effort)
Relative Impact on Decision Making
Other Explicit Contracts E.g. consulting and
outsourcing services to Enron increased revenue
for Andersen from on-selling opportunities
Explicit Contract Auditor Contract Standard
Auditors contract between Enron and Andersen
Enron employs Arthur Andersen
Enrons decline
Time
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Lessons - Corporation

• Creative Accounting
• Short-term benefit
• Facilitates a positive valuation of corporation
  for investors
• Standards developed to influence corporate
  behaviour
• Could be misused by corporations
• Financial statements not true and fair
  representation
• Creative Accounting and Incentive Schemes
• Increasing shareholder value as a pretence to
  senior managers increasing their own return
  through creative accounting
• Eg. Enron senior managers had significant stock
  holdings
• Excessive compensation for unsustainable increase
  in share value
• Eg. Enron CFO paid bonuses for setting up special
  purpose entities
• Creative Accounting and Corporate Governance
• Lack of attention by members of the board
• Eg. Enron

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Changing Roles

• Banks
• - Policies to take into account ethical
  standing of future and current clientele
• Engagement
• Preference
• Screening (Ethical Investment Research
  Services)
• Triple Bottom-line.
• Profitability, Philanthropy, Social
  Responsibility
• Increased scrutiny of clients
• Sources of revenue and their sustainability
• Controlling the use of funds (covenants)
• Signalling effect
• Any corporation that fails to receive credit due
  to unethical practices may cause share market
  reaction
• Needs Collaborative Effort!

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Changing Roles

• Auditors
• Separate auditing and consulting functions
• Increased regulatory requirements for
  independence
• Expand definition of auditing to encompass
  social considerations
• Important to the development of the social
  economy.
• Difficult to measure the extent of ethical
  compliance needs clear definitions and more
  regulations
• Extra cost and time burden on organisations

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