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Business with Integrity

Business with Integrity. Ned C. Hill, Dean Marriott School of Management Brigham Young University Inland Empire Management Society Banta Center for Business, Ethics and Society February 2006. Brigham Young University. Sponsored by the Church of Jesus Christ of Latter-day Saints

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Business with Integrity

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  1. Business with Integrity Ned C. Hill, Dean Marriott School of Management Brigham Young University Inland Empire Management Society Banta Center for Business, Ethics and Society February 2006

  2. Brigham Young University Sponsored by the Church of Jesus Christ of Latter-day Saints 31,000 students at BYU 3,000 in the Marriott School Marriott School of Management MBA, MPA, MAcc, MISM programs Bus. Mgmt, IS, Acct, undergrads

  3. First… Permit a little bragging!

  4. WSJ MBARankings • #6 among “Regional Schools” • Among “National Schools” we are— At Worst #25 Optimistically #15

  5. Other MBA Rankings • 2nd for “Ethics” in WSJ • 4th in “Accounting” in WSJ • 17th in Forbes • “TOP 20” in Chief Executive Magazine • 38th in U.S.News & World Report • 45th in Financial Times (27th in U.S.)

  6. Accounting Rankings • 2nd Undergraduate Accounting (Public Accounting Report) • 2nd Graduate Accounting (Public Accounting Report) • 2nd in World (Financial Times) • 6th in U.S. (U.S. News & World Report)

  7. Other Rankings • International Program 21st (U.S. News & World Report) • Undergraduate Management 35th(U.S. News & World Report) • MPA 65th (U.S. News & World Report) • Entrepreneurship 1st Tier (Top 13) (Entrepreneur, 2005)

  8. Sample of Student Achievements Association of Collegiate Entrepreneurs Conference in Chicago (120 colleges)First place in 5 of 14 categories, incl. “Best Chapter” 2005 International Case Competition at Ohio State (schools from US, Hong Kong, Denmark, Ireland, Mexico)BYU MBA team wins “First Place” 2005 Deloitte National Student Case CompetitionBYU team wins “First Place” 2005

  9. MBA team wins the University of Denver 2004 Ethics Case Competition Jamilla Cutliff—”Outstanding MBA Student Award,” National Black MBA Association 2005 Sample of Student Achievements

  10. Unparalleled Accomplishment Undergraduate accounting students took second place at the Deloitte Tax Case Study Competition. Eight times in the fourteen-year history of the competition both BYU grad & undergrad teams placed among the top three places—an unparalleled accomplishment.

  11. Outline • What do we mean by “integrity?” • How big is the problem? • Examples of problems of business integrity: • The market crash of 2000-2002 • Ponzi schemes • Large, complex corporations • Can integrity be taught? • What BYU’s Marriott School is doing

  12. Integrity • Conducting one’s life in complete accord with a firmly held set of values and principles • These principles may be derived from religious beliefs, philosophical understanding, etc. • Application should be in all areas of one’s life: personal, family, business, social, etc. • Integrity can be considered the application of ethical principles to life.

  13. Behavior Tied to Set of Values Professional Standards What is Integrity? Legal Requirements

  14. Are There Universal Values We Can All Agree Upon? 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

  15. 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

  16. How Important is Integrity in a Leader? • In a survey of 54,000 people Integrity was by far the number one attribute desired in a leader (Quoted in Stephen R. Covey’s preface to Business with Integrity, p. xx)

  17. Questionable State of Our Integrity 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

  18. Questionable State of Our Integrity 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

  19. Questionable Integrity 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

  20. Deterioration in Honesty over Time YearYear College students who cheated in H.S. 1940 (20%) 2002 (75-98%) Self-reported cheating 1983 (11%) 1993 (49%) Believe cheating is common 1940 (20%) 1997 (88%) Used cheat sheets 1969 (34%) 1989 (68%) Let others copy work 1969 (58%) 1989 (98%) Willing to lie to get job 2000 (28%) 2002 (39%) Students who had stolen 2000 (35%) 2002 (38%) (Based on several different ethics studies)

  21. 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

  22. What is the Cost of Lack of Integrity in the US? • Employee fraud $400 B • Time theft $230 B • Industrial espionage $200 B • Counterfeiting $200 B • Employee dishonesty $120 B • Identity theft $ 50 B (Quoted in Stephen R. Covey’s preface to Business with Integrity, p. xx)

  23. Examples • The market crash of 2000-2002

  24. 391% 78% 9/11 5049 5000 4000 3000 2000 1114 1000 The NASDAQ “Bubble” 1996 1997 1998 1999 2000 2001 2002 2003 2004

  25. Other markets looked very similar Total market loss worldwide… $15 trillion

  26. Why the Crash—What Happened? Misstated financial statements: Qwest, Enron, Global Crossing, HeathSouth, WorldCom, Xerox, Rite-Aid, etc. Executive loans and corporate looting: John Rigas (Adelphia), Dennis Kozlowski (Tyco), Bernie Ebbers (WorldCom) Insider trading scandals: Martha Stewart, Sam Waksal, etc. Massive fraud by employees

  27. 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: Enron legal fees >$10B Mutual fund frauds

  28. Consequences of These Problems • Lost confidence in capital markets • Lawsuits—one company has over 3,000 • Bankruptcies • Lost reputation and bad press • Longer and more expensive audits, special inquiries • Fines & investigations • Damaged employees & reputations • Lost retirement and pension funds • Damaged directors —WorldCom directors—$18M • Losses from fraud • Significant legislative activity

  29. Lost Reputation

  30. The Cost of Bad Press

  31. Largest Bankruptcy Filings

  32. 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 stock value $7 million fraud

  33. 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!

  34. Fraud Against OrganizationsA Costly Business Problem • Large Fraud of $2.6 Billion over 9 years—one person • Year 1 $600K • Year 3 $4 million • Year 5 $80 million • Year 7 $600 million • Year 9 $2.6 billion • In years 8 and 9, four of the world’s largest banks were involved and lost over $500 million Some of the organizations involved: Merrill Lynch, J.P. Morgan Chase, Union Bank of Switzerland, Credit Lyonnaise, Sumitomo, and others.

  35. 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 Why Fraud Against Organizations is a Costly Business Problem Revenues $100 100% Expenses 90 90% Net Income $ 10 10% Fraud 1 Remaining $ 9 To restore the $1 of lost income, need $10 more dollars of revenue.

  36. General Motors $436 Million Fraud Profit Margin = 10% $4.36 Billion in Revenues Needed At $20,000 per Car, 218,000 Cars Why Fraud Against Organizations is a Costly Business Problem

  37. Why Did So Many Financial Statement Frauds Occur? • Good economy was masking many problems • Moral decay in society • Misplaced executive incentives • Unachievable Wall Street expectations • 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 • Board failures • Regulator failure "The Perfect Storm"

  38. 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

  39. Example: Bernie Ebbers, WorldCom Million $

  40. Meeting WS Projections Firm1st Qtr 2nd Qtr3rd Qtr Morgan Stanley $ 0.17 $0.23 Smith Barney 0.17 $0.21 0.23 Robertson Stephens 0.17 0.25 0.24 Cowen & Co. 0.18 0.21 Alex Brown 0.18 0.25 Paine Webber 0.21 0.28 Goldman Sachs 0.17 Furman Selz 0.17 0.21 0.23 Hambrecht & Quist 0.17 0.21 0.23 Actual Earnings $0.08 $0.13 $0.16 Fraud 0.09 0.09 0.07 Reported EPS 0.17 0.22 0.23 Fraud (Millions) $62 M $61M $71M Wall Street expectations were especially high for certain industries such as the telecom industry (e.g. Global Crossing, ATT, WorldCom, Quest)

  41. 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. Twenty-eight people were involved in making or instructing to make similar entries.

  42. Enron—Poster Child for the Crash of 2000 • Financial statement fraud • Misleading transactions • Incentives for behaving without integrity Required reading: The Smartest Guys in the Room and Conspiracy of Fools

  43. Ethical Issues Raised • Dishonesty in reporting, deception • Taking advantage of the uninformed and less able to weather reversals (retirement funds) • Unjust enrichment—greed • Etc., etc., etc.

  44. Examples • The market crash of 2000-2002 • Ponzi schemes

  45. Ponzi Schemes • Promise huge returns • Sometimes mix in “real” economic activity • Depend on gullible people—take advantage of uninformed • Last in are the ones hurt—otherwise, no one complains • One company has >350,000 members

  46. Ethical Issues Raised • Taking advantage of the less informed • Basically a pure redistribution of wealth from one party to another with no value given in return • Dishonest communications • Violation of law

  47. Examples • The market crash of 2000-2002 • Ponzi schemes • Behavior of large corporations—the case of WalMart

  48. The Good WalMart • Awards • Fortune’s “Most Admired Corporation” 2003, 2004 • Largest corporate contributor to charity—2003 • Top 50 company for diversity • One of best places to work for people with disabilities • Top 10 companies for Asian Americans • Top 30 companies for African Americans • One third of Americans visit a WalMart at least weekly • Has led technological innovation (especially in supply chain) • Provides low cost products—about 14% lower than competitors • Has led large productivity increases in the US economy • Strict ethical policies for buyers • ¾ of employees have health coverage (largest coverage in nation)

  49. The Problematic WalMart • Ruthless—drives out competition, squeezes suppliers • Many lawsuits charging gender, racial discrimination • Low wages (about $10.31 on average) forcing state and federal governments to absorb costs • 46% of children in WalMart families have no health insurance • Accused of buying from “sweat shop” suppliers outside US • Accused of unfair labor practices • Union prevention • Unpaid overtime • Locking employees in for the night

  50. Ethical Issues Raised • Taking advantage of the less powerful • Low wage workers • Immigrants • Foreign workers • Externalizing its cost of business • Destructive pressure on employees and suppliers • Others?

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