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Advanced Technology and Globalization - Ethics in Finance

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In an age of advanced technology and globalization, where free markets are playing a key role in the economy, the responsibility of making the right decision is often being forgotten by today's society. Especially in the world of finance, the terms moral and honesty seem not to be a common daily vocabulary. Probably most financial professions would agree on the statement "Don't steal money", but besides that everyone has his own personal standard of ethics. One explanation is that finance is a subject where experts benefit more of their expertise then in other fields like politics or religion (Taleb, 2007). At the same time the expert-knowledge is tempting to conduct unethical behavior, as the change of getting caught is low. Another incentive is the tremendous size of financial transactions and their effect to the economy. How easy would it be for a fund manager to invest in stocks of his friends or stocks where he gets a commission? Illter (2009) describes three conditions in the theory of fraud: Incentives and Pressure, Opportunities, and Attitudes and Rationalization. The financial industry seems to be a best match.

The Harris Poll revealed that 66 per cent of the participants agreed that, "most people on Wall Street would be willing to break the law if they believed they could make a lot of money and get away with it" and 64 per cent disagree that "in general, people on Wall Street are as honest and moral as other people" (Harris Interactive, 2010) . Scandals such as the collapse of the Enron Corporation in December 2001, where its chief financial officer formed off-balance-sheet partnerships to create phantom profits and to cover vast amounts of debts (Boatright, 2008) or the Ford Pinto Case, where the management chose not to spend US$ 11 in order to save 180 people from burning car to death and another 180 from suffering serious burn injuries each year (Birsch and Fielder, 1994), underline the popular view of the financial world as a selfish and greedy one, and the need for ethics in finance. A need which has revival and enforcement of both honour and virtue of financial professions, as its ultimate goals.

Ethics in Finance


Ethics is defined as the science of right and wrong, the science of duty, the science of moral principles, the science of moral judgment and conduct. It analyses and explains moral phenomena on their subjective as well as on their objective side. It reflects upon them, thinks them over and attempts to answer all possible questions which may be asked with reference to them (Thilly, 2005).

As the definition beyond describes, ethics is concerned about a person making the "right" or "wrong" decision. Such decision-situations can appear in every single aspect of life, including business and finance. However, high levels of complexity in finance makes decisions hard to choose. Ethics in finance does not only address problems of individual professions but also those which arise in financial markets and financial institutions. Market regulations need to be fair and equal for all participants, and therefore financial ethics has to include the question of "What are fair trading practices?" The financial service sector deals mainly with management of assets of its clients, where an ethical dilemma between principal and agent may occur. Moreover finance is also a subunit in very enterprise, nonprofit organization and governmental department. Generally speaking finance can be divided in three parts, personal finance, corporate finance and public finance. Personal finance describes individuals, who are saving, investing and borrowing money for their daily life purposes. In corporate finance, managers have to decide on how to raise and manage capital with the goal of enhancing economic output. Public finance denotes the raise and distribution of funds by governments. These funds can be raised by taxation and the issue of new government bonds respectively (Boatright, 2008). As a consequence of the interference of the stated duties with market imperfections, personal, client and market conflicts emerge as ethical dilemmas.

Conflicts of Interest

The first reason why code of ethics is needed in finance is because of the existence of conflicts of interest. When two parties enter a negotiation it is often that they fail to reach a win-win situation where both parties gain additional benefit from the argumentation (Thompson, 2009). A win-win situation can only be achieved if the interest of both parties are clearly identified and articulated. Interest should not to be mixed up with positions. While interest defines the underlying reason of the negotiation, positions indicate stated stances and objectives of the negotiating parties (Fischer and Ury, 1981). Situations in which real interests are hidden lead to poor information exchange and ineffective teamwork. Such a situation also known as the agency dilemma, a principal (e.g. managers, clients, companies) hires an agent (e.g. analysts, brokers, banks) with the promise that the agent will act in the interest of the principal (Boatright, 2008). The theory says, agents will try to achieve a goal with the least amount of effort or will use every opportunity, which creates a benefit for their own position at the cost of the principal. The latter emerge through the principal's inability of total surveillance of his agent, namely agency loss. Agent-Principal relations are not avoidable in the financial world. Financial services are operating as intermediaries for their client's transactions or as managers of their financial assets. A successful manager in today's world is delegating work and over viewing strategy. For example Fund Managers have almost outsourced all the physical work to custodians. The creation of such an agency relation is only profitable if the advantages of the outsourcing overweight the agency loss. Benefits of custodians would be economies of scale, high technology and smaller administration fees.

Conflicts of interest arise due to the obligation of financial services to act as intermediaries of their clients. This means that financial service providers need to put the interest of their customers before their own in order to provide a good product. A recent example of conflicts of interest is the Timberwolf deal by Goldman Sachs (GS). To begin with, American International Group (AIG), the world's largest insurance company, was selling credit default swaps



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