Ethics and conflict of interest Flashcards
How should we judge the ethics of IB/firm?
- what it does
- the impact it has
- overall corporate character
What are the different theories in business ethics?
1) Deontological theories
2) Consequentialist theories (teleological)
3) Stakeholder theories
4) Virtue theories
What are deontological theories?
Actions NOT justified by consequences
- judges morality of action based on action’s ADHERENCE TO A RULE
- “bind you to your duty”
- action has intrinsic value that is seperate from consequences
What is an example of a deontological theory?
Absolutism of Kant 1778
- actions are inherently moral or immoral regardless of beliefs & goals of individual
What are teleological/consequential theories
- looks at MORAL WORTH of an action
- robin hood
- tax authorities, social network
- what makes an action right or wrong? Determined by GOOD or EVIL that is produced by act NOT ACT ITSELF
- “ends” analysis prescribed
- “means to end”
What is the utilitarinism
Bentham & Mill 1800
- consider best alternative: that what leads to greatest possible good for greatest # people (max total utility)
- promotes welfare by:
minimising harm and/or maximising benefits
What are stakeholder theories
corporation should be managed for benefit of stakeholders: customers, suppliers, owners, employees, local communities
“stakeholder groups must participate in decisions that substantially affect their welfare” - Freeman 1984
What are virtue theories?
- what is difference between “right” and “wrong”
grounded in ‘character-centred’ judgements, describe person as good or bad - virtue traits of character are the prime function of morality
- theory deals with:
type of person one is and the qualities one possesses
What do most virtue theories take their inspiration from?
Aristotles virtues:
1) liberality
2) Courage
3) Temperance
4) Shame
5) Maginificence
6) Pride
7) Good temper
8) Justice
9) Friendliness
10) Truthfulness
What questions need to be considered in order to analyse: do IBs act in ethical manner?
- Can impacts be appropriately be measured?
- can the ‘moral worth’ of an action be meaningfully seperated from its consequences
- what is the basis used to choose between conflicting rights?
- from what perspective are we looking?
Why are codes of ethics generally considered inadequate?
They do not define the principles underlying ethical behaviour.
They are usually not known by employees or effectively ignored.
Name examples of ethical conflicts
- insider dealing
- market manipulation
- misselling in m&A advisory
- unauthorised trading
- speculation
- short-selling
When did criticism of remuneration start?
post 2007/2008 credit crisis.
resulted in higer base salaries and lower bonuses
What are the implications of bonuses being paid in shares?
- long-term view for employees (incentive to make the shares worth more)
- may not be sold for long period of time
Why are bonuses considered bad?
They encourage risk-taking and violate ethical behaviour
What are ethical issues in determining bonuses?
- Incentiveses employees to exaggerate contribution to success of deals
- if they dont put in the same (excessive/unhealthy) effort, they get lower bonuses
- violates Kant’s categorical imperative (act in appropriate manner)
What is the ethical issue with size of bonuses?
- ‘relative remuneration’
- relationship of employee remuneration relative to other employees and relative to shareholders! (especially with state-funded bank)
What are conflicts of interest for analysts in IB?
Wihtin the bank:
1) corp fin division:
- underwriters work in interest of issuers and to attract new clients: need analyst coverage and positive recommendations
2) brokerage division:
- analysts work in interest of investors
- given recommodations regarding buy/sell shares
- BUT work to max commission
SO “positive” vs “unbiased” recommendations
What is the I/B/E/S
Institutional Investor Brokerage System:
widely used database that aggregates and disseminates financial analysts’ earnings forecasts and recommendations
How can I/B/E/S lead to herding behaviour?
- Information Cascade (self-reinforcing cycle)
- Influence of analyst recommendations:
Pos/neg recomms from analysts: attention - Incentive structures: deviating too far from avg forecast can be seen risky/ harm career
- Anchoring and confirmation bias
Why can remuneration of analysts lead to conflict of interest?
- “quality” of recommendation signal
- importance relative performance
- can lead to fear: dont deviate from benkmark/house analyst forecast
What are the consequences of conflict of interest?
1) Recommendation bias:
- affiliated analysts: house broker, PE of IB, related to firm, corp. fin division: more favourable
2) Pre-recommendaton price performance:
- if stock performance poor: postive recommendation (undervalued) to boost price
What is strategic bias in earnings forecast?
company management manipulate earnings - i.e. to give “surprises”: guide analysts into toning down their forecasts to ensure that actual earnings match/surpass forecasts
Where do conflicts of interest in earnings announcements arise from?
1) repeated close contacts with management
2) affiliation with underwriter/ib (internally & externally) (lt syndicate deals)
3) holding/owning corporate stock
- to keep current IB clients & attract future business: avoid earnings disappointments
What are investor reactions to recommendations?
- if know bias: react - to affiliate recommendations
i.e. “buy” recom from aff less positive reaction than from nonaff and hold/sell more neg reaction from aff - LT p performance: lower returns following affiliated recommendations
What are the empirical findings of Lin and McNichols (1998)
- analysts are overoptimistic when issuing ‘hold’ recommendations (avoid sell to maintain client relations)
- no diff in returns to affiliated and unaffiliated analysts “buy” & “strong buy”
- no diff in LT returns 1-2 yrs
What are reasons for analyst optimism?
1) Maintain client relations (conflict of interest):
2) Cognitive bias: hubristic tendency of overconfidence
3) Selection bias (or self-selection bias): company choose analysts that are in favour of company/industry
4) Insider information: good relations with company allows access to material non-public info (info asymmetry)
How can conflict of interest be combatted?
- only independent analysts (unaffiliated) (unrealistic)
- codes of conduct!! (since tech bubble):
- longer quiet period (25days) (decreases research quantity and impact)
- enforced division between analyst and underwriters
What is GARS?
Global Analyst Research Settlement (2001):
Securities Industry Assosciation: ‘best practice’:
1) “ Analyst compensations shouldnt be directly linked to specific IB transactions, sales and trading revenues”
2) “ Recommendations should be transparent and consistent with the analysts fundamental analysis”
3) “ Analysts should be independent observers of industries they follow”
4) “ Analysts should always put customer interests ahead of personal investments”
When did NY attorney general begin investigating ML?
June 2001:
first $100m (may 2002) and then $100m fine on alleged misconduct by security analyst
- changes monitoring and compensation
When did the SEC approve new rules for sell-side analysts?
July 2002:
- limited relationship/communication between IB& research dep.
- stringent DISCLOSURE REQUIREMENTS for research reports
- prohibit analyst compensation based on specific IB transaction
- banned affiliated companies from revriewing research report publications
When was the GARS and implications?
20 Decemeber 2002:
- SEC, NYSE, NASD, NY attorney general & 10 (later 12) US IBs
- severing ties between IB &research departments (physically)
- quiet period 25->40days
- $1.4bn total fines and penalties: $400m Smith Barney, $200m merril lynch, $15m some analysts
What was the impact of GARS?
- before: affiliated analysts 22% more likely positive recommendations, this ceased
- but still reluctant for pessimistic recommendations
What did Kadan et al 2009 find?
informativeness:
- post-regulation: analysts less optimistic
- “buy” recommendations become more informative (higher pos price reaction)
- “sell” recommendations less informative (less neg price react)
- overall less informative
- investors “reinterprated” neutral (hold) recommendations
