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Ethics and Agency Theory Essay

  1. Introduction

It is generally accepted that a CEO of organization must be a competent person or must what he or she is doing in how to run the corporation in term of attaining the corporate goals and objectives. With the CEO at the helm the organization, the same person is in the best position to influence the direction of the organization in the attainment of corporate goals and objectives. But before objectives must be met there are choices that must be made by the same CEO which must be guided by organization’s philosophy and which indispensably code of conducts that would the company’s philosophy.  As such ethics must come into play. Ethics is therefore a matter of choice but it since it includes the CEO as the major decision maker in the success of the organization.  Moreover, it is worth investigating whether ethical value or ideology of the CEO is also important to the organization in making choices for the organization as decisions are made.  This paper will therefore answer the question:  Does the ethical value of the CEO matter in the organization that he or she leads?

This paper seeks to write a literature review using three articles that would attempt to critically evaluate whether the ethical value or ideology of the CEO really matterss in organizations.  The articles include the following: (1) “The Effect of Ethical Orientation and Professional Commitment on Earnings Management Behavior” by Greenfield, Jr, et. al; (2)  “The Escalation of Deception”  by Fleming and Zyglidopoulos;[1]  and (3)  “The CEO’s influence on corporate foundation giving” by Werbel and Carter.

  1. Analysis and Discussion

2.1 “The Effect of Ethical Orientation and Professional Commitment on Earnings Management Behavior”

        In making their work entitled “The Effect of Ethical Orientation and Professional Commitment on Earnings Management Behavior,” Greenfield, Jr, et. al,[2] upheld the importance of ethical value of the CEO when they directly found  the clear impact of a person’s ethical ideology or value and his or her level of professional commitment on the earnings management decision. The authors used  of 375 undergraduate business majors as sample in their research and the  results of their analysis revealed an individual’s ethical orientation and decision-making which are significantly related to each other by statistical computations.[3] That ethical orientation or ideology to have significant relationship with ethical decision making may not be hard to accept since to make a decisions essentially involves invoking values and beliefs of the decision maker in a particular situation.  This ideology may be called a bias but the most important is that it matters in following a certain choice.

The study made by the authors primarily found that person’s ethical orientation acts as a go-between an implied relationship of such person’s personal benefit and earnings management behavior.  The study in effect further improved or created an explanation of previous research on the matter asserts that inclination to participate in earnings management came was due mostly to personal benefit mostly.  They pointed out that one’s ethical position partakes of equal if not of greater importance in understanding earnings management behavior.  The authors specifically refer to relativistic ethical orientation of a person to more likely influence a CEO to engage in earnings management practices as compared to one which is idealistic.[4]

 Using Generally Accepted Accounting Principles (GAAP) which the authors claim to allow some discretion on the part of decision maker to make a choice to what will be used in the organization way of computing its income or earnings per share; they did found evidence of an impact of an ethical belief on managing earnings.[5] An earnings per share is computed essentially dividing net income of a given year divided by average outstanding share.

It may be pointed out however that with the authors finding that ethical position is equally or more important than personal benefit in understanding behavior, they impliedly appear in a sense to have separated personal benefit from ethical orientation and made finding for the latter.

What they claimed as decisions allowed by GAAP after citing relevant authorities, include the capacity of business to report income that had not yet been earned and the stability of income reporting or income smoothing. They cited the experiences of Enron, Allied Carpet and Sunbeam to prove their assumptions.[6] The authors may have cited works where they assumed that GAAP allows certain decisions but this researcher has some reservations on the validity of assumption. Thus without actually accepting the validity of the assumption used since GAAP is for accrual accounting where it would allow what is earned to be recognized only than what is collected, the findings of authors may still be given credit if they just meant that doing such what they apparently referred as what GAAP allows are part of the choice of respondents to their study.

A finding that a level of professional commitment is related to the earnings management decision was also made known and explained by the authors.  In this aspect, they found that personally committed person are less likely to behave opportunistically.[7] The fact that persons with higher levels of professional commitment would have less attraction to engage in earnings management practices and to behave opportunistically clearly speaks for the important of ethical values of CEO that may be measured by level of professional commitment to the organization that they are working.  The study appears to have the limitation that respondents are not actual managers or CEOs but were just undergraduate majors in which case their finding could have some degree of speculation.

The authors also stated the existing research on earnings management reports entail the managers’ employing of different ways to manage earnings in accomplishing different objectives.[8]  Said objectives may benefit the manager only or the company represented or both. Citing Clikeman and Henning, they separated the benefits into three kinds or as stated.[9] The ideal objective is of course to benefit the company only because of the agency theory[10] that supports the primacy of the interest of stockholders above those of the officers.[11]  From this they did find personal benefit have impacted earnings management behavior with ethical orientation assuming the roles of a go-between.

2.2 “The Escalation of Deception”

 In “The Escalation of Deception”[12] Fleming and Zyglidopoulos found that a single lie if it will remained undetected at the start could actually escalate into such a degree that could affect the whole organization. The authors basically have argued that deception is a specific case of corruption from other wrongdoing as to way to emphasize the importance of its effect on organization.

Citing the number of organizations like the case Enron, WorldCom and other companies that collapsed because of corruption which started with undetected deception, the authors argued for the need to stop deception at the early bud before it could affect the whole organization.  They also asserted that understanding deception as separate act of corruption from other wrongdoing separately affords one to understand the refinements of lying.[13]  There is basis to believe the analysis of the authors since there are indeed a number of possibilities from a single act of deception or in certain case deception may be just considered just an element of other wrongdoings. Or possibly there are really other wrongdoings which may not necessarily include deception.

But it could not be denied that an organization lacking integrity is an organization will not last. Given the principles of agency theory where everything is almost based on trust between the agent and principal, lying should be the last thing that should be allowed in an organization.  If officers of the corporation could not be trusted by the stockholders, then there is no use to making them as them agents who are considered as stewards of the corporate property.  CEO then must be a man of integrity if he or she is to lead an organization that runs on ethics. Stockholders under the agency theory[14] are likewise to act with integrity to their creditors since their relationship entail great respect for trust confidence which must have a solid and unshakable foundation on integrity.

  1. 3 “The CEO’s influence on corporate foundation giving”

The importance of ethical value of a CEO is further supported by the work of Werbel and Carter, which deals the propriety of an organization giving acts of altruism to foundations which may badly need funds.[15]  The study involved actual CEOs this time instead of undergraduate majors as respondent. Werbel and Carter have in effect validated the arguments of some scholars that a CEO may have excessive influence on their foundation to support the CEO’s personal causes.[16] This means that that any charitable giving by CEO from corporate funds may be tainted with some not ethical at all because the same is motivated by the personal interests of said CEO rather than the organization. The CEO may be therefore lying to his or her teeth when he or she pretends to be promoting the interest of the organization when the act of giving or donating funds to foundations of which they are connected.

He or she could in fact be just increasing their influence to the organization because he or she is also an officer to that foundation that receives the funds.  The CEO cannot therefore invoke giving to a foundation of which he or she is connected directly or indirectly as a matter ethical obligation from a deontological perspective because conflict on interest is really evident.  CEOs are heads of corporations and they occupy great political influence as far as corporate funds are concerned. Doing things with conflict of interest will transgress the principles of agency theory and stewardship theory on the ground that the effect would be to put the personal interest of the CEO over that of the stockholders. The stockholders are the principals through the corporation and the CEO as part of the officers who are agent of the stockholders acting through the corporation.

  1. Conclusion

The ethical values of the CEO do matter in the organization that he/she leads as the same could lead to downfall of the organization.  The work of Greenfield, Jr, et. al, found that a CEO’s ethical orientation or ideology does have significant relationship with ethical decision-making. It must be easy to accept this finding since to decide is to invoke values and beliefs of the decision maker in a particular situation. The authors’ finding  that ethical position is equally or more important than personal benefit in understanding behavior after they attempted in the paper to separate personal benefit from ethical orientation does support the need for the CEO to have ethical value. Their distinction of relativistic orientation from idealistic orientation where the first would engage more in earning management practices is also very much confirmatory of the relevance of having the proper ethical value for the CEO.  Earning management could result to scandals since managers may be preparing their financial reports by extending the limit of what GAAP may ideally provide.

It must be pointed however that authors have cited works of other researchers where they assumed that GAAP allows certain things to happen like the allowing business to report income that is still not earned, a stability of income reporting citing as example case of Enron, Allied Carpet and Sunbeam which this present researcher does not readily accept. However if what is just meant by the authors was to include all the possibility of doing things including those that possibly violated GAAP which in a sense became part of the choice  or respondent, this researcher would be ready to accept the part of the conclusion that may result to choosing what is unethical. This is on the premise that if the other decisions are allowed by GAAP the respondent could not be choosing unethical ones.

The authors’ further found that persons with higher levels of professional commitment would have less attraction to engage in earnings management practices and to behave opportunistically which again strengthens the thesis of this paper that CEO which must have ethical values.  However, since respondents are undergraduate majors and not actual managers or CEOS, this researcher makes reservation that there could be some speculative part of the conclusions made by authors.  Moreover, the study’s claim to have isolated personal benefit from the other objective of solely benefiting the company or both the CEO and the company and allow them to focus on ethical orientation and its effect on earnings management behavior is also taken with caution. This is on the ground that their success in actually separating personal benefit from the two to possibility appears is a difficult thing to do.

The importance of having the ethical values of the CEO gets further support from Fleming and Zyglidopoulos, who have asserted that deception could escalate in an organization and in a way that it can even consume the organization. The authors separated deception as a specific case of corruption from other wrongdoing to emphasize the importance of its effect on organization.  Citing collapse of organizations like the case Enron, WorldCom and other companies, it not difficult to believe the great connection of lack of ethics of the CEO and the failure of the organizations they lead.[17] By asserting that deception is separate from other wrongdoing, the authors have in effect emphasized the need to understand deception as a serious that would require the organization to address the same in making the code of ethics of organizations to prevent any kind of deception or even lying that could put the company in danger of losing its credibility.

Since the authors are basically suggesting a prevention of the escalation by managers, all fingers are pointed to the CEO who has the primarily responsibility and control leading an organization with integrity as a rule.  CEO must have integrity or must possess the requisite moral values and must not allow deception to reach an irreversible point.

Although the first two articles are empirical research works they sound to in need of actual applications.  Incidentally the work of Werbel and Carter (2002) could provide a classic example.  Since this study involved actual CEOs as this time, the theory of this paper may appear more convincing and more attuned CEO should not be easily trusted in term of giving help to foundations in the guise of promoting the interest of the company represented. The CEO may not therefore invoke giving as an ethical obligation from a deontological perspective because his or her interest is conflict with giving to charitable foundations as this violate the principles of agency theory and stewardship theory. The CEO should be serving first the stockholders before his own.  With the authors’ finding of significance from the difference of greater giving if the CEO is affiliated with a found than when there is no relationship is  a  proof that philanthropic giving is not always good for the organization because it would just result to benefit of CEO at the expense of the organization.   Every act of giving for altruistic purposes is not always good if the CEO benefit personally at expense of the organization the he or she is representing.

Works Cited

Bowie and Freeman, Ethics and Agency Theory: An Introduction, Oxford University Press, 1992

Fleming and Zyglidopoulos, The Escalation of Deception, Journal of Business Ethics (2008) 81:837–850

Greenfield, Jr, et. al, The Effect of Ethical Orientation and Professional Commitment on Earnings Management Behavior,  Journal of Business Ethics (2008) 83:419–434

Werbel and Carter, The CEO’s influence on corporate foundation giving, Journal of Business Ethics (2002).  Vol. 40,  Iss. 1,  Part 3  pp. 47-60

[1] Fleming and Zyglidopoulos,  The Escalation of Deception,  Journal of Business Ethics (2008) 81:837–850

[2] Greenfield, Jr, et. al, The Effect of Ethical Orientation and Professional Commitment on Earnings Management Behavior,  Journal of Business Ethics (2008) 83:419–434

[3] Greenfield, Jr, et. al, The Effect of Ethical Orientation and Professional Commitment on Earnings Management Behavior,  Journal of Business Ethics (2008) 83:419–434

[4]  Greenfield, Jr, et. al, The Effect of Ethical Orientation and Professional Commitment on Earnings Management Behavior,  Journal of Business Ethics (2008) 83:419–434

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[7] Greenfield, Jr, et. al, The Effect of Ethical Orientation and Professional Commitment on Earnings Management Behavior,  Journal of Business Ethics (2008) 83:419–434

[9] Ibid, citing Clikeman, and Henning, The Socialization of Undergraduate Accounting Students, Issues in Accounting Education (2000) 15 (February), 1–17

[10]  Bowie and Freeman, Ethics and Agency Theory: An Introduction, Oxford University Press, 1992

[11] Greenfield, Jr, et. al, The Effect of Ethical Orientation and Professional Commitment on Earnings Management Behavior,  Journal of Business Ethics (2008) 83:419–434

[12] Fleming and Zyglidopoulos,  The Escalation of Deception,  Journal of Business Ethics (2008) 81:837–850

[13] Fleming and Zyglidopoulos, see above

[14] Bowie and Freeman, Ethics and Agency Theory: An Introduction, Oxford University Press, 1992

[15] Werbel and Carter, The CEO’s influence on corporate foundation giving,  Journal of Business Ethics (2002).  Vol. 40,  Iss. 1,  Part 3  pp. 47-60

[16] Ibid

[17] Fleming and Zyglidopoulos,  The Escalation of Deception,  Journal of Business Ethics (2008) 81:837–850

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