Ecology

Diesel gate • https://www.independent.co.uk/topic/dieselgate

On September 18th, 2015, the US Environmental Protection Agency (EPA) reported that VW had
installed illegal "defeat devices" in hundreds of thousands of engines in the United States since 2009.

The software -- used in the Volkswagen, Porsche, Audi, Seat and Skoda brands -- helped the cars meet
exhaust pollution standards when monitored in tests even though their emissions actually exceeded the
limits.

It meant that some cars spewed out up to 40 times more harmful nitrogen oxide -- linked to respiratory
and cardiovascular diseases -- than legally allowed.

The company later admitted that 11 million diesel vehicles worldwide, including 8.5 million in Europe
and 600,000 in the United States, had been fitted with the software, most of them in the VW brand.

What is this from a legal point of view?

 Fraud; Unfair Competition;

 False certifications; Illegal advertising

Finance
Tesco accounting scandal:

Tesco’s annual report and financial statements published on 22 May 2014 reported that UK revenue for
the financial year ending 22 February 2014 was £43bn with a trading profit of £2.19bn

On 29 August 2014, Tesco issued a trading update for expected Group profits for the 6 months to 23
August 2014 which was incorrect and overstated by over £250m. This overstatement was not corrected
until 22 September 2014.

The overstatement predominantly arose as a result of the dishonest falsification by TSL of its results for
the 6 month period, known as H1 2014/15, upon which the Group trading forecast was based

The effect of it was: a. falsely to inflate TSL commercial income figures; b. to create a false account of the
financial position of TSL; c.to distort the process by which TSL budgets, based on reported past
performance, were fixed;

Those senior leaders in TSL who were aware of the overstatement continued to fail to report it, with the
result that the half year Tesco interim results continued to be prepared by Group Finance in the mistaken
belief the figures were correct

The problem with criminal sanctions: Establishing corporate criminal liability in fraud cases requires
proving there was a “directing mind” — that senior executives knew of the crime. Such knowledge is
what the SFO failed to demonstrate in the Tesco trial. Tesco’s UK stores arm agreed a DPA and £129m
fine last year which did not address whether liability attached to Tesco Plc or any past or present
employees.

Services
PPI:a type of insurance attached to loans and credit cards that was designed to help borrowers keep
servicing their debts if they fell ill or lost their jobs. However, in the late 1990s and early 2000s, banks
began pushing the highly profitable product to as many customers as possible, even those not eligible
for payouts or who did not know they were buying it.
https://www.ft.com/content/78da80e0-d2c9-11e9-8367-
807ebd53ab77
Libor
Libor: one example “FCA has handed Deutsche Bank AG (Deutsche Bank) a £227 million ($340 million)
fine, its largest ever for LIBOR and EURIBOR-related (collectively known as IBOR) misconduct. The fine is
so large because Deutsche Bank also misled the regulator, which could have hampered its investigation

 which have an impact on their financial health • So this is when “ethics” turns into a prudential
and a COB problem..

Corruption
The Bribery Act 2010 – Ministry of Justice (MoJ) Guidance -
https://www.justice.gov.uk/downloads/legislation/bribery-act-2010-guidance.pdf

Bribery blights lives. Its immediate victims include firms that lose out unfairly. The wider victims are
government and society, undermined by a weakened rule of law and damaged social and economic
development. At stake is the principle of free and fair competition, which stands diminished by each
bribe offered or accepted.

The Bribery Act 2010 - https://www.legislation.gov.uk/ukpga/2010/23/contents

BAE bribery case - https://www.theguardian.com/world/2010/feb/05/bae-systems-arms-deal-

corruption

The perfect storm of rationalising bribery (video) - https://www.youtube.com/watch?

v=yTVD5Y9S7AM

Why bribe?

- Corporate culture – you get paid for high performance (sales/deals), not for complying with the
rules
- Remoteness from the office and its policies
- Rationalising bribery – no one would ever know
- Delusion that bribery is a victimless crime

Regulatory landscape
 The Banking Standards Board
 The FICC Markets Board (Fixed Income Currencies and Commodities Market Board)
 The Financial Conduct Authority

Changing banking for good Report of the Parliamentary Commission on Banking Standards:

https://www.parliament.uk/globalassets/documents/banking-commission/Banking-final-report-vol-ii.pdf
CG:
“relates to the way in which suppliers of finance to corporations assure themselves of getting a return on
their investment ” (Shleifer Vishny, 1997)

“CG is an efficient form of economic organisation within the set of contracts perspective” (Fama, 1980;)

“CG as the design of institutions that induce or force management to internalise the welfare of
stakeholders” (Tirole 2000)

The rules and regulations (including self regulation) that govern:

• the relationship between managers of a corporation their shareholders and stakeholders (including
labor)

• as well as the internal organisation of the company (committees)

• And the responsibilities of its governing bodies (board, GSM, audit)

How are companies organised? Berle Mean • The problem of agency costs in corporation Jensen
Mecking • What determines ownership? Bebchuk Roe • Whom should CG represent? Berle vs Dodd •
What is the final aim of a corporation? Friedman

Moral Hazard relates to the tendency of engaging in risky behaviour

But also it relates to any type of suboptimal behaviour of a manager from “low efforts to private benefit
from inefficient investment to accounting and market value manipulation”

[how to align the interest of managers to those of shareholders?]

 Through the use of “performance based incentive schemes”

 Through monitoring
 Through institutional arrangements (voting rights) and the establishment of a system of directors
duties

CG regulation

 As mentioned, aspects are included in legal provisions ( also, do not forget labour, tax and
accountancy law)
 However internal codes of conduct, listing requirements, and voluntary standards (national and
international) play a big role
 The most well know initiatives are the OECD Principles, the FRC CG code; the EU commission
Green Paper and the BCBC CG Principles for Banks
Agency Theory, Reasoning and Culture at Enron: In Search of a Solution
Author(s): Brian W. Kulik
There is a growing consensus on the idea that Enron's culture, rather than the isolated actions of a few
individuals, was the key enabling mechanism that allowed the widespread practice of unethical and
illegal behaviour based on self-interest.

In particular, agency theory states that, in a public corporation, there exists a central problem with
regard to shareholders' interests: top management does always act to maximize shareholders' return on
investment. With regard to a corporate executive, "agency costs will be generated by the divergence
between his interest and those of outside shareholders"

My argument is in two steps: (1) Enron's senior executives used agency reasoning to both determine and
explain their behavior and (2) this agency reasoning resulted in a corporate attitude throughout the
organization that led to a culturaUy accepted behavioral norm: an agency culture.

Mark, however, made money on the project because she had 'incentive' to close the deal ? the biggest
possible - but no 'incentive' to show profitability from operations or even a finished project. Thus, Mark
aUowed herself to foUow her own self interest as long as the boundaries set by control mechanisms
(such as scrutiny by Enron's award winning board of directors or internal managerial accounting efforts)
were not crossed and sufficient 'incentive' .

These results suggest that leaders' values, beliefs, assumptions, and expectations may at least partiaUy
explain the behavior of foUowers, especiaUy for value-oriented transformational-style leaders.

Individual behavior and motivation was explained by a particular combination of pay and perquisites
Jensen and Meckling's? (1976) 'pay package point' where, in the Enron case, high levels of motivation
and incentive alignment (personal and corporate interests) were associated with the high position of
each individual's pay package point.

As mentioned above, culture is considered an important behavioral control mechanism of an

organization's ular, strong there is a

In particular in which strong homogeneity of behefs held the organization is expected to decrease the
cost of controls (i.e., reduce agency costs), and increase financial performance.

Strong culture was also an agency culture: employees and owners assume a divergence of interest from
stockholders in the first place, and then concentrated on that divergence of interest throughout the
duration of the employment contract.

Approaches to ‘fight’ agency culture:

1. Integrity and selection – to nominate on higher positions only those who already have high
moral standards and integrity (was difficult in Enron case as all the employees came from the
same environment)
2. Integrity and objectivist ethics (in Enron’s case there was narrow space for self-development in
the corporate culture)
Objectivists, then, "define integrity as loyalty, in action, to rational principles (general truths) and
values... Integrity requires acting in accordance with rational values" (Becker, 1998, p. 157). Thus,
objectivist ethicists assume that each individual rationaUy develops a moral code of principles
and values, and upgrades it periodicaUy based on the congruence of observed results with one's
own long-term survival.
3. Integrity and Integrity capacity
In short, integrity capacity explains that an organization's members exhibiting high levels of
 integrity capacity cognitively balance the use of four ethics theories (teleological, deontological,
virtue, and systems development), combined with the balanced use of four legal theories
(positive law, natural law, civic responsibility, and social reform) to develop (from coUective
connivance to compliance to integrity) and institutionalize a system of ongoing moral
improvement
4. Stewardship theory
Stewardship theory, developed as the antithesis to agency theory, assumes that the agent's
sense of responsibility has already ahgned her or his interests with that of the principal:
"Stewardship theory defines situations in which managers are not motivated by individual goals,
but rather are stewards whose motives are ahgned with the objectives of their principals"

The term financial capitalism developed negative connotations as soon as it first

became popular in the 1930s with the publication of George W. Edwards’s
The Evolution of Finance Capitalism.1 Edwards saw a conspiracy of large finan-
cial institutions, with J. P. Morgan at the lead. He called it the Pax Morgana.
During the Great Depression critics and much of the public at large blamed
the financial system for their plight; they viewed the system as almost feudal,
with financiers replacing the lords.

At its broadest level, finance is the science of goal architecture—of the struc-
turing of the economic arrangements necessary to achieve a set of goals and
of the stewardship of the assets needed for that achievement.

Board of Directors’ Duties

 Videos:
Moral relativism + concept of free market and rational behaviour (profit maximisation) => no
need for ethics at all.

Ethic theories:
1. Consequentialism (utilitarianism) – assessing ethical level based on result (Robin Hood was
ethical according to this theory)
2. Deontological – to act according to ethical principals
3. Vertue ethics – based on person’s own ethical code
4. Theory of Justice –

banks [...] are unique among large companies in that the equity shareholders in reality only provide 2
per cent or 3 per cent of the capital of a business [...] Much of the capital is[...] in effect employed by
bond holders.1

The misalignment between the incentives of asset manager and the long-term interests of a company,
coupled with the fact that shareholders contribute only a tiny sliver of a bank’s balance sheet, mean it
would be a mistake to expect greater empowerment and engagement of shareholders to lead to the
exercise of profound and positive influence on the governance of banks.

We therefore concentrate on assessing proposals for change against four basic principles, which are
connected: ensuring personal responsibility of board members; ensuring that there is adequate
challenge within boards; preventing boards from constructing internal firewalls that leave them in wilful
ignorance and excuse them from proper accountability for the firm; and reflecting the differences
between banks and other public companies arising from the fact that shareholder equity represents only
a tiny sliver of the balance sheet.

These primarily reflect the systemic risks associated with banking, and also specific regulatory
requirements to mitigate conduct risk. As a result of their ‘too important to fail’ status, banks benefit
from an implicit subsidy.

Governor’s stance: certain “institutions were simply too big and complex for anyone to genuinely know
exactly what was going on”.

A key theme to emerge in our work on corporate governance was the importance of non-executive
directors exercising a ‘challenge’ function with respect to executives and acting as an effective check and
balance on senior management. This ‘challenge’ function is set out in the Code, which states that “non-
executive directors should constructively challenge and help develop proposals on strategy1152 [...] [as
well as] scrutinise the performance of management in meeting agreed goals and objectives. They should
satisfy themselves on the integrity of financial information and ensure that financial controls and
systems of risk management are robust and defensible”

Boards driven in many cases by a concern about short-term profit and loss and the quarterly earnings
announcement, have in my view been too passive and accepting of what was proposed by the executive.

8. The UK has traditionally operated a unitary board structure.1162 In other countries such as Germany,
however, the supervisory two-board structure has been prevalent. This system consists of a supervisory
board of non-executive directors and a separate management board of executive directors.

It argued that the unitary board structure had important benefits: [it] promotes collective responsibility
for decision-making, and non-executive directors can challenge and develop proposals on strategy. We
believe that two-tier boards are susceptible to a lack of consistency, communication gaps and slow
decision-making.

Cevian Capital, a fund manager, noted that “in the UK, the nomination process for NEDs is typically
controlled by company chairmen, and the shareholder approval vote is almost always an empty
formality”

The “three lines of defence” have not prevented banks’ control frameworks failing in the past in part
because the lines were blurred and the status of the front-line, remunerated for revenue generation, was
dominant over the compliance, risk and audit apparatus. Mere organisational change is very unlikely, on
its own, to ensure success in future. Our recommendations provide for these lines to be separate, with
distinct authority given to internal control and give particular non-executive directors individual personal
responsibility for protecting the independence of those responsible for key internal controls

We believe that the delivery of real cultural change is more likely to be a consequence of having created
a good company that serves its customers well than of having implemented a standalone programme of
cultural change.

Poor standards in banking are not the consequence of absent or deficient company value statements.
Nor are they the result of the inadequate deployment of the latest management jargon to promulgate
concepts of shared values. They are, at least in part, a reflection of the flagrant disregard for the
numerous sensible codes that already existed.