COVER PAGE

Title : Ethical Issues in Corporate Governance

Subject : OVBE

Level / Semester : I / Feb 2010

Programme : MBA-FULL TIME

Subject Tutor : Dr. Jaishree Desai

Name of Student : Vivekanandan M

Student’s Registration Number : GPBL-B/F10/15

Date of Submission : Apr 16, 2010

Word Count : 2769 words

Word Limit : 3000 words

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Checklist

Students Name Vivekanandan M

Registration Number GPBL-B/F10/15

Date of submission of the Assignment 16/04/2010

Is the cover page in the correct format as indicated in the “Guidelines to writing Assignments”?

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Have I done a complete spell-check of the Assignment? Yes

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Does the table of contents include numbers? Yes

Are the pages numbered correctly? Yes

Are the figures numbered correctly? NA

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Are the references/bibliography listed in the Assignment? Yes

Are the references cited correctly in the text? NA

All references material has been cited from the books & the University of Wales online library. Any other internet

source quoted is with the permission of the module tutor.

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Are the references in the text in the proper format as

indicated in the “Guidelines to Writing Assignments”

Yes

Has the soft copy of the Assignment been enclosed? Yes

Declaration:

All material written in this assignment is my own and I have not used any material, content or information of others claiming them to be mine. Wherever materials have

been used, proper citation has been done in the text. I am fully aware of the rules and regulations governing plagiarism. Should at any point of time my work be

suspected/investigated and established to have been plagiarized, I am aware of the consequences. I have read the Student’s Handbook in detail.

___________________ Signature of the student Date: 16/04/2010

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TABLE OF CONTENTS PAGE No.

Introduction to Corporate Governance 1

Shareholder activism – Ethical issues 1

Three models of management ethics 2

Ethical views in Corporate Governance 2

Dilemmas and contradictions in Corporate Governance 3

Introduction to Galleon Scam 7

Ethical Issues in Corporate Governance of Galleon 7

Conclusion 8

Bibliography 9

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1

Introduction to Corporate Governance

An economy consists of producers and consumers. Company or business produce and distribute

goods or services and to the people. Thus for the growth of an economy, business plays a very

important role. Corporate governance has evolved to control business activities which will

always lead to economic growth. Collapse of businesses will lead to employees losing their jobs,

investors losing their money. A business could collapse for many reasons, and one important

reason is dishonesty and greed of few employees. These greedy employees should be made

accountable for the collapse of the business which in turn will slow down the economic growth.

Corporate governance is a system that is built over a period of time, to govern the way in which a

business is directed, administered and controlled. Corporate governance structure defines the

responsibilities for all the participants, including board of directors, CEO, share holders, clients

and business managers.

Corporate governance is a field in economics that studies the impact of business decisions on the

economy. Corporate governance is also defined as the set of guidelines and standards for

conducting business in compliance with code of ethics.

Financial regulatory body like Securities and Exchange Board of India (SEBI) has come with the

standards for corporate governance for financial failure. Industry lead and managed

organizations like Confederation of Indian Industries (CII) has come with the standards for

corporate governance, focusing on transparency and governance in business. Ministry of

Corporate Affairs, Government of India has set up National Foundation for Corporate

Governance (NFCG) to act as a catalyst in making India the best in corporate governance.

Sarbanes Oxley was enacted in United States federal law to protect investors against accounting

scandals.

Shareholder activism - Ethical Issue

Ethics is a field of study dealing with what is right or wrong for a given situation. Corporate

governance ethics or business ethics refers to examination of ethical problem that arise in

business environment. It applies to all aspect of conducting business, which includes conduct of

individuals and business as whole. Business ethics is the application of ethical judgments to

business activities.

The main objective of any business is to maximize the profit, without compromising on the

principles. There are various stake holders in a business – both internal and external. Following

figure show the various stake holders of a business:

Share holders activism is the way in which share holders assert their powers as owners of the

company to influence the business operations. Activism includes – not voting, private discussion

or public communication with corporate boards & management, blogging, press campaign,

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putting forward shareholder resolutions, calling share holders meeting – seeking to replace entire

board or individual director. In some cases, share holder activism is directed against larger share

holders.

Companies with active share holder are more likely to be successful, as they play the role of fire

alarm. When companies perform badly, shareholder activism bring change to company.

Three models of Management Ethics

Three models of management ethics are,

a. Immoral management – This type of management is devoid of ethical principles and

opposes what is ethical. They care only about their company and their goal is to achieve

profitability and organizational success at any cost. They exploit opportunities for

corporate gains.

b. Moral management – This type of management conforms to high standard of ethical

behavior. They want to succeed by following ethical practices.

c. Amoral management – This type of management are casual or careless about ethical

considerations in business. Their main objective is profit. They give managers full power

for profit maximization.

Ethical views in Corporate Governance

There are three different views that argue on morality and ethics in business:

a. Unitarian view

b. Separatist view

c. Integration view

According to Unitarian view, morality and ethics are related to business. According to Separatist

view, business is to generate profits and ethics and morality do not form a part of any business.

According to Integration view, ethical behavior and business are integrated. External forces like

government, business market and law will guide the ethical behavior of business.

In Unitarian view, shareholder activism against immoral management and amoral management is

ethical, as they bring positive change to the company and gives an opportunity to change the

management and this ensures smooth running of the business. In Unitarian view, shareholder

activism against moral management is unethical, as they bring negative change to the business,

which could lead to the close of business.

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In Separatist view, immoral management and amoral management is ethical, because the

management is working towards generating profits.

In Integration view, shareholder activism against immoral management and amoral management

is ethical, as these external forces guide the ethical behavior of business.

Dilemmas and contradictions in Business Ethics/Corporate Governance

Ethical problems in business ethics leads to dilemmas for the managers, as there is a conflict

between the business performance and social outcomes. Social outcomes include – protecting

employees, protecting the environment, etc. Managers use value judgment to take a decision.

Following are ethical problems in a business which leads to Dilemmas and contradictions:

a. Ethical issues in Business

1. Ethical rights and duties existing between company and society

The objective of any business is to make and supply goods or services to customers,

which will lead to prosperity of the economy. Business which make goods like –

alcohol, cigarettes, drugs etc.. are ethical dilemma for business, as society sees these

products as goods that are not good for the society.

The contradiction is, these companies offer employment opportunities to many people

in the society.

2. Moral rights between company and stake holders

To keep the stake holders happy, company indulge in various unethical activities like

– manipulating the book of accounts to show higher profits, reducing the work force

to show higher earnings.

3. Ethical issues relating to the relationship between companies – hostile takeover,

industry espionage

In business, takeover is acquisition of one company by another. In friendly takeover,

both the parties negotiate; get the approval from their share holders and then takeover

the business. In case of hostile takeover, the company acquires target company,

without the willingness of the target company board.

The contradiction here is, the company might have indulged in hostile takeover which

can result in higher profits for both the business, hence more employment opportunity

in the society.

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Industry espionage refers to the activities such as theft of trade secrets, bribery,

blackmail, spying on commercial organizations to increase their profits or for their

survival. In Technology industry, Industry espionage refers to creation of spyware

and malware to destroy the competition.

4. Political contribution made by companies

In some countries like India, corporate contribute some of their profits to political

parties, in return expecting the government to frame policies which will help grow

their business.

The contradiction is, companies can contribute some funds towards the growth of the

political party, which will work towards the growth of people and the society.

5. Corporate Social Responsibility

Corporate allocate some portion of their profit for corporate social responsibility

(CSR). CSR activities are aligned towards the development of the economy. Some

companies use CSR as a platform to promote their business and generate more

profits.

b. Accounting and financial information

1. Misleading financial information

Some companies willfully disclose incorrect financial information to keep their share

holders happy, assuming that they can take corrective action to improve their

financial situation in the future.

2. Insider trading

Some companies, especially hedge funds and other investment companies get non-

public information about a company through some means and use that information to

trade in those company stocks for quicker profits.

The contradiction is, the non-public information could have been shared for monetary

benefits or on personal relationship.

3. Securities fraud

Some companies induce investors to make purchase or sale of a particular company

stock based on the false information. This generally leads to loss for the investor.

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Sometimes the false information could be correct (if it comes as a news item to the

entire public), which can potentially give huge returns for the investor.

4. Executive compensation

Executive compensation refers to the salary, bonus, stock option, and other benefits

that top executives receive from the company. The compensation for these executive

has grown drastically when compared to the average salary of employees. There is a

contradiction that, it is because of the employees the company is making huge profits

and not because of the top executives. Another point of view is, it is because of these

top executives, the company gets new business, which in turn will require employees

for the execution.

5. Bribery

Bribery is a form of corruption, to influence the behavior of a person by giving gifts

or money, which will benefit the business.

In some countries, it is ethical for a person to give money to influence a person’s

behavior and that is termed as consultation fees.

c. Human resource management

1. Representation of employees – Union

Group of employees/labor join together to form unions and their main objective is to

improve the working condition of labors and ensure that labors are properly

compensated.

In contradiction, top executives feel that unions will decrease the company’s

productivity, which will in turn affect the growth and profits of the company. They

also feel that some employees will take advantage by not performing any work.

2. Privacy of employees

This refers to the monitoring of phone calls, emails, internet activities of employees

by the employer.

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Employees feel that they are they do not have privacy in the activities that they

perform within the organization.

Management monitors phone calls, emails, and internet activities to ensure that no

confidential information is transmitted outside the company utilizing the company

resources. According to the latest corporate law/act, all the activities performed by an

employee within an organization is the property of the organization and the company

has full rights to access those information.

3. Privacy of employer (whistle-blowing)

Whistle blower is a person who raises an alarm on the wrong doing within an

organization. Wrong doing includes – violation of law, violation of rules and

regulation, fraud, any threat to public, corruption, health/safety violation.

4. Employee safety and health

It is the responsibility of every organization to take care of the safety and health of

their employees. Some companies consider these investments as waste of money and

does not provide required safety for their employees. To enforce employee safety,

there are various quality standards from ISO to take care of the employee safety.

Some organization feel that investing in getting ISO standards is an expenditure,

instead share that money with their employees.

d. Sales and marketing

1. Pricing – Price discrimination, Price skimming

Some companies intentionally fix high price to get maximum profits, even though the

cost of production is less. Their main objective is to make money and they do not care

about the market segment who will be interested in buying their product at lower cost.

2. Anti competitive practices

Some companies indulge in anti competitive practices, like pricing their product too

low, which will ensure that their products are sold and their competitor lose the

market share and eventually goes out of business. This can also be viewed as an

opportunity for the competitor to price their product which is competitive in the

market. The other view is, to kill the competitor business, companies having huge

fund, come with cheaper pricing, thus creating huge demand for their product over

the competitor’s product. Cheap pricing of product will not result in profits for the

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initial few years, but eventually after destroying the competitor, the company will

start making huge profits, which will cover up the loss incurred during the initial

stages.

Introduction to Galleon Scam

Galleon is a privately owned hedge fund, which provides financial services to investors. Galleon

invests in equity market all over the world. They also invest in private equity. The fund primarily

invests in growth stocks and they have internal research team which performs fundamental

research and technical analysis for short term and long term investments. Galleon was founded

by Mr. Raj Rajaratnam.

The hedge fund was charge sheeted with insider trading on Oct 16, 2009 and the CEO was

arrested on the same day by FBI. They were involved in insider trading of Google Inc shares,

Polycom Inc shares, Hilton Hotels shares, AMD shares. The hedge fund has managed funds

worth over $7 billion. They were one among the top hedge funds during the early 2000. The fund

has been giving an average return of 21% every year since 1992, while the S&P index has

returned only 7% annually.

Mr. Rajaratnam, started his career with Needham & Co, New York based investment bank

during 1985. The primary focus of investment bank was in technology, health care and

electronics industry. In 1987, he became head research and in 1989 he became the chief

operating officer and later became president in 1991. He started Galleon, partnering with

Needham & Co colleagues during 1997. The networth of the fund rose to $850 million at the end

of the first year operation. During dot com durst, Galleon gave return of 44%, while S&P index

returned -37%. Galleon assert rose to $5 billion by end of 2001.

Mr. Rajaratnam, a Srilankan Tamil by birth, has donated $5 million for tsunami relief in

Srilanka. The hedge fund has also give $0.4 million to LTTE through a charity in Maryland.

Mr. Rajaratnam is charge sheet with 13 frauds and conspiracy. The hedge fund has made

millions of dollar by investing on the tips got from credit rating firms, and employees working

with Intel Capital, IBM and McKinsey.

Ethical issues in Corporate Governance of Galleon

Mr. Rajaratnam, being a billionaire and running a billion dollar hedge fund, has engaged in

unethical behavior of insider trading, risking all that he has earned for over the period of time. In

spite of so many insider trading frauds and other financial frauds, Mr. Rajaratnam failed to learn

from the mistakes others have done.

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Galleon management followed immoral management style. They indulged in unethical activities,

like getting insider information from credit rating firms and other hedge funds like Intel Capital,

IBM and McKinsey for their business. The management was selfish and their main objective was

profit making. In spite of knowing about many insider trading frauds and its consequences, the

management broke all the laws to achieve their business mission. The management’s strategy

was to exploit all the opportunities for their business benefit. Mr. Rajaratnam allowed their

traders, directly in charge for the large amount of the capital, which is against the industry

standards. In general, analyst and portfolio managers were responsible for the fund and the

traders will execute the orders. Mr. Rajaratnam also expected his traders to demand sensitive

information about companies, before those information were made public. The culture of the

company did not encourage morality and ethics for individuals. The business managers at

Galleon lacked personal ethics and they followed Amoral management style. They were

responsible for managing billion dollar fund.

The consequences of Galleon scam could lead to 20 years imprisonment for Mr. Rajaratnam and

other executives, who helped him in insider trading. Galleon filing bankruptcy has created

mistrust in investors, and destruction of his own family and further damaging the image of

financial sector. This scam has brought the public and US government question the need for

further regulation for financial and accounting transparency and disclosure on how fund

managers make money for the company.

Mr. Rajaratnam can rationalize his behavior, saying that others were also involved in the past in

insider trading. The amount of money he personally made through insider trading is less when

compared to the money thaws was created for their customers and their responsibility is to keep

their customer happy by giving maximum returns. Mr. Rajaratnam created his business

philosophy around these standards.

Conclusion

To address all ethical issues related to business, organizations should create a new role – Chief

Ethical Officer, who will be responsible to look into the code of ethics followed by each groups.

The new role should conduct periodic internal audit and ensure that all the groups are in

compliance with the standards. The organization should also ensure that each group’s

goal/mission should have high ethical standard. The organization should also have code of ethics

for its business, which should be strictly followed by all the employees. The company should

give periodic training to all its employees, to ensure that all business operations are done

ethically. The company should also have a dedicated team – Ethical Management, who shall

help/mentor managers in taking moral judgment.

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Bibliography

http://en.wikipedia.org/wiki/Corporate_governance

http://en.wikipedia.org/wiki/Economics_portal

http://www.nfcgindia.org/

http://www.sebi.gov.in/

http://www.cii.in/

http://en.wikipedia.org/wiki/Sarbanes%E2%80%93Oxley_Act

http://en.wikipedia.org/wiki/Business_ethics

http://www.financialexpress.com/news/galleon-scam-sparks-crackdown-on-insidertrading-

networks/530674/

http://www.bloomberg.com/apps/news?pid=20601087&sid=apNewkPGwwrE

http://www.bloomberg.com/apps/news?pid=20601087&sid=aAEHm_2lsa1A

http://laprinting.wordpress.com/2010/04/11/the-ethical- issue-of- insider-trading-of-galleon-ceo/

http://practicalstockinvesting.com/2009/11/05/the-galleon-hedge-fund-and-trading-on-inside-

information/