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«Global TrusT and EThics in FinancE Innovative Ideas from the Robin Cosgrove Prize Carol Cosgrove-Sacks / Paul H. Dembinski Editors Trust and Ethics in ...»

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The proposed solution to this conflict, in which clashes of interest and lack of trust between parties lead to increased costs, is collaboration between stakeholders. This will mean pursuing a joint interest that yields greater value for every interest group by lowering transaction costs and reducing risks. It is based on the Mutual Trust Perspective (MTP) proposed by Dees and Cramton (1991): it is unfair to require an individual to take a significant risk or incur a significant cost out of respect for the moral rights of others unless the individual has sufficient reason to trust those others to incur the same risk or cost. This effectively states that “a party will only incur significant costs out of respect for the other party’s interests or moral rights if it is satisfied that the other party would make the same sacrifice in the same situation” – an approach based on Kant’s categorical imperative, which is often rendered as “do not do unto others as you would not have them do unto you”, in other words avoid doing anything that you would not like another economic player or interest group to do to you.

Ethical Cash Management? 73 When seeking to establish a mutual cash holding relationship for

purposes of cash management, we must take due account of two factors:

the expectation that the other party will respond, and the cost. Trust between organisations is not just a decision-making issue; it increases or decreases on the basis of continuing relationships over a period of time.

It will therefore be easier if the first step is taken by the party that has more power and fewer costs, or to which a breach of trust would be less costly.

This means that it is easier to establish a mutual cash-holding relationship if this is proposed by the party or stakeholder with more power, provided that the cost of a possible breakdown in this relationship of trust is not too great. Furthermore, if the relationship of trust is to continue over a period of time, the arrangement must have clear benefits for both parties.

The proper balance between interests

A company cannot be conceived of in isolation from its stakeholders, since, aside from the company’s virtual existence as a legal entity, in practice it can only be viewed as a web of relationships between its various stakeholders (whether in the broad or narrow sense). The company must therefore take account of the interests of one or more stakeholders.

The problem is how to strike a proper balance between their various interests.

This balance is examined from the point of view of corporate ethics, which attempts to determine what that balance should be and how it can be achieved. A number of problems arise here, such as how to justify potential stakeholders’ rights, what scope agents really have for arbitration between interest groups’ conflicting demands, and relationships with non-stakeholders (i.e. interest groups that do not directly affect or are not directly affected by the company’s goals, but may affect or be afTrust and Ethics in Finance fected by them indirectly or at some point in the future). In the current crisis, these problems are being looked at carefully.

However, it should be borne in mind that, within companies, most players’ direct or indirect interests are monetary in nature. In general, and aside from other psychological and professional components, stakeholders’ legitimate interests almost always involve increasing value and earning money.

Up to now, most publications on the subject have explicitly or implicitly focused on management and conflicts over how value is shared out; however, the monetary realisation of value is undoubtedly a key factor in many conflicts between supposedly legitimate interests.

Such conflicts may be either internal or external. Internal conflicts involve stakeholders who are legally and permanently linked to the company, the main groups being shareholders and employees. External conflicts involve those who are linked to the company contractually or operationally, but whose connection with the company is contracted and undetermined, e.g. suppliers, customers, financiers or the government.

In all these cases, in theory, the parties may have conflicting interests regarding payment dates – debtors will benefit from late payment and creditors from early payment.

Mutual cash holding

The solution to this conflict may be coercion (a position of strength based on power asymmetry), for example when a shopping centre only pays its suppliers after 90 days, or when the government requires VAT to be paid quarterly. Another solution may be negotiation, for example when stakeholders mutually agree on a payment date. Finally, the solution may be a unilateral concession, for example when a seller finances a customer by only billing him after six months. Whether they involve coercion, negotiation or concession, all such solutions have one feature in Ethical Cash Management? 75 common – they solely take account of the stakeholders’ own cash management.

The proposal we are making here is that the various stakeholders should also take account of their partner’s cash holdings, in order to arrive at a solution that is most beneficial to both. Although this may seem an impossible approach to cash holdings, it is already starting to be introduced in connection with account management using new technologies and joint invoice management between financial institutions and companies, banks’ electronic invoices or even factoring and confirming.

The extension of such techniques may lead to mutual cash holding, and to a financial culture and financial techniques based on mutual trust, yielding benefits and satisfactory results for all concerned.

The timing of debt payment

Clearly, the timing of debt payment is a fundamental management issue. In fact this is a basic assumption in financial theory, which pays considerable attention to cash management or cash holdings and treats these as key tools in the running of companies. Paradoxically, however, financial ethics has paid little or no attention to the timing of debt payment, which is treated as a purely technical issue. What this means is that selfish corporate behaviour, based on optimisation of one’s own cash holdings, is taken for granted.

In a perfect market, in which the strengths of the various stakeholders are in equilibrium, contracts may be expected to produce fair agreements that benefit both parties; in practice, however, the market is imperfect and there is evident information and power asymmetry between the players, so that acceptation of the principle of optimising one’s own cash holdings turns selfish behaviour (which exploits asymmetry) into a morally acceptable approach and violates the generally accepted Kantian principle of ethical behaviour between companies.

76 Trust and Ethics in Finance Even though finance has not developed with ethical behaviour in mind, there is a general consensus that it is unfair for someone to pay a supplier several years after the service has been provided, unless the agreement between the two parties makes the mutual benefits of such an arrangement clear. In itself, such a restriction on delayed payment may imply the existence of ethical criteria of fairness that extend beyond purely contractual requirements. In this connection we may note the Spanish government’s decision to restrict delayed payment by major shopping centres.

The approach we propose here goes well beyond the issue of timing of debt payment, or the development of rules, standards and guidelines on how best to manage this in relations between stakeholders. Indeed, in our view, that would mean taking selfish behaviour for granted as a means of interaction, on the assumption that companies, or the various stakeholders, must always seek to maximise their own cash-management interests at the expense of those of their partners. The limits now being imposed are simply designed to ensure that the existing asymmetry does not create unfair situations for the weaker party.

A number of comments need to be made here. On the one hand, negative practices need to be restricted on both ethical and economic grounds; on the other, it would be interesting to know whether the recent recommendations and legal restrictions are in fact motivated by ethical considerations. However, the main contribution of ethics must be to try and change the selfish attitudes on which financial relationships between companies and interest groups have hitherto been based.

We therefore believe it is vital to replace conflict-based selfish approaches with ones that seek to optimise stakeholders’ long-term benefits, on the basis of mutual trust. This would not only be more appropriate from an ethical point of view, but would also be more beneficial for stakeholders and for society as a whole. Mutual cash holding by compaEthical Cash Management? 77 nies or stakeholders with conflicting interests would thus yield greater long-term benefits for stakeholders and society.

A change in attitude is needed This paper proposes a theoretical mutual cash-holding model based on trust, which is fostered by power asymmetry. Mutual cash holding could produce more beneficial results for all the stakeholders that influence or are influenced by companies.

Existing cash-holding techniques and cash-management models are designed to improve the financial position of the company that applies and introduces them. They thus focus on maximising shareholders’ profits and rely on players behaving selfishly. Since no specific account is taken of other stakeholders, value is not generated for all of them. This paper makes clear that cash management is a key factor in the relationship and equilibrium between the various stakeholders and their interests. It is therefore necessary to ensure that cash management satisfies stakeholders’ interests, which may conflict in the short term, in such a balanced manner that they converge in the long term. In the long term, mutual cash holding by stakeholders will produce benefits for all of them, by increasing solvency and liquidity, and for society as a whole, by reducing insolvency. It must also be borne in mind that this approach can only succeed if it is introduced by the stronger partner in the relationship.

Its theoretical acceptance will ultimately depend on a change of attitude towards cooperation and the elimination of information asymmetry and of barriers to mutual trust that prevent people from accepting the obvious before even considering how the system might work.

Bibliography Boatright, J.R., 2008. Ethics in Finance, Malden: Blackwell.

Coase, R.H., 1937. “The Nature of the Firm”, Economica, November.

78 Trust and Ethics in Finance Dees, J.G./ Cramton, P.C., 1991. “Shrewd bargaining on the moral frontier: toward a theory of morality in practice”, Business Ethics Quarterly 1 (2).

Dittmar, A. et al., 2003. “International Corporate Governance and Corporate Cash Holdings”, Journal of Financial and Quantitative Analysis 38 (1).

Gitman, J. et al., 1976. Principles of Managerial Finance, New York, Harper and Row, Inc.

Jensen, M.C., 1986. “Agency costs of free cash flow, corporate finance and takeovers”, American Economic Review 6.

Jensen, M.C./ Meckling, W.H., 1976. “Theory of the firm: managerial behaviour, agency costs and ownership structure”, Journal of Financial Economics 3.

Kalcheva, I./ Lins, K.V., 2007. “International Evidence on Cash Holdings and Expected Managerial Agency Problems”, Review of Financial Studies 20 (4).

Myers, S.C., 1977. “Determinants of Corporate Borrowing”, Journal of Financial Economics 5.

Myers, S.C./ Majluf, N.S., 1984. “Corporate financing and investment decisions when firms have information that investors do not have”, Journal of Financial Economicsi 13.

Pinkowitz, L. et al., 2006. “Do firms in countries with poor protection of investor rights hold more cash?” Journal of Finance 61 (6).



–  –  –

When prosperity reigns, and the financial markets seem intent on zooming into outer space, the world of Finance happily locks itself away in an ivory tower. But in the sort of crisis period that we are living through now, society feels thoroughly contaminated and claims the right to scrutinise more closely the behaviour of those who control the flow of finance. Declarations, accusations, and legislative activity come thick and fast. And it’s then that we are reminded that the circulation of money entails political consequences… and that it ought to follow ethical rules.

Subjected to a media trial, the court of public opinion and accusations from politicians, we suddenly realise that the discourse on ethics emanating from the financial milieu over the past few years has centred on issues such as the carbon balance, renewable energy or recycling concerns that are often far removed from the core issues of business and enterprise – most of all the issues facing companies working in the financial sector! Even though the financial community has finally begun to address matters of social responsibility and sustainable development, it has managed to avoid the really troublesome subjects – first and foreTrust and Ethics in Finance most how to measure its own responsibility… and the ethical demands that result from it.

Ethics or morality?

It is financial market players who are first and foremost confronted with ethical concerns. By players we mean both individuals and the companies that employ them, and beyond these the global structure of the financial world that sets the framework for their behaviour. In order to be able to propose a solution that will foster ethics in finance, we need first of all to decipher this formula and identify what’s gone wrong.

Today, the term “ethics” is used loosely in a variety of ways. In common parlance, “ethics” and “ethical” are more or less synonymous with “morals” and “moral” but as a sort of toned-down, softer version of this concept, which might sound altogether too austere, guilt-inducing and Judeo-Christian to some ears. Those who study philosophy know, however, that morals and ethics have nothing to do with each other.

Whereas morality lays down a prescriptive system, based on the distinction between what is right and what is wrong, ethics addresses the rules of one’s behaviour (ethos) in action. Morality tells you what to do and what to think at any time and under any circumstances. Ethics tries to define what you are able to do starting out from a cocktail of freedoms and constraints.

The domain of ethics is not therefore about distinguishing between Good and Evil, but defining correct and prudent behaviour in a given context – what Aristotle in his Nicomachean Ethics (Book II, Chapter 6) called arêtè. This Greek word is usually translated as virtue, but not in the sense of the purity of the frightened virgin. It is used to signify the strength of a man who is able to control his passions; that is to say it is not an end in itself, but a means to an end. Ethics, in contrast with morality, does not seek to make Good prevail, or to foster noble sentiments.

Ethics and Order 81 It tries to order action in such a way that it is efficient, by means of virtue, which basically means strength.

Ethics: a guide to action In this sense, ethics is as much about the individual as about society.

A well-ordered personal life is a guarantee of happiness, a well-ordered society a guarantee of justice. Ethics has right action – what is orderly – as its objective, not good. The first conclusion from this definition is that ethics is effective, valuable in the true sense of the word. It is productive and adds value. The demands of ethics seem therefore from the outset more likely to prove themselves than those of morality, with which they are often equated. As the famous Liberal maxim has it: we should set more store by a man’s self-interest than by his benevolence.

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