Ethical responsibilities of the owners and managers of businesses

Welcome to the World of Business Ethics!

Hello there! Welcome to one of the most interesting parts of the CB1 – Business Finance syllabus. While a lot of finance is about numbers, ratios, and formulas, this chapter is about people and the choices they make. We are going to explore the ethical responsibilities of those who own businesses and those who run them. Don't worry if this seems a bit "wordy" compared to the math parts of the course—we will break it down step-by-step so you can ace your exam!

1. The Core Relationship: Owners vs. Managers

Before we dive into ethics, we need to understand the relationship between the two main groups in a company. In a large company, the people who own the business (the shareholders) are usually not the same people who manage it (the board of directors).

The Agency Theory

In finance, we call this the Agency Relationship. Think of it like this: You are the Principal (the owner), and you hire an Agent (the manager) to look after your house while you're away. You expect them to keep it clean and safe, but they might be tempted to throw a party instead! This potential for conflict is what we call the Agency Problem.

Quick Review: Key Roles
• Principal (Owner/Shareholder): Provides the capital and wants the business to grow in value.
• Agent (Manager/Director): Makes the day-to-day decisions and expects a salary/bonus.

Key Takeaway:

Ethical issues arise because managers might act in their own self-interest (e.g., taking a massive bonus) rather than in the best interest of the owners (e.g., paying out dividends).

2. Ethical Responsibilities of Managers

Managers have a "fiduciary duty." This is a fancy way of saying they have a legal and moral obligation to act in the best interests of the company and its owners. Let's look at what this looks like in practice.

A. Integrity and Honesty

Managers must be truthful. This means not "window dressing" the financial statements to make the company look more profitable than it actually is. If the company is struggling, the managers have an ethical duty to tell the truth to the shareholders.

B. Avoiding Conflicts of Interest

Managers should never use their position to benefit themselves at the expense of the company.
Example: A manager shouldn't award a huge supply contract to their brother's company if another supplier is cheaper and better.

C. Transparency and Disclosure

Managers must provide clear, accurate, and timely information. This allows owners to make informed decisions about whether to keep their shares or sell them.

D. Compliance with the Law

While this sounds obvious, ethical management goes beyond just following the law; it involves doing the right thing even when the law is silent.

Memory Aid: The "FAIR" Manager
F – Faithful (to the company's goals)
A – Accountable (for their actions)
I – Integrity (being honest)
R – Responsible (to all stakeholders)

3. Ethical Responsibilities of Owners (Shareholders)

It’s not just the managers who have responsibilities! Owners also have an ethical part to play, especially large institutional investors (like pension funds or insurance companies).

A. Monitoring and Oversight

Owners shouldn't just "buy and forget." They have an ethical duty to monitor what the managers are doing. This is called Stewardship. If they see managers behaving badly, they should use their voting power to demand change.

B. Responsible Investment

Many owners now consider ESG factors (Environmental, Social, and Governance). An ethical owner might choose not to invest in companies that harm the environment or use child labor, even if those companies are profitable.

C. Exercising Voting Rights

In every Annual General Meeting (AGM), shareholders get to vote on important things like director pay and board appointments. Exercising this vote is a key ethical responsibility.

Did you know?
Institutional investors (like the ones actuaries often work for) hold so much power that their "ethical voice" can force a giant corporation to change its entire environmental policy!

4. Shareholder vs. Stakeholder Theory

This is a classic debate in the CB1 curriculum. Who should the company be run for?

The Shareholder View (The "Friedman" View)

This view argues that the only ethical responsibility of a business is to maximise profits for the owners (within the law). The idea is that if the company is profitable, it creates jobs and pays taxes, which helps society indirectly.

The Stakeholder View

This view argues that managers should balance the needs of all groups affected by the business. This includes:
• Employees (Fair wages and safety)
• Customers (Quality and honesty)
• Suppliers (Fair payment terms)
• The Community (Environmental protection)

Key Takeaway:

Modern corporate governance usually leans toward the Stakeholder View. It suggests that a company that treats its employees and customers well is more likely to be successful for its shareholders in the long run.

5. Professional Ethics and Codes of Conduct

Many managers and owners are also members of professional bodies (like the IFoA for actuaries!). These bodies have their own Codes of Ethics that members must follow.

Common Principles in Professional Codes:

1. Integrity: Being straightforward and honest.
2. Competence and Due Care: Only doing work you are qualified to do and doing it carefully.
3. Confidentiality: Respecting the privacy of company information.
4. Objectivity: Not letting bias or conflict of interest influence your professional judgment.

Common Mistake to Avoid:
Don't assume that if something is legal, it is automatically ethical. Many things that are technically legal (like aggressive tax avoidance) might be considered unethical by shareholders and the public.

6. Summary Quick-Check

Before you move on, make sure you can answer these questions:
1. What is the Agency Problem? (Conflict between owners and managers)
2. Name two ethical duties of a manager. (e.g., Transparency and avoiding conflicts of interest)
3. What is Stewardship? (Owners monitoring and taking responsibility for their investment)
4. What is the difference between a Shareholder and a Stakeholder? (Owners vs. anyone affected by the business)

Great job! Ethics can feel a bit abstract, but just remember: it's all about building trust. Without trust, people wouldn't invest money, and the whole financial system would stop working. Keep going, you're doing brilliantly!