Ethical Implications of Takeovers - Case Study Example

Student: Instructor: Course; Date: Introduction The current business environment has increasingly become competitive and highly dynamic. As such, many companies are faced with the challenge of enhancing their productivity and profitability. In essence, business entities have to be efficient, flexible, profitable, and adaptable in order to gain a comparative advantage over their competitors, as well as attain a dominant market position. Thus, mergers and acquisitions (henceforth M&A) are now an essential component in enabling companies to grow and survive (Taneja and Saxena 69). Much as M&A facilitate companies to grow and expand, they have often resulted into unethical and unprofessional behavior. Therefore, it is imperative to develop strategies and guidelines that curb the fraud associated with M&A. The unprecedented rise in M&A has also paralleled the increase cases of corporate fraud and unethical behavior. Historically, concerns over corporate fraud focused on product safety, marketing irregularities and environmental safeguards. Nonetheless, the emphasis has now shifted towards corporate governance, corrupt deals, accounting fraud, and financial reporting (Wells 15). Responsibility is a critical component of business social performance because it emphasizes an enterprise’ ethical performance. Ethics essentially differentiates between right and good. Within the contest of M&A, ethical considerations entail the moral correctness of all decisions regarding the M&A (Taneja and Saxena 72). Conversely, the issue of fraud in both friendly and unfriendly M&A has often overshadowed the rights of employees and stakeholders’ responsibilities. These two issues also raise questionable ethical practices. In the first instance, employees are never part or aware of the M&A until the last moment. On the other hand, stakeholders should bear some obligations or responsibilities of accrued rights if they are the fiduciary recipients of M&A (Brenkert and Beauchamp 24). It follows that M&A should follow a utilitarian and rights approach to ensure ethical and professional conduct (Boatright 40). Hence, this paper will identify the ethical issues surrounding the M&A involving Lisa Michaels, Finance Manager at Home and Personal Care Products. Ethical Issues The primary ethical issue arising from this case study is the capitalization of expenses. Lisa identified “Other Assets” in the acquired balance as being strange given their unusual high proportion. In the same vein, she found out that the majority of these assets were capitalized marketing expenses. Capital expenditures benefit a company for more than one accounting period. Companies normally capitalize their revenue-based expenses to increase assets and income given that they are amortized for an extended time instead of being expensed instantly. However, capitalizing expenditures as assets and then failing to expense them during the current period overstates income (Wells 370). The majority of previous frauds during M&A have always involved the improper expense capitalization in financial statements. Standard practice requires the capitalization of expenditures that enhance the value of the company’s assets. Furthermore, expenses that extend the usefulness of company assets beyond their original useful life or those that enhance the assets’ productive capability are capitalized. On the contrary, expenditures that maintain or restore the assets at their original condition are expensed rather than capitalized (Brenkert & Beauchamp 43). From the case study, the acquired company had capitalized marketing expenses that neither add value to corporate assets nor extend the original timeframe of the assets. The unethical issue underlying the capitalization of marketing expenses means that the acquired company had materially overstated the income that it had recorded on its financial statements. Lisa discovered that the acquired company’s Chief Financial Officer (CFO) had capitalized both television and print commercials, which amounted to several million dollars in some cases. Consequently, the company portrayed itself falsely as a profitable business by concealing large losses. The most disturbing discovery is that Mr. Anderson (the Controller from the acquired company) treated this revelation as a trivial matter that should not worry Lisa. Nonetheless, this matter was serious considering that the capitalized expenses had inflated the acquired company’s income. The other ethical concern that has emerged from this case study is the issue of “Other accrued liabilities.” The problem is heightened further by the absence of standing journal entries to support these liabilities. Journals are financial records that detail fiscal transactions with their corresponding accounts. Accounting principles mandate the recording of all business transactions in the journals initially prior to transferring them into financial reports (Boatright 58). According to Boatright, auditors rely on journal entries to ascertain the impact of financial transactions on a business (62). The absence of these journal entries indicates two aspects. First, bookkeeping practices at the acquired company did not follow standard procedures. Secondly, the acquired company may have withheld the journals deliberately for sordid gain. Stakeholders Involved The ethical issues in this case study has brought to the forefront two groups of stakeholders: the acquired team and the finance team. First, the due diligence by Lisa has revealed improper capitalization of expenditure, as well as accrued liabilities that do not have backing evidence from journal entries. Therefore, these findings may cast the acquired team in bad light as lacking transparency and unprofessionalism. Second, the ethical and professional issues raised in the case study are all financial in nature. Thus, they bring into focus the role of the financial team in the M&A. Brenkert and Beauchamp have opined that officials often collude during the M&A process to achieve financial gains (67). Hence, the role of the financial team will be significant in this case study to avert instances of fraud. Alternative Course of Action Lisa decided to meet Mr. Anderson after realizing anomalies during the preliminary observations of the acquired assets. Lisa particularly intended to discuss with Mr. Anderson the issue of improperly capitalized expenditures and documented journals entries for “Other accrued liabilities.” However, these actions have not borne any fruits given that Mr. Anderson shrugged off the claims. Nevertheless, she also decided to challenge the acquired company’s conservative accounting policies. Nonetheless, the latter course of action may place her in collusion with the finance and acquired teams. Therefore, the need has arisen to assume an alternative course of action in order to prevent fraud. The alternative course of action that Lisa could take is to conduct a full audit of all financial accounts from the parent and acquired company prior to finalizing the M&A. It is clear from the case study that Mr. Anderson was not interested in the parent company’s accounting manual and the plan for asset valuation. it can be assumed that Mr. Anderson is aware of impending issues in the financial statements and valuation that Lisa is yet to identify. Therefore, Lisa could proceed to audit all the accounts in order to ascertain the actual value of the acquired assets. For instance, Wells has indicated that improperly capitalized expenditures reduce income in the future after accounting for asset depreciation. One of the principal unethical and unprofessional conducts during M&A is fraud concealed in financial statements (Taneja & Saxena 72). Hence, the auditor is burdened with the task of detecting and reporting ethical and professional erosions that arise from the misappropriation of assets (Boatright 73). Lisa could use auditing standards to discover deliberate financial misrepresentations. However, the dilemma that Lisa faced was that her actions would distance the acquired team and losing the trust of both Mr. Anderson and the finance team. Consequently, it will be essential to consult the services of an independent auditor. The Best Course of Action The case study has presented ethical dilemmas that Lisa faced. Kidder has defined ethical dilemmas as “right vs. right”. Accordingly, Kidder has argued that the “right” should be maintained on both sides of the continuum (Kidder 5). The application of Kidder’s school of thought in Lisa’s case will be to ensure that the M&A is successful while at the same time curbing all forms of fraud. The aforementioned objectives are genuine ethical dilemmas because core values underpin each aspect. For instance, the success M&A is crucial for the survival of the company while social responsibility demands that the M&A is transparent. Kidder has opined that when people are confronted with these tough choices is never about right vs. wrong, but rather right vs. right (15). The best course of action is to ensure that the action taken is acceptable to the public. Media reports have always reported cases of corporate fraud during M&A, which is often seen as violating societal and business norms. Therefore, the decision that Lisa should be based on the four rules that govern ethical decision-making: utilitarian rule, moral rights rule, justice rule and practical rule (Boatright 102). First, the utilitarian rule will ensure that the decision taken benefits the greatest number of individuals. Second, the moral rights rule entails protecting the unalienable, fundamental privileges and rights of the affected individuals. Third, the justice rule will guarantee the distribution of benefits and harms equally. Finally, practical rule demands that the chosen decision can be communicated and acceptable to the society (Brenkert & Beauchamp 73). Conclusion Mergers and acquisitions have increasingly become essential components that help companies in the contemporary society to remain afloat. Conversely, M&E are oftentimes riddled with fraud and other unethical behavior. The majority of fraud cases arise from the inflation of company assets to increase the value of the acquired company. However, auditors are normally confronted with ethical dilemmas due to competing interests from different stakeholders. Thus, it is imperative to conduct due diligence, particularly full audit of financial statements, to ensure that the M&A is above board. Most importantly, the utilitarian, moral rights, justice, and practical rules are critical to make informed decisions when faced with ethical dilemmas. Works Cited Boatright, John R. Finance Ethics: Critical Issues in Theory and Practice. New Jersey: John Wiley & Sons, 2010. Print. Brenkert, George G., & Tom L. Beauchamp. The Oxford Handbook of Business Ethics. New York: Oxford University Press, 2012. Print. Kidder, Rushworth, M. How God People Make Tough Choices Rev Ed: Resolving the Dilemmas of Ethical Living. 2009. New York: HarperCollins. Print. Taneja, Mayur, & Noopur Saxena. ‘Mergers and Acquisitions with a reference to Ethical, Social and Human Resource.’ IOSR Journal of Business and Management 16.3 (2014): 69-72. Print. Wells, Joseph T. Corporate Fraud Handbook: Prevention and Detection. New Jersey: John Wiley & Sons, 2011. Print. Read More