Unit 1

I believe that you will all be managers someday maybe for your own business or maybe even
multinational companies, it is important to determine the goals of a corporation, know the different
interest groups involved as well as their relationship so we will find out potential conflicts of interests.
So in Unit 1, we will get to know different people, their respective ethical duties.
Just a review, I know you have taken up the revised corporation code, a corporation is an artificial being
created by operation of law, having the right of succession and the powers, attributes, and properties
expressly authorized by law or incidental to its existence.

Now I know there are different kinds of corporation but in this subject we are focusing more on
corporations whose objective or purpose to conduct a lawful, ethical, profitable and sustainable
business in order to ensure its success and grow its value over the long term. This requires consideration
of all the stakeholders that are critical to its success (shareholders, employees, customers, suppliers and
communities), as determined by the corporation and its board of directors using their business
judgment and with regular engagement with shareholders, who are essential partners in supporting the
corporation’s pursuit of its purpose. Fulfilling purpose in such manner is fully consistent with the
fiduciary duties of the board of directors and the stewardship obligations of shareholders. Maintaining
ethical behaviour would in fact, be the foundation of all the relationships a company has with all its
partners – customers, employees, investors, vendors and other stakeholders.

In a corporation there is a web of contractual relations among different interest groups.

Shareholders
So basically, these are the owners of the business which means they have the have rights to vote on
company decisions and ensure that the company is well run and well managed. They do this by
monitoring the performance of the company and raising their objections or giving their approval to the
actions of the management of the company so this is actually an ethical duty of a shareholder. These
rights are actually protected by law, and honoring them is one of the objectives in corporate
governance.
Employees
Employees have a legal and moral obligation to conduct themselves ethically in regard to their
employer. There are several ways that employees can be ethical, such as being loyal, honoring work
time, using funds appropriately, and being respectful. Ethical employees are always honest, consistently
giving truthful information to their employers and, in doing so, helping the employer make informed
decisions.

Ethical organizations hire fairly and without discrimination based on age, race, ethnicity, gender, religion
or disability. They also communicate honestly with employees and provide a workplace that aligns with
human resource laws and ethical standards. Paying employees for all hours worked, giving required
breaks, provide accurate and timely feedback on performance and listening to concerns about
harassment, violence or other workplace issues are among ethical considerations.

Customers
Ethical behavior of a company with its customers includes (but is not limited to) providing true
information and impressions to customers. Ethical behaviour with customers under all situations and
circumstances leads to strong and sustainable relationships with them. Businesses that run a ‘tight ship’
with regard to ethical behaviour will be highly respected by customers, employees, investors, other
stakeholders and even competitors. It takes years to build such a reputation but a company with such
character would be tough to beat. Customers prefer to do business with a company that they can trust
and would even be more comfortable paying more so long as they know that irrespective of the
circumstance, the company would always stick to ethical behavior.
Suppliers
Manufacturers, wholesalers, retailers and service businesses rely on suppliers for basic business
equipment and resale goods. Though a supplier benefits from the profit it makes by selling to you,
trusted relationships with core suppliers also give value to your company.
Companies also interact with business suppliers and partners. Retailers, for instance, typically buy
supplies and resale products from distributors. Fair and honest practices in such interactions are also
ethical matters. Honest communication when entering business agreements and paying bills on time are
a couple specific ethical applications. Maintaining trusting relationships with suppliers and partners is
also wise from a long-term perspective, as they aid your business in performing its operations.

Conflict of interest
Shareholders & Bondholders
A bondholder is an investor or the owner of debt securities that are typically issued by corporations and
governments. Bondholders are essentially lending money to the bond issuers. In return, bond investors
receive their principal—initial investment—back when the bonds mature. For most bonds, the
bondholder also receives periodic interest payments and so bondholders enjoy certain protections and
priority over shareholders. Bonds are typically considered safer investments than stocks because
bondholders have a higher claim on the issuing company's assets in the event of bankruptcy. In other
words, if the company must sell or liquidate its assets, any proceeds will go to bondholders before
common stockholders.

A tension exists between the stockholders and bondholders of a company. For example, if stockholders
use their control to pay themselves high dividends, thus weakening the company's ability to pay its
debts as they come due, the value of bonds falls. Likewise, if a company takes on a heavy debt burden,
swamping it with interest obligations, stockholders may not be paid dividends.

This tension is particularly visible in a leveraged buyout (LBO), where an acquirer pays a premium to
stockholders to buy their shares and acquire control, and then uses that control to have the company
take on new debt to finance the payments made to the shareholders. As a result on the new debt,
bondholders of the company find themselves with a much riskier investment - and falling prices for their
bonds.

Thus, in an LBO a company acquires its common stock by taking on new high-risk debt. From the
perspective of existing debt holders, an LBO represents a fundamental shift of the company's capital
structure from one of low leverage (debt/equity ratio) to high leverage. The effect of an LBO is that the
existing debt falls in value as the company's risk profile changes overnight. Do existing debt holders,
particularly as long-term bondholders, have any rights to prevent this change or to seek compensation
for the revaluation of their interests? Put another way, does the company board of directors owe
fiduciary duties to existing debt holders not to transform and undermine their investment?

As the stockholders' agent, corporate management has a fiduciary duty to look out for the investors. The
board and the CEO don't have the same obligation to put their creditors' interests first. That's the basic
conflict between shareholders and bondholders.
A corporation could, for example, respond to shareholder demands by issuing huge dividends, even if
this is bad for the company's long-term health. Taken to the extreme, this behavior puts bondholders
and other creditors at financial risk. The company could wind up an empty shell that can't pay back its
debts.

Some companies even issue added debt so that they can keep paying dividends. This avoids the wrath of
shareholders who might be able to force a change in management. Taking on added debt doesn't
benefit bondholders, but they don't have the same influence.

Bankers

Shareholders and Directors (corporate management)

he board makes the decisions and management carries them out

The relationship between shareholders and corporate management is one of principal to agent. The
shareholders, as the owners of the company, are the principals. The corporation's management is the
agent charged to act in the shareholders’ interest. Any principal/agent relationship has the potential for
conflict. Is the agent making decisions to benefit themselves rather than the principal? Is the agent
doing a bad job because they're incompetent?

In corporate governance, shareholders want good money management from their agent. They want to
know where their money went, and they want a return on their investment either from dividends or
from rising stock prices. If it doesn't happen, they want to know why their agent didn't deliver.

Agency Theory
Agency theory is used to understand the relationships between agents and principals. The agent
represents the principal in a particular business transaction and is expected to represent the best
interests of the principal without regard for self-interest. The different interests of principals and agents
may become a source of conflict, as some agents may not perfectly act in the principal's best interests.
The resulting miscommunication and disagreement may result in various problems and discord within
companies. Incompatible desires may drive a wedge between each stakeholder and cause inefficiencies
and financial losses. This leads to the principal-agent problem.

The principal-agent problem occurs when the interests of a principal and agent come into conflict.
Companies should seek to minimize these situations through solid corporate policy. These conflicts
present normally ethical individuals with opportunities for moral hazard. Incentives may be used to
redirect the behavior of the agent to realign these interests with the principal's concerns.

Corporate governance can be used to change the rules under which the agent operates and restore the
principal's interests. The principal, by employing the agent to represent the principal's interests, must
overcome a lack of information about the agent's performance of the task. Agents must have incentives
encouraging them to act in unison with the principal's interests. Agency theory may be used to design
these incentives appropriately by considering what interests motivate the agent to act. Incentives
encouraging the wrong behavior must be removed, and rules discouraging moral hazard must be in
place. Understanding the mechanisms that create problems helps businesses develop better corporate
policy.

To determine whether or not an agent acts in their principal's best interest, the standard of "agency
loss" has emerged as a commonly used metric. Strictly defined, agency loss is the difference between
the optimal results for the principal and the consequences of the agent's behavior. For example, when
an agent routinely performs with the principal's best interest in mind, agency loss is zero. But the further
an agent's actions diverge from the principal's best interests, the greater the agency loss becomes.

Solution

Bond Covenants
One way corporations can reduce agency conflicts is with bond covenants. These are agreements that
obligate the corporation to follow policies that protect the bondholders. They can include both positive
and negative covenants.

Negative covenants forbid the corporation from taking certain actions, even if the stockholders demand
it:

Restrictions on issuing further debt.

Restrictions on securing new debts with corporate assets. Secured debt goes to the head of the line in
bankruptcy, ahead of bondholders.

Setting a limit on the amount of dividends the company pays out.

Limiting other kinds of payments such as share repurchases.

Restricting asset sales and mergers.

Positive covenants require the corporation to act, rather than refrain from doing something:

Filing regular financial statements.

Maintaining their property.

Insuring their assets.

Hedging against volatility in interest rates.

Committing the corporation to use the bond money for a specific purpose.

The company has to maintain certain financial ratios, such as net worth or debt to earnings.

The company has to check its financial ratios if it takes certain steps, such as issuing added debt.

The company will increase coupon payments on the bonds if its credit rating drops. This covenant is
used primarily on high-yield, high-risk bonds.
The bondholders can sell their bonds back to the company at a premium if ownership changes, the
credit rating is downgraded, or other trigger events come to pass.

The corporation will pay off the bond within 30 to 90 days if certain conditions happen. These could
include bankruptcy or a large legal judgment against the company.

Drawbacks to Covenants
Covenants are a common solution to conflicts between shareholders and bondholders, but they aren't a
perfect one. For example, the bond issuer may find the covenant terms restrict them so tightly they
can't make necessary investment and financial decisions. Restrictions on issuing further debt may block
the company from raising money when it needs to.

Financial ratio covenants are often a sub-optimal choice for minimizing conflicts with shareholders. It
takes regular monitoring to confirm that companies are maintaining the required financial ratio. Banks
are well equipped for that work, but most other bondholders aren't.

By the time a bondholder discovers the issuer has exceeded the financial ratios, the corporation may
already be insolvent. Setting specific terms on the policies that the business should or should not follow
is usually more effective for a company that doesn't want to monitor the ratios constantly.

Added Fiduciary Duty

One proposal for reducing conflicts in the future is to give bondholders a say in corporate governance.
The need to keep shareholders happy may lead corporate heads to make decisions that don't benefit
the business. Giving bondholders more influence could counteract that.

Shareholders benefit if corporations take risky gambles that pay off. Bondholders benefit if corporations
play it safe. Bonds are widely traded after the initial issue. Bond buyers who want to sell need
corporations to make decisions that keep the bonds' highly rated, promising a safe return on
investment.

The bondholders' need for security could counterbalance the stockholders' interest in risk. If
bondholders exercised more direct control, that might increase the health and productivity of the
corporate sector for the long haul.

Goal congruence
Non-executive directors
Administrators
Management buy-outs and buy-ins
Executive share schemes

Means of promoting ethical behavior within the organization and in relation to the outside world

CFO
Audit committee
Internal auditor
External auditor

https://corp.yonyx.com/customer-service/ethical-behaviour-with-customers/
https://courses.lumenlearning.com/boundless-finance/chapter/agency-and-conflicts-of-interest/
https://users.wfu.edu/palmitar/Law&Valuation/chapter%204/4-3-5.htm
https://bizfluent.com/how-10048573-reduce-agency-conflicts-between-stockholders-bondholders.html
https://www.mbaknol.com/financial-management/ways-of-resolving-agency-problems-and-costs/