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Professor Michael Mainelli, Executive Director, The Z/Yen Group

An edited version of this article first appeared as "Caseless Wonders: Finance Courses and Ethics", Finance & The Common Good/Bien Commun, Number 30 – 1/2008, Observatoire de la Finance (June 2008) pages 81-90.]

Ethical Popularity

Cynics call “business ethics” an oxymoron.  Yet, corporations are expected to hold forth publicly their business ethics while at the same time individuals become increasingly private about their morals, perhaps politicians excepted.  Adding the adjective “business” to create the phrase “business ethics” implies that “business” holds a different kind of ethics, or provides a different environment for ethics or uses different tools than plain old ethics. 

Since the mid-1980’s, MBA programmes in business ethics have grown in popularity, as a simple internet search for “MBA course business ethics” demonstrates.  There are strong arguments for and against teaching these courses.  Proponents of business ethics courses point out the increasing intrusion of moral arguments into business, e.g. social and ethical labelling, sexual harassment, racial equality or environmentalism, the importance of relationships with non-governmental organisations, brand valuation and consumer trends.  Courses on business ethics supposedly help students become familiar with frameworks that will help them think through ethical problems.  Opponents of business ethics courses point out the relativism of socially-based morality, the lack of coherence in courses so far and the irrelevance of ethics to business.  It is worth questioning whether business ethics is intrinsically different from societal ethics.

Business – A Different Kind Of Ethics?

If we limit the term “business” to companies with dispersed shareholdings, it could be claimed that business ethics is far simpler than personal ethics.  At the core of business ethics is a transaction whereby a shareholder pays for a stake in a business venture.  So long as the manager of the business venture acts within the law and attempts to maximise shareholder value, there should be few ethical issues.  Milton Friedman [Friedman, 1962] views wider social responsibility as irrelevant or even pernicious:

“Few trends could so thoroughly undermine the very foundations of our free society as the acceptance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible.  This is a fundamentally subversive doctrine.  If businessmen do have a social responsibility other than making maximum profits for stockholders, how are they to know what it is? Can self-selected private individuals decide what the social interest is?”

By restricting managers to maximising shareholder value legally, it would appear that there is little to study in business ethics.  Analogies to some of the classic ethical paradoxes, e.g. “should you steal to feed your starving family?”, seem irrelevant.  Others, such as “does an unborn foetus have rights?” can be compared with “do non-shareholders have rights?”, but seem irrelevant to day-to-day business management.  Where can we find the “case studies” to analyse in class? There are a few richer questions to ask about the shareholder-manager contract such as, “does a shareholder have an obligation to stop a manager’s unlawful actions?”, i.e. harming himself or herself, but perhaps these are mostly a question of law rather than business ethics.

Budding “corporate officials” studying for an MBA are part of Friedman’s “free society” and come with a typical moral code common in their society.  Why should they need further study beyond the norm? If business students need ethical frameworks above and beyond the norm, why shouldn’t pipefitters and politicians have to attend ethics courses? Why should business students not acquire other useful social tools in their stretched MBA course time, e.g. a new language or studying Social Manipulation & Scheming 101, rather than wasting time on abstruse ethical questions in a one-dimensional situation where the “shareholder is always right”.

Of course, MBAs do not take jobs exclusively at companies with dispersed shareholdings; they find themselves working in owner-managed businesses, starting their own businesses, working for government or leading NGOs.  These organisations do not have a core ethical transaction, rather much more complex stakeholder relationships and measures [Harris, Mainelli and O’Callaghan, 2002]. Nevertheless, it is doubtful that the set of values guiding decisions of moral duty and obligations is inherently different in the field of “business administration” than in “society”.

Business – A Different Environment For Ethics?

However, things are not that simple.  Shareholders are able to change the nature of the contract with managers, which leads to a class of ethical questions circling around “does a shareholder have an obligation to ask a manager to limit social effects or maximise social value-added?”. If shareholders as a group agree, these changes can be written into articles of association or set out in strategies on which shareholders may vote or implicit when shareholders vote to choose a manager.  Further, managers often suggest social goals to shareholders.  For example, in the course of raising money for a new venture, managers may suggest it adds social value.  If, under stress, activities to increase social value are put to the side, there are ethical issues around the conflict to adhere to the social value goals in the contract over survival.  A good example might be a direct lending or micro-finance organisation that raised money from shareholders to “do good as well as make money”. Under stress to survive or to provide returns that keep managers in their jobs, the firm might increase lending rates to customers to levels equivalent to competitors rather than at a more charitable level.

Managers often find that shareholders are not homogenous.  Even when all shareholders are passive, managers face ethical problems.  Some of these problems arise in distribution, e.g. dividends can benefit some shareholders, while buying back shares can favour others.  Other problems are temporal.  Should managers aggressively distribute earnings or build reserves for a more stable business, i.e. favour tomorrow’s shareholders over today’s? Yet more problems concern levels of risk and control.  Should managers run a highly-geared business that increases shareholder returns alongside increasing the risk that control of the business passes from shareholders to banks? How much overhead should managers incur to reduce the risk that shareholders’ monies are not safeguarded from misappropriation and waste? Finally, “what is a ‘fair rent’ for managers themselves” is a crucial problem at the heart of Agency Theory.  Remuneration structures that successfully align shareholder and manager interests through a wide range of circumstances are rare.

Shareholders are also not homogenous across society; they vary; they hold different views.  Sometimes shareholder views correlate with communities of race, creed, political orientation, geography, sex, history, social standing, economic standing or education, to name a few.  Business students could legitimately study these varying value systems as part of just learning to market to them with some social sensitivity, to improve their ethical decision frameworks through contrast and example or to better understand their future shareholders.

Of course, there are numerous examples of ethical problems around customers in the deployment of new technologies ranging from drug treatments to care homes to information technology.  Just to set out one example, take a mobile phone payment system being deployed in a developing country by a firm.  The firm might normally trial a new developed country jurisdiction for two years, deploying new and only-partially-tested technology.  If the jurisdiction fails to make an adequate return, the mobile phone payment firm turns off the service and seeks new business elsewhere.  But in a developing country things are different.  The investment of time and money for the developing countries’ users leads to an argument that the trial periods must be longer and the payment system much more thoroughly tested than in a developing country.  Proportionately these people are investing far far more of their savings and risking far more on each new phone, so the firm has a greater obligation to try and get things right beforehand, and afterwards.  An opposing argument is that rapid deployment of the untried technology might lead to more rapid realisation of benefits for users who desperately need help.  Deploying new technology is fraught with such dilemmas as any perusal of medical ethics journal shows.

As stewards of shareholder interests, managers are expected by non-shareholders to exhibit Corporate Social Responsibility (CSR) – conducting business with the wider interests of society in mind.  Underneath most CSR lies the concept of “sustainability”, which the Brundtland Report defined in 1987 as, “development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” How can you argue with CSR and sustainability? Well, problems include too much CSR (so many initiatives), conflicting CSR responses (e.g., NGOs disagreeing on the worse evil, child labour or poverty) and form over substance (even Enron had a “Code of Ethics”). David Henderson [Henderson, 2001] goes further, arguing forcefully in his 2001 essay “Misguided Virtue: False Notions of Corporate Social Responsibility” that the burden of CSR on organisations is harming organisations and society.  He notes that CSR objectives are neither well-defined nor free from controversy, and that many corporations are unconsciously and irresponsibly endorsing anti-business hostility to the market economy.  CSR has the potential to do real harm.

There are a number of ways in which organizations might be rewarded for CSR initiatives, both ‘carrots’ for success and freedom from ‘sticks’. Freedom from ‘sticks’ includes not being subject to NGO attacks, not having government impositions, not being boycotted from regions or markets, or not losing key employees with different ethical values.  ‘Carrots’ might include good public relations, brand enhancement, and access to contracts with CSR requirements, positive relations with NGOs, attracting higher-quality staff at lower rates or preferential access to capital.  All of these carrots and sticks affect shareholder value.

For a senior marketing manager, if society values it then CSR investment should lead to a demonstrable increase in shareholder value.  Thus, CSR should feature in financial decision-making models and be subject to cost/benefit approaches.  Paradoxically, if CSR cannot fit into financial models, then the senior marketing manager’s firm runs the risk of poor investment decisions leading to under or overinvestment in CSR with the consequent waste of resources that under or over investment implies.

Attempts to measure CSR benefits are numerous, and inconclusive.  One authoritative review in 2004 by the United Nations Environment Programme Finance Initiative [UNEPFI, 2004], working with major global investment banks on 11 studies, concluded that it is too early to prove that CSR leads to superior performance – “The majority of analysts noted difficulties in comparative analysis due to the range of reporting practices for environmental, social and corporate governance risks and opportunities”. But can we measure CSR cost/benefit at a firm level? If we could measure overall CSR cost/benefit we could set an appropriate level in marketing for CSR activities using traditional financial techniques.

Business – Different Tools?

When people are responsible for all and measured on everything, governance becomes impossible and valuation tools useless.  Business people are often criticised for trying to bring everything back to one variable, money.  Critics laud initiatives that lead to multiple bottom lines, e.g.  the Triple Bottom Line of “people, planet, profit”. But decisions are far easier to make, and should also be better decisions, if they can be evaluated using a single measure.  Intriguingly, this leads us to consider financial evaluation itself with the implication that a key ethical question worthy of study in business schools and finance courses is “how can financial evaluation tools help us make ethical decisions?”.

One intriguing approach starts with the concept that companies adhering to CSR should reduce earnings volatility [Mainelli, 2004]. Investors favour low profit volatility, thus low profit volatility increases shareholder value.  CSR should make a company more ‘sustainable’. The company should be less vulnerable to actions against it, e.g., attacks from NGOs or government inquiries or bad PR or shareholder dissent.  The company should have fewer staff problems or be able to work in longer term, more stable partnerships.  And we have the tools, e.g. option theory, to model these valuations.  Similar volatility reduction arguments apply to public sector projects [Mainelli and Harris 2004]

In real life, one large telecommunications firm tries to value its CSR expenditure in terms of shareholder value.  For instance, locating transmission masts away from schools costs more, but leads to a reduced risk of being affected by possible future public concerns about the safety of schoolchildren near mobile phone masts.  A financial model gives managers some basic shareholder value estimates using option valuation of CSR initiatives linked to the firm’s share price.  By knowing the value of CSR, the telecommunications firm pursues network provision at higher cost knowing that it probably adds to net shareholder worth and protects brand value.  If ethical activities and CSR benefits can be measured, be quantified and be shown to be superior, then is activity that “pays back” an ethical choice or just a normal business investment decision?

As well as using option theory to value volatility reduction, another financial evaluation method with ethical applications is the use of the discount rate in investment decisions such as new plants or project finance.  In business, the correct discount rate is not necessarily obvious and can be the cause of heated discussion.  Typically, for business projects business people calculate a cost-of-capital to arrive at a discount rate.  Cost-of-capital can be a fairly complex calculation that employs the Capital Asset Pricing Model, which in turn depends on factors such as the risk-free rate of return, the equity rate, the bond-rate, and the debt/equity structure of the organization.  Some taxation systems favour expenditure over capital investment, or vice versa.  Some taxation systems favour debt over equity, or vice versa.  Somewhat ironically, despite all these machinations, the discount rate used by most business people seems to circle around 8% to 10%.  In addition there are complex risk calculations to add, whether the projects achieve their objectives at the cost stated when the decision is made, or achieve their objectives at all.  There are advanced techniques for investment appraisal used by the cognoscenti and taught in business schools, such as discounted cash flows, real option theory and portfolio analysis.

The discount rate, i.e. claiming that future expenditure is worth less than today’s, is fundamental to financially-based decisions on third-world projects, new technology investments, pension plan funding, sustainability or resource utilisation.  There are three common reasons for discounting future consumption:

  • consumption levels will be higher in the future, so the marginal utility of additional consumption will be lower;

  • future consumption levels are uncertain;

  • future consumption should be discounted simply because it takes place in the future and people generally prefer the present to the future.

But discounting future consumption can lead to conundra (a conundrum of a plural), particularly over finite resources.  Global fishing is a $55 billion industry, possibly on its way to extinction.  Taken to the extreme, eating a $6 fish tonight can be calculated as worth more than consuming all the fish in the world a couple of millennia from now at a discount rate of 1%.  At a discount rate of 10%, tonight’s $6 is worth all the world’s commercial fish stocks 260 years from now.

One of the biggest issues in economics is the discount rate to use under various circumstances.  Businesses have to use something close to their cost of capital, but governments have more leeway.  In 2002 HM Treasury stated that, “The current discount rate is being ‘unbundled’ so that the new rate reflects only one factor (the social time preference rate), set at 3.5%.  The current rate of 6% implicitly allows for such factors as risk, optimism bias, and the cost of variability.  It is now proposed that these are dealt with separately and explicitly.” If you think about it, a pure time discount rate of 3% implies that someone born in 1982 ‘counts’ for roughly twice as much as someone born in 2007 simply because of the difference in their birth dates.  Now there is an ethical problem.

For economic evaluations across society, discount rates are typically lower.  When people attempt to estimate intergenerational transfers, they attempt to estimate the ‘pure rate of time preference’ – the rate people would ethically use to evaluate transfers to future generations.  To get there, analysts sample the population using ethical questions about saving lives versus costs to try and find these utility functions, often arriving through a thicket of contradictions, as did HM Treasury, at an estimate around 1.5%.  Because people die, and the average annual death rate for adults is about 1.5%, this is not a surprising number.  In some ways, there is no such thing as society, only individuals.  Society, if it had a mind, might think that it will live forever and try to balance income across everyone in all generations.  Individuals, at this point in time, quite rightly want to see payback in their lifetimes.  No wonder old people are crotchety about long-term investments.  It will be interesting to see if longer lifespans, perhaps even immortality, decrease the pure rate of time preference.

Having established a pure rate of time preference, we still need to establish a pure time discount rate for investment decisions.  The pure time discount rate should be higher than the pure rate of time preference, reflecting the fact that you can’t do everything.  If we set the pure time discount rate to zero, we find that our offspring are too numerous and infinity is a long time.  Very tiny income streams have enormous net present values.  Thus we find ourselves having to do everything now for “infinite generations yet unborn”. HM Treasury’s social time preference rate seems reasonable at 3.5%.  One way to estimate the pure time discount rate is by examination of global long-term real interest rates, now about 2% for the industrialised nations.  But a decade ago, global long-term real interest rates were about 4%.  Do we care more about the future now than we did a decade ago? Victorian engineers, who made things to last for 200 years, clearly applied a very much lower discount rate to their descendants than we do to ours.

Discount rates much above 3% often render major long-term investments unattractive.  Despite this governments often take a short-term view of issues, will investment affect re-election? Does today’s tax pain (unless they can hide the tax somehow, perhaps off-balance-sheet) help the next election? This implies that they will often use relatively high discount rates, perhaps 20%, when evaluating investment decisions because they want quick returns.  Discount rates such as 3%, 5% and 10% are widely used in economics, but there is little consensus on what value is appropriate in any given circumstance.

Caseful Wonders

Stern points out that ethics is at the heart of economics.  Economics certainly provides a wealth of ethical case studies.  Stern believes that future generations should be protected from harm, that future generations should have a right to a standard of living no lower than the current one, and that the world should be passed on in at least as good a state as inherited from the previous generation.  [Stern, 2006, pages 46-48] Dasgupta and others criticise Stern for ignoring the rights of people currently living on the planet to a standard of living no lower than others.  By comparison Bjørn Lomborg claims that “Spending just a fraction of this [Stern Review] figure - $75 billion - the UN estimates that we could solve all the world’s major basic problems.  We could give everyone clean drinking water, sanitation, basic health care and education right now.  Is that not better?” [Lomborg, 2004] So equality conflicts with intertemporal transfer.  If global population keeps on growing, do we owe future generations a planet as good as the one we have on an absolute or a per capita basis? More ethical issues that financial tools can help enlighten.

Part of the problem with the discussion around the Stern Review’s discount rate is that ethical arguments are being used to justify a discount rate.  It’s not at heart an economic question.  If I believed eradicating malaria was more important than climate change, I might deploy ethical arguments to support a discount rate of zero for finding a way to eliminate the malaria parasite, below the Stern Review’s discount rate for climate change.  A third person convinced of peak oil might even argue for a negative discount rate; today’s oil is worth less than tomorrow’s oil given future scarcity.  The discount rate you choose is an ethical question based, to some degree, on whether you care about the future.  Stern does not reach this low pure rate of time preference rate conclusion lightly.  “If you do not care about the long-term future, simply because it is in the future, you will not care about climate change.” He devotes an annex to his second chapter on “Ethical Frameworks and Intertemporal Equity” – basically about the relationship between the discount rate, the pure rate of time preference and intergenerational transfers.

In the end, it’s of little concern that business ethics may not differ from wider societal ethics.  In some ways it’s comforting.  Yet business ethics is worthy of study because the ethical problems thrown up by businesses illuminate wider ethical issues.  In turn, an appreciation of ethics helps to improve business decisions.  Further, the financial tools covered in MBA and finance courses can be of great importance in informing and framing ethical decisions in society.  Financial models help us understand reality.  As Samuel Carlin notes, their job is “to sharpen the questions”. So long as reality ultimately drives the decisions, not the models, financial models improve society’s ethical choices.  Given the clear limitations of financial tools in many cases, further research and improvement of our financial models must be ongoing.  Clearly the ethical course of action for business students is to become financially astute. 

Further Reading

  1. FRIEDMAN, Milton, Capitalism and Freedom, University of Chicago Press (1962 and 1982).

  2. HARRIS, Ian, MAINELLI, Michael and O’CALLAGHAN, Mary, “Evidence of Worth in Not-for-Profit Sector Organisations”, Journal of Strategic Change, Volume 11, Number 8, pages 399-410, John Wiley & Sons (December 2002).

  3. HENDERSON, David, Misguided Virtue: False Notions of Corporate Social Responsibility, Hobart paper 142, Institute of Economic Affairs, London (2001).

  4. LOMBORG, Bjørn (ed) et al, Global Crises, Global Solutions: Priorities for a World of Scarcity, Cambridge University Press (2004).

  5. MAINELLI, Michael and HARRIS, Ian, “Risks, Rewards and Reliability”, European Business Forum (Summer 2004).

  6. MAINELLI, Michael, “Ethical Volatility: How CSR Ratings and Returns Might be Changing the World of Risk”, Balance Sheet, The Michael Mainelli Column, Volume 12, Number 1, pages 42-45, Emerald Group Publishing Limited (January 2004).

  7. STERN, Nicholas, The Economics of Climate Change: The Stern Review, Cabinet Office - HM Treasury, Cambridge University Press (2006).

  8. THE ECONOMIST, “Corporate Social Responsibility: Special Report” (17 January 2008).

  9. UNITED NATIONS ENVIRONMENT PROGRAMME FINANCE INITIATIVE, “The Materiality of Social, Environmental and Corporate Governance Issues to Equity Pricing” (June 2004).


I would like to thank In Harris, William Joseph and Jan-Peter Onstwedder for their assistance in shaping this article.

Professor Michael Mainelli, PhD FCCA FSI, originally undertook aerospace and computing research, followed by seven years as a partner in a large international accountancy practice before a spell as Corporate Development Director of Europe’s largest R&D organisation, the UK’s Defence Evaluation and Research Agency, and becoming a director of Z/Yen ( Michael is Mercers’ School Memorial Professor of Commerce at Gresham College (

Z/Yen operates as a commercial think-tank that asks, solves and acts on strategy, finance, systems, marketing and intelligence projects in a wide variety of fields (, such as developing an award-winning risk/reward prediction engine, helping a global charity win a good governance award or benchmarking transaction costs across global investment banks.  Z/Yen’s humorous risk/reward management novel, Clean Business Cuisine: Now and Z/Yen, was published in 2000; it was a Sunday Times Book of the Week; Accountancy Age described it as “surprisingly funny considering it is written by a couple of accountants”.

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