How Financial Ethics and Profitability Are Connected
If your small business engages in ethical financial practices, it will be more profitable in the long-run than a small business that does not. Lack of ethics in finance is one of the primary factors that led to the fall of Wall Street and the near collapse of the U.S. economy in September and October of 2008. This precipitated the worst recession since the Great Depression. Many large banking and insurance firms failed. Small business failed as well, including small banks that made risky loans.
After the deregulation of the banking system that started in the 1980's and continued through the 1990's and into the turn of the new century, banks operated in the U.S. financial system rather freely and without much to control factors like corporate greed and fraud. They began to make risky loans, particularly risky mortgage loans. Banks, including those classified as a small business, participated as well.
The result was inevitable. When company's serve themselves rather than their stakeholders, they are doomed to fail. This is true whether they are a large business or a small business. Here are the issues.
We Live in a Capitalist Society in the U.S.
If you look up the word capitalism, you will find that it means we live in a society based on an economic system that emphasizes private ownership of the means of production or a privately controlled economy. In a capitalist society, you have a free market and companies live by the profit motive. They exist to make money.
Companies in a capitalist society exist to make money but what is the best way to do that? We've seen, through the fall of Wall Street, that corporate greed and fraud doesn't do it, at least not in the long run. Greed and fraud may make short-term profits for both large and small businesses. But, if companies are to stay alive, short-term profit isn't very important. Long-term viability is the issue.
That raises the question of how does a business, whether a large or small business, stay viable and strong in the long-term? The answer is through satisfying its stakeholders. Just who are these stakeholders? They are the groups that are invested in the future of the company, whether a large or small business.
Investors or Stockholders
One group of stakeholders is the investors in the company or the stockholders. A small business may not have outside investors. The only investor may be the owner. The small business may have the owner and family and friends as investors. Alternatively, the small business may seek out angel or venture capital funding and have outside investors. Large businesses almost always have stockholders.
Stockholders have made an investment in your firm. They want a return on that investment. You, as a small business owner, have an obligation to try to provide them with a return on their investment. During the crash on Wall Street, we saw stockholders earning large returns through management employing fraudulent means in operating their businesses. Many stockholders eventually lost their entire investment in some of these firms because the firms failed. Obviously, this is not the goal of the stockholders.
In a capitalist society, small businesses and large businesses alike should have the goal of maximizing the wealth of their stockholders. That means that the management of the small business should take actions to increase the stock price of the small business, if it is publicly traded, or the return to the stockholder, if it is not. These actions must be geared toward the long term, not the short term.
Here's an example. Let's say that your small business is a small manufacturing facility. You produce a product that can cause water pollution during the production process. If you don't control that pollution, it's much cheaper for you to produce your product and you can promise your shareholders larger returns in the short-term. However, if you do control the pollution and promise cleaner water, it might cost more in the short-term and short-term returns may suffer, but, in the long-term, your small business will be more respected, will attract more business and investors, and your stockholders will profit for a long period of time.
Employees as Stakeholders
Another group of stakeholders in your small business is your employees. A small business has a responsibility to its employees. They deserve to be treated with dignity, respect, and fairness. Your small business should provide jobs that improve your workers' living conditions, respect their health, and avoid any discriminatory practices.
Employees are hurt if the management of a small business does not act in good faith or does not maintain the highest standards with regard to financial ethics. When Wall Street crashed in September/October of 2008, tens of thousands of financial employees were immediately out of a job. This was a direct result of the fraudulent activities of their employers. This trickled down through the economy until we reached an unemployment rate close to 10%.
Many of those financial employees on Wall Street were highly paid. That may have been good in the short run. In the long run, they don't have a job and many of them may never be able to find a job in their field again.
Customers as Stakeholders
A small business should consider its customer base as a stakeholder. Customers, like employees, must be treated with respect and dignity. Live by the principles of business ethics. Without employees and customers, your small business would not be operating. Treat your customers fairly and maintain a high level of customer service. In a recessionary economy, customer service is one factor that will help maintain your customer base.
Respect your customers in all aspects of your business, including product pricing, advertising, and marketing. Keep the culture of your customers in mind. After the collapse of Wall Street, customers seeking financial services are going to be suspicious and afraid to trust financial institutions. If your small business is a small credit union or bank, for example, you will have to make every effort to instill trust back into your customer base.
Society as a Stakeholder
Since, in a capitalist society, the means of production are privately held by business firms, society itself is a stakeholder for the large and small business alike. Small businesses, as well as large firms, must promote harmonious relationships between business and government and between business and other segments of society. It is the responsibility of all businesses to have a commitment to raise the standard of living and promote sustainable development. Small businesses must strive to contribute to their community and be good corporate citizens.
Somewhere along the way, the financial firms on Wall Street forgot this very important lesson of capitalism.
The near collapse of our economic system really began sometime back with the financial failure of firms like Enron. The Enron Corporation was a huge energy company that went bankrupt in 2001. It employed 22,000 people and had innumerable shareholders. It collapsed due to an accounting scandal, or "cooking the books," perpetuated by its own auditing firm, Arthur Andersen, one of the premier accounting firms in the U.S., which also collapsed. Tens of thousands of employees were left without a job and more shareholders were left with a retirement portfolio full of worthless Enron stock.
Enron was the country's largest bankruptcy until 2008 and Lehman Brothers, a huge Wall Street financial services firm. Lehman went under primarily due to the subprime mortgages it made during the 1990s and the early 21st century. The bankruptcy of Lehman Brothers began a domino effect on Wall Street. In order to prevent massive financial firm failures, the Bush Administration put together a huge financial bailout, called TARP, to save most of the other large Wall Street banks.
Since the fall of 2008, we have had many financial firm failures and failures in other business sectors. Failures have not been confined to large businesses. Small businesses have had their share of failures, primarily due to the economic recession that resulted from the collapse of Wall Street and the credit crisis that resulted.
The only way for capitalism to truly prosper is for every business, large business and small business alike, to subscribe to a doctrine of financial and business ethics. If a business tries to take shortcuts to profits, they will fail in the long run as we've seen during the early part of the 21st century. Small business plays a crucial role in the American economy. It can be the difference between the success and failure of our economy and financial system.