Chapter 1: Free Market System and Business

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Chapter 1Free MarketSystem and Business

• L. Murphy Smith
• Texas AM University

Tuesday, January 6, 2009
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Chapter 1 Free Market System and Business

• Ethics and corporate governance play key roles in
  the capital markets.
• Corporate and accounting scandals at the
  beginning of the millennium eroded investor
  confidence, which led to reforms.

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Lecture Outline

• Free market system and business
• Responsibilities of business
• Primary goal of corp. governance
• Power sharing
• Reliable and transparent financial info.
• Investor confidence
• Corp. governance reforms
• Business ethics

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Free market system and business

• The free enterprise system is the bedrock
  principle of the U.S. economy and its capital
  markets are the backbone of the system.
• U.S. capital markets worlds largest, deepest,
  and safest
• Home to the worlds largest financial
  institutions
• More than 100 million Americans have provided
  capital to the markets
• Capital will always go where it is welcome and
  stay where it is well treated Wm. Donaldson,
  former chairman of the U.S. SEC.

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Are financial scandals inevitable cycles of
history?

• 1930s corp. scandals led to securities acts
• 1980s savings and loan debacles led to FDIC
  Improvements Act of 1991
• Financial scandals fo late 1990s and early 2000s
  led to SOX of 2002, creation of PCAOB and more
  than 20 SEC rules
• Teamwork Q 1, 2

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Americans have increased responsibility to ensure
security of their financial future and retirement
funds

• Free enterprise and dispersed capital ownership
  require effective corp. governance and business
  ethics
• Wealth of Nations, Adam Smith, 1776 a free and
  competitive market economy enables best use of
  societys resources in creating value
• Market mechanisms alone were once thought
  sufficient to prevent corporations from abusing
  power.
• Appropriate securities laws (established and
  enforced) are essential in sustaining investor
  confidence

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Global capital markets

• A healthy financial sector and efficient capital
  markets are vital to economic growth and
  prosperity in any nation
• U.S. capital markets face competition from other
  capital markets e.g. London and Hong Kong
• Regulations should attract investors seeking
  proper protection
• Regulations that are overbearing will be regarded
  as constraints to entering capital markets
• Teamwork Q 7, 8

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Public Trust and Investor Confidence

• Public trust and investor confidence drive
  economic growth, prosperity, and financial
  stability
• Historically, U.S. capital markets regarded as
  most transparent, efficient, and fair worldwide
• Result 1 efficiently allocates the scarce
  resource of capital
• Result 2 enables public companies to raise
  capital
• Result 3 provides a safe and lucrative
  financial marketplace for investors (save for
  retirement, save for childrens education, etc.)

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Lynn Turner, Former Chief Accountant at the SEC

• the ability of the U.S. capital markets to
  attract capital depends on investors having
  confidence in the integrity and transparency of
  the markets. Confidence is earned over time
  through honest and fair markets that provide
  investors with the material information they need
  to make informed decisions.
• Teamwork DQ 1, 2

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Role and Responsibility of Business in Society

• Public companies engines for economic growth
  and prosperity
• U.S. corporations viewed as creators of value for
  all concerned stakeholders (see Figure 1.1, p.
  8) shareholders, suppliers, employees,
  government, customers, and creditors
• All stakeholders have incentives and
  opportunities to reward good performance and
  discipline/punish poor performance.
• Corp. governance, two goals value creation and
  value protection
• Teamwork DQ 7, 8

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Role of Financial Information in the Capital
Markets

• Financial information necessary for
  decision-making by investors, lenders, and
  others.
• U.S. public companies are required to file
  financial reports with the SEC, including audited
  financial statements on Form 10-K, reviewed
  quarterly F/Ss on Form 10-Q, extraordinary
  transactions on a current basis (e.g. departure
  of directors, officers, auditors), in addition to
  proxy F/Ss submitted to investors.
• SOX requires F/Ss filed with the SEC to be
  certified by the companys senior executives (CEO
  and CFO) SOX also requires public companies to
  file management and auditor reports on their
  internal control over financial reporting.

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Role of Financial Information in the Capital
Markets

• Sustainability and financial health of public
  companies, public trust, and investor confidence
  in financial reports are essential to the
  efficient working of the capital markets.
• The efficient working of the capital markets is
  essential to the economic growth and prosperity
  of the nation.
• Figure 1.3 (p. 14) show that high-quality
  financial info is more accurate, complete
  transparent, trustworthy, and value-relevant than
  low-quality financial reports.
• Figure 1.4 (p. 15) shows layers of financial
  statement scrutiny.

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Introduction to Corporate Governance

• Effective corp. governance ensures corp.
  accountability, enhances reliability and quality
  of public financial information, enhances
  integrity and efficiency of the capital market,
  and thus improves investor confidence.
• Financial scandals of high-profile companies e.g.
  Enron and WorldCom tarnished corporate
  trustworthiness.
• Lack of investor confidence in corporate America
  and its fin. reports has adversely affected
  vibrancy of the capital market.

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Intro to Business Ethics

• Ethics a set of moral principles a theory or
  system of moral values (Merriam-Websters
  Dictionary).
• Business ethics requires that corporations
  promote a culture of moral responsibility to
  society.
• Be sure youre right, then go ahead (David
  Crockett).
• Corporations should set an appropriate tone at
  the top to effectively integrate a culture of
  ethics and compliance.

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Summary

• Good corp. governance lays the foundation for the
  integrity and efficiency of the capital markets.
• Corp. governance involves relationships and power
  sharing between a companys management, board,
  shareholders, and other stakeholders.
• Corp. governance provides the structure for
  determining company objectives, attaining those
  objectives, and monitoring company performance.
• Corporations should set an appropriate tone at
  the top to effectively integrate a culture of
  ethics and compliance.