BUS202: Principles of Finance

LEARNING OBJECTIVES

• Explain the concept of fiduciary duty.
• Discuss examples of ethical issues that arise in finance.

As those who are trained in finance are often in charge of other people's money, it is important to understand the concept of fiduciary duty, which entails putting another's interests (especially financial) before personal interests. The other party (the "principal") is typically at a disadvantage, either in access to information or experience, to the fiduciary, and thus relies upon the good faith of the fiduciary. There are legal definitions of when fiduciary duty exists in the relationship; there exist cases, however, where there is no legal burden but do invlove an ethical burden.

An example: a trader is told that her client would like to sell shares of stock ABC. The client's order would depress the stock price. It would be a breach of fiduciary duty for the trader to liquidate her position before executing the client's order (this is also called "front running").

Consider the possibility of adopting an accounting strategy that would minimize tax payments. On the one hand, this will increase profits for shareholders, but it will also reduce the amount of taxes paid to the government. Does the company have a responsibility to pay taxes to the government, and if so, does it only extend to the letter of the law?

Another scenario involves a company in distress selling off valuable assets to make interest payments to bondholders. A financial manager has a responsibility to pay the bondholders what they are due, while a duty to the shareholders to not cripple the ability of the company to function as a going concern.

In each of these cases, the interests of one party conflict with another's, and a financial manager will have to determine how to evaluate and resolve the issue. While there can be legal guidance (especially in the case of fiduciary duty), often it will be up to the manager to make the choice he or she deems appropriate.