In 1997, the Subcommittee on Reports, Accounting, and Managing of the United States Senate Committee on Governmental Affairs (the Metcalf Committee) released a report titled “The Accounting Establishment,” in which it expressed deep concern about “improving the professionalism and independence of auditors”:

The committee is also committed to fair competition as a basic principle of the Nation’s economic system. The benefits derived from professional self‐regulation carry with them a corresponding responsibility of self‐restraint from engaging in activities that detract from professional ideals. The subcommittee firmly believes the important function of independently auditing, publicly owned corporations should be and is financially rewarding and personally satisfying in its own right without any need for engaging in activities that appear to detract from professional responsibilities. (Italics added.)¹

Whether the regulatory scrutiny worked during the 1970s to the 1990s is a matter for dispute. A series of high‐profile corporate accounting “frauds that auditors missed at companies including Cendant, Sunbeam and Livent occurred. Public shareholders lost hundreds of millions of dollars in these cases, and confidence in accountants was shaken.”²

[In] January [1999], partners and employees at PricewaterhouseCoopers were found by the S.E.C. to have routinely violated rules forbidding their ownership of stock in companies they were auditing. The investigation found 8,064 violations at the firm, which then dismissed five partners. Pricewaterhouse said at the time that it did not believe that the integrity of any audit had been compromised by the violations.³

The role Arthur Andersen played in the Enron collapse led Business Week to author a special report called “Accounting in Crisis.” According to the article:

As shocking as Enron is, it’s only the latest in a dizzying succession of accounting meltdowns, from Waste Management to Cendant. Lynn E. Turner, former chief accountant for the SEC and now a professor at Colorado State University, calculates that in the past half‐dozen years investors have lost close to $200 billion in earnings restatements and lost market capitalization following audit failures. And the pace seems to be accelerating. Between 1997 and 2000 the number of restatements doubled, from 116 to 233.⁴

These inappropriate behaviors by accounting firms led to the passage of the Sarbanes–Oxley Act (SOX), which set limitations on what accounting firms are able to do. We will discuss SOX later in this chapter. For now, we ask these questions: What is going on in the accounting establishment today? Is the general tenor of what is happening ethically acceptable?

It is important to ask what brought about the accounting scandals, and whether or not those practices still exist in the profession. Critics of the direction that accounting is taking claim that it has ceased to be a profession and is driven by the profit motive. John C. Bogle, former CEO of the Vanguard Group and former member of the now defunct Independence Standards Board, contends that the accounting profession, rather than remaining an honorable profession where members look out for clients and the public, got involved in the enterprise of business, where its main concern is fidelity not to its various trusts but to the bottom line. Such critics insist that, just as commercialization is infecting professions like medicine, teaching, and law, profit‐motivated business interests are interfering with accountants’ professional responsibilities and corrupting their behavior. This tension between the demands of professionalism and the demands of business has created an identity crisis in the industry today.

We examine that crisis in this chapter.

Accounting as a Business

An old adage says that there is no such thing as business ethics. A more sophisticated version of the adage claims that business ethics is an oxymoron like military intelligence or jumbo shrimp. Sometimes, these quips are the self‐righteous condemnation of business by anti‐business academics or artists, who rarely engage in business (or so they think). They maintain that business activity is banal. Their attitude goes as far back as ancient Greek philosophers, who asserted that to engage in business activities is to do something illiberal. For philosophers such as Plato and Aristotle, business was not a worthy pursuit for a free human being. Academic and artistic elitists who assume that viewpoint today have a negative opinion of business and deplore the concern with materialistic goods and conspicuous consumption that business creates.

Sometimes, criticisms of business ethics are delivered by businesspeople simply to rationalize their own unethical business behavior. They fail to see that the majority of business dealings are ethical; if they weren’t, business as we know it would cease to function. Criticism also comes from individuals who recognize that there is ethical behavior in business but bemoan the lack of it from their competitors.

Our contention – in spite of the seemingly unchecked greed of Enron and similar cases – is that ethics is essential for business to run smoothly. And what holds for business in general holds for accounting specifically.

Consider what it would mean if a businessperson really believed there was no such thing as business ethics. He would think it’s okay to be dishonest in his dealings with you, to sell you a faulty product to make his company more money, or to tamper with the books if it helps the bottom line.

Now ask that business person this question: If he really thinks acting unethically is all right, why would he tell you that? If someone says, “I cheat all the time,” I would be a fool to trust that person. Clever cheats keep silent about their dealings. A person who truly believes that there is no ethics in business is really just unscrupulous – and foolish enough to reveal it. Don’t deal with foolish and unscrupulous people.

The claim that there is no such thing as business ethics is indefensible. Furthermore, it is outmoded and has outworn its usefulness, if it ever had any. Good business ethics is generally good business. When good ethics is not good business – situations that occur but rarely – then business interests should capitulate to ethical interests. For example, in a situation where doing the ethical thing will jeopardize profit, a businessperson with integrity will defer the pursuit of profit to do what is right.

If, however, it is nonsense to claim that business ethics is an oxymoron, it is important to ask why such nonsense occurs in the first place. Nonsense or not, this attitude has become part of our cultural fiber and is used to justify (rationalize) a lot of unethical behavior. Recognizing why the attitude has developed may help us to understand the dilemma between professionalism and profit that besets the accounting industry today. The attitude arises, we believe, from a mistaken, but widely held, consensus that the purpose, nature, and responsibility of business are to maximize profit or shareholder value.

To the extent that an accounting firm is a business, it falls under the profit‐maximizing rubric. But when an accounting firm sees itself primarily as a business, making a profit overrides its main function of attesting to the truth and correctness of financial statements. The movement in accounting from auditing and attesting functions to management consulting changed it from a profession dedicated to public services to a business committed to maximizing partner or shareholder wealth. How did this ideal develop, and is it defensible?

The Social Responsibility of Business

The contemporary idea of business as a social institution developed from the perception that its fundamental concern is to make a profit. Consider this statement by Milton Friedman in Morals by Agreement:

The primary and only responsibility of business is to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception and fraud.”⁵

This principle refocused business’s primary purpose from generating products and services (for example, attest and audit in accounting) to accumulating money. In doing so, promoters apparently forgot Friedman’s constraints about staying within the rules of the game and avoiding deception and fraud. The generation of products and services was displaced as business’s chief purpose and became merely instrumental to making a profit. This puts the cart before the horse. Let’s see how.

This concept that the primary function of business is profit making has its roots in a reading (we would argue an incomplete reading) of the eighteenth‐century classic The Wealth of Nations by Adam Smith. (Also see Chapter 3 for more material on Adam Smith.) Smith introduced the model of the rational maximizer – a person concerned with increasing his or her own utility – and sees humans as motivated by self‐interest. He notes, “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.”⁶

Smith’s genius was maintaining that it is the pursuit of self‐interest that makes commerce and society flourish by setting up free markets. He gave currency to the belief that the entire society will be better off if each businessperson pursues his or her own interest – that is, if we leave the market forces alone, people’s pursuit of their individual interests will make the entire society flourish. In arguing this, he refers to the “invisible hand,” which describes the self‐regulating nature of the economy:

As every individual, therefore, endeavors as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value, every individual necessarily labors to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it, and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.⁷

Milton Friedman and other contemporary followers of Smith claim that the success of our economic system can be attributed to this philosophy. When we let business worry about nothing but profit, competition is created, more goods are produced, and the entire society enjoys a higher standard of living. The fact that the economic system of capitalism has led to the production of more goods and services than any other economic system in the history of mankind – and the highest material standard of living for more people – is the evidence for the invisible hand argument.⁸

The utilitarian structure of the argument is simple enough to see. (See Chapter 3 for a discussion of utilitarianism.) The practice of self‐interested pursuits is justified because of the good that will accrue to society in adopting a profit‐oriented system. In short, the greatest good for the greatest number will be served if the market, driven by self‐interest, is allowed to operate. Look out for your own concerns and society, as a whole, will benefit. That is probably true, most of the time.

If, however, we forget that the goal of pursuing our own interests is to make the society better off, a problem arises. Societal benefit is the end that justifies the pursuit of profit. The pursuit of profit cannot stand as an end in itself. The unconstrained and exclusive pursuit of self‐interest can hurt others. Thus, it is not always true that self‐interested pursuits make the society better off. When these activities are at others’ expense, what is the proper thing to do? Pursue profits, or not hurt others? If societal benefit justifies self‐interest, what happens when there is no benefit? At those times, the self‐interested pursuit must be constrained. According to Smith, the pursuit of self‐interest is justified only so long as it does not violate the laws of justice:

Every man is left perfectly free to pursue his own interest, his own way, and to bring both his industry and capital into competition with those of any other man, or order of men, as long as he does not violate the laws of justice.⁹

Because business was constructed by society, we must assume that it was constructed to benefit society – no society or group would create a social institution to harm itself. Rather, institutions are created and approved to the extent that they promote some good for the society or group. The purpose of any societally constructed system or institution, therefore, has to be an end that is compatible with some social good, which may or may not be compatible with an individual’s interest. For example, our society does not sanction the manufacture and distribution of heroin or the production of pornographic films that exploit children, because society does not regard these activities as having any redeeming social value.

It follows, then, that society instituted (or should have instituted) business to help itself (society) develop and survive. Business, including its practices and rules, was created to benefit society. If the business is harmful to society, society should modify it or close it down. Hence, the assertion is made, from Adam Smith on down, that a competitive, profit‐motivated free‐enterprise system is an effective means to bring about a laudable goal – benefits to society.

Our somewhat regulated capitalist economic system is permitted because it is productive. Although it is not the only way to produce goods and services, it is the most efficient. This capitalist system centers on rules governing the distribution of profits. Profits are utilized to motivate or incentivize the entrepreneur. But profits are not the be all and end all. They are merely the means to achieve the purpose of business, and as the means, they should not usurp the ultimate goal of business.

The view that business’s primary responsibility is to maximize profits confuses the self‐interested motive and incentive for doing business – profit making – with the purpose of business – the generation of goods and services. Turning the means – self‐interested motivation – into the purpose opens a Pandora’s box. The legitimization of a self‐interested means unleashes what theologians call “greed.” The rational maximizer can become a greedy, grasping, acquisitive, profit‐motivated, bottom‐line‐oriented entrepreneur who feels no responsibility to the public welfare. The benefits of utilizing the profit motive are obvious; so are the undesirable externalities.

There is a counter argument to the Friedmanian stance. If the purpose of business is to provide goods and services and the motive is to make a profit, management’s responsibility is not simply to pursue profits, but to pursue them as regulated by the demands of the public interest. Although determining the extent of all those demands is beyond the scope of this discussion, it is clear that legislation requiring audits of publicly held corporations has the public purpose of ensuring that financial statements are accurate and useful to those who need them. Thus, auditing firms are incentivized by making money, but their purpose is to serve the public. Public accountants, fulfilling their public auditing role, have a purpose given to them by the government. They are watchdogs of the financial systems. That is their role and responsibility.

We see, then, that if we confuse the purpose of an activity or practice with the motives for performing it and thereby reduce the former (purpose) to the latter (motive), there are no theoretical grounds for legitimate ethical restraints on business (other than those required by a Kantian formalism). Conversely, if we construe business as an artifact created for the sake of society, specifically for the sake of the production of goods and services, we have grounds for constraints when its operations fail to fulfill its purpose or violate the demands of justice. An ethical business fulfills its purposes and betters society through production of goods and services. An ethical accounting firm fulfills its purpose by being faithful to the needs of society, for which it has been given a specific mandate.

Is this a mere semantic quibble between motives and purposes? We think not. The meaning of the word “purpose” encompasses the “what for” of an activity. Purposes direct us to an activity’s goal. Goals, however, are not motivating forces. Motivating forces are the psychological “whys” for doing things. They are not necessarily self‐justifying, and they must be constrained by purposes. To confuse a purpose with a motive is like confusing the purpose of a train – to get people from place to place – with what drives the train – the engine. The engine is analogous to the motive, because it moves the train.

From a societal point of view, then, the purpose of business is to produce and distribute goods and/or services, not to benefit the producer. Society certainly needs to incentivize and motivate producers, but that is always for a further purpose. Clarifying the distinction helps us to identify greed not as the ultimate driving force of business, but as a force that does not fulfill – and often frustrates – its purpose.

Motives are not the same as purposes. Furthermore, there can be many motives for the same action. For example, the purpose of giving to charity is to help the poor. But I may not be the least bit interested in helping the poor when I give to charity. I may do so simply to impress my friends. Hence, there is a social (outside) view of the purpose and a personal (inside) view of the motive. If giving to charity not only satisfies my motive but also rewards me, I’ll be even more inclined to do so. But whether or not I donate to charity, there is still the need for charity. Similarly, the purpose of business is not to benefit me. It is not to make a profit. If doing business rewards me with a profit, I will be inclined to participate in it, but the purpose of business – why society allows it to exist in its profit‐oriented form – is to provide goods and services.

There are all sorts of ways to make money, and wanting to make money is certainly okay as a motive, but the purpose of the practice of accounting is not to make money, any more than it is in the practice of medicine. Medicine’s purpose is to minister to the sick. Auditing’s purpose is to ensure that financial statements are accurate. Thus, social practices have their own purposes, independent of the motives of the persons engaged in the practices. Therefore, our motives for doing something may or may not accord with the activity’s purpose.

A recurrent theme of this book is that it is important, from an ethical standpoint, to be clear about something’s purpose. Knowing its purpose gives us a standard by which to judge it. Just as we judge a knife by how well it fulfills its purpose – to cut – we can judge a business by how well it fulfills its purpose. If its purpose is to make a profit, then a business that keeps generating healthy profits is a good business, no matter how it helps or hurts people. But if the purpose of business is to provide goods and services, and it is for that purpose that society allows businesses to exist, then we cannot judge a business simply on how much profit it generates. We must consider how good its products or services are. A good business is one that provides acceptable goods and services to the benefit of society. Making a profit may be a necessary condition for business to survive, and it is certainly a motive for doing business, but it is not its primary purpose.

Good Ethics is Good Business

How do we motivate ethical behavior? Current thinking, encouraged by a shared ethical concern, has been to try to conflate the purpose and motives of business. Hence, the maxim, “Good ethics is good business.” Consider the following:

Although behaving ethically should be an end in itself, there also are valid business reasons for doing what’s right. If you look closely at examples of unethical business behavior, you discover two things: the company derives only short‐term advantages from its actions, and over the longer term, skimping on quality or service doesn’t pay. It’s not good business.

Consider the food company that, a few years ago, came under fire for selling a sweet‐flavored and colored drink labeled as pure apple juice. Whatever short‐term profits it gained in passing off the cheaper drink as fruit juice, the damage to a good company’s reputation was far more costly in the long run.

Another example is the Lockheed Corporation, whose aircraft have served this country in times of war and peace. Yet, some people remember it for a long‐ago bribery scandal, and the company has had to spend years fighting the adverse publicity generated by the case.

On the other hand, Johnson and Johnson immediately took its pain reliever, Tylenol, off the market when faced with claims of product tampering. J&J knew the decision would be costly in dollars, but refused to put a price tag on its integrity. Some thought their sales could never recover, but the company ended up reinforcing its strong market leadership.¹⁰

Let’s explore how the maxim that good ethics is good business applies to the accounting profession.

To begin, good ethics affects the good name of the company and builds trust. It is obvious that to cut corners for short‐term gain will only erode the company’s reputation. An accounting firm that cannot be trusted is useless, because people depend on the firm and individual accountants to provide them with accurate pictures of organizations’ financial status.

Next, a firm that treats its clients or customers well and fairly should see a positive effect not only on its sales but also on its employees. Business ethicist Archie Carroll describes what happens to companies motivated only by greed:

If Management is actively opposed to what is regarded as ethical, the clear implication is that management knows right from wrong and chooses to do wrong. Thus, it is motivated by greed. Its goals are profitability and organizational success at almost any price. Immoral management does not care about others’ claims to be treated fairly or justly.¹¹

Employees are aware when a company is greedy, and that greed, that uncaring search for profit, erodes their morale and loyalty as they realize that it is their company’s only motivation. If the company puts its customers second, behind profit, where does it put its employees?

Being ethical has another more subtle benefit for managers, as Kenneth Lux points out in an article in Business Ethics:

From the self‐interest doctrine we inherit the picture of the businessman or woman as only greedy. This is exemplified by Dickens’ portrayal of Scrooge, which is just one among scores of such portraits. But the real story may be rather different. The book that is the foundation of modern management theory, The Human Side of Enterprise, by Douglas McGregor (1960), recognized the virtues of the businessperson, as well as the economic value of those virtues. All contemporary business texts (which are distinguished, ironically, from economic texts) of any influence reflect the same humanistic values that McGregor recognized and advocated.¹²

The benefit, then, is that managers in ethical companies are allowed to let their humanism show. We don’t have to act like Scrooge to achieve business success. In fact, our society today is saying that the cynical phrase to justify unethical behavior, “That’s just business,” is no longer acceptable. When ethical behavior overrides business greed, managers do not have to live in two worlds – one, their humanistic ethical world, and the other, their ruthless business world. Managers do not need to check their ethics at the door when they come to work.

Thus, there is a fourfold motivation for ethical behavior. Ethical behavior leads to (i) long‐term profits for the company, (ii) personal integrity and satisfaction for the individuals engaged in business, (iii) honesty and loyalty from the employees, and (iv) confidence and satisfaction from the customer. Corporations should behave ethically, in part because it will have good consequences for the company. Arthur Andersen’s collapse because of its role in the Enron debacle attests to the dangers of profit‐driven motivation. Ethical behavior in business is an idea whose time has come.

Still, as David Vogel points out, ethics and profit do not always go hand in hand. Sometimes, management will have to choose between what is right and what is lucrative. By and large, however, it is more prudent to be ethical than not. When the right choice is the nonprofitable one, we would hope that business would make the ethical decision because it has responsibilities over and above making a profit.

Ethical Responsibilities of Accounting Firms

What is the ethical responsibility of business in general and of accounting firms in particular?

Businesses, through their owners and managers, enter into relationships with individuals and groups; relationships involve responsibilities. These relationships become the basis of the ethical obligations between the business and its stakeholders.

Certainly, an accounting firm must make some profit or increase the value of the business or partnership, but there are limits on profit making. To be sure, no firm – accounting or otherwise – can stay in existence without attention to the bottom line, but an accounting firm has other responsibilities beyond profit.

Accounting is a service industry that came into existence to benefit its clients and the public. Hence, harming its clients or the public in the name of profit violates its explicit purpose. Accounting firms have specific functions, which society has licensed. The chief function is to provide information about a company’s financial situation. Another is to attest to the accuracy of that information. Thus, a good accounting firm should present as clear a picture as possible of an organization’s financial condition, and/or attest to the fairness of that picture. Any practice that violates that purpose contradicts the firm’s very essence.

The Accounting Profession in Crisis

The Arthur Andersen/Enron fiasco has made it abundantly clear that it is naïve to think that accounting firms are not manipulated by the profit motive. There are troubles in the profession and among firms. The pressure to maximize profits has placed the contemporary accounting profession in crisis.

But we knew this even before Enron imploded. Abraham J. Briloff, the perennial scold of the accounting profession, in a 1999 article in Accounting Today, pointed to the gap between the “is” of the accounting profession and the “ought” of the accounting profession – what accountants do as opposed to what they ought to do.¹³ In an editorial on the same page of that publication, Rick Telberg lamented a move by KPMG to merge with Cisco Systems, because it jeopardized the independence of the Peat Marwick branch of the corporation.¹⁴ In a 1998 article in Forbes magazine, Jane Novack condemns Deloitte and Touche’s “hustling” tax strategies.¹⁵

Defenders of these practices argue that they are necessary, given the competitive marketplace. If, however, accountants comply with such pressures, Telberg says, “the profession’s entire system and philosophy of independence will need re‐thinking.”¹⁶

We repeat Telberg’s pessimistic words, quoted in the beginning of this book:

In fact we are probably past the time when independence mattered. CPA firms long ago became more like insurance companies – complete with their focus on assurances and risk‐managed audits – than attesters. Auditors are backed by malpractice insurance in the same way that a re‐insurer backs an insurance company, so they have become less like judges of financial statements than underwriters weighing probabilities.

Some in the profession have even argued that auditors should function less like ultimate arbiters of fact and financial reality, and be allowed, instead, to function more like investment bankers, and provide only “due diligence.” So that CPAs, who once valued fairness and truthfulness in financial reporting, would then promise little more than nods and winks, all beyond the reach of meaningful oversight.¹⁷

If every auditor or attestor acted as Telberg describes, the audits and attestations would be worthless. There would still be a use for accountants as tax preparers and financial reporters, but the audit function – the heart of the accounting profession – would be rendered virtually useless by misuse. We could, of course, concede that the accountant’s function as simply to do what is required for a company to flourish monetarily. But that would be to view profit maximization as the only purpose of business. It would mean the absence of ethics.

Do Telberg’s words signal the demise of accounting? Hardly. Telberg fails to take into account that the economic system would still need truthful and accurate audited reports so that financial operations could continue effectively. Thus, even if the delivery of these reports is not profitable and accounting firms eliminate the audit function to maximize their own profits, there will still be a large accounting task. Someone will step into the gap to perform the service. New firms will arise, and the people in them will be subject to the same ethical requirements as today’s professional auditor, while the auditor will be just another management consultant with accounting expertise. The names may change, but the function, and hence the ethical responsibilities, will remain.

Whatever form accounting takes, the biggest challenge will be to remain professional. That means, as we have emphasized throughout this book, putting the interest of clients, and especially the public, above considerations of self‐interest.

Just before the Enron/Andersen collapse, John Bogle delivered a speech that is remarkably prophetic, aptly named “Public Accounting: Profession or Business?” It is so perceptive, it deserves to be liberally quoted. In it, Bogle identifies the main factors pushing accounting away from the dedication to its professional goals into the arena of a profit‐maximizing operation.¹⁸ He observes that there are numerous issues that pressure accountants and accounting firms to put profit maximization ahead of professionalism, citing these five as the most important:

• Adequacy of GAAP.
• Earnings management.
• Accounting for stock options.
• Overly aggressive tax shelters.
• Alternative business structures

Let’s examine each of the five issues more fully.

Discussion Questions

1. What ethical issues do you see with the move of accounting as a business?
2. What is the purpose of accounting and how does this set with Milton Friedman’s statement of the responsibility of business?
3. What are the implications for an accounting firm that is motivated by greed?
4. Having completed this book, what are your takeaways of accounting ethics?

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