Cognitive moral development theory and moral maturity of accounting and finance professionals

Cognitive moral development theory and moral maturity of accounting and finance professionals

COLLEGE OF MANAGEMENT AND TECHNOLOGY

This is to certify that the doctoral dissertation by

Phyllis Rhodes

has been found to be complete and satisfactory in all respects,

and that any and all revisions required by

the review committee have been made

Review Committee

Dr Robert Aubey, Committee Chairperson,

Applied Management and Decision Sciences Faculty

Dr William Brent, Committee Member,

Applied Management and Decision Sciences Faculty

Dr Rodney Ford, Committee Member,

Applied Management and Decision Sciences Faculty

Chief Academic OfficerDenise DeZolt, Ph.D

Walden University2010

Cognitive Moral Development Theory and Moral Maturity of

Accounting and Finance Professionals

byPhyllis N Rhodes

M.B.A., Belhaven College, 1999B.S.B.A Alcorn State University, 1983

Dissertation Submitted in Partial Fulfillment of

the Requirements for the Degree of

Doctor of PhilosophyApplied Management and Decision Sciences

Walden UniversityFebruary 2010

Fraud has infiltrated several corporate financial statements, thus bringing attention to theaccounting and finance profession The purpose of this study was to determine if age,gender, and former ethics education had an impact on the moral decision-making process

of finance and accounting professionals below the Chief Executive Officer (CEO) andChief Financial Officer (CFO) levels Due to the increased number of women in theworkforce, it is important to understand the differences in ethical judgment betweenwomen and men It is also important to understand if ethical maturity increases with ageand it is equally important to make a determination as to whether business ethics coursesare adequate in meeting the demand for integrity in financial reporting Kohlberg’s theory

of cognitive moral development was used as the theoretical foundation, and the DefiningIssues Test (DIT) survey was used to collect data via the Internet ANOVA and

independent samples t test results revealed no statistical difference in ethical maturity by

any of the 3 independent variables; age, gender, and formal ethics training One

recommendation coming from this study is that companies and educational institutionsshould develop more ethics courses that are targeted at finance and accounting

professionals The implications for positive social change result from the study’s

contribution toward providing an avenue by which corporations and educational

institutions can began to develop ethics courses that will prepare students to be ethicalfinance professionals and will restore consumer confidence and strengthen satisfaction inthe nation’s financial institutions and markets

byPhyllis N Rhodes

M.B.A., Belhaven College, 1999B.S.B.A Alcorn State University, 1983

Dissertation Submitted in Partial Fulfillment

of the Requirements for the Degree of

Doctor of PhilosophyApplied Management and Decision Sciences

Walden UniversityFebruary 2010

UMI Number: 3396810

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I wish to first acknowledge the Lord Jesus Christ for helping me to complete thisarduous and monumental task in my life I would also like to acknowledge all the people,colleagues, friends, and family who supported this effort by offering encouragement,assistance, patience, and guidance I want to give specific acknowledgement to Dr

Robert Aubey who served as my faculty mentor and committee chair Dr Aubey and myother committee members, Dr William Brent and Dr Rodney Ford, have providedconstant guidance to me throughout the dissertation process I am grateful to them fortheir expertise and guidance I would also like to thank the University Reviewers for theirreview and assistance in making my dissertation a much better product Last but not least,

I would like to give special acknowledgement to my husband Michael Rhodes, Sr for hisunderstanding during long nights when I was constantly on the computer My two

children Ava Rhodes and Michael Rhodes, Jr have been encouraging and patient with

me throughout this process I dedicate this work to my family and God whom I love andappreciate more than anything else in this world

LIST OF TABLES v

LIST OF FIGURES vi

CHAPTER 1: INTRODUCTION TO THE STUDY 1

Background 1

Problem Statement 2

Research Questions 3

Purpose of the Study 7

Cognitive Moral Development and Ethical Decision Making 10

Operational Definitions 12

Assumptions 15

Limitations of the Study 16

Scope 17 Significance and Social Change 17

Summary 20

CHAPTER 2: LITERATURE REVIEW 22

Introduction 22

The Corporate Ethical Dilemma: Shareholder Wealth Maximization 22

Finance Theories 27

Cognitive Moral Development Evolution 34

Neo-Kohlbergian Era 43

Ethics Education 46

Gender and Ethics 49

Age and Ethics 51

CHAPTER 3: RESEARCH METHOD 54

Introduction 54

Research Design and Approach 55

Research Data and Sample Size 56

Instrumentation and Materials 57

Data Collection 63

Protecting Participant Rights 65

Summary of Methodology 66

CHAPTER 4: RESULTS 68

Introduction 68

Data Collection and Instrumentation 69

Data Analysis 75

Demographics Analysis 76

CHAPTER 5: RECOMMENDATIONS AND CONCLUSIONS 90

Findings and Data Analysis 91

Application of Cognitive Moral Development Theory 96

Social Change Implications 97

Recommendations for Action 99

Recommendations for Further Study and Limitations 101

Conclusion 102

REFERENCES 104

APPENDIX A: EMAIL ANNOUNCING RESEARCH STUDY 111

APPENDIX B: SURVEY INSTRUMENT 112

APPENDIX APPENDIX C: : PERMISSION TO USE SURVEY 128

APPENDIX D: THANK YOU EMAIL 129

APPENDIX E: CURRICULUM VITAE 130

Table 1 Piaget’s Cognitive Development 35

Table 2 Rest’s Four Components of Moral Behavior 45

Table 3 Women Labor Statistics in Thousands 49

Table 4 Mean N2 Score and Standard Deviations by Age Category 59

Table 5 Defining Issues Test Stage Score Definitions 70

Table 6 Summary of Schema Scores - Age 72

Table 7 Summary of Schema Scores - Gender 72

Table 8 Summary of Schema Scores – Formal Ethics Training 73

Table 9 Demographics Analysis 76

Table 10 P-Score for each Independent Variable 78

Table 11 DIT-2 Scores Descriptive Statistics by Age 81

Table 12 DIT-2 Scores ANOVA by Age using P-Score 82

Table 13 DIT-2 Scores ANOVA by Age using N2-Score 83

Table 14 DIT-2 Scores Descriptive Statistics by Gender 84

Table 15 DIT-2 Scores T-test by Gender 85

Table 16 DIT-2 N2-Scores ANOVA by Gender 86

Table 17 DIT-2 Scores Descriptive Statistics Ethics Training 87

Table 18 DIT-2 N2 Scores ANOVA for Ethics Training 87

Table 19 Summary and Interpretations 95

Table 20 Comparison between SCMD and DIT Scoring 96

viFigure 1 Fraud triangle 24

BackgroundFinancial management within publicly owned companies has received a hugeamount of attention over the past decade Several studies (Hake, 2005; Malone, 2006;Pandey & Verma, 2005) have been conducted in the area of business ethics since thecollapse of companies such as Enron, WorldCom, and other major corporations that werefound to be in violation of numerous financial reporting regulations Previous research onthis topic has primarily focused on the executive level positions, such as CEOs, CFOs,and Board of Directors; however, little research has examined the ethical decision-

making processes of finance professionals below the CFO level in public firms

Rocknesses in their (2005) Journal of Business Ethics article suggested that Enron’s

activities included many employees who had full knowledge of the deceptive accountingschemes Those who knew about the accounting fraud and did nothing to stop it

perpetuated the corrupt and unethical behavior, yet the question of how so many other,lower level finance professionals could go along with the fraud has yet to be explored.This research will focus on determining the thought process of those who went alongwith these crimes knowing that it was wrong to do so

Ethical behaviors of the contributory level employee are the focus of this study

A recent study documented in the Treadway Commission Report stated that “creating anethical climate may be the answer to deterring fraudulent financial reporting” (Brief,Brett, Brown, & Dukerich, 1996, p 184) Enron fostered a climate of corruption and

greed which, in fact supported fraudulent behavior Accountants and financial analystswere all partakers in this unethical climate According to Staubus (2005), “if accountantsand financial analysts fail to provide investors with reliable information that is relevant totheir capital allocation decisions, investors and all citizens with interest in the success ofthe economic system will suffer” (p 6) Staubus’s statement illustrates the need forempirical studies that focus on the accountants’ and financial analysts’ ethical behaviors.

This study focused on the relationship between ethical maturity and gender, age,and formal ethics training The participants in this study were contributory level

employees with various financial and accounting backgrounds The study provided agreater understanding of how gender, age, and ethical maturity may affect decision

making and moral maturity levels of finance professionals In order to facilitate a culture

of ethical behavior throughout the organization, a better understanding is needed of thedecision-making process finance professionals take when faced with ethical situations

Problem StatementPrevious reports of fraud infiltrating corporate financial statements have fostered

a lack of public confidence in North America’s financial system and have brought

attention to the accounting and finance profession As a result of unethical making practices among managers and finance professionals, shareholders and

decision-stakeholders have demanded increased accountability from corporate executives in thearea of ethical behavior

Corporate managers and agents have a fiduciary responsibility to represent thecompany free from fraudulent claims and activities Ethical practices are important touphold capital markets and the welfare of investors and citizens Accountants and

financial analysts have a responsibility to provide investors with reliable information Ifthe information is unreliable investors and citizens with interest in the success of theeconomic system will suffer (Staubus, 2005, p 6) It is necessary to understand thedecision-making process of finance professionals In particular it is important to

understand whether gender, age and formal ethics training have a relationship with

ethical decision-making skills In this study, the ethical decision-making skills of a group

of finance and accounting professionals were explored The Defining Issues Test (Rest,1999), also called the DIT, was used to determine the participants’ ethical decision-making process The DIT is explained in detail in Instrumentation and Materials section

of chapter 3

Research Questions

I explored the relationship that age, gender, and formal ethics training may have

on the various stages of cognitive moral development The results of the study will add

to the body of literature on financial fraud and business ethics This study also bringsincreased awareness to the cognitive moral development stages involved when financialprofessionals are faced with making ethical decisions This information provides insightinto the behaviors of finance professionals who are not in executive level positions, butrather are individual contributors within their organizations

After careful consideration of the reviewed literature, the following null andalternate hypotheses have been formulated The research hypotheses focus on the

variables of age, gender, and the completion or absence of ethics training

Research Question 1

Is there a difference in ethical maturity level between different age groups offinance professionals? That is, is there a difference in ethical maturity as measured bythe Defining Issues Test, between finance professionals who are in different age groupcategories?

Is there a difference in ethical maturity level between different finance

professionals who have taken formal ethics training? In other words, is there a difference

in ethical maturity level, as measured by the Defining Issues Test, between finance

professionals who have taken ethics training as a course in either school or a companyprogram and finance professionals who have not had ethics training in school or as acompany program?

Null Hypothesis 3

H03: There is no difference in the ethical maturity level between finance

professionals who have taken an ethics course in school or as a company program

Alternative Hypothesis 3

Ha3: There is a difference in ethical maturity level between finance professionalswho have taken an ethics course in school or at work Professionals who have takenformer ethics courses have greater ethical maturity

According to Aczel and Sounderpandian (2006, p 277) A null hypothesis is anassertion about the value of a population parameter This assertion is held true unlessthere is sufficient statistical evidence to conclude otherwise the notation is:

Ho: µ1= µ2

Ha: µ1 µ2

where,

Hoand Ha= Null hypothesis and Alternative hypothesis respectively (Aczel &

Sounderpandian, p 280) Also, µ1and µ 2= represent the arithmetic mean of the twopopulations

The DIT was used in this study to measure ethical maturity as a dependent

variable The DIT is an online survey that presents respondents with moral dilemmascenarios The DIT determines what people see as crucial moral issues in a situation(Sapp, 1986) The DIT is concerned with how people at different developmental stages,choose different statements as representing the most important issue in a moral dilemma.The survey presented the respondents with a series of issues and questions to be

considered when making a decision regarding the most appropriate ethical outcome Therespondent must consider each dilemma, make a decision, and indicate which issuesinfluenced their decision Chapter 3 provides more detailed discussion on the how theDIT scores were tabulated and how they were used to test the hypotheses

Purpose of the StudyThe aims of this study are to reveal the role of cognitive moral development onethical decision-making practices, and to determine the relationship between age, gender,and formal ethics training in decision-making skills This research illustrates how thestages of cognitive moral development theory might lead to the development of higherethical practices among financial professionals below the CFO level Such formalizedmoral and ethical examinations are necessary because of the spectacular ethical lapsesthat led companies such as Enron and WorldCom to collapse Although, several argued

in Gini (2004, p 12) that it might have been impossible to implement ethical making practices at Enron because of its corporate culture; The problem was that Enron,WorldCom, and several other companies associated with unethical business practicesinvolved compensation strategies that were based on performance at all costs and

decision-included reward systems that reinforced this particular philosophy

Ethical leadership should come directly from the upper management of a firm andthen move its way down through lower levels of financial management within the firm(Copeland, 2005, p 36) The CFO of a company must make it a point that the firm will,while remaining competitive, transact all its financial practices in an ethical manner (p.36) Additionally, an ethical practice program is always beneficial in public firms as itaccomplishes several imperatives First, a well-defined ethical training program providesconcrete guidelines to the firm’s employees who define the parameters of what behavior

is acceptable and which behavior is not acceptable Second, an ethical practice program

reinforces financial managers’ perceptions that the company values ethical behavior morethan the performance related financial figures (p 36) Thus, this research project

leverages the stages of cognitive moral development theory into a pragmatic ethicaldecision-making framework that is applicable for all levels of financial management inpublic companies The research has been performed by analyzing empirical data onethical issues According to Copeland (2005, p 40), “The destruction of our ethicalconsensus is not the fault of our institutions, but rather is caused by the individuals in theinstitutions.” Copeland also noted that “intimidation from aggressive senior managementcreates pressure on finance professionals to cook up accounting schemes they know areinappropriate” (p.40) Finance professionals lack sufficient personal courage and

character to stand up to threats, such as demotion or termination by senior management(p 40) Accounting firms, such as Arthur Anderson collapsed under Enron becauseauditors were afraid the senior management of Enron would switch auditors The

outcome of this research provides all levels of financial management with adequatesupport structures to encourage finance professionals to do what is right even if it costindividual hardship, such as the loose of one’s job

Moral Reasoning

In this dissertation, I explored the moral decision-making process of financeprofessionals and ascertained the relationship between formal ethics education, age, andgender in making ethical decisions using Lawrence Kohlberg’s theory of cognitive moraldevelopment Kohlberg’s levels of cognitive moral development were measured in this

study by using the Defining Issues Test (DIT), a measure developed by James Rest

(1979) Rest developed the DIT as a method to measure ethical reasoning levels TheDIT has been widely used in the accounting profession to measure ethical decision-making ability (Armstrong, 1993; Jones & Hiltebeitel, 1995; Elm et al., 2001; Ponemon

& Glazer, 1990; Shaub, 1994 as cited in Venezia, 2008) In these particular studies,results have indicated by using the DIT model that gender, education, age, and takingethics courses may affect moral reasoning abilities Venezia found a relationship existsbetween gender groups and ethical behavior The study revealed that female accountingstudents possessed higher levels of ethical reasoning than male accounting students;However, the research was not all conclusive and recommended that further study bepursued in the area of gender and ethics Venezia’s research was grounded in cognitivemoral development theory In the study the author explained how Lawrence Kohlbergmodified Piaget’s theory on the moral judgment of the child to develop six stages ofcognitive moral development Kohlberg’s six stages are as follows:

Level I: Pre-conventional Morality

Stage 1 The Morality of Obedience: You do what you’re told

Stage 2 Individualism, Instrumental Egoism, and Simple Exchange: Let’s make adeal

Level II: Conventional Morality

Stage 3 The Morality of Personal Concordance: Be considerate, nice and kind,and you’ll get along with others

Stage 4 The Morality of Law and Duty to the Social Order: Everyone in society

is obligated to and protected by the law

Level III: Post-conventional Morality

Stage 5 The Morality of Societal Consensus: You are obligated by whateverarrangements are agreed to by due process procedures

Stage 6 The Morality of Universal Ethical Principles: How rational and impartialpeople would organize cooperation is moral (Clouse, 1985, pp 108-110)

Review of the literature supports the use of the DIT as the most valid instrument to

determine moral reasoning In chapter 2 under the Ethics Education section, detailedinformation is provided concerning wide usage of the DIT in conducting research onmoral values The DIT has been validated in over 500 studies (Rest, 1999) There areconsistent empirical findings suggesting formal education is a reasonable facilitator ofmoral reasoning (Bruess & Pearson, 2002, p 44) Ethics courses are designed to create

an awareness of situations with shades of gray It is important to understand if ethicseducation courses are successful in fostering integrity and ethical behavior within financeprofessionals This study is a continuous investigation of Kohlberg’s cognitive moraldevelopment theory by using Rest’s DIT model to analyze the data

Cognitive Moral Development and Ethical Decision Making

In this research, project I will examine the relationship between cognitive moraldevelopment and ethical decision-making among finance professionals The theoreticalfoundation is important because moral and ethical behavior often defies any type of

quantification unless the appropriate theoretical perspective is first identified The

theoretical framework for this particular study includes the stages of cognitive moraldevelopment theory, which was first proposed by Lawrence Kohlberg (1984) In 1984,Kohlberg first theorized that a relationship exists between moral development and ethicaldecision-making in a study on the moral decision-making behaviors of adolescents andyoung adults Kohlberg’s theory was an expansion to Piaget’s theory on the moral

judgment of a child He expanded Piaget’s two-process system to a six-stage sequencethat extended from early childhood through adulthood (Clouse, p 125) The six-stagesequence is discussed in detail in chapter 2 under Cognitive Moral Development

Evolution heading

Ongoing disagreement exists regarding whether the stages of cognitive moraldevelopment can predict ethical decision-making The ability to make such assumptionsand relationships seems to be lacking both within the stages of cognitive moral

development as well as within other theoretical structures related to ethical behavior Therelationship between moral judgment and moral behavior are not always congruent, that

is, to know good is not the same as doing good and thinking about moral issues is not asubstitute for moral living Kohlberg’s theory on moral judgment and behavior wastested by Malinowski and Smith (1985) who found that an inverse relation between moraljudgment and dishonesty is not expected under all conditions, but it should occur whenthere is an implicit or explicit understanding that cheating is not to take place, and whenthere are no other considerations that make cheating appear to be a relatively moral act

The results indicate that the procedures effectively aroused temptation because 77% ofthe subjects cheated on at least one trial Moral judgment is negatively related to thenumber of trials on which subjects cheated and the number of seconds by which subjectsinflated their scores It is clear that moral judgment is only one of several determinants

of Kohlberg’s cognitive moral development theory and includes a measurement toolcalled the defining issues test or DIT

Operational DefinitionsThe following definitions establish meaningful application of words and conceptsthat should be understood within the context of this study

Agency theory: Explains the behavior of managers acting as agents to companies

they do not own (Chew, 2005, p 1)

Business ethics: A specialty within applied ethics in which ethical principles and

moral issues are either normatively or descriptively analyzed (Haines, Street & Haines,

2008) It comprises principles and standards that guide behavior in the business world(Weiss, 2006).

Cognitive: The mental thought process or the process of knowing (Kohlberg,

1984)

Cognitive moral development: The development of thought processes including

remembering, problem-solving, and decision-making, from childhood through

adolescence to adulthood (Kohlberg, 1984)

Defining Issues Test (DIT): a measure that examines ethical and even moral

dilemmas using a scale similar to the Likert scale (Loviscky, Trevino & Jacobs, 2007) Aseries of five moral dilemmas were used to identify how study participants would

respond over the various stages of their psychological development

Ethics: A set of guidelines based on value-sets as instituted by an organization

and usually based on the value-sets of the society in which the organization functions(Nonis & Swift, 2001, p 251)

Efficient Market Theory: EMT A theory in which stock prices fully reflect

available information (Jaffe, et al., 2005)

Financial management: Issues related to capital assets within a firm and how

those capital assets are allocated (Stein, 2008)

Formal ethics education: A systematic educational activity whether taught in

school or on the job that creates an awareness of situations with shades of gray, in which

small problems can increase and become big problems with undesirable consequences(Emiliani, 2004).

Fraud: The intentional distortion of the truth, for whatever purpose, is contrary to

most conceptions of morality as well as to codes of practice and codes of ethics in theprofessions (Soskoline, 1996)

Morals: The principles of right and wrong.

Moral judgment: Piaget’s concept of the moral judgment of the child used

philosophical parameters to identify morality, which he described as being universallyapplicable, generalizable, and obligatory (Darley & Shultz, 1990) The impact is thatmorality and ethics are acquired through social transmission

Moral maturity: The considerations taken into account when making moral

decisions and kind of prioritizing and integrating principles used to determine favor ofone line of action or another (Rest, 1980, p 602)

Moral or Ethical Dilemma: A condition in which there is no choice, which is

clearly superior to the others, and all the various alternatives to some degree violate one

or more ethical standards (Kohlberg, 1984)

Shareholder wealth maximization: A world best practice that empowers

organizations to increase the value or worth of their business (Economic Solutions, 1997)

Stages of Cognitive Moral Development Theory (SCMDT): A theory of the ways

in which moral and ethical perspectives are developed within the individual (Lind, 1985).SCMDT’s first proponent was Kohlberg who identified six developmental stages to

moral development in the typical individual and determined that the process of handlingmoral dilemmas successively led to moral or ethical maturity.

AssumptionsOne of the primary assumptions of this research project is that all parties agree onthe same definition or concept of ethics Ethics are defined as a set of guidelines based onvalue-sets as instituted by an organization and usually based on the value-sets of thesociety in which the organization functions (Nonis & Swift, 2001, p.251) According toNonis and Swift, values are the most basic characteristics of adaptation that guide

individuals in deciding which situations they should enter and what they should do inthem (p 251) Values are related to morals as well as to moral training and

indoctrination

A strong, values-based organization that conducts business with a well delineatedethical framework to guide all decision making is rewarded (discounting issues of poormanagement, market forces, competitive forces, etc.) with positive financial performanceover the long term Kamberg (2001) stated that “Johnson & Johnson Corporation took ahuge hit financially, but they got good publicity out of it And the product sold well afterthat it is good business to behave in an ethical way” (p 25) Kamberg’s example

illustrates that it pays to make the right decisions Johnson & Johnson was able to savetheir reputation and earned better respect from their customers

Although Kamberg (2001) has an optimistic view of making good ethical

business decisions, the inconsistent set of values and beliefs that people embrace makes it

difficult to address the ethical issues surrounding finance and other economic matters.The current tide of economic policy is caused by the growing influence of narrowlydefined corporate interests (Hake, 2005) Deregulation produced a fragile capital

structure and loosened oversight encouraged the exploration of the boundaries of

corporate practice (p 596) In exploring the boundaries, executives found themselves in

a precarious situation, manipulating financial assets such that they became a more

important source of corporate value than the act of production and sale (p 597)

The study assumes that the existing cognitive moral development model

developed by Lawrence Kohlberg and expanded by James Rest, reveals a relationshipbetween moral development and ethical decision making Ongoing disagreement existsregarding whether or not levels of cognitive moral development can actually predictethical decision-making (Clouse, p 119); however, that debate was not considered amajor factor in this study

Limitations of the StudyThis study was limited by a self-imposed data collection time frame of 30 days

As an exploratory study, a simple canvass of finance and accounting professionals

derived from an Internet list-server residing on the Academy of Management website wasthe target population for this study The list-servers are publicly available anyone withaccess to an e-mail account can use the service (Academy of Management, 2009) Thescope of this study was limited to Finance professionals who was contacted throughpublicly available Internet list servers Consequently, the domain of this study does not

present a full reflection of all finance professionals Nevertheless, the participants’involvement is necessary to add to the body of knowledge concerning ethical decisionmaking of finance and accounting professionals.

ScopeThe scope of this study includes finance professionals who may also be

Accounting professionals The list of potential participants includes individuals who arefinance practitioners, project managers, academicians, and students who have an interest

in areas, such as behavioral finance, fraud prevention, forensic accounting, and corporatefinance Several studies have been conducted to determine the ethical behavior of

students majoring in accounting (Armstrong, 1993; Ponemon and Glazer, 1990; Shaub,

1994, and Venezia, 2008) In this study I did not delineate decision-making skills basedupon field of study or financial background Instead I was limited to individuals whowere either working toward a career in finance and accounting or already had a career inthe finance and accounting field Age is a variable that was examined in order to betterdetermine if there was a relationship between age and the stages of cognitive moraldevelopment

Significance and Social Change

In this study I explored the impact of age, gender, and formal ethics training onthe various stages of cognitive moral development and ethical decision-making skillsamong finance and accounting professionals The first goal of this research project was todetermine the difference in ethical maturity levels between different age groups of

finance professionals at various levels within a firm; The second goal was to determinethe difference in ethical maturity levels between different groups of finance professionalswho have received formal ethics training The last goal was to determine the difference inethical maturity levels between gender groups of finance professionals.

This project will contribute a positive social change in human development bypromoting ethical social responsibility among business and finance professionals Suchstrategies are necessary because the lack of ethical decision-making within the last fiveyears has led to a host of corporate implosions: Enron, WorldCom, Adelphia, GlobalCrossing, Qwest, Tyco, etc These unethical practices have destroyed some of the

world’s largest companies and hundreds of billions of dollars in shareholder value

(Copeland, 2005, p 36) Although many of these companies that lost billions of dollarsstill exist, the unethical financial practices of their executives often benefit at the expense

Making unethical decisions and operating the business unethically is often the route taken

by executives in the short term

The ethical considerations for the firms previously mentioned have been

condensed into the ethical failings of top management Only top management has thepower and authority to undertake such huge transgressions; however, they rely on eitherthe active or passive silence and cooperation of corporate finance professionals at alllevels of the organization

By establishing well-founded decision-making practices that are steeped in astrong consideration of ethical processes, firms can be rewarded (Copeland, 2005)

Copeland’s observation justifies how theoretical constructs, such as cognitive moraldevelopment theory, influence ethical decision-making within a firm’s financial

management The most obvious reward for ethical behavior is sustainable business

Ethical behaviors and ethical decision making are not processes implemented on awhim, rather, it is a process instilled from executive level financial managers down to thelowest financial professional in the firm This study will assist companies in developingethical compliance programs and fraud prevention programs that will add to the skill set

of finance professionals, thus making finance professionals more aware of their fiduciaryresponsibilities in maintaining accuracy and integrity in financial data and reporting.Providing an ethics program that recognizes the impact of age, gender, and formal ethicstraining on behaviors could enhance the company’s ability to train, monitor, and enforceethics compliance This study provides assistance in understanding the variables that canlead to a morality breakdown in the decision-making process by Accounting and

Financial professionals The study provides a better understanding of whether age,

gender, or ethics education has any impact on the decision-making process Previousstudies conducted by Armstrong, 1993; Ponemon and Glazer, 1990; Shaub, 1994, andVenezia, 2008, were found to be inconclusive as to whether the variables age, gender,and ethics education can predict ethical behavior The researchers all recommended thatfurther study be pursued in the area of gender, age, and ethics education The results ofthis study will add to the body of knowledge by gaining a better understanding how thestages of cognitive moral development theory might lead to the development of higherethical practices among financial professionals below the CFO level The knowledgegained from this study will improve society by increasing a corporation’s effectiveness inproviding a viable ethics and compliance program that leads to integrity in financialreporting to shareholders and stakeholders.

SummaryImmediate lessons may be learned by analyzing ethical decision-making

processes Corporations both public and private must establish the processes and

procedures to monitor themselves if true integrity is sought in the field of financial

management Although a number of regulations can attempt to prevent unethical financialdecision making and behavior, companies need integrated checks and balances to ensurethat such excesses do not occur This study explored the relationship between ethicaldecision-making among finance professionals in regard to age, gender, and formal ethicstraining The theory being tested in this study includes Lawrence Kohlberg’s stages ofcognitive development theory, which suggests a positive relationship between cognitive

maturity and moral behavior Chapter 1 has provided an introduction to the study,

background of the problem, purpose of the study, nature of the study, assumptions,

limitations of the study, significance of the study, and its implication to affect positivesocial change Chapter 2 will provide a review of the literature on the subjects of moralmaturity and ethical decision-making in business In chapter 2 a description of the

instrumentation used in data collection will be discussed A detailed discussion on thereliability and validity of the instrument will be presented also; in chapter 3 a discussion

on the statistical method used to analyze the data will be discussed

IntroductionThis chapter will provide a review of the literature topics concerning cognitivemoral development and ethical behavior Cognitive moral development theory is themain theoretical basis for this dissertation The literature reviewed for this study includedacademic and professional publications, textbooks, and electronic website information.The goal of this chapter is to synthesize previous works related to financial ethics withinthe framework of cognitive moral development theories Topics will include a discussion

on creating shareholder wealth and value maximization, the evolution of cognitive moraldevelopment, ethical gender differences, ethical age differences, and an overview offormal ethics education This review of the literature includes arguments and

counterarguments surrounding the debate on ethical decision making and cognitive moraldevelopment

The Corporate Ethical Dilemma: Shareholder Wealth Maximization

Many people have concluded that corporate greed permeates North America(Duska, 2005) According to Duska, corporate executives who have committed fraud byfalsifying earnings to meet financial expectations are suffering from what may be calledmoral schizophrenia because they are pulled in two different directions: one is the

accumulation of wealth and the other is the devotion to carry out their professional

mission Duska, said that “the executive’s goals and responsibilities are maintained byhaving integrity” (p.28) A person’s responsibilities should not become subordinate toselfish desires to accumulate wealth Integrity is a principle in most codes of ethics

governing financial management Perhaps the most puzzling dilemma of all is the

employee’s willingness to persistently participate in the corrupt actions Employees canrationalize their actions by a view that the corrupt acts are justified because others aroundthem are participating in the behavior (Anand, Ashforth, & Mahendra, 2005, p 9)

According to Anand et al 2005, this type of justification is known as socialization

rationalization Socialization tactics include newcomers who are entering corrupt units,and being induced to accept and practice the ongoing unethical acts and their associatedrationalizations The rationalization and socialization practice cause perpetrators ofunethical activities to believe like moral and ethical individuals, thereby allowing them tocontinue to engage in unethical practices without feelings of guilt Those participating inunethical acts usually deny any responsibility for their actions They usually see

themselves forced into corruption because of intense pressure from others Corruptioncan become routine and carried on as normal business activity if rationalization andsocialization are left unchecked (Anand, et al., p 11)

Another theory that supports the rationalization behavior is called the fraud

triangle (Ramamoorti, 2008) The Auditing Standards Board and the American Institute

of Certified Public Accountants (2002), along with other institutions introduced theconcept of the fraud triangle In their Statement of Auditing Standards The fraud trianglehas three elements: perceived pressures (also called motivations for the crime), perceivedopportunities, and justification or rationalization of the fraudulent behavior The fraudtriangle is a model used by internal auditors to help examiners determine why a person

committed a crime Donald Cressey, who is an advocate of the fraud triangle, believedthat these three basic drivers are the root cause of many fraudulent acts (Murdoch, 2008,

p 81) Below is a diagram depicting the fraud triangle:

Figure 1 Fraud triangle, by S Ramamoorti, September 2008, Issues in Accounting Education, 23( 4), p 525.

The first aspect of the fraud triangle is Pressures or Motivations The perceivedpressures or motivation can come from several sources One that is relatively commonamong corporate executives is the pressure to create and sustain high financial returns.Pressures that affect subordinates and those below the executive level can come fromseveral areas, such as housing expenses, child’s tuition payments, unexpected medicalbills, gambling habits, drug addictions, extramarital relationships, the need to sustainlavish lifestyle, or avoid the appearance of failure due to their reputation (Murdoch, 2008,

p 81)

The second aspect of the triangle is Opportunity If an organization does not haveeffective controls the perpetrator can see an opportunity to commit fraud Weak controlscreate opportunities for fraud The lack of oversight of certain transactions below a

monetary threshold is insufficient in deterring fraud People will seek opportunity tocommit fraud when internal controls are lacking or weak.

The third point of the triangle is called Rationalization or Justification Thepersons who committed the fraudulent act will sometimes provide justification for theirwrongdoing One rationalization technique employees use is the socialization

rationalization concept, where employees believe the corrupt acts are justified becauseothers around them are participating in the behavior Other rationalizations may includebeing overlooked for a promotion they believe they deserve, reduction in employeebenefits, feeling underpaid, and other times an individual may rationalize that funds wereborrowed and will be returned at a later date (Murdoch, 2008, p 82)

In the three dimensions of fraud Murdoch (2008) explains that the fraud triangle

is useful in categorizing the causes of fraudulent behavior, but auditors must consider aperson’s character He explains that individuals bring elements of their cultural, ethical,and moral beliefs to a position Murdoch asserts that these three elements are the

foundation of people’s attitudes and the key ingredients to determine their character

Financial economic theory suggests the ultimate goal of a business organization is

to maximize shareholder wealth Dobson (1999) evaluated if shareholder wealth

maximization is a moral justification for behavior in business Dobson asserted that themaximization of shareholder wealth is in conflict with ethical business practices Itcreates a dilemma for corporate executives The executives and managers of an

organization should have sound moral values Dobson says “the moral worth of the

organization is inseparable from the moral worth of the decision makers in it” (p 69) Ifexecutives are determined to overlook the moral implications of shareholder

maximization, they will be clouded by shortsightedness and greed (p 69) The idea thatshareholder wealth maximization is neutral to ethics is an unwarranted myth held byfinancial economists Belief in this myth exempts financial economists from moral self-examination The goal of shareholder wealth maximization is rarely held up againstethical scrutiny because according to Dobson, p 70 a manager acting in accordance withshareholder wealth maximization is not exercising any particular moral judgment

Although Dobson asserts that the maximization of shareholder wealth is in

conflict with ethical business practices, in an article written by Padelford and White(2009, p 68) the authors suggest that profits should not act as a moral constraint in thefield of business ethics They argue that profits could act as an ethical motivation forbusinesses to accomplish other socially valuable and responsible goals Social

contribution by companies is possible only if the company is profitable Profit should not

be the primary purpose of a business, but profitability helps the business pass the test ofbeing a valid and viable company There can be a moral legitimate pursuit of profits that

is good both for the business and society According to Padelford & White the questionshould not be whether corporate profits is right or wrong, but rather “Does the profitmanifest the best ideals of the organization? Does it render an employee or managerwhole or does it tear a person to pieces, walling off one aspect of a personality from

another and leaving one part to apologize or feel ashamed before the other.’’ (Solomon,

as cited in Padelford & White 2009)

Finance TheoriesFinance theories, such as the agency cost theory, efficient market theory, andfinancial distress theory are all theories that should assist the organization in its ultimategoal of shareholder wealth creation and maximization; however, these theories, whentaken in the view of ethical lenses, have proven to be very pervasive in upholding moralcharacter

of the capital structure of the firm takes place Haugen and Senbet (1974) concluded that

in a market with rational investors, bankruptcy costs are trivial or nonexistent in

determining an optimal capital structure Haugen and Senbet’s assertion that bankruptcycosts are trivial refers to the liquidating costs associated with selling the distressed firm

If shares of common stock are sold and the proceeds are used to repurchase the debt onthe open market the bankruptcy is transparent to stockholders This phenomenon can

result in a lack of moral judgment because the financial manager is only concerned withshareholder wealth.

Another concern with the Agency Theory is that of Chief Executive Officers(CEO) pay packages One of the most perplexing problems in agency theory is why theassociation between pay and performance is not more robust (Bert, Finkelstein, &

Hambrick 2008) One reason there is a weak association between pay and performance isthat the agent is not necessarily a fully rational risk-adverse leader, but rather an

individual whose complex motivations and interests cannot be documented (Bert,

Finkelstein, & Hambrick, p 328) Pay and performance are not always related and therelationship between pay and performance is contingency driven meaning that it dependsupon such factors as the board of directors’ effectiveness and other agent’s performance.The moral hazards associated with Agency Theory occur when managers, acting asagents for shareholders, behave in ways that are against the principals’ interests Someexamples of executive moral hazards include:

Asset expropriation, misstatements and nondisclosures that place

non-management shareholders at a disadvantage, consumption of costly projects,pursuit of personal objectives, such as increased compensation, through

diversification and growth ventures that misuse free cash flow; foregoing

investments in projects that have positive net present values to avoid risk if theproject fail, and extraordinary efforts to remain in power by fighting takeoverattempts that might benefit shareholders (O’Connor, Priem, Coombs, & Gilley

2006, p 483)

Unethical or illegal behavior, particularly that involving financial reporting, erodesshareholder value (O’Connor et al., p 483) In O’Connor et al., 2006 study they found acomplex set of interactions that suggest stock options increased fraudulent reporting

when the (a) CEO was also the Board Chairman and the board did not earn stock optionsitself, and (b) the CEO was not Board Chairman, but the board did have stock options (p.483) This supports the argument that current compensation practices are problematicfrom both the standpoint of distributive justice and fairness, and also that exorbitantincentive pay exacerbates the agency problem it is purported to solve (Harris, 2009)

The debate over CEO pay and poor corporate performance has breed contentionfrom shareholders and finance professionals for quite some time Recently the NorthAmerican Government gave billions of dollars to troubled financial institutions facingcollapse in wake of the crumbling housing markets Several of the institutions that

received Government funding paid billions of dollars in executive bonuses Lawmakersquestioned CEOs on why fat bonuses were paid and lending had not improved (Stone,2009) Representative Barney Frank, Democrat from Massachusetts, chairman of theHouse Committee on Financial Services asked the CEOs this question, “Why do youneed to be bribed to have your interests aligned with the people who are paying yoursalary? Why do you need bonuses? Can’t we just give you good salaries” (Stone, 2009)?

In an article written by Gogoi (n.d.) he explains that Merrill Lynch paid bonuses of morethan $1 million each to 696 employees in December, with four of the highest-paid

employees getting a total of $121 million dollars The top four executives received $121million dollars, the next four received $62 million and the next six received $66 million

Weiss (2006) founded that CEOs running 100 of North America’s largest

companies pulled in a median compensation of $33.4M in 2002 The disconnect between