Ethics in Cyberspace

Ethics in Cyberspace

In the so-called “new economy,” it may seem that the rules of business have changed to suit the faster pace of the technological times. Certainly, the landscape for business is different from what it was ten years ago. But as we examine the conduct and consequence of the new companies that rode the tidal wave of the new economy, one thing becomes increasingly clear: There is nothing new under the sun. There is no such thing as “cyberethics” or “ethics in e-commerce.” There is simply the practice of business ethics.

I have found that this idea is not always an easy sell, especially to new-economy converts. For example, early in 2000 I gave a speech on the importance of ethics in business to an audience of very young and successful e-commerce entrepreneurs. They offered a chilly reception for my discussion on the importance of honesty and keeping one’s word in business. When I had finished, one young man approached me and said, “You’re just going to have to face the fact that with new ways of doing business, these old rules don’t work. You can’t expect us to live by them.”

I left the speech with significantly increased self-doubt. I questioned whether my expectations about ethics in business were unrealistic or old-fashioned. I feared I had become one of those stodgy professors who fails to grasp business trends and simply continues teaching the irrelevant.

However, over the next year increasing revelations about the practices of companies in the “new economy” and the market’s downturn renewed my commitment to teaching traditional ethical values and principles in business, no matter what trends surround it. Those basic principles I discussed nearly two years ago with that somewhat hostile crowd still hold true today.

And judging from the ethical missteps of companies in the new economy, as noted in the discussion and lessons that follow, we have not done as much in academia as we should have to help future business leaders understand the whats, whys, and hows of business ethics.

A look at these ethical missteps offers a perfect teaching opportunity for lessons in business ethics. Students can see for themselves the consequences when these basic principles are violated—the same principles that have been labeled by too many as outmoded or inapplicable to new forms of business.

Honesty Is the Best Policy

In 1993, Andrew Stark published his seminal piece, “What’s the Matter with Business Ethics?” in Harvard Business Review. Professor Stark concluded that the discipline of business ethics had provided very little to managers because of its focus on theory and the impractical. Further, he indicted members of the discipline for their unrealistic expectations for business behavior. Unfortunately, Professor Stark was simply part of the discipline’s majority who believe that ethics and business are mutually exclusive terms: It must be all or nothing at all.

Likewise, theorists in business ethics frequently condemn a business for being in business. These theorists might advise a company to go out of business rather than violate their self-defined ethical principles. Professor Stark understandably chastised this group for being impractical. But he then went on to take the position at the opposite extreme—that sometimes a business has to be unethical to survive.

One of the clear lessons of the new economy is that neither approach is realistic, practical, or even frequent in running a business. Just because a business is “soft,” in the sense that it has no factories or produces no pollutants—as nearly all new economy companies were in the late 1990s—does not mean that it is ethical. And very often it is the decision to behave in an unethical fashion that prompts the demise of a business rather than assures its survival.

The underlying “social responsibility” arguments about business—particularly the pro-environment focus—have not served as accurate predictors of honesty-in-fact in terms of business behavior, especially among the “new economy” companies. These leaders possessed an odd sense of immunity, a sense of ethical invincibility perhaps born of years of business ethics instruction centered on topics of social responsibility. So long as the company employees were engaged in volunteer work, there seemed little cause to worry about undisclosed risk, postponed write-downs, and conflicts of interest. Who can blame them?

For the past decade, ethics instruction has focused on topics such as global warming, sweatshops, environmentalism, and diversity. While those are important topics in the field, few scholars were doing research or teaching the ethics of earnings management. And, as examples below will indicate, earnings management became an art form in new economy companies, bordering on cooking the books.

But a look at the lack of transparency in the financial statements of many of the new economy companies tells us that perhaps, as a matter of business ethics, we should begin with disclosure of expenses. Only then should we work our way up to saving the planet.

As we teach business ethics, one of the foremost lessons is perhaps that no one business ethics principle provides a free pass from accountability in other areas. Virtue does not result from obscuring financial activities. An ethical company has a multifaceted approach to creating its culture. Our responsibility is to be certain students understand all aspects of business ethics so that they can create, and work within, that culture effectively.

History Repeats Itself

Consider a scenario with the following characteristics:

  • High-price earnings multipliers
  • Economic disturbances abroad
  • High levels of optimism
  • Insiders selling their shares
  • Insider trading
  • An abundance of options
  • Speculation
  • A false security and a feeling of invincibility

This list seems to be a description of market conditions before the bubble began to burst in April 2000. However, those factors actually were taken from readings on the climate that preceded the 1929 stock market crash and the Holland Tulip Market of the 1600s (from The Causes of the 1929 Stock Market Crash by Harold Bierman Jr., and Tulipmania: The Story of the World’s Most Coveted Flower and the Extraordinary Passions It Aroused by Michael Dash). Historical perspective is crucial to understanding the present. Our role as academicians surely includes providing students with that perspective so that they can understand that their experiences are not unique, and that history does have its lessons.

The Holland Tulip market was one that evolved from the love of a new flower. As the price for the flower increased, investors began to purchase tulip bulbs. As bulb prices increased and supplies decreased, investors sought bulb futures, an investment in air! At one point, one tulip bulb future was selling for $10,000 in today’s dollars. When everyone realized that there was nothing to their investments, save the hope of a bulb sometime in the future, the market collapsed. Investors and companies wanted it all as quickly as possible and discarded the basics of sound investment to be part of a wild scheme.

Sound familiar? As students examine the investments in dot-coms that had no record of earnings—just expenses and hope for the future—the Holland tulip market becomes incredibly relevant. During the height of the dot-com mania in which IPOs were creating billionaires overnight, it was as if the financial statements of these companies were reading, “Well, if it hadn’t been for all of our expenses, we would have made money.”

While we may think that the recent evolution in business has presented us with new rules, some fundamental principles do not change. Expenses in excess of earnings, no matter how sound the model for predicting future earnings, are still expenses that reduce earnings.

Establishing the ground rules for business and business ethics still remains a critical part of a solid business education. A simple look at even the California gold rush provides students with a historical foundation. At the time, many individuals and businesses purchased land, options, and investments in mines. Their risk was high and not always undertaken with complete or honest information. Quick returns, frauds, and schemes were the downfall of nearly all involved.

Their dreams turned to dust, but the true winners from the gold rush economy were those very staid businesses that supplied the materials for the expanded mining industry there. For example, Levi Strauss, the company that sold the miners their pants, remains an established company today, just as the companies that sold the dot-coms their furniture, supplies, and services survive.

There is an element of patience and virtue in the long term that should be taught as part of the study of ethics. Double-digit growth is not sustainable for extended periods of time, but steadily increasing growth is. With that knowledge base, students can understand how often ethical shortcuts interfere with that long-term goal of increasing success.

What Goes Around Comes Around

Two examples of new economy companies and their financial statements illustrate the ease with which business ethics can be incorporated into discussion. A look at MicroStrategy Inc. and Dell Computers offers students a challenging example of why transparent financial statements matter.

When MicroStrategy issued its IPO, its share price was $6. By March 2000, that price had climbed to $333. However, when MicroStrategy announced in December 2000 that the Securities Exchange Commission was investigating it for “accounting improprieties,” its share price dropped 62 percent in one day.

As the investigation unfolded, we learned the following:

  • PricewaterhouseCoopers certified its financials for 1999 (profit figure).
  • PricewaterhouseCoopers then forced Microstrategy to correct the 1999 financials—they showed a loss.
  • PricewaterhouseCoopers settled a lawsuit with shareholders for $51 million (plus interest from September 2000) on May 10, 2001.
  • Share price on May 10, 2001, was $4.95, and on October 11, $1.61, up from $1.40.

MicroStrategy then offered the following explanation in its annual reports filed with the SEC:

The Company has concluded that certain of its software sales that include service relationships will be accounted for using contract accounting, which spreads the recognition of revenue over the entire contract period as opposed to separating it between the software and services components. The effect of these revisions is to defer the time when revenue is recognized for large, complex contracts that combine both products and services.

The Company, with the concurrence of PricewaterhouseCoopers, LLP, its auditors, will reduce its 1999 reported revenue from $205.3 million to between approximately $150.0 million and $155.0 million, and its results of operations from diluted net income per share of $0.15 to a diluted loss per share between approximately ($0.43) and ($0.51).


MicroStrategy broke no laws in its interpretation of accounting principles with regard to booking revenues. But a change, insisted upon by its auditors, took the company financials from a position of net income per share to a net loss of some $0.58 per share lower. Here, the moment for teaching business ethics comes when we ask not simply whether Micro Strategy could report its earnings this way, but whether it should.

Students are able to see the long-term impact of that choice, or that interpretation of an accounting rule, on the company and all of its stakeholders. More than the restatement of earnings and its impact is the psychological impact on the market as the company loses reputational capital in terms of the reliability of its financial reports.

A related ethical issue surrounding financial reporting choices is the absence of independent boards among the dotcom companies. That false sense of invincibility was evident as the majority of the dot-coms opted not to have outsiders on their boards. There are reasons and historical foundations for independence on boards, particularly in audit committees.

However, the dot-coms seemed particularly hostile to the very suggestion of such outside input. When asked in 1999 about the lack of outsiders on his board, Jeff Dachis, the former CEO of Razorfish, said, “I control 10 percent of the company. What’s good for me is good for all shareholders. Management isn’t screwing up. We’ve created enormous shareholder value.” Razorfish’s IPO sold at $56 per share; it was at $1.11 in May 2001. Dachis was replaced as CEO in 2000. The stock price in October 2001 was $0.21, up from $0.14 per share.

Dell Computer provides another example of ethical issues in financial reporting and how earnings are obtained. During the late 1990s, a sizable percentage of Dell’s earnings was the result of the company’s rather complex stock purchase program that employed puts and calls. Dell was using its own stock to hedge earnings, and doing a darn good job of it, so long as the company’s stock price was increasing and Dell was on the correct side in terms of its balance of puts and calls. But when the market took its downturn, Dell experienced reductions in earnings.

This type of accounting practice resulted in increased SEC oversight and disclosure rules in which companies must be specific in disclosing their OCI (Other Comprehensive Income). Further, the SEC has new rules in place on puts and calls by companies in their own stock because of the potential for manipulation of stock prices.

Warren Buffett has commented on the new liberties in financial reporting and referred to some of the creative accounting methods used to report earnings as the “distortion du jour.” Mr. Buffett offers the ethical perspective on these issues as he raises the issue of whether the United States is losing its longstanding position of candor, or transparency, in its companies’ financial statements.

While these financial reporting issues are not new, the new economy seemed to provide the incentives for pushing the envelope on managing earnings practices, resulting in new regulations for those abuses of transparency. Interestingly, 66 percent of all of the SEC investigations for accounting fraud now involve dot-com companies.

While many investors have lost significant amounts, study of these experiences is valuable to students. Students must explore the basic ethical questions: Are these disclosures complete and honest? What are the implications for this decision on how to report revenue? If I were an investor, is this information I would want disclosed? And would I want more discussion of the risk involved in this approach to financial reporting?

Trust Must Be Earned

The May 14, 2001, cover of Fortune magazine has a photo of Mary Meeker, the new economy analyst from Morgan Stanley, and the question, “Can we ever trust again?” Inside the magazine, the stories raise two basic concerns in business ethics: conflicts of interest and insider trading.

The conflicts of interest in the new economy centered on the role of analysts. While many investors assumed that analysts such as Meeker were offering their candid assessments of companies, the analysts very often stood to benefit personally, or through their companies, if they endorsed an IPO. Many became cheerleaders for the companies they were supposed to be evaluating independently.

Other players also had conflicts of interest in the new economy stock offerings. Lawyers who were offering their professional opinions as part of the disclosures in the IPO registration materials often were to be paid in shares of the new company. Their opinions on the legal issues facing the company were in conflict with their economic interest in the IPO not only going forward, but going well.

In addition, insider trading occurred in the form of the socalled “pump and dump” stock sales. In this money-making venture, even television analysts got in on the game of purchasing a particular stock and then taking to the airways, the Internet, and the print media to pump the stock to investors. When the investors took the bait and bought, increasing the value of the shares, the pumper would then dump the shares at a significant profit. Even a teenager, 15-year-old Jonathan Lebed, managed to turn an investment of $8,000 into a handsome $800,000 profit. He used different screen names to pump shares he had purchased, and then sold them after intrigued investors caused the prices to climb. And he did all this without missing a day of school.

These conflicts and self-dealing stock-trading scenarios are teaching moments to show what happens to markets when investors lose trust in the fundamental fairness that they assumed existed. Beyond the ethical principles is the exploration of the underlying reasons they exist—that markets function because of certain assumptions about values and behaviors. Investors hold back when they perceive that they cannot get a fair shake in a market that has no level playing field. An examination of economic volatility differences across nations can show students what happens when there is a perception of corruption in markets. In this respect, stock market investments are no more sophisticated than money kept in a jar or under a mattress.

The very nature of e-commerce demands more trust than has ever existed in our business transactions. We trust that those responding via electronic means are indeed who they purport to be. We trust that companies will not misuse the credit information we provide to them to pay for merchandise ordered electronically. And we trust that everyone will honor pledges made with simply a click.

Go Back to the Basics

As I think back to the young man’s skepticism about the role of ethics in the new economy, my mindset has changed. It is because of the nature of the new economy and e-commerce, not in spite of it, that we need basic ethics more than ever.

As teachers and scholars, we and our students can benefit from the experiences of the fallen dot-com companies in the now not-so-new new economy. They serve as the perfect examples to demonstrate how the basic principles of ethics, such as honesty, fairness, and the avoidance of conflicts of interest, are a cornerstone to success, even when the means for doing business changes.

Marianne Jennings is a professor of legal and ethical studies at the College of Business at Arizona State University in Tempe, Arizona.