smith versus friedman markets and ethics 2007 critical perspectives on accounting

8/10/2019 Smith Versus Friedman Markets and Ethics 2007 Critical Perspectives on Accounting

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Critical Perspectives on Accounting 18 (2007) 159188

Smith versus Friedman: Markets and ethics

A. Craig Keller

School of Accountancy, College of Business Administration, Missouri State University,

901 South National Avenue, Springfield, MO 65897, United States

Received 1 November 2004; received in revised form 12 November 2005; accepted 15 December 2005

Abstract

This paper addresses the issue of ethics in modern business thought from the perspective of the

father of modern economics Adam Smith using both An Inquiry Into the Nature and Causes of the

Wealth of Nationsand The Theory of Moral Sentiments. The foundation of modern business thought

is represented by the Chicago/Austrian School of economic thought using Milton Friedman as a basis

and examples from the popular business press and from the work of accounting scholars to illustrate

the pervasiveness of this idea of market solutions to ethical problems.

It is contended that modern business theory, as represented by this neoclassical economic paradigm,

has established a moral code for business based on efficiency of outcome and the assumed link of

efficiency to self-interested behavior. The result is markets as the arbitrators of ethical outcomes, andprofit maximization as the ultimate moral code.

2005 Elsevier Ltd. All rights reserved.

Keywords: Adam Smith; Milton Friedman; Markets; Accounting; Ethics; Accounting education; Economics;

Profit maximization; Baumal, W.J.; Business ethics

1. Introduction

On October 21st, 2003, the incoming chairman of the AICPA gave a speech on integrity

and stated that the basis for the other two core values (competence and objectivity) isintegrity (Voynich, 2003). Without integrity, competence is dangerous and without integrity,

objectivity will always be questioned. An objective expert system that becomes a legal

Tel.: +1 417 836 8470; fax: +1 417 836 5164.

E-mail address:[email protected].

1045-2354/$ see front matter 2005 Elsevier Ltd. All rights reserved.

doi:10.1016/j.cpa.2005.12.001


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160 A.C. Keller / Critical Perspectives on Accounting 18 (2007) 159188

shield to avoid the consequences of poor decisions displays both a lack of competence and

a lack of integrity. On the other hand, competence without integrity is a successful fraud

waiting to happen. Ultimately integrity is destroyed by a weak moral code or by uncertaintyabout standards of conduct. A lack of integrity may lead to unethical behavior but more

importantly a lack of ethical understanding may lead to a lack of integrity. This completes

the circle because there are levels of competence for ethics as well, and Voynichs approach

to integrity, presented in his October 2003 speech, highlighted the competence aspect of

integrity because the code of behavior appears as an integral part of the definition.

When I speak about our core values, I always put competence in the

middleintegrity, competence, and objectivity. I do this because I believe integrity

and objectivity are the strengths that hold up and give life to our competence. In other

words, our value is not given to us because of our technical abilities. Our value is

attributed to us by the way we practice our profession and live by the code of ethics

in all aspects of our daily lives.

Integrity, by definition, is key to our profession. Integrity: a rigid adherence to a code

of behavior. We are expected to live by a code of ethics which serves as the North

Star for all of our activities. (Voynich, 2003,p. 3)

In short, integrity does not stand alone, nor is it fully supported by competence and

objectivity because integrity demands an underlying moral code.1 Moral integrity demands

competence in morality but few business students will find ethics in the school curriculum.

Very few business students will take ethics classes outside of the business curriculum, and

many will not take a separate business ethics course, but every business major will take a

macro and microeconomics sequence.

In this sequence, the student will be presented with the rational utility maximizing viewof human behavior. The ethical content of these economics classes is ignored because

we present the economic ideas as positive social science and therefore value free. In the

neoclassical economic view of the world a set of behaviors is assumed that is taught will

result in the best outcome for society. The calculus of pleasure and pain is displayed with

graphs and mathematical formulas with the assumptions underpinning the efficient solutions

presented to imply that any deviation from these behaviors is antithetical to capitalism. The

behaviors presented include utility maximization and profit maximization as necessary

ingredients to the market solution. This is all presented as a science, as a world of positive

ideas and ultimately serves as the basis for positive accounting theory.

The standard for behavior presented as the foundation for neoclassical economic models

is often referred to as Social Darwinism, a standard not far removed from survival of the

fittest, and any violation of these strict requirements is considered antithetical to the ulti-

mate goal of markets: efficiency. In the economics of the Chicago School (of which Milton

Friedman is a leading light) and the Austrian School, all human motivation is limited to

rational utility maximization and all decisions are exchanges based on utility maximization.

This has the effect of turning everything, into a commodity, including sex and the decision

1 In the extreme the defense in the Nuremburg trials was integrity because in the end just following orders when

the line of command is clear is just integrity when the code calls for unblinking obedience to a cause.


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A.C. Keller / Critical Perspectives on Accounting 18 (2007) 159188 161

to have children. The extreme individualism of the conservative model has become a hall-

mark of the US economy and, when mixed with the Ricardian model of trade, the call to

globalization. Ultimately the behavioral model is based on Jeremy Benthems calculus ofpleasure and pain. People avoid pain and seek pleasure, and by freeing people to behave in

this way with the least restriction, the results are the best outcome, economically speaking.

A key question for this paper is: can this economic philosophy have an impact on how

accountants view ethics, and how they behave in times when there is an ethical decision to

be made in business?

Another lesson taught in these early economics classes is that economics is amoral and

that it cannot be used to answer normative questions like the fairness of the distribution of

income, or questions of ethics. The statement that economics is amoral is a way of placing

economics on a par with science. Assumptionsaremade about behavior, andresults obtained

analytically, that prove efficient outcomes for markets given the assumptions.2 The violation

of the assumptions of this model of perfect competition by the true relationships that exist

in the economy do not mean the model is wrong, it means the economy is flawed because

it falls short of the models standards for economic efficiency. In essence, the neoclassical

economic ideal presents us with an ethic by placing economic efficiency before us as the

highest end, and utility/profit maximization as the only means to that end.

It amounts to an ethic taught to every accounting student in the United States and the

power of the message of the ultimate justice of the market system is reasserted daily on the

pages of business publications. Profit maximization, greed and self-interest are the ethical

standards presented as the driving force for the greatest good for the greatest number. The

founding father for this ethic is often cited as Adam Smith. It is the goal of this paper to

support the claim that economics, as it is currently taught, does express an ethic and that

the ethic is a part of the problem we face as accountants. Additionally, evidence will be

presented to detach Adam Smith from this negative ethic and to reintroduce Adam Smithsstandards for moral sentiments.

The plan for the paper is as follows. Section one examines conservative neoclassical

economic social theory through the statements of Milton Friedman and others as well as

examples from the current business press and develops the idea of profit maximization and

self-interest as neoclassical ethical standards. Section two presents the ideas of Adam Smith

using extensive quotes fromThe Wealth of NationsandThe Theory of Moral Sentiments to

support the separation of his teachings from the neoclassical model. Section three directly

addresses the problems with using markets as arbiters of ethical solutions with examples

fromaccountingresearch. Section fourconcludesthe paper with suggestions for accountants

and accounting educators.

2. Adam Smith versus Milton Friedman

Adam Smith left us with an amazing document recording what he thought were the bene-

fits and the potential problems of a market economy, The Nature and Causes of the Wealth of

2 Many buyers and sellers, homogeneous products, perfect information about prices and no barriers to entry or

exit in the long run. All parties are price takers.


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Nations. Smith is credited with recognizing the benefits to be derived from allowing people

to follow their enlightened self-interest (Smith, 1776,p. 14). The benefits have been cited

countless times in support of unfettered free markets and market solutions for all kinds ofproblems, while the problems he witnessed are often ignored. The statement of problems

contained inThe Wealth of Nationsand the prescriptions for an ethical society contained in

his earlier work,The Theory of Moral Sentiments, form the foundation for this paper.

Friedmans ideas are presented as examples of the moral code at work in the economy

today. For Friedman markets are the basis of a free society because in a market economy,

economic power stands against government power (Friedman, 1962, 1970).The ultimate,

almost utopian, vision is the market replacing the government in all things. In this utopia, all

roads are toll roads, doctors are not licensed, monetary policy is made by rule, and regulation

does not exist (Friedman, 1962). Libertarians often cite Adam Smith as their foundation, but

(The) Chicago (School) is their Mecca and Milton Friedman the true founder. Adam Smith

has no problem with some role for government, even a regulatory role. On the other hand,

Friedman labels any manager averting his gaze from profit-maximization a subversive, and

the government is at best inefficient at worst an evil entity overcome by the market. The

Soviet Union is the specter in the background.

Underlying Friedmans unwavering support of unregulated markets is a belief that the

economic conditions demanded by Coases theorem are both desirable and in some measure

achievable. From this belief we are confronted with a science of positive economics that

has been used as an analytical replacement for empirical testing bringing us to the point

where blackboard economics (Coase, 1988, p. 28) sets policies, while the negative results

and failures of policies designed to achieve these results are ignored, or the failures blamed

on our societys failure to achieve the utopian dream. In the end, the conservative schools

of economic thought leave us with an analytical framework based on, what economists

admit, are unrealistic assumptions, but still provide prescriptive advice on issues deservingmore pragmatic solutions. From these scientific models come societal norms (behavioral

assumptions) that lead to prescriptions for behavior that leave society with a negative ethical

base, greed. This ethical foundation has been used to force the consideration of market

solutions for a broad range of social problems including ethical problems. It is this ethical

base that is at issue for this paper.

3. Defining ethics

The utility/profit-maximizing mantra is at the center of the current ethical dilemmas

facing business and accounting. But this mantra is not really ethics, is it? If it were ethics itwould indicate that it is a general pattern or way of life or a set of rules of conduct or

moral code or an inquiryaboutways of life and rules of conduct (Abelson and Nielsen,

1967,p. 81). To Socrates the beginning of ethics was a simple a question of, How should

one live. This simple and very general question started ethical history for the west at a time

when society was changing dramatically . . .from agrarian monarchy to commercial and

industrial democracy (Abelson and Nielsen, 1967,p. 82). Social changes had not only

made certain types of conduct, once socially accepted, problematic, but had also rendered

problematic, the concepts which had defined the moral framework of an earlier world


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(MacIntyre, 1966,p. 5). The seeming relativity of ethical codes of conduct is a function of

this connectedness of ethics to social life. The universality of ethics is not in the details as

much as in the subject matter. Codes may change but the types of questions asked whichcan be labeled as questions of ethics revolve around what is just, what is good, what is fair,

what is ones duty, and what is virtue among others. The answers to these questions may

change with the change in social life but the questions tend to stay the same.

All of these ethics questions relate back to the larger question of How one should live.

and the general answer to that question, offered by early philosophers, is focused on living

a life of reason. The unexamined life is not worth living is a lesson also attributed to

Socrates indicating that reason was the key to how one should live. As democracy emerged

in a society long ruled by tradition and the codes of a monarchy, the importance of the

role of reason increased. Justice is easy when it is decided for you. Rejecting the easy

solutions to ethical questions (Justice is the rule of the stronger Sophists) Socrates ini-

tiated the discussion we still trouble over. Plato and Aristotle offered answers to some

of Socrates questions but the answers open the door to more questions. Platos Form of

Good is a universal in which all good things participate. Not understanding, or a lack of

reason, are the only causes of evil to Plato. Aristotle divides goods into categories like

medical arts, shipbuilding, strategy and economics based on the ends of each. His category

politics aims at the highest good socially, subsuming all the others listed above, because

the others are used in the pursuit of the highest good in politics. For the individual the

highest good falls under the heading of ethics. Happiness is the aim of ethics, and the

general welfare or the good of man the aim of politics (Aristotle, 1980; Abelson and

Nielsen, 1967).Happiness is an end in itself, a final cause of seeking the good in other

pursuits.

Certain economic concepts were the subject of discourse among the early scholars of

the Catholic Church known as the scholastics. The scholastics asked questions and usedcategories, which current neoclassical economic writers reject as non-scientific, such as

usury, and the concept of the just price. A Catholic textbook on Political Economics from

the early 20th century defined ethics as . . . the science that directs human actions according

to the principles of right reason (Burke, 1913, p. 4). Under this definition the author

concluded that political economics . . .is subject to the laws of Ethics (Burke, 1913,p. 4).

The reasoning behind this inclusion is rooted in the idea that ethics is a higher science than

political economics with immutable laws and these laws of Ethics cannot be superseded by

laws formulated by political economics. When Political Economy . . . attempts to lay down

principles that run counter to the acknowledged principles of Ethics, it so far ceases to be a

science (Burke, 1913, p. 5). Burke acknowledges those schools of Political Economics that

do not consider Ethics, but he determines that, (E)very volitional act of man is imputableto man, is deserving of either praise or blame, and comes within the domain of morality

(Burke, 1913,p. 5). Burke even subsumes Political Economy to Political Science which he

defines in much the same way as Aristotle did in the Nicomachean Ethics. The persistence

of the Catholic Churchs view of political economy, as subsumed to ethics, into the 20th

century serves as a reminder of the foundation of such ethically charged economic terms as

the just price and even usury. It was the disembeddedness with this social structure created

by religion that was seen by Karl Polanyi as the beginning of the transformation from

feudalism to capitalism.


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Ultimately, Immanuel Kants ideas came to have a powerful influence on ethics that

continues to this day. Kant listed ethics as one of two philosophical sciences (the other

being physics) and defined ethics as the philosophical science that . . .

deals with the lawsof free moral action (Kant, 1964,p. 13). Kant is especially important in reference to the

subject at hand because some accounting scholars have listed the school of deontology,

into which Kant fits, as the preferred basis of ethics in accounting ( Epstein and Spalding,

1993).Kants theories on ethics are grounded in the idea of free will, which he states makes

oughta possibility for human beings. Described as existing in a dual world of nature, with

immutable laws, and a world of intelligence and reason, the human being is capable of

actions reflecting reason as opposed to being hostage to the laws of nature.

His elaboration of this point has important implications for the basis of neoclassical value

theory, utility theory or the hedonistic calculus, because the utility maximizing concepts

form the limits for human action in neoclassical economics and are therefore presented as

natural law. It is precisely the possibility that human beings can stand above such cause

and effect relations with nature that make ethics a possibility. In an interesting turn of

phrase, Kant implies that it is the, ought to, that follows an action known to be against

reason that exemplifies the free will side of our internal dialectic. Kant included the idea

ofdutyin constructing a categorical imperative that he felt captured the essential character

of ethics. That imperative, . . . I ought never to act except in such a way that I can also

will that my maxim should become a natural law(Kant, 1964,p. 70). Kant saw this as

a duty. Kant also rejected the basis of the limits that are often placed on business ethics,

laws, as necessarily incomplete. No set of laws can possibly cover all circumstances but

the categorical imperative when applied with reason can bridge the gaps. The shortcoming

for Kants method is that there is no guidance as to what these universal laws are, therefore

we are left with the possibility of a community prescribed reasonthat is developed in the

society that leaves the individual with a basis of reason devoid of ethical content.If Kants concept of duty is a valid way to define ethics then Milton Friedman, has placed

the goal of profit maximization on a footing with ethics, Few trends could so thoroughly

undermine the very foundations of our free society as the acceptance by corporate officials

of a responsibility other than to make as much money for their stockholders as possible

(Friedman, 1962,p. 133). Friedman considered other motives subversive. If we substitute

the word duty for responsibility then Friedmans statement takes on the form of an

imperative but it is not a categorical imperative, like Kants, because it has a purpose.

4. Friedman and the ethics of value free economics or why economics is not

amoral

The statement that acting out of a motive of social responsibility is a subversive act is

born out of the belief that: competitive capitalism. . .promotes political freedom because

it separates economic power from political power and in this way enables the one to offset

the other (Friedman, 1962,p. 9). Friedman believed as part of this, competitive capitalism

provides freedom directly (Canterbery, 1987, p. 16). It needs to be noted that it is political

power, and more specifically the political mechanism, as opposed to the market mecha-

nism that represents the danger of managers acting out of social responsibility (Friedman,


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1970, p. 46). If managers or the owners pursue goals that do not have profit maximization as

the only end, the efficient outcome theorized as the outcome of profit maximizing behavior

of the owner/manager is not obtainable. The foundation of the efficiency criteria of maxi-mization of profit is the maximization of utility so this motive, and the freedom to pursue

this motive, provide the foundation for the efficiency criteria of competitive capitalism. It

is not the efficiency that concerns Friedman instead it is the ideal of the free market with its

lack of coercion, voluntary cooperation and extreme individualism (Friedman, 1970).

When this mechanism is replaced with the political mechanism conformity is demanded

as is service to . . . a more general social interest (Friedman, 1970,p. 46). An intense

distrust of government action is displayed in Friedmans writings on this subject. It might be

countered that Friedmans ideas on this subject are a function of the form they are presented,

i.e. popular works of non-fiction and a NY Times article but other notable economists,

and Friedmans own writing on more technical economic subjects, speak to power of the

neoclassical economic belief in unfettered free markets as mechanisms of immense ethical

importance.

Baumal (1991, pp. 501) presents a similar argument based on this pure economics when

he describes the prospects of management engaging in volunteer social responsibility as

. . . a rather frightening proposition and a . . .threat to effective democracy. . .. This

argument is constructed on what Baumal labels (Almost) Perfect Competition (Contesta-

bility) (Baumal, 1991,p. 1). This label is a reference to Baumals own model of perfect

contestability which made the case that the efficiency outcomes predicted for the model

of perfect competition could still be obtained even if the key assumption ofmany sellers

was relaxed. The foundation in the model of contestable markets is the credible threat of

competition because of low barriers to entry. The efficiency argument does not change in

this modification of the market model because it is the threat of competition that forces the

firm to minimize costs or face elimination.Baumal presents three attributes that are representative of demands from non-economists

on business people to behave virtuously and not just cleave to the goal of allocative effi-

ciency: . . . maintenance in integrity of product quality . . ., . . . voluntary pursuit of social

goals. . . and . . .avoidance of any taint of discrimination in employment by race, sex,

or religious affiliation. . . (Baumal, 1991,p. 2). Baumal rejects the idea that economics is

neutral with regard to these virtuous goals:

Under perfect competition or perfect contestability, morality of eachof the three types

on our list is removed almost entirely from the discretion of the business decision

maker. Instead, at least so far as the first two of the three virtues are concerned,

business firms are condemned to behave exactly as they do, (almost) regardless of

personal preference. . .

In particular,. . .

perfection in competition or contestability

precludes all genuine businessvoluntarism, includingcare for the environment beyond

that imposed by law, or voluntary donations to beneficent eleemosynary institutions.

Thus, in this arena, these perfect market forms impose vice rather than virtue.

(Baumal, 1991,p. 3)3

3 The third virtue of non-discrimination is thought to be aided by the perfect markets forms because discrimi-

nation, on the bases listed above, is considered less efficient than non-discrimination.


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The more competitive (or contestable) the market, the more necessary it is for social

virtues to be uniformly required across all firms in an industry. Therefore, we might expect

to find that those firms faced with greater pressures to live up to standards of social respon-sibility engaged in seeking regulations to force the standards on all its competitors. In the

current era of globalization, all of its competitors, increasingly refers to global competi-

tors, but global standards for the three virtues are weak, or non-existent, therefore it is often

left to the management of individual firms to address social issues with reference to social

justice in individual countries. Baumals comments on this brings him closer to Friedman:

(C)ertainly we do not want management to use the capital we have entrusted to it

to impose its notions of international morality upon the world. One can be equally

suspicious of the proposal that the business executive be empowered to decide on the

allocation of other peoples money under their control among the competing claims

of hospitals, educational institutions, arts organizations, and environmental causes.

Why should the businessperson be entrusted with the power to set such priorities forall of society?

An increase in corporate power is probably the last thing that those who call for

greater corporate responsibility would want. (Baumal, 1991,pp. 512)

In Baumals assessment, we can see more than the shadow of Adam Smiths distrust

of decisions made by the merchants and manufacturers. Baumals solutions differ from

Friedmans. His role for government is supported by quotes from Adam Smith but that role

still centers on a price-based solution using the same tools as markets to make free goods

into commodities but couched in very pragmatic terms that challenge economists to step

clear of purely theoretical solutions.

Koslowski (1996, p. 40) views this approach as an, . . .

irrational passion for dispassion-ate rationality. . . that he says is common to economic theory. By this approach economic

theorist can discount any non-market-based solutions to moral problems because the non-

market solution will destroy the system. He contends that the, (C)ritique of ideology adopts

an ideological character itself when it denies the intrinsic value of moral action or constructs

an opposition between morality and advantage, which ethical theory has always doubted.

(Koslowski, 1996, pp. 401) Business ethics from Koslowskis perspective allows that busi-

nesses are not operating on the edge so that there is room for business owners and managers

to address social issues without necessarily failing in the process.

In addition, Koslowski points to the research evidence of many noted scholars of advan-

tages to ethical behavior in business including reduced bargaining costs, reduced needs

for control of large groups, solution of the isolation paradox, lower transactions costs andimprovements in economic growth. But a curious problem surfaces in the analysis that

severs the link between the purely competitive (or contestable) model of the neoclassical

economist, of Baumal and Friedman, and the conclusions of the benefits of business ethics.

There is an almost imperceptible shift of the model from neoclassical to New Institionalist

economics. The examples presented of the benefits of business ethics are a combination

of the two with the reduced transactions costs and bargaining costs of the Institutionalists,

interspersed with the need for trust caused by violations of the perfect information model

of the neoclassical school. The focus of the morality question is still economic efficiency


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but underlying all of the benefits of ethical behavior are basic violations of the model of

perfect competition: a lack of perfect information and the existence of the firm.

Even the mechanistic model of general equilibrium theory of neo-classical eco-

nomics does not render ethics as the trans-economic evaluation of alternative actions

superfluous. To decrease transaction costs, moral rules ought to be made generally

binding and be internalized by market participants. Micro-economic theory shows the

need for a business ethics and for reembedding business, the market and the economic

motivation into ethical and social norms. Thus, the structural characteristics of capi-

talism should be reembedded in the ethics and the culture of a society. (Koslowski,

1996,p. 42)

In the quote above, we see a curious juxtaposition of ethics and economics with the moral

code idea being used to insure a more efficient outcome by minimizing transactions costs,

but then the causation is reversed because it is the structural characteristics of capitalism

that need to be embedded into ethics and culture. The structural characteristics of capitalism

are listed as:

1. private property-of means of production as well;

2. profit and utility maximization as economic purposes; and

3. coordination of economic activities by markets and prices. (Koslowski, 1996,p. 11)

The idea of disembeddedness of markets from the context of a societys network of

other relations and institutions is attributed to Karl Polanyi. In viewing market relations as

somehow apart from other social relations, Polanyi was presenting a picture very different

from the neoclassical economist who views the motives and interactions, that they see as

characteristic of market exchanges, as universal laws of human behavior. Polanyi rejected

this idea of universality at its core by pointing to research that suggested that primitivepeople had an aversion to barter and that trade was only engaged in between communities

not within communities (Polanyi, 1944,p. 274). Markets for Polanyi are formal structures,

representing one among many forms of exchange, characterized by impersonal relations

between individuals.

The importance of this re-embeddedness is highlighted by Koslowskis belief that, . . .

the moral neutralization of profit maximization as a respectable motive and driving force

of the economy is the event that . . .signifies the advent of capitalism . . .(Koslowski,

1996,p. 12). The same moral neutralization and social disembeddedness of the other two

characteristics of capitalism, along with that of profit maximization, form the basis for ques-

tioning the morality of capitalism (Koslowski, 1996,p. 13). The idea of embeddedness

and of re-emmbedding capitalist structures into the . . .

ethics and culture of a society iskey to understanding the seriousness of Friedmans claims about the subversive nature of

managers acting in other than profit maximizing ways.

Consider the significance placed on profit maximization as a motive in Koslowskis

quote and to Friedman the advent of capitalism is considered the foundation of all of our

political freedoms. Friedman is merely defending in popular terms what Koslowski believes

to be the basis for a society structured on free markets, where free markets are the basis for

overcoming the past evils of feudalism and slavery, and what Friedman believed would save

us from the future evils of communism and socialism. In a sense, Friedmans statements


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about profit maximization and subversion can be seen as an attempt at re-embeddedness

because the criteria that provides the basis for judging the support for the social structure of

capitalism, profit maximization, is held up against a basis for judgment, socialresponsibility,that is considered inferior because it asks the manager to act on ideas of social justice that

will lead to a less efficient outcome and socialism. In presenting profit maximization as a

primary duty, the violation of which would undermine the very foundation of capitalism,

Friedman embeds profit maximization in the social and cultural norms and in the process

morally de-neutralizes his model of capitalism.

Sen (1988)presents the argument that neoclassical economics emerged from one branch

of economics which he labels the engineering approach and contends that economics has

been impoverished by the decision to distance economics from ethics. The resulting very

narrowly defined human motivations make the model mechanically eloquent but limited.

The welfare of a society depends, in the broadest sense, upon the satisfaction levels of all

its consumers (Henderson and Quandt, 1980, p. 285). A footnote appended to this sentence

clearly states the authors assessment of this statement as non-scientific, Statements of this

kind are based on ethical beliefs or value judgments and cannot be proved (Henderson and

Quandt, 1980,p. 285n).

The standard method of judgment used in welfare economics is Pareto Optimality, which

focuses on . . .the economic efficiency of allocations. . .(Henderson and Quandt, 1980,

p. 286) but this method cannot be used to judge questions of distribution. For example, an

economy that has the vast majority of its resources in the hands of a single individual can

be judged as Pareto optimal but to make judgments about redistribution of the resources

from the individual to be more fair is outside of the scope of welfare economics because

that would involve . . .explicit value judgments (Henderson and Quandt, 1980,p. 286).

Even a Pareto superior allocation must not leave any individual with lower utility than in

the previous allocation.Reiter examines storytelling in FinancialEconomics and argues thatby connecting claims

of efficiency to natural law in Financial Economics claims are made of a system, ethically

in balance (Reiter, 1997, p. 14). Reiter claims that the issues . . . at the heart of the

ethics of financial economics. . . include (T)he efficiency of the securities markets, the

meaning of market prices, and the source and disposition of the gains from acquisition

activity. . . (Reiter, 1997,p. 2). This way of viewing the story has as its underpinning the

assumption that maximization of shareholder value is a moral claim (because it brings about

beneficial social consequences). In the stories told by financial economists, the question is

not morality, rather of a self-regulating system. It is central to the neoclassical argument

that there is no claim to morality associated with equilibrium merely a claim to economic

efficiency. Reiters point is that the stories reveal an ethical foundation that remains mostlyhidden from accountants but that accountants tacitly accept this ethical foundation as they

go about their work of providing support for the system of profit maximization.

The claim that the only duty that the manager has is to maximize shareholder value, based

on a basic violation of the neoclassical assumptions, separation of ownership and control

(also presented in Reiter, 1997 and Sen, 1988) is basic to the claims to morality made in this

article, but the ethical issues are not the claims to equilibrium, rather they are the claims that

other systems, socialism or communism, are in some way evil. To the extent that socialism is

perceived as universally bad, any attempt to act out of social responsibility by the manager,


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in his role as an agent is a violation of the morally superior means of overcoming the

ownership and control problem so that the foundational connection between the motivation

of profit maximization, action and efficiency can be maintained. It is not that capitalismleads to some ethical outcome such as an ethical equilibrium rather that the alternative is

evil, the opposite of a free society.

Of course the real violation of the utopian story of capitalism is the firm itself. The

most interesting aspect of the models put forth is that they emerge from Ronald Coases

attempt to explain the existence of firms. His fictional story of perfect markets was his

attempt to describe a set of conditions that would have to exist for firms tonotexist. Now

the same perfect market models are used to try and justify market solutions for enormous

firms. The takeovers described are of one enormous market gobbling entity being taken

over by another market gobbling entity, but efficiently regulated by a perfect market for

the best outcome for society. So that these two huge planning entities that exist because

they can organize millions of transactions more efficiently than markets somehow are held

hostage to a market transaction as powerless price takers. Coase derisively referred to this

as blackboard economics.

The major problem with the Reiter argument is revealed in her conclusion when she

asks (W)hat is the true point of Financial Economic story building if not to understand

real-world phenomena? (Reiter, 1997, p. 29). It is to predict. The real world is not the issue.

The issue is science and scientific method. As Kenneth Arrow pointed out, An economist

by training thinks of himself as the guardian of rationality, the ascriber of rationality to

others, and the prescriber of rationality to the social world ( Williamson, 1997,p. 2). Note

that the term used is prescriber of rationality not describer of reality.

What could be wrong with this after all to be rational is to be human so it seems but

when the rationality is extreme and is really a way of developing a system that can be

placed neatly into mathematical formulas then the power can be seen. It is the assumptionof rational behavior by individuals that is a foundation for the profit prescription/prediction

so that the underlying goal is clearly stated and clearly a normative prescription for action.

This is not to say that irrationality in general would be better but it is to say that what is then

defined as rational behavior by economists becomes the Holy Grail, or rather the method for

obtaining the Holy Grail, so violation of the prescription is subversive to the higher order.

If we factor in all the other rational ideas that society might consider as equally rational but

somehow have become normative in the economic literature we might lose the parsimony

and we might explain but not predict. In fact if we question the profit motive at its root we are

questioning not capitalism instead we are questioning the existence of the corporation, just

as Coase questioned the existence of the firm, because profit maximization in corporations

proxies for the utility maximization of the owner operated firm in the absence of ownershipcontrol.

This is a crucial point because if it is possible to step back from Baumals assertions

about vice not because of Koslowskis slack, rather it is because the individual owner

can maximize utility without maximizing economic profit. The basic model of perfect

competition assumes that economic profit will be zero but that the owner will cover their

opportunity cost which would include income but would also include less tangible returns

like the positive utility gained from self-employment or even the positive utility gained

from knowing you are providing a high quality product or from a sense of duty to the local


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community of providing jobs, even though lower cost workers may be available in other

communities. This is not excluded in the model that recognizes the full breath of utility

maximization for individuals. On the other hand, neither the manager, the economist northe accountant can measure this psychic income, so the measure of maximization becomes

limited to profit as money profit. Profit as it is recognized in the sphere of circulation and

therefore as it is measured by the accountant.

In this way the separation of ownership from control becomes the nexusfor the separation

of ethics from business ethics, but when the profit motive becomes the overawing motive

in the society at large, the business ethic becomes the ethic for the society. The illusion

that business ethics can be separated from ethics at large is born out of the idea that the

firms exists as an aberration, a bastard born of imperfection, as if imperfection were not the

condition that we normally face.

Milton Friedmans positive science of economics is considered amoral (Hollis and Nell,

1975,p. 9), but in his statements about the subversive nature of social responsibility as a

motive, an ethic is clearly stated. The subversive nature of acting out of social responsibility

can be made to look scientific by economists because, its presumed opposite, profit maxi-

mization, is accepted as an unquestionable objectivegoal in the pursuit of efficiency. The

pursuit of efficiency is an end in itself measured by profitability which ignores the original

reason the efficiency end came to be valued. Treating these economic ideas as scientific

assumes the accuracy of utility maximization as descriptive of all behavior, and has moved

us beyond the idea that utility theory is merely useful in predictive modeling, to a point

where any solution for ethical problems must pass through the utility criteria before being

acceptable. Put another way, if an ethical act is a socially responsible act, but is not at the

same time profit maximizing, then acting ethically becomes an act of subversion. This is the

ethical model implied by Friedmans calculus. So a question needs to be asked: if a profit

maximizing action is unethical, but not illegal, is it subversive to not to pursue it? Is it evenpossible for the action to beBusinessunethical if it is not illegal?

In addition, when the utility maximization model is accepted as descriptive of all action,

any act of ethical behavior must be the result of an act of rational utility maximization. The

logic in this argument is that all actions are taken to maximize utility prior to considering

the ethical content of the action or the result, because people have no tendency to be ethical

unless motivated by utility. This solution assumes that all people are engaging in the rational

utility maximizing calculus all the time (McKinzie and Tullock, 1975,p. 28), and that a

result that implies ethical intentmeansthat being ethical increasesthe utility of the individual

behaving ethically. Acting any other way implies irrationality.

The Austrians and the Chicago School contend that their economic model is a unified

theory of human behavior and economics not unlike the same quest for a unified theory ofphysics. While it is true that a firms owners and managers can behave ethically to maintain

a reputation, which in the long run may be profit maximizing, their ethical behavior is still

of a type that ignores an independent grounding for ethical action. Ethical action becomes

just a means to a self-interested end. Is this ethics?

Adopting this neoclassical framework of egoistic maximization is problematic because

no system of incentives is complete, and to insure the best outcome for society, controls, in

the form of laws, contracts or regulations must be in place to make the negative utility (pain)

of engaging in an unethical act greater than the positive utility to be gained by what may be


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the profit maximizing action. An incomplete system (which is guaranteed because no system

is complete) in the absence of the basic ethical foundation of the honest person is inviting

disaster. Even in the absence of Friedmans warnings about subversion, the dishonest personis likely to take unethical actions when an unethical but profitable opportunity presents itself.

Add Friedmans statements about social responsibility and there is an added social stricture

which may make a socially responsible ethical act an act of subversion. In this case, ethics

become accidental, the result of the accidental confluence of ethics and profit.

Far from being amoral, neoclassical economics is highly moralistic in its support of an

ethic of acquisitiveness. As ethics go, we may not see the connection of this formulation

with earlier ethical forms but we can even find authors twisting the language so dear to

the ethicist vocabulary into forms so grotesque that a person reading it with grounding in

previous ethical models is torn between nervous laughter and rage.4

5. Co-opting altruism or popularizing the ethic of profit maximization

The moral core of capitalism is the essential altruism of enterprise ( Gilder, 1998)

At least one writer in the popular business press has defined the process of supply as

an altruistic act where the entrepreneur who maximizes her profit is really the person who

maximizes her altruism (Gilder, 1998).Having found this connection between altruism and

profit maximization, Profit is an index of the altruism of a product . . .(Gilder, 1998),

the circle is complete. There is no need to even be conscious of the needs of others except

as it relates to supplying their desires in the marketplace. Uncertainty, defined as risk in

neoclassical economics, is redefined as the attribute that makes an investment a gift. So the

hero of the story becomes the entrepreneur, painted by Gilder as an individual driven by

altruism andeven a visionaryin theservice of others. Underlying hisargument is theultimate

moral superiority of the system of capitalism and the morality of profit maximization. The

myth presented by Gilder is of the sturdy but hapless entrepreneur speaking haltingly in

broken English and only wanting what is best for others which leads to profit maximization.

Supply becomes an act of altruism.

The importance of this use of altruism to glorify the actions of entrepreneurs is that

altruism enjoys a special place in ethics, because an act that is altruistic is the one done out

of regard for others rather than for self-interest. In its purest form, the needs of the self are

completely ignored such as the soldier who throws herself on top of a hand grenade to save

her buddies. Facing certain death the motive is selfless. In a way, altruism is the highest

form of ethics and the debate about the possibility of altruism as a prime mover of actions

4 Take the neoclassical model to its logical conclusion for scholars. What can an individual with years of

intellectual offerings, and a career based on this line of thought, gain from opening the door to alternative views,

whether he genuinely believes its prescriptions or not. The self-interested person has no need for truth other than

in a way that it might serve his self-interest. This is an extension of logic contradictory of the all scientific method,

yet even with reality screaming NO in his face, the self-interested scientist must still defend the YES of his self-

interest. This logic may make you feel torn between nervous laughter and rage. I do not assert that this is what is

happening, merely that this is the logical extension of the model as it applies to scientific reasoning.


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is common to debates about ethics. By appropriating this word, altruism, and defining it in

the way that Gilder did, a signal is broadcast that mirrors Friedmans statements about the

subversive nature of acting out of social responsibility. When Gilders argument is addedto the mix, the maximization of profits becomes the ultimate ethical act replacing even the

conscience with the market. It is a claim to moral superiority for one form of income, profit,

over others.

In Gilders essay on the spirit of enterprise there is an attack on Adam Smith for his

distrust of businessmen and Gilder even states that Adam Smith is where (T)he problem

began. . . (Gilder, 1998).The problem is . . .a vision of capitalism without capitalists

(Gilder, 1998).It is unfortunate that Gilder in writing his essay ignored Adam Smith the

moral philosopher. Borrowing freely from Thorstein Veblen and the Institutionalists, Gilder

constructs a moral system that places the entrepreneur in an almost Christlike stature, . . .

continually giving back their earnings in the practical cause of human betterment, and thus

doing the work of God (Gilder, 1998).

Gilder just assumes the gift impulse and transforms the capitalist into the ultimate

altruistic ethicist. While Gilder does not possess the credentials of Milton Friedman or

Adam Smith his readership in the popular business press (Forbes Magazine) may still

derive comfort from believing that they are doing the work of God.

6. Adam Smith and the employer class

What has been lost of Adam Smith in the translation to neoclassical economics is the

basis of morality and control that Smith envisioned would go hand-in-hand with market

efficiency and that the goal of an economy must be the greater economic welfare of the

society. In short, efficiency is not an end in itself. Gilders criticism of Adam Smith isbased on Smiths conviction that the employer class interests are not aligned with the best

interests of society, a conviction rooted in the idea that as profit as an income share grows,

the welfare of the society at large declines:

But the rate of profit does not, like rent and wages, rise with the prosperity, and fall

with the declension, of the society. On the contrary, it is naturally low in rich, and

high in poor countries, and it is always highest in countries which are going fastest

to ruin. The interest of this third order, therefore, has not the same connexion (sic)

with the general interest of the society as that of the other two. Merchants and master

manufacturers are, in this order, the two classes of people who commonly employ the

largest capitals, and who by their wealth draw to themselves the greatest share of the

public consideration. (Smith, 1776,pp. 24950)

Adam Smiths basic premise is that the rational maximizing owner of capital, in attempt-

ing to maximize profit, is performing an action that is only accidentally of benefit to society

at large.

The act of maximizing profit is not in and of itself a good thing as Gilder would assert.

As Smith put it: (T)he consideration of his own private profit, is the sole motive which

determines the owner of any capital to employ it either in agriculture, in manufacture, or

in some particular branch of the wholesale or retail trade (1776, p. 355). He goes on to


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say that the owner of capital is unconcerned with how the capital is used, and implies that

its use may or may not be the most advantageous for the society. The different quantities

of productive labour which it may put into motion, and the different values which it mayadd to the annual produce of the land and labour of the society, according as it is employed

in one or the other of these different ways, never enter into his thoughts (Smith, 1776,p.

355).

Adam Smith has been interpreted as providing the foundation for Friedmans claims.

After all, it was Smith who presented us with a picture of a society whose productive power

was maximized by an invisible handthe market, with self-interested suppliers on one

side and self-interested buyers on the other. His statement about the best motivation for

a fair price and good quality was self-love (Smith, 1776,p. 14). Despite this Smith was

particularly weary of the employer class as he called them.

What Smith considered advantageous for the society, what was revolutionary in his

economics, was the recognition that the putting into motion of productive labor led to the

most productive society. So it is not profit by itself that insures the growth and prosperity of a

nation, but the return of revenue, earned by the sale of goods that are produced by productive

labor (in the form of wages, rent, and profit) to its use as capital. The wage earners will return

their portionalmost all of itto capital by consuming goods that are produced by other

productive workers. These workers include those employed in manufactures, agriculture,

and the owners, the merchants and retailers (Smith, 1776).

While it is true that Adam Smith provided much of the intellectual foundation for what

has come to be called capitalism, he was not blind to its potential faults. The primary

problems he saw were not with workers seeking too high a wage (Smith, 1776,p. 98), as

Wall Street seems to be focused on, or the landlords famous love of reaping where he has

not sown (Smith, 1776,p. 49) instead it is with the employer class, and with the potential

problems caused by both their knowledge and ability to convince those in power that theinterests of his class was the same as the public interest.5 How strongly did Smith hold this

conviction?

The proposal of any new law or regulation of commerce which comes from this

order (the employers), ought always to be listened to with great precaution, and ought

5 As during their (the employers) whole lives they are engaged in plans and projects, they have frequently more

acuteness of understanding than the greater part of country gentlemen. As their thoughts, however, are commonly

exercised rather about the interest of their own particular branch of business, than about that of the society, their

judgment, even when given with the greatest candour (sic) (which it has not been on every occasion), is much

more to be depended upon with regard to the former of those two objects, than with regard to the latter. Their

superiority over the country gentleman is, not so much in their knowledge of the public interest, as in their having

a better knowledge of their own interest than he has of his. It is by this superior knowledge of their own interest

that they have frequently imposed upon his generosity, and persuaded him to give up both his own interest and

that of the public, from a very simple but honest conviction, that their interest, and not his, was the interest of the

public. The interest of the dealers, however, in any particular branch of trade or manufacturers, is always in some

respects different from, and even opposite to, that of the public. To widen the market and to narrow thecompetition

is always the interest of the dealers. To widen the market may frequently be agreeable enough to the interest of

the public; but to narrow the competition must always be against it, and can serve only to enable the dealers, by

raising their profits above what they naturally would be, to levy, for their own benefit, an absurd tax upon the rest

of their fellow-citizens. (Smith, 1776,p. 250)


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never to be adopted till after having been long and carefully examined, not only with

the most scrupulous, but with the most suspicious attention. It comes from an order

of men, whose interest is never exactly the same with that of the public, who havegenerally an interest to deceive and even to oppress the public, and who accordingly

have, upon many occasions, both deceived and oppressed it. (Smith, 1776,p. 250)

The Wealth of Nations is littered with equally clear warnings about the employers true

motivationsand theproblems that we might face if we allowthe employer to make judgments

for us. Adam Smiths warnings include the dulling effects of specialization, the employers

conspiring to push wages below subsistence (Smith, 1776, p. 67) and their concern for

wages that are too high, while extraordinary profits receive little attention (Smith, 1776,p.

565). Do we recognize any of these concerns as hallmarks of our current social problems?

If we do not, does that mean they are not problems, or that the alignment of interests is

complete?

Power was also an issue for Smith, with the concern being that employers would use their

power to abuse workers. The power he spoke of was conditioned on the ability of employers

andothers with wealth, or capital, to be able to sustain themselves fora longerperiod without

the services of workers. Workers who need the access to capital to earn their wages generally

cannotlastforlongwithouttheuseofthecapitalcontrolledbytheemployers(Smith, 1776, p.

66). Implicit in this is the idea that the two (workers and employers) groups are dependent on

each other butthe workers dependence is more immediate. Modern Neoclassical economics

assumes such situations away with the phrase, assume no wealth effects. By doing so

neoclassical economics ignores power derived from wealth and therefore assumes that the

choices that wage earners make in the job market are equivalent to the choices one makes

in the market for stocks or consumer goods. Did Smith distrust government and prescribe

the least government? Yes he did. Would he support the version of the least governmentthat has the employers interest as its foundation? He would trust it even less.

7. Adam Smith moral philosopher

The key to understanding Adam Smith is the recognition that he was a moral philosopher

and was best known in his life time as the author ofThe Theory of Moral Sentiments, which

describes an altruistic theory of ethics based on human happiness and well-being which

extends beyond the individual to the family, his social group, the state and all of mankind

(Canterbery, 1987, p. 17). A premise basic to Smiths ideas on morality is that people behave

well because of a sense of empathy. Empathy is the ultimate foundation of Adam Smithshoped for just society. Yet it is the limits of empathy that explains the excesses we witness

in todays business world. It cannot be assumed that ethics will extend beyond social and

political boundaries to include groups not considered within the sphere of the business

persons limits of empathy.

Adam Smith is honest about the limitations inherent in his approach to morality. As

an individual is both geographically and socially further removed from the object of his

potentialempathy the less likely is he to be empathetic, claiming that a man wouldultimately

have more real distress over the loss of a finger than hearing of the loss of millions of lives


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in some distant land (Smith, 1759,p. 192). Even with these limits we find a very different

picture from Friedmans amoral calculus, When the happiness or misery of others depends

in any respect upon our conduct, we dare not, as self-love might suggest to us, prefer theinterest of the one to that of the many. (Smith, 1759,p. 194) doing otherwise would open

us to being the . . . proper object of contempt and indignation of our brethren (Smith,

1759,p. 194). Smith does not mean that the interests of the welfare of all society should

make us blind to our own self-interest but that the welfare of society should be the highest

in an ordering of motives (Smith, 1759,p. 446).

Adam Smith allows us self-interested action as a motive that can lead to moral behavior

but then states that doing what is good, and just, and right for self-interested motives is

not to be held in as high esteem, as the same acts done selflessly (Smith, 1759,p. 442).

What will make us do what is right and good and do our duty: an internalization of our

judgment of others acts (Smith, 1759, p. xxx). When we see that a person does an evil thing

our judgment that it is evil, will set up in us a form of judgment of ourselves in the same

circumstance, and ultimately a sense of duty, even authority (Smith, 1759,p. xxi). A sort of

tension builds in us. The same is true of good acts. In this case we approbate that morality

as our own, but only as we feel an empathy with that individual (Smith, 1759,p. 161).

Ultimately the actions of the just person should be worthy of approbation by other people

as just and proper (Smith, 1759,p. xxvii). Again a tension is present which identifies the

individual conscious with the societal judgment, so that the judgment is internalized. There

are pitfalls to be avoided that are worth mentioning because they are salient to our question:

This disposition to admire, and almost worship, the rich and the powerful, and to

despise, or, at least, to neglect, persons of poor and mean condition, though necessary

both to establish and to maintain the distinction of ranks and the order of society,

is, at the same time, the great and most universal cause of the corruption of ourmoral sentiments. That wealth and greatness are often regarded with the respect and

admiration which are due only to wisdom and virtue . . .has been the complaint of

moralists of all ages. (Smith, 1759,p. 84)

Smith then goes on to complain about those who gain wealth by abandoning the virtue

only to try and make up for their lack of virtue by latter more virtuous conduct. We have

seen this working in our own society with inside traders who then rehabilitated themselves

with good acts. Even custom and fashion can influence moral sentiment making the vices

of those admired seem as virtues (Smith, 1759,p. 290). In short, we are beset by many

influences that will form our ethic. More now than in Smiths time it seems.

Smiths prescription for morality requires us to be connected to each other in a societal

moral code. That we witness the acts of others and judge those actions as good or bad actsis the basis of our moral code. We are limited in our own actions by the need to be accepted

and, having judged others for their behavior, must realize the constant judgments formed

about us. This does not eliminate the neoclassical idea of self-interest as a motive rather it

offers a broader set of motives for ethical action and judges the self-interested motive as an

inferior reason for acting ethically. Compare this with the Chicago/Austrian School where

all human activity is exchange, where gains and loses are calculated, . . .to maximize the

excess of the utility of the gain over the disutility of the cost (Hunt, 1979,p. 435) therefore

no other motive is recognized.


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A thread that has run through this paper is the limit of self-interest as a tool for taking

ethical action andas a tool for people to use when deciding what is ethical. Ultimately, unless

the ethical end is the end that gives you the greatest happiness (utility), self-interest will notlead you to an ethical end. So we have these ethical choices forwhichself-interested behavior

will only be of accidental use, therefore we prescribe incentives to shape self-interest to meet

the ethical needs of the incentivizer. In this way accountants function to identify incentives

and goals that, when met, trigger the incentives. Under the Chicago/Austrian economic

system this is all the accountants can do.

Should we reject this model as too limited, the question still remains: what ethical needs

will be met and to what degree? Even Smith points out that empathy can lead to admiration

of outcomes and behaviors that are not in the best interest of society, therefore merely saying

that empathy is a means of acquiring a moral code does not solve the problem. If we are to

use Smiths moral code we need to find objects of empathy that reflect the ethical values

that work for the best outcome for society.

The model of perfect self-interest is such a model for Friedman and Gilder. For Smith

it is a model for economic behavior that needs the foundation of a society of otherwise

ethical people. Where Friedman is admonishing managers to . . . follow the rules . . .

(Friedman, 1962, p. 133), Smith is admonishing us to be careful who makes the rules.

Friedman tells us that even with monopoly power the market works (Friedman, 1962,p.

121;Hunt, 1979,p. 431); Coase tells us that the existence of even the smallest firm means

the market mechanism is flawed (Coase, 1988,p. 38). Smith finds a whole list of evils to

associate with monopolies including the distortion of the distribution of stocks from what

they would have been had competition been in place (Smith, 1776,p. 595). Gilder offers

us the solution of the businessperson as the paragon of ethical virtue. Would that ethical

behavior could be accomplished so effortlessly, but ethics is more than changing the rules

to meet the requirements of your preconceived notions. Gilders ideas represent the worstnightmare of Adam Smith born of his concern with employers as policymakers.

Combine Adam Smiths warnings about the motives of employers, with our societys

propensity to worship material success, and with the fact that moral codes are human

constructs born of societal influences, and the result is a moral code that has built virtues

out of greed and acquisitiveness leaving the ethical questions to be answered with reference

to efficiency rather than what is good and right and just.

8. Accounting and the efficient solution to ethical problems

One of the first lessons an accountant learns is the importance of presenting a pictureof the firm that will allow the reader of the financial statements to take actions that they

would have taken had they been a witness to the day to day operations of the business. The

need for this function is created by the separation of ownership from control of business.

The separation of ownership from control creates difficulties for neoclassical economists

because of the assumption that the profit maximizing business owner is functioning as

an efficiency mechanism in the market. When control of the business is in the hands of

(utility maximizing) managers they have incentives to engage in activities that do not mimic

the actions of the profit maximizing business owner making the efficiency claim suspect.


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Accountants play key roles in overcoming this (and other) violation(s) of the efficiency

criteria. One of the roles is to keep the absentee owner informed.

When looking at the neoclassical model of markets we are captured by the self-enforcingnature of the model. We use terms like invisible hand, price taker, and Marginal Cost equals

Marginal Revenue to describe an unforgiving system of market relationships that ignore

power. We are left with the task of measuring the outcome of these seemingly benign

relationships. We are bean counters with the task of keeping score. The importance of our

task is supported by an enormous literature on Capital Markets and the central focus of

that task has been reinforced by the passage of the Sarbanes Oxley Act. The focus of this

act is on insuring that capital markets receive the information they need to more closely

approximate perfectly competitive markets.

In the context of Adam Smiths description of owners as a class, this task is too narrow

because even if the goals of the owners and the managers are perfectly aligned, we will

confront owners and managers whose interests are not aligned with the rest of society. This

makes the task of the auditor a social one in a broader sense. Admittedly the ownership

of corporations is broader than the ownership of businesses in Adam Smiths time, but the

basic economic issues are still the same to widen the market (globalization) and narrow the

competition (M&A).

Yet the focus of the education of the accountant is on the audit in a narrow sense, to

the exclusion of the broader social task which falls to us by reason of our place as definers

and primary interpreters of the language of business. Even beyond this we are tasked with

giving an account, using that business language, and by doing so setting a moral tone for

the corporation (Schweiker, 1993).This role is hermeneutics. We interpret and decide the

true face of the corporation. As auditors, it is notour task to help the corporation to meet

some earnings target or maximize value for its shareholders. If we participate in that task

we lose our objectivity, a fact recognized by Sarbanes Oxley, to a limit.

9. The accountants expanded role in Smiths world view

Smith saw that the appropriation of values required a watchful eye to ensure that ethical

values do not deteriorate, which creates a unique need for information. The importance of

this need for information is presented by Smith:

The propriety of our moral sentiments is never so apt to be corrupted as when the

indulgent and partial spectator is at hand, while the indifferent and impartial one is at

a great distance. (Smith, 1759,p. 217)

This statement speaks volumes about our duty as accountants. The accountant is the

impartial (objective) spectator who must not be indulgent so that she can maintain her

integrity.

At least some of the business ethics problems we have faced in the first decade of the

21st century appear to be linked to violations of this warning. For example a quote in

the Wall Street Journal reported that in 2000 Anderson considered itself a committed

member of [WorldComs] team and saw the company as a flagship client and a crown

jewel of the firm (Weil, 2004,p. A14). The terms indulgent and partial seem appropriate


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as adjectives for Anderson from this quote. Objectivity seems a remote possibility but in the

case of WorldCom and even HealthSouth the functions of objectivity, and to some extent

competence, were turned over to a practice known as a risk-based audit (Weil, 2004,p. A1). Again efficiency has become the goal rather than the audit. The internal control

certifications required by Sarbanes Oxley are an attempt to enable the risk-based audit to

continue with a more objective measure of risk in hand.

If we accept Smiths critique of the employer class and his theories on moral sentiment,

our task is more social. We are tasked with being the observer of the principle and the agent,

and we are tasked with providing the information necessary for the owners and agents to

be the proper objects of approbation or scorn. Our need for integrity is not a personal need;

it is a societal need just as our needs for objectivity and competence are social needs. The

audit function is a great social responsibility, even if wedo accept the neoclassical model

as descriptive. It is more so when we realize that the societal need for accounting service is

the result of violations of the perfect market model. Add to this the fact that the basic moral

code we face may be as much the result of attendance at business school and economics

classes, as it is from attendance at church, and our social role broadens to include the role of

the indifferent impartial spectator tasked with aligning the moral sentiments of the employer

class with the larger society.

How likely is it that accountants schooled in the same buildings and in the same eco-

nomics lectures and having heard what is right is what is right for business for so long will

be able to play this role. Have we lost our objectivity because we have been schooled in

the same economic ethic? The ethic usually says no solution is really necessary; just tweak

the incentive structure and let the market take care of the problem. The broader statement

made by the economic ethic is, if the market solution is not working, it is not a problem

with the market solution, it is a problem with society not meeting the requirements of the

market solution. Society is expected to bend to the market, to meet the markets needs orto construct market solutions in places where markets do not yet exist.

Even in the accounting literature on ethics, we can find the market being used to enable

an efficient outcome for ethical questions.

Although ethical behavior and value-maximizing behavior obviously are not equiv-

alent, economic theory suggests one special case in which ethical problems are

efficiently resolved. Consider as a benchmark case the frictionless economy that

Ronald Cozse[sic]6 (1960) imagined and further presume that there are no wealth

effects. In such a setting, unregulated private markets will exhaust all available gains

from trade and the resulting set of actions by individuals within the economy and

the associated allocation of resources will be efficient. This resource allocation will

reflect accurately societys opportunities and preferences.

Note that within this setting, individuals still may disagree on ethical standards. (As

we argued above, there appears to be no universal standard as to what constitutes

ethical behavior.) Thus, it would not be difficult to find specific individuals who

might charge that a broad array of valuemaximizing corporate policies violate their

6 It is assumed that the authors are referring to Ronald Coases 1960 article The Problem of Social Coast.

(Coase 1960)


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individual notions of ethical behavior. But within this setting, such disagreements

could be addressed using the same basic mechanisms through which externalities

are internalizedside payments from those who want to undertake a given action tothose who might have their notions of ethics offended by such actions. (Brickley et

al., 2000,p. 20)

It is submitted that the market for ethics presented in this case has been in operation for

some time. The side payments in question have come in the form of audit and consulting

contracts or bonuses. Other contracts both, implicit and explicit, have served to enforce the

agreements. What has come under scrutiny in the recent cases of fraud is the efficiency of

the outcome.

The question can be asked, bywhatmeasure is whatoutcomeefficient? The measure is

the market. That it is unethical implies that it could negatively impact the lives of some other

people besides the individual paid so the ethical externality may still exist. The fact that the

unethical act still takes place is not the issue because the marketcriteria have been preserved.

The implication is that the ethical problem is not a problem of ethics rather it is a problem of

ethics getting in the way of efficiency. To eliminate the problem you eliminate the person(s)

who has an ethical codethatmay beableto stand in yourway. Inthiscase, the individual must

be paid a price for their conscience. The authors admit that this solution contains a high level

of abstraction but that theabstractionis used speaksvolumesabout thedesire of businessaca-

demics to find economic answers to any question. Are we witnessing some of Koslowskis

. . .irrational passion for dispassionate rationality. . .(Koslowski, 1996,p. 40)?

When economists and accounting scholars assume that utility maximization is the only

motive that people live by, and that business people are adept at focusing their utility max-

imizing efforts on profit, they do more than describe a prescriptive formulation rather they

make a bold statement of a superior way to organize society with self-interested behavioras its foundation. Even Gilder states his disagreement with this organizational motive, but

quickly replaces it with a semantic equivalent. The assumptions of the neoclassical model

have become an ethic.Brickley et al. (2000)say that ethics appears to be relative. In fact,

if the self-interested motive is accepted as descriptive, we should expect ethical standards

to appear to be perfectly relative. Add to this the admonition that people behaving in a

perfectly self-interested way results in some form of economically and politically superior

society, and the limits to ethical questions have been set.

One defense of the market solution to ethics problems has become that the market

provides fiduciary incentives to behave ethically. A wealth of anecdotal evidence makes

it clear that the markets also provide fiduciary incentives to behave unethically. When the

punishments for unethical behavior are low, relative to the material rewards, as they havebeen in corporate America, the ethical standards of the individuals involved must be very

high if people are to behave ethically. In neoclassical terms the opportunity cost of unethical

behavior rises as an individuals ethical standards increase. More importantly, if the moral

code of the community condones the unethical behavior, under the same conditions, the

opportunity cost of the unethical act is lowered and may even create a new moral code.

A recentinterview of a prominentbusiness personrelated this story from the1980s: John

McArthur, the former dean of Harvard Business School . . . interviewed students about what

they thought about the corruption within corporations, the students were horrifiednot


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about the corruption, but because the corporations were stupid enough to get caught!

(Shinn, 2004, p. 26). The attitude that the interviewee says he is witnessing in many students

today is: I want to work for one of these companies where I can move high up and makemillions of dollars and get away with something (Shinn, 2004,p. 26). The most striking

feature of these quotes is that the students of the 1980swere so shameless in their statements.

Shame is considered a quasi-virtue by Aristotle but only in the young because acting on

the passion of youth they are restrained by shame (Aristotle, 1980, pp. 1045). The

sentiments expressed by the students of the 1980s and today reveal a moral code guided by

greed and indicate an empathy with business people who are successful committing frauds.

The lack of shame at displayed by making such a statement to your Dean is at the very least

troubling from an ethical standpoint.

It might be said that this greed driven behavior does not constitute a moral code; that

it is just unethical behavior but it is important to understand if the students considered the

actions of the corporate officers unethical and did not care, or if they considered the actions

ethical or to have no ethical content. If the individual is taught that maximizing his utility is

what is best for him and for the society, and his utility is maximized by wealth and power,

because that is what the society glorifies as the highest goal, then to behave otherwise is

to behave against the best interests of society. In this logic there is an identity between the

utility maximizing interests of the individual and what is best for society. In the extreme, not

committing fraud when it would maximize your utility is against the best interest of society.

The forgoing logic seems absurd, not because the logic is flawed, but because the result

is shocking. The absurdity of the outcome is matched by the absurdity of clinging to a

model of atomistic consumers and producers in the face of the world of massive and very

powerful corporate giants. If there appears to be no universal ethical standard ( Brickley et

al., 2000), it is because the logic of the system which connects the good of the society, to the

actions of the individual is perfectly relative. In a society structured around a market-basedethic, a system of incentives varied and complete enough to provide ethical outcomes may

be neither very efficient nor ethical.

Some types of market solutions are rejected by business scholars and the rejection raises

questions about the foundation of the analysis.

Our analysis suggests that a board of directors concerned with the ethical conduct of

the firms employees should spend less time exhorting the human resource manager

to search for honest employees (like Diogenes search for an honest man). They should

identify potential incentive problems between the firm and its customers, creditors, or

employees. Once identified, attention can be focused on the constructive resolution

of the incentive problems. (Brickley et al., 2000,p. 21)

Why is the labor market treated as though it cannot help meet ethical standards? The

cynicism apparent in this quote stems from a basic belief that the applicant pool is tainted.

Unfortunately, the applicant pool is tainted by the assumed motivations used as a foundation

of the economic analysis.

Additional proof of this is evident in Buckley et al.s contention that the addition of

academic and religious leaders to boards of directors make the boards promise to focus on

value-maximizing polices credible when the board meets in private (Brickley et al., 2000,

p. 18). This is because this board members . . . career choices indicate that maximizing


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income is not that individuals most important goal . . . (Brickley et al., 2000, p. 18).

This is an interesting statement that the CEO, and even the owners of firms, are suspect

when setting value-maximizing policies because they want to maximize their income? Itappears that the motivation income maximization automatically makes a person suspect of

unethical intentions.

By abandoning the market in the critical area of human resources, by giving up on the

possibility of the ethical person, ethical problems are relegated to the realm of externalities

requiring a system of incentives or side payments (Brickley et al., 2000,p. 20) to ensure

ethical behavior. Faced with an incomplete structure of incentives to behave ethically, uneth-

ical managers, employees and owners present an invitation to disaster and a legal system

so clogged with cases it cannot function.

The ethical person is the foundation of any program designed to maximize the possibility

of an ethical outcome at the lowest cost, in any system, but the question still remains, what

constitutes ethics in a market system designed for efficiency, when efficiency is expected

to result from self-interested behavior and efficiency is a goal with the status of an ethic.

The government official tasked with the solution to the p

smith versus friedman markets and ethics 2007 critical perspectives on accounting

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