In the U.S. and in most developed countries, adherence to ethical standards is the accepted business practice. This is not the case in many developing markets, however. Consequently, ethical dilemmas can arise between conflicting standards. It is therefore important to educate clients and their stakeholders about the long-term financial benefits of avoiding ethical pitfalls in their international business dealings.
When ethical questions arise in international deals or deals involving foreign constituents, they can initially appear to be of secondary importance. Ethical issues, however, can present various short- and long-term consequences that should be at the front of the client’s decision-making process. There are several recurring, interconnected themes that routinely arise that should be addressed with clients: (1) the long-term business and financial benefits of acting ethically; (2) the importance of transparency and disclosure; and (3) the value of protecting minority shareholders.
Proactively educating clients on the specific benefits of ethical behavior is much more effective than taking an ad hoc approach. Emphasizing the financial benefits of ethical behavior is much more effective than appealing to a client’s moral conscience. Consequently, a significant amount of time and attention should be devoted to the education process, and this process should begin at outset of the engagement.
The educational discussion with an international client begins with explaining the difference between what is acceptable in the U.S. and what is not, and then explaining the need to adhere to U.S. standards. International clients must understand that meeting legal requirements alone is not sufficient, and that there are also business standards that need to be considered. Generally, international clients expect to operate in U.S. transactions with the same level of “secrecy” they enjoy in home markets, and the concepts of “open book” and “all bad news on the table up-front” are particularly difficult for many international clients to initially accept. In many cases, this lack of transparency is not because of the client’s unethical activities, but more because of their cultural and historical way of doing business.
Thus, as part of the education process, it is important to help international clients not only understand ethical standards, but also the long-term financial benefits of transparency, and to discourage the client from succumbing to the temptation to sacrifice ethics in exchange for short-term gains.
For example, reputation is a threshold issue when analyzing a company’s ability to raise capital in international markets. Therefore, everything that management can do to maintain its reputation will enhance its ability to tap these markets. Good ethics and transparency imply less risk for investors on all fronts, and will facilitate better results in whatever type of transaction is being contemplated.
Capital is global and can be invested much more freely and quickly across borders. Investing or lending to an existing company located in a foreign market is less cumbersome than managing an operation there. When a U.S. equity investor becomes involved with an existing international company, it assumes some level of risk for the company’s behavior. Likewise, a U.S. company must be aware of the impact of raising capital from questionable sources. While neither party is fully responsible for the activities of its counterpart, both parties have a responsibility to avoid dangerous relationships.
The due-diligence process in the U.S. generally brings to light any major ethical issues that are a concern to the parties. There is a default assumption in the U.S. that most domestic parties to significant transactions have previously been vetted. This is not an assumption that is made when dealing with certain international companies. Consequently, when dealing with international companies, especially from developing countries, investors and lenders are much more focused on the ethical issues (real or perceived). As a result, international companies with no track record in the U.S. might be held to a higher standard because of the perceived (rather than actual) risk. International companies that invest time and effort up-front to improve transparency are more successful in raising capital outside of their home markets.
Disclosure and transparency go hand-in-hand with ethical standards. There is enhanced access to capital when there is ample disclosure about operations, finances and risks. Many foreign owners, even those operating very ethically, will initially resist disclosure because they are used to being very private and discrete. Some privately held companies choose to limit their disclosure, usually citing arguments relating to competitive forces or personal security. Lack of transparency can also reflect different cultural and historical ways of doing business. Regardless of the underlying reason, lack of transparency severely stunts growth and limits capital-raising alternatives. Clients should be informed that disclosure and transparency are important in a consideration of ethical standards and that, regardless of the underlying reason, lack of transparency will severely stunt growth and limit capital-raising alternatives.
It is also important to educate international clients on the issue of the treatment of minority interests. In many international companies, the distinction of the interests of the company vs. the interests of the shareholders may not be clearly defined. As a result, minority shareholders often face difficulties.
Considerable time and energy should be spent educating foreign clients that their treatment of existing minority interests will have a direct impact on their ability to attract debt and equity investment from international institutional sources. If potential new stakeholders discover activities while conducting their due diligence that unduly benefit specific parties at the expense of others, it will greatly increase the difficulty in completing a transaction. At a minimum, these factors will increase the cost of debt and equity financing, and may in fact lead to a transaction not being completed at all.
The most effective way to minimize unnecessary conflicts among shareholders is to ensure that transactions are always conducted at arm’s length. Another way is to create and defend a culture of ethical responsibility, which includes building an organization around people who are both talented and ethical.
Perhaps the most effective method for avoiding unfair treatment of minority interests is transparency and full disclosure. If a company fully discloses all information about its operations and financial situation to all of its stakeholders, any unfair advantage granted to specific stakeholders with beneficial conditions will be made evident and clear. This will also facilitate action to remediate the situation. It stands to reason that a company that places importance on being transparent is also one that will protect its own minority shareholders.
Conclusion
When dealing with international constituents, ethical considerations can have a major financial impact on a client. Educating the client that there is a direct return on investment for ethical behavior early in an engagement is an important function for any advisor involved in international transactions.