Assignment Business Case:

Anne Brown is a senior fixed-income analyst at Green Financial Corporation (GFC) located in New York City. Her main area of expertise is developing financial models for predicting changes in stock prices. Based on the premise that the stocks of firms targeted for leveraged buyouts (LBO's) often decline in value, Ms. Brown has developed a model to predict which firms are likely to be subject to LBOs. Ms. Brown works very closely with another analyst, Robert White. Mr. White frequently uses Ms. Brown's model to identify potential LBO targets for further research. Using the model and his extensive research skills, Mr. White has been able to make timely investment recommendations. Mr. White recently accepted an employment offer from the asset management division of Shady Investments, Inc. (SI), a diversified financial services firm. With Ms. Brown's permission, he downloaded the model before leaving Green Financial. Mr. White's remuneration package at SI includes a salary, a company car and a graduated cash bonus scheme based on net annual earnings generated by his recommendations. At SI, Mr. White presented the idea of predicting LBO targets as a way to identify stocks that might decline in value and thus would be good "sell" recommendations. After he walked John Doe, CEO and Chairman of the Board, through the model, Mr. Doe commented, "I like your idea and your model, Bob. I can see we made the right decision in hiring you. Two highly qualified female candidates also applied for the position, and according to the company's diversity policy, I should have hired one of them, but in my view, finance always was and always will be a man's world." Because SI has both Investment Banking and Asset Management divisions, the company's Code of Ethical Conduct states that there should be no contact between the two divisions. It further mentions that: We earn the trust of our clients, regulators, investors and each other by always acting with integrity and holding ourselves to high standards. Acting according to our code of conduct is vital for achieving sustainable success. Employees must not engage in activities, practices or conduct that are manipulative, illegal, anticompetitive, or unethical, that are contrary to industry standards or applicable regulations, or that are otherwise damaging to our reputation. In fact, it is strict company policy that there should be absolutely no conversation about divisional business in common areas, such as in hallways, bathrooms, elevators or in the cafeteria. 5 The following week, Mr. White was riding alone in the elevator when it stopped on an IB floor. As the doors opened, Mr. White heard someone say, "I am very pleased that we were able to put together the financing for Engulf and Devour (E&D). I was concerned because the leverage will go up to 80% - much higher than our typical deal." As soon as the doors opened enough to reveal that the elevator was occupied, all conversation stopped. Late that afternoon, Mr. White used the LBO model to measure the probability of E&D receiving a leveraged buyout offer. According to the model, he determined that the probability of an LBO was 62% - slightly more than the 60% threshold Mr. White set for doing additional research. Unfortunately, there was not enough time to thoroughly research the stocks before the end of the trading day. Accordingly, he decided to immediately recommend selling E&D's stocks held in any long-only accounts. He also recommended establishing positions in derivative contracts that will benefit from a decline in value of E&D's stocks. The next morning, after the firm had taken the derivatives positions that he recommended, Mr. White called Ms. Brown. Knowing that Ms. Brown would be preparing GFC's newsletter. He told her that he ran E&D through her model, and he thought they will very likely receive an LBO offer. He gave her some additional details about E&D including their international holding structure with branch offices in Bahrain and in the British Virgin Islands and the volume of preferred shares of approximately 10%. At the conclusion of the conversation Ms. Brown told him that he might be right. "E&D does sound like a possible LBO candidate, and of course a sell rating on their stocks would be in order." She said she would try to finish researching it in time to include a sell recommendation in the newsletter to investors. After their conversation, Ms. Brown quickly ran E&D through her model and determined the probability of an LBO at only 40%...not enough to warrant further research. She wondered about the reason for the discrepancy.

Tasks: 1. Using appropriate standards and norms, identify issues of ethical concern and discuss them from deontological, consequentialist and virtue-ethics perspectives.

2. In terms of Agency Theory, what specific measures do you recommend SI take to avoid unethical actions by "rogue" analysts?

3. What are the potential economic and ethical risks associated with an LBO? Under what circumstances might an LBO be characterized as a "hostile takeover" and why?