Monday, October 3, 2016

Ethics In Finance

You may have noticed that there is not a lot of discussion of ethics in your textbook. A major reason is that from a financial view, if the market or society values ethical behavior, unethical behavior by a company will hurt its market value, thus defeating the goal of maximizing shareholder value. Consider the case of Wells Fargo, which is under fire for fraudulently creating up to 2 million deposit and credit card accounts. In addition to the fines paid by the company, last week, California announced that it was barring state transactions with Wells Fargo, including underwriting state bond issues. Today, Chicago announced that it was divesting $25 million that it has invested with Wells Fargo and next week Illinois plans to announce its plans to suspend Wells Fargo from the state investment network. So, while Wells Fargo may have temporarily increased value by fraudulent actions, these actions will now negatively affect shareholder value. 

Ticked Off

If you look at stock prices, you will see bid and ask prices that may only be different by a penny. What you may not realize is that this has only occurred since 2001. Prior to that, stock prices were quoted in eighths or sixteenths, so a price quote of 40 1/8 meant $40.125. Part of the reason for the change was that the bid-ask spread was the dealer profit, which also meant that investors were paying this difference. However, it has been argued that small cap stocks were hurt by decimalization because market makers have less incentive to trade less liquid small cap stocks and this has also lead to less research on small companies. Today, a pilot program was begun in which 10 small company stocks began trading on 5 cent tick sizes, meaning the smallest change in the stock price for these stocks is now a nickel. About 1,200 stocks will eventually be included in the test program, with three different groups with different trading rules. The goal of the study is to determine if increasing the tick size can lead to increased liquidity in small cap stocks.