Defining Business Ethics

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BUS560 2012 CH

MODULE 1

Mar 11th 2013

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Read issues one and two from Taking Sides. Choose one issue to respond to. Which viewpoint do you

side with? Why? Explain. Reference at least two outside resources that further support the view point

you side with.

Is Risk the Best Theory for capitalism?

Yes they explain that when imprudent risks are taken whether in life or in business, the consequences of

bad risks do not change their views on the value of risk in business.

Risk is an ever-present condition of human endeavor and of all financial and business activity. Business

people have been struggling to manage risk for millennia. Insurance contracts date back to multiple

ancient civilizations. Contract and tort law developed, in part, as mechanisms for allocating risk. Risk

diversification and risk management are among the central pillars of modern finance and investment.

Of course, risk is not all bad. Nothing ventured, nothing gained is an ancient principle that was only

formalized by modern finance theory. Innovation is necessarily risky at the very least; there is the risk of

wasting time. Developing new products, entering new markets, acquiring companies these are all risky

yet potentially profitable projects.

What is bad, however, is underestimating risk or assuming that you have mastered it. Both of these

factors contributed to the current global economic crisis.

The main causes of the crisis are well known, although there are debates about their relative

importance. The following will focus on the underestimating or mismanagement of risk. The most

common place to look for excessive risk is leverage. When it collapsed, Lehman Brothers holdings Inc.

had a leverage ratio above 30. Its assets were worth more than 30 times its capital. However, simply

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blaming leverage is not strictly accurate. First high leverage is not necessarily risky it depends on what is

done with the borrowed money. For example borrowing a little money to bet on one number on the

roulette wheel is riskier than borrowing a lot of money to invest in treasury bonds.

Second, insolvency is not what killed Lehman, at least not directly. Lehman fell victim to a modern-day

bank run, in which financial institution declined to renew their short-term funding. The precipitating

cause of Lehman’s failure was not leverage, but liquidity risk which no one was prepared for. The

Lehman bankruptcy itself and the resulting settlement of hundreds of billions of dollars of credit-default

swaps it forced the reserve fund to break the buck, freezing money markets. In addition, seeing a major

bank vanish awaked all financial institutions to the reality of counterparty risk the chance that your

counterparty might not be there when needed to close a trade which was the single biggest reason for

the American international Group Inc. bailout.

AIG was a major trader in credit-default swaps contracts to insure bonds or bond like securities against

default as the subprime crisis deepened and the likelihood of default increased, AIG potential

obligations increased. When the bond rating agencies downgraded AIG, potential obligations increased.

When the bond rating agencies downgraded AIG, investors with a CDS contract with AIG started

wondering if the firm could pay, and those with CDS contracts with other third parties started

wondering if they were dependent on AIG.

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Reference page

Leeson, P. T. (2010). Two cheers for capitalism? Society, 47(3), 227-233.

doi:http://dx.doi.org/10.1007/s12115-010-9305-7

Prothero, A., & Fitchett, J. A. (2000). Greening capitalism: Opportunities for a green community. Journal

of Macromarketing,20(1), 46-55. Retrieved from http://search.proquest.com/docview/215870728?

accountid=34574

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Rajan, R. G., & Zingales, L. (2004, 03). Capitalism for everyone. The National Interest, (74), 133-141. Retrieved from http://search.proquest.com/docview/218399367?accountid=34574