Scruffy Murphy is the president and principal stockholder of Scruffy’s Bar and G

Question

Scruffy Murphy is the president and principal stockholder of Scruffy’s Bar and Grill Inc. To expand the business, the corporation is applying for a $250,000 bank loan. To increase the chance of getting the loan, Murphy is considering two options for beefing up the owners’ equity of the corporation:

            Option 1:        Issue $100,000 of common stock for cash. A friend has been wanting to invest in the company. This may be the right time to extend the offer.

            Option 2:        Transfer $100,000 of Murphy’s personal land to the corporation, and issue common stock to Murphy. Then, after obtaining the loan, Murphy                                        can transfer the land back to himself and zero out the common stock.

Using your judgment, please answer the following:

What is the ethical issue?

Who would be affected by the choice between these two options? And what are the possible consequences to them?

Option 1

Option 2

What do you think about these two options from the following standpoints:

Economic:

Ethical:

What would you do? How would you justify your decision?

Explanation / Answer

What is the ethical issue?

Showing better financial position for approval of loans is unethical because selling common stock of $100000 to his friend is unethical and also violation of true & fair view of the financial statements. It is clear that selling common stock of $100000 to his friend, is just done for showing better financial position before getting approval of loans. So as a result we can say that it is an unethical financial practice.

Transfer $100,000 of Murphy’s personal land to the company, and issue common stock to Murphy, is also unethical because it is only a artificial transaction because this transaction is done for improving financial position this transaction will be reversed after getting loan from bank. Hence this financial transaction is also unethical issue because it will affect various stakeholders of the company.

Who would be affected by the choice between these two options? And what are the possible consequences to them?

Option 1;

In this option various prospective investors will be affected because just selling shares to his friend is the violation of process of selling shares to public. Hence it will also affect existing shareholders and prospective shareholders of this company.

Apart from this bank will be also affected because after seeing this unethical transaction bank will grant loan to company but after passing time bank will realize about true story about the company hence bank will be badly affected.

As we know that every company have various stakeholders thus all these stakeholders like; employees, public, lenders, government etc. will be affected.

Option 2;

As we know that every business is a separate entity hence transfer of personal land to the business without following proper process will be unethical and invalid too because it is done for just showing better financial position for taking bank loan. Hence following stakeholders will be affected;

Existing shareholders, employees, government, prospective shareholders, lenders, bank, customers etc.

What do you think about these two options from the following standpoints:

Economic;

It will affect overall economic condition of Scruffy’s Bar and Grill Inc. because after getting loan from bank this company will have to pay a regular interest on this loan and this loan amount also need to be repaid after some time. But we know that actual condition of this company is not good hence only such fictitious financial transactions will make negative economic impact on Scruffy’s Bar and Grill Inc.

Ethical;

We know that some ethics must be followed so that stakeholders can not be affected from such unethical business practices. So we can say that just selling shares to his friend and transfer of personal land is the violation of ethics.

So in a company shares can not sold to a friend because shares must be available for sale to all through an open process and personal land also should not be transferred just for showing better finnacial position. And if these transactions take place then it will be violation of ethics.

What would you do?

First of all I will avoid such fictitious fianancial transactions because it will not show true picture of the financial statements. Apart from this I will go to bank with true financial statements and try to convince bank’s authority that my company will try to use given loan for better returns. Thus I will not violate any ethical way and will follow only true and fair business practices so that no stakeholder should be negatively affected.

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