Ethics
Ethics and conflicts of interest
Conflicts of interest are structural, and expected-value arithmetic can be correct while leaving out the costs that matter most.
Definition
A conflict of interest exists when a decision that should serve one party also benefits the person making it. The conflict is structural; it exists whether or not the individual acts dishonestly.
Ethical judgement in finance is therefore not only about rules. It is about recognising where incentives distort numbers, disclosing the distortion, and refusing to let a defensible calculation settle a question it cannot answer.
Intuition
Numbers are inputs to a decision, not a substitute for one. A negative net present value does not make a wrong action right, and a positive one does not make it safe.
When to use it
- Designing a control, review, or disclosure process.
- Challenging an assumption whose owner benefits from the answer.
- Deciding whether a concern needs escalation rather than local resolution.
When not to use it
- To settle an ethical question with a single probability-weighted number.
- Assuming disclosure alone removes a conflict.
Formula
Expected penalty
Expected penalty = Probability × Size of penalty
The probability-weighted cost of a failure.
Formula
Net present value of controls
NPV = PV(Expected penalty avoided) − Cost of controls
Whether prevention pays on the measurable numbers alone.
Worked example
Is compliance worth it?
A firm can spend ৳20,00,000 now to remove a 15% chance of a ৳1,20,00,000 penalty in two years. The discount rate is 10%.
- 1
Expected penalty
0.15 × ৳1,20,00,000 = ৳18,00,000.
- 2
Present value
18,00,000 ÷ 1.1² = ৳14,87,603.
- 3
Net present value
14,87,603 − 20,00,000 = −৳5,12,397.
The arithmetic says no. The answer is correct on the numbers given and incomplete on the decision, because trust, licence, and staff losses are real costs that never entered the model.
Common mistakes
- Treating a conflict as dishonesty, and therefore missing it in honest people.
- Assuming a disclosed conflict no longer influences the advice.
- Escalating late, when the only remaining option is public correction.
How it connects
relates to
Useful to study together, in either order.
- Behavioural finance and bias: Recognising bias is the first defence against a distorted incentive.
- NPV and IRR: Expected-value arithmetic is an input to an ethical decision, not the decision.