AIG: ACCOUNTING AND ETHICAL

LAPSES

Mary D. Maury, Irene N. McCarthy, and

Victoria Shoaf

ABSTRACT

American International Group, Inc. (AIG) has recently been charged

with reporting bogus transactions that hid losses and inflated its net

worth. The New York State Attorney General Eliot Spitzer alleges that

AIG inflated reserves used for paying claims by millions of dollars and

that AIG’s CEO Maurice Greenberg repeatedly directed AIG traders late

in the day to buy AIG shares to prop up its price, among other allegations.

We examine the accounting errors for which AIG and Greenberg are

being charged and analyze the opportunities missed by the auditors to

detect problems, within the framework of corporate governance. That is,

we evaluate the corporate environment that supported these lapses and

provided an environment conducive to the perpetration and acceptance of

fradulent reporting. We discuss how corporate governance not only pro-

motes better financial reporting, but provides a level of scrutiny that

encourages more ethical behavior at all levels of the corporate hierarchy,

and we discuss the imperative for accounting education.

Insurance Ethics for a More Ethical World

Research in Ethical Issues in Organizations, Volume 7, 39–53

Copyright r 2007 by Elsevier Ltd.

All rights of reproduction in any form reserved

ISSN: 1529-2096/doi:10.1016/S1529-2096(06)07003-9

39

MARY D. MAURY ET AL.40

INTRODUCTION

According to the AIG website, ‘‘American International Group, Inc. (AIG)is the world’s leading international insurance and financial services organ-ization, with operations in more than 130 countries and jurisdictions. y Inthe United States, AIG companies are the largest underwriters of commer-cial and industrial insurance’’ (http://ir.aigcorporate.com). Business Insur-

ance (2004) recognizes AIG as ‘‘one of the nation’s most profitablecompanies’’; it earned $11 billion last year alone. It is also listed as number 3of the top 10 companies on The Forbes Global 2000 List (2000) which isbased on a composite ranking from four metrics: sales, profits, assets, andmarket value (http://www.forbes.com). Why, then, has it become the posterchild of malfeasance in the insurance industry? A Wall Street Journal articledated March 28, 2005, pointed out that ‘‘accounting at AIG is being in-vestigated by the SEC, Justice Department, the New York attorney generaland New York state insurance regulators, besides its own board’’ (Langley,Solomon, Francis, & McDonald, 2005). Additionally, according to Squeoand Francis (2005) the FBI is now ‘‘conducting a wide-ranging inquiry intothe insurance industry’’ (p. A-3), which could extend into related industriessuch as banking and finance as a result of the developments at AIG.

On March 31, 2005, AIG acknowledged that its accounting for a numberof transactions was improper (Anderson, 2005). In May, the companystated, after an extensive internal review, that it would restate more than 4years of financial statements, reducing its net worth by $2.7 billion(McDonald & Francis, 2005). That admission caused the rating servicesto downgrade AIG’s long-term counterparty credit and senior debt ratingsand that of its subsidiaries (Ha & Hay, 2005).

In many ways, the story of AIG’s legal troubles is intrinsically tied to thefortunes of Maurice R. (Hank) Greenberg, who has been at its helm since1967; he oversaw an organization whose profits rose under his leadershipfrom $14 million in 1967 to $11 billion in 2004. Despite this formidablerecord, he was removed as chief executive ‘‘with a heavy heart’’ by unan-imous consent of AIG’s board on March 13, 2005, while remaining aschairman, only to be forced to resign from the company entirely by March28, 2005 (Eichenwald & Anderson, 2005).

Greenberg was by all accounts unlike any of the other chief executiveswho have gotten themselves in trouble. He was not trying to increase hispersonal wealth or hide a failing company as were many of the characters inthe news of late (such as Lay, Ebbers, Rigas, Kozlowski). Instead, Murray(2005) describes him as ‘‘a man of great pride who cared deeply about the

AIG: Accounting and Ethical Lapses 41

company he ran.’’ Unfortunately, according to Murray, rather than beingcomfortable taking the long view, he obsessed about the daily fluctuations inthe company’s stock price and was thus led astray. ‘‘Mr. Greenberg knewbetter than anyone that the transactions were merely short-term fixes. Butthere’s no evidence that he sold stock in the short term, and therefore noreason to think he personally benefited. Instead, his actions were more likelyrooted in his pride – an intense desire to succeed by the measures the marketset for him’’ (Murray, 2005).

In an article about Greenberg in Fortune, the authors note that his mostfrequent quote is ‘‘All I want in life is an unfair advantage’’ (Leonard,Elkind, & Burke, 2005). Greenberg is known to be regarded by most people,even his enemies – of which he made more than a few – as a business genius.However, he has a strong personality to go with it ‘‘To be sure, Greenbergwas famously brutal with competitors, employees, analysts, customers –even members of AIG’s boardy. He ran roughshod over state insuranceregulators. But all that was viewed as part of his genius, evidence of howmuch smarter and tougher he was than anyone else’’ (Leonard et al., 2005).

In the press release put out by Elliot Spitzer, the New York State At-torney General, upon filing the lawsuit against AIG and its top managersfor a pattern of fraud at AIG on May 26, 2005, he stated that ‘‘The irony ofthis case is that AIG was a well-run and profitable company that didn’t needto cheat. And yet, the former top management routinely and persistentlyresorted to deception and fraud in an apparent effort to improve the com-pany’s financial results’’ (Office of the Attorney General, 2005b).

WHAT WENT WRONG?

The insurance business is structured in such a way that companies generallylose money writing policies but earn their profits by investing the premiumsthey collect. Greenberg, however, emphasized that underwriting was theirmost important business, and Wall Street rewarded AIG’s record of makingmoney on underwriting with a premium multiple, indicating that the marketalso valued underwriting profits more highly than unpredictable investingresults. They used large amounts of reinsurance to grow.

Reinsurers are the behind-the-scenes companies, frequently located inoffshore islands such as Bermuda and Barbados that are outside of thejurisdiction of U.S. regulators and with no corporate income tax. They alsohave laws that are less strict about establishing reserves for anticipatedlosses. These offshore islands allow discounting of the loss reserves based on

MARY D. MAURY ET AL.42

the premise that losses will be paid out over time. Insurance companies arenot required to book the entire amount of potential loss through the incomestatement immediately as they are in the United States, but can reportinstead a discounted amount, based on the time value of money, therebyneeding a smaller amount of loss reserves. Thus, reinsurers sell insurance toinsurers, lessening their risk and thereby letting them shrink their bookedreserves.

AIG regularly used these reinsurance companies to keep its reservesdown, especially on some of the more risky policies that it was willing towrite for such risks as expropriation of property by foreign governmentsand terrorism. AIG used reinsurance companies for as much as 70% of itspremiums, while competitors only utilized reinsurers for about 10% of theirpremiums. This policy, while causing the company to give up some ofits profits, allowed it to continue to grow using its limited capital (Leonardet al., 2005).

One of the issues that came under investigation was whether AIG wasusing reinsurance companies that it controlled while treating them as sep-arate entities to minimize its risk exposure. The question was whether thesewere really loans and whether assets and liabilities were swapped to smoothout earnings. The biggest acknowledgment of ‘‘improper’’ accounting in-volved a finite reinsurance transaction with Berkshire Hathaway’s GeneralRe unit using a sham risk-free swap of insurance assets that allowed AIG toartificially inflate its premium growth and temporarily boost claims reservesin order to keep the analysts happy. ‘‘The AIG/General Re deal, in twoseparate transactions in late 2000 and early 2001, shifted $500 million ofexpected claims to AIG from Gen Re, along with $500 million of premiums.AIG recorded the premiums as revenue and added $500 million to its re-serves to show its obligation to pay claims’’ (Ha & Hays, 2005, p. 7). Ha andHays also report that AIG admitted that its Gen Re deal should have beenrecorded as loans, not as insurance, due to lack of evidence of risk and thatthe company has since said, ‘‘They will now be listed as deposits rather thanconsolidated net premiums’’ (p. 7).

As the investigations and scrutiny increased, AIG began an extensivereview of its books and records in preparation for its 2004 Annual Report.On May 1, 2005, AIG issued a news release that stated: ‘‘The findings of thatreview, together with the results to date of investigations conducted byoutside counsel at the request of AIG’s Audit Committee and in consul-tation with AIG’s independent auditors, PricewaterhouseCoopers LLP haveresulted in AIG’s decision to restate its financial statements for the yearsended December 31, 2003, 2002, 2001, and 2000, the quarters ended March

AIG: Accounting and Ethical Lapses 43

31, June 30 and September 30, 2004 and 2003 and the quarter endedDecember 31, 2003’’ (AIG, 2005). It also announced that it expected to fileits 2004 Form 10-K by May 31, 2005.

Among the items listed in its news release was an anticipated decrease ofapproximately 3.3% in AIG’s unaudited consolidated shareholders’ equityof $82.87 billion at December 31, 2004. There would also be corrections ofaccounting errors totaling approximately $2.0 billion, as well as fourthquarter changes in estimates – tax accruals, deferred acquisition costs, con-tingencies, and allowances – totaling approximately $700 million.

In the news release AIG revealed that ‘‘The restatement will correct errorsin prior accounting for improper or inappropriate transactions or entriesthat appear to have had the purpose of achieving an accounting result thatwould enhance measures important to the financial community and thatmay have involved documentation that did not accurately reflect the natureof the arrangements.’’ In many cases, these improper entries resulted from‘‘top level’’ adjustments, which were possible because of ‘‘certain controldeficiencies, including (i) the ability of certain former members of seniormanagement to circumvent internal controls over financial reporting incertain circumstances, (ii) ineffective controls over accounting for certainstructured transactions and transactions involving complex accountingstandards and (iii) ineffective balance sheet reconciliation processes. Thesedeficiencies are ‘material weaknesses’ as defined by the Public CompanyOversight Board’s Auditing Standards No. 2. Consequently, managementhas concluded that AIG’s internal control over financial reporting was in-effective as of December 31, 2004.’’

The news release contained a list of many of the expected changes, whichincluded reclassifying realized capital gains to net investment income, in-creasing expense deferrals, decreasing reserves to shift income between re-porting periods or among business segments. Some other changes that werenoted included:

�

Foreign currency translation did not in some cases comply with the func-tional currency determination;

�

Life settlements designed to assist life insurance policyholders to monetizethe existing value of life insurance policies; AIG determined that certainaspects of its prior accounting for this business were incorrect, but theappropriate treatment is still being discussed by AIG and PWC with theregulatory authorities;

�

Deferred acquisition costs (DAC) reflected incorrect application of ac-counting principles regarding DAC, and adjustments to reduce the DAC

MARY D. MAURY ET AL.44

asset are necessary. Cumulative effect of adjustments will be approxi-mately a $200 million decrease in stockholders’ equity; and

�

SICO deferred compensation: The internal review determined that AIGshould have been expensing amounts attributable to deferred compensa-tion granted to certain AIG employees by SICO, a private holding com-pany that owns approximately 12% of AIG’s common stock.

In addition to this aforementioned plethora of troubles that AIG un-earthed, on April 26, 2005, the office of the New York State AttorneyGeneral issued a press release stating that AIG was to be audited for allegedmisreporting of workers’ compensation premiums. It alleges that there was apractice that lasted for a decade despite challenges from AIG insiders re-peatedly challenging its legality, involving the booking of premiums forworkers’ compensation coverage as premiums for general liability coverage(Office of the Attorney General, 2005a).

In reviewing this litany of transgressions, one would have to agree withthe article in Fortune magazine that aptly states: ‘‘A simple, mystifyingquestion looms over all this: Why? Why would such an iconic corporatefigure – Spitzer calls him ‘the most powerful businessman in the world,’ andit’s only a slight stretch – engage in so many deceptions that ultimately madelittle difference to his company’s rise? After sifting through the questionabletransactions, AIG reduced its net worth by $2.26 billion – a decrease ofonly 2.7% and less than the company makes in a typical quarter. Thegames Greenberg is accused of playing were intended to address mundaneproblems: a short-term stock decline, the failure of a new business venture,an analyst’s criticism that AIG was under-reserved for potential losses’’(Leonard et al., 2005, 17).

WHERE WERE THE AUDITORS?

As the picture of accounting improprieties and allegations of illegal acts atAIG unfolds, it is evident that not all of AIG’s transgressions are recent.However, only recently did its auditors, PricewaterhouseCoopers, balk atapproving its reports until the accused CEO Greenberg was removed fromthe board (Kadlec, 2005). In the post-Enron era, with increased scrutiny ofinternal controls and every phase of external auditing, the question arises asto how this number of accounting errors could have been missed.

In the 2004 10-K, the new AIG management team seems ready and willingto heap the blame for past transgressions on the officers named in the

AIG: Accounting and Ethical Lapses 45

charges, who had stepped down or been fired by the company; they areclearly eager to clear the air and start afresh. In the Management Discussion

& Analysis, the new management asserts:

Certain of AIG’s controls within its control environment were not effective to prevent

certain members of senior management, including the former Chief Executive Officer

and former Chief Financial Officer, from having the ability, which in certain instances

was utilized, to override certain controls and effect certain transactions and accounting

entries. In certain of these instances, such transactions and accounting entries appear to

have been largely motivated to achieve desired accounting results and were not properly

accounted for in accordance with GAAP. Further, in certain of these instances, infor-

mation critical to an effective review of transactions, accounting entries, and certain

entities used in these transactions and accounting entries, were not disclosed to the

appropriate financial and accounting personnel, regulators and AIG’s independent reg-

istered public accounting firm. As a result, discussion and thorough legal, accounting,

actuarial or other professional analysis did not occur. This control deficiency is based

primarily on these overrides.

In effect, the new management exonerates the auditors, among others, whowere apparently misled by the former CEO and CFO. While Pricewater-houseCoopers may be pleased with this pass – and has not, to date, beennamed in any law suits related to the misstatements (Glater, 2005) – point-ing the finger somehow misdirects the question. Is not the purpose of therecent focus on improving the quality of audits and other aspects of cor-porate governance to circumvent a situation where one or more top-levelemployees can ‘‘cook the books’’?

The overbearing manner in which Greenberg exercised his role as CEOwas certainly a key factor in the fraud at AIG, but the overall weakness incorporate governance allowed the fraud to flourish. There is empirical ev-idence in the accounting literature (e.g., Dechow et al., 1996; Beasley, 1996;Farber, 2005) indicating that weak corporate governance is associated withfinancial reporting fraud. Farber (2005) finds that the weaker governanceassociated with reporting frauds includes few outside board members, fewaudit committee meetings, few financial experts on the audit committee, andthe role of the CEO on the board of directors. We believe that these andother factors operative at AIG – such as its size and success, the encour-agement of ruthless and competitive behavior, the closeness of the relation-ship with the auditors – provided an environment conducive to theperpetration and acceptance of fraudulent reporting.

While others in the insurance industry were moving toward recruitingmore outside directors ‘‘with the CEO having a more limited degree ofinvolvement’’ (Bowers, 2004), AIG’s board was still composed of internal(management executive) directors and outside directors selected by

MARY D. MAURY ET AL.46

Greenberg. Hence, the board lacked the element of independence that mighthave been useful in directing and assessing the company’s management andin protecting the shareholders’ interests. The board was clearly dominatedby Greenberg. Indeed, board members, as well as AIG executives andformer executives, also served on the board of Starr International, one ofthree other organizations headed by Greenberg. Starr International pro-vided a deferred compensation package to AIG executives, and when thepropriety of using Starr International as a compensation vehicle was raised,the board even declined Greenberg’s suggestion to put it to a shareholdervote (Francis & McDonald, 2005a), indicating the strength of Greenberg’sinfluence. Since the 10-K restatement, institutional investors have expressedtheir desire for AIG to reform its board with independent directors (Lubin,Langley, & Francis, 2005). Indeed, one of the proxy-advisory firms hired byAIG’s new management recommended removing 10 of the 15 board mem-bers, retaining only the new CEO, the interim Chairman, and the 3 boardmembers appointed after Greenberg’s departure (Francis, 2005a) – a rec-ommendation which AIG has not, to date, acted upon.

One reason that Greenberg may have succeeded unquestioned and un-checked in his domination of the corporate environment and the undercut-ting of balanced corporate governance at AIG is the tremendous success ofthe company. The company’s success brought praise and financial rewardsto its executives and directors, secure employment to lower level employees,and wealth to its shareholders. With such success, scrutiny by the board(and the auditors, regulators, and others) undoubtedly became lax; therewas no apparent need to be concerned for the welfare of comfortable, con-tented shareholders. The reliance on success to maintain domination with-out criticism may even have precipitated the fraudulent behavior. Aspreviously noted, there was no need to augment the company’s already goodprofits, and there was no personal gain obtained by Greenberg or otherexecutives from maintaining the stock price. In 1987, one of the factorsdocumented by The National Commission on Fraudulent Financial Re-porting (the Treadway Commission) as underlying accounting frauds was aneed to meet specific performance expectations – in this case, perhaps,Greenberg’s own preoccupation with Wall Street expectations and main-taining the ascent of his dominion.

With such a dominating CEO, the tone at the top likely permeated thecorporate culture, and the competitive tone is probably best exemplified byGreenberg’s favorite quotation, noted above. Numerous anecdotes haveappeared since the charges were released showing the encouragement ofruthless and competitive behavior by AIG’s management team. For

AIG: Accounting and Ethical Lapses 47

instance, lower level employees apparently engineered the practice of undercontributing to worker’s compensation funds and underpaying taxes onworkers’ compensation premiums, thus shifting the burden to its compet-itors and other firms. Greenberg is said to have supported the practice andlaughed at an underling’s observation that ‘‘if we were legal, we wouldn’t bein business’’ (Coy, 2005). This interchange suggests a bond among man-agement levels in a corporate community, a winning-side arrogance andsense of entitlement.

The auditors may also have been bound to the AIG community by acommon history. Five of the top executives, including the chief financialofficer, were formerly employed by PricewaterhouseCoopers (Tuckey,2005). As such, the executives certainly knew the audit procedures, possi-bly some members of the audit team, and vice versa. The possible impair-ment of independence by hiring from the audit firm is implied by itsprohibition in the Sarbanes-Oxley Act of 2002. While these events pre-datedthat law, and may not have directly affected independence, they certainlymust have contributed to the level of comfort the auditors felt with AIG,along with AIG’s size and level of success.

Even if the auditors were comfortable in the environment and lax inscrutinizing AIG’s financial reports, however, it would have been extraor-dinary for them to have missed errors of the magnitude indicated by the2004 10-K restatement. In fact, the release of this document, with its pointedaccusations, caused Greenberg to issue his own 51-page ‘‘white paper’’ thatdefends the accounting decisions made while he was CEO of AIG andasserts that they were made with the assistance and knowledge of auditorsfrom PricewaterhouseCoopers. At the same time, he accuses the currentmanagement of inflating the charges against income in the restatement inorder to make future performance look better (Francis & McDonald,2000b). Indeed, others have suggested that the ‘‘frightened AIG board’’ mayhave over-reacted to the legal actions brought by New York State AttorneyGeneral Eliot Spitzer (Melloan, 2005).

How could PricewaterhouseCoopers and AIG’s accounting and financialteam, many of whom participated in drafting the original documents, nowdecide that such a massive restatement was necessary? One problem is thatthe accounting guidelines are not specific.

Corporate accounting, contrary to popular belief, is chock-full of judgment callsy. But

most people don’t know how flexible corporate accounting can be, particularly in an

insurance companyy. Restatements in such a complex world aren’t extraordinary, for

reasons, like honest mistakes, that are not criminal in nature. Merely adjusting the

MARY D. MAURY ET AL.48

amount of earnings set aside for loss reserves – a judgment call based on guesses about

what damage the future holds – can make a world of difference (Melloan, 2005).

It is not unusual to find differences in judgment, and in the face of theallegations of fraud made against it, AIG and PricewaterhouseCoopers mayhave decided to make much more conservative choices than they did in theprevious statements. To some extent, it is credible that at least some of thealleged ‘‘accounting errors’’ represent only a difference in judgment.

It may be prudent, however, to question the use of accounting judgment.In the allegation of fraudulently reporting a transaction with General Re asreinsurence, for instance, instead of a loan, Greenberg’s ‘‘white paper’’ says:‘‘The process for determining whether a finite reinsurance contract qualifiesfor reinsurance accounting has historically been complex and highly sub-jective’’ (Parekh, 2005). It goes on to point out that even the new rules beingdiscussed by the National Association of Insurance commissioners wouldpermit AIG’s original treatment of it. Greenberg’s judgment appears to bethat if there is no ‘‘bright line’’ excluding the transaction from reinsuranceaccounting, then it should be allowed. This rules-based approach, everseeking the loophole, is exactly what the Securities Exchange Commission(SEC) has denounced in recent publications and communications with theFinancial Accounting Standards Board (FASB). The SEC has requestedthat the FASB adopt a more principles-based or objectives-based approachto setting accounting standards, so that judgment, when exercised, wouldbe to determine whether the objectives of the standard in reflectingthe economic reality are met – not to determine whether the rules aretechnically, however minimally, implemented (see, for instance, SEC, 2003).In Greenberg’s case, the transaction did not have the essential economicelements of reinsurance, including transfer of risk, so good judgment shouldhave dictated a different accounting treatment.

Certainly, PricewaterhouseCoopers auditors were familiar with the weakcorporate governance at AIG – the dependency of the board members andthe CEO’s domineering style. It would have been remarkable if they had notalso have been aware of the executives’ ability to make top-down adjust-ments, and indeed, they apparently did know about the actual exercise ofthose ‘‘overrides’’ described in AIG’s 2004 10-K but judged them to beimmaterial (Francis, 2005b). In short, the auditors knew that the means andopportunity for fraud were overtly present in the corporate environment atAIG; only the motive was absent. The apparent lack of motive, given AIG’ssuccess, seems to have hypnotized the board, the auditors, and the regu-lators into accepting accounting treatment that skimmed the ‘‘bright lines’’

AIG: Accounting and Ethical Lapses 49

of accounting rules. Whether these transgressions represent crimes, ormerely instances of poor judgment, remains to be decided by the courts.

Interestingly, in the aftermath of the furor caused by the charges beingbrought against Greenberg and AIG and the subsequent 2004 10-K re-statement, AIG is continuing to follow a rules-based approach toward re-deeming the corporate culture. That is, the company almost appears to befollowing a corporate governance checklist in developing its new CorporateGovernance Committee, a Code of Conduct, and a corporate-level compli-ance framework, as the 2005 Proxy Statement indicates. The discussion onthe improvement of the ethical climate – referred to as the ‘‘compliancefunction’’ – appears under ‘‘Regulatory Matters’’ in the new CEO’s letter tothe shareholders. However, as Verschoor (2005) points out, most of theimprovements merely bring AIG up to the minimum requirements, and infact, ‘‘AIG seems to be embracing a more ethical structure only because oflegal requirements’’ (p. 18). Falling within the ‘‘bright lines’’ of the rules willnot bring about the lasting change to its corporate culture that AIG needs.

WHAT CAN WE DO?

Avoiding future situations like the one currently unfolding at AIG – and itspredecessors at Enron, Worldcom, and the like – requires more than com-pliance with minimum standards of corporate governance after the fact. Itmay require a complete overhaul, beginning with the housecleaning andsubsequent maintenance of our corporate governance framework and thenreaching back to the beginning in the business education of our corporateleaders.

In the current post-Enron environment, companies are falling all overthemselves to hire ethics officers, announce ethics codes, set up whistle-blower hotlines, and launch ethics training. As at AIG, these efforts oftenreflect a compliance, check-box attitude toward corporate governance. In-deed, in some cases, these changes are part of deferred prosecution ar-rangements. In other cases, they stem from the 2002 Sarbanes-Oxleylegislation. More important to the overhaul of corporate governance, per-haps, is the ethics framework created by the 2004 revision of the Organ-izational Sentencing Guidelines. These guidelines say that if firms wantleniency during a prosecution, they must have an effective ethics program inplace. More fundamentally, however, the guidelines say that companiesmust create an organizational culture that encourages ethics (Kelly, 2005). In

MARY D. MAURY ET AL.50

other words, companies need a willingness to look at the culture that allowsor even encourages unethical behavior, such as that at AIG.

Almost two decades ago, the Treadway Commission outlined the com-ponents of an effective system of internal controls recognizing the criticalrole of internal controls over financial reporting. The foundation of thatframework is a strong control environment, including tone at the top.

Castellano and Lightle (2005) suggest that a cultural audit would provide ameans for assessing the tone at the top and the attitude toward internalcontrols and ethical decision-making. The authors propose that the board ofdirectors, through the audit committee, should retain an outside firm toconduct a cultural audit every three years. External auditors should includein their internal control assessments and risk management profiles a processdesigned to assess tone at the top and the resulting impact on a company’sculture. The authors cite three issues that need to be addressed:

�

the degree to which preoccupation with meeting the analyst’s expectationspermeates the organizational climate;

�

the degree of fear and pressure associated with meeting numerical goalsand targets; and

�

the compensation and incentive plans that may encourage unacceptable,unethical, and illegal forms of earnings management.

Such a cultural audit at AIG would immediately have revealed the aspectsof the corporate environment conducive to fraud. Of course, it is unlikelythat AIG would have pursued such an audit unless it were required legallyor by industry regulators. We believe that the presence of such a require-ment would make it difficult for companies to maintain a weak corporategovernance and would, in essence, force the housecleaning that may benecessary.

While immediate action is necessary to restore corporate governance, thelonger view dictates that we focus on the education of our future leaders.The recent scandals have raised a serious question about the accountingeducation that public accountants obtain. Waddock (2005) believes thatbusiness schools must focus on integrity at the individual, company, andsocietal levels – that is, on business in society, not just business in economy.She suggests that future accountants receive a ‘‘mindful accounting educa-tion’’ that includes awareness of their belief systems, consciousness of con-sequences, and the capablity of thinking broadly about the impact of theiractions and decisions. The function of accounting education should be thatethics, accuracy, and transparency are integral to accounting, not somethingto consider only when dilemmas arise. She states that it is the integrated

AIG: Accounting and Ethical Lapses 51

relationship of ethics and accounting that business schools have gener-ally failed to recognize. Further, to assume the role of a ‘‘professional,’’future accountants must assume responsibility for the welfare of others, notjust themselves. Waddock believes that accountants must be able to makedecisions based on principles and relationships – that they will not beoperating from conventional levels of moral reasoning, but from post-conventional levels that will require them to view situations from a varietyof perspectives that include all stakeholders and society as a whole (Rest,Narvaez, Bebeau, & Thomas, 1999).

Business schools have been under pressure to improve their teaching ofethics in the wake of corporate scandals over the last few years (Mangan,2004). In January 2004, business schools and the Business Roundtable, anassociation of CEOs, joined together to form a new ethics institute to behoused at the University of Virginia’s Darden Graduate School of BusinessAdministration. The independent center, the Business Roundtable Institutefor Corporate Ethics, was backed by $2.7 million from the business group;its function will be to conduct research, create courses, and lead executiveseminars on business ethics. R. Edward Freeman, the institute’s academicdirector and a leading ethics expert, argues that there is nothing new abouttoday’s corporate scandals. He believes they reflect the broad, longstandingproblem in business that managers are often judged almost completely byhow much they increase profits and add value for shareholders. The Insti-tute is a first step toward convincing business schools to take that infor-mation and overhaul their curricula, which is what is really needed.

There is some evidence that the teaching of ethics is becoming morecentral to business education. For instance, Columbia’s revamped program,The Individual, Business and Society: Tradeoffs, Choices and Accountabil-ity, is no longer a separate course with its own final and grade (Alsop, 2005).Columbia now requires its professors to weave in ethics in the content of itscore courses. The revised ethics program also features many activities out-side the classroom, such as a morality play, guest lecturers, and panel dis-cussions. Columbia claims its approach of blending ethics with socialresponsibility and corporate governance is not an attempt to teach studentsright from wrong but rather to give students strategies for protecting theirintegrity in the workplace. Harvard Business School’s new required course,Leadership and Corporate Accountability (Alsop, 2005) also places ethicswithin a larger framework, using the case-study format. The course includessections on personal values and leadership, governance issues and the legal,ethical, and economic responsibilities of companies to their stakeholders.Harvard is still committed to a stand-alone course, citing the crowding out

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of ethics discussion in management courses, and the lack of training offaculty members in ethics and law and inability to incorporate them well.

In contemplating what can be done in business education, we believe thatWaddock (2005) said it best ‘‘Until business schools teach future account-ants and leaders how deep the connections are between business, society,nature, and the world, corporations will continue to be run by hollow lead-ers who have no sense of ethics or responsibility. Accounting for perform-ance is likely to remain too narrowly focused to be helpful in today’sdemanding environment.’’

We believe that the combination of improved ethics education in businessschools and the introduction of cultural audits of businesses would have aprofound effect on improving corporate governance and decreasing the riskof fraudulent financial reporting.

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