Question

1. You are working as a financial analyst at a brokerage firm and a colleague says to you “the Potts Corporation had a return on equity (ROE) of 20% last year. We should recommend the stock to our clients.” How would you respond to your colleague? (Note: Your response for this question should be no more than 100 words)
   
2. A corporation’s earnings and associated ratios, such as earnings per share, are metrics that investors and other stakeholders use when making decisions. The SEC recently began investigating corporations for manipulating earnings via rounding errors. In the early 2000s, it became clear that corporation’s rarely missed earnings estimates provided by financial analysts. Offer your opinion on the ethics underlying these practices, any possible broader implications of such behavior, and any real-life experiences you may have come across that are similar.
   • See Assigned Readings “Related to agency theory and the goal of financial management”

PLEASE GIVE AN ORIGINAL ANSWER DO NOT COPY AND PASTE FROM OTHERS

Answer 1

1. The RoE of 20% is not sufficient information to recommend the stock to the clients as the figure of RoE is also industry dependent. It might be that other stocks in this industry might have a higher RoE. Also, RoE in itself is not that great an indicator without having extra data because of leverage. The firm might have a high debt on their balance sheets which might result in a higher RoE.

2. The corporation not missing the analysts estimates suggests that there is some sort of collision or manipulation in place. This is not an ethical behavior on the part of the corporations as they are supposed to give a clear picture of the earnings and the performance of the company as they are serving the shareholders. There is an element of trust involved between the shareholders and the management and being involved in such practices is a violation of that trust.