Ethics Case 14 8 Hunt Manufacturing Debt for equity swaps have your cake and eat it too LO5 The cloudy afternoon mirrored the mood of the conference of division managers Claude Meyer assistant to the controller for Hunt Manufacturing wore one of the gloomy faces that were just emerging from the conference room Wow I knew it was bad but not that bad Claude thought to himself I don t look forward to sharing those numbers with shareholders The numbers he discussed with himself were fourth quarter losses which more than offset the profits of the first three quarters Everyone had known for some time that poor sales forecasts and production delays had wreaked havoc on the bottom line but most were caught off guard by the severity of damage Later that night he sat alone in his office scanning and rescanning the preliminary financial statements on his computer monitor Suddenly his mood brightened This may work he said aloud though no one could hear Fifteen minutes later he congratulated himself Yes The next day he eagerly explained his plan to Susan Barr controller of Hunt for the last six years The plan involved 300 million in convertible bonds issued three years earlier Meyer By swapping stock for the bonds we can eliminate a substantial liability from the balance sheet wipe out most of our interest expense and reduce our loss In fact the book value of the bonds is significantly more than the market value of the stock we d issue I think we can produce a profit Barr But Claude our bondholders are not inclined to convert the bonds Meyer Right But the bonds are callable As of this year we can call the bonds at a call premium of 1 Given the choice of accepting that redemption price or converting to stock they ll all convert We won t have to pay a cent And since no cash will be paid we won t pay taxes either Required Do you perceive an ethical dilemma What would be the impact of following up on Claude s plan Who would benefit Who would be injured Ethics Case 14 8 Yes the ethical dilemma is Hunt Manufacturing is attempting to cover up their poor fiscal performance by entering into these transactions without the considerations of economic reasoning They are playing with the company s numbers in attempt to fool their Shareholders potential Shareholders and creditors Thus making their company look more profitable and stable then it really is They are making their company look better by calling in their Bonds knowing that the current Bondholders will not want the 1 callable redemption price thereby choosing the convertible stock option The company managers stand to benefit by the higher profits no out of pocket expense for the conversion and zero tax liability Also by playing with the bottom line Meyer Barr managers employees and Hunt s auditors all stand to gain by making the company look financially sound However the real losers in this scenario are the Bondholders Shareholders Potential shareholders and creditors Because they are being misled into thinking that the company is doing better than it really is They are being willfully deceived