Lee Adsitt and Alex Wiren were best friends at a small undergraduate college and they fought side by side in the jungles of Vietnam. On returning to the United States, they went their separate ways to pursue MBA degrees, Lee to a prestigious East Coast business school and Alex to an equally prestigious west Coast school. However, 40 years later, their paths crossed again.
By 2003, Alex had become president and CEO of Hayden Electronics after 15 years with the firm. Lee had started working for American Airlines, but had left after 9 years to start his own firm, Adsitt Transport. In April 2008, Adsitt Transport was near bankruptcy when Lee approached his old friend for help. Alex Wiren answered his friend’s call, and Hayden Electronics bought 19% of the stock of Adsitt Transport.
In 2013, Adsitt was financially stable and Hayden was struggling. In fact, Alex Wiren thought his job as CEO might be in jeopardy if Hayden did not report income up to expectations. Late in 2013, Alex approached Lee with a request—quadruple Adsitt’s dividends so Hayden could recognize $760,000 of investment income. Hayden had listed its investment in Adsitt as an available-for-sale security. Although Adsitt had never paid dividends of more than 25% of net income, and it had plenty of use for excess cash, Lee felt a deep obligation to Alex. Thus, he agreed to a $4 million dividend on net income of $4.5 million.
1. Why does the dividend policy of Adsitt Transport affect the income of Hayden Electronics? Is this consistent with the intent of the accounting principles relating to the market and equity methods for intercorporate investments? Explain.
2. Comment on the ethical issues in the arrangements between Lee Adsitt and Alex Wiren.