Media One owns 15% of the voting shares of Online Inc. The remainder of the Online shares are held by numerous investors with small holdings. Austin Cohen, president of Media One and a member of Online's board of directors, heavily influences Online's policies.
Under the fair-value method of accounting for investments, Media One's net income increases as it receives dividend revenue from Online. Media One pays President Cohen a bonus, computed as a percentage of Media One's net income. Therefore, Cohen can control his personal bonus to a certain extent by influencing Online's dividends.
A recession occurs in 2014, and Media One's income is low. Cohen uses his power to have Online pay a large cash dividend. The action requires Online to borrow in order to pay the dividend.
Requirements
1. In getting Online to pay the large cash dividend, is Cohen acting within his authority as a member of the Online board of directors? Are Cohen's actions ethical? Whom can his actions harm?
2. Discuss how using the equity method of accounting for investment would decrease Cohen's potential for manipulating his bonus.