Corporate Governance and Ethics

Chapter 11: Corporate Performance, Governance, and Business Ethics

# Stakeholders and Corporate Performance

Stakeholders are individuals or groups with an interest, claim, or stake in the company, what it does, and
how well it performs.
Stakeholders are in an exchange relationship with the company:
a. Contributions: they supply the organization with important resources
b. Inducements: in exchange they expect their interests to be satisfied
Companies should pursue strategies that maximize long-run shareholder value and must also behave in an
ethical and socially responsible manner.
# Stakeholders and the Enterprise

# Stakeholder Impact Analysis

i. Identify stakeholders most critical to survival:
a. Identify which stakeholders
b. The stakeholders’ interests and concerns
c. Claims stakeholders are likely to make on the organization
d. Stakeholders who are most important to the organization’s perspective
e. Identify the resulting strategic challenges
ii. Usually the most important:
a. Customers
b. Employees
c. Stockholders
Companies must identify the most important stakeholders and give highest priority to pursuing strategies
that satisfy their needs.

# The Unique Role of Stockholders

Stockholders are a company’s legal owners and the provider of risk capital, a major source of capital to
operate a business.
Risk capital –
No guarantee to the stockholders that:
• They will recoup their investment
• Or earn a decent return
ESOPs – Employee Stock Option Plans
Employees may also be shareholders
Maximizing long-run profitability & profit growth is the route to maximizing returns to shareholders, as
well as satisfying the claims of most other stakeholder groups.
# Profitability, Profit Growth and Stakeholder Claims
To grow profits, companies must be doing one or more of the following:
i. Participating in a market that is growing
ii. Taking market share away from competitors
iii. Consolidating the industry via horizontal integration
iv. Developing new markets through:
a. Diversification
b. Vertical Integration
c. International Expansion
Stockholders receive their returns as:
i. Dividend payments
ii. Capital appreciation in market value of shares
ROIC is an excellent measure of profitability. A company generating positive ROIC is adding to
shareholders’ equity and increasing shareholder value.
# Agency Theory
Agency relationships arise whenever one-party delegates decision-making authority or control over
resources to another.
Principal-agent relationships
• Principal: person delegating authority
• Agent: person to whom authority is delegated
The agency problem:
i. Agents and principals may have different goals.
ii. Agents may pursue goals that are not in the best interests of their principals.
iii. Agents may take advantage of information asymmetries to maximize their interests at the
expense of principals.
 iv. It is difficult for principals to measure performance.
v. Trust
vi. On-the-job consumption
vii. Empire building
# The Tradeoff Between Profitability and Revenue Growth Rates
Need to maximize long-run shareholder returns by
seeking the right balance between company growth
and profitability and profit growth.

# The Challenge for Principals

Confronted with agency problems, the challenge for principals is to:
1. Shape the behavior of agents so that they act in accordance with goals set by principals.
2. Reduce information asymmetry between agents and principals.
3. Develop mechanisms for removing agents who do not act in accordance with goals and principals.
Principals try to deal with these challenges through a series of governance mechanisms.
# Governance Mechanisms
Governance mechanisms serve to limit the agency problem by aligning incentives between agents and
principals and by monitoring and controlling agents.
1. The Board of Directors
a. Elected by stockholders
b. Legally accountable
c. Monitors corporate strategy decisions
d. Authority to hire, fire, and compensate
e. Ensures accuracy of audited financial statements
f. Inside directors
g. Outside directors
 2. Stock-Based Compensation
a. Pay-for-performance
b. Stock options:
The right to buy company shares at a predetermined price at some point in the future
3. Financial Statements
a. Auditors
b. SEC
c. GAAP
4. The Takeover Constraint
a. Limits strategies that ignore shareholder interests
b. Corporate raiders
# How Options Skew the Bottom Line

# Governance Mechanisms Inside a Company

Important agency relationships also exist between levels of management within a company. Internal
agency problems can be reduced by:
1. Strategic control systems
a. To establish standards against which performance can be measured
b. To create systems for measuring and monitoring performance
c. To compare actual performance against targets
d. To evaluate results and take corrective actions
Balanced Scorecard model approach is used to drive future performance
2. Employee incentives
a. Employee stock options and stock ownership plans
b. Compensation tied to the attainment of superior efficiency, quality, innovation, and
responsiveness to customers
# A Balanced Scorecard Approach
# Ethics and Strategy
Business ethics are the accepted principles of right or wrong governing the conduct of businesspeople.
 Ethical dilemmas occur when:
• There is no agreement over what the accepted principles are
• None of the available alternatives seem ethically acceptable
 Many accepted principles are codified into laws:
• Tort laws – governing product liability
• Contract law – contracts and breaches of contracts
• Intellectual property law – protection of intellectual property
• Antitrust law – governing competitive behavior
• Securities law - issuing and selling securities
 Behaving ethically goes beyond staying within the law
An ethical strategy is one that does not violate the accepted principles.
# Ethical Issues in Strategy
Ethical issues are due to a potential conflict between the goals of the enterprise, or the goals of the
individual managers, and the rights of important stakeholders:
i. Self-dealing: Managers feather their nest with corporate monies
ii. Information manipulation: Distort or hide information to enhance competitive or personal situation
iii. Anticompetitive behavior: Actions aimed at harming actual or potential competitors
iv. Opportunistic exploitation: Of other players in the value chain in which the firm is embedded
v. Substandard working condition: Underinvest in working conditions or pay below market wages
vi. Environmental degradation: Directly or indirectly take actions that result in environmental harm
vii. Corruption: Companies pay bribes to gain access to lucrative business contracts.
# The Roots of Unethical Behavior
Why do some managers behave unethically?
No simple answers, but some generalizations:
 1. Personal ethics code: will have a profound influence on behavior as a businessperson
2. Do not realize they are behaving unethically: by failing to ask the right questions
3. Organization’s culture: de-emphasizes ethics and considers primarily economic consequences
4. Unrealistic performance goals: encouraging and legitimizing unethical behavior
5. Unethical leadership: that encourages and tolerates behavior that is ethically suspect
# Philosophical Approaches to Ethics
Philosophical underpinnings of business ethics that can provide managers with a moral compass to help
navigate through difficult ethical issues:
1. The Friedman Doctrine
Milton Friedman’s basic position is that the only social responsibility of business is to increase
profits, as long as the company stays within the law and the rules of the game without deception or
fraud.
2. Utilitarian and Kantian Ethics
The moral worth of actions is determined by its consequences – leading to the best possible
balance of good versus bad consequences. Committed to the maximization of good and the
minimization of harm.
3. Rights Theories
Recognizes that human beings have fundamental rights and privileges. Rights establish a minimum
level of morally acceptable behavior.
4. Justice Theories
Focus on the attainment of a just distribution of economic goods and services that is considered to
be fair and equitable.
# Behaving Ethically
i. To make sure that ethical issues are considered in business decisions, managers should:
ii. Favor hiring and promoting people with a well-grounded sense of personal ethics.
iii. Build an organizational culture that places a high value on ethical behavior.
iv. Make sure that leaders not only articulate but also act in an ethical manner.
v. Put decision-making processes in place that require people to consider the ethical dimension of
business decisions.
vi. Use ethics officers.
vii. Put strong corporate governance processes in place.
viii. Act with moral courage and encourage others to do the same.
# The International Product Life Cycle

Corporate Governance and Ethics

Course Teacher: Professor Mahbub Uddin Chowdhury
Chapter 04: ETHICS AND ETHICAL BEHAVIOR

# Ethics
Ethical behavior is values-driven. What is considered ethical varies among moral reasoning approaches.
What is considered ethical can vary across cultures. Ethical dilemmas arise as tests of personal ethics and
values. People have tendencies to rationalize unethical behaviors. Ethical behavior changes over time.
What may have been considered unethical fifty years ago, may be considered ethical today. The opposite is
also true.
Ethics: A code of moral standards of conduct for what is “good” and “right” as opposed to what is “bad” or
“wrong”.
Ethical Behavior: That which is “right” or “good” in the context of governing moral code. Ethical behavior is
value-driven.
Because ethical behavior is value-driven, it is a complex subject. What is ethical to one person may not be
ethical to another. The question of “Does the end justify the means?” is key to the consideration of ethical
behavior.
# Values
Values: Broad beliefs about what is appropriate behavior.
Terminal Values: Preferences about desired end states.
Instrumental Values: Preferences regarding the means to desired ends.
# Moral Reasoning
Here are four different ways of determining whether something is right or wrong. Reasons for various
ethical practices:

# Ethics and Culture

Cultural Relativism suggests that there is no one right way to behave; cultural context determines ethical
behavior. To make matters more complex, culture place a significant role in determining ethical behavior.
What is accepted in one country may be unethical or even illegal in another.

Excerpt From Universal Declaration of Human Rights United Nations

Article 1—All human beings are born free and equal in dignity and right
Article 18—Everyone has the right to freedom of thought, conscience, and religion
Article 19—Everyone has the right to freedom of opinion and expression
Article 23—Everyone has the right to work, to free choice of employment, to just and favorable conditions
of work
Article 26—Everyone has the right to education
But there are attempts to arrive at some basic understanding as shown here.
# Ethical Dilemma
Ethical Dilemma is a situation that, although offering potential benefits, is unethical. One of the most
common ethical dilemmas occurs when a company’s culture conflicts with an employee’s personal ethics.
If you find yourself in this situation, find another company.
# Organizational Ethics Management Tips
Checklist for dealing with ethical dilemmas:
Step 1. Recognize the ethical dilemma.
Step 2. Get the facts.
Step 3. Identify your options.
Step 4. Test each option: Is it legal? Is it right? Is it beneficial?
Step 5. Decide which option to follow.
Step 6. Ask the “Spotlight Questions”: To double check your decision.
“How would I feel if my family found out about my decision?”
“How would I feel if the local newspaper printed my decision?”
Step 7. Take action.
Ethical dilemmas become more apparent when others around you are behaving in an unethical manner.
# Ethics and Work
The Wall Street Journal reports:
• 36% of workers calling in sick are lying.
• 35% keep quiet about co-worker misconduct.
• 12% of job resumes contain falsehoods.
• Managers are more likely than other workers to report wrongdoing.
• Managers with 0–3 years of experience feel the most pressure to violate personal ethics.
This is not good news. And, unfortunately, reports of unethical corporate behavior are not any better.
# Rationalizing Unethical Behavior
Four reasons:
1. “What I’m doing is not really illegal.”
2. “My behavior is in everyone’s best interests.”
3. “Nobody will ever find out what I’ve done.”
4. “The organization will protect me.”
Rationalizing does not make a wrong deed right.
# Organizational Ethics
There are many factors influencing organizational ethics.
i. Personal and contextual factors influence ethical conduct
ii. Training in ethical decision making may improve ethical conduct
iii. Protection of whistleblowers may encourage ethical conduct
iv. Managers acting as positive role models may motivate others toward ethical conduct
v. Formal codes of ethics set standards for ethical conduct
Training can help employees understand the corporate culture and expectations regarding ethical behavior
but what employees see is more important.
Organizational Ethics Training:
Ethics Training: Seeks to help people understand the ethical aspects of decision-making and to incorporate
high ethical standards into their daily behavior.
Code of Ethics: A formal statement of values and ethical standards
Spotlight Questions: Highlight the risk of public exposure of one’s actions:
“How would I feel if my family found out about my decision?”
How would I feel if the local newspaper printed my decision?
These are good gut-feel questions. If it doesn’t feel good, don’t do it.

Whistleblowers:
Persons who expose organizational misdeeds in order to preserve ethical standards and protect against
wasteful, harmful, or illegal acts are known as Whistleblowers. Many whistleblowers were/are fired for
their actions. State and federal laws now offer some protection. Whistleblowers face a very difficult
situation. Many are fired or put in meaningless positions.
Management Behavior:
In order to have a positive impact on ethical conduct throughout an organization, those at the top must
walk the talk. Management behavior is the most important determination of employee behavior.