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How should corporate boards deal with trends favouring an engagement with the ethical dimensions of business and stakeholder orientation, and with any potential tensions of this engagement with shareholder returns. Illustrate your analysis with recent specific examples
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This essay explores the role of the board, different stakeholder perspectives on ethics and offers practical insights for handling them.
Shareholders are significant stakeholders that expect higher returns on their investment than with risk free savings. Yet organisations cannot exist in isolation; operate without employees or acceptance by broader society. This human dimension periodically conflicts with the wealth creation objective. Employees and society are also important stakeholders, holding different perspectives.
Milton Friedman (1982) Edward Freeman (1984)
The only group with a moral claim on the corporation is the people who own shares of the stock (shareholders) Many groups have a moral claim on the corporation that derives from the corporation’s potential to harm or benefit them (stakeholders)
Freeman et al (2007)
The dominance of investor rights, the diminishment of good, moral decisions question if we should consider value systems when assessing a business decision. The focus is on the conflicting demands of labor, government, investors, and managers in the hopes of resolving the ‘inherent’ conflicts. As such, one group must dominate in order to win.
Stakeholders’ contradictory values require consideration by the CEO to select an appropriate strategic path.
Stakeholder Group Interests Ethical Dimension
Managers Power, prestige, compensation, legacy Potential conflicts of interest with shareholder value
Service, product quality, value
Not taking defective product to market
No price fixing, participating in cartels, no misleading advertisements
Security of capital
CEO may pursue overseas expansion policy putting funds at risk for unknown returns
Regular payments, continuity of business
Avoidance of paying or soliciting bribes. Policy on acceptance of gifts.
Shareholders Dividends, Capital growth, safe Short term vs. long term strategy. Returns from low cost countries may be through exploitation
Government Taxes, Employment Tax avoidance schemes. Corruption in developing nations may require payment of “facilitation” fees
Society No harm to employees. Employment. Preservation of environment Movement of jobs to low cost countries and ensuring health and safety practices followed even if country has lower standard.
The CEO/management team are also stakeholders. Thus, tensions exist between the management and the governance board, which have a fiduciary duty to the principals (shareholders). The Board performs due diligence to ensure the appointed executive managing the firm acts appropriately in the interests of shareholders. An agency problem, where the goals of the shareholders (maximising returns) and the (management) agent are in potential conflict is challenging for the principals to confirm the agent is acting appropriately. E.g. the CEO wishes to pursue an ethical approach in the supply chain that costs more than the current standard, that shareholders find unattractive due to lower returns. A strong board could experience tensions in power and influence such that non executive directors use their position to balance control in the interests of shareholders. The board’s ability to replace the CEO is the ultimate threat, which should also ensure compliance with any ethical code. A firm with good governance wouldn’t combine the roles of Board Chairman and CEO, due to conflict of interest. Non profit organisations without shareholders also balance stakeholder concerns.
Ethics, the moral principles that guide organizational behaviour are an area where a strategic choice can be made to be a leader (active stance) or merely respond to legislation (passive). It’s the purview of management to determine the ethical position. The organization develops a code to support the practice. The ethical stance is likely to lead to diverse stakeholder opinions. For the ethical standard to be meaningful, performance should be measured. Business results still matter but so do how they were achieved. The emergence of the triple bottom line concept, which states that measures of Corporate Social Responsibility (CSR) should be included equally with financial and other performance indicators has highlighted the ethical position of firms.
Concerns about shareholder value have begun to influence major strategic choices, and not always to the good.
While it’s reasonable that shareholders expect a return on their investment, many are short term holders looking for quick returns. With CEOs under pressure to produce immediate results, fundamentally conflicting values emerge within the company’s stakeholders. An ethical stance could cost more through sustainable sourcing, investing in people and supporting auditing procedures. The additional expense burden may be considered too high in the current challenging economic climate. Abandoning ethical principles could be costly if Governments/trade associations levy fines for standards violations or adverse publicity results in loss of sales.
Application of the Environment Strategy Competencies Organisation (ESCO) framework, Heracleous (2009), identifies potential stakeholder tensions around ethical issues, which will be discussed later.
Political Increasing legislation on pollution & advertising. Standards for minimum wages and safety.
Social Growing concern for quality of life creates pressure to reduce exploitation and conserve the environment/resources.
Increasing number of pressure groups representing under privileged groups with special interests.
Economic Globalisation of companies requiring many to operate in developing countries.
New technologies alter working practices such as automation reducing manual labour but balanced against employment loss.
Low cost Outsourcing/off shoring to low cost countries requires thorough audit to meet ethical standards
Differentiation Marketing ethical products at a premium requires rigorous compliance programme. Higher standards may apply to belong to “ethical” funds or associations
Cost control Ethics as core value helps appreciate customer perspective. Ethical position may be higher cost
Process Procedures, checklists or guidance on ethical issues available and training to support
Seek synergies with ethical dimensions
Culture Embed values in organisation stories, management living the values. Align reward system with ethical results
People Selection and retention through ethical values. Board competent to challenge management
Holistic personnel development
Structure Ethics officer role, decisions on how to operate overseas may be influenced by level of control
Society expects organizations not to harm employees or the environment.
For profitability in the current business situation, organizations can’t afford to have an ethical image at odds with the values of contemporary society. It’s good for business to take ethical positions, which can directly influence consumers and also indirectly shape government perceptions of the industry to help avoid legislative hindrances. Porter’s (1985) bargaining power of consumers and suppliers of labour, are increasingly influenced by ethics. An ethical approach to employment through non discrimination and fair pay assists in the attraction and retention of talent that avoids further associated costs.
As ethics involves exercising judgement it’s not easy to teach. Paine (2000)
For many, “running the numbers” is a more enjoyable type of mental activity than deliberating about the issues. As the less favored cognitive capacities fall into disuse, they can be expected to deteriorate.
This makes it harder for board directors to make sound decisions and also for firms to train personnel and codify. Yet this complexity is no excuse for not trying.
The firm may target the ethically/socially aware consumer segment. Firms with high active engagement are considered “ethical organizations” where their philosophy drives both what the company does and how it achieves it. This requires commitment to high standards, rigorous training and monitoring/publishing of data. Management evaluates the advantages of this approach and determines if it’s appropriate for the business. There may be significant consequences for failure to deliver potential loss of status in “ethical” funds with associated loss of investment and potential decrease in market capitalisation. Some ethical funds use shareholder pressure to bring about changes in company policy. Usually an active screening process will remove organizations from the fund that have behaved negatively with respect to core values such as corruption or exploitation.
There are different ways to take stakeholder views into consideration when making company decisions and it would be advisable to have principles to guide the process.
Power brings influence, so large multinational companies in particular have high ethical/social impact. This can be harnessed as a force for good. However, whether it is the role of organisations is debatable. Increasingly consumers and businesses prefer to purchase from organisations with high ethical standards. Trudel and Cotte (2009) found
• consumers with high existing ethical expectations will allow a greater price premium
• punishment is greater than the premium prepared to pay
• companies needn’t be 100% ethical to be rewarded
Organisations pursuing an ethically responsible differentiation strategy could market at premium price provided consumers are educated about those products. Certain consumer groups may push for the entire range to be ethical which may increase costs or otherwise prove challenging. Equally consumer expectations may shift and force 100%.
At lower levels, management should enforce the ethical principles that have been set. There are two possible approaches: through compliance or integrity (value) based. Managers should explain the position with respect to issues that employees are likely to face like accepting gifts that may be deemed inducements. If employees believe their ability to do their job is negatively impacted they might not support the principles. The organisation ought to ensure rewards align with desirable behaviour and there are consequences for non compliance.
Exploration of ethical issues
When short term shortages exist, such as with swine flu medication an ethical debate for management may surface as to whether to exploit the situation and request higher prices. However, pharmaceutical companies elected not to, as they position themselves, as highly ethical and apparent profiteering from vulnerable people would contradict their stated values. Public sensitivity to drug pricing is high. Yet pharmaceutical companies choose to obey the letter of the law with respect to low cost generics rather than its spirit, which allows them to continue to reap high financial returns for modest payoffs. While they claim to use the revenue for further research it’s arguably at odds with the greater benefit of society not all stakeholders are equal.
As part of its drive to cut health care costs, the Obama administration wants to stop payments pharmaceutical companies make to generic drug makers to delay the launch of cheap copies. Drug companies have successfully argued in court that their patents allow them to make the deals.
Conformance with legislation is expected. Companies that violate rules are rightly punished. Pharmaceutical companies could find the Obama response is more severe than the prior value of legal compliance.
There are obvious ethical issues associated with advertising to children. Other marketing issues that may stimulate debate between management and the board are withholding information that may adversely influence purchase decisions or handling unhealthy products.
The Independent (2009)
French government bans all advertising of mobile phones to children under 12 is announced by the Environment Minister, and he will ban the sale of any phone designed to be used by those under six.
The majority of children in Western society have mobiles and many firms have used “pester power” to their advantage. The introduction of legislation confirms society’s distaste for the practice and good boards should have used environmental scanning to see this trend emerge, proactively determine a favourable company stance and if necessary challenge management executives on their policy. Failure to clean up one’s own area can lead to harsher standards when Governments are forced to act.
The firm should recognise the importance of satisfying different stakeholders but agree that customers are vital, as it costs less to retain customers than to attract them. Reichheld (1994) found a 5% increase in customer loyalty led to significant increases in profits (25 100%) through further purchases and recommendations, providing a cost effective marketing advantage. A strong ethical stance could be a strategic lever to generate consumer loyalty. Innovations that are more environmentally friendly or ethically based are key for future success to align with society’s expectations and could also be a source of competitive advantage. Ethics may become a tiebreaker between competitors so companies need to understand key customer values that drive purchase decisions. Ultimately consumer pressure may require ethical standards to become a core business driver rather than representative of the philanthropic values of the company.
Tobacco firms have been heavily criticised for their advertising. BAT has gone beyond the requirements of legislation in many countries and is proud of their stance as evidenced on their website.
If a business is managing products which pose health risks, it is all the more important that it does so responsibly.
Our International Marketing Standards (IMS) set down detailed guidance on all aspects of tobacco marketing. Central to the IMS is our long held commitment to ensuring that no marketing activity is directed at, or particularly appeals to, youth. The IMS are globally applicable. Adherence by our companies forms part of our regular internal audit process. We publicly report any instances of incomplete adherence each year.
The Co operative website declares
While other retailers have recently discovered the commercial benefits of an ethical approach to business, our beliefs define who we are. We’re proud that our ethical approach started in 1844 when the Rochdale Pioneers established a set of values and principles in response to a society that was being exploited.
Understandably the co op is the UK’s longest supporter of Fairtrade products. Fairtrade ensures producers operate sustainably and applies a premium for investment in education healthcare or farm improvements. UK Fairtrade sales have increased 4267% since 1998. (Fair trade website). The Co op also offers banking, which operates ethically including its investment portfolio. They experience little conflict between stakeholders’ positions as they trade on their philosophy.
The Guardian reported Primark fired three of its Indian clothing suppliers after discovering they were using child labour to work long hours in poor conditions. Many organizations are pursuing cost cutting in the current economic climate. However, there are clearly ethical and monitoring issues related to outsourcing to low cost countries. Global trading now impacts even minor purchasing decisions. Financial concerns like tax efficiency and lower overheads are increasingly becoming a more important element of competitive (cost reduction) strategy. This puts pressure on management to ensure such sourcing is conducted to appropriate standards and a robust audit programme exists for overseas subcontractors. With management from a distance there are options for visibility and control.
The debate to exercise a high degree of control in local markets may mean elevated costs associated with establishing a subsidiary or joint venture. As the higher costs of ethical control may not be in the best financial interests of shareholders this conversation may reach the Board for discussion of congruence with the financial position and overall strategy. In some countries managers preferentially employ family members. From an ethics perspective employment should be offered to the best qualified candidate.
It can readily be envisaged that managers put pressure on employees to meet targets and this may give rise to ethical dilemmas. The tensions that arise could be simply whether to lie about the reason for a late delivery to appease a client. However, honesty is what most people desire and forcing this issue could damage the company reputation if it later came out, but is also likely to demoralise employees such that they disengage in other aspects of their work, standards fall and higher costs ensue. The board would want evidence that management are fostering the correct approach in the culture of the organisation so access to reports is fundamental.
Mintzberg (1983) viewed shareholders’ control as inadequate as they are usually passive. However, Shell shareholders voted against the company’s executive pay plan (BBC 2009). This increased shareholder activism was prompted by poor performance and high executive rewards were inappropriate in such circumstances. The board should have a compensation committee to recommend appropriate levels and be cognisant of public opinion. Stakeholders, including some shareholders consider excessive pay unethical.
Guardian (Dec 2008) Siemens
Ex chairman and chief executive Heinrich von Pierer is under heavy suspicion of failing to stop the bribery when he and his board were informed. He has consistently denied any knowledge of corruption.
Without naming names, the DoJ/SEC findings point the finger at the former board for failing in its fiduciary duties. Siemens is already demanding compensation from 11 former executives.
as part of the US settlement, Siemens made Theo Waigel, former German finance minister, its first “compliance monitor”.
At Siemens organisational culture permitted participation in bribery as an acceptable standard of conduct. There was insufficient influence from the board to fully embed an ethical stance in the processes or daily culture. Nor did the board or management set an appropriate tone as a cultural reference point. The board had an obligation to prevent illegal practices. They should have realised the risks of non compliance and sought pertinent information if it was not offered. Siemens should have had a compliance role at senior management level. There is less flexibility in the response when it’s mandated than had they been proactive. The board didn’t effectively monitor management on behalf of shareholders or evaluate the CEO’s performance in an honest and open manner. As CEO and chairman roles were combined one person had a high degree influence. While this may have made it harder to challenge him they should have used their legitimate powers to do so. They failed the interests of shareholders and didn’t perform their fiduciary role, which is serious dereliction of duty. Further they ignored their role of understanding and determining strategic risks and ensuring compliance with laws and regulations. Siemens competed aggressively and unfairly with their competitors. They risked Government intervention to free markets and financial loss.
As illustrated the introduction of a code of ethics is not sufficient by itself to encourage ethical behaviour. Senior management should positively support a cultural change to foster the appropriate values, patterns of thinking and behaviour.
As McKinney and Moore (2008) attest:
The mere existence of written codes of ethics cannot be expected to be the answer to the international bribery problem. Ethical behavior must be modeled in the corporation from the top down so that it permeates the entire organization.
Organizations should utilise HR practices to recruit /select for promotion people who model the correct values, provide further training and align incentives to objectives around ethics. In extreme cases they may need to discipline people for non compliance. BP reports how many employees it has fired for violations.
In some countries gifts/incentives to companies or government officials are prevalent. Even in civilised societies like Japan use gifts but a policy will help prevent confusion. Bribery, extortion and facilitation fees are more clearly delineated as unethical conduct. Firms need to determine their level of engagement, which may acknowledge it, exists and try to change practice from within or avoid altogether. Head office has to set the tone for overseas managers who may feel they should adopt the local custom because they see it as acceptable through continued exposure.
Telegraph Mabey website
Mabey & Johnson plead guilty to 10 charges of corruption and violating sanctions.
The company tried to influence officials in Jamaica and Ghana when bidding for public contracts. It also paid more than €422,000 to Saddam Hussein’s regime.
Mabey & Johnson faces fines and will make reparations to Jamaica, Ghana and a UN programme which benefits Iraq. It has agreed to an “internal compliance programme” carried out by an “SFO approved independent monitor”.
The SFO’s director said: “These are serious offences and it is significant that Mabey & Johnson has co operated with us to get to this landmark point.
“This …is a model for other companies who want to self report corruption and have it dealt with quickly and fairly.” Peter Lloyd, (new) managing director, said: “We deeply regret the past conduct of our company, and we have committed to making a fresh start.”
Staff have been retrained and sales and associated systems reviewed.
The move follows the company’s voluntary disclosure to the SFO of evidence that it may have engaged in corrupt practices. The information came to light in the course of an internal investigation by the company’s solicitors.
Five of Mabey & Johnson’s eight directors have stepped down since spring 2008 when the company told the SFO of the corruption offences.
Excerpt from their code of ethics:
policy not to offer, give or accept bribes, excess hospitality or substantial favours
Failure to align with the environment is a common mistake evidenced by Siemens and Mabey. Secondly the organisational elements of process, structure and culture are critical factors where misalignment highlights ethical tokenism saying one thing but rewarding another. Kerr (1975) found people respond to what they think others value so hoping for a positive outcome while rewarding contrary behaviour is a mismatch. Organisational culture can seriously undermine strategy and the pursuit of ethical objectives. If the reward system doesn’t encourage ethical conduct and managers or board turn a blind eye to conduct in order to achieve business objectives its no surprise that employees follow suit.
The company’s strategic direction could incorporate an ethical position that becomes a differentiator. As value drivers are different for the various points on the ethical continuum, management makes conscious trade off decisions in selecting a particular strategy, which may be dependent on firm specific factors and their core competencies. There is also a balancing of ethics and economic logic. Innovation to meet new regulations or ethical demands by consumers can mean better products and services are developed, providing a competitive edge. Technology now exists to recycle rubber from training shoes into playground flooring.
Conformance with legislation is the minimum expectation and companies that violate the rules increasingly face more acute and vocal penalties for unethical conduct such as disruption of shareholder meetings.
Successful companies with formal ethics rankings have codes of conduct, CSR/ethics officers, demonstrate management support and publish results on the company scorecard (e.g. Boots). Practical checklists would be helpful for employees to record decisions and also enable effective monitoring to take place.
Good governance requires moral fibre and mental fortitude to make difficult judgment based decisions. Boards are accountable and need to use their powers to enforce the appropriate actions. Companies could seek compensation for board failures to act so the acceptance of the role comes with responsibilities. Good stewardship of the company’s ethical integrity is an important board role.
Boards should proactively engage in strategic decisions, overseeing compliance and fulfilling their obligations. In addition, a mitigation plan to deal with disclosure of unethical behaviour is beneficial. Boards should take immediate action on any violations and review the circumstances for lessons learned. Scenario planning could identify possible scandals so boards can prepare how to respond while maintaining the highest ethical position possible. In Siemens’ case they were defensive, reactive, and slow, taking action after the public were aware. Conversely at Mabey they uncovered the issue themselves through audit, contacted the authorities and took a proactive stance using their website to communicate the issue and resolution. They even obtained valuable 3rd party endorsement for their actions from the Serious Fraud Office, who held them up as an example.
Boards reviewing strategic choices need access to data and useful tools. They should use their legitimate authority to request information if it’s not forthcoming. As well as investigating misalignments highlighted in an ESCO model the board are advised to apply the Cultural Administrative Geographic Economic (CAGE) distance framework (Brennan 2009) to proposals for operating overseas. This tool highlights the types of issues to be encountered and shows risks that might otherwise be overlooked in a traditional country portfolio analysis. The Board could then determine if operating in the proposed country is economically viable and doesn’t compromise their ethics position. Detailed economic analysis may be required as overseas financial rewards are often over estimated the costs of corruption could offset lower production costs.
Hills, G; Fiske,L & Mahmud, A (2009)
Corruption adds expense throughout the corporate value chain and can lead to costly operational disruptions. Current studies suggest corruption adds more than 10 percent to the cost of doing business in many countries, and that moving business from a country with low levels of corruption to a country with medium to high levels is equivalent to a 20 percent tax.
Cultural Administrative Geographic Economic
Diverse ethnic backgrounds in workforce potential discrimination issues.
Society norms do not include basic safety or hygiene factors.
Child labour prevalent
Gifts accepted practice Political ambivalence may require organisation to pay “facilitation fees”
Remoteness and time differences may risk diluting organisation’s values
Different attitudes to quality more likely to approve defective or dangerous products.
Higher costs of training employees in developing nations to internal standards. Higher potential for fines with less educated workforce
With so many aspects to ethics a critical limitation of this review is the range of dimensions covered.
The role of the board in oversight of organizations is critical to ensuring shareholders interests are appropriately reflected amongst diverse stakeholder views. While there may be some tensions, increasingly opinion on ethical issues is aligned and organizations are expected to operate to a moral code. Ethics are context specific as countries have different standards. Judgment on ethical issues isn’t easy. Hence ethics programmes should cover overarching principles, and firms should have processes to train personnel and monitor results. Over time society’s values can change and new trends emerge, so environmental scanning is important for all strategic positioning, including ethics. Boards should review this information and management’s perspective on what opportunities these conditions create to set strategic direction. The pressure to perform financially has adversely influenced ethical decision making and embedding an ethical philosophy within the organisation is challenging, yet brings significant rewards.
Bartlett CA, (1990), Facing up to Complexity, McKinsey Quarterly, Spring pp27 35
Brennan (2009) Warwick MMBA Strategy & Practice course notes delivered June 8 12.
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