Case For Ethical Behaviour And Stakeholder Orientation Business Essay

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Stakeholders are defined as any group or individual who can affect, or is affected by, the achievement of an organisation's purpose. Stakeholders include shareholders, employees, consumers, competitors, unions and suppliers. Wang and Dewhirst (1992) show that ‘distinct groups of stakeholders are perceived by boards of directors and that they are prioritised in the following way; customers, government, stockholders, employees and society'.

Those board members who operate the business day to day, such as the CEO, have a definite ‘default' stakeholder orientation; Greenley & Foxall, (1997) demonstrate ‘that consumers are prioritised as the most important stakeholder group'. Wang and Dewhirst (1992) show that CEO and non CEO directors have differing priorities; specifically CEO directors see the government and customer groups of stakeholders as more important. The clear message here is that CEOs and other directors are aware of the need to satisfy more than one group of stakeholders.

Corporate financial performance may be measured explicitly in terms of return on equity (ROE) or return on assets (ROA). Corporate social performance is more challenging to measure, but the idea is a powerful one and allows us to consider how well an organisation deals with social and ethical issues. Deckop et al (2006) give the following definition: ‘Corporate social performance is essentially an organisation's response to expectations and demands of social responsibility'.

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Old economy businesses, which include stable manufacturing and raw material extraction operations, are often driven by underlying economic performance to such an extent that they can ‘perform well while paying limited attention to the interests of their stakeholders' (Greenley & Foxall, 1997). However, new economy businesses that must compete on more than scope and scale economies have their competitive advantages eroded quickly and as a result must compete on many fronts, including the ethical dimensions of business. The new economy businesses that are networked and global are typically service industry businesses and their reliance on human and social capital, which are influenced by issues like corporate social performance, means that an engagement with the ethical dimensions of business and a stakeholder orientation are significantly more important than for old economy businesses.

The hard line - Shareholder wealth

Boards of directors can, and have, taken the hard line approach favoured by CEOs like Jack Welch. The hard line approach is that the only objective of a for profit business is to maximise return to shareholders and that other stakeholders' interests take a back seat. The general caveat to this is that the interest of customers and the government must be served first in order to allow a return to shareholders. This view has driven successful businesses for many decades, such as General Electric during the Jack Welch era, and would seem applicable to many old economy businesses.

The view that the objective of a business is to maximise shareholder return is well evidenced by the short term behaviour of listed businesses. Investors expect returns from equity stakes in a business in the form of dividends and capital gains. If businesses do not deliver these cash flows, the market capitalisation will reduce and a large part of the manager's compensation will be withheld. As a result, managers will take decisions that ensure returns to shareholders.

The view that ethical initiatives, such as corporate social responsibility, must add value to the business, or must prevent at least as much value being destroyed if it were not implemented, is the typical take on the ethical dimensions of business. Initiatives, such as reducing CO2 footprint through reducing gas and electricity consumption, directly lower operating costs and enhance the net present value of the business.

The real dangers for boards that take this approach is that they will be left behind by those in their peer group that do advance ethical issues and engage with stakeholders, or that their business may attract unwanted legal attention - especially if they are the worst in the peer group.

A case for ethical behaviour and stakeholder orientation

Boards need to be aware that there are many business cases for engaging with the ethical dimensions of a business. These include avoiding potential regulation, creating a barrier to market entry for competitors and risk management. These initiatives can enhance the value of a business and allow a higher level of corporate social performance to be achieved. These initiatives are not incompatible with maximising shareholder wealth, indeed, Moneva et al (2007) show that ‘by generating value for the different stakeholders, value is also generated for the shareholder'.

Avoidance of regulation

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An example of avoiding regulation is provided by the recent partnership between Nokia, Ericsson and other mobile phone manufacturers to produce a universal mobile phone charger. They are addressing the problem that people amass a large number of incompatible phone chargers within a few short years, wasting resources and producing excessive waste. This partnership is intended to head off the engagement of the EU in more heavily regulating the mobile phone market.

There are industries that should comply with advancing regulation. Examples include the aerospace electronics industry, which has so far been exempt from the environmental regulation of RoHS, REACH and WEEE levied at the consumer electronics industry. Businesses that consider current compliance with environmental megatrends and future compliance with new regulations can realise a source of competitive advantage over their competitors. Airbus has been engaged in a pilot aircraft and avionics recycling programme that is intended to provide a competitive advantage in the longer term. This project is aimed at the environmentally concerned ‘customers' customer'.

Capturing a negative externality

A business can use ethical issues and a stakeholder orientation to out manoeuvre the competition. A large number of businesses externalise some costs on society: this is beneficial to the business as the benefit is localised within the business, while the costs are diffused within society. To behave more ethically, a business could include the cost of a traditional negative externality in its operating costs. Carefully communicated, this will help to create a source of competitive advantage when compared to the competition that may still be externalising on society. Marks & Spencer has introduced a scheme where it charges for carrier bags, with the aim of spending the money gained to redress the damage done by using oil to produce these carrier bags. This has prompted the competition to launch similar schemes to reward customers for using fewer bags, for example Tesco's green club card points, but the issue of the externality remains.
Shareholder differentiation

Just as businesses choose their customers through processes like market segmentation, it is possible to differentiate the business through ethical business practices so that specific types of investors are attracted to the listed equity of the business. Stocks are often split along dimensions including dividend payout and growth. In a similar manner, investment funds that specialise in ethical investments are now available and will wish to identify equity ownership opportunities along an ethical dimension. Ethical companies should look for the shareholders who want to share in their long term plans and by careful analysis of stakeholders and PEST drivers, corporate social performance can be managed to create competitive advantage. While the Co operative is a partnership business model, it attracts and retains partners through a green image that extends from groceries to financial products.

Pitfalls of a Stakeholder orientation

Boards of directors need to be aware that engagement with stakeholders is not always a straightforward and value enhancing process, there are pitfalls to be avoided and issues to consider.

Limited engagement

Certain businesses may choose not to engage with all stakeholders due to the cost or capability of doing so. ‘Some companies may be unable to address all these interests, owing to a scarcity of resources', (Greenley & Foxall, 1997). An example of this behaviour would include the BAA owned Heathrow airport. The business has to remain profitable and needs to address stakeholders including the local community on issues such as the reduction of noise pollution and night flights, however the airport is unable to engage with more hard line green campaigners who would rather see runways shut and expansion plans blocked. The cost of engaging with these stakeholders would put the airport into a loss making situation.

Strategic contradiction

Engaging with certain stakeholders may appear to be at odds with a stated strategic intention. It important for businesses to engage in a thorough stakeholder analysis to ensure damage will not be done by engaging with some stakeholders or by ignoring others. Greenley & Foxall (1997) state that, ‘failure to address this range of interests may be detrimental to the achievement of an organisation's purpose and performance'. A possible emerging example of this behaviour might be the Nationwide Building Society which has started to offer 125% mortgages to those customers with negative equity, who wish to move house. Engaging with the customer stakeholder group in such a way may prove to be at odds with the stated strategic intention of ‘maximise value for our members over the long term, in terms of pricing benefit and retained profits' (Nationwide, 2009); especially if interest rates rise as many predict they will during a period of deflation.

Philanthropy

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When engagement with the ethical dimensions of business turns to philanthropy or charity, there is a strong case for drawing a line in the sand. Investors are usually rational and follow a process of diversification based on portfolio theory. Rose (2004) explains that

‘If all investors are rational and follow efficient portfolio theory, we should see that dominant shareholders are rare in large companies as the investor will choose to diversify to reduce risk.'

As a result there are many shareholders in listed companies, and it is unlikely that their charitable interests will align. Rose (2004) continues:

‘If the proportion of shareholders who does not share the organisations charitable purpose is high, management should refrain from such an action in the first place. Instead the company should distribute its proceeds to the individual shareholders who afterwards have the possibility to donate the proceeds to the organization they prefer the most.'

As a result, businesses should look to maximise shareholder wealth by addressing the needs of stakeholders, so far as it adds value to the business and hence enhances shareholder wealth. This process is known as “strategic stakeholder management” and it identified by Berman et al (1999) who state that ‘with strategic stakeholder management, firms address stakeholder concerns when they believe doing so will enhance firm financial performance'.

Organisational moral development

Boards of directors who decide to take a greater interest in ethical issues and a stakeholder orientation need to turn to a framework or model to understand what stage the business is at in terms of its moral development, and how to take the business moral development forward. Logsdon & Yuthas (1997) suggest a framework for developing and monitoring a business's behaviour that is based on Kohlberg's theory of moral development. This framework could be used by boards of directors to show the intent of the business and to help the business to lead its peer group in terms of corporate social performance. This would be particularly appealing to investors and employees who want to be stakeholders in a business that is more than simply profit focussed.

This framework is ideal for understanding the business and identifying any gap between current and wanted levels of ethical behaviour. Logsdon & Yuthas (1997) propose that ‘how the organisation views its goals and relationships to various stakeholders is an important indicator of its moral development, just as the moral development of individuals is indicated by whether and how they take others into account'.

The idea that companies can gain a competitive advantage by rejecting self interested behaviour, and instead taking a more ethical approach, is not new in business. This behaviour is illustrated by the Toyota production system, where Toyota will work with partners to reduce costs through knowledge sharing, instead of simply chasing the lowest bidder at contract renewal. Short sighted and self interested behaviours only add value in the short term, and do not allow for the sustainable competitive advantage demonstrated by Toyota.

As ‘the primary force in determining the level of moral development is the set of ethical expectations held by top management', (Logsdon & Yuthas, 1997), the board of directors and management must influence organisational culture by handling situations in a more measured way and ensuring a balanced outcome for all.

The CEO and a stakeholder orientation

A board of directors needs to be aware of the orientation of the CEO. How the CEO views stakeholders and the ethical dimensions of business is absolutely key, as without the CEO's support, any stakeholder orientation or ethical initiative will be flawed. It is possible to motivate the CEO appropriately by aligning his or her interests with those of the board.

Engaging in costly exchanges with stakeholders and ethical initiatives ‘may represent an opportunity cost for the CEO' Deckop et al (2006). These costs may distract the CEO from maximising the short term performance of the business. In order to ensure that the CEO's interests are aligned with ethical behaviour and engagement with stakeholders, the CEO's pay package should be biased towards rewarding long term performance rather than short term. This idea is consistent with the findings of Deckop et al (2006) who note that ‘the more firms have a short term focus on CEO pay, as measured by the percentage value of bonus in the total pay package, the less the firm's CSP' and that ‘long term pay focus provides incentive for CEOs to engage in CSP.'

Stakeholder orientation and the ESCO model

Boards of directors can understand strategic alignment by using the ESCO model. This model requires that strategy must be aligned to the environment, the strategy should be supported by the right competencies and the business should have the right organisational configuration to deliver the strategy. The impact of boards of directors dealing with ethical issues and a stakeholder orientation are readily applicable to this framework.

Environment

The environment has a great influence on what is expected from a business. The government and society at large have expectations of ethical performance that go beyond laws, which often dictate only the minimum acceptable standard. For a business's strategy to align with the environment, it is critical that the strategy address the needs of the stakeholders in the business as far as is practical. The competitive environment plays a large part in the degree to which a stakeholder orientation must be followed, as in boom times it may be possible to perform well while neglecting stakeholders to some degree. However, during times of recession, it is more important that relationships with key stakeholders are strong, as the business may need their support.

Recently British Airways announced that it had asked staff to work for a month without pay. The move did not attract widespread support from staff and their failure must, to some degree, have been influenced by the poor relationship that BA has with its unions and staff. The relationship may have been soured by the way in which BA dealt with the problem of staff taking too many sick days.

Complimenting competencies

If a company develops a competency in aligning itself with the needs of its stakeholders, then it will benefit from a competitive advantage over the competition that may not pursue this competency. When an industry has a high environmental velocity, typical advantages, such as innovation, may be more commonplace and more exotic advantages, such as a strong stakeholder orientation, may allow a business to achieve higher performance.

Organisation - cultural dimensions

The organisation is influenced by the manner in which the board of directors and the senior management team make decisions. An organisation's culture may in part be driven by these influences and, as a result, when the board and the senior management team display an ethical approach to business, so does the workforce. This cultural influence will support a stakeholder strategy and, provided this is aligned with the environment, the business will be better placed and regarded more highly on ethical dimensions than its competitors.

The implementation of CSR strategies and the incorporation of changes into corporate culture are positive for the firm's performance. A corporate culture that is strong and committed to certain social and ethical values, can attract and maintain the best employees, increase productivity, create a better reputation and avoid legal infractions, (Moneva et al 2007).

Ethics in a high performance culture

Leaders can shape organisational culture through their actions over time. A high performance culture is aligned with the organisational strategy and, if the board and senior management wish to instil a stakeholder orientation in the culture, they must empower the workforce to behave more ethically through their own actions.
Leaders can shape culture by configuring performance management and can show how they prioritise stakeholders through resource allocation decisions. In addition to this, ethical behaviour during crisis management and criteria for hiring and firing can play a large part in influencing a culture that considers all stakeholders.
Logsdon & Yuthas (1997) support this assertion: ‘Managerial expectations are conveyed to other members of the firm, and thus eventually embodied in organisational moral norms, through the organisational processes of strategic formulation, distribution of resources and power, employee socialization, and reward systems.'
Berman et al (1999) go further than this. They state that: ‘Relationships with stakeholders have a direct impact on financial performance' and that ‘stakeholder relationships and resource allocation decisions are inseparable, because how managers distribute resources inevitably has implications for the strength of stakeholder relationships.' For these reasons, a culture that is aligned with a strategy that includes a stakeholder orientation is key for enhancing the business performance above and beyond that of the peer group.

Changing culture

Changing culture is a complex challenge as it involves many groups of people including cynics, supporters, champions and detractors. Change requires that these groups of people travel along the change curve through the stages of optimism, shock, resistance, acceptance, exploration and finally commitment. Different groups of stakeholders will progress along the change curve at different speeds, as their view on the required changes will be different. In times of change, actions speak louder than words and boards must communicate their cultural change message by example.

The agency problem

A final consideration for the board of directors is the implication of agency theory. Shareholders hire boards of directors to oversee the senior management of the business and so need to be aware of this relationship and its implications if they are to successfully monitor senior management. An agency relationship exists when shareholders, as a principal, hire managers as their agents. In this agency relationship, a risk bearing specialist and a managerial decision making specialist enter into an agreement. The problem is that the desires and goals of the principal and agent are conflicted, and it is known to be difficult to verify appropriate behaviour.

Deckop et al, (2006) state that: ‘Agency theory provides a theoretical basis with which to describe the potential divergent and convergent interests between CEOs and other stakeholders and predict how this affects CSP.' Deckop et al, (2006) find evidence to support the predictions of agency theory: ‘Our research has demonstrated the relevance of agency theory in predicting management pursuit of CSP'. However Wang and Dewhirst (1992) show that, ‘contrary to agency theory, there is little difference between executive and non executive director's attitudes towards stock holders'. This calls into question the applicability of agency theory, specifically that it may too narrow to apply to the study of corporate boards.

Conclusion

The hard line view that shareholder wealth should dominate the strategy and culture of a business at the expense of other stakeholders is outdated and short sighted in the modern world. Both old and new economy businesses need to be aware that taking a stakeholder orientation and dealing sensitively with ethical issues is required if they are to compete with and potentially beat their peer group.

Strategic stakeholder management, where shareholder wealth is maximised through addressing the needs of stakeholders so far as it adds value, is advised as a minimum requirement for all businesses.

Differentiating the business on ethical and stakeholder issues and competing against your peer group on this basis is a valid approach and requires a well thought out and communicated strategy for doing so. This could involve capturing negative externalities, leading the charge with initiatives that head off potential regulation or marketing the business as an ethical investment opportunity.

Boards must be aware of the potential pitfalls of taking a strong stakeholder orientation; these include charity and philanthropy for publicly traded businesses and engaging with stakeholder groups that will destroy the value generated by the business.

It is important to remember that ‘what gets measured, gets managed' (Moneva et al, 2007) and that the CEO must be correctly incentivised to ensure the success of any ethical or stakeholder orientation initiative.

Boards of directors can use the ESCO model to conduct analysis of the ethical aspects of the business and the stakeholders that need to be engaged with. In parallel with this, the moral framework suggested by Logsdon & Yuthas will assist the business in identifying how the business needs to develop its organisational morality.

If the board decides that a culture change is required in order to behave more ethically and engage with appropriate stakeholders, then the way in which board decisions are made must reflect the desired culture. This must flow down to the senior management team who must lead through example and ensure that any culture change is effectively managed to ensure that no group of people are left behind doing things the old way.

References

[1] Berman, S. Wicks, A. Kotha, S. Jones, T. (1999) ‘Does Stakeholder Orientation Matter? The Relationship between Stakeholder Management Models and Firm Financial Performance' The Academy of Management Journal, Volume 42: pp. 488 506

[2] Deckop, J. Merriman, K. and Gupta, S. (2006) ‘The Effects of CEO Pay Structure on Corporate Social Performance' Journal of Management, Volume 32: pp 329 341

[3] Greenley, G. Foxall, G. (1997) ‘Multiple Stakeholder Orientation in UK Companies and the Implications for Company Performance' Journal of Management Studies Volume: 32 pp 259 - 284

[4] Logsdon, J. Yuthas, K. (1997) ‘Corporate Social Performance, Stakeholder Orientation, and Organizational Moral Development' Journal of Business Ethics Volume 16: pp 1213 - 1226

[5] Moneva, J. Rivera Lirio, J. Munoz Torres, M. (2007) ‘The corporate stakeholder commitment and social and financial performance' Industrial Management & Data Systems Volume 107: pp 84 102

[6] Nationwide Building Society. (2009) ‘Investor Relations - Strategy'
http://www.nationwide.co.uk/investorrelations/strategy/default.htm

[7] Rose, C. (2004) ‘Stakeholder Orientation vs. Shareholder Value - A Matter of Contractual Failures' European Journal of Law and Economics Volume 18: pp 77 97

[8] Wang, J. Dewhirst, H D. (1992) ‘Boards of Directors and Stakeholder Orientation' Journal of Business Ethics Volume: 11, pp 115 - 123