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Introduction to Business Ethics

James Fieser University of Tennessee at Martin

Alexander Moseley

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James Fieser

Alexander Moseley

Introduction to Business Ethics

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Chapter 1: Ethical Principles and Business Decisions . . . . . . .1

Chapter 2: Capitalism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27

Chapter 3: Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .55

Chapter 4: Consumers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83

Chapter 5: Discrimination in the Workplace . . . . . . . . . . . . .111

Chapter 6: Employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .137

Chapter 7: Financial Ethics . . . . . . . . . . . . . . . . . . . . . . . . . . .165

Chapter 8: International Business and Multinationals . . . .187

Chapter 9: Environmental Issues . . . . . . . . . . . . . . . . . . . . . .211

Chapter 10: Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .237

Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .255

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .267

Brief Contents

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About the Author xv

Acknowledgments xvii

Preface xix

chapter 1 Ethical Principles and Business Decisions 1

1.1 Introduction 2

1.2 Where Moral Values Come From 3 Moral Objectivism and Moral Relativism 4 Religion and Morality 5

1.3 Ethics and Psychology 7 Egoism and Altruism 7 Gender and Morality 8

1.4 Moral Standards 9 Virtues 10 Duties 11 Utilitarianism 13

1.5 Morality and Government 15 The Social Contract 15 Human Rights 17 Principles of Governmental Coercion 19

1.6 Conclusion 21

Summary 22 Discussion Questions 23 Key Terms 24

Contents

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CONTENTS

chapter 2 Capitalism 27

2.1 Introduction 28

2.2 Capitalism and Socialism Defined 29 Capitalism 29 Socialism 31

2.3 Adam Smith’s Capitalism 33 Selfish Desire for Luxury Goods 33 The Invisible Hand 34 Limited Role of Government 36

2.4 Karl Marx’s Socialism 37 Alienated Labor 37 Class Struggle 39 Revolution 40

2.5 Assessment of Capitalism and Socialism 41 Criticisms of Capitalism 42 Criticisms of Socialism 42 Moderate Versions 43

2.6 Anticompetitive Practices 44 Monopolies and Oligopolies 44 Price Fixing, Bid Rigging, and Price Gouging 46

2.7 Regulating the Free Market 47 Reasons for Government Regulation 47 Mechanisms for Government Regulation 49

Antitrust Acts 49 The Federal Trade Commission (FTC) 49

2.8 Conclusion 50

Summary 51 Discussion Questions 52 Key Terms 52

chapter 3 Corporations 55

3.1 Introduction 56

3.2 The Nature of Corporations 57 Corporate Structure 57 Four Features of Corporations 58

Creation by Statute 58

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CONTENTS

Perpetual Existence 59 Recognition as Legal Persons 59 Limited Liability 60

Shell Corporations 60 Moral Agency of Corporations 61

Position 1: Corporations Can Be Genuine Moral Agents 62 Position 2: Corporations Cannot Be Moral Agents 62 Issues at Stake 62

3.3 Punishing Corporations 63 Six Types of Corporate Punishment 63

Fines 64 Equity Fines 65 Corporate Incapacitation 65 Corporate Death Penalty 65 Corporate Shaming 66 Community-Service Order 66

Federal Sentencing Guidelines 67 Consumer Retaliation 67

3.4 Ethical Corporate Culture 69 Stakeholders and Corporate Social Responsibility 69 Mission Statements and Codes of Ethics 71

3.5 Threats to Ethical Corporate Culture 74 The Profit Motive 74 Strategic Misrepresentation 76 Groupthink and Organizational Schizophrenia 77

Groupthink 77 Organizational Schizophrenia 78

3.6 Conclusion 79

Summary 79 Discussion Questions 80 Key Terms 81

chapter 4 Consumers 83

4.1 Introduction 84

4.2 Consumer Advocacy 85 History of Consumer Advocacy 85

Governmental Agencies Established 86 Responding to Business Conduct 87 Consumer Bill of Rights 87 Consumer Product Safety Commission 88 U.N. Guidelines for Consumer Protection 88

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CONTENTS

4.3 Product Safety 89 Safety and User Reviews 89 Unsafe Automobiles 91

Ralph Nader and the Chevrolet Corvair 92 The Ford Pinto 92

4.4 Deceptive Advertising 94 Deceptive Food Packaging 96 Deception Versus Puffery 97 Punishment for Deceptive Advertising 98

Unofficial Punishment 98 Official Punishment 99 Corrective Advertising 100

4.5 Targeting Vulnerable Groups 101 Child Advertising 102

4.6 Unfair Sales Tactics 104 Misuse of Legal Tactics 105

Sales Commissions 105 Direct-to-Consumer Advertising 105 Default Opt-In 106

4.7 Conclusion 107

Summary 108 Discussion Questions 109 Key Terms 109

chapter 5 Discrimination in the Workplace 111

5.1 Introduction 112

5.2 Discrimination 113 Features of Discrimination 113 Social Institutions and Discrimination 114 Types of Discrimination 114 Evidence of Discrimination 115

5.3 Affirmative Action 117 Features of Affirmative Action 118

Preferential Treatment 118 Compensation for Discrimination 119

Arguments for Affirmative Action 120 Helps Create Fairness 120 Helps Reduce Poverty 121 Helps Reduce Racism 121

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CONTENTS

Arguments Against Affirmative Action 121 Creates Reverse Discrimination 121 Creates Social Tension and Negative Attitudes About Minorities 122 Exceeds Sufficient Nondiscrimination Without Preferential Treatment 123

5.4 Affirmative Action in U.S. Law 123 Two Laws and Two Governmental Agencies 124

Enforcing Title VII and Executive Order No. 11246 125 Protected Classes and Minorities 125

Compliance Guidelines and Plans 126 Supreme Court Cases 128

5.5 Conclusion 131

Summary 132 Discussion Questions 133 Key Terms 133

chapter 6 Employees 137

6.1 Introduction 138

6.2 Ethical Theories of Employment 139 The Capitalist View 139 The Socialist View 140 The Middle Ground: Virtue Ethics 140 Employment and Social Power Conflicts 141

The Case of Company Towns 142

6.3 Hiring and Firing 143 Interviews 144

Unstructured Versus Structured Interviews 145 Background Checks 146 Due Diligence 147 Negligent Hiring 148

Firing 148 Employment at Will 149

6.4 Wages 149 Fair Pay 150 Minimum Wage 150 Salary Caps 151

6.5 Working Conditions 152 Occupational Health and Safety 152 Understanding Hazards 153

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CONTENTS

6.6 Unions 154 History of Unions 154 Professional Unions 156

6.7 Whistleblowing 157 Types of Whistleblowing 157 Whistleblowing Guidelines 158 Whistleblowing Laws 159

The False Claims Act of 1863 159 The Whistleblower Protection Act of 1989 160 The No FEAR Act of 2002 160

6.8 Conclusion 160

Summary 161 Discussion Questions 161 Key Terms 162

chapter 7 Financial Ethics 165

7.1 Introduction 166

7.2 The Ethics of Accounting 167 Impartiality 168 Berle and Means Versus Henry Manne: Two Views of Corporate Corruption 168

Berle and Means: We Need Regulation 169 Manne: The Marketplace Can Decide 169

Cooking the Books 170 Example of Cooking the Books: Computer Associates 171 Example of Cooking the Books: Enron 171

Transfer Pricing and Costing 172 The Ethics of Deception 173 U.S. Accounting and Reporting History 174

Early Reforms 175 Sarbox 175

7.3 Commercial Conflicts of Interest 175 The Buyer-Beware Principle 176 Complex Products 176 Should Customers Do Their Homework? 177

7.4 Insider Trading 178 Insider Trading Defined 178 Examples of Insider Trading 178

Example of Getting Away with Insider Trading: Vincent Chiarella 178 Example of Insider Trading: Michael Milken and Ivan Boesky 179 Example of Insider Trading: Martha Stewart 179

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CONTENTS

The Free Market Perspective 180 An Issue of Fairness 181 Legal Theory of Misappropriation 181

7.5 Rogue Trading 182 Example of Rogue Trading: Nick Leeson 183 What Can Be Done? 184

7.6 Conclusion 184

Summary 185 Discussion Questions 185 Key Terms 186

chapter 8 International Business and Multinationals 187

8.1 Introduction 188

8.2 Tax and Environmental Issues 189 Multinationals and Tax Avoidance 189 Gift Giving and Bribery 190 Environmental Restrictions 191

8.3 Labor Issues 193 Child Labor 193

A Historical Perspective 193 Protecting Children 194 In Defense of Children’s Right to Work 195 Won’t Child Labor Just Disappear? 195

Sweatshops 196 A Historical Note 196 The Benefits of Sweatshops 197

Illegal-Immigrant Workers 198

8.4 Technology Issues 199 Intellectual Property Theft 199 Technological Transfers 200

8.5 Ethically Evaluating Multinational Business Activities 201 Relativism: Western Cultural Norms Affecting Other Cultures 201

Ethical Imperialism 202 Pros and Cons of Multinational Businesses 203 Creating a Global Business Ethic 205

8.6 Conclusion 207

Summary 207 Discussion Questions 208 Key Terms 208

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CONTENTS

chapter 9 Environmental Issues 211

9.1 Introduction 212

9.2 Environmentalist Ethics 213 Economic Growth and Environmental Damage 213

Mastering the Planet 213 Destroying the Planet 214

Varieties of Environmentalist Positions 214 Free Market Response to Environmentalism 216

9.3 Pollution 217 The Right to Trade in Emissions 218

Emissions Regulations 218 Does Emissions Trading Work? 218

9.4 Habitat Destruction 219 The Environmentalist Critique 219 The Regulatory Response 221

The Organic Act of 1897 221 The National Forest Management Act of 1976 222

Privatizing Government Lands 222

9.5 Resource Depletion and Sustainability 224 Peak Oil 224 Should Consumers Change Their Behavior? 224

9.6 Global Warming/Climate Change 226 Problems with the Science 226

Environmentalist Claims 227 Free Market Response 227 Could Businesses Lead the Way? 227

Alternative Energy Sources 228 Nuclear Energy 228

9.7 Environmental Restriction Versus Economic Freedom 229 U.S. Laws Restricting Access 230 Private Trusts Restricting Access 230 The Problem of the Beautiful Valley 230 Cost-Benefit Analysis of Environmental Responsibility 231 Social and Private Costs 232

9.8 Conclusion 233

Summary 234 Discussion Questions 234 Key Terms 235

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CONTENTS

chapter 10 Investments 237

10.1 Introduction 238

10.2 Ethical Investing 239 Features of Ethical Investing 239 Sustainable Investing 240 Community-Development Financing 240 Impact Investing 241 Socially Responsible Investing Funds and Green Funds 242

10.3 Potentially Unethical Investments 243 Environmentally Damaging Products 243 Genetically Modified Foods 244 Pharmaceutical Products 245 Military Weapons 247

10.4 Investing Versus Spending 250 The Economic Harm of Hoarding 250 Does Investment Harm Recession Recovery? 251

10.5 Conclusion 252

Summary 252 Discussion Questions 253 Key Terms 253

Glossary 255

References 267

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Dr. James Fieser is Professor of Philosophy at the University of Tennessee at Martin. He received his BA from Berea College, and his MA and PhD in philosophy from Purdue University. He is author, co-author, or editor of ten textbooks, including Socrates to Sartre and Beyond (9/e 2012), Ethics: Discovering Right and Wrong (7/e 2012), Business Ethics and the Bottom Line (2012), A Historical Introduction to Philosophy (2003), and Moral Philosophy through the Ages (2001). He has edited and annotated the ten-volume Early Responses to Hume (2/e 2005) and the five-vol- ume Scottish Common Sense Philosophy (2000). He is founder and general editor of the Internet Encyclopedia of Philosophy website (www.iep.utm.edu). His personal website can be accessed at www.utm.edu/staff/jfieser.

Dr. Alexander Moseley earned his degrees in England, Ontario, and Scotland and was an Assis- tant Professor in Economics for the University of Evansville before setting up a tutorial company in the English Midlands. He is the author of several books, including An A–Z of Philosophy, Intro- duction to Political Philosophy, and A Philosophy of War. He has published papers in the field of military ethics and on the philosophy of John Locke and is an active member of military ethics societies in Europe. He is currently working on a third novel and expanding his business so he can one day open up an independent school.

About the Author

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In the preparation of this book, we wish to thank Steve Wainwright, Shannon LeMay-Finn, Daniel Moneypenny, and the rest of the talented editorial staff at Bridgepoint Education for their exper- tise and good nature. Thanks also to the following Ashford professors who made valuable sugges- tions for improving the book manuscript: Carolyn Broner, Frank Czarny, Anthony Biduck, Richard Hassler, Stephen Carter, and Ronald Cubit.

Acknowledgments

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Businesses are among the most important institutions that we have. They are responsible for making our lives happy with products that we could never acquire on our own. They give us jobs that help define who we are as people. And, more generally, they push society forward through cultural advancement.

But there is a sinister side to the business world, where a company might do anything in its power, moral or immoral, to beat the competition and make profits. It is the same insatiable drive for money that fuels society’s progress yet at the same time oppresses workers, misleads consum- ers, destroys the environment, and cannibalizes the very economy that gives it life. By ignoring its good, we fail to give credit to the driving force that pulled humans out of the Stone Age. But by ignoring its bad, we unleash a conscienceless predator upon society. This is a real life drama that we all witness and participate in as workers, consumers, and entrepreneurs. The task of business ethics is to understand that drama and suggest ways to maximize the good and minimize the bad.

Discussions of business ethics are exceptionally varied. Some approaches are theoretical and explore the nature of ethical obligation, human greed, and the limits of economic freedom. Other business ethics discussions are more concrete and, like a social scientist, attempt to itemize and describe the numerous types of questionable business practices that have outraged society. There are deceptive advertising, price fixing, and unsafe working conditions, just to name a few. In many ways, the heart of business ethics involves identifying and describing the most common unethical practices. By knowing concretely what these various areas of concern are, we may be more alert to abuses when we enter into those territories on the job.

Still other discussions of business ethics emphasize specific cases in which businesses have notori- ously gone astray, such as the Union Carbide chemical plant explosion in India, the Exxon Valdez oil spill in Alaska, and the Enron financial collapse. We learn by example, and when we see dramatic instances of corporate moral failure, the stories stick with us.

Finally, there are business ethics discussions that offer practical advice for avoiding unethical busi- ness decisions. For example, we might learn that apathy toward society promotes governmental intervention, or that heavy pressure from top management to meet performance goals sets a climate for illegal action. The practice of drawing a moral conclusion at the close of a business ethics discussion is itself a skill that everyone in business can and should learn. Here is an area of corporate abuse: What can we learn from it to help us avoid going down that path?

Preface

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PREFACE

This book adopts all of these approaches. The first three chapters are more theoretical, establish- ing a broad framework of ethical and social concepts. Specifically, they deal with ethical principles, capitalism, and the corporation. The three next chapters focus on business issues that affect peo- ple individually: specifically, as consumers, as minorities who might face discrimination, and as workers. From here, the scope of the chapters broadens to include internal practices of finance, accounting, and investment. The scope widens further with chapters on multinationals and the environment.

Throughout this book, the discussions reflect an appreciation of the free market system, what it has done to advance both the personal lives of people and civilization as a whole. At the same time, though, it exposes how unethical business practices can transform a beneficial social institu- tion into one that can potentially cause great harm and human suffering. As ethical people, we must respect the rights and dignity of those around us, and this is the fundamental moral lesson that children learn from their parents right from the start. As ethical business people, we must continue that lesson regarding how we treat consumers, coworkers, and society at large. That, ultimately, is what it takes for a business to be ethical.

To be sure, many business ethics issues covered in this book are hotly debated, such as the nature of capitalism, corporate personhood, and worker’s rights. However, these debates teach us that some of our most important social and economic values may not be as firmly established as we might think, and we must show respect toward those on the opposite side of the issue. We can- not be good business colleagues—or good citizens for that matter—if we are contentious on value issues where reasonable people may disagree.

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Ethical Principles and Business Decisions

Learning Objectives

After completing this chapter, you should be able to:

• Describe moral objectivism, moral relativism, and divine command theory. • Explain the theories of psychological egoism and psychological altruism, and the relation between gender and morality.

• Explain how virtue theory, duty theory, and utilitarianism provide standards of morality. • Describe the relation between morality and government in social contract theory, human-rights theory, and the four principles of governmental coercion.

Comstock

1

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CHAPTER 1Section 1.1 Introduction

Chapter Outline

1.1 Introduction

1.2 Where Moral Values Come From

Moral Objectivism and Moral Relativism Religion and Morality

1.3 Ethics and Psychology

Egoism and Altruism Gender and Morality

1.4 Moral Standards

Virtues Duties Utilitarianism

1.5 Morality and Government

The Social Contract Human Rights Principles of Governmental Coercion

1.6 Conclusion

1.1 Introduction Some jobs have higher moral reputations than others, and national surveys are routinely con- ducted to reveal public attitudes about various professions. One poll asked people to rate the honesty and ethical standards of people in different fields (Jones, 2010). The results of the survey were as follows (the numbers indicated the percentage of those surveyed who ranked the respec- tive vocations very high in terms of honesty and ethical standards):

Nurses: 81%

Military officers: 73%

Druggists, pharmacists: 71%

Grade school teachers: 67%

Medical doctors: 66%

Police officers: 57%

Clergy: 53%

Day care providers: 47%

Judges: 47%

Auto mechanics: 28%

Nursing home operators: 26%

Bankers: 23%

TV reporters: 23%

Newspaper reporters: 22%

Local officeholders: 20%

Lawyers: 17%

Business executives: 15%

State officeholders: 12%

Advertising practitioners: 11%

Members of Congress: 9%

Lobbyists: 7%

Car salespeople: 7%

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CHAPTER 1Section 1.2 Where Moral Values Come From

There is a clear pattern here. The highest ranking professions involve helping people, and nurses, who are at the very top, are clear examples. Among the lowest ranking occupations are those associated with the business world: bankers, business executives, advertisers, and, at the very bottom, car salespeople.

What is it that makes us have such low opinions of the moral integrity of the business world? Part of it may be that, in contrast with nurses, businesses have the reputation of caring only for them- selves and not for others. Part of it may also be that the competitive nature of business pushes even the most decent of people to put profits above responsibility to the public. The concept of business ethics is by no means new; in fact, some of the earliest written documents in human civilization wrestle with these issues. The Mesopotamian Code of Hammurabi, from almost 4,000 years ago, had this to say about the responsibility of building contractors:

If a builder build a house for some one, even though he has not yet completed it; if then the walls seem toppling, the builder must make the walls solid from his own means.

. . .

If a shipbuilder build a boat for some one, and do not make it tight, if during that same year that boat is sent away and suffers injury, the shipbuilder shall take the boat apart and put it together tight at his own expense. (trans. 1915 by L. W. King, sections 233 and 235; see http://www.fordham.edu/halsall/ancient/ hamcode.asp#text)

This entire book is devoted to understanding the ethical challenges that businesses face and what can be done to meet those challenges. In this chapter, we will explore several basic and time- tested principles of morality. Some of history’s greatest minds have reflected on the nature of morality and devised theories of where morality comes from and how moral principles should guide our conduct. Many of these principles have direct application to ethical issues within busi- ness, and we will explore that connection.

1.2 Where Moral Values Come From A good definition of ethics is that it is an organized analysis of values relating to human conduct, with respect to their rightness and wrongness. Ethics is not the same as etiquette, which merely involves customary codes of polite behavior, such as how we greet people and how we seat guests at a table. The issue in ethics is not what is polite, but what is obligatory. Ethics is closely related to morality, and although some ethicists make subtle distinctions between the two, they are more often used interchangeably, as will be done throughout this book.

One of the most basic ethical issues involves an understanding of where our moral values come from. Consider the moral mandates that we should not kill, steal, or lie. Are these universal and unchanging truths that are somehow embedded in the fabric of the universe, or are they change- able guidelines that we humans have created ourselves to suit our needs of the moment? The question of where our moral values come from often involves two issues: The first is a debate between objectivism and relativism, and the second concerns the relation between morality and religion. We will look at each of these.

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CHAPTER 1Section 1.2 Where Moral Values Come From

Moral Objectivism and Moral Relativism

Some years ago, the Lockheed Corporation was caught offering a quarter of a billion dollars in bribes overseas. A major U.S. defense contractor, Lockheed fell on economic hard times. The U.S. government commissioned the company to design a hybrid aircraft, but after one crashed, the government canceled orders. Because of this and other mishaps, Lockheed believed that the solu- tion to its financial woes was to expand its aircraft sales into foreign countries. To get military aircraft contracts with foreign governments, it made a series of payoffs to middlemen who had political influence in West Germany, Japan, Saudi Arabia, and several other countries. The com- pany was eventually caught and punished with a heavy fine, and its chairman and president were forced to resign. A consequence of this event was the creation of the U.S. Foreign Corrupt Prac- tices Act, which includes an anti-bribery provision that involves stiff fines and prison terms for offenders. The message of the law was that, when in Rome, you should not do as the Romans do. There are overarching standards of ethical conduct that business are expected to follow, regard- less of where they are in the world and what the local business practices are there.

When Lockheed engaged in systematic bribery, did it violate a universal standard of morality that is binding on all human societies, or did it just violate a standard of morality that is merely our personal preference in the United States? On the one side of this question is the theory of moral objectivism, which has three key components:

1. Morality is objective: Moral standards are not created by human beings or human societ- ies. According to many objectivists, they exist in a higher spirit realm that is completely apart from the physical world around us.

2. Moral standards are unchanging: Moral standards are eternal and do not change throughout time or from location to location. No matter where you are in the world or at what point in history, the same principles apply.

3. Moral standards are universal: There is a uniform set of moral standards that is the same for all people, regardless of human differences like race, gender, wealth, and social standing.

The classic champion of this view is the ancient Greek philosopher Plato (424 BCE–347 BCE), who argued that moral truths exist in a higher level of reality that is spiritual in nature. According to Plato, the universe as a whole is two-tiered. There is the lower physical level that consists of rocks, trees, human bodies, and every other material object that we see around us. All of this is constantly changing, either decaying or morphing into something else. Within this level of the universe, nothing is permanent.

On the other hand, Plato argued, there is a higher level of the universe, which is nonphysical and is the home of eternal truths. He called this the realm of the forms, which are perfect pat- terns or blueprints for all things. Mathematical principles are good examples. They are completely unchanging and in no way dependent for their existence on the changing physical world. Even if the entire physical universe were destroyed, and another emerged, the principles of mathematics would remain the same, unchanged.

According to Plato, moral principles are just like mathematical principles in that respect, and they also exist in the higher realm of the forms. Just as the principle that 1 + 1 = 2 exists perma- nently in this realm, so too do moral principles of goodness, justice, charity, and many others. The greatest appeal of Plato’s theory is that it gives us a sense of moral stability. When someone is murdered, we often believe that an absolute and unchanging moral principle has been violated

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CHAPTER 1Section 1.2 Where Moral Values Come From

that goes well beyond the shifting preferences of our particular human community.

On the other side of this dispute is the theory of moral relativism, which has three contrasting key features:

1. Morality is not objective: Moral standards are purely human inventions, created by either individual people or human societies.

2. Moral standards are not unchanging: Moral standards change throughout time and from society to society.

3. Moral standards are not universal: Moral standards do not necessarily apply universally to all people, and their application depends on human preference.

Defenders of moral relativism are typically skeptical about the existence of any higher realm of absolute truth, such as Plato’s realm of the forms. Although notions of eternal moral truths are appealing, the fact is, says the moral relativist, we do not have any direct experience that such higher realms exist. What we know for sure is the physical world around us, which contains societies of human beings that are ever- changing. The moral values that we see throughout these societies are ones that are created by human preference and change throughout history and with geographical location. Simply put, morality is a human creation, not an eternal truth.

Between moral objectivism and moral relativism, which is right? Some philosophical questions are not likely to be answered any time soon, and this is one of them. However, we can take inspira- tion from both sides of the debate. With the Lockheed bribery incident, the position of the U.S. government was that there is a standard of integrity in business that applies worldwide, not just within U.S. borders. This is a concession to moral objectivism. On the other hand, some business practices are culturally dependent. In Japan, new businesses typically have an opening ceremony in which a Shinto priest blesses the company building. U.S. companies operating in Japan often follow this practice, and this is a concession to moral relativism.

Religion and Morality

An organization called the Center for Christian Business Ethics Today offers a Christian approach to ethical issues in business. According to the organization, God is the ultimate source of moral val- ues: “God’s standards as set forth in God’s Word, the Bible, transcend while incorporating both the law and ethics” (Center for Christian Business Ethics Today, n.d.). This view is by no means unique, and is in fact part of a long history of efforts to ground morality in some aspect of religion. Accord- ing to the classic view of religious ethics, true morality does not emerge from human thought processes or human society alone. It begins with God establishing moral truths, instilling moral

Associated Press/Jim Mone

Many hospitals have password protected medication cabinets to prevent drug theft. But is stealing always wrong? Would your answer change if you knew the person stealing the drug needed it for her cancer treatment? What if she were stealing it for her child?

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CHAPTER 1Section 1.2 Where Moral Values Come From

convictions within human nature, and reinforcing those moral truths through scripture. Religious believers who follow God’s path will be motivated to follow God’s established moral truths, per- haps more so than non-believers who view ethics as a purely human invention. This classic view of religious ethics raises two questions:

1. Is God the creator of moral values? 2. Do religious believers have better access to moral truth than non-believers?

Regarding the first question—whether God creates moral values—a position called divine command theory answers yes: Moral standards are created by God’s will. God in essence creates them from nothing, not even basing them on any prior standard of reason or logic. God pronounces them into existence through a pure act of will. There are two challenges that divine-command theory faces:

1. It presumes in the first place that God exists, and that is an assumption that non-believers would reject from the start. Many religious believers themselves would hold that belief in God is a matter of personal faith, not absolute proof, and so we must be cautious about the kinds of activities that we ascribe to God, such as creating absolute moral truths.

2. The moral standards that God willfully creates would be arbitrary if they were made purely from scratch, without relying on any prior standard of reason. What would pre- vent God from willfully creating a random set of moral values, which might include prin- ciples like “lying is OK” or “stealing is OK”? God could also willfully change his mind about which moral principles he commands. Maybe he could mandate that stealing is wrong on Monday, Wednesday, and Friday, but that stealing is OK during the rest of the week.

Many ethicists throughout history—even ones who were devout religious believers—have rejected divine command theory for this reason. To avoid arbitrariness, it seems that morality would need to

be grounded in some stable rational standard, such as with Plato’s view of absolute moral truths. That is, God would merely endorse these absolute moral truths since they seem rationally compelling to him; and he does not literally create them from nothing. If moral- ity, then, is really grounded in preexisting truths, then we humans can discover them on our own, and do not need to depend on God for our moral knowledge.

Again, the second question raised by the classic view of religious ethics is whether believers have better access to moral truth than non-believers. The answer to this throughout much of history was yes: Religion is an essential motivation for moral conduct. To behave properly, people need to believe that a divine being is watching them and will punish them in the afterlife for immoral conduct. The French moral philosopher Vol- taire (1694–1778) famously stated that “if God did not exist, it would be necessary to invent him,” precisely because moral behavior depends so much on belief in divine judgment (quoted in Gay 1988, pg. 265). In more recent times, this position has fallen out of favor, and there is wider acceptance of the view that believ- ers are not necessarily more moral than non-believers.

Copyright Bettmann/Corbis/AP Images/Anonymous

Voltaire (1694–1778), the French philoso- pher who famously stated that “if God did not exist, it would be necessary to invent him.”

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CHAPTER 1Section 1.3 Ethics and Psychology

One reason for this change in attitude is that our society as a whole has become much more secularized than Voltaire’s was, and, from our experience, non-believers do not appear to be par- ticularly bad citizens. Also, it appears that believers fall into the same moral traps as everyone else.

The upshot is that both components of classic religious ethics are difficult to establish: It is not clear that God creates moral values, assuming that God exists, and it is not clear that believers have a special advantage in following moral rules. It is undeniable that, for many believers, religion is an important source of moral inspiration, and that fact should not be minimized. Undoubtedly, this is true for the members of the Center for Christian Business Ethics Today. At the same time, though, there are plenty of nonreligious motivations to do the right thing, such as a fear of going to jail, a desire to be accepted by one’s family and friends, or a sense of personal integrity. In the business world there are additional motivations to be moral, such as the desire to avoid lawsuits, costly fines, or tarnishing the company name.

1.3 Ethics and Psychology An important set of ethical issues involves our psychological makeup as human beings. There is no doubt that our personal expectations, desires, and thought processes have an impact on what motivates us to behave morally. In this section, we will look at two issues of moral psychology; one focuses on our psychological inclination to be selfish, and the other on how gender shapes our moral outlook.

Egoism and Altruism

When the U.S. Gulf Coast was pummeled by Hurricane Katrina, the home-improvement company Lowe’s donated millions of dollars and coordinated busloads of volunteers to help with the cleanup. Working alongside the nonprofit organization Habitat for Humanity, they helped rebuild homes for people across the Gulf Coast region. Since the time of Katrina, Lowe’s has continued the practice of partnering with charitable organizations to help rebuild disaster-stricken areas. Why do they do this? Is it purely from a sense of goodwill towards those in need, or do they expect to get some benefit out of it, such as free publicity? We can ask this same kind of question about our conduct as individuals: Are we capable of acting solely for the benefit of others, or do we always act in ways that ultimately benefit ourselves? There are two competing theories that address this question:

• Psychological egoism: Human conduct is selfishly motivated and we cannot perform actions from any other motive.

• Psychological altruism: Human beings are at least occasionally capable of acting selflessly.

Both of these theories are “psychological” in the sense that they are making claims about what motivates human behavior.

Psychological egoism maintains that all of our actions, without exception, are motivated by some selfish drive. Even when I am doing something, like donating to charity, that appears to be purely for the benefit of someone else, there are hidden selfish motives at work within me and I am only acting to benefit myself. Maybe through my charitable action I secretly hope that I will receive a Citizen of the Year award. Maybe I desire to hear the recipient of my charity thank me with gush- ing words of appreciation so that I can feel good about myself. The English philosopher Thomas

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CHAPTER 1Section 1.3 Ethics and Psychology

Hobbes (1588–1679) argued that all acts of charity could be reduced to our private desire to exercise control over other people’s lives. For Hobbes, I am the one who decides whether a poor person will have enough food to eat today, and I am on a private power trip if I help that person out (1650/1811 Human Nature). A psychological egoist would look at Lowe’s with similar suspicion: Their public acts of charity are great public-relations tools that associate their name and products with social responsibility. Through press releases and adver- tisements, Lowe’s spreads the news of its charitable work far and wide.

The rival theory of psychological altruism concedes that much of

our human conduct is indeed motivated by selfish desire. But, according to the altruist, there is more going on with us psychologically than just that. We have the capacity to break free of the grip that selfishness has on us and at least occasionally act purely for the betterment of other people. Perhaps we have an instinct of human kindness that exhibits itself when we see people who are truly in need. Our hearts go out to them and we want to help, regardless of whether there is any benefit to ourselves. Maybe some of that is behind Lowe’s charitable programs. Its corporate offi- cers and managers are personally moved by tragedies such as Katrina and recognize that Lowe’s has unique resources to help. The public relations benefit it gains from those acts is secondary, and the spark that ignites its charitable response is genuine concern.

Like the dispute between objectivism and relativism, this debate between psychological egoism and altruism will not be resolved any time soon. But even if psychological egoists are correct that all of our actions are selfishly motivated, the fact remains that human beings do perform acts of charity, and, morally speaking, it is good for us to do so. What matters is that Lowe’s engages in charitable projects, regardless of whether their main motivation is to bolster their corporate image.

Gender and Morality

A recent study suggested that businesses led by women place a higher value on social responsibil- ity than do those led by men. According to the director of the study, “women are taking the lead in showing that profit and social responsibility can go hand-in-hand” (Llanza, 2011). Women tend to look for a balance between profits and non-economic goals such as environmental sustainability, charity, and community involvement. Do businessmen and businesswomen really have differing attitudes about the role of ethics within their companies?

Underlying this question is the issue of whether men and women generally speaking have differ- ent ways of thinking about morality. The long standing assumption about morality has been that

Associated Press/Shane Bevel

Do companies like Lowe’s, which donated supplies such as this shipment of water to Hurricane Katrina victims, act charitably out of a sense of goodwill towards those in need, or do they expect to get some other benefit out of it?

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CHAPTER 1Section 1.4 Moral Standards

there is only one way of thinking about it, regardless of gender. There are moral rules that guide our conduct; we all need to learn those rules and follow them in our behavior. It is much like any other task that we perform: If I am playing a sport, performing on a musical instrument, or operat- ing a circular saw, there are clear rules for how I should proceed. If I do not follow those rules, then I will not be good at the task. So too with morality: We all need to understand the rules of ethics and follow them in order to be morally good people.

However, in recent years, this one-size-fits-all assumption about morality has been called into question based on a reexamination of the different psychological tendencies of men and women. Consider the types of college majors that attract men and women, respectively. Some are very male dominated, such as mathematics, physics, and engineering. Others are dominated by women, such as psychology, social work, nursing, and education. This suggests that men have a thought process that emphasizes rules and are thus attracted to those disciplines that emphasize them. Women, by contrast, place greater value on nurturing and caring for others and are thus attracted to those dis- ciplines. It may well be that these gender issues are operating on our conceptions of morality: For men, morality mainly involves following rules, and for women, it mainly involves caring for others.

A recent theory called care ethics advances this view, maintaining that women see morality as the need to care for people who are in situations of vulnerability and dependency. They are not suggest- ing that we should leave the task of caring and nurturing to women, while letting men adhere to their rule-following inclinations. Rather, the task of moral care falls upon all of us, although we should expect women to place greater emphasis on this than men.

Within the business world, it may well be that women are more predisposed to integrate social concern with profit-driven business goals, as the study mentioned before suggests. But again, this does not mean that socially responsible conduct should be left to women. Rather, men may just need to try harder at integrating ethical values into business planning.

1.4 Moral Standards So far we have looked at where morality comes from and how it is shaped by human psychology. Although these theories are important for telling us about the nature of morality, they do not nec- essarily tell us how we should behave, and what the moral standards are that we should follow.

Associated Press/Manuel Balce Ceneta

In this 2009 photo, first lady Michelle Obama stands at the Capital Area Food Bank with Jill Biden (left) and Vicki Escarra (right). Escarra was the chief marketing officer of Delta Air Lines before becoming the CEO of Feeding America, “the nation’s leading domestic hunger-relief charity” (Feeding America, n.d.). Within the business world, are women are more predisposed to integrate social concern with profit-driven business goals?

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CHAPTER 1Section 1.4 Moral Standards

We turn next to that issue and explore three approaches to moral standards: virtue theory, duty theory, and utilitarianism.

Virtues

One of the strangest business stories in recent years is that of Bernard Madoff, who scammed investors out of $65 billion in a Ponzi scheme. He started out as a small-time investment manager, but, courting wealthy investors from around the globe, he eventually built his roster of clients up to 4,800. Offering a steady return of about 10% per year, he covered these payouts with money coming in from new investors. But when his clients rushed to withdraw $7 billion during a major stock-market decline, he could not cover those expenses and he confessed to the fraud.

The humiliation for Madoff’s whole family was so great that he and his wife attempted suicide, and shortly afterward their son did kill himself. When we look at Madoff as a human being, we see that his immoral business conduct was a consequence of his flawed character. His desire for money, power, and a lavish lifestyle became so excessive that it created a trap for him from

which he could not break free. He had what moral philosophers call vices: bad habits of character that result in a serious moral failing. He was unjust, deceitful, intemper- ate, overambitious, and immod- est. What Madoff lacked were virtues—the opposite of vices— which are good habits of character that result in morally proper behav- ior. He did not have the virtues of justice, truthfulness, temperance, restraint, and modesty.

Virtue theory is the view that morality is grounded in the virtu- ous character traits that people acquire. The ancient Greek phi- losopher Aristotle (384 BCE–322 BCE) developed the most influen- tial analysis of virtues, which even

today is considered the standard view of the subject (trans. 2002 by J. Sachs). It all begins with our natural urges. For example, we all have natural desires for pleasure, and we automatically gravitate towards pleasurable activities such as entertainment, romance, eating, and even social drinking. With each of these pleasurable activities, though, there are three distinct habits that we can develop. On the one hand, we might eat too much, drink too much, and become addicted to all sorts of pleasurable activities. This is the vice of overindulgence. At the opposite extreme, we might reject every form of pleasure that comes our way, and live like monks locked in their monastery cells. This is the vice of insensibility, insofar as we have become desensitized to the happiness that pleasures can bring us. There is, though, a third habitual response to pleasure that stands midway between these two extremes: We can enjoy a wide range of pleasures in moderate amounts, and this is the virtue of temperance.

Jeff Daly/Picture Group via AP Images

This 2011 photo shows rows of Bernie Madoff’s shoes, which U.S. marshals put up for auction, along with many of his other belongings, to help repay the victims of his crimes.

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According to Aristotle, most virtues and vices match this scheme:

• There is a natural urge, • there is a vice of excess, • there is a vice of deficiency, and • there is a virtue at the middle position between the two extremes.

Take the virtue of courage, which is driven by our natural fear of danger. If we go to an excess, we develop the vice of rashness, where we lose all fear of danger and rush into hazardous situations that might kill us. If we are deficient in courage, we become timid and develop the vice of coward- liness. The virtuous middle ground of courage is one in which we respect the dangers before us but, when the circumstances are right, we rise above our fears.

A large part of our childhood involves cultivating virtuous habits and avoiding vicious ones, and during our formative years our parents bear much of the responsibility to shape us in virtuous directions. As I become older, though, the responsibility becomes mine alone, and I must think carefully about exactly where that virtuous middle ground is. How much habitual eating can I do before I become overindulgent? How much can I habitually hide from danger before I become a coward? Finding that perfect middle ground, Aristotle says, is not easy, but it is something that the moral person must figure out nonetheless. Madoff did not even come close. His desires for wealth, power, and fame were so all-consuming that the virtue of temperance became out of reach for him.

Duties

A small computer software company named Plurk accused the software giant Microsoft of com- puter code theft. The product in question was blogging software that Microsoft developed for its market in China and which it hoped would catch hold in that country the way Facebook has in the United States. Around 80% of the computer code for Microsoft’s product was lifted directly from blogging software created by Plurk. Microsoft apologized for the episode and said that the fault rested with an outside company it had hired to develop the blogging software. It was that outside company that copied Plurk’s computer code (Nystedt, 2009). The irony is that Microsoft zealously guards against software piracy and code theft of its own products, but here it did that very thing, even if only indirectly. In this situation, there was no moral gray area: Theft is wrong, the evidence for code theft was incontestable, and Microsoft had no choice but to immediately admit to it and apologize.

This Microsoft case highlights the fact that there are at least some principles of morality that we all clearly recognize and endorse. One moral theory in particular emphasizes the obvious and intui- tive nature of moral principles. Duty theory is the position that moral standards are grounded in instinctive obligations—or duties—that we have. It is also called deontological theory, from the Greek word for duty. The idea behind duty theory is that we are all born with basic moral prin- ciples or guidelines embedded in us, and we use these to judge the morality of people’s actions.

There are two approaches to duty theory. First, some moral theorists hold that we have a long catalog of instinctive obligations. The list of the Ten Commandments is a classic example. Among those listed are obligations not to kill, steal, bear false witness, or covet your neighbor’s things. These are all basic moral principles that cultures around the world have endorsed from the earliest

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times. If you are thinking about stealing your neighbor’s car, these principles tell you that it would be wrong to do so. With enough principles like these, we will have some standard for judging a wide range of human actions. Many moral philosophers have developed and expanded the list of our intuitive duties beyond the Ten Commandments to include a few dozen of them.

The second approach is that there is a single instinctive principle of duty that we all should fol- low; the Golden Rule is the best example of this. That is, I should do to others what I would want them to do to me. If I am thinking about stealing someone’s car, I should consider whether I would want someone to steal my car. If I am thinking about lying to someone, I should consider whether I would want someone to lie to me. So too with good actions: When considering whether I should donate to charity, I should consider how I would feel if I were a needy person dependent on the charity of others. Like those in the Ten Com- mandments, the Golden Rule is a time-honored moral principle that we find in cultural traditions around the world, dating back thousands of years.

In more recent times, one of the most influential theo- ries of duty is that developed by the German philoso- pher Immanuel Kant (1724–1804). Inspired by the Golden Rule, Kant offered a single principle of moral duty, which he called the “categorical imperative”— a term which simply means “absolute command” (1785/1996). The categorical imperative, for Kant, was this: Treat people as an end, and never merely as a means to an end. His point was that we should treat all people as beings that have value in and of them- selves, and not treat anyone as a mere instrument for our own advantage.

There are two parts to his point. The first involves treating people as ends that have value in and of themselves. We value many things in life, such as our cars, our homes, and a good job. Most of the things we value, though, have only instrumental value, that is, value as a means for achieving something else. Our cars are instruments of transportation. Our homes are instruments of shelter. Our jobs are instruments of obtaining money.

Other times, though, we appreciate things because they have intrinsic value: We value them for the special qualities that they have in and of themselves, and not because of any instrumental value that they have. Human happiness has intrinsic value, and so too do experiences of beauty and friendship. The first part of the categorical imperative, then, says that we should treat all people as beings with intrinsic value and regard them as highly as we would our own happiness. If I steal someone’s car, I am not respecting the owner the way I value my own happiness. The second part of the categorical imperative is that we should not treat people as things that have mere instrumental value. People are not tools or objects that we should manipulate for our own gratification. If steal a car, I am using the owner for my own gain.

Copyright Bettmann/Corbis/AP Images

Immanuel Kant (1724–1804), the German philosopher who developed the moral principle of the categorical imperative, stat- ing that we should treat people as an end, and never merely as a means to an end.

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CHAPTER 1Section 1.4 Moral Standards

Like the Golden Rule, the categorical imperative provides a litmus test for determining whether any action is right or wrong. It not only detects immoral actions such as lying and stealing, but it also tells us when actions are moral. When I donate to charity, for example, I am thinking of the value of the needy people who will benefit from my contribution; I am not merely thinking of any benefit that I may receive through my charity.

In the business world, there are occasionally times when an action is so obviously wrong that there is no point in defending it. That was true of Microsoft and also of Madoff, who immediately admitted to his crime once his company became insolvent. In cases like these, duty theory is at its best. In other cases, though, morality is a little more blurry. Napster is a good example. Napster was the first widely used peer-to-peer file-sharing program, and it enabled users to easily pirate MP3 music files, directly violating the copyrights of record companies. While this at first appears to be a clear case of a software product that intentionally enabled users to steal, many people within the music industry itself defended Napster. Record companies had become stuck in their old ways of selling records and CDs and had not developed a good mechanism for consumers to purchase MP3 files separately at a reasonable price. Napster entered the music market as a rogue competitor, and forced record companies to be more responsive to the needs of their consumers. In a sense, Napster was a positive force within the music industry. Duty theory may not be well suited for making moral pronouncements in complex cases like Napster’s; other moral theories discussed in this chapter may need to be drawn upon.

Utilitarianism

Some years ago, a pesticide factory in Bhopal, India, owned by Union Carbide, exploded, killing 2,500 people and injuring an additional 300,000. The active ingredient for the pesticide was stored in 600-gal tanks. The size of the tanks themselves was a problem. Larger tanks are economically efficient, since they hold more gas, but they pose greater risks in case of a tank leak. For this rea- son, regulations at a similar Union Carbide factory in Germany required tank sizes to be restricted to 100 gal. Also, the tank that exploded in the Indian plant was supposed to be refrigerated to 0 °C. Instead, the refrigeration unit was not working and the tank was at room temperature. Although the Indian factory had safety features to prevent disasters, several of the safety systems were not functioning. The explosion started when someone added water to a 600-gal tank of the chemical, perhaps an act of sabotage by a disgruntled employee. The temperature in the tank rose in a chain reaction, and the tank blew up. A fog of the gas drifted through the streets of Bhopal, killing people on the spots where they stood. Although Union Carbide responded quickly and compassionately to the disaster, the tragedy raised questions about their views on safety in developing countries.

All businesses make decisions based on a cost-benefit analysis: They research both the costs and the benefits of a particular decision, then determine whether the costs outweigh the benefits or vice versa. In Union Carbide’s case, they determined that economic savings outweighed the eco- nomic costs of stricter safety protocols. In retrospect, it is clear that the company miscalculated and should have given greater weight to safety.

Cost-benefit analysis is the distinguishing feature of the moral theory of utilitarianism: An action is morally right if the consequences of that action are more favorable than unfavorable to every- one. When determining the morality of any given action, we should list all of the good and bad consequences that would result, determine which side is weightier, and judge the action to be

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right if the good outweighs the bad. There are three components to this theory. First, it empha- sizes consequences. One of the founders of utilitarianism was the British philosopher Jeremy Ben- tham (1748–1832), who argued that by focusing on consequences, we make our moral judgments more scientific (1789/1907). To ground morality in the will of God requires that we have a special ability to know God’s thoughts. To ground morality in conscience or instinctive duties requires that we have special mental faculties and know how to use them properly. None of this is precise, and

it all relies too much on hunches. According to Ben- tham, a more scientific approach to morality would look only at the facts that everyone can plainly see, and consequences of actions are those facts. If I steal a car, there are very clear consequences: I gain a vehicle, but I cause financial harm and distress to the victim and put myself at risk of a long stay in prison. We all can see these consequences and assess their weights. Bentham held that we can even give numerical values to the various consequences and mathematically cal- culate whether the good outweighs the bad, a prac- tice that we now call the utilitarian calculus. Not all utilitarians go this far, but it does highlight the central role that publicly observed consequences play in the utilitarian conception of morality.

The second component of utilitarianism is that it focuses on the consequences of happiness and unhap- piness. While businesses assess costs and benefits in terms of financial gains and losses, utilitarianism focuses instead on how our actions affect human hap- piness. Some utilitarians, like Bentham, emphasize pleasure and pain; others emphasize goodness and badness; and still others emphasize overall benefit and disbenefit. What they have in common, though, is that moral conduct is in some way linked with human happiness and immoral conduct with unhappiness.

The third component of utilitarianism is that we need to assess the beneficial consequences of actions as everyone is affected. If I am thinking about stealing a car, I need to consider the conse- quences of my conduct for myself, my family, the victim, the victim’s family, and anyone else who might be affected by my action. This is reflected in utilitarianism’s famous motto that we should seek the greatest good for the greatest number of people.

Because businesspeople are so familiar with financial cost-benefit analysis, utilitarianism is a natu- ral way to make moral assessments with business decisions. Take the Bhopal catastrophe as an example. In retrospect, we can see that the company and its stockholders gained a certain amount of benefit through financial savings from lax safety regulations. However, at the same time, we can see that this was greatly outweighed by the disbenefit from the deaths and injuries. It also created disbenefits for the company itself in terms of bad public relations, lawsuits, and decreased stock value. At the time, of course, Union Carbide could not have known with certainty that its lax safety standards would have resulted in a disaster of such magnitude. However, an impartial risk assess- ment of its facility would have revealed that there were serious safety hazards, and that alone would have tipped the utilitarian scale.

Associated Press/nmg

Jeremy Bentham (1748–1832), the Brit- ish philosopher who developed the moral principle, which we now call the utilitarian calculus, that morality is determined by numerically tallying the degree of pleasure and pain that arises from our actions.

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CHAPTER 1Section 1.5 Morality and Government

1.5 Morality and Government In this final section, we will examine some moral theories that pertain to governments and the laws that they create. From the start, it is important to look at the boundaries that separate moral- ity and the law that governments create. What they have in common is that they both command us to behave in certain ways, and often their edicts are the same. It is immoral to steal, and it is also illegal. It is immoral to assault someone, and it is also illegal.

However, there are many instances where morality and legality do not overlap. Adultery, for example, is immoral, but in the United States it is not illegal in most states. So too with cheating on school exams. Similarly, there are some actions that are illegal but not immoral. Going 36 in a 35-mph zone is illegal but not necessarily immoral. Similarly, some instances of mercy killing may be morally justifiable, even though they are currently illegal.

Morality is an important source of inspiration for the law, but it is not the last word on the issue. In business ethics, it is often important to consider issues of morality and legality separately. Perhaps we will find some immoral actions in business which are not illegal but should be. Or we might find some morally permissible actions that are illegal, but should be made legal.

The three main issues that we will focus on are social-contract theory, human-rights theory, and theories of governmental coercion. The driving questions here are: What is the origin of govern- mental authority? What is the main purpose that governments serve? What are the limits to the laws that governments can create?

The Social Contract

Business by its very nature is dog-eat-dog, where one company tries to draw customers away from the competition, perhaps to the point of putting the competition out of business. Sometimes efforts to succeed can go too far and involve intentionally sabotaging the competition by steal- ing trade secrets, publishing misleading attack ads, or even vandalizing property. For example, an owner of a pizza restaurant in Philadelphia was charged with releasing mice into two competing pizzerias. The owner went into the bathroom of one competitor and placed a bag of mice in the drop ceiling. He then crossed the street, entered a second one, and placed another bag of mice into a garbage can. When caught and arrested, he claimed that he was just getting even for his competition doing the same thing to him (Kim, 2011).

Even though business is inherently cutthroat, there are still requirements for civil behavior and limits on how far one can go in defeating the competition. Without those requirements, business competition would descend into gang warfare and ultimately destroy the economic playing field that is required for businesses to even exist.

This is precisely the rationale behind social contract theory: To preserve our individual lives, we agree to set aside our hostilities towards each other in exchange for the peace that a civilized society offers. The champion of this view is Thomas Hobbes, who, as we saw earlier, defended the theory of psychological egoism. Hobbes began by having us think about what the world would be like if there were no governments and laws to keep society peaceful. In his words, what would the state of nature be like, in which every person was seeking to survive in competition with everyone else, without the protection of the government? His answer was that it would be a condition of war between every person, and two factors make this so:

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1. First, life’s necessities are scarce, and it is a constant struggle for us to adequately supply our basic needs like food, clothing, and shelter.

2. Second, we are not by nature generous, and we will not be inclined to share what we have with others.

As a psychological egoist, Hobbes held that we will always be interested in our own personal interests and that we are not capable of acting towards others with true altruism. If we were capable of acting self- lessly, then we would peacefully divide up the scarce resources that we all need. If I find an apple, and then see that you are hungry, I will naturally be inclined to split the apple with you. But, according to Hobbes, our natural inclination towards selfishness prevents us from doing this. The result, then, is that the state of nature is really a state of war, which he vividly describes here:

In such condition there is no place for industry, because the fruit thereof is uncertain, and consequently, no culture of the earth, no navigation, nor use of the commodities that may be imported by sea, no commodious building, no instruments of moving and removing such things as require much force, no knowledge of the face of the earth, no account of time, no arts, no letters, no society, and which is worst of all, con- tinual fear and danger of violent death, and the life of man, solitary, poor, nasty, brutish, and short. (Hobbes, 1651/1994)

Within the state of nature, there is no point in my even trying to grow a garden, build a home, or furnish it: Someone would just come along and take it from me by force.

How, then, do we escape from the horrible conditions of the state of nature? The answer for Hobbes was the social contract, which has three steps:

1. First, I must recognize that seeking peace is the best way for me to preserve my life. I will always be selfish, and that will never change. However, I must see that I can better my own situation by seeking peace with my competition.

2. Second, I must negotiate a peace settlement with you: I will set aside my hostilities towards you if you set aside your hostilities towards me. If we mutually agree to be civil to each other, then we will both have the hope of living better lives.

3. Third, we must establish a governmental authority that will punish us if we break our agreement. Talk is cheap, and I can verbally agree to a peace treaty with you but then attack you when your guard is down. And you can do exactly the same thing to me. But if we create a policing power to watch over us, then I will be strongly motivated to hold to my agreement with you, and so will you.

Copyright Bettmann/Corbis/AP Images/Anonymous

Thomas Hobbes (1588–1679), the English philosopher who developed the concept of the social contract, and famously stated that in the state of nature, “the life of man [is] solitary, poor, nasty, brutish, and short.”

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CHAPTER 1Section 1.5 Morality and Government

In the business world, it is essentially a social-contract agreement that keeps us from sabotaging our competitors. Our natural selfish inclination might be to destroy our competition by any means necessary, but doing so would lead to a savage state of war where we would all be losers. The best business strategy, then, is a negotiated peace settlement where all businesses play by a set of rules. To keep us from cheating on those rules, there are governing bodies such as governments and professional business associations that can punish us when we break them. Business is still motivated by self-interest, but it is now constrained to be civil.

Human Rights

The U.S. Civil War was in many ways the result of a business-ethics dispute. The earliest Spanish settlers of North America brought African slaves with them to help cultivate the land and build towns, and slavery quickly became integral to business activities throughout the colonies. By the time of the American Revolution, slavery in the North had declined, partly because of a manufac- turing economy where it cost more to own and maintain slaves than the slaves could economically produce. However, in the agricultural economy of the South, slave labor was still cost-effective. As the antislavery movement took hold, Southern slaveholders asked who would compensate them for their financial investment in their slaves if the slaves were to be freed. There were no clear answers to this question, and so the slaveholders saw abolitionism as a direct threat to their economic rights. They saw the North as posturing to steal their property and gut their capacity to compete in the agricultural marketplace.

We now see slavery as one of the worst chapters in American history, regardless of the economic arguments of the slaveholders. And even today, we are horrified to hear of slavery-like condi- tions around the world, where laborers are sometimes kidnapped or otherwise coerced into working in sweatshops or on farms with grueling hours, horrible conditions, and meager pay. We see these as rights violations that can never be morally justified by any economic benefit to the business owner.

The central idea here is that of a right, which is a justified claim against another person’s behavior. For example, I can rightfully claim that you cannot steal from me, torture me, enslave me, or kill me. I am making a claim about what you can and cannot do. When asserting our various rights, it is important to distinguish between two types:

• Legal rights are those created by governments. The government, for example, has estab- lished laws that grant me the right to drive when I reach a certain age, or carry certain types of weapons, or visit publicly owned parks.

• Human rights—also called natural rights—are not created by governments but are rights all people around the world have regardless of the country in which they live. The rights against slavery and torture are commonly listed among these.

There are three distinct features of human rights:

• They are natural in the sense that we are born with them. They are not given to us by the government or any other human institution, but are part of our identity by our merely being born as human beings.

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CHAPTER 1Section 1.5 Morality and Government

• They are universal in that all humans worldwide possess them. No matter who you are or where you live, you have human rights.

• They are equal in the sense that we all have the same list of fundamental human rights, and no one has more or fewer than another person.

The concept of human rights was first developed by the English philosopher John Locke (1632–1704), who argued that by nature everyone has the basic rights to life, health, liberty, and possessions. God gives us these when we are born, and we retain them through- out life, so long as we do not violate the rights of oth- ers. For Locke, the right to acquire possessions was the source of our economic freedom and the ability to conduct business transactions. Once I rightfully acquire possessions, I can keep them or sell them as I see fit. However, just as Hobbes warned, the world is a nasty place, and many out there will want to violate my rights and take what I have. According to Locke, we establish governments specifically for the pur- pose of protecting our fundamental rights: We sub- contract to the government the job of keeping the peace. If the government adequately performs its task of protecting our rights, then we all benefit. If

the government fails in that task, however, we have a right to overthrow the government and replace it with a better one that can more adequately do its job.

Thomas Jefferson, when penning the Declaration of Independence, latched onto this exact part of Locke’s theory:

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty, and the pursuit of Happiness. That, to secure these rights, Gov- ernments are instituted among Men, deriving their just Powers from the consent of the governed. That, whenever any form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government.

Through Jefferson, the concept of human rights has become embedded into the American mind- set, and it has inspired countries around the world to similarly acknowledge human rights.

But the concept of human rights took its modern form through a document called the Universal Declaration of Human Rights, which was adopted by the United Nations General Assembly in 1948. The Universal Declaration reiterates the same core set of human rights as Locke and Jefferson: “Everyone has the right to life, liberty and security of person” (1948, Article 3). However, the docu- ment continues by listing a range of very specific rights, such as these pertaining to businesses:

Copyright Bettmann/Corbis/AP Images/Anonymous

John Locke (1632–1704), the English phi- losopher who developed the concept of natural rights and the right of citizens to overthrow governments that fail to protect their rights.

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CHAPTER 1Section 1.5 Morality and Government

1. Everyone has the right to work, to free choice of employment, to just and favourable condi- tions of work and to protection against unemployment.

2. Everyone, without any discrimi- nation, has the right to equal pay for equal work.

3. Everyone who works has the right to just and favourable remuneration ensuring for him- self and his family an existence worthy of human dignity, and supplemented, if necessary, by other means of social protection.

4. Everyone has the right to form and to join trade unions for the protection of his interests.

Everyone has the right to rest and leisure, including reasonable limitation of work- ing hours and periodic holidays with pay. (Universal Declaration of Human Rights, 1948, Articles 23–24)

Although not all of the human rights listed in the Uni- versal Declaration have yet become a reality around the world, it is nevertheless the standard towards which all countries within the United Nations have pledged to work.

Principles of Governmental Coercion

To effectively compete in the marketplace, businesses are continually pushing the boundaries of tasteful adver- tising. Presenting shocking and even offensive images in advertisements will attract attention, and may gen- erate sales. A quick online image search for “offensive advertisement” will reveal a range of troubling ads that are sexually explicit, demeaning to women or minority groups, or offensive to religious groups. A case in point is an advertisement by the Italian clothing company Benetton that contained an altered image of the Catho- lic pope romantically kissing a Muslim imam. In keeping with the company’s theme of multicultural- ism, a spokesperson said that “the meaning of this campaign is exclusively to combat the culture of hatred in all its forms” (Rocca, 2011). When the Vatican threatened to sue, Benetton removed the ad.

What Would You Do?

Say you are a midlevel supervisor at a sportswear company that special- izes in athletic footwear. You have just found out that some of your manu- facturing facilities in Bangladesh hire child workers as young as age 10. They work 14 hours a day, 7 days a week, and receive wages as low as 20 cents an hour. You know that this is a clear human-rights violation.

1. Would you discuss your moral concerns with your superiors in the company?

2. Suppose you did discuss your con- cerns with them and their response was essentially that this was stan- dard practice in Asian countries, and what your company was doing was no different from what any other company does that has tex- tile facilities in those countries. Also, if your company set higher standards, it would not be able to compete in the marketplace. Would this explanation satisfy you?

3. Suppose that the response of your superiors was that they acknowl- edged the problem and were working on it, but that it would take several years before this prac- tice could be eliminated. Would this explanation satisfy you?

4. Suppose that your company stated in its advertising and packaging that no child labor was used in manufacturing its products. You knew, though, that this was not true. Would you bring this to the attention of a government agency?

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CHAPTER 1Section 1.5 Morality and Government

While ads like Benetton’s may be offensive to some people, they nevertheless may be perfectly legal. That raises the question of how bad an action needs to be before the government steps in and makes it illegal. All governments are coercive in the sense that they force us to conform to laws under threat of punishment. PepsiCo would not burn down Coca-Cola’s company headquar- ters, even if it wanted to, because of how the government would punish it. But governments can- not randomly single out some actions as criminal and allow others to be legal. There are reasons why some actions are prohibited and others are not. There are four common justifications of gov- ernmental coercion: the harm principle, the offense principle, the principle of legal paternalism, and the principle of legal moralism.

The first is the harm principle: Governments may restrict our conduct when it harms other people. Burning down Coca-Cola’s headquarters could injure and kill many people, and would undoubt- edly cause financial harm to the company. However, for the government to step in and outlaw harmful actions, the injury must be serious, not trivial. For example, almost all fast-food products are harmful in comparison to organic food alternatives. However, serving unhealthy food is far less serious than serving food tainted with salmonella, which causes severe illness and even death. Thus, the government cannot reasonably outlaw fast food, whereas it justifiably can do so with salmonella-tainted food.

Second is the offense principle: Governments may keep us from offending others. We cannot walk naked through the streets, be publicly intoxicated, or shout obscenities in playgrounds. As with the harm principle, the offense principle also looks at the degree to which a particular action is objectionable: Is it outrageously offensive or merely a nuisance? Benetton’s ad touches on this very issue. It was certainly offensive to specific groups of Catholics and Muslims, but whether it was deeply offensive to society at large is another matter. Again, Benetton’s ad was perfectly legal, which means that in our present cultural climate, it was not offensive enough to be illegal.

Third is the principle of legal paternalism, which is a sister concept to the harm principle. While the harm principle focuses on the harm our actions cause to other people, legal paternalism looks at the harm that we cause ourselves through our actions and maintains that the government can restrict such conduct. I can hurt myself by participating in a dangerous sport such as cliff diving or by working in a dangerous occupation such as tree trimming. When the government mandates that I wear a seat belt when driving, the concern is principally with protecting me from my own careless conduct. The term paternalism comes from that Latin word for father, which implies that the government is overseeing my conduct in the way that parents try to protect their children. But does the government have any business in doing this? Yet again, the question is one of degree. With our stupidest and most dangerous actions, we may want the government to protect us from ourselves. However, with an action that does not cause serious harm to me, I may want the gov- ernment to just leave me alone.

Finally, there is legal moralism: Governments may restrict conduct that is especially sinful or immoral. Prime examples of this are laws against blasphemy and some sex acts, such as sodomy. The question here is not whether a type of conduct is harmful to others, publicly offensive, or harmful to oneself. It is a matter of whether an act, even when done privately, crosses some moral boundary that justifies the government’s stepping in. Of all the principles of govern- mental coercion, legal moralism is probably the weakest. One reason is that many moral and religious standards vary widely, and by outlawing an action solely on moral or religious grounds, the government may be unfairly adopting the standards of one cultural group and applying them to everyone.

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CHAPTER 1Section 1.6 Conclusion

Although legal moralism may be the weakest of the four principles, some of the others may also be seri- ously questionable. The British philosopher John Stuart Mill argued that, in fact, only one principle of governmental coercion is justifiable, namely the harm principle. The government has no right to restrict our conduct on the other three grounds. In Mill’s words:

The only purpose for which power can be rightfully exercised over any member of a civilized community, against his will, is to prevent harm to others. His own good, either physical or moral, is not a sufficient warrant (1859/1999).

The reason, according to Mill, is that a wide sphere of personal liberty is essential for a happy society, and that includes the possibility of offending others, harming ourselves, or crossing some traditional moral boundary. Do we want to decide for ourselves what makes us happy, or do we want the government to do so? From Mill’s perspective, I am a better judge of my own happiness than the government ever could be, and society on the whole will be a happier place when we are each allowed that freedom.

All of these principles of governmental coercion apply to businesses just as they do to individual people. Again, with Benetton, although their ad was offensive to some groups, the offense was not serious or widespread enough to justify its being illegal. But with many ad campaigns, merely being legal may not be good enough. Public opinion can be as coercive as any government-imposed restriction. If Microsoft, PepsiCo, or any other Fortune 500 company published an ad with the pope kissing a Muslim, the backlash would likely be financially crippling. Catholics and Muslims worldwide might boycott their products. Benetton is a much smaller company, with a specialized market niche and a history of using shocking ads to get con- sumers’ attention. Not so with Microsoft and PepsiCo, which have much broader customer bases worldwide. With them, consumer coercion is as powerful as governmental coercion.

1.6 Conclusion In this chapter we have looked at a wide spectrum of classic moral theories and showed how they apply to an equally broad spectrum of business ethics issues. These are moral theories that, 1,000 years from now, will be just as important as they are today; in a sense, they define the moral thought process for humans. The philosophers who proposed these various theories were not always in agreement with each other; in fact, they rejected many rival moral theories. Bentham believed that all moral and social issues should be decided solely using the utilitarian principle, not through theories about religion, virtue, duty, social contracts, or human rights.

Copyright Bettmann/Corbis/AP Images/Anonymous

John Stuart Mill (1806–1873), a British philosopher who defended personal lib- erty and argued that government should restrict our conduct only when we harm others, not when we merely offend others, harm ourselves, or behave immorally.

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CHAPTER 1Summary

Similarly, Kant believed that the categorical imperative was the single moral litmus test. But exclusive claims like these are much like efforts at brand loyalty in the business world. Walmart would like us to shop at only their stores. Coca-Cola would like us to drink only their beverages. Exxon would like us to buy only their gas. But in the real world, our purchasing habits are more diverse and we are drawn to a range of different stores and products.

So too with moral theories: In the real world, when we reflect on moral issues, some theories will be more relevant or illuminating than others. Bentham’s utilitarianism may be helpful with some types of moral evaluations, but not with others. The same is true for the other theories that we have examined. We are trapped in a morally complex world that demands that we make moral choices. One way or another we will do that, and drawing on all of the various moral theories can help make the job easier.

In the following chapters of this book, all of the issues covered can be analyzed using these classic moral theories. As authors, though, we have not forced that approach. Issues such as price fixing, corporate punishment, consumer advocacy, insider trading, and others are challenging enough in their own right, without the added intricacies of a utilitarian or duty-theory analysis. Neverthe- less, classic moral theories are always lurking in the background of most of these discussions. Does a particular government regulation serve the greatest good for the greatest number of people? Do affirmative action policies violate the rights of majority groups? Do we have special moral duties to protect the environment? A full evaluation of business-ethics issues may greatly benefit from the contributions of classic moral theories.

Summary We began this chapter looking at theories of where morality comes from and the debate between moral objectivism and moral relativism. Moral objectivists claim that moral standards are not cre- ated by human beings, are unchanging, and are universal. Moral relativists hold the opposite view, that moral standards are created by human beings, change from society to society, and are not universal. Also relevant to the question of where morality comes from is the connection between religion and ethics. Divine command theory is the position that moral standards are created by God’s will, but we saw some challenges to this view. Religious ethical theories also commonly hold that religious believers have a special moral ability; we looked at challenges to this view as well.

We next looked at ways in which our human psychological makeup might affect how we view morality. One issue concerns our ability to act selflessly. Psychological egoists hold that human conduct is selfishly motivated and we cannot perform actions from any other motive. By contrast, psychological altruists hold that people are at least occasionally capable of acting selflessly. Also of relevance is how gender shapes men’s and women’s conceptions of morality. Care ethics is the theory that women see morality as the need to care for people who are in situations of vulner- ability and dependency.

One of the central concerns of ethical theory is to present and explain the moral standards that guide our behavior. One such approach is virtue theory, which is the view that morality is grounded in the virtuous character traits that people acquire. According to Aristotle, virtues are good mental habits that regulate our urges and stand at a mean between vices of deficiency and vices of excess. Another approach is duty theory, which holds that moral standards are grounded in instinctive

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CHAPTER 1Summary

obligations. Some duty theories propose a list of obligations, such as the Ten Commandments, and others propose a single principle, such as the Golden Rule. Kant offered a single principle that he called the categorical imperative, which states that we should treat people as an end and never as a means to an end. A third approach is the theory of utilitarianism, which holds that an action is morally right if the consequences of that action are more favorable than unfavorable to every- one. Bentham developed the idea of the utilitarian calculus, whereby numerical values could be assigned to the positive and negative consequences of actions.

The final component of this chapter explored the relationship between morality and government. One major theory on this is social contract theory. Hobbes described a warring state of nature gen- erated by human selfishness and scarcity of necessities. The solution is the social contract, which holds that, to preserve our individual lives, we agree to set aside our hostilities towards each other in exchange for the peace that a civilized society offers. A second important theory on the relation- ship between morality and government is the concept of human rights. These are rights that are not created by government, but are held equally by all people around the world regardless of the country in which they live. The theory was developed by Locke, who held that by nature, everyone has the basic rights to life, health, liberty, and possessions. People establish governments for the purpose of protecting those fundamental rights, and governments can be overthrown when they fail to perform that task. A third theory on the relation between morality and government involves four principles of governmental coercion. They are the harm principle, whereby governments may restrict our conduct when it harms other people; the offense principle, which restricts our behav- ior that offends others; legal paternalism, which restricts an individual’s actions that harm him- or herself; and legal moralism, which restricts especially sinful or immoral conduct. Mill argued that only the harm principle is justified, and the other three are not.

Discussion Questions

1. There are several theories about where moral values come from, including moral objec- tivism, moral relativism, and divine-command theory. Which if any of these theories works best when understanding the moral obligations of businesses?

2. Assume that the theory of psychological egoism is true, that all human actions are self- ishly motivated. Is there a way that the decision-making process within a large corpora- tion can overcome this fact of human selfishness? Could the corporation, for example, establish a charity program that was designed only to benefit the needy, with no public relations benefit to the company at all?

3. According to virtue theory, to be morally good people we should develop virtuous habits like courage, temperance, wisdom, and justice. Can there be such a thing as a “virtuous corporation”? If so, what are the virtuous habits that it would need to have?

4. According to duty theory, there are fundamental principles of moral obligation that we all know instinctively, such as do not kill or steal. Are there any fundamental principles of business ethics that everyone in business automatically knows they should follow?

5. According to Kant’s theory of the categorical imperative, we should treat people as an end, and never merely as a means to an end. Think of an example in business that vio- lates this principle and explain how it does that.

6. Consider the issue of child labor mentioned in the “What Would You Do?” box. Use a utilitarian analysis to determine whether use of such labor would be morally permissible for your company.

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CHAPTER 1Summary

7. The Universal Declaration of Human Rights lists several rights that pertain to businesses (see that list in the chapter). Would you agree that all of those are genuine human rights? Explain.

8. There are four principles of governmental coercion that explain why the government is justified in restricting our actions. It is clear how the harm principle applies directly to businesses: Businesses should not engage in conduct that causes serious harm to others, such as by manufacturing unsafe products, dumping toxic waste, or having unsafe work- ing conditions for employees. Explain how the other three principles of governmental coercion might apply to business conduct.

Key Terms

care ethics The theory that women see moral- ity as the need to care for people who are in situations of vulnerability and dependency.

categorical imperative The moral principle proposed by Immanuel Kant that we should treat people as an end, and never merely as a means to an end.

cost benefit analysis The economic model- ing of a project to check whether the benefits outweigh the costs.

divine-command theory The view that moral standards are created by God’s will.

duty theory The view that moral standards are grounded in instinctive obligations, that is, duties.

ethics An organized analysis of values relating to human conduct, with respect to their right- ness and wrongness.

Foreign Corrupt Practices Act A U.S. Federal law regulating the operation of U.S. companies in foreign countries, which includes an anti- bribery provision.

harm principle The view that governments may restrict our conduct when it harms other people.

human rights Rights that are not created by government, but held by all people around the world regardless of the country in which they live.

legal moralism The view that governments may restrict conduct that is especially sinful or immoral.

legal paternalism The view that governments can restrict the conduct of an individual who harms him- or herself.

legal rights Rights that are created by governments.

moral objectivism The theory that moral stan- dards are not created by human beings, are unchanging, and are universal.

moral relativism The theory that moral stan- dards are created by human beings, change from society to society, and are not universal.

offense principle The view that governments may keep us from offending others.

psychological altruism The theory that human beings are at least occasionally capable of act- ing selflessly.

psychological egoism The theory that human conduct is selfishly motivated and we cannot perform actions from any other motive.

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CHAPTER 1Summary

right A justified claim against another person’s behavior.

social-contract theory The moral and political theory that, to preserve our individual lives, we agree to set aside our hostilities towards each other in exchange for the peace that a civilized society offers.

utilitarianism The theory that an action is mor- ally right if the consequences of that action are more favorable than unfavorable to everyone.

virtue theory The view that morality is grounded in the virtuous character traits that people acquire.

virtues Good habits of character that result in morally proper behavior.

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Capitalism

Learning Objectives

After completing this chapter, you should be able to:

• Describe the main features of capitalism and socialism. • Explain the three main aspects of Adam Smith’s account of capitalism and Karl Marx’s account of socialism. • Assess the main criticisms of capitalism and socialism. • Explain how various anticompetitive practices undermine capitalism. • Describe the reasons and mechanisms for government regulation of the marketplace.

eyetwist/kevin balluff

2

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CHAPTER 2Section 2.1 Introduction

Chapter Outline

2.1 Introduction

2.2 Capitalism and Socialism Defined

Capitalism Socialism

2.3 Adam Smith’s Capitalism

Selfish Desire for Luxury Goods The Invisible Hand Limited Role of Government

2.4 Karl Marx’s Socialism

Alienated Labor Class Struggle Revolution

2.5 Assessment of Capitalism and Socialism

Criticisms of Capitalism Criticisms of Socialism Moderate Versions

2.6 Anticompetitive Practices

Monopolies and Oligopolies Price Fixing, Bid Rigging, and Price Gouging

2.7 Regulating the Free Market

Reasons for Government Regulation Mechanisms for Government Regulation

2.8 Conclusion

2.1 Introduction In the spring of 2000, protestors took to the streets in Bolivia, South America’s poorest coun- try. The reason? The Bolivian government had leased the water rights of several regions in the drought-stricken nation to private companies. One was the U.S. engineering company Bechtel, which agreed to expand and bring efficiency to the water resources of those regions. This meant that all of the area’s water resources fell within its domain, even the gathering of rainwater. Shortly after Bechtel took control, water prices in one city tripled, sparking major protests. The government declared martial law and police were called in, killing at least six protesters and injuring over 170 others. The Bolivian government subsequently canceled the water contract with Bechtel.

Bechtel was not an inherently evil corporation that intentionally entered Bolivia to extract money from a poverty-stricken population. In their defense, company executives said that the price increases were initiated by the local government, not by them. Bechtel was experienced in the

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CHAPTER 2Section 2.2 Capitalism and Socialism Defined

managing of water resources and was simply there to do a job. Nevertheless, the company’s involvement in the privatization of water became a symbol for capi- talism’s having gone too far. Once water was priva- tized, the Bolivians could not even collect rainwater for their own drinking without first obtaining a permit. This appears to be a situation of forcing private mar- ket solutions upon what are ultimately public-sector problems. Water access, it seems, is a public right, and when water becomes scarce, the task of managing those resources should fall to the government, whose primary task is to protect the public good.

At the heart of many issues in business ethics, like the privatization of water, is the economic system under which businesses themselves operate; gener- ally speaking, the two competing economic systems are capitalism and socialism. The one looks to the free market, the other to government control. In this chap- ter, we will look at the tension between these two ide- ologies, and the ethical implications of adopting one of these systems over the other. We will consider their essential features and the specific theories of their two most famous defenders, Adam Smith and Karl Marx. We will then examine anticompetitive business practices that undermine the free market, and the role of the government in keeping the market competitive.

2.2 Capitalism and Socialism Defined There are no official definitions of either capitalism or socialism upon which everyone agrees. One reason for this is that these theories are so multifaceted and all-encompassing that they resist being distilled into a single formula. Another reason is that the concepts are at the center of an intense ideological battle, which often makes it difficult to avoid personal bias even with simple formulations of the concepts. Nevertheless, there are recurring themes with both of these notions, which can provide a starting point for discussion.

Capitalism

As an economic theory, capitalism maintains that

• personal self-interest, not community interest, motivates economic development; • the major sources of society’s economic production should be privately owned, not gov-

ernmentally owned; and • economic planning should be decentralized through market competition, not centralized

through government policy.

Associated Press/Julie Plasencia

In this photo, a Bolivian man demonstrates against the privatization of water and sub- sequent rate hikes in his region. He holds a sign that says, “What is ours is ours and it cannot be taken away.”

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CHAPTER 2Section 2.2 Capitalism and Socialism Defined

To clarify, the first point maintains that the engine that drives all business activity is the desire for personal gain. This does not necessarily commit the capitalist to the radical theory of psychologi- cal egoism, which states that all human actions are selfishly motivated and that humans are psy- chologically incapable of performing purely altruistic actions. However, it does imply that, within the arena of business activity, all players do what they do in hopes of financial gain. Whether it is the venture capitalist, the private entrepreneur, the corporate executive, or the worker, the pros- pect of making money is the carrot that motivates.

In economics, this idea is expressed in the concept of the profit motive: The ultimate purpose of a commercial enterprise is to earn a profit. That is the reason that businesses exist. According to this view, it is a psychological fact that self-interest motivates economic activity, and from an ethical perspective, that is the way it should be. Throughout history, the flourishing of civilizations has gone hand in hand with vigorous economic activity—craftsmanship, industry, and trade with neighboring countries. Whatever gains societies make through economic development owe at least in part to this kind of self-interest.

One popular way of expressing this notion is with the idea that greed is good: With life in general and the business world in particular, the human drive of self-interest directs our energy and cre- ativity. The term greed is not the most flattering way of depicting the idea of the profit motive; since the Middle Ages, greed has been listed as one of the seven deadly sins. However, by desig- nating greed as morally “good,” the implication is that this aspect of human nature can be redi- rected to motivate business activity in a proficient and positive way. In the words of the character Gordon Gekko in the movie Wall Street, “Greed, for lack of a better word, is good. Greed is right. Greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit” (Pressman & Stone, 1987).

The second tenet of capitalism is that the major sources of society’s economic production should be privately owned, not governmentally owned. This includes land, raw materials, factories, retail stores, transportation services, communication networks, and any other major component of a country’s economy. According to capitalists, all of these things function better when owned and operated by private individuals or organizations than when owned by the government. Part of the reason for this is efficiency: If you own your own business, you will be personally motivated to do everything in your power to succeed. You will be responsive to the needs and demands of con- sumers; if you are not, you risk going out of business. With government ownership, that element of personal interest is stripped away.

Another justification for private ownership is the very notion of the moral right to private prop- erty: The businesses that we create are part of our personal property, and we are entitled to keep them. While the political concept of the natural right to property is only about three centuries old, the human sense of entitlement to personal property is much older and part of human nature itself. At the purely animalistic level, it is a manifestation of territoriality, in the same way that birds own their nests and beavers own their dams. The Italian philosopher Niccolò Machiavelli vividly encapsulated the zeal we have for private property: A political ruler “must keep his hands off the property of others, because people more quickly forget the death of their father than the loss of their inheritance” (1532/1988). According to capitalists, a government’s taking away our private property is one of the greatest moral violations.

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CHAPTER 2Section 2.2 Capitalism and Socialism Defined

Concerning the third point of capitalism, that eco- nomic planning should be decentralized through mar- ket competition, this is the basic idea of free market economics. That is, businesses should be governed by the laws of supply and demand, not restrained by government interference. The idea of competition in a free market is often compared with the evolutionary notion of survival of the fittest. With the evolution- ary notion, species with the best adaptations, such as long claws, win out over rival species that are less well adapted, such as those with shorter claws. The losers die out and the winners live to compete against future rivals. In business, companies are best adapted to a competitive marketplace when they can offer a higher quality product for a cheaper price. Companies that are nimble and can quickly seize new market oppor- tunities are the ones that will survive; the losers will go out of business. In the process, products improve, consumers are happier, jobs are created, and wealth is generated. Contrast that with a situation where govern- ments control or severely restrict business production and the ability to compete against rivals. Prices would remain fixed, quality would stagnate, and responsive- ness to consumer demands would be low. According to capitalists, governments should simply stay out of the marketplace—as indicated by the adopted French expression laissez-faire, “leave it alone.”

Socialism

We turn now to the concept of socialism, which holds the exact opposite of the three tenets of capitalism mentioned previously. That is,

• community interest, not personal self-interest, should motivate economic development; • the major sources of society’s economic production should be governmentally owned,

not privately owned; and • economic planning should be centralized through government policy, not decentralized

through market competition.

Regarding the first point, socialists do not deny the place that self-interest holds in human motiva- tion. We are clearly selfish creatures at many levels, and some of that selfishness may be unavoid- able. However, we are not at our best when our actions are dominated by selfish inclinations and we behave more like animals. Within human nature there is another drive—a community-ori- ented one—that better reflects our true human character. Virtually every political philosopher for the past 2,500 years has acknowledged the social character of human nature: We cannot survive

Associated Press/Bikas Das

In this 2011 photo, activists from the Socialist Unity Center of India (SUCI) show their support for the Occupy movement that originated in the United States.

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CHAPTER 2Section 2.2 Capitalism and Socialism Defined

on our own, and we require a community of diverse members to meet our survival needs. We are not lone survivalists, fending for ourselves in the untamed wild; in fact, the human species was never like that. For the vast majority of our 500,000-year existence as a species, we lived in tribes as hunter-gatherers. These were small groups, typically extended families, and most tribal activity focused on the survival of the community. The concept of “every man for himself” did not make much sense in that context. It was only with the emergence of city life 12,000 years ago, during the agricultural revolution, that the opportunity even arose for an economic system that could be driven by personal greed.

That chapter of human history has not been a pretty one. Land and other resources have been plundered, workers have been exploited and enslaved. These and other morally heinous acts are the regular consequence of an economic system dominated by self-interest. Socialism, by contrast, involves shaping an economic system in a way that is more consistent with our community interests.

The second tenet of socialism is that the major sources of society’s economic production should be governmentally owned, not privately owned. Private ownership of the economic base leads to the accumulation of wealth in the hands of a few powerful owners and the degeneration of society into a system of those who have and those who have not. The socialist writer Pierre-Joseph Proud- hon made the famous statement that “property is theft,” by which he meant that business owners steal profits from the workers. Workers are the ones who essentially create the wealth, but they are coerced into a working situation where they reap almost none of the rewards. To that extent, it is much like slavery. Further, with regard to private ownership, socialists believe that owners have too much control over how they manage their property, and that they can act in ways that harm society as a whole. Owners can wipe out natural resources, such as timber and even water. They can take the best land for themselves, leaving nothing of value to the masses of the poor. They can sell off the nation’s food supply to foreign markets if that becomes profitable. All of these ethical abuses of property cease when the property is owned and managed by a government that sees its mission as the betterment of society as a whole, including all of the social classes it contains.

The third tenet of socialism is that economic planning should be centralized through government policy, not decentralized through market competition. Consider again the “survival of the fittest” metaphor of market competition. What capitalists emphasize is the lower prices and higher qual- ity of goods that result from competition. What they sweep under the carpet, according to social- ists, are the more negative aspects of survival of the fittest. For every winner there is a loser, and when a company goes under, it is the army of unemployed workers who suffer the most. They often have no financial safety net in the way that wealthy business owners do, and they often need to uproot their families and relocate in hopes of finding other employment. Further, when competition is stiff, there is pressure for a business to survive at all costs; owners will continually find creative ways to cheat, either in direct violation of laws or with unethical tactics that stay just one step ahead of lawmakers. All of these ethical problems are eliminated when a government itself plans the economy in response to consumer needs. Rather than have businesses claw each other to death as they fight to dominate every new consumer market, the government addresses those needs in an orderly way that causes the least amount of social upheaval.

Again, these descriptions of capitalism and socialism express recurring themes in these ideologies, and different proponents will have their own points of emphasis. Two economists are associated with the opposing systems of capitalism and socialism, namely Adam Smith (1723–1790) and Karl Marx (1818–1883). No capitalist or socialist accepts as truth every point that these thinkers made. But their writings are still held in almost scriptural reverence, and long after the words of contemporary

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CHAPTER 2Section 2.3 Adam Smith’s Capitalism

defenders of those rival ideologies are forgotten, the writings of Smith and Marx will remain as blue- prints for the economic systems that they forged. We will look at highlights of their respective views next, particularly ones that are as relevant today as they were in the two men’s lifetimes.

2.3 Adam Smith’s Capitalism The Scottish philosopher Adam Smith was a professor of moral philosophy at the University of Glasgow and the author of two important works in ethics and economics: The Theory of Moral Sentiments (1759) and An Inquiry Into the Nature and Causes of the Wealth of Nations (1776). Although Smith’s theory of capitalism is detailed, there are three concepts central to it:

1. The economy is driven by selfish desire for luxury goods; 2. economic balance is achieved through a self-regulating invisible hand; and 3. the government’s role in a nation’s economic system should be limited.

We will look at each of these concepts.

Selfish Desire for Luxury Goods

Selfishness, according to Smith, is a fundamental driving force of human conduct. Although Smith did not go so far as to say that every human action arises from selfish motives, he believed that selfishness is the foundation of an important segment of our public actions. It drives each person to take “proper care of his health, his life, or his fortune,” which are among the most important moral duties that we owe to ourselves (Smith, 1759/1982, 4.2.3). It is also the fundamental motive that determines how we acquire from others what we need for our survival and success. I cannot survive on my own, and my most basic needs for food can only be met through the cooperation of others. To get you to help me, though, I cannot rely on your kindness. Rather, I must find some way for you to personally benefit before you will consider assisting me. Smith wrote:

Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages. (1776/1981, 1.2)

To get what I need, it will always come down to the old adage that I will scratch your back if you scratch mine.

Just as selfishness drives me to acquire life’s necessities, it also motivates me to acquire luxuries, improve my position in society, and climb the ladder of financial success. According to Smith, a poor person envies the easy and comfortable lifestyles of the rich, wants that for him- or herself, and works diligently and with great difficulty to acquire it. The person devotes years to education, acquires a marketable skill, and struggles to build up a client base, often working for people he or she hates. Throughout life, the person is driven by the selfish belief that achieving an opulent

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CHAPTER 2Section 2.3 Adam Smith’s Capitalism

life with wealth and disposable luxury goods will bring happiness. The fact is that it will not necessarily make the person happier, and in the end the person will prob- ably be more miserable for all those efforts: “Through the whole of his life he pursues the idea of a certain artificial and elegant repose which he may never arrive at, for which he sacrifices a real tranquility that is at all times in his power” (Smith, 1759/1982, 4.1).

Smith’s point is that we naturally desire luxury items that appear to be a means of happiness, and thus we block out the thoughts of toil and misery that go along with acquiring and maintaining those things. If it looks like it will make our lives happier, we will want it and pursue it, even if on balance that effort will make us unhappier. It is this desire for luxury that drives the economy, and the irony is that it is grounded in a natu- ral deception. Smith wrote:

It is this deception which rouses and keeps in continual motion the industry of mankind. It is this which first prompted them to cultivate the ground, to build houses, to found cities and commonwealths, and to invent and improve all the sciences and arts, which ennoble and embellish human life; which have entirely changed the whole face of the globe. (1759/1982, 4.1)

In sum, selfishness motivates our desire for both necessities and luxuries, and we get what we desire only by appealing to the selfishness of others. Also, the selfish desire for luxuries is what drives the whole economy.

The Invisible Hand

The second component of Smith’s theory is perhaps what he is most famous for, namely the idea that by pursuing our self-interest, we indirectly promote the good of society as if directed by an invisible hand. There is a natural tendency towards self-regulation in economic systems, which creates economic balance within society. Smith used the expression “invisible hand” only twice in his economic writings, emphasizing a different point each time. First he described how the wealth of the rich will be automatically distributed to poor workers. As we accumulate our wealth, there is still only a limited amount that any one person can consume, and the remainder of that wealth will ultimately make its way to workers who make our wealth and lifestyle possible. He wrote:

[The rich] consume little more than the poor, and in spite of their natural selfishness and rapacity . . . they divide with the poor the produce of all their improvements. They are led by an invisible hand to make nearly the same distribution of the neces- saries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing

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According to Smith, the desire for luxury drives the economy. In this photo, a pedes- trian walks past a Max Mara luxury store in Shanghai.

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CHAPTER 2Section 2.3 Adam Smith’s Capitalism

it, advance the interest of the society, and afford means to the multiplication of the species. When providence divided the earth among a few lordly masters, it neither forgot nor abandoned those who seemed to have been left out in the partition. These last too enjoy their share of all that it produces. (Smith, 1759/1982, 4.1)

According to this view, economic growth flows down from the top to the bottom, indirectly benefit- ing those at the bottom. To support their luxurious lifestyles, the rich need a network of workers to produce goods and provide services. This occurs when, for example, a rich farmer employs labor-

ers to grow crops and maintain the property. It also occurs when the farmer buys luxury goods, thereby giving work to carpenters, clothiers, artists, and book publishers who might live a hundred miles away or more. This automatic spreading of wealth throughout society is an important moral good.

Smith’s other description of the invisible hand involves international trade; he supported what we now call free trade, namely the concept that trade across national boundaries should take place without inter- ference from the respective governments. In Smith’s day, as now, individual countries typically tried to acquire more wealth than rival countries. The for- mula for doing this is to increase one’s exports while, at the same time, decreasing one’s imports. Govern- ments have used a range of protectionist policies to achieve these goals, such as placing taxes and caps on imported items. Smith rejected these protectionist policies and argued that if we just allow businesses to follow their own self-interest, their country’s economy as a whole will improve. I, as a businessperson, know that my company will perform better when the econ- omy of the whole country thrives. I will thus be natu- rally inclined to support the domestic economy, even when my principal aim is to increase my own business. Smith wrote:

By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. (1776/1981, 1.2)

Although these are the only two instances where Smith used the expression “invisible hand,” in this quote he indicated that “in many other cases” the concept of the invisible hand applies, and a larger moral and social benefit is achieved when we pursue our own interests.

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Adam Smith’s theory of capitalism contains three central concepts: (1) The economy is driven by selfish desire for luxury goods, (2) economic balance is achieved through a self-regulating invisible hand, and (3) the government’s role in a nation’s economic system should be limited.

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CHAPTER 2Section 2.3 Adam Smith’s Capitalism

Limited Role of Government

The third component of Smith’s theory is that, although the presence of government is sometimes necessary in the economic development of a society, its role should be limited and, when possible, it should allow private industries to assume tasks. Governments often take on the kind of activities that private industries and organizations do. They own and operate post offices, energy services, water utilities, transportation networks, educational institutions, and even religious establishments. Smith argued that there are three fundamental duties of governments, and that beyond those, pri- vate industries are better suited to take on tasks. The first governmental duty is defense, the use of military force to protect society from violence and attack from rival countries. The more advanced the society is, the more expensive its weaponry will be, and there is no avoiding those costs to the public. The government’s second duty is to run a judicial system that protects “every member of the society from the injustice or oppression of every other member of it” (Smith, 1776/1981, 5.1.2). The costs of running a judicial system, Smith argued, can to a large extent be defrayed through court fees.

Even among the most extreme critics of big government, there is little dispute about the gov- ernment’s fundamental role in defending the country and operating a judicial system. However, according to Smith, there is yet a third area of legitimate government involvement, and that involves public works and institutions that are of great benefit to society but too unprofitable to be taken on through private industry. These, according to Smith, fall into three categories:

1. First, there are public works and institu- tions that are necessary for businesses to operate effectively, including the creation of roadways, bridges, harbors, and other parts of the transportation infrastructure. Smith also mentioned post offices and foreign embassies as institutions that are essential for commerce. Much of the cost of these commerce-based projects can be covered through tolls and user fees, without placing a burden on general public funds.

2. Second, there are government programs devoted to public education. The government has a strong interest in educating “inferior ranks of people,” who, Smith said, seem to be “mutilated and deformed in a still more essential part of the character of human nature” (1776/1981, 5.1.3). Through educa- tion, people will be less prone to superstition, and therefore to public disorder. Also, when properly educated, the masses are “less apt to be misled into any wanton or unnecessary opposition to the measures of government” (Smith, 1776/1981, 5.1.3). Costs of public edu- cation, Smith argued, can be paid for through student fees or educational endowments.

3. Third, there are public institutions that are responsible for religious instruction. The United Kingdom, in Smith’s day as now, had a

What Would You Do?

You are a congressional representa- tive. Up for debate is whether several popular government programs should continue to be funded through tax dol- lars or instead be privatized and run as for-profit businesses. The central issues are the social importance of these pro- grams, the question of whether they could be economically viable if priva- tized, and your moral responsibility to your constituents.

1. Would you privatize the interstate highway system and have motor- ists pay for its use through tolls?

2. Would you privatize NASA, and essentially make space exploration a for-profit venture?

3. Would you privatize all K–12 school systems, thereby permitting them to be for-profit companies?

4. Would you privatize Social Secu- rity, thereby making Social Security retirement benefits vulnerable to poor investment decisions and market volatility?

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CHAPTER 2Section 2.4 Karl Marx’s Socialism

state-funded religion, namely the Church of England. Smith’s view on the public funding of religion was rather radical. The worst part about religion, he argued, is that it perpetu- ates fanaticism, superstition, and civil unrest. State-supported religions are particularly bad at this, he argued, and the United Kingdom’s state-run church was responsible for the deaths of thousands through religious persecutions. According to Smith, religion would be more moderate if churches were run privately in a competitive free market, where each church would of necessity learn to be tolerant of its rivals. Although state religions should be abolished, according to Smith, the government should create pro- grams to reduce religious superstition even further. For example, the educated class could be required to study science, which, he said, “is the great antidote to the poison of enthusiasm and superstition.” The government should also publicly fund “painting, poetry, music, dancing” and other forms of art that Smith believed help remove the gloominess of religious fanaticism (Smith, 1776/1981, 5.1.3).

All three of these roles of government, according to Smith, aim at enhancing the well-being of society in ways that private industries are incapable of doing by themselves.

2.4 Karl Marx’s Socialism Born in Germany, Karl Marx was trained as a philoso- pher, but he is best remembered as a political activist and champion of the theory of communism, a radical form of socialism that aims to abolish all social classes, private property, and even government. Although Marx was a prolific writer, his two most famous works are The Communist Manifesto (1848), a document calling for workers to launch a revolution, and Capital (1867–1894), which critiques the capitalist economic system. Like Smith’s theory, Marx’s view of socialism is detailed, but there are three main features of it that we will examine:

1. In a capitalist system, workers are alienated from their labor;

2. in capitalism, there is a class struggle between the working class and the business owners; and

3. workers must improve their situation by revolting against capitalist forces in society.

Alienated Labor

Like Smith, Marx believed that egoism is a strong moti- vating force for people’s conduct and that people are naturally driven to seek their own benefit in economic matters. But, he argued, our egoistic tendencies are a distortion of a more inner and essential part of human

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Karl Marx’s theory of communism contains three main features: (1) In a capitalist system, workers are alienated from their labor; (2) in capitalism, there is a class struggle between the working class and the business owners; and (3) workers must improve their situation by revolting against capitalist forces in society.

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CHAPTER 2Section 2.4 Karl Marx’s Socialism

nature that is community oriented. Through our community nature, our choices and actions are connected with others around us, not in conflict with others. But according to Marx, capitalist societies and economic systems have embraced the egoistic, dog-eat-dog part of human nature, and this egoism is evident in the so-called natural rights that countries like the United States and France have embraced.

The right to liberty gives us a private sphere of conduct in which we can do what we want in iso- lation of others. Marx wrote, “The right of man to liberty is based not on the association of man with man, but on the separation of man from man. It is the right of this separation, the right of the restricted individual, withdrawn into himself” (1843/1926). The natural right to private prop- erty works the same way: It allows us to accumulate wealth for our own selfish needs, “without regard to other men, independently of society” (Marx, 1843). The natural right of equality simply says that each person is equally entitled to live and act in isolation from others. Still worse is the natural right to security, which states that governments and their policing power are established to protect us as we exercise our liberties for our own benefit in isolation from others.

Marx argued that when our entire social and economic systems are directed towards egoistic needs, then we as individual people become fractured and alienated from our inner community nature. This is most evident in how the vast majority of workers are forced into job environments in which they become mere tools for the egoistic benefit of the owners. Take a typical factory job. I need money to survive, and my only employment opportunity requires me to labor in a textile factory, performing specific tasks on a textile loom all day, all for the financial benefit of the owner. Although I get paid, I have no choice in what I do, no personal stake or say in what happens to the products that I make, and, most importantly, no opportunity to connect my labor to the commu- nity in a meaningful way. This is Marx’s notion of alienated labor: I become alienated from my true inner nature when I am forced to give my labor away to the factory owner. Workers have nothing left to sell to survive but their own labor. Marx argued that this is much like prostitution: Out of financial desperation, the prostitute sells off a critical part of her identity that she would other- wise reserve for the intimate bonding with her spouse. In a more perfect economic environment, I would not be coerced into prostituting my labor for a measly paycheck. I would be more in control of what I produce and how I use my labor to bond with the larger community.

For Marx, here is what happens when our labor is not alienated and, instead, our job routines are in accord with our true community nature. Suppose that I have a cottage industry in which I design and manufacture shirts within my house.

1. First, when I produce a shirt through my labor, I impose my creative identity on the world. Who I am as a person in some sense becomes transformed into the physical world, and I can take pleasure in seeing the physical expression of my creative personal- ity with my own two eyes.

2. Second, when you need a shirt and buy it from me, I can take pleasure in the fact that I have satisfied a specific human need that you have.

3. Third, I become the social mediator between you and your human need, and because of that you acknowledge my role in completing a necessary part of your identity.

4. Finally, the shirt that you now wear becomes part of your identity. Through the creative expression of my life, then, “I would have directly created your expression of your life” (Marx, 1844).

The end result is that through my creative expression, I connect with my community. In Marx’s words, “in my individual activity I would have directly confirmed and realized my true nature, my

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CHAPTER 2Section 2.4 Karl Marx’s Socialism

human nature, my communal nature” (1844). The financial exchange between you and me will still be part of the transaction, and I will still need your money in order to survive. However, the financial component will be more of a secondary issue, and the primary issues of our transaction will be self-expression and commu- nity bonding. This removes the alienation of labor and places economic transactions on a higher moral level.

Even today we see this community bonding with craftspeople who have a love for their trade and enjoy sharing their goods with others. But this unalienated approach to labor is very difficult to achieve in modern capitalist and industrial work environments. Businesses do what they can to get their workers to identify with their products and the benefit that they bring to soci- ety. The more hierarchical terms employee and super- visor have commonly been replaced with the more group-oriented terms team member and team leader. In a sense, this acknowledges Marx’s assessment of worker psychology: We do not want to feel like prosti- tutes in our jobs, and we want some creative input. The critical issue, though, is whether the reality of one’s job can live up to the managerial jargon of “team member- ship,” which Marx would undoubtedly say it cannot do.

Class Struggle

Within the typical capitalist system, then, workers are coerced into prostituting their labor, they are alien- ated from their true communal nature, and, as a result, they are very unhappy. This leads to the next major component of Marx’s theory: class struggle.

Throughout history, societies have evolved through conflicts between the social classes of those who do the work and those who are in charge and benefit from that work. The class conflicts that occurred throughout history were not simple ones involving bad worker attitudes; rather, they often resulted in great social upheavals and revolutions. Marx wrote:

The history of all hitherto existing societies is the history of class struggles. Free- man and slave, patrician and plebeian, lord and serf, guild-master and journey- man, in a word, oppressor and oppressed, stood in constant opposition to one another, carried on an uninterrupted, now hidden, now open fight, a fight that each time ended, either in a revolutionary re-constitution of society at large, or in the common ruin of the contending classes (1848/1967).

For Marx, the class struggles throughout history revealed a very noticeable pattern between oppressors and the oppressed workers. In Roman times there was a major class struggle between masters and slaves. Tensions grew, which included slave rebellions, and in time, that system of slavery was replaced by a slightly different social hierarchy in the Middle Ages, between nobles

Xie Zhengyi/Imaginechina; Associated Press/Hadi Mizban

Why is the relational level of communica- tion especially important in building cus- tomer relationships?

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CHAPTER 2Section 2.4 Karl Marx’s Socialism

and serfs. That tension was eventually replaced during the Renaissance with the emergence of the middle class. But the oppression still continued, as the middle class gained financial strength and formed a capitalist economic system that continued to oppress workers.

Marx witnessed firsthand the 19th-century industrial revolution, which radically transformed the manufacturing of coal, iron, textile, and glass. This was the first time that nonaristocrat busi- ness owners controlled major industries, and to that extent, it was a social triumph. However, this new class of large-scale business owners—the bourgeoisie, as Marx called them—were as oppressive to workers as previous members of the ruling class had been. Working conditions were ghastly, pay was minuscule, and workers had next to no political representation. Charles Dickens’s novels, such as Hard Times, give us a glimpse of the oppressive working conditions during the 19th century that Marx was reacting against. In many ways, the economic realities of the industrial revolution made working conditions even worse for workers than they had been in previous eras. Manufacturing facilities became larger and, through division of labor, work tasks became more tedious:

Owing to the extensive use of machinery and to division of labor, the work of the proletarians has lost all individual character, and consequently, all charm for the workman. He becomes an appendage of the machine, and it is only the most simple, most monotonous, and most easily acquired skill, that is required of him. Hence, the cost of production of a workman is restricted, almost entirely, to the means of subsistence that he requires for his maintenance, and for the propaga- tion of his race (Marx, 1848/1967).

Workers must sell themselves for the performance of these tedious tasks and become one more commodity in the economic system. Like articles of commerce, they are “exposed to all the risks of competition, to all the fluctuations of the market” (Marx, 1848/1967). The situation for workers gets progressively worse as their value in the market decreases.

Revolution

Marx argued that the time for change had come, and in the next phase of social progress, workers would once more rise up against their oppressors. But this time it would be different. In previous phases of social history, changes in hierarchy did not end oppression: The bosses changed, but the exploitation of workers remained the same. With this next phase, the workers would overthrow the ruling class, seize control of the economy, and destroy the institution of private property, which has always been the principal source of exploitation.

For Marx, the long-term goal of the revolution was communism, which, as indicated before, involves the creation of a society without private property, class division, or government. To achieve that ultimate goal, however, Marx argued that after the revolution, society must go through a transi- tional phase of socialism where the government takes control of major economic resources within society and enacts policies to reduce class distinctions between the rich and poor. Marx recognized that the ruling class would be horrified at the idea of revolutionaries abolishing private property, but, he continued, in existing capitalist societies, “private property is already done away with for nine-tenths of the population” (1848/1967). The abolition of private property cannot come about through reforms of existing governmental policies, since governments are so embedded with the interests of the ruling class. Only a full-scale revolution will make it possible—one country at a time. This, he believed, is inevitable.

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CHAPTER 2Section 2.5 Assessment of Capitalism and Socialism

Once the working class has control, Marx argued, the process of abolishing private property will differ somewhat from country to country, but the more advanced countries will follow a common path. That is, a transitional system of socialism will be put in place, which, step by step, will dis- mantle the social framework of capitalism and replace it with a more community-oriented set of policies. Here, in Marx’s words (1848/1967), are the steps that he envisioned, now referred to as the Ten Planks of Communism:

1. Abolition of property in land and application of all rents of land to public purposes. 2. A heavy progressive or graduated income tax. 3. Abolition of all right of inheritance. 4. Confiscation of the property of all emigrants and rebels. 5. Centralization of credit in the hands of the State, by means of a national bank with State

capital and an exclusive monopoly. 6. Centralization of the means of communication and transport in the hands of the State. 7. Extension of factories and instruments of production owned by the State; the bringing

into cultivation of waste-lands, and the improvement of the soil generally in accordance with a common plan.

8. Equal liability of all to labor. Establishment of industrial armies, especially for agriculture. 9. Combination of agriculture with manufacturing industries; gradual abolition of the

distinction between town and country, by a more equable distribution of the population over the country.

10. Free education for all children in public schools. Abolition of children’s factory labor in its present form. Combination of education with industrial production, etc.

The socialist revolution, as Marx envisioned it, constitutes a thor- ough moral transformation of soci- ety that eliminates the alienation and oppression of workers and makes social benefits available to all people equally. For Marx, when the residue of capitalism has been thor- oughly scrubbed away, society will enter an era of true communism. All class distinctions will disappear, since there will no longer be a class of workers that is distinct from a class of owners. Without private property, economic conflict will also disappear, at which point the gov- ernment’s role in social organization will become unnecessary and the government will eventually die out.

2.5 Assessment of Capitalism and Socialism The theories of capitalism and socialism have both been hotly debated since they were first forged; we will look at some of the standard criticisms of each. As complex as both theories are,

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This 1950 poster, which was displayed in Moscow, urged citi- zens to vote for candidates such as Joseph Stalin. The poster reads, “A human being has the right to study, rest, and work.”

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CHAPTER 2Section 2.5 Assessment of Capitalism and Socialism

we cannot expect simple criticisms to decisively refute either of them. Further, over time, defend- ers of both theories have attempted to address problems posed by critics and revise their theories accordingly. Those revised theories are often even more resilient to standard attacks. Neverthe- less, general criticisms do reveal potential weak links in the theories.

Criticisms of Capitalism

The fundamental criticism of capitalism is that competitive markets have a built-in bias towards private interests rather than public ones. There are several manifestations of this bias:

• Capitalism leads to dramatic economic inequality and introduces class divisions between the rich and poor, which is precisely what was of concern to Marx.

• It is a system in which the worker’s labor is a commodity to be bought and sold, which often leads to dreadful working conditions. It is true that many companies today realize the value of people and have spent considerable effort and research to create job satisfaction. Nevertheless, job satisfaction remains low among workers in unskilled and semiskilled jobs, such as laborers, packagers, food preparers, cashiers, stockers, and servers (Smith, 2007). And for many workers in foreign countries who manufacture products sold in the United States, their situation is not much different from that of laborers in Marx’s day.

• It fosters environmental destruction and has no built-in incentive for environmental stewardship.

• It tends to be politically undemocratic by enabling large businesses to use their enormous wealth to lobby the government against consumer interests in favor of their own financial well-being.

• It cannot be trusted to shape national policy in the interests of the public, as witnessed by the elimination of public transportation systems throughout the United States and the movement of manufacturing facilities overseas.

• It creates antisocial motivations in both buyers and sellers. Buyers take advantage of return policies and are quick to sue companies for even honest mistakes. Sellers mislead buyers about the quality of their products and services. Buyer and seller become more like adversaries in the market, rather than partners.

There are countless examples of how capitalism is inherently in tension with moral responsibility to the public, and most of the problems and famous examples covered in this book arise from that tension. In a sense, the entire study of business ethics is a testament to the fundamental problems of capitalism.

Criticisms of Socialism

Turning next to socialism, we find three main criticisms. First, we cannot restrain our motivations of personal self-interest in the manner that socialists advise. Although socialists agree that it is impossible to fully eradicate human selfishness, they recommend subduing it to the point that our community-oriented motivations guide how we develop society’s institutions and economic struc- ture. But even that might be asking too much. Personal self-interest drives us to devote time and energy to better our situation, and without some substantial personal reward, we might not be willing to devote that kind of effort to the greater social good. Personal ambition has been at the forefront of technological innovation and personal progress, and socialists have not adequately explained how we can transfer that drive to public interests.

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CHAPTER 2Section 2.5 Assessment of Capitalism and Socialism

A second and related criticism of socialism concerns the difficulty in significantly scaling back on private property, as more extreme socialists advise. Like human selfishness, property owner- ship is deeply ingrained in human nature—even monks, who take vows of poverty and live their entire lives in communal monasteries, still own their own toothbrushes. In a sense, socialists attempt to impose a prehistoric model of communal society on modern economy. According to socialists, just as primitive tribes held their major resources in common, so too should we in modern society hold ours in common. But according to critics, the fit does not work very well in the modern setting. We have moved beyond our hunter-gatherer roots, and through the com- plex demands of urbanization, we have reinvented ourselves and found a new way to flourish based on harnessing our private desires for wealth and property. The tie that binds together tribal societies is daily contact with each other; the life and activity of one tribe member imme- diately overlaps with those of others, like a large family. But modern society is too large to be like a real family; it is a mere abstract concept that does not allow for the same bonding experi- ence that is possible in small tribal groups. As the size of society grows, so too does our impulse towards private property.

Finally, socialist policies of centralized planning are ineffective ways of structuring the economy, as the failed efforts of the former Soviet Union with centralized planning teach us. Banking, indus- trial production, and distribution of goods and services were organized and carried out based on a master plan devised by the Soviet government. The principal problem with such centralization is inefficiency: It creates unpredictable deficiencies and surpluses. As hard as the Soviet government tried to predict how much bread or toilet paper its citizens needed on a daily or weekly basis, there would nevertheless be great deficiencies in some cities on some days and great surpluses in others. Breadlines were a common occurrence, where people would stand outside a bread store all night to buy as much bread as permitted the next morning before supplies ran out.

Moderate Versions

These are just some of the standard arguments against both socialism and capitalism, and again, defenders of each of these ideologies certainly have rebuttals. But when assessing the respective merits of both ideologies, it is important to recognize that there are both extreme and moder- ate versions of each, which fall along a spectrum from the most extreme capitalism to the most extreme socialism. Very few theorists espouse the most extreme versions, and in the real world, very few if any countries have ever implemented their economies in such extreme ways. Adam Smith himself recognized the need for the government’s involvement in the national economy, such as to provide armies, roads, and schools and to undertake certain commercial ventures. Marx himself acknowledged that during the transitional period of socialism, there still would be some private ownership of the country’s economic base.

More moderate versions of capitalism and socialism each aim to allow at least some market- based economy while at the same time providing a social safety net to citizens. One such posi- tion on the capitalist side of the spectrum is welfare capitalism, a term that originally referred to social-welfare services provided by employers in the early 20th century, such as paid vacations, medical benefits, and pensions. More recently it has come to refer to economic systems that are capitalistic but have social programs that the government runs, such as national health care and government-run child care.

On the socialist side there is market socialism. This term originally referred to worker-owned cooperative enterprises that operate within free-market systems but are set up in ways that

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CHAPTER 2Section 2.6 Anticompetitive Practices

prevent worker exploitation. Today it refers to economic systems that are socialist in terms of govern- ment ownership and control of major economic enterprises, but at the same time incorporate some capitalist policies, such as relying on supply and demand in the mar- ket to set prices.

Just as there are a variety of theo- retical models of both capitalism and socialism, in the real world there are a variety of capitalist and socialist systems throughout the world. There is a benefit to this vari- ety, in that each country functions like a laboratory experiment in eco- nomic policy that others through- out the world can observe and learn from. What are the failures and successes of these countries, and how might this knowledge help us improve our system?

2.6 Anticompetitive Practices Economists classify the economic system of the United States as a type of welfare capitalism, similar to those of Australia and the United Kingdom. For countries like the United States that are committed to capitalism as an economic system, efforts are needed to keep the marketplace com- petitive and fair, and to prevent the free market itself from being destroyed. We will look at some of the most notorious anticompetitive business practices that must be guarded against.

Monopolies and Oligopolies

A natural outcome of competition in the marketplace is the emergence of monopolies, where a single company controls all or nearly all of the market for a given type of product or service. Sup- pose that a new market opens up for a 3-D TV, and 10 companies manufacture the product. In the normal course of competition, some companies will go under for having inferior technology or poor marketing. Other companies will merge, and in time, only one may be left standing. This scenario has played out again and again in the last few centuries, with notable examples from the past including Western Union, Standard Oil, U.S. Steel, and AT&T controlling the telegraph, petro- leum, steel, and telephone markets, respectively. In more recent years, we have seen movement towards monopolies with De Beers and the diamond trade, Microsoft and computer operating systems, and Monsanto and the commercial seed market.

Dapd/Michael Probst

Originally founded in Sweden, Ikea is a home-furnishings com- pany that features Scandinavian-designed products. Sweden is an example of a country that adopts elements of both capital- ism and socialism. On the capitalist side, their system allows for private ownership of businesses large and small. On the social- ist side, their high tax rate of around 50% funds government programs of free health care and education.

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CHAPTER 2Section 2.6 Anticompetitive Practices

What, though, is so bad about monopolies? If a company wins fairly in its battle for market share, does it not deserve its position of dominance? Critics argue that monopolies destroy the very competitive markets that first created them, and in the process they eliminate the two key ben- efits of a capitalist economic system. That is, competition is no longer present to drive down prices and improve quality. For example, when AT&T dominated the telephone industry, prices were comparatively higher than they were after the company was forced to break up, and consumers had fewer options than after the breakup. Imagine what using the phone would be like today if AT&T were the only game in town. The almost infinite variety of cellular-phone applications that we have come to rely on would likely be only futuristic dreams.

But the companies accused of holding monopolies tell a different story. In the 2001 court case against Microsoft, for example, the software company argued that its dominance in the market had enhanced rather than harmed the innovation process throughout the entire software indus- try. Consumers, it argued, had also benefited from the low price of its operating system, its free applications, and the impact Microsoft had had in accelerating computer-software innovation more generally. It would be difficult to demonstrate that all monopolies will lead to a decrease in innovation and higher prices; however, there is a realistic fear that at least some monopolies will do so, and that is enough to make a monopoly a potentially anticompetitive practice.

Similar to a monopoly is an oligopoly, where the market is dominated by a small number of businesses that collectively exert control over that market’s supply and prices. The petroleum, telecommunication, automobile, and soft-drink industries are the clear examples, but with other products, oligopolies are more concealed. There are, for example, dozens of national brands of laundry detergents on the market, but the vast majority are produced by only three companies. As with monopolies, the question remains whether the dominance of an oligopoly in a given market will of necessity harm inno- vation and result in higher prices.

Two mechanisms that can lead to both monopolies and oligopolies are mergers and acquisitions. A merger is when two companies of roughly the same size agree to combine as equals to form a new company. An example is the 1989 merger of Time Inc. with Warner Communications to create Time Warner, one of the world’s larg- est media companies. An acquisi- tion, by contrast, is when a larger company buys a smaller company, which is then swallowed up and loses its identity within the larger one. Nothing is inherently anti- competitive about mergers and acquisitions, and they are in fact a normal part of business transac- tions. But when these mechanisms

Associated Press/J. Scott Applewhite

In this 2011 photo, Jeremy Stoppelman (left), CEO of Yelp, tes- tifies at a Senate hearing held to determine whether Google used its power unfairly to expand into services and markets other than search-engine services. Nextag CEO Jeff Katz (cen- ter) and former Justice Department antitrust director Thomas Barnett (right) are also shown.

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CHAPTER 2Section 2.6 Anticompetitive Practices

are used repeatedly within a given market and produce monopolies and oligopolies, they may create a potentially anticompetitive situation.

Price Fixing, Bid Rigging, and Price Gouging

Whereas monopolies and oligopolies are only potentially anticompetitive, other business prac- tices are anticompetitive by their nature and are both unethical and illegal. One such practice is price fixing, where business competitors conspire to set their prices at a fixed point. In usual cases, the businesses set their product prices high; without cheaper alternatives available, con- sumers are forced to buy at the high price. Price fixing often occurs in markets that are dominated by oligopolies, where the small number of competitors makes it easier to enter into price-fixing agreements. For example, in 1999 six major vitamin manufacturers reached a settlement to pay over $1 billion in a price-fixing lawsuit, which was the highest amount paid in an antitrust case up to that point. Although the six companies do not have commonly recognizable names, among them was F. Hoffmann-La Roche of Switzerland, the maker of the popular tranquilizer drug Valium. During a 9-year period, the companies controlled 80% of the wholesale market for vitamins A, C, and E, which they supplied in bulk to almost 1,000 food companies—including Coca-Cola, General Mills, and Kraft Foods. These companies, in turn, used the vitamins as ingredients in food products such as breakfast cereals. The six companies conspired to artificially inflate the prices that they charged, and these inflated prices were then passed onto consumers.

A variation on price fixing is bid rigging, where competing businesses agree that one of them will place a bid on a contract at a predetermined price. Often this is done in rotation, where the conspiring businesses take turns offering the lowest bid. A notable case involved several dozen electrical equipment companies, including General Electric and Westinghouse, which engaged in a bid-rigging conspiracy during the 1950s for products such as power transformers and genera- tors. Every 4 weeks, the companies would rotate who would place the lowest bid, ensuring that each would have a turn. What gave them away was that many of the high bids were identical to each other, which would not likely occur by accident. In one case, 12 of the bids quoted the same delivery price, despite the fact that driving distances from the respective factories varied greatly. In total, 29 companies were found guilty in this “Great Conspiracy,” as it was called, and 30 execu- tives received jail sentences. In addition to criminal fines, customers brought over 2,000 lawsuits against the companies, resulting in hundreds of millions of dollars in damages.

A final type of unfair competitive practice is price gouging, which occurs when a business sells a product for a price that is much higher than is considered reasonable or fair or sustainable in a truly competitive environment. Price gouging often occurs when there are too few competitors in a given market, which would otherwise drive prices down. The pharmaceutical industry is notori- ous for this, and two factors make it particularly so:

• Drug patents grant a temporary monopoly. When a company produces a new drug, it is granted a legal monopoly on the sale and manufacture of it for approximately 10 years. In many cases—with breakthrough drugs—there is no competition whatsoever. The purpose of drug patents is to encourage innovation by financially rewarding companies that invest in the research and development of new drugs. But the patent itself creates a temporary monopoly until the formula is released into the public domain, when competitors can make generic versions of it.

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CHAPTER 2Section 2.7 Regulating the Free Market

• Demand for a product does not change according to the price. With normal products, price and demand are directly connected. If I charge $100 for a can of cola, the demand for my product will be very low. But if I charge 5 cents per can, demand will be high. Econ- omists call this relation elasticity. But with pharmaceuticals, the relation between price and demand is inelastic: If I need a drug to stay alive, price is no consideration. Whether it costs 5 cents a pill or $100 a pill, I will pay for it.

Here are a few examples. When the AIDS epidemic emerged in the mid-1980s, the first available treatment was the antiretroviral drug AZT, which came with an initial price tag of $7,000 a year. After intense pressure by HIV-advocacy groups, that price was eventually lowered to $3,000. The manufacturer justified the original cost on a couple grounds. First, it was initially approved for a comparatively small market of 50,000 patients who were seriously ill with AIDS—although it was later approved for anyone who tested HIV positive. Second, since AZT was not a cure and would only delay death by about 1 year, the market was literally short-lived.

Another case involved the tranquilizer Valium. The active ingredient cost the manufacturer $50 a kilogram. They sold to subsidiaries at $23,000 a kilogram, and eventually to customers at the equivalent of $50,000 a kilogram. A third case involved an antiworm drug for sheep called levami- sole, manufactured by Johnson and Johnson. When new research found that the drug was an effective treatment for colon cancer, the company made it available in drug stores at a cost to patients of around $1,200 a year, whereas farmers could buy the same quantity for their sheep for $15. The research linking levamisole with colon cancer treatment was funded by the federal government at a cost of $11 million, and the research was freely given to the drug company. In all of these cases, the monopoly on the drug allowed the manufacturer to dramatically inflate prices, with full knowledge that desperate patients would still pay them.

2.7 Regulating the Free Market To preserve a truly competitive state within the free market, the government must sometimes step in to prevent anticompetitive practices and unfairness. The free market is not so much a natu- ral state of affairs for business transactions, but is instead more like a game where participants agree to follow established rules and the government stands by like an umpire to assure that the process runs smoothly. To that extent, a pure capitalist system does not seem possible; any func- tioning free market will involve government intervention of at least some sort.

Reasons for Government Regulation

In the face of the many problems inherent in capitalist economic systems, the solution of choice is government regulation—that is, rules and policies imposed by the government on various aspects of commerce within a country. The underlying justification is that responsibility in the business world comes about only through legislating it. Here is a simple example. Some financial investments, such as stocks, are regulated by the U.S. Securities and Exchange Commission (SEC), whereas other investments, such as collectible stamps, are not. A respected stamp dealer was recently called out for making exaggerated claims about his stamp investment plan. One financial analyst explained:

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CHAPTER 2Section 2.7 Regulating the Free Market

Reading the marketing material made me shiver. It highlights how careful inves- tors have to be when buying unregulated products—like stamps and other collectables[sic]. If I tried to sell investments like this to my customers I’d be shut down by the regulator . . . . [The stamp dealer] uses every trick in the book to make people part with their money. There is no attempt to explain the risks involved, or detail potential downsides, like early exit charges. (Ian Lowes, quoted in Simon, 2011)

In this quotation, the financial analyst indicates how important investment regulation is for the protection of consumers. Investment markets without such regulation create opportunities for investment businesses to act irresponsibly.

There are three fundamental justifications for governmental regulation within capitalist economic systems. First, regulation aims to protect consumers, workers, minorities, the environment, and any other interest or group of people that could be exploited in a competitive marketplace. The example of stamp investments shows how great the temptation is for financial-investment busi-

nesses to misrepresent their products, and, thus, how great the need for rules of transparency and for enforcement of those rules. A second justification is to assure that business markets remain competitive, by guarding against monopolies and prohibiting anticom- petitive practices such as price fixing.

There is a third and more controversial justification of government regulation, which is to help redistribute the wealth of society. As the gap between the rich and poor grows, society risks becoming stratified into two classes. At least some efforts at governmental regula- tions attempt to address this. Minimum wage is a case in point, and the need for government involvement here is demonstrated every few years when Congress debates minimum-wage increases. In 1938, the year of its inception in the United States, the federal mini- mum wage was set at 25 cents per hour, and it has been increased around 30 times since then. The lon- gest period without an increase was 10 years, between 1997 and 2007, and during that time the prices of con- sumer goods rose considerably through inflation. Each time the issue was before Congress—and 2007 was no exception—business groups lobbied against an increase for the simple reason that increasing wages harms the bottom line. Like the minimum-wage regulation, gov- ernment regulations that require health-care insurance for workers, worker’s compensation, and Social Secu- rity all aim at preventing an impoverished underclass.

Associated Press/Bebeto Matthews

The notion of government regulation of the financial industry came up again recently. In this 2011 photo, we see the JPMorgan Chase building in New York. Lawyers seek- ing to win back money for the victims of fraudulent financier Bernard Madoff claimed that e-mails and other documents showed that JPMorgan Chase executives were complicit in Madoff’s crimes.

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CHAPTER 2Section 2.7 Regulating the Free Market

Mechanisms for Government Regulation

There are two approaches to government regulation, one direct and the other indirect. Direct governmental regulation occurs when specific regulatory policies are established by an actual branch or agency of the government, such as Congress or the SEC. The indirect variety involves government-mandated self-regulation: In lieu of direct government involvement, the govern- ment mandates that a private self-regulatory organization set policies in a given market and the government then defers to that organization. For example, within the financial market, the Finan- cial Industry Regulatory Authority is the private self-regulatory organization that operates in con- cert with the SEC to assure that the securities industry operates fairly and honestly. Although it is not itself a government agency, it nevertheless operates under the oversight of the SEC.

Another example vividly illustrates the relation between the government and self-regulatory organi- zations. In the 1980s, the U.S. Senate held committee hearings about the need for warning labels on music albums that would help alert parents to songs with violent or sexually explicit lyrics. While the Senate committee itself did not want to be accused of censoring artists or creating federal guide- lines for the warning labels, they pressured the Recording Industry Association of America to create a labeling system. One senator made the direct threat that “unless the [record] industry ‘cleans up their act’ . . . there is likely to be legislation” (Record Labeling, 1985). The outcome of this hearing was the parental advisory label for music CDs that bears the words “Parental advisory—explicit content.” Music lyrics and financial investments are just two examples where self-regulatory orga- nizations fill some important gap in the absence of direct government regulation. Many business professions have some type of self-regulatory organization, with notable ones being the American Medical Association, the American Dental Association, and the National Association of Realtors.

Antitrust Acts Two laws are particularly important for setting the parameters of the free market in the United States. One is the Sherman Antitrust Act of 1890, the first federal law to outlaw price fixing and restrict monopolies. In the language of the statute, “Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony” (Sherman Antitrust Act of 1890, Section 2). The aim of the law is to punish not businesses who become monopolies through fair competition, but only those who do so through anticompetitive misconduct. Monopolies themselves are not illegal, but the abuse of a dominant position is.

The second law is the Clayton Antitrust Act of 1914, which restricts specific types of business practices that might potentially lead to anticompetitiveness, such as mergers and acquisitions that aim to create monopolistic power. Both of these laws laid the groundwork for antitrust policies in the United States that continue to the present day.

The Federal Trade Commission (FTC) The government agency that is directly responsible for combating anticompetitive business prac- tices is the Federal Trade Commission (FTC), founded in 1914. The initial purpose of the FTC was to prevent unfair methods of competition in commerce that led to monopolies and oligopo- lies—which at the time were called trusts. Since that time, Congress has given the agency greater

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CHAPTER 2Section 2.8 Conclusion

authority to police anticompetitive practices. To this end, the FTC performs three central tasks:

• reviewing mergers and acquisitions, and chal- lenging those that would likely lead to higher prices, fewer choices, or less innovation;

• seeking out and challenging anticompetitive conduct in the marketplace, including monop- olization and agreements between competi- tors; and

• promoting competition in industries where consumer impact is high, such as health care, real estate, oil and gas, technology, and con- sumer goods (“Federal Trade Commission,” n.d.).

Regarding the first point, the FTC does not scrutinize all mergers, but only those that risk undermining market competition. The FTC has the authority to bring civil cases against offending businesses, and when the situ- ation is bad enough, they work with the Department of Justice to bring criminal charges against offending businesses.

2.8 Conclusion Winston Churchill famously said, “Democracy is the worst form of government, except for all the others.” This may apply equally to capitalism: Capitalism is the worst economic system, except for all the others. Undoubtedly, capitalism has advanced society in remarkable ways, and the long history of capitalism in the United States has made for the world’s strongest national economy. But these successes do not mean that capitalism is without serious problems. We have seen that an unregulated marketplace will lead to anticompetitive practices that can destroy all that is good about capitalism. With the profit motive as strong as it is, it is unrealistic to think that businesses will regulate themselves out of a sense of duty to society at large. For lack of any better regulatory mechanism, the government must assume that responsibility.

This often places businesses and the government in an adversarial relationship, where businesses lobby against virtually every proposed regulation and, what is more, for the repeal of important regulations that are already in place. If businesses achieved everything they wanted with their antiregulatory lobbying efforts, unfair and anticompetitive business practices could reach epi- demic proportions. Although the regulatory relationship between business and government is imperfect, it is an important safeguard for capitalism’s health. In our opening example, we saw that Bolivia’s experiment with privatizing water led to massive protests. Marx warned that it could get much worse: Workers might launch a full-scale revolution in reaction to being systematically exploited by capitalist business owners. This worst-case scenario has played out in dozens of coun- tries within the last century, and the stakes are too high to risk that happening in the United States

What Would You Do?

You are the chair of the Federal Trade Commission, and you are reviewing a possible merger between Subway and McDonalds, the two largest fast-food restaurant chains in the United States. At issue is whether the merger would create an anticompetitive environment in that industry.

1. Would you block the merger? If so, what would be your rationale?

2. Suppose these two companies were also seeking to merge with Starbucks, Pizza Hut, and Burger King, the next three largest fast- food restaurant chains. Would you block that merger? Why?

3. Suppose the 100 largest fast-food chains wanted to merge. Would you block that? Why?

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CHAPTER 2Summary

and other welfare capitalist countries. This may well be a situation in which doing the ethical thing in business requires the acceptance of government involvement.

Summary We began this chapter looking at three key features of capitalism and socialism, respectively. For capitalism they are, first, that personal self-interest, not community interest, motivates eco- nomic development; second, that the major sources of society’s economic production should be privately owned, not governmentally owned; and third, that economic planning should be decentralized through market competition, not centralized through government policy. By con- trast, the three main features of socialism are, first, that community interest, not personal self- interest, should motivate economic development; second, that the major sources of society’s economic production should be governmentally owned, not privately owned; and third, that economic planning should be centralized through government policy, not decentralized through market competition.

The most famous advocate of capitalism is Adam Smith, who argued for three main points. First, selfish desire drives the economy. To get what I need to survive, I cannot rely on your kindness but must find some way for you to personally benefit before you will consider assisting me. Second, by pursuing our self-interest, we indirectly promote the good of society as if directed by an invisible hand. Third, the presence of government is sometimes necessary for society’s economic development, but its role should be limited. Among the government’s main respon- sibilities are national defense, the judicial system, and public works that benefit society but are too unprofitable for private industries to take on themselves, such as roads, public education, science, and the arts.

The leading critic of capitalism and defender of socialism is Karl Marx, who held three principal positions. First, capitalist systems put workers in a position where they become separated from their true inner nature when forced to give their labor away to the factory owner. Second, his- tory involves a succession of class struggles between those who do the work and those who own the business or industry. Third, the current class struggle between wealthy business owners and exploited workers will end in a revolution that will ultimately put an end to all private property, social classes, and government itself.

The leading criticism of capitalism is that it creates a bias towards private interests rather than public ones. Socialism, by contrast, is faulted for underestimating the importance of personal self-interest, private property, and free-market economic planning. Moderate versions of both capitalism and socialism attempt to strike a middle ground and thereby avoid the problems asso- ciated with the more extreme versions of each. Within free-market economies, some business practices are potentially hazardous to capitalism and must be monitored, namely monopolies, oligopolies, mergers, and acquisitions. Other anticompetitive business practices are so damaging to capitalism that they are illegal, namely price fixing, bid rigging, and price gouging. To keep mar- kets competitive, the government can help control business activity by either directly regulating it through laws and policies or requiring that a private self-regulatory organization establish poli- cies within a given market.

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CHAPTER 2Summary

Discussion Questions

1. Adam Smith argued that self-interest is a critical element in a society’s economic devel- opment. Karl Marx, by contrast, argued that society functions better when each of us is more community oriented. Explain each of their views on this issue, and discuss when greed and selfishness in businesses go too far and become a hazard to society.

2. Adam Smith is remembered for his view of the “invisible hand,” the idea that by pursu- ing our self-interest, we indirectly promote the good of society. Smith himself provided two examples of this, but said that the invisible hand is also evident in “many other cases.” Explain Smith’s two examples, and speculate about other situations in which the concept of the invisible hand may be valid.

3. Smith held that, even within a capitalist economic system, the government plays a criti- cal role in supporting or running important public projects that are too unprofitable to be taken on by private industry. Among these are roads, public education, science, and the arts. In the United States, the government indeed funds these projects, and many more. What are some of these other projects, and would they, or the projects that Smith himself mentioned, be best left to private industry?

4. Marx argued that, in capitalist economic systems, workers become alienated from their labor in the sense that they forced to give their labor away to the factory owner, with no personal stake in the products they make and no meaningful connection to the commu- nity. What are ways in which business owners today try to reduce this sense of alienated labor among their employees? Do those methods work?

5. Marx was convinced that worker exploitation would inevitably lead to revolution: It happened in the past with slave and peasant revolts, and it is just a question of time before it happens with workers in capitalist societies. Even in the United States, there are regular protests against unequal wealth distribution; the Occupy movement is just one example. How bad would it have to get in the United States before peaceful protests would turn into full-scale revolution?

6. Monopolies and oligopolies are potentially harmful to free-market capitalism, and for that reason the government sometimes breaks companies up or regulates them in some significant way. Think of an example of a monopoly or oligopoly—such as Microsoft, Monsanto, or Coca-Cola and PepsiCo—and discuss the benefits and harms of their domi- nance over their specific market.

Key Terms

acquisition When a larger company buys a smaller company, which is then swallowed up and loses its identity within the larger one.

alienated labor Labor that a worker is forced to give away to a factory owner.

bid rigging When competing businesses agree that one of them will place a bid on a contract at a predetermined price.

bourgeoisie Karl Marx’s term for a class of large-scale business owners that oppresses workers.

capitalism The economic theory that main- tains that (1) personal self-interest, not community interest, motivates economic development, (2) the major sources of soci- ety’s economic production should be privately owned, not governmentally owned, and (3) economic planning should be decentralized through market competition, not centralized through government policy.

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CHAPTER 2Summary

class struggle The socialist view that through- out history, societies have evolved through conflicts between the social classes of those who do the work and those who are in charge and benefit from that work.

Clayton Antitrust Act of 1914 U.S. federal law that restricts specific types of business prac- tices that might potentially lead to anticom- petitiveness, such as mergers and acquisitions that aim to create monopolistic power.

communism A radical form of socialism that aims to abolish all social classes, private prop- erty, and government.

direct governmental regulation When specific regulatory policies are established by an actual branch or agency of the government, such as Congress or the SEC.

Federal Trade Commission (FTC) U.S. federal agency established to prevent unfair methods of competition in commerce.

free market economics The view that busi- nesses should be governed by the laws of supply and demand, not restrained by govern- ment interference.

free trade The concept that trade across national boundaries should take place without interference from the respective governments.

government regulation Rules and poli- cies imposed by the government on various aspects of commerce within a country.

government-mandated self-regulation When, in lieu of direct government involvement, the government mandates that a private self- regulatory organization set policies in a given market and defers to that organization.

greed is good The view that, in the business world, the human drive of self-interest directs our energy and creativity.

invisible hand The view proposed by Adam Smith that, by pursuing our self-interest, we indirectly promote the good of society as if directed by an invisible hand.

laissez faire French term; literally “leave it alone,” expressing the free market idea that governments should stay out of the market place.

market socialism Socialist economic systems where governments own and control major economic enterprises yet incorporate some capitalist policies, such as relying on supply and demand in the market to set prices.

merger When two companies of roughly the same size agree to combine as equals to form a new company.

monopoly Control by a single company of all or nearly all of the market for a given type of product or service.

oligopoly Market domination by a small num- ber of businesses that collectively exert control over that market’s supply and prices.

price fixing When business competitors con- spire to set their prices at a fixed point.

price gouging When a business sells a product for a price that is much higher than is consid- ered reasonable or fair or sustainable in a truly competitive environment.

profit motive The view that the ultimate purpose of a commercial enterprise is to earn a profit.

Securities and Exchange Commission (SEC) Agency of the federal government that regulates stocks.

Sherman Antitrust Act of 1890 First U.S. federal law to outlaw price fixing and restrict monopolies.

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CHAPTER 2Summary

socialism The economic theory that (1) com- munity interest, not personal self-interest, should motivate economic development, (2) the major sources of society’s economic production should be governmentally owned, not privately owned, and (3) economic plan- ning should be centralized through govern- ment policy, not decentralized through market competition.

survival of the fittest The evolutionary notion that species with the best adaptations will win out over rival species that are less well adapted.

Ten Planks of Communism Karl Marx’s set of 10 policies to transition into socialism.

welfare capitalism Social programs in market economies that the government runs, such as national health care and government-run child care.

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Corporations

Learning Objectives

After completing this chapter, you should be able to:

• Explain the nature and main features of corporations. • Discuss the principal ways of punishing corporations. • Assess the merits of various efforts to create an ethical corporate culture. • Discuss the main threats to ethical corporate culture and how to combat them.

Michael S. Yamashita

3

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CHAPTER 3Section 3.1 Introduction

Chapter Outline

3.1 Introduction

3.2 The Nature of Corporations

Corporate Structure Four Features of Corporations Shell Corporations Moral Agency of Corporations

3.3 Punishing Corporations

Six Types of Corporate Punishment Federal Sentencing Guidelines Consumer Retaliation

3.4 Ethical Corporate Culture

Stakeholders and Corporate Social Responsibility Mission Statements and Codes of Ethics

3.5 Threats to Ethical Corporate Culture

The Profit Motive Strategic Misrepresentation Groupthink and Organizational Schizophrenia

3.6 Conclusion

3.1 Introduction Corporations have existed for around 2,000 years, and in fact, the first permanent colonial settle- ments in North America were the result of corporate activity. In medieval times, corporations had already been used for establishing churches, universities, and monasteries. They were also used for creating trade guilds, which were associations of craftspeople, somewhat like trade unions.

But by the 15th century, corporations had become an important tool for funding colonial ventures as well. Establishing colonies in distant lands was a vastly expensive undertaking, but through the mechanism of incorporation, the investment costs could be covered by a number of people, not just a single investor. Thus, in 1606, the king of England granted a corporate charter to the Virginia Company to establish settlements along the Atlantic coast, and investors held stock in that com- pany. Its first settlement, Jamestown, was a disaster, with all but 61 of its first 500 settlers dying from disease and starvation. After 18 years of struggle, the king revoked the Virginia Company’s corporate charter and took governmental control of its colonies.

Many early colonial corporate ventures like the Virginia Company were affiliated with govern- ments and were intended to establish territorial monopolies for imports and exports. But with the movement towards free-market economics in the late 18th century, newer corporations became less affiliated with guilds and governments and more with private businesses. This is the model of the corporation that we have today. In the United States alone, in 2007 there were

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CHAPTER 3Section 3.2 The Nature of Corporations

around 28 million corporations, generating in excess of $30 trillion a year (U.S. Census Bureau, n.d.). The vast majority of these companies are small, with less than 1% employing 500 or more people. In fact, three quarters of all companies have no employees at all and serve specialized functions within larger corporations.

Whether large or small, conducting business today means running a corporation—so much so that the terms business and corporation are almost synonymous. In this chapter, we will look at the defining characteristics of a corporation, methods of punishing those that break the law, and the ethical character of corporate culture.

3.2 The Nature of Corporations The first issue to consider is the nature of the corporation itself. In this section we discuss corpo- rate structure, the four main features that define a corporation, shell corporations, and whether corporations can have moral responsibility in the way that people do.

Corporate Structure

Some issues in business ethics emerge from the nature and hierarchy of the corporation itself. As everyone in business knows, the basic structure of a corporation consists of three main levels of authority:

1. Stockholders own the corporation by obtaining shares of stock in it. 2. The stockholders, in turn, elect a board of directors to manage the corporation. 3. The board then designates

officers to operate the business, with the chief executive officer (CEO) at the top and various levels of managers beneath.

The board and officers of a cor- poration have a fiduciary duty to the stockholders: They are under a legal obligation to manage the company in a way that protects the stockholders’ investment. Thus, the stockholders’ drive to make a profit on an investment transfers down through the whole corporate hier- archy. In his book The Corporation, legal scholar Joel Bakan argued that corporations are so driven by self- interest and financial greed that they fit the personality profile of a psychopathic individual. He wrote:

Associated Press/Pat Sullivan

This 2002 photo shows the Enron logo in the company’s head- quarters in Houston, Texas. Enron hid billions of dollars of debt from its investors through accounting fraud and subsequently went bankrupt.

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CHAPTER 3Section 3.2 The Nature of Corporations

The corporation’s legally defined mandate is to pursue, relentlessly and without exception, its own self-interest, regardless of the often harmful consequences it might cause to others. As a result, . . . the corporation is a pathological institution, a dangerous possessor of the great power it wields over people and societies (Bakan, 2005, p. 1).

Undoubtedly, some corporations are as pathologically dangerous as Bakan maintained; the Enron Corporation is a poster child for that. Through accounting fraud, Enron hid billions of dollars of debt from its investors, all the while fooling everyone into thinking that it was a robust business. For 6 years running, it was hailed as America’s most innovative company by Fortune magazine. However, in California it secretly restricted the supply of natural gas, which created blackouts and caused an 800% increase in natural gas prices. When Enron executives became aware that the company was about to collapse, they sold their personal shares of company stock while encour- aging investors to buy more. News of Enron’s problems soon became public, its stock prices fell to a fraction of their original value, and its subsequent bankruptcy became the largest up to that point in U.S. history. But although Enron may have brought corporate corruption to a new level, it is not clear that the nature of the corporation itself forces companies to systematically engage in unethical behavior.

Four Features of Corporations

There are four main features of a corporation:

1. creation by statute, 2. perpetual existence, 3. recognition as legal persons, and 4. limited liability.

All of these features have important implications. Let us look at each one in more detail.

Creation by Statute The first feature of a corporation is its creation by statute. Corporations come into existence through the creation of a legal document called a charter, which in the United States is granted by an individual state. The person seeking the corporation draws up a charter and submits it to a state commission for approval. The fact that corporations come into existence through govern- ment action suggests that their very character and range of freedoms are shaped by what the government thinks is best, and that has changed over time. An early landmark U.S. Supreme Court case, Dartmouth College v. Woodward (1819), was responsible for giving greater independence to corporations outside of government control. The issue in that case had to do with Dartmouth College’s right to appoint its own presidents and trustees, independent of influence by the state of New Hampshire. Dartmouth was granted a corporate charter prior to the American Revolution, when New Hampshire was just a British colony. After U.S. independence, the New Hampshire legislature attempted to take administrative control of the college and appoint its president and trustees. The college challenged the state, and the Supreme Court sided with Dartmouth, allowing it to continue as a private institution.

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CHAPTER 3Section 3.2 The Nature of Corporations

Perpetual Existence Second, corporations have perpetual existence, which means that, unlike mortal human beings, they can continue indefinitely and thus independently of the temporary lives of their managers and shareholders. Some corporations may be created to exist for only a limited period of time, but most are granted perpetual existence. The oldest currently existing corporation is the Stora Kop- parberg Mining Company in Sweden, which obtained its charter in 1347.

Although their existence is perpetual, corporations may be dissolved at the direction of the state, a court, or the shareholders themselves. William Blackstone, an influential 18th-century English legal scholar, argued that “legal immortality” is the key practical benefit of creating corporations:

All personal rights die with the person; and, as the necessary forms of investing a series of individuals, one after another, with the same identical rights, would be very inconvenient, if not impracticable; it has been found necessary, when it is for the advantage of the public to have any particular rights kept on foot and contin- ued, to constitute artificial persons, who may maintain a perpetual succession, and enjoy a kind of legal immortality (Blackstone, 1765–1769).

In Dartmouth College v. Woodward, the Supreme Court also argued the fundamental justification for creating corporations’ perpetual existence, as explained in the following famous passage:

Among the most important [properties of a corporation] are immortality, and, if the expression may be allowed, individuality; properties by which a perpetual succession of many persons are considered as the same, and may act as a single individual. They enable a corporation to manage its own affairs and to hold prop- erty without the perplexing intricacies, the hazardous and endless necessity of perpetual conveyances for the purpose of transmitting it from hand to hand. It is chiefly for the purpose of clothing bodies of men, in succession, with these quali- ties and capacities that corporations were invented and are in use. (1819)

The point is that a corporation has a life independent of the people who formed it, and can con- tinue to exist perpetually even as the various members of the corporation come and go.

Recognition as Legal Persons Third, corporations are legal persons in the sense that they are nonhuman entities regarded by law as having the status of a person. They have what is called legal standing, which means that they can sue others and be sued by others, own property, and make contracts with others. It is legal personhood that also makes corporations legally accountable for wrongdoing, and thus capable of being punished for crimes. Without legal personhood, corporations could not be legally punished for wrongdoing any more than an unruly mob could be punished as a collective entity, beyond the actions of the individuals within that mob. Thus, corporations can be criminally con- victed of fraud, manslaughter, and even human-rights violations.

In the words of one Supreme Court justice, the corporation is “capable of being treated as a citizen of [the state which created it] as much as a natural person” (Louisville, Cincinnati & Charleston R. Co. v. Letson, 1844). Determining exactly how corporations can lay claim to their rights as persons

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CHAPTER 3Section 3.2 The Nature of Corporations

and citizens is an ongoing challenge. A controversial Supreme Court case, Citizens United v. Federal Election Commission (2010), established that corporations’ rights to free speech entitled them to spend unlimited amounts of money in campaign contributions. In essence, it said that for cor- porations, money is speech. The question this raises is whether there is an essential difference between corporate persons and natural persons that prevents them from having exactly the same rights in a meaningful way. Corporations cannot marry, vote, or hold public office in the way that natural persons can. And for critics of the court’s decision, money simply is not the same thing as speech, especially considering the vast wealth of corporations and the corrupting influence that money has in political campaigns. The harshest critics argue further that the very idea of corporate personhood is a horrible mistake, and corporations simply are not people.

Limited Liability The fourth attribute of corporations is limited liability, which means that a stockholder can- not lose more than the amount that he or she invested. In normal circumstances, the cor- poration as a legal entity, not the shareholders themselves, is liable for payment of debts. In the event that the corporation fails, the shareholders can lose their investments, but they are not responsible for paying any remaining debts that the corporation owes to its creditors. The

purpose of limited liability is that it encourages investment: People are more likely to invest in some- thing when they know that their risk is limited.

In unusual circumstances, however, shareholders may become liable for corporate debts if the corpo- ration is used to commit fraud on people that it deals with, such as creditors. This may also occur if the shareholder runs the business as though the corporation did not exist, for example, by not holding meetings or not keeping corpo- rate records. In these cases, to use a legal expression, the “corporate veil” is pierced, and the owners behind that veil are exposed.

Shell Corporations

One particularly odd issue surrounding the incorporation process involves what are called shell corporations—that is, corporations that exist on paper but have no active business operations or significant assets. Often these are used for legitimate purposes. For example, sometimes one company might set up a series of shell corporations and then sell them off the shelf to someone else as a way of simplifying the process of creating a corporation. The new owner can then change the corporate name and officers at any time.

Associated Press/Anonymous

Stockholders in companies like BP, which was involved in the Gulf oil spill of 2011, are not liable for payment of debts of the corporations they invest in.

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However, shell companies can be abused. Enron made heavy use of shell companies: By transfer- ring its accumulating debt to them, the company was able to hide its financial failures from inves- tors and the public, thus creating the illusion that it was a healthy and vibrant company. More often, though, shell companies are created for purposes of tax avoidance. For example, a company based in California might conduct its international business through a shell company that is incor- porated in a tax-haven country like Belize. The principal corporation in California can then avoid reporting the shell company’s income to the U.S. government, and thereby avoid paying taxes on that income.

Although this practice is technically legal, it is one that U.S. lawmakers hate but have difficulty combating. In fact, even within the United States, some states have themselves become tax havens because of their lax incorporation laws, and shell companies are flourishing there. For example, a small house in Cheyenne, Wyoming, is the official address of 2,000 shell companies (NPR Staff, 2011). All of these examples show how the laws that enable the creation of corporations can be manipulated for a wide range of potentially unethical business practices. In the worst cases, the shell corporations are created solely as a vehicle for wrongdoing and have no further redeeming value whatsoever as a business entity.

Moral Agency of Corporations

The status of corporations as legal persons makes them legally responsible for misdeeds, such as bribery, discrimination, unsafe working conditions, and false advertising. They can be charged with crimes and face penalties. However, it is common to hear people attack a company for being immoral, and the implication is that the business is morally responsible for its misconduct, not just legally responsible. That is, businesses are not merely legal persons but are also moral persons, or moral agents, who are morally responsible for their actions.

Take this example that appeared on a blog. A customer signed a contract with a home-security company and was told by the sales agent that it was for the duration of 2 years. At the close of the second year, the customer contacted the company saying that she did not want to renew the contract; the company said that the contract was for 3 years, not 2. The customer waited a year and repeated her request. The company responded that they require a 60-day notice for nonre- newal, and if they do not receive it, the customer is automatically renewed for another 3 years. The customer believed that the business was scamming her and, consequently, maintained that the company acted immorally (Samantha, 2009).

If this were a small, family-operated business, we could easily say that the business was immoral, since the fault would trace directly back to the family owners themselves: It is the owners who acted immorally through their business operations. Suppose, however, that the security company was a national chain with thousands of employees, each of whom was playing only a small and limited role in the operation of the business. Could we still say that this security company as a whole acted immorally in the same way that we commonly say that an individual human acted immorally?

The issue here is that of corporate moral agency, which concerns whether businesses are morally responsible for their actions, similar to how individual people are morally responsible for theirs. There are two main positions on this issue.

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CHAPTER 3Section 3.2 The Nature of Corporations

Position 1: Corporations Can Be Genuine Moral Agents The first position is that corporations can be genuine moral agents. In the words of Peter French, the leading proponent of this view, “corporations can be full-fledged moral persons and have whatever privileges, rights and duties as are, in the normal course of affairs, accorded to moral persons” (1979). Corporations have what French has called a “corporate internal decision struc- ture”—that is, a procedure for carrying out decisions—and this procedure has all the necessary elements to qualify as a “moral” decision-making process. It has two main components:

• It has a responsibility flowchart—similar to a corporate organizational chart—that shows the various management levels within the corporation’s hierarchy, and who is responsible for what.

• The corporation has rules (usually within its bylaws) to determine whether a manager is making a decision on behalf of the corporation itself or merely making a personal deci- sion. For example, if the unscrupulous home-security company described earlier were a large corporation, we would be able to identify which manager in the corporate hierarchy was responsible for the renewal scam, and whether that decision was a personal one or a corporate one.

With French’s model of corporate moral agency, human beings are still the ones making the deci- sions, but those people are making choices for the corporation, not for themselves. Thus, the intention behind that decision is the intention of the corporation, not of the individual person.

Position 2: Corporations Cannot Be Moral Agents The second and opposing position is that corporations cannot be moral agents. According to this view, the immoral actions of a corporation are attributable to the decisions of the individual actors within the corporation, not to the corporation as a whole. The leading proponent of this view, Manuel Velasquez, has argued that “corporate organization lacks the kind of causal powers and intentionality that an entity must possess to be morally responsible for what it does” (2003). According to Velasquez, to speak of a corporation as having intentions is only a metaphor, and nothing in the corporate internal decision structure can “transform a metaphorical intention into a real one,” nor can it “create group mental states nor group minds in any literal sense.” Human intentions, he has argued, are mental in character and can only occur within a conscious human mind. To talk about corporate “intentions” in a literal sense would mean that a corporation has a unified conscious mind, which is absurd. At best, a corporation consists only of people with con- scious minds who are disconnected from each other. Workers, not the abstract corporate group, are the ones that carry moral responsibility for their on-the-job decisions (Velasquez, 2003).

Issues at Stake There are two issues at stake in this debate:

• Whether corporations can themselves be accused of being “immoral.” If I rob a bank, I can justly be called an immoral person. But if a corporation intentionally defrauds consumers, can it also be called “immoral” in the same way? French says yes; Velasquez says no.

• Whether workers in corporations should be punished individually for their immoral deci- sions, beyond the punishment that the corporation receives. French says they should not; Velasquez says they should.

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CHAPTER 3Section 3.3 Punishing Corporations

We should emphasize, though, that regardless of whether there is a moral justification for punish- ing corporations, from a purely legal standpoint corporations are in fact liable for punishment by the state. They are legal persons and, as such, have legal liability in the way that you or I do.

3.3 Punishing Corporations The next issue concerns the type of punishments that governments can impose on corporations, and what society hopes to accomplish through those punishments. The issue of punishment in general is a complex one. Therefore, it will help if we start by looking at the methods and justifica- tions for punishing individual people, and turn to corporations after that.

The ways in which society can punish individuals for crimes are varied. Suppose, for example, that you are caught shoplifting from a local store. A possible punishment would be paying a fine or serving a few weeks of community service. With some crimes, like drunk driving, judges can get creative and make you put an embarrassing sign on your car that says “I’m a convicted drunk driver.” If your crime is even more severe, you might spend years in prison, or even be executed.

There is a wide range of punishments available for criminals in part because there are a variety of objectives society has for punishing them in the first place:

• There is deterrence, where an offender is punished to set an example that might discour- age others from committing similar crimes.

• There is incapacitation, where, by being removed from society, an offender is prevented from committing further similar crimes.

• There is rehabilitation, where, through reform techniques, changes are made to an offender’s future behavior.

• There is retribution, where punishment balances the scales of justice. An offender com- mitted a crime, and this requires that the person be punished accordingly.

• Finally, there is reparation, where an offender must repay a victim for the injury that the offense caused.

Six Types of Corporate Punishment

Let us now turn to the issue of punishing corporations. An immediate way of approaching the task is to hunt down the people within the corporate hierarchy who are responsible for a crime and punish them individually. This in fact occurs regularly. For example, former Enron president Jeff Skilling received a 24-year prison sentence for fraud and insider trading. Bernie Ebbers, cofounder and former CEO of the WorldCom telecommunications company, was sentenced to 25 years for fraud and conspiracy.

However, merely going after the key players within a company is often not enough. In many cases, the causes of corporate misconduct are dispersed so widely within the company that there may be no one individual who intentionally committed an illegal act. Rather, it may only be the accu- mulated efforts of many blameless individuals that ultimately give rise to a corporate misdeed. More importantly, the status of corporations as legal persons makes a company itself liable to

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CHAPTER 3Section 3.3 Punishing Corporations

prosecution, in addition to any cor- rupt corporate executive who might be involved. But although a corpo- ration is considered a legal person, it is not a giant human being. Thus, at least some of the penalties that we impose on individual people would not be appropriate for cor- porations. We cannot, for example, literally imprison a corporation. There are six basic types of punish- ment for corporations:

• fines, • equity fines, • corporate incapacitation, • the corporate death

penalty, • corporate shaming, and • community-service orders.

We will examine each of these here.

Fines Perhaps the most common way of punishing a corporation is through a fine, a payment of money imposed as a penalty for an offense. For example, the pharmaceutical company Eli Lilly was ordered to pay a $515 million fine—the largest criminal fine up to that point in history—for decep- tively marketing the antipsychotic drug Zyprexa. Although fines may be the usual way of punishing a corporation, there are several problems associated with this approach:

• If the company is large and the fine is small, it will be ineffective in rehabilitating an unethical company. The com- pany may see the fine as just another cost of doing busi- ness. This leaves the public with the impression that cor- porate crime is permissible as long as the company merely pays the going price.

• If the company is small and the fine is large, the company may not be able to afford to pay it. And if the fine is lowered for that company, the cost will not serve as an effective deterrent for other companies.

Associated Press/Louis Lanzano

In this photo, former WorldCom CEO Bernie Ebbers leaves a New York federal court. Ebbers is currently serving a 25-year prison sentence based on his involvement in and cover-up of an $11 billion accounting scandal that led the company to file for bankruptcy. Time magazine recently named Ebbers one of its “Top 10 Crooked CEOs.”

Associated Press/Darron Cummings

The pharmaceutical company Eli Lilly was ordered to pay a $515 million fine for deceptively marketing the antipsychotic drug Zyprexa.

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CHAPTER 3Section 3.3 Punishing Corporations

• Corporate fines can harm innocent people associated with the company. A hefty fine can financially harm a company to the point that it must decrease employees’ salaries or even lay employees off. In addition, fines might result in reduced dividends and stock value for shareholders. The company might also pass the costs of the fines on to consumers. A case in point is a sewer company in California that was fined $1.6 million when millions of gal- lons of raw sewage spilled from its treatment plant. According to the plant manager, one option for covering the fines was to increase fees to consumers (Staats, 2008).

Equity Fines Another type of corporate punishment is a variation on the fine. With an equity fine, the payment is made in shares of the company, not in money. The effect is that the value of the company is diluted in the market, which may serve as a greater deterrent to companies than monetary fines. The key advantage of equity fines is that they avoid forcing financially weak companies out of business, and thus protect innocent employees and creditors. This form of corporate punishment is not yet practiced in the United States, but the Scottish parliament has been debating legislation allowing equity fines.

Corporate Incapacitation Another form of punishment is corporate incapacitation. With this punishment, a court issues an order to restrain the activities of a corporation in some area of business. The court may temporarily restrict a company’s commercial activity for some line of business, in some geographical area, or with some client. The court may temporarily revoke a company’s operational license, or disqualify the company from obtaining specific contracts. It may also freeze the company’s profits. The United States has these kinds of provisions for corporate incapacitation, the aim of which is to stop busi- nesses from engaging in a practice that consistently operates outside the law (Walt & Laufer, 1992).

Corporate Death Penalty Occasionally, a company commits a crime that is so egregious that, for punishment, it receives what is called a corporate death penalty. The company is forced to go out of business, such as by revocation of its corporate charter. This is what happened with the account- ing firm Arthur Andersen. In 2002 it was convicted of obstruction of justice for shredding docu- ments connected to its auditing of Enron. Because of the convic- tion—and the fact that convicted felons are not permitted to audit public companies—the company was forced to surrender its CPA license, thus forcing it to close its doors for good.

Associated Press/Stephen J. Boitano

In this 2002 photo, Joseph Berardino, former CEO of the Arthur Andersen accounting firm, is being sworn in before the House Financial Services Committee. He testified on behalf of his com- pany about its audit of Enron.

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The downside to the corporate death penalty is that it harms the vast majority of the workers who are innocent of wrongdoing—thousands of them, in the case of Arthur Andersen. The families of these workers suffer as well. The corporate death penalty can also be misused in political battles. For example, a new Arizona law allows for the revocation of business licenses for companies that are discovered to have knowingly employed illegal immigrants. Although it is reasonable to pun- ish a company when it breaks the law by hiring illegal immigrants, critics of the law argue that is excessive to impose upon that company the punishment of corporate death. The issue of illegal immigration is a controversial one that generates extreme opinions, and in this case, the Arizona law has used the corporate death penalty to achieve an ideological goal.

Corporate Shaming Another option for punishment is corporate shaming, where the government requires a guilty company to make a public announcement that threatens its reputation and social standing. For example, a Massachusetts ferryboat company was required to place an ad in the Boston Her- ald that stated, “Our company has discharged human waste directly into coastal Massachusetts waters.” The federal prosecutor in this case argued that the goal was to deter others, but the pun- ishment had the added benefit of satisfying the public “when it doesn’t appear that the company has been punished sufficiently enough, by simply writing a check” (Tovia, 2010). The problem with corporate shaming is that the humiliation and embar- rassment are projected onto innocent workers, not just the guilty ones. Further, the loss of prestige might contribute to the financial failure of the corporation and thus adversely affect innocent workers.

Community-Service Order A final type of punishment is a community-service order, where, similar to community-service punish- ments for individuals, a company must participate in some project that benefits the community in some way. For example, six New York bakeries were convicted of price fixing. As punishment, they were ordered to donate baked goods to charitable organizations for 1 year (United States v. Danilow Pastry Co., 1983). One advantage to this approach is that, when a large num- ber of unidentifiable people have been harmed by mis- conduct, community service is a way to distribute some benefit back to the wider community rather than to an individual victim. Also, community-service orders do not put companies at risk that are in financial difficulty in the way that fines do, and thus they insulate innocent parties such as creditors and workers. This was one of the motivations for the order in the bakery price-fixing case. Community-service punishment is sometimes criticized for being potentially image enhancing: The company might publicize its service activity in a way that increases its reputation as a socially responsible organization. Defenders, however, argue that the fact

What Would You Do?

You are a judge and before you is a case in which an auto dealership with 50 employees has been found guilty of false advertising. The dealership rou- tinely advertises vehicles at low prices, but once customers are on the lot, it sells them at much higher ones. Your concern is that a hefty fine might force the dealership out of business and thus adversely affect the lives of the inno- cent employees.

1. Would you impose the fine or con- sider alternative forms of punish- ment, such as incapacitation, sham- ing, or a community service order?

2. Suppose the dealership only switched prices for its customers who had above-average incomes. Would that make a difference in your decision?

3. What if it only involved customers with below-average incomes?

4. What if all of the employees in the dealership knew about the scam, and they all received bonuses based on the higher selling prices?

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CHAPTER 3Section 3.3 Punishing Corporations

that the service is done under court order makes it less likely that the company will draw that kind of attention to itself.

Federal Sentencing Guidelines

The U.S. government punishes a wide range of corporate offenses. In 1991, it established guide- lines for sentences imposed by federal judges, known as the Federal Sentencing Guidelines for Organizations (FSGO). The types of punishments imposed are wide-ranging, and include restitu- tion, remedial orders, community service, and fines. Individuals can serve jail terms and pay large fines, the costs of which the corporations themselves are not permitted to cover. The guidelines make use of a point system for determining the severity of an offense as well as increasing levels of fines that correspond to severity. Severity increases when the company has a history of such misconduct, when it obstructs justice during the investigation, and when “an individual within high-level personnel of the organization participated in, condoned, or was willfully ignorant of the offense” (2011 Federal Sentencing Guidelines Manual, 2011). The guidelines encourage orga- nizations to create compliance and ethics programs to prevent and detect illegal conduct, recom- mending that these programs include seven specific steps:

1. Organizational implementation of compliance standards and procedures that are reason- ably capable of reducing the prospect of criminal conduct.

2. Assignment of high-level personnel to oversee compliance with such standards and procedures.

3. Due care in avoiding delegation to individuals whom the organization knows, or should know, has a propensity to engage in illegal activities.

4. Communication of standards and procedures by requiring participation in training pro- grams or by disseminating publications that explain in a practical manner what is required.

5. Establishment of monitoring, auditing, and reporting systems by creating and publicizing a reporting system whereby employees and other agents can report criminal conduct without fear of retribution.

6. Enforcement of standards through appropriate mechanisms, including, as appropriate, discipline of individuals responsible for the failure to detect an offense.

7. Development of appropriate responses to offenses by taking all reasonable steps to respond appropriately and to prevent further similar offenses, including any necessary modification of programs (Federal Sentencing Guidelines, 2005).

Corporations have a special incentive for creating compliance and ethics programs that include these seven steps: If in the future they are ever prosecuted for a crime, they will receive a reduced punishment. In this way, the government aims to build into corporations a procedure that will reduce the likelihood of their engaging in illegal conduct.

Consumer Retaliation

Another mechanism for punishing companies is initiated by the public rather than by the govern- ment. Just as the government keeps a watchful eye on businesses, so, too, do consumers. Consumer retaliation is when individual consumers or consumer groups express dissatisfaction with a company through some effort that harms it financially. Consumers can write letters of complaint to govern- ment agencies, file civil lawsuits against offending companies, and use every possible form of media to bring public attention to issues of corporate misconduct. We will examine many of these efforts

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CHAPTER 3Section 3.3 Punishing Corporations

in a future chapter, but one mecha- nism for consumer retaliation we can note here. This is the consumer boycott, when a group of people act together to abstain from buy- ing from or dealing with a business. The name boycott is derived from a British land agent in Ireland, Charles Boycott, who himself was the target of a systematic boycott when, dur- ing a particularly bad growing sea- son, he refused to lower the rent for farmers who leased land from him. The farmers moved off his property to other locations, and he had trou- ble finding people who would har- vest his fields.

There are two important advan- tages to consumer boycotts as supplemental ways of punishing companies:

• Companies are often directly involved in shaping the laws that apply to their industry, and thus government-sanctioned punishments are not possible when the laws are lax to begin with. Boycotts fill that void by holding companies accountable when governments fail to do so.

• Even when the government does get involved by making tough laws, it often takes sev- eral years before the laws are passed and take effect. In the meantime, the company can continue with its practice. Boycotts—or even the threat of them—can hold companies accountable during this period of legislative limbo, and also keep up public support for the proposed legislation.

One of the more famous consumer boycotts was against the textile manufacturer J. P. Stevens, for resisting unionization. On a specific day designated as “Justice for J. P. Stevens’s Workers Day,” thousands of protesters marched on the company’s headquarters, along with other protests in 74 cities. Dozens of politicians and celebrities supported the boycott; New York governor-elect Mario Cuomo stated that consumers should “shun the products of J. P. Stevens as [they] would shun the fruit of an unholy tree.” While J. P. Stevens stood fast in refusing to sign an agreement with the union, the boycott nevertheless took a financial toll on the company and drew national attention to the issue (Minchin, 2005). Events surrounding the boycott were later depicted in the film Norma Rae, which further increased public awareness.

In the same vein as the J. P. Stevens boycott, more recently the United Auto Workers union threat- ened to launch the world’s largest consumer boycott by targeting an automobile manufacturer that opposed unionization of its workers. The boycott, they explained, would be accompanied by picket demonstrations at several hundred car dealerships associated with the manufacturer (Szc- zesny, 2011). The boycott never happened, but the threat itself was an important tool for getting auto companies to negotiate with the union.

Associated Press/Irwin Fedriansyah

In this 2010 photo, Greenpeace activists in Indonesia protest outside a Nestlé building. The protesters criticized the company for using suppliers that caused damage to rain forests in sup- plying palm oil to the company. Nestlé says it has since stopped using the supplier (“Successful Boycotts,” n.d.).

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CHAPTER 3Section 3.4 Ethical Corporate Culture

3.4 Ethical Corporate Culture From what we’ve seen so far, there are several motivations for corporations to abide by the law and avoid immoral behavior. There is the looming threat of criminal punishment, and all the bad publicity that goes along with it. There is the possibility of consumer retaliation, such as civil suits and consumer boycotts. Next we will look at mechanisms within the corporate structure itself that create an ethical corporate culture.

Stakeholders and Corporate Social Responsibility

An important concept in the creation of an ethical corporate culture is that of the stakeholder, which is any party who is affected by, or has a stake in, a business practice. This includes employ- ees, suppliers, customers, creditors, competitors, governments, and communities, as well as stock- holders. The stakeholder approach to responsible corporate conduct is that businesses should consider all stakeholders’ interests, not just those of the stockholders. By considering the interests of the full range of stakeholders, companies will be less likely to exploit these groups for financial gain.

The challenge of the stakeholder theory is to prioritize the interests of the various stakeholders. Every stake- holder wants to carve into the financial pie, and there is not enough to go around for everyone. Stockhold- ers seek to maximize their investments, employees want higher wages, governments want more taxes, and environmentalists want to see more eco-friendly policies. The stakeholders and their claims must be prioritized and, at a minimum, categorized into two groups: primary stakeholders and secondary stake- holders. Of necessity, the stockholders will be primary stakeholders—perhaps the only ones—since they are the ones who own the company and ultimately call the shots regarding corporate policy. While stockhold- ers may be willing to give in to reasonable demands of secondary stakeholders, they are still investing in the company to make money, and are certainly not willing to hand it all away.

The stakeholder theory does not come with a built- in formula for prioritizing the competing interests of primary and secondary stakeholders. However, its greatest significance may be the growing popularity of the word stakeholder itself and its use throughout the business world today. Through its heavy use, the idea of social responsibility has become an integral part of normal business vocabulary. It is more than a faddish buzzword; the identification of stakeholders is often part of a company’s strategic planning process.

What Would You Do?

You are the CEO of a coal company that uses the controversial technique of mountaintop removal. This involves bulldozing away the top of a mountain to get at the coal, then filling in sur- rounding valleys with the removed soil. Technically you are not breaking the law, but this method is both environ- mentally damaging and visually ugly. You could use underground mining, which is less harmful, but it would cut into your profits.

1. Who are the various stakeholders in this situation?

2. Which ones are primary, and which are secondary?

3. At what point might you find the profit loss from underground mining acceptable: a loss of 20%, 10%, 5%?

4. Suppose that local residents regularly set up picket lines at the entrance to the jobsite, which is regularly featured in the news. How might that affect your assessment of how much profit loss would be acceptable for switching to an underground min- ing method?

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CHAPTER 3Section 3.4 Ethical Corporate Culture

Although stakeholder theory is a popular way of articulating the social mission of companies, it is not the only one. Another concept is the triple bottom line (3BL), which is that successful compa- nies must pursue three distinct values:

• people, • the planet, and • profit.

That is, there should be social benefit to workers and the community, environmental benefit with the implementation of sustainable ecological practices, and economic benefit only after all hidden environmental costs have been factored in.

Yet another similar concept is that of corporate social responsibility (CSR)—also called corporate conscience or corporate citizenship. This generally refers to a corporation’s efforts to take respon- sibility for its effects on the environment and its impact on social welfare. It typically applies to efforts of companies that go beyond what is required by governmental regulations.

The Center for Corporate Citizenship at Boston College recently devised a Corporate Social Respon- sibility Index that ranks companies based on public perceptions of their citizenship, governance, and workplace (Boston College Center for Corporate Citizenship & Reputation Institute, 2010). Figure 3.1 lists the recent top 10 spots. As you can see, these spots were held by very recognizable companies.

The rankings were obtained from a sample of 7,790 online consumers who evaluated 230 selected companies, and they only reflect the consumers’ perception of the companies, without any description of what those companies’ citizenship policies are. The odds are slim that the consum- ers who were surveyed had any detailed knowledge about the companies’ policies. Their percep- tions were likely guided by product-name recognition, company advertising, news stories, and personal experience with the product.

Figure 3.1: Center for Corporate Citizenship’s Top 10 Ranked Companies: Citizenship

Source: Boston College Center for Corporate Citizenship & Reputation Institute. (2010). The 2010 corporate social responsibility index. Retrieved from www.bcccc.net/pdf/CSRIReport2010.pdf

1 2 3 4 5 6 7 8 9

10

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Johnson and Johnson

The Walt Disney Company

PepsiCo

Microsoft

Kraft Foods

S.C. Johnson

Kellogg

Apple

Green Mountain Coffee Roasters

The Hershey Company

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CHAPTER 3Section 3.4 Ethical Corporate Culture

Nevertheless, the compilers of this index have maintained that corporate reputations are valu- able intangible assets, since “they influence the decisions of con- sumers about which products and services they will buy” (Boston Col- lege Center for Corporate Citizen- ship & Reputation Institute, 2010). But therein lies the problem: If the goal is to increase public percep- tion, a company can often achieve this more inexpensively through a sophisticated marketing strategy than through engaging in costly social projects. This is particularly common with claims about envi- ronmental responsibility: Virtually every company attempts to project itself as eco-friendly, regardless of how environmentally harmful its business operations are. The term greenwashing refers to pretended efforts at environmental responsibility and, more broadly, at corporate responsibility. In a sense, the Corporate Social Responsibility Index exacerbates this problem, since it tells companies how successfully they are competing in the battle for public perception. What is currently lacking is an index that ranks the actual performance of companies in key areas of social responsibility, rather than simply public perceptions of their performance.

Although companies may sometimes fake commitment to social responsibility, consumers take it seriously; one poll indicated that 79% of Americans take corporate social responsibility into account when making purchasing decisions. It was an important factor for 36%. The same study showed that 71% consider corporate social responsibility with investment decisions. And 12% went so far as to say that they would purchase stock in socially responsible companies even if it meant accepting lower financial returns (Verschoor, 2001).

Mission Statements and Codes of Ethics

There are concrete ways within the corporate structure to mark out ethical boundaries for employ- ees. The most common ways are through mission statements and codes of ethics. A mission state- ment is a short account of the company’s fundamental purpose, and many companies use them as a way of broadcasting their commitment to ethical standards. Here, for example, is PepsiCo’s mission statement:

Our mission is to be the world’s premier consumer products company focused on convenient foods and beverages. We seek to produce financial rewards to inves- tors as we provide opportunities for growth and enrichment to our employees, our business partners and the communities in which we operate. And in every- thing we do, we strive for honesty, fairness and integrity. (n.d.)

Associated Press/Akira Suemori

In this 2010 photo, a group called the Greenwash Guerrillas takes part in a mock cleaning job at the National Portrait Gal- lery in London. The group criticized the gallery for its hosting of the BP Portrait Award ceremony, claiming that doing so helps the oil company greenwash its public image.

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CHAPTER 3Section 3.4 Ethical Corporate Culture

In the first sentence, PepsiCo indicates its main product line and how it sees itself in the world market. The second sentence describes its financial success. In the third sentence we see the ethi- cal component: All company conduct aims for honesty, fairness, and integrity. Here are the ethical parts of mission statements from other large companies:

• Microsoft: “Accessibility is a business practice that is part of Microsoft’s Trustworthy Com- puting efforts which focus on integrity and responsibility in our business practices” (n.d.).

• Kraft Foods: “We understand that actions speak louder than words, so at Kraft Foods: We inspire trust. We act like owners. We keep it simple. We are open and inclusive. We tell it like it is. We lead from the head and the heart. We discuss. We decide. We deliver” (n.d.).

• Kellogg: “Our Vision encompasses the full spectrum of our stakeholders including share- owners, employees, customers, consumers and communities. Our Mission articulates where we are as a company today and where we wish to be in the future” (n.d.).

• Pfizer: “We demand of ourselves and others the highest ethical standards, and our prod- ucts and processes will be of the highest quality. We start every task by asking: Would we be proud to explain how we are achieving our results? Are we doing the right thing, in the right way?” (n.d.).

• Dow Chemical Company: “We are now even more dedicated to the fulfillment of our cus- tomers’ needs, protecting the planet and the environment, and building relationships based on mutual respect and esteem” (n.d.).

Socially progressive companies often have even more aggressive ethical agendas in their mission statements. For example, Just Us Coffee Roasters Co-op’s mission statement includes the slogan “people and the planet before profits” (n.d.). This suggests that, among the various stakeholders in that business, the stockholders are secondary to society and the environment. Although this is not typical of corporate stakeholder priorities, it does show that corporations do not always need to place profits above all else. It is a question of how a company defines its mission.

While mission statements are designed to be short, businesses commonly have more detailed corporate codes of ethics that express principles of conduct within the organization to guide deci- sion making and behavior. Codes of ethics vary in length and detail, but the more meticulous ones typically have five parts:

1. A letter from the CEO endorsing the code and explaining why it is important. Heads of companies know that they must lead by example and that hopes of creating a moral climate must begin with them. One way to do this is for the CEO to publicly stand behind the company’s ethical code. Here are key passages from four CEO letters of endorsement: • Nike: “This Code of Ethics is vitally important. It contains the rules of the game for

Nike, the rules we live by and what we stand for. Please read it. And if you’ve read it before, read it again.”

• General Dynamics: “Please read the Blue Book [on ethics policy] carefully. It reminds each of us of our shared responsibilities to our shareholders, our customers, our business partners, and to each other. It calls on us to do the right thing and to seek guidance if needed.”

• Coca-Cola: “The Code of Business Conduct is our guide to appropriate conduct. Together with other Company guidelines, such as our Workplace Rights Policy, we have set standards to ensure that we all do the right thing. Keep the Code with you and refer to it often.”

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CHAPTER 3Section 3.4 Ethical Corporate Culture

• Home Depot: “Please become familiar with this Policy, as well as all of our Corporate Compliance Policies and Standard Operating Procedures. As you review these mate- rials, please keep in mind that it is not simply the letter of the policy, but the spirit of our Policies that we all must embrace.”

In each of these cases, the CEO stresses the need for employees to take the company’s ethical code seriously.

2. A general statement of values. The values listed are often varied but may include honesty, qual- ity, integrity, respect for all people, building strong relationships, taking care of employees, giving back to the community, excellence in customer service, strong shareholder returns, wise use of assets, environmental responsibility, respect for human rights, and keeping promises.

3. A statement of commitment towards the company’s different stakeholders. This usu- ally includes employees, customers, suppliers, shareholders, and society at large.

4. Company policies on a range of ethical issues that arise on the job. These include drug and alcohol use, safe working conditions, employee privacy, discrimination, sexual harassment, work- place violence, conflicts of interest, accepting gifts, insider trading, bribery, and price fixing.

5. A discussion on how the code is carried out within the organization, and punishments for code vio- lation. The administrative implementation of the code sometimes is assigned to an ethics officer within the company, who holds workers account- able to the company’s ethical standards. Punish- ments for code violations may include letters of warning, counseling, loss of employment, and, in extreme cases, legal charges.

In addition to these five points, many codes include an intuitive guide for employees to test their decisions, such as the following from Allstate:

Ask yourself the following questions when you face a decision that involves ethics:

• Is it legal? • Does it comply with this Code and with policies that apply to the situation? • How will it affect others—consumers, competitors, shareholders, other

employees, agencies, the community, and you? • How will it look to others? Innocent actions sometimes can give the

appearance of wrongdoing. • How would you feel if this decision was made public? • Should you ask for advice before acting?

If you are still uncertain, ask your manager or contact another resource listed in this Code (Allstate, n.d.).

Associated Press/Scott A. Miller

Companies like Nike carefully craft corpo- rate codes of ethics. Should the sports stars they sponsor, such as Tiger Woods, be held to the same codes?

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CHAPTER 3Section 3.5 Threats to Ethical Corporate Culture

Codes of ethics are not a perfect solution to the problems of immoral business conduct. Many of the principles advanced are too general to be of much guidance, such as the values of honesty, quality, and integrity, which are listed in many such codes. And sometimes they seem to be mere public relations tools to make an unscrupulous company appear to be committed to ethical prin- ciples. Before its collapse in 2001, for example, Enron’s published statement of corporate values included the following:

• Respect: We treat others as we would like to be treated ourselves. We do not tolerate abusive or disrespectful treatment. Ruthlessness, callous- ness, and arrogance don’t belong here.

• Integrity: We work with customers and prospects openly, honestly, and sincerely. When we say we will do something, we will do it; when we say we cannot or will not do something, then we won’t do it (Enron, n.d.).

From what we now know of Enron’s activities, the claims of respect and integrity are laughable. There are certainly other companies today that, like Enron, behave shamefully while at the same time making grandiose claims about their ethical standards. Nevertheless, many companies do take their codes seriously, and look to them to safeguard against criminal charges by the government, lawsuits by customers, and bad publicity by the media, all of which can financially cripple a company.

3.5 Threats to Ethical Corporate Culture We turn finally to an examination of aspects of corporate culture that can undermine a company’s commitment to moral integrity and social responsibility. We will consider four such factors:

• the profit motive, • strategic misrepresentation, • groupthink, and • organizational schizophrenia.

None of these are immoral in and of themselves, and to some degree they are even facts of life when running a business. But if left unchecked, they can create moral and legal problems.

The Profit Motive

Several times so far we have seen that a company’s motive to make profits can conflict with its sense of social responsibility. Stockholders expect to see a return on their investments, and the corporate officers have a fiduciary duty to oblige them, to the point that the officers might neglect the interests of all other stakeholders.

Not only is this a possible outcome, but economist Milton Friedman famously argued that this is exactly how it should be: Businesses should stay away from social responsibility and keep focused on making profits. He did not advocate that businesses violate the law when pursuing profits, but only that they avoid taking positive steps towards social causes beyond what the law requires. “Few trends,” he argued, “could so thoroughly undermine the very foundation of our free society as the acceptance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible” (Friedman, 1962, SM17.).

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According to Friedman, it is contrary to the nature of a well-run corporation to advocate social responsibility, since it amounts to a hidden social tax. That is, it places an extra financial cost on consumers for some social benefit that has no direct connection with the product that they are purchasing. Suppose that a corporate executive refrains from increasing the price of a product, to help prevent inflation; spends vast amounts of money on reducing pollution beyond what the law requires, to help improve the environment; or hires an underqualified unemployed person, to help reduce poverty. “In each of these cases, the corporate executive would be spending someone else’s money for a general social interest” (Friedman, 1970, SM17). It would also mean reduced returns for stockholders, higher prices for customers, or lower wages for employees. This makes the socially minded executive an unelected civil servant who, in many cases, will not be properly educated about which actions will indeed promote social benefit. In this way, it is subversive to a free society. The only responsibility of a business, then, is to increase its profits, so long as it stays within the bounds of the law.

Friedman’s argument against corporate social responsibility is a rather extreme one that is hard to defend. Here are just two problems with it:

• Business money spent on social causes is unlike a tax in at least one important way. Taxes imposed by governments are mandatory, but no one’s association with a socially responsible corporation is mandatory. Consumers can choose to spend their money elsewhere; workers can choose to be employed elsewhere; stockholders can choose to invest elsewhere. Since these are free associations, it is difficult to see how such corporate social responsibility is subversive to a free society. On the contrary, it is part of a free society to experiment with company policies, and find creative ways to attract customers, employees, and investors.

• Many consumers will be attracted to corporations with strong social agendas, which will increase company profits. Ben and Jerry’s is a case in point. When the company first began manufacturing ice cream, it adopted a unique social mission:

to operate the company in a way that actively recognizes the central role that business plays in the structure of society by initiating innovative ways to improve the quality of life locally, nationally, and internationally (Ben and Jerry’s, n.d.).

The company professes to have a “progres- sive, nonpartisan social mission” that aims to eliminate injustices locally and globally, and supports nonviolent ways to achieve peace and justice (Ben and Jerry’s, n.d.). At one point in its history, the company donated an unusually high percentage of its profits to philanthropic causes—7.5%, as compared with the norm of 1%. It had paid its workers what the company called a “liv- ing wage,” well above industry standards, and has a range of environmentally respon- sible policies (Ben & Jerry’s, 2010). With all

Associated Press/Tammie Arroyo

Ben Cohen (left) and Jerry Greenfield of Ben and Jerry’s have a social mission that seeks to rid society of injustices.

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CHAPTER 3Section 3.5 Threats to Ethical Corporate Culture

its emphasis on social responsibility, the company has not only survived, but thrived. With that kind of financial outcome, even a cynical stockholder might want the corpo- rate executive to engage in a reasonable amount of social projects.

Strategic Misrepresentation

Another component of corporate culture that can lead to flawed decisions is strategic misrep- resentation, which is the intentional and systematic distortion or misstatement of facts for the purpose of gaining a financial advantage. A simple example is with automobile dealers: Suppose that a dealer knows very well what the weaknesses are with the vehicles being sold but intention- ally conceals those problems from customers. If the dealer were completely truthful, customers would simply go elsewhere. Businesses routinely exaggerate the value of their products, the qual- ity of their customer service and satisfaction, and their overall financial health.

Although strategic misrepresentation is undoubtedly common in business negotiations, some have argued that it is simply part of the nature of doing business, and it cannot be eliminated. Nor should we try to eliminate it. Albert Carr championed this view in an influential essay titled “Is Business Bluffing Ethical?” In some situations, he argued, bluffing one’s opponents is a normal part of the game. In poker, for example, a player strategically tries to get opponents to think that his or her hand of cards is either stronger or weaker than it actually is. So too in business. In fact, Carr argued, if a businessperson feels obligated to always tell the truth, he or she “is ignoring opportunities permitted under the rules and is at a heavy disadvantage in his [or her] business dealings” (1968).

Most executives are compelled from time to time to be deceptive when negotiating with deal- ers, labor unions, government officials, and even other departments within their own companies. According to Carr, “Falsehood ceases to be falsehood when it is understood on all sides that the truth is not expected to be spoken” (1968). For example, a criminal does not lie when he or she pleads “not guilty,” even when he or she committed the crime, since this is just a part of the judi- cial process. In the workplace, similar kinds of acceptable deception can occur from the moment we fill out our job applications and exaggerate our strengths while downplaying our weaknesses. When our bosses ask for our opinion, we often say yes when we really believe no. There is no place for the Golden Rule in business, and “a good part of the time the businessman is trying to do unto others as he hopes others will not do unto him” (Carr, 1968).

A famous case illustrates Carr’s position. Some years ago, the founder of the computer software company Borland wanted to place an advertisement in Byte magazine to help launch its products. He needed good credit terms with Byte to pay for the ads, but his company was not established enough to qualify for them. He then devised to trick Byte into believing that Borland was larger than it was and had venture capital financing, which it really did not. When the sales representa- tive for Byte visited the new company to inspect it, Borland’s founder had paid actors on hand to look like employees, had office phones ring continuously, and had a pretend advertising plan in plain view for the sales representative to see. Borland got the credit to place the ad, and shortly after, the company became a major player in the software industry. In short, Carr and others have reasoned that deception is part of the rules of the business game. Since we do not morally con- demn poker players for attempting to deceive opponents with their poker faces, by analogy we should not condemn businesses for doing what is necessary, even when it involves going contrary to our common moral intuitions.

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The problem with this line of reasoning is that strategic misrepresentation is acceptable only when the rules are clearly known to everyone involved. Poker players know the rules of the game beforehand, and join the game in full knowledge of those rules. Indeed, with businesses, in many instances the rules are very clear. Consumers know that advertisers will remain silent about the drawbacks of their products and exaggerate their qualities. In labor negotiations, businesses and labor unions both bluff about how far they are willing to bend the rules.

However, in other situations, the rules of business require complete honesty, and when busi- nesses strategically misrepresent themselves, they are on the side of wrong and can be held legally responsible for their conduct. For example, to enhance its financial image, General Motors claimed in a national advertisement that it had repaid a bailout loan it received from the U.S. gov- ernment “in full, with interest, five years ahead of schedule” (Tapscott, 2010). This claim conveyed the impression that GM had paid off all its government loans, and with its own money. In point of fact, however, neither of these statements was true. It paid off its loan with money it had received from a second government bailout loan. Thus, it still owed the government money, and it did not use its own money to pay back the loan. As a consequence, GM was sued for deceptive advertis- ing. This was a case of strategic misrepresentation that violated the rules of the game.

What is fundamentally wrong about Carr’s position is that, just because strategic misrepresenta- tion is a socially accepted practice in some business situations, it is not necessarily acceptable in every case. A businessperson who rushes into strategic misrepresentation could easily make misleading claims that cross the line of legality. It is all a matter of knowing what the rules of the game are, and when they do not allow for misrepresentation.

Groupthink and Organizational Schizophrenia

Within the field of industrial-organizational psychology, there are a few concepts that describe how decisions are made in group environments and how these can sometimes lead to bad choices. We’ll look at two in this section: groupthink and organizational schizophrenia.

Groupthink Groupthink refers to the practice of thinking or making decisions as a group in a way that discour- ages creativity or individual responsibility. Group members become so focused on arriving at a decision as a cohesive unit that they set aside their private ethical concerns. In criminal courts of law, juries by their very nature face this problem. Twelve people are instructed by a judge to reach a unanimous decision, and they must do so to assure the success of the judicial process. To reach a unanimous decision, though, some jury members must give in to the views of the whole; it is only the most stubborn members who resist to the end and thereby create a hung jury.

The same thing happens within businesses. Suppose, for example, that an appliance company manufacturers a new microwave oven, and in research and development there is some indication that the unit might overheat and catch fire. The evidence isn’t conclusive, and it only happens with one test model operating in an extreme situation. Members of the research team have to decide whether the product is ready to move forward into production. Suppose further that there is pressure within the company to bring out new products within specified time frames. When the research team makes its final judgment, the group as a whole, influenced by that pressure, may decide that the unit falls within the limits of acceptable risk and is thus ready to go. Individually,

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CHAPTER 3Section 3.5 Threats to Ethical Corporate Culture

some of the members might feel that production of the unit should be delayed until more testing can be done. But they agree anyway, since the consensus of the group is to move forward. It is only later, when customers are injured and the product is recalled for being a fire hazard, that the flawed nature of the group’s decision-making pro- cess becomes evident.

The groupthink phenomenon is helpful for understanding how it is that many unethical business deci- sions can be made, whether with regard to product safety, discrimi- natory hiring practices, or shady bookkeeping. Each member of the

group may personally have a high level of moral integrity. But when making tough decisions in a competitive business market, they may set their personal moral convictions aside in favor of a group consensus. Perhaps the group as a whole feels that the action falls into a moral gray area that is within the limits of acceptable risk. Perhaps the group as a whole is more interested in the benefits of the proposed course of action than an impartial analysis of its costs. In any event, members of the group end up making unethical choices that they would not in their private lives.

One analysis of the groupthink phenomenon describes four symptoms of it:

• The group feels that it is invulnerable to harm. It is in a position to make an authoritative decision and, perhaps influenced by a track record of previous successes, it ignores the possible negative consequences of its decision.

• The group members are unanimous in their beliefs—or at least in the expressed views of each member—and thus have the confidence to move forward with their decision.

• If there are dissenters, pressure is put on them to accept the views of the group. • Someone in the group functions as a kind of “mind guard” who filters out information that

is inconsistent with the group’s view (Levy, 2010).

One way to combat the groupthink phenomenon is to watch out for these four symptoms when making group decisions, and, if they do appear, to actively seek out unspoken or minority viewpoints.

Organizational Schizophrenia Another component of industrial-organizational psychology is organizational schizophrenia, where tension exists between competing goals or values within a corporation. The organization presents mixed messages to its employees about what is important, and the employees are left to work out a course of action on their own. The term schizophrenia is borrowed from the field of psychology and refers to a psychological disorder in which a person is motivated by contradictory or conflicting principles. The use of the term in industrial-organizational psychology applies more generally to any set of competing agendas in an organization when there is no clear resolution between the two.

Royalty-free

Did groupthink contribute to the recent housing collapse and economic crisis in the United States?

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CHAPTER 3Summary

Some organizations are by their very nature schizophrenic. For example, pharmaceutical compa- nies have an important social mission to improve people’s health, on the one hand, yet at the same time have an obligation to shareholders to make a profit. For this reason, pharmaceutical compa- nies are regularly called out in the media for allowing profits to overtake their social responsibil- ity. In a more general way, this same tension is present in virtually all businesses: Employees are instructed to behave ethically, yet at the same time their jobs require them to maximize profits. When the pressure to maximize profits is too great, it may obscure ethical responsibilities, such as the duty to manufacture microwave ovens that do not catch on fire.

But the two goals of ethics and profit do not have to be in a schizophrenic relationship. They can be compatible when the boundaries of ethical behavior are clearly indicated to employ- ees. It is much like playing a sport: There is the playing field where the principal activity occurs (analogous to maximizing profits) and there are boundaries beyond which players cannot stray (analogous to ethical boundaries). When employees have clear knowledge of where those ethi- cal boundaries are, such as through corporate codes of ethics, they can safely do their part to maximize profits.

3.6 Conclusion Corporations have come a long way since the founding of Jamestown by the Virginia Company. In the 400 years since that time, they have become independent of governmental affiliation, have gained the status of legal persons, and have proliferated in number to the point that, in the United States, there is one corporation for every 11 people. It is precisely these changes that led Bakan to depict corporations as psychopaths with personality traits of irresponsibility, manipulation, grandiosity, superficiality, lack of empathy, and the inability to feel remorse. But even Bakan has recognized that a corporation’s psychopathic behavior will ultimately lead to its own destruction, as happened with Enron. Thus, for a corporation to avoid a self-created downfall, at some point it must stop short of Enron-like behavior and take into account the wider interests of its various stakeholders. We have seen that within corporate culture, there are mechanisms already in place for reinforcing socially responsible behavior, such as through codes of ethics and the seven steps of ethical compliance included in the Federal Sentencing Guidelines for Organizations. There are also warning signs for when companies become ethically at risk. The issue becomes whether a corporation is willing to take seriously these aspects of ethical corporate culture. There will always be companies like Enron, but the goal is to make their occurrences few and far between.

Summary We began this chapter looking at the nature of corporations, and their four main features. That is, corporations are created by the states in which they are chartered, they can continue to exist indefinitely, they are regarded by the law as having the status of a person, and stockholders’ liabil- ity is limited to the amount of money that they invest. Shell corporations, which exist on paper but have no active business operations, can manipulate the laws that create corporations and exist solely for unethical or illegal purposes, such as tax havens. A critical issue with the nature of corporations is whether they are moral agents, which are morally responsible for their actions beyond the responsibility individual corporate employees have. Peter French argued that they are moral agents, but Manuel Velasquez argued that they are not.

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CHAPTER 3Summary

The next issue of the chapter involved punishing corporations. Punishment in general is typically justified on five grounds, all of which apply to corporations as well as individual people: deter- rence, incapacitation, rehabilitation, retribution, and reparation. Just as there are different forms of punishment for individual people, there are also different ways of punishing corporations. Six of these are monetary fines, equity fines, corporate incapacitation, the corporate death penalty, corporate shaming, and community-service orders. The selection of an appropriate corporate punishment often hinges on whether it will harm innocent people, such as employees, custom- ers, and creditors, and also whether the punishment is severe enough to have a real impact on the corporation’s conduct. The U.S. government established the Federal Sentencing Guidelines for Organizations (FSGO), which guide federal judges in imposing punishments on corporations. These guidelines also recommend steps for corporations to follow to maintain high standards of ethics and thus avoid illegal conduct. In addition to governmentally imposed punishments, con- sumers can also retaliate against unethical companies through boycotts and civil lawsuits.

The creation of an ethical culture within corporations often focuses on three notions: the stake- holder, the triple bottom line, and corporate social responsibility. Many corporations express their commitment to ethical standards within their mission statements and, in a more detailed way, through a corporate code of ethics. A common criticism of these public statements is that they can be insincere efforts to make a company appear to be more ethical than it really is. In spite of even sincere efforts to create an ethical corporate climate, four things can hamper those efforts. First is the profit motive itself, which can incline companies to minimize their social responsibility in their efforts to increase profits. Second is strategic misrepresentation, where a corporation intention- ally misstates facts to gain a financial advantage. Third is groupthink, where employees might set aside their ethical convictions in the process of building group consensus. Fourth is organizational schizophrenia, where management can send conflicting messages to employees about the corpo- ration’s ethical priorities.

Discussion Questions

1. Legal scholars like William Blackstone have argued that perpetual existence is one of the main benefits of creating corporations. As tragic as death is for natural persons, it nev- ertheless makes way for younger generations of people to put their mark on the world. Might there be a similar benefit if corporations were required to die after, say, 100 years of existence? What might the disadvantages be if such a policy were enacted?

2. One issue of corporate moral agency involves whether corporations can be accused of being immoral, beyond the immoral conduct of their employees. Peter French and Manuel Velasquez have taken opposing views on this. Explain their views and discuss which of the two you believe is correct.

3. Some codes of ethics include an intuitive guide for employees to assess their decisions. Look at the guide presented from Allstate in the chapter. Are all of the questions that are asked helpful for guiding ethical choices (such as “Is it legal?”)? Are there other ques- tions that you think should be on the list?

4. Milton Friedman argued that businesses’ only responsibility is to make profits, and they should avoid all efforts at social responsibility. Explain the rationale for his position, and discuss whether you agree.

5. Albert Carr defended strategic misrepresentation as a normal part of the business game. Think of an example in which you believe Carr is correct, and another example in which you believe that strategic misrepresentation is wrong.

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CHAPTER 3Summary

Key Terms

board of directors Group of individuals elected by corporation stockholders to manage the corporation.

community-service order A corporate punish- ment where a company must participate in some project that benefits the community in some way.

consumer boycott When a group of people act together to abstain from buying from or dealing with a business.

consumer retaliation When individual consumers or consumer groups express dis- satisfaction with a company through some effort that harms it financially, e.g., boycotts, complaints to government agencies, or civil lawsuits.

corporate codes of ethics Detailed accounts of the principles of conduct within organiza- tions that guide decision making and behavior.

corporate death penalty A corporate punish- ment where a company is forced to go out of business, such as by the revocation of its corporate charter.

corporate incapacitation A corporate punish- ment where a court issues an order to restrain the activities of a corporation in some area of business.

corporate moral agency The concept that businesses are morally responsible for their actions, similar to how individual people are morally responsible for theirs.

corporate shaming A corporate punish- ment where the government requires a guilty company to make a public announcement that threatens its reputation and social standing.

corporate social responsibility (CSR) A cor- poration’s efforts to take responsibility for its effects on the environment and its impact on social welfare.

Corporate Social Responsibility Index An index created by the Center for Corporate Citizenship at Boston College that ranks com- panies based on public perceptions of their citizenship, governance, and workplace.

creation by statute The legal concept that corporations come into existence through the creation of a legal document called a charter.

deterrence A justification of punishment where an offender is punished to set an example that might discourage others from committing similar crimes.

equity fine A corporate punishment where a fine payment is made in shares of the com- pany, not in money.

ethics officer An administrator within a com- pany who holds workers accountable to the company’s ethical standards.

Federal Sentencing Guidelines for Organiza- tions (FSGO) U.S. government guidelines for sentences imposed by federal judges, which include restitution, remedial orders, commu- nity service, fines, and jail terms.

fiduciary duty A legal obligation to manage a company in a way that protects the owners’ investment.

fine A payment of money imposed as a pen- alty for an offense.

greenwashing A term referring to pretended efforts at environmental responsibility and, more broadly, at corporate responsibility.

groupthink The practice of thinking or making decisions as a group in a way that discourages creativity or individual responsibility.

incapacitation A justification of punishment where removing an offender from society prevents the offender from committing similar crimes.

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CHAPTER 3Summary

legal person A nonhuman entity regarded by law as having the status of a person.

legal standing The legal concept that a person can sue others and be sued by others, own property, and make contracts with others.

limited liability The legal concept that a stock- holder cannot lose more than the amount that he or she invested.

mission statement A short account of a company’s fundamental purpose, which may include a statement of ethical standards.

officers Individuals designated by a corpora- tion’s board of directors to operate the busi- ness, with the chief executive officer (CEO) at the top and various levels of managers below.

organizational schizophrenia Tension between competing goals or values within a corporation.

perpetual existence The legal concept that corporations can continue indefinitely and independently of the temporary lives of their managers and shareholders.

rehabilitation A justification of punishment where, through reform techniques, changes are made to an offender’s future behavior.

reparation A justification of punishment where an offender must repay the victim for the injury that the offense caused.

retribution A justification of punishment where punishment balances the scales of jus- tice; a crime requires a punishment.

shell corporations Corporations that exist on paper but have no active business operations or significant assets.

stakeholder Any party who is affected by, or who has a stake in, a business practice, includ- ing employees, suppliers, customers, creditors, competitors, governments, communities, and stockholders.

stockholders Those who own a corporation by obtaining shares of stock in it.

strategic misrepresentation The intentional and systematic distortion or misstatement of facts for the purpose of gaining a financial advantage.

triple bottom line (3BL) The view that suc- cessful companies must pursue three distinct values: people, the planet, and profit.

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Consumers

Learning Objectives

After completing this chapter, you should be able to:

• Describe the nature and history of consumer advocacy. • Outline the principal issues surrounding product safety. • Explain the forms of deceptive advertising. • Describe the problems surrounding the targeting of vulnerable groups. • Describe the different unfair sales tactics.

Associated Press/Robert F. Bukaty

4

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CHAPTER 4Section 4.1 Introduction

Chapter Outline

4.1 Introduction

4.2 Consumer Advocacy

History of Consumer Advocacy

4.3 Product Safety

Safety and User Reviews Unsafe Automobiles

4.4 Deceptive Advertising

Deceptive Food Packaging Deception Versus Puffery Punishment for Deceptive Advertising

4.5 Targeting Vulnerable Groups

Child Advertising

4.6 Unfair Sales Tactics

Misuse of Legal Tactics

4.7 Conclusion

4.1 Introduction The Beech-Nut company manufactured an apple juice for babies that contained no apple juice whatsoever (Hartley, 1993). Exxon advertised that one of its brands of gasoline made engines cleaner and reduced auto-maintenance costs, a claim that it did not substantiate (Federal Trade Commission, 1996). Hundreds of toy products manufactured in China were recalled in a 1-year period for containing toxic lead paint or presenting a choking and strangulation hazard. These are just a few of the hundreds of consumer complaints against businesses that have grabbed head- lines over the years.

Let the buyer beware! This is a general word of warning to consumers that we have all heard in our buying experience. The warning alerts us to the fact that the products we buy may not be qual- ity items as the seller claims, and that the burden may fall on us as consumers to research those products before we purchase them. However, although this warning is good advice, it does not apply to an array of products we routinely buy. This is because in the United States we have laws in place that prevent businesses from taking advantage of consumers, and in fact many businesses zealously guard their reputation as manufacturers or retailers of high-quality items.

Indeed, even in bygone eras, consumers had some protection. The ancient Babylonian Code of Hammurabi (which we mentioned in Chapter 1), from around 1750 BCE, gave this stern warn- ing to building contractors: “If a builder build a house for some one, and does not construct it properly, and the house which he built fall in and kill its owner, then that builder shall be put to death” (trans. 1915 by L. W. King, section 229; see http://www.fordham.edu/halsall/ancient/ hamcode.asp#text). If we go back further in time, to hunter-gatherer days when people lived in

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CHAPTER 4Section 4.2 Consumer Advocacy

small tribes, we can imagine that even then traders would have been under pressure to sell qual- ity goods. Their trading capacity with other tribes might abruptly end if they gained reputations for selling shoddy merchandise, thus isolating the traders and their tribes and putting their very survival at risk.

Thus, whether it is laws or built-in market forces, we have some security that many, if not most, of the products we buy are good ones. Yet despite the reasonable amount of confidence consum- ers can have in the marketplace, there are still businesses that prey on consumers, unconcerned about the legal consequences or their business reputations. Not knowing when these situations might arise, consumers must indeed be on their guard; each year brings in new examples of busi- nesses that have taken advantage of the trust that buyers place in them. In this chapter, we will look at a cluster of issues often associated with consumer interests, namely product safety, decep- tive advertising, exploitation of vulnerable groups, and a variety of manipulative sales tactics.

4.2 Consumer Advocacy The heart of the consumer-interest issue lies in what is called consumer autonomy: the notion that consumers should be in charge of determining what to purchase after being supplied with relevant information. Businesses should not be permitted to conceal important information about their products or manipulate consumers into purchases. If we choose to buy something that is useless or of poor quality, that is our choice as informed consumers. But we should not be forced into that situation by manipulation and deception from companies. For a consumer to make an informed choice, two critical conditions must be met:

• the consumer must know how the product performs, and • the consumer must know how that performance compares to those of other products.

According to this view, it is not good enough for consumers to get half-truths about a product or be lured into a purchase through advertising hype. What is needed is relevant information, about both a given product and alternatives to that product.

But how do we get deceitful businesses to deal fairly with consumers? The answer is consumer advocacy, which is an organized effort to protect consumers against dangerous products, unfair pricing, deceptive advertising, and manipulative sales practices. Much consumer advocacy stems from governmental agencies that set standards of responsible dealings with consumers and pun- ish offending businesses. Other efforts at consumer advocacy are spawned by concerned individu- als or nongovernmental organizations that draw public attention to abuses and pressure change through negative public reaction, lawsuits, and governmental lobbying. Countries throughout the world typically have their own consumer-advocacy organizations, but the movement itself is a relatively recent phenomenon.

History of Consumer Advocacy

In the United States, consumer advocacy began in the early 1900s during what is known as the progressive era, a period of social activism and reform that focused heavily on rooting out fraud and corruption in politics and business. Journalists played a large role at the time—”muckrakers,”

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CHAPTER 4Section 4.2 Consumer Advocacy

as they were called—by drawing attention to wrongdoing of all sorts, such as the predatory business practices of Standard Oil. The journalist Upton Sinclair vividly depicted the exploita- tion of American workers and the unsanitary conditions in the meatpacking industry in his novel The Jungle (1906). His most sensational description was of workers falling into lard tanks, being ground up with animal fat, and ultimately being sold as lard. Public reaction to the book was so strong that the government was pressured into creating legislation to correct the problems in the meat industry. This resulted in the Pure Food and Drug Act of 1906, the stated aim of which was to prevent “the manufacture, sale, or transportation of adulterated or misbranded or poisonous or deleterious foods, drugs, medicines, and liquors” (Federal Food and Drugs Act of 1906, 1906).

Governmental Agencies Established Within this historical context, two important governmental agencies were set up to protect con- sumer interests: the FTC and the FDA. The Federal Trade Commission (FTC) was established in 1914 to prevent businesses “from using unfair methods of competition in commerce.” The agency’s scope broadened over the years and now includes the Bureau of Consumer Protection, whose aim is to “protect consumers against unfair, deceptive, or fraudulent practices” (Vladeck, n.d.). Figure 4.1 lists the top 10 consumer complaints reported to the FTC in 2010. The FTC’s top 10 list changes slightly from year to year, but for the past decade, identity theft has consistently been at the top.

Next, the Food and Drug Administration (FDA) was formed in 1927 for the purpose of carrying out the tasks specified in the Pure Food and Drug Act of 1906. In addition to these two impor- tant governmental agencies, in 1936 the nonprofit organization Consumers Union formed in response to advertising’s first flooding the mass media. As it says in the mission statement of the

Figure 4.1: Top 10 consumer complaints reported to the FTC, 2010

Source: Federal Trade Commission. (2011). Consumer Sentinel Network data book for January–December 2010 (p. 6). Retrieved from http://ftc.gov/sentinel/reports/ sentinel-annual-reports/sentinel-cy2010.pdf

1 2 3 4 5 6 7 8 9

10

.

.

.

.

.

.

.

.

.

.

Identity Theft (19%)

Debt Collection (11%)

Internet Services (5%)

Prizes, Sweepstakes, and Lotteries (5%)

Shop-at-Home and Catalog Sales (4%)

Imposter Scams (4%)

Internet Auctions (4%)

Foreign Money/Counterfeit Check Scams (3%)

Telephone and Mobile Services (3%)

Credit Cards (2%)

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CHAPTER 4Section 4.2 Consumer Advocacy

organization’s Consumer Reports magazine, consumers at that time “lacked a reliable source of infor- mation they could depend on to help them distinguish hype from fact and good products from bad ones” (Consumer Reports, n.d.). Since its inception, Consumers Union has conducted quality tests on hundreds of products each year, from breakfast cereals to automo- biles, and has published its results in Consumer Reports. A negative review of a given product can dev- astate that product’s sales, and manufacturers often take the mag- azine’s assessments seriously.

Responding to Business Conduct The consumer-advocacy movement continued to grow in the mid-20th century, often in response to outrageous conduct by businesses. Once such case was the manu- facture of an antibacterial medicine called Elixir Sulfanilamide, which in 1937 caused the deaths of over 100 people. The raspberry-flavored product was prepared with a solvent that, unbeknownst to the manufacturers, was poisonous. When the deadly effect of the drug was discovered, govern- ment agencies were successful in retrieving most of the distributed supply. The company owner denied responsibility for the tragedy, stating, “My chemists and I deeply regret the fatal results, but there was no error in the manufacture of the product. We have been supplying a legitimate profes- sional demand and not once could have foreseen the unlooked-for results. I do not feel that there was any responsibility on our part” (S. E. Massengill, quoted in “Elixir Sulfanilamide—Massengill,” 1938, p. 69). The chemist himself, though, committed suicide while awaiting trial. A consequence of this episode was the passage of the Federal Food, Drug, and Cosmetic Act of 1938, which gave the FDA greater power to regulate the testing, labeling, and marketing of drugs.

Consumer Bill of Rights President John F. Kennedy propelled consumer advocacy further in a landmark speech in 1962 when he articulated four fundamental consumers’ rights, later known as the Consumer Bill of Rights:

1. The right to safety—to be protected against the marketing of goods which are hazardous to health or life.

2. The right to be informed—to be protected against fraudulent, deceitful, or grossly mis- leading information, advertising, labeling, or other practices, and to be given the facts necessary to make an informed choice.

AP Images for Consumer Reports/Diane Bondareff

In this 2011 photo, a Consumer Reports employee talks to visi- tors as they taste test bagels. Consumer Reports refers to itself as an “expert, independent, nonprofit organization whose mission is to work for a fair, just, and safe marketplace for all consumers and to empower consumers to protect themselves” (Consumer Reports, n.d.).

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CHAPTER 4Section 4.2 Consumer Advocacy

3. The right to choose—to be assured, wherever possible, access to a variety of products and services at competitive prices; and in those industries in which competition is not workable and government regulation is substituted, an assurance of satisfactory quality and service at fair prices.

4. The right to be heard—to be assured that consumer interests will receive full and sym- pathetic consideration in the formulation of government policy, and fair and expeditious treatment in its administrative tribunals. (Kennedy, 1962)

These rights, according to Kennedy, required support through governmental regulations and agencies. Through them, he argued, food, drugs, and automobiles would become safer, financial markets would become more secure, and deceptive trade practices would be curtailed.

Consumer Product Safety Commission In 1972, the Consumer Product Safety Commission (CPSC) was founded for the purpose of protecting the public “against unreasonable risks of injuries and deaths associated with con- sumer products” (Consumer Product Safety Act of 1972, Section 2). The CPSC has jurisdiction over about 15,000 types of consumer products, including coffeemakers, toys, lawn mowers, and fireworks. The commission sets product-safety standards, oversees product labeling, and orders recalls of unsafe or defective products. It also requires businesses themselves to report any prod-

uct that “contains a defect which could create a substantial risk of injury to the public or presents an unreasonable risk of serious injury or death” (U.S. Consumer Prod- uct Safety Commission, n.d.). The CPSC provides step-by-step guide- lines for issuing product recalls and alerting the public to the problem. The biggest year for recalled items was 2007—nearly 500 items were recalled, over half of them prod- ucts from China, and many were toys (Lipton & Barboza, 2007). As a result of the 2007 recall crisis, Congress passed the Consumer Product Safety Improvement Act of 2008, which gave more power and resources to the CPSC.

U.N. Guidelines for Consumer Protection In 1985, the United Nations enacted a set of Guidelines for Consumer Protection. The 1999 expanded version of the guidelines specified the following seven fundamental consumer needs that should be met:

A. The protection of consumers from hazards to their health and safety; B. The promotion and protection of the economic interests of consumers;

Associated Press/Jose Luis Magaña

This photo shows toys that were recalled by the U.S. Consumer Product Safety Commission in 2009.

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CHAPTER 4Section 4.3 Product Safety

C. Access of consumers to adequate information to enable them to make informed choices according to individual wishes and needs;

D. Consumer education, including education on the environmental, social and economic impacts of consumer choice;

E. Availability of effective consumer redress; F. Freedom to form consumer and other relevant groups or organizations and

the opportunity of such organizations to present their views in decision-mak- ing processes affecting them;

G. The promotion of sustainable consumption patterns. (United Nations Confer- ence on Trade and Development, 2001, p. 3)

Although these guidelines are not binding on the member nations of the United Nations, they offer a model for how each member nation might implement those ideals within its own government.

4.3 Product Safety A major focus of consumer advocacy—whether governmental or nongovernmental—is product safety. Some consumer items are by their nature unavoidably unsafe products, in the sense that if they were made safe they would not be useful for their intended purpose. Lawn mowers, kitchen knives, drain cleaners, nail-polish remover, and firearms are examples; in each of these cases, making them completely safe would make them useless. What is of concern is not whether the product is inherently unsafe, but whether it has a substandard design that makes it less safe than an alternative and more acceptable design. The CPSC lists three hazard levels of products:

Class A hazard: Exists when a risk of death or grievous injury or illness is likely or very likely, or serious injury or illness is very likely.

Class B hazard: Exists when a risk of death or grievous injury or illness is not likely to occur, but is possible, or when serious injury or illness is likely, or moderate injury or illness is very likely.

Class C hazard: Exists when a risk of serious injury or illness is not likely, but is possible, or when moderate injury or illness is not necessarily likely, but is possible. (U.S. Consumer Product Safety Commission, 1999)

The more serious the hazard, the higher the priority for notifying the public and issuing recalls. The CPSC has a “fast track product recall program” designed for companies that can move quickly with a voluntary recall of their product. This eliminates some procedural steps in the recall pro- cess, specifically the need for a preliminary determination by the CPSC about whether the product contains a defect that presents a substantial hazard.

Safety and User Reviews

With the rapid increase of online retail stores, buyers have had access to countless user reviews of various products, which forewarn them of difficulties with those items. This body of information is an invaluable resource to consumers today that was simply unavailable in previous generations. It has thus created a new public forum for individuals to voice their objections to products and

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CHAPTER 4Section 4.3 Product Safety

business practices. For example, the expression “cheap piece of junk”— and similar wording—appears in over 10,000 user reviews on Ama- zon.com. The products in question include alarm clocks, money clips, toy magic wands, computer-game controllers, bongo drums, heart- rate monitors, and paper shred- ders. The expression “dangerous product” is found in several thou- sand reviews, including those of chairs, toasters, gas cans, lawn mowers, weight-loss drugs, pet chew toys, oven liners, seat-belt adjusters, exercise weights, outlet adapters, and toy mirrors. A com- mon phrase in reviews of computer and other electronic devices is “unreliable product.”

User reviews not only help buyers sort out good products from bad ones, but they allow retailers and manufacturers to monitor them for indications of what the product does right and wrong. Nega- tive reviews are sources of embarrassment for companies, and they forecast financial problems as a result of decreased sales, product returns, and perhaps even product recalls and lawsuits.

The government itself has gotten on board with grassroots consumer activism and has created a Web site—SaferProducts.gov (run by the CPSC)—where consumers can report unsafe products. Businesses also have the opportunity to post responses to complaints. Here is a posted complaint of a malfunctioning refrigerator light bulb, with the manufacturer’s response:

Complaint: “The light bulbs in my refrigerator failed to turn off. The bulb housing melted and sagged, the roof of the refrigerator has bubbled, and the bulb sockets appear scorched. It appears the manufacturer is aware of this problem, but did not notify me.”

Response: “Sears Holdings takes product safety issues very seriously. We investi- gate each CPSC database incident report. We encourage our customers to provide additional information about incidents to our Customer Care Network, by calling 800-549-4505.” (SaferProducts.gov, 2011)

Sears’s response is a general statement that they use in many of their comments on this Web site; other companies use similar stock responses to reported problems. Here is a more serious com- plaint about a child choking on a toy:

Complaint: “My four year old son put a small toy in his mouth. The toy went back into his throat and was lodged in his esophagus. Initially, he had trouble

Cheng quan qd/Imaginechina

In this 2011 photo, workers in China damage a Lamborghini. The workers were hired to destroy the car by its disgruntled owner, who wished to stage a public protest over what he felt was inadequate service and a violation of his consumer rights by the Lamborghini dealer. According to the car’s owner, the dealer refused to fix the car’s engine, which quit starting 6 months after he purchased it.

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CHAPTER 4Section 4.3 Product Safety

breathing. Then, it got lodged down farther. He was transported to the hospital after calling 911”

Response: “Spin Master Ltd was very concerned to learn of this incident with the Wal-Mart exclusive Action Dragon figure produced for the Train Your Dragon movie. The product is no longer in production as the toys were related to the movie release. When we work on a toy, we diligently assess the designs, and production products, using external, qualified third party labs. This product was reviewed, tested and assessed for all applicable toy standards and age grade. The product has passed all testing with no issues. The product is marked clearly with a warning for choking hazard due to small parts, and age graded for 5 plus years. Despite passing all safety testing, when we learn of an incident, we take it very seriously and will incorporate the knowledge into our design assessments for future products” (SaferProducts.gov, 2011).

Unlike Sears’s response, Spin Master’s comment is particular to the customer’s specific complaint. In the excerpt quoted here, they express concern over the choking but maintain that their product was safe.

An objection that has been voiced about the SaferProducts.gov site is that it does not filter out consumer complaints that may be inaccurate. Representative Mike Pompeo even attempted to shut down the site by eliminating its funding, on the grounds that it would harm U.S. busi-

nesses. He argued that the site’s managers do not sufficiently weed out false or inaccurate claims, the presence of which will mislead consumers and damage the reputation of innocent and safety-conscious manufacturers (Pompeo, 2011). On the other side of the debate, however, unfiltered customer reviews are so commonplace on the Internet now that there is nothing unique about what the site is doing— other than the fact that it is run by a government agency. Further, the CPSC stated that it would not post reports that have missing or clearly untrue information, so it is not entirely unfiltered.

Unsafe Automobiles

One product that qualifies as “unavoidably unsafe” is the automobile, which today accounts for over 30,000 deaths in the United States per year. The automobile is an inherently unsafe prod- uct because it is designed to hurl us down the road at such high speeds that, upon collision, the human body cannot withstand impact. The responsibility of auto manufacturers is to seek out ways to make their vehicles safer, even though the risk can never be fully eliminated. That is

Associated Press/Anonymous

This 2011 photo shows the CPSC’s new Web site, SaferProducts .gov, where consumers can report unsafe products. Businesses also have the opportunity to post responses to complaints.

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CHAPTER 4Section 4.3 Product Safety

precisely what has occurred in automobile manufacturing over the past half century. The most important of the design changes have been seat belts, crash crumple zones, collapsible steering columns, air bags, stronger roof supports, rollover bars, and antilock brakes.

With these safety improvements, the number of automobile fatalities per year in the United States has been dramatically decreasing—and this is while, at the same time, the number of hours that the population spends on the road each year has been increasing. But automobile manufacturers have often resisted making changes for the simple reason that safety costs money. The changes that have taken place were largely the result of external pressure by legislators, governmental agencies, and consumers. Two important cases are connected with increased public conscious- ness about automobile safety.

Ralph Nader and the Chevrolet Corvair The case that kicked off the safety revolution in auto- mobile manufacturing involved Ralph Nader and the Chevrolet Corvair. In 1960, General Motors introduced the Corvair as a small, sporty, and comparatively low- cost vehicle. But a design flaw with the car’s suspen- sion caused the rear tire to tuck under in sharp turns and flip the car. Such accidents prompted over 100 lawsuits against GM. A redesign of the vehicle in 1964 addressed the problem with the inclusion of an anti- sway bar, but GM decided not to recall the earlier vehicles, to avoid repair costs of $25 million.

In 1965, Nader, a young attorney, published his book Unsafe at Any Speed, which criticized automobile man- ufacturers for resisting safety improvements to save money. The book’s first chapter, titled “The Sporty Cor- vair—The One-Car Accident” described how GM persis- tently dodged the safety issue with the early Corvairs. Nader also accused the manufacturer of “one of the greatest acts of industrial irresponsibility in the present century.” In response, GM attempted to discredit Nader through a campaign of investigation that included sur- veillance, late-night harassing phone calls, and ques- tioning of associates about his lifestyle. Nader sued GM for $26 million but settled for just under a half million. GM finally discontinued the Corvair as sales of the vehicle dropped to 13,000 in its final year of production, compared to 230,000 in its first year. The public attention that Nader drew to this issue helped bring about the National Traffic and Motor Vehicle Safety Act of 1966 and the subsequent creation of the National Highway Traffic Safety Administration (NHTSA), whose stated mission is to “save lives, prevent injuries, and reduce economic costs due to road traffic crashes” (n.d.).

The Ford Pinto The case that most represents automobile manufacturers’ resistance to safety changes is the Ford Pinto. Introduced in 1970, the Pinto, like the Corvair, was a compact and comparatively inexpensive

Associated Press/Susan Walsh

In this 2006 photo, Ralph Nader is shown with his book Unsafe at Any Speed, which celebrated the 40th anniversary of its pub- lication that year.

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CHAPTER 4Section 4.3 Product Safety

car. Preliminary tests of the vehicle showed that it could not withstand a 20-mph rear-end collision without rup- turing the gas tank. Ford nevertheless put the car into production and made no changes to its gas-tank design in subsequent years. The decision was based on a cost- benefit analysis. While the estimated costs of improv- ing the Pinto’s safety were comparatively low, at $11 per vehicle, the total cost would outweigh the bene- fits: $138 million to fix the problem versus $50 million in injury costs. In what is now called the “Ford Pinto Memo,” the company laid out estimated injury costs. First, the NHTSA had itself calculated that the total cost of a death from an automobile accident was around $200,000 in the year 1972. NHTSA’s analysis is here:

Future productivity losses

Direct: $132,000

Indirect: $41,000

Medical costs—Hospital: $700; Other: $425

Property damages: $1,500

Insurance administration: $4,700

Legal and court expenses: $3,000

Employer losses: $1,000

Victim’s pain and suffering: $10,000

Funeral: $900

Assets (lost consumption): $5,000

Miscellaneous accident costs: $200

Total cost per fatality: $200,425

The Ford Pinto Memo took this figure of roughly $200,000 and included it in the following cost- benefit analysis, based on an estimated 180 burn deaths and 180 burn injuries per year:

Benefits

180 burn deaths, 180 serious burn injuries, 2,100 burned vehicles

Unit cost: $200,000 per death, $67,000 per injury, $700 per vehicle

Total Benefit: (180 × $200,000) + (180 × $67,000) + (2,100 × $700) = $49.53 million

Costs

Sales: 11 million cars, 1.5 million light trucks

Unit cost: $11 per car or truck

Total cost: 12.5 million × $11 = $137.5 million

What Would You Do?

You are the CEO of an automobile company. Your research and develop- ment department has a safety design that will improve passenger protec- tion in side-impact collisions. If it is implemented in all of your company’s vehicles, an estimated 100 lives will be saved each year. However, the design change will increase the cost of each vehicle by $500, which will put you at a competitive disadvantage and decrease company profits by 10%.

1. Would you implement the design change on all of your vehicles, only some, or none?

2. Suppose that the change would save 1,000 lives per year. Would that make a difference in your decision?

3. Your marketing department tells you that car buyers are mainly motivated by the appearance, comfort, and performance of a vehicle, and safety is typically a low priority. Would that marketing fact impact your decision?

4. Suppose that your company had a patent on the design change. Would you make it available to your competitors for free, knowing that it would save more lives if you did?

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CHAPTER 4Section 4.4 Deceptive Advertising

The upshot is that the company would save $85 million by not fix- ing the problem, and simply paying damages from burning deaths and injuries. However, starting in 1976, the NHTSA required that vehicles pass a 30-mph collision test. Ford redesigned the Pinto’s fuel tank to meet that standard and issued recalls on all previous models. Ford’s costs from the recall and design changes completely elimi- nated any savings they might have otherwise gained by neglecting the problem for so many years. Further, the Ford Pinto Memo painted the company as a heartless and cynical institution that put a low value on human life and cared more about cutting costs than about prevent-

ing its customers’ being burned alive in its poorly designed vehicle. The bad publicity that Ford received from this episode has itself become a lesson in business ethics about insensitivity towards product-safety issues. Automobiles today are still regularly recalled, but the system for doing so is more reliable, and the stories of the Corvair and the Pinto stand as warnings to car manufacturers who resist corrective action (Dowie, 1977).

4.4 Deceptive Advertising As consumers, we are inundated with advertising messages on TV, radio, billboards, and almost every page of the Internet. Some are overt pleas to buy products. Others are sneaky product placements, such as in movies when a character laces up a pair of name-brand tennis shoes. The hype in these ads is relentless, as each one attempts to compete with others for our atten- tion. We learn to psychologically block out most ads, just so we can get through the day without being immobilized from distraction. We also automatically tone down the exaggerated claims that sound too good to be true, and selectively pick out information from ads that we find relevant.

At the same time, though, we know that advertisers often go too far in their claims and make out- right lies about their products. Deceptive advertising—also called false and misleading advertis- ing—is advertising that intentionally misleads or confuses consumers. The deception may involve ambiguity, concealment of facts, gross exaggeration, or outright false statements. In each case, though, it contains a substantial falsehood such that consumers would not buy the product if they knew the truth about it. Advertisers are not required to present all the facts about their products to escape the charge of deceptive advertising. In fact, the very nature of advertising is the use of selective information to get a person to identify and select a given product on the store shelf. Advertising is deceptive, however, if false information is the fundamental cause for a person to select one product over another.

Associated Press

This photo shows a 1973 Ford Pinto after a rear-end crash. In 1976, Ford was forced to redesign the Pinto’s fuel tank to meet new safety standards, and issued recalls on all previous models.

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CHAPTER 4Section 4.4 Deceptive Advertising

From a moral standpoint, deceptive advertising is wrong for three reasons:

1. It involves a lie, either a direct one through a blatantly false statement or an indirect one through a subtly misleading statement.

2. It is morally wrong, since relevant information is covered up that is essential for making a genuinely rational choice. Suppose I am interested in losing weight and am looking at a nutritional supplement called Fat Dissolver. The advertiser knows the kind of informa- tion I need to make a rational choice to buy a weight-loss product, but also knows facts about Fat Dissolver that will not meet that standard of information. The advertiser, then, misrepresents the information about the product so that it meets my threshold for mak- ing a rational decision. By concealing the true nature of the product, the advertiser is mistreating me as a rational being and essentially swindling me into a purchase I other- wise would not have made.

3. It is morally wrong, since it is a type of unfair competition. Suppose there are five com- peting weight-loss products on the market, four of which make truthful claims in their advertisements. Advertisers of Fat Dissolver, however, make their product more appeal- ing by misrepresenting the facts about it. They have beaten the competitors but have done so unfairly through deceit.

Figure 4.2 shows FTC commissioner Roscoe Starek’s list of “Myths and Half-Truths About Decep- tive Advertising” as warnings to potentially deceitful advertisers. The underlying theme of these myths is that advertisers should not be lazy in the fact-gathering process. There are scientifically respectable standards for determining what counts as a factual claim about a product, and those are the standards upon which advertisers should rely.

Figure 4.2: Myths and half-truths about deceptive advertising

Source: Starek, R. B., III. (1996, October). Myths and half-truths about deceptive advertising. Presented at the National Infomercial Marketing Association, Las Vegas, NV. Retrieved from http://www.ftc.gov/speeches/starek/nima96d4.shtm

1

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5

6 7

8

9

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If a couple of studies support your claim, it is substantiated.

If your product has some benefits, your ads won’t be challanged.

Testimonials are substantiation.

So long as endorsers really use the product, and really like it, you can safely use their endorsements.

If you contradict a deceptive claim with a disclosure, you immunize yourself from liability.

“Results may vary” is an adequate disclosure.

Dietary supplement ads are not regulated.

If all you do is produce the informercial, you are not responsible for deceptive claims. No rules apply to advertising on the internet.

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CHAPTER 4Section 4.4 Deceptive Advertising

Deceptive Food Packaging

Statements about the health benefits of food products are an area where advertisers have been notoriously negligent about backing up their claims with scientific evidence. For example, Dannon settled a $21 million class-action lawsuit for misleading claims that bacteria in its Activia yogurt help relieve irregularity and that its DanActive drink boosts immunity. According to the FTC, the evidence was not there to back up the claim. The FTC’s chairman stated, “Consumers want, and are entitled to, accurate information when it comes to their health. Companies like Dannon shouldn’t exag- gerate the strength of scientific support for their prod- ucts” (Federal Trade Commission, 2010).

Even when nutritional claims on food packages are, strictly speaking, true, they can be fundamentally misleading. A mother of a 4-year-old girl filed a class- action lawsuit against the manufacturers of Nutella hazelnut spread for deceptive advertising. She pur- chased the product based on advertisement claims that it was a healthy and nutritious breakfast food. However, when learning of its high fat and sugar con- tent, she concluded that it was “the next best thing to a candy bar” (Weiss, 2011). Nutella is clearly not alone in broadcasting nutritional claims in ads and packag- ing. Statements such as “high in vitamins” “low in carbohydrates,” and “an excellent source of calcium” create the illusion that a product is, on the whole, healthy, when the selective information presented may be irrelevant to the buyer’s actual health needs. One study of this subject concluded that claims on food packaging should speak directly to the most critical health issues of buyers:

Nutrition rating systems and symbols on the fronts of food packaging would be most useful to shoppers if they highlighted four nutrients of greatest concern— calories, saturated fat, trans fat, and sodium. . . . These food components are routinely overconsumed and associated most strongly with diet-related health problems affecting many Americans, including obesity, heart disease, high blood pressure, Type 2 diabetes, and certain types of cancer (Institute of Medicine of the National Academies, 2010).

According to this study, major public-health issues could be better addressed if product packaging focused on calories, saturated fat, trans fat, and sodium rather than on less important nutritional claims. This would eliminate much of the nutritional hype on food packaging and prominently display the health information that consumers need most.

However, the problem is that comparatively few prepared foods would qualify for these kinds of labels. There is a natural human craving for fatty, salty, and high-calorie foods, which were

Associated Press/byline withheld

Dannon recently settled a $21 million class- action lawsuit for misleading claims that bacteria in its Activia yogurt help relieve irregularity. According to the FTC, the evi- dence was not there to back up the claim.

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CHAPTER 4Section 4.4 Deceptive Advertising

important for sustaining human survival in hunter-gatherer days. With food supplies being scarce, early humans’ next meal needed to meet their most urgent physiological demands. Although food supplies are not scarce for most of us today, we nevertheless retain our prehistoric cravings, and food producers are quick to supply us with products we desire. Modern consumers, then, are send- ing mixed messages to food manufacturers: We crave fatty, salty, and high-calorie foods, while at the same time we would like to know that what we are eating is healthy. The manufacturer, then, obliges. So far, the FDA forbids only false nutritional claims. It remains to be seen whether they will require packaging to proactively address the health risks of fatty, salty, and high-calorie foods.

Deception Versus Puffery

What we have seen so far is that advertising that blatantly makes false claims is both morally wrong and legally prohibited. But what about exaggerated claims like “the best dishwashing liquid of all time,” or “the world’s richest cup of coffee,” or “the number 1 best tasting,” or “the most delicious way to eat healthy”? Although these statements are not, strictly speaking, true, are they misleading?

In the advertising world this is called puffery, and there are two distinct elements to it:

• It involves an exaggeration that no reasonable person would take as factual. If I claim that my product is the best and greatest creation on the planet, you would not believe me. You would see it as just my attempt to get your attention. No one believes that the Energizer Bunny literally keeps on going and going.

• The claim is too vague to be provable. What sort of scientific test could we devise to prove that a specific brand of hot dog is “the finest in the world”? The word finest is so vague that we cannot establish a clear criterion to determine whether something does or does not count as the finest. The term world is also vague. Does it include all nations and cul- tures on earth? Does it include homemade hot dogs throughout the world, or just mass- produced ones? A claim cannot count as factual when there is no method we can devise to prove or disprove its truth.

This point is illustrated in a case involving American Italian Pasta Company, which placed “Amer- ica’s favorite pasta” on its packaging of Mueller’s-brand dried pasta. A rival manufacturer, New World Pasta Company, challenged the company, arguing that the phrase constituted false and misleading advertising. The judge ruled that the slogan was not deceptive since “‘America’s Favor- ite Pasta’ is not a specific, measurable claim and cannot be reasonably interpreted as an objective fact.” He further explained the distinction between puffery and factual statements:

Puffery and statements of fact are mutually exclusive. If a statement is a specific, measurable claim or can be reasonably interpreted as being a factual claim, i.e., one capable of verification, the statement is one of fact. Conversely, if the state- ment is not specific and measurable, and cannot be reasonably interpreted as providing a benchmark by which the veracity of the statement can be ascertained, the statement constitutes puffery (quoted in Hoffman, 2004)

In short, if a claim is puffery, then it cannot be a measurable statement of fact.

Sometimes exaggerated claims in advertising might appear to be mere puffery, but they still con- tain a factual element that can be tested, such as “Our coffee is even better than Starbucks.” In this

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CHAPTER 4Section 4.4 Deceptive Advertising

statement, a direct comparison is being claimed between two products, and this requires factual confirmation. FTC commissioner Roscoe Starek makes this point here:

The FTC does not pursue subjective claims or puffery—claims like “this is the best hairspray in the world.” But if there is an objective component to the claim—such as “more consumers prefer our hairspray to any other” or “our hairspray lasts longer than the most popular brands”—then you need to be sure that the claim is not deceptive and that you have adequate substantiation before you make the claim. (1996, paragraph 4)

This is precisely what happened in a lawsuit against Papa John’s Pizza for use of its slogan “Better ingredients. Better pizza.” Pizza Hut sued, arguing that within the context of Papa John’s overall advertising campaign, the slogan was making a comparison with other companies and thus con- stituted false advertising. In one of its ads, for example, Papa John’s made the comparative claim that its pizza “won big time” in taste tests over Pizza Hut. Papa John’s responded that its slogan was mere puffery and not a factual statement. However, the judge agreed with Pizza Hut: By directly comparing the ingredients of rival pizza chains in its ads, Papa John’s Pizza had created a context that no longer qualified as puffery. And within that larger context, Papa John’s could not prove that its fresher ingredients resulted in better tasting pizza. The company was then prohib- ited from using the word better to describe its pizza.

On appeal, however, Papa John’s was permitted to continue using its slogan, since Pizza Hut did not prove that the slogan itself improved Papa John’s sales. But the appeals court did agree with the critical point that the slogan was misleading within the context of its ad campaign. This case illustrates what is known as the puffery legal defense: When charged with false advertising, a company claims that it was only engaging in puffery. As a legal strategy, it aims to protect advertis- ers whose speech is not strictly factual. In this case, the strategy did not work for Papa John’s Pizza.

Punishment for Deceptive Advertising

When companies do engage in deceptive advertising, what sorts of punishments might they face, either unofficially or officially?

Unofficial Punishment Unofficially, consumers themselves can seek vindication in their product reviews when a pur- chased item does not live up to claims in advertisements. Also, journalists and consumer-advo- cacy organizations can embarrass companies by bringing public attention to deceptive ads. For example, Consumer Reports, on the last page of each issue, has a segment called “Selling It,” which shows pictures of misleading advertising and labeling such as:

• Large boxes of food that contain only a tiny amount of product. • An advertisement for Internet services boldly proclaiming that prices are “guaranteed to

never go up,” while tiny fine print in the same ad states “rates increase after two years.” • Packaging on a frozen juice bar that states “orange” and “naturally flavored juice bar,” but

the only juice listed in the ingredients is apple. • A piece of junk mail from a car company that comes in an envelope that at first glance

looks like an important letter from the IRS.

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CHAPTER 4Section 4.4 Deceptive Advertising

• A car-dealership billboard that has the words “Below cost!” in enormous letters, but just above it is almost unreadable small print which makes the full sentence read: “With prices so low, you’ll think we’re pricing them . . . below cost!”

• An advertisement for a car-rental company that prominently displays a picture of an expensive sports car, but the fine print states that the rental company does not currently have that car in its fleet.

All of these examples are for famous name-brand products, and it is humiliating for any of these companies to have their conduct placed on public display like this.

Official Punishment There are also more official ways of punishing deceptive advertisers. For example, when an adver- tisement makes an unfair comparison with a competitor’s product, the competitor can sue for damages, just as Pizza Hut did with Papa John’s. Also, individual citizens can file class-action law- suits against companies with deceptive ads, just as the mother did against Nutella. In both of these cases, the company might have to pay damages.

An alternative to using the legal system is a mechanism of self-regulated advertising, where the industry monitors and corrects false advertising by itself, without reliance on government agen- cies and courts. The National Advertising Review Council (NARC) is the primary self-regulatory body for the advertising industry in the United States. It sets policies and procedures for advertis- ers and seeks to minimize governmental involvement in the advertising business. The rationale behind self-regulation in advertising is that each business is sufficiently motivated to monitor the false advertising of its competitors. Suppose that you and I manufacture rival brands of hot dogs, and in your ads you make outrageous health claims about yours, such as your hot dogs cure heart disease. To prevent you from unfairly getting a larger share of the hot-dog market, I will want to stop your ads.

Government regulation, NARC argues, is costly and burdensome, and they offer businesses an arbitration system to resolve disputes with competitors without the involvement of courts. NARC will also address consumer complaints about misleading claims in national advertisements, such as those about product performance, superiority against competitive products, and technical facts. Armed with these consumer complaints, NARC itself can approach businesses to correct the problems, without involving the government.

The FTC is the final governmental authority on deceptive advertising. It has a long-standing policy of encouraging advertising self-regulation programs such as NARC’s. As one FTC commissioner stated, “In a rapidly-evolving marketplace, a responsive self-regulatory body may be more nim- ble than government regulators at addressing changes and correcting problems” (Harbour, 2005, p. 2). However, the FTC believes that self-regulation has not been effective in curbing advertis- ing abuses in some very specific areas. These include weight-loss claims in advertisements, food advertising to children, alcohol advertising to youth, Internet advertising through spam and spy- ware, and advertising regarding violent or explicit movies, music, and electronic games. In these cases, the motive for self-regulation is compromised because the products themselves are often morally questionable.

Suppose that you and I sell rival weight-loss drugs that are virtually worthless, and we each make bogus claims about how great our respective products are. I will not complain to the FTC or NARC

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CHAPTER 4Section 4.4 Deceptive Advertising

about your deceptive advertising, since I am doing the same thing and do not want to ruin things for myself. So, too, with exploitive advertising of unhealthy snack foods and violent video games, as well as the usual products associated with Internet spamming and spyware—namely financial scams and worthless software products. If there is a moral taint to the product itself, the company has already crossed a moral line and will likely lack moral convictions when advertising its prod- ucts. In these cases, then, competition will not create self-regulation.

Law enforcement through the FTC is the last line of defense against deceptive advertising, and when user reviews, consumer magazines, lawsuits, and self-regulation fail, the FTC must step in. When prosecuting deceptive advertising, the FTC can order the termination of deceptive adver- tisements; file civil lawsuits against companies, involving tens of millions of dollars in damages; and, in extreme cases, file criminal charges through the Department of Justice, which can involve prison time for company executives. This is what happened to the infomercial company ITV Direct, which advertised a nutritional product that it falsely claimed could prevent, treat, and cure cancer, heart disease, arthritis, and diabetes. The company was ordered to stop running the ads and to pay upwards of $50 million in restitution, and the company president faced up to 3 years in prison on criminal charges.

Corrective Advertising One controversial form of punishment used by the FTC is corrective advertising—requiring com- panies to publish notices that correct consumers’ mistaken impressions created by deceptive advertisements in the past. There are three objectives of corrective advertising:

• eliminating the lingering effects of deceptive advertisements, • helping return competition to the condition it was in before the deceptive ads influenced

the market, and • taking away from companies the profits they improperly acquired through their deceptive

ads.

The concept behind corrective advertising was first suggested in 1968 when the FTC charged the Campbell Soup Company with deceptive advertising. In its television ads, the company placed marbles in a bowl of soup to make it appear meatier. A group of concerned law students who were familiar with the case argued that merely requiring Campbell to remove the ads was not a sufficient remedy for the offense. They posited that the company needed to go further and cor- rect the false public impression created by the ads. Although the FTC did not require corrective advertising in this case, it accepted the principle behind the idea and has used it on occasion in the decades since.

The FTC specifically considers corrective advertising in cases where consumers are likely to con- tinue to buy a product based on erroneous beliefs. The following are some of the cases in which corrective advertising has been ordered:

• The STP company, manufacturers of the motor-oil treatment by the same name, made a series of unsubstantiated claims about the benefits of their oil-thickening additive.

• Warner-Lambert, makers of Listerine mouthwash, had a 51-year advertising campaign making the unsubstantiated claim that Listerine mouthwash was effective in treating colds and sore throats.

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CHAPTER 4Section 4.5 Targeting Vulnerable Groups

• Novartis, makers of Doan’s Pills, made the unsubstantiated claim that the product was more effective than other analgesics.

• Bayer, manufacturers of Yaz contraceptives, made the unsubstantiated claim that the product would improve women’s moods and clear up acne.

In each of these cases, the companies made claims they either did not or could not prove through sci- entific testing. Although the FTC only rarely orders corrective advertising as a form of punishment, it has been required enough times to serve as a deterrent for particularly egregious acts of deception.

4.5 Targeting Vulnerable Groups A normal marketing technique in business is to focus advertisements on customers who are most likely to buy one’s product. This is target marketing—namely breaking the market for one’s prod- uct into segments and then focusing marketing activities on one or a few major segments. The segmentation is commonly based on factors such as gender, age, education level, income, geo- graphical location, or lifestyle preferences. This in and of itself is morally unobjectionable and makes good business sense. If you sell sporting goods, you obviously want to focus your advertis- ing on people who have some interest in athletics.

Problems occur, however, when the targeted group has a vulnerability that compromises their con- sumer autonomy. Vulnerable groups include children, the elderly, the disabled, and the poor. For these people, their mental, physical, or economic conditions may make them easily susceptible to persuasive advertising and motivate them to buy products that can cause them harm. With at least some of these groups, target marketing can be done responsibly, especially when the product meets a genuine need—for example, marketing fiber supplements to the elderly. But it is the poten- tial harm from products that makes the targeting of vulnerable groups a problem. The elderly are prime targets for financial scams such as time-shares and living trusts. The poor are targets for quick credit and rent-to-own financial services, which frequently compound their economic problems.

Another prominent example is the marketing of malt liquor to inner-city Blacks, a group that has a disproportionally high level of alcohol-related health problems, including cirrhosis of the liver. Malt liquor is essentially beer with a higher alcohol content. However, for a drink to be legally called beer, its alcohol level cannot be above 5%; If it is, the drink must go by another designation, such as malt liquor, ale, or lager. Although malt liquor was initially aimed at the middle class, it has become especially popular among low-income groups, and particularly with inner-city popula- tions. Part of it is marketing. As one article stated:

Malt liquor brands . . . are used by the alcohol industry to connote power and machismo and lure youth and young adults into the market. Rap artists have been popular images in malt liquor advertising and “gangsta” rap performers portray malt liquor as a sign of masculinity. (Jones-Webb & McKee, 2008)

One particular malt liquor is closely associated with this controversy. In 1991, the G. Heileman Brew- ing Company launched a new product, Power Master malt liquor, which had an alcohol content of 5.9%, unusually high at the time. Its initial market was Chicago, and its advertisements featured rap singers, which created a firestorm of criticism that the company was targeting young inner-city Blacks. Concerned citizens, led by local Black clergy, publicly protested Heileman’s tactics. The U.S. surgeon

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CHAPTER 4Section 4.5 Targeting Vulnerable Groups

general stated that the company was socially irresponsible and, on a subconscious level, thought that their young Black consumers were “expendable” (Farhi, 1991). The U.S. Bureau of Alcohol, Tobacco, and Firearms then stepped in and announced that it was withdrawing approval of the product since the product violated a law prohibiting the promotion of a beer’s strength on its label. The very term Power Master, the bureau argued, did this. Heileman capitulated and discontinued the product because of the “economic burden a legal contest would entail” (Eichenwald, 1991).

Child Advertising

Another instance of companies targeting a vulnerable group is with child advertising—directing an advertisement toward either a young child under age 8 or an older child between ages 8 and 12. With young children, the basic advertising strategy is to first create a desire in a child for a particular product, and then have the child coax his or her parents into buying the product. The parents are essentially harassed into buying the product, and this violates their autonomy to make informed choices as consumers. But even when advertising is directed at older children, who may have allowances and know how to interact with cashiers, the problem remains that their decision- making abilities differ from those of adults. They lack a sense of time and do not understand basic finances, such as what it means for something to be too expensive. Further, developmental psy-

chologists often assist advertisers in illuminating how young minds work. For example, through them advertisers understand that chil- dren under 8 like to play dress-up and those 8 or over like to collect things. This enables advertisers to more carefully tailor their pitches to meet the desires of the children and thus exploit their weaknesses.

While several countries around the world have laws that regulate child advertising, the approach in the United States has been one of self- regulation. The principal guidelines have been set by the Children’s Advertising Review Unit (CARU), a branch of NARC. Their guidelines for child advertising include these:

• Advertising should not stimulate children’s unreasonable expectations about product quality or performance.

• Products and content inappropriate for children should not be advertised directly to them. • Advertisers are encouraged to capitalize on the potential of advertising to serve an educa-

tional role and influence positive personal qualities and behaviors in children, e.g., being honest and respectful of others, taking safety precautions, engaging in physical activity.

• Although there are many influences that affect a child’s personal and social development, it remains the prime responsibility of the parents to provide guidance for children. Adver- tisers should contribute to this parent-child relationship in a constructive manner. (Chil- dren’s Advertising Review Unit, 2009, p. 5)

Associated Press/Ted S. Warren

In this 2009 photo, consumer advocate Blair Anundson holds a popular Toy Story toy that he says is small enough to pose a choking hazard to young children.

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CHAPTER 4Section 4.5 Targeting Vulnerable Groups

The theme of these guidelines is that advertisers need to recognize that children are impression- able. An irresponsible ad can make children have unreasonable expectations about a product, whereas a responsible one can reinforce virtues and contribute to the parent–child relationship. Within these guidelines, though, there is great latitude, and several instances of child advertising have spawned public discussion.

With young children, there is the controversy over the inclusion of toys with kids’ meals at fast- food restaurants. The toys in these meals, critics argue, are extra incentives for children to desire them, but the meals themselves are typically high in salt, sugar, fat, and calories and contribute to childhood obesity. San Francisco and a neighboring county have taken the bold step of banning kids’-meal toys, and restaurants that violate the ordinance face stiff fines.

A controversy with older children is that involving direct advertis- ing in public schools. For decades, older schoolchildren have been exposed to national-brand prod- ucts and corporate logos in school newspaper ads and on athletic scoreboards and textbook covers. Added to that now is Channel One News, a 12-minute current-events program for teens that is broadcast to over one third of the middle and high schools in the United States. The news shows carry 2 minutes of commercials. In all of these cases of advertising in schools, advertisers benefit by having an opportunity to instill brand loyalty in consum- ers at early ages. The schools ben- efit from the income or equipment they receive through the ad spon- sorship. The larger question, how- ever, is how the students benefit. Many of the ads are for food products, such as fast foods, soft drinks, chips, and candy, which, again, touches on the issue of childhood obesity. A documentary film on this subject described the recent surge in classroom advertising and its impact on children (Jhally, 2003). One expert in the film stated that “children are being described as objects, whose primary purpose is to be manipu- lated for some benefit to an adult.” Another said that “the values and goals of education are very different than the values and goals of advertising.”

With all of these cases of child advertising, the critical issue is whether the ad seriously under- mines the child’s autonomy. In some cases, there may be room for debate. Concerning toys in kids’ meals, some parents in the California case have protested that the ban on kids’-meal toys compromises their autonomy as parents. They prefer to have the opportunity to buy the meals with toys, and in any event, parents always have the option to tell the cashier to leave the toy out. With direct advertising in public schools, a critical question is whether those ads have an added brainwashing effect on the children, or whether they are simply part of the modern marketing landscape that children have already become used to, and to at least some degree already phase

Associated Press/Eric Risberg

San Francisco and a neighboring county banned free kids’-meal toys in various parts of the county. However, McDonald’s res- taurants in San Francisco have been able to skirt the law by charging 10 cents for the toys that come with Happy Meals. The company says the money paid for the toys will go toward Ron- ald McDonald House Charities (Conley, 2011).

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CHAPTER 4Section 4.6 Unfair Sales Tactics

out. If it’s the latter, then cluttering the school with advertisements may be more an issue of aesthetics and interior decorating than one of autonomy. It is unreasonable to ban ads in school simply because they are ugly.

4.6 Unfair Sales Tactics Businesses use an array of sales strategies that effectively motivate consumers to buy products— free samples, discount coupons, promotional items, rebates, closeouts. Many of these are per- fectly acceptable. Others, though, can be unfair and predatory. We will look at some that are particularly infamous.

Perhaps the most well-known example of an unfair sales tactic is the bait and switch: Customers are attracted into a store to buy an artificially low-priced product and then are persuaded to buy a more expen- sive one. This practice is prohibited by the FTC, which states, “No advertisement containing an offer to sell a product should be published when the offer is not a bona fide effort to sell the advertised product” (n.d.).

Bait-and-switch tactics should not be confused with other sales techniques that are acceptable, particularly loss-leader strategies, where a product is sold below cost to generate customer traffic but no pressure is put on the customer to buy anything else. As examples, two separate lawsuits were filed against Dell accusing them of bait-and-switch tactics. According to a 2005 lawsuit in California, Dell allegedly advertised low-priced com- puters, but when some buyers tried to purchase them at the advertised price, they found that the computers were no longer available for that price. Dell had substi- tuted them for either a more expensive computer or one of lesser quality. According to the complaint,

Dell baits consumers with advertisements for computers and computer products at rock-bottom prices. Then, when the con- sumer contacts Dell to purchase a Dell product via the internet or telephone, Dell makes the switch, substituting lesser qual- ity components, increasing the purchase price without notice, canceling orders Dell is unwilling to honor, or steering the unso- phisticated consumers to other higher priced computer systems which Dell wants to unload, based on inventory con- trol considerations. (Weber v. Dell, 2005)

What Would You Do?

You are a floor salesperson at a major consumer-electronics store, and you receive commission on your sales. Your company has advertised an inex- pensive laptop for $300, and you have plenty in the stockroom, but none on the display shelf. A customer comes in asking for one.

1. Do you get one right away, or point out some of the higher priced ones first?

2. Do you point out all the disadvan- tages of the inexpensive one, mak- ing it seem virtually worthless?

3. Suppose that the customer says the computer is really just for check- ing e-mail from the grandchildren and playing computer solitaire. You know that the inexpensive one will serve the customer’s needs per- fectly. Do you still redirect the cus- tomer to more expensive ones with features that will never be used?

4. Your manager advises you that when a customer asks for the inexpensive computer, you should vaguely say, “We don’t have any on display right now.” Although the statement is technically true, it will make the customer think there are none left in the store. Do you follow your manager’s direction?

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CHAPTER 4Section 4.6 Unfair Sales Tactics

In a 2008 New York lawsuit, Dell’s financing operation was accused of luring customers with adver- tised “no interest” or “no payment” financing, while, according to the complaint, the vast majority of consumers, even those with very good credit scores, were denied these deals.

Another infamous sales tactic is loan packing, which occurs when loans for a product include charges for additional items—or “add-ons”—that are concealed from the consumer. Common examples of this are automobile loans that might be packed with extra charges for loan insurance, extended warranties, window tinting, fabric protection, and rustproofing. The costs for these extra items are added onto the cost of the car and included in the loan without telling the customer. Typically, the car dealer first quotes the customer an inflated monthly loan payment, and when the customer agrees to that amount, the dealer adds the extra items to the loan contract. All the while, the buyer assumes that the extra items are free bonuses included with the car purchase rather than options that cost extra. California—a leader in consumer protection—passed a law called the Car Buyer’s Bill of Rights that, among other protections, prohibits loan packing. The law includes a requirement for dealers to itemize in the sales contract any add-ons, to let buyers decide whether they want to buy them.

Misuse of Legal Tactics

Bait and switch and loan packing are both inherently unfair sales tactics, and there are laws against them. There are other types of sales techniques, however, which are not wrong in themselves but have led to abuse in the marketplace.

Sales Commissions One misused sales technique is the sales commission—paying employees an amount of money based on their level of sales. Sometimes the commission supplements fixed wages and salary; other times the commission is the sole financial compensation for the employee. In either case, the basic formula for commission compensation is simple: The more the employee sells, the more he or she gets. The rationale is that it motivates employees to perform at their best. At the same time, however, this can put pressure on salespeople to make sales by deceiving customers, using scare tactics, exaggerating the benefits of the product, and exploiting weaknesses in customers.

This is especially prevalent in areas where consumers are at the mercy of the salespeople for their expertise. A classic case of this was Sears, which in 1992 was charged with systematically defraud- ing customers at its auto centers by performing unnecessary service and repairs. Sales goals were set, and repair people were paid commissions that encouraged phony diagnoses. Sears initially denied the charges and argued that replacing good parts before they fail was simple preventive maintenance and a common practice in the industry. Later, however, it accepted responsibility and restructured its automotive division, eliminating the commissions. It agreed to a settlement of $8 million and to make restitution to nearly 1,000,000 customers in the United States.

Direct-to-Consumer Advertising Another misused sales tactic is direct-to-consumer advertising, a form of advertising, used principally by pharmaceutical companies, where patients are targeted rather than health-care

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CHAPTER 4Section 4.6 Unfair Sales Tactics

professionals. Companies began the practice in 1982. The FDA is responsible for overseeing this type of advertising and has a series of conditions that must be met:

• The ad must make clear that “only a prescribing healthcare professional can decide whether the product is appropriate for a patient.”

• It must also present “a fair balance between information about effectiveness and informa- tion about risk”; and while it does not need to list all of the drug’s risks, it must present “the product’s most important risk information in consumer-friendly language.”

• Finally, it must make provisions for consumers to access the full label of the drug through the Internet, by mail, or by phone (U.S. Department of Health and Human Services, Food and Drug Administration, 1999).

In spite of these safeguards, direct-to-consumer advertising is controversial. A common complaint is that physicians feel pressured by patients into prescribing a drug they might not otherwise have recommended. One study showed that direct-to-consumer advertising does indeed influ- ence what physicians recommend: A 10% increase in direct-to-consumer advertising for a drug results in a 1% increase in sales within that specific drug class (Henry J. Kaiser Family Foundation, 2003, p. 1).

There is also controversy about using direct-to-consumer advertising for drugs that have a high potential for abuse. The policy has been for the pharmaceutical industry itself to voluntarily refrain from this type of advertising. However, in 2001 the U.S. Drug Enforcement Administration (DEA) issued a letter of complaint to a pharmaceutical company for its direct-to-consumer magazine ads of a psychostimulant drug, methylphenidate, which the DEA classifies as a Schedule II con- trolled substance. In the letter, the DEA stated that direct-to-consumer advertising of controlled substances “is contrary to the spirit of the [Controlled Substances Act] and contrary to the public health and safety” (U.S. Department of Justice, Drug Enforcement Administration, 2001). Such advertising, it argued, is problematic “because of the inability of patients to understand medical information and make a rational, informed choice of medication from an array of drugs making similar claims.” The DEA was further concerned about “the messages conveyed to our youth” through such advertising.

Default Opt-In A final example of a misused sales tactic is the default opt-in. This is a feature of contracts where the customer is automatically enrolled in some unnecessary and costly secondary service, typi- cally without knowing about it. In the past, banks routinely used default opt-in to enroll customers in credit-card overcharge protection and debit-card overdraft protection services. Suppose, for example, that your credit card has a $1,000 limit, and you are at $998. You go to a restaurant and buy a cup of coffee for $3 with your card. You might expect your card to be rejected, since you are now overcharged by $1. However, your credit-card company would allow the purchase to go through since you have “overcharge protection,” but they would charge you a fee of up to $40. Your $3 cup of coffee has in essence cost you $43. You were not asked if you wanted the over- charge service; the credit-card contract had you opt in by default.

Why would you ever want such a service that is so costly to you? The explanation that banks and credit-card companies give is that it is a service to consumers that saves them the embarrass- ment of having their credit cards rejected at the checkout counter. However, the economic truth behind these default opt-in policies on credit and debit cards was that it was a major source of

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CHAPTER 4Section 4.7 Conclusion

revenue—an estimated $37 billion per year for banks through debit-card overdraft fees. As public outrage against these practices grew, Congress passed laws against them, and since July of 2010, the default enrollment policy has been “opt-out.” Consumers can still get overdraft protection, but they have to request it.

4.7 Conclusion At the outset of this chapter we made note of the famed expression “let the buyer beware” and its contemptuous message that consumers always need to be on guard against abusive business practices. There is, however, a counterpart to this expression, namely “let the seller beware.” The message here is that businesses need to be on guard against consumer retaliation for abusive practices. Whether for subpar product safety, deceptive advertising, targeting vulnerable groups, or predatory sales tactics, businesses may pay a hefty price. None of this should come as a surprise to businesses. We’ve seen that the Consumer Product Safety Commission has clear guidelines about dangerous products, and the Federal Trade Commission about deceptive advertising. The National Advertising Review Council and its various self-regulatory branches also have clear prin- ciples of responsible advertising. Added to that are the ethical codes of professional businesses associations. The American Marketing Association, for example, has a code of ethics that includes six fundamental ethical values for marketers:

1. Honesty, which includes offering “products of value that do what we claim in our communications.”

2. Responsibility, which includes recognizing “our special commitments to vulnerable mar- ket segments such as children, seniors, the economically impoverished, market illiterates and others who may be substantially disadvantaged.”

3. Fairness, which includes avoiding “false, misleading and deceptive promotion,” and rejecting “manipulations and sales tactics that harm customer trust.”

4. Respect, which includes avoiding “stereotyping customers or depicting demographic groups (e.g., gender, race, sexual orientation) in a negative or dehumanizing way.”

5. Transparency, which includes disclosing “list prices and terms of financing as well as available price deals and adjustments.”

6. Citizenship, which includes protecting the environment, making charitable donations, and ensuring fairness for “producers in developing countries.” (American Marketing Association, n.d.)

We see in this list references to many of the abuses described in this chapter—deceptive advertis- ing, unfair sales tactics, and targeting vulnerable groups. Similar principles are espoused by the Organization for Economic Co-operation and Development (OECD), an international group that advises governments on business issues. A section of their Guidelines for Multinational Enterprises is devoted specifically to serving consumer interests, including recommendations that businesses:

1. Ensure that the goods or services they provide meet all agreed or legally required standards for consumer health and safety, including health warnings and product safety and information labels.

2. As appropriate to the goods or services, provide accurate and clear informa- tion regarding their content, safe use, maintenance, storage, and disposal suf- ficient to enable consumers to make informed decisions.

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CHAPTER 4Summary

3. Provide transparent and effective procedures that address consumer com- plaints and contribute to fair and timely resolution of consumer disputes without undue cost or burden.

4. Not make representations or omissions, nor engage in any other practices, that are deceptive, misleading, fraudulent, or unfair.

5. Respect consumer privacy and provide protection for personal data. 6. Co-operate fully and in a transparent manner with public authorities in the

prevention or removal of serious threats to public health and safety deriving from the consumption or use of their products. (Organization for Economic Co-operation and Development, 2008, p. 22)

Added to all of these laws, regulations, and guidelines are codes of ethics and best practices that individual companies devise for themselves. The bottom line: Businesses that engage in abusive consumer practices cannot plead ignorance. If their own consciences will not tell them what is expected of them, countless agencies and organizations have already broadcast loud and clear what consumers expect in a fair marketplace.

Summary At the outset of this chapter, we introduced the concept of consumer advocacy, which is an organized effort to protect consumers against dangerous products, unfair pricing, deceptive advertising, and manipulative sales practices. In the United States, consumer advocacy took hold in the first decades of the 20th century with the creation of the Pure Food and Drug Act, the Federal Trade Commis- sion, the Food and Drug Administration, and Consumers Union. A major concern for consumers is product safety, which to a large degree is monitored by the Consumer Product Safety Commis- sion (CPSC). The CPSC oversees consumer-product recalls and runs the Web site SaferProducts.gov, where consumers can lodge complaints. Automobiles, since their inception, have presented safety concerns; the cases of the Chevrolet Corvair and Ford Pinto illustrate automobile manufacturers’ resistance to safety improvements that carve into company profits.

Another area of concern for consumers is deceptive advertising, which intentionally misleads or confuses consumers. Though not, strictly speaking, deceptive, puffery involves exaggerated claims in advertising that no reasonable person would take as factual and that are too vague to be provable. The puffery legal defense is a tactic used by companies when they are charged with false advertising, where they claim to be only engaging in puffery. Unofficially, companies can be punished for deceptive advertising by consumers, journalists, and consumer-advocacy groups by bringing offenses to public attention. Officially, companies can be punished for deceptive adver- tising with criminal prosecution, lawsuits, and correction by a self-regulated advertising organi- zation, particularly the National Advertising Review Council (NARC). Corrective advertising is a punishment that requires companies to publish notices that correct consumers’ mistaken impres- sions created by deceptive advertisements in the past.

Advertising can also run afoul of consumer-protection interests when it targets vulnerable groups, as occurred with the marketing of Power Master malt liquor to inner-city youth. Child advertising is a sensitive subject; it can manipulate young children into nagging their parents, and with older children it takes advantage of their undeveloped decision-making abilities. Some sales tactics are outright illegal, such as the bait and switch, where customers are attracted into a store to buy an

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CHAPTER 4Summary

artificially low-priced product and then are persuaded to buy a more expensive one. So too with loan packing, which involves loans for a product that include hidden charges for additional items. Some legal sales tactics can be abused, such as sales commissions, direct-to-consumer advertis- ing, and default opt-in policies.

Discussion Questions

1. Consumer autonomy is the notion that consumers should be in charge of determining what to purchase after being supplied with relevant information. Consider, though, how much information any of us can truly have with most of our purchases. We do not fully know how the products are made, how long they will last, or whether they have hidden harms. Pick an example, such as a food product or an electronic device, and discuss the kind of information that you would need in order to have a reasonable amount of con- sumer autonomy.

2. A major political controversy involves the degree to which the government should regulate business activities. The conservative position is that governments should leave businesses to regulate themselves, whereas the liberal position is that government regu- lation is needed to force businesses to act responsibly. Consider all the laws and govern- ment agencies discussed in this chapter that are devoted to protecting consumers from unethical business practices. Is there too much government involvement with consumer advocacy? Explain why or why not.

3. A critical point of distinction between deceptive advertising and mere puffery is whether a claim is a measurable statement of fact. Think of some examples of each and explain why they are or are not measurable statements of fact.

4. Kids’-meal toys at fast-food restaurants are a major marketing draw for families with young children. Santa Clara County in California banned such toys, suggesting that it is a case of targeting a vulnerable group. Do you agree? Explain.

5. Explain the difference between bait-and-switch and loss-leader marketing tactics, using examples of each.

Key Terms

bait and switch An illegal sales strategy where customers are attracted into a store to buy an artificially low-priced product and then are persuaded to buy a more expensive one.

child advertising The marketing strategy of directing an advertisement toward either a young child under age 8 or an older child between ages 8 and 12.

consumer advocacy An organized effort to protect consumers against dangerous prod- ucts, unfair pricing, deceptive advertising, and manipulative sales practices.

consumer autonomy The notion that consum- ers should be in charge of determining what to purchase after being supplied with relevant information.

Consumer Bill of Rights Four consumer rights articulated in a 1962 speech by President John F. Kennedy: (1) the right to safety, (2) the right to be informed, (3) the right to choose, and (4) the right to be heard.

Consumer Product Safety Commission (CPSC) U.S. federal agency founded in 1972 for the purpose of protecting the public “against unreasonable risks of injuries and deaths

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CHAPTER 4Summary

associated with consumer products.”

Consumers Union Nonprofit consumer-advo- cacy organization founded in 1936, publisher of Consumer Reports magazine.

corrective advertising A punishment that requires companies to publish notices that cor- rect consumers’ mistaken impressions created by deceptive advertisements in the past.

deceptive advertising Advertising that inten- tionally misleads or confuses consumers.

default opt-in A feature of sales contracts where the customer is automatically enrolled in some unnecessary and costly secondary service, typically without knowing about it.

direct-to-consumer advertising An advertis- ing strategy, used especially by pharmaceutical companies, where patients are targeted rather than health-care professionals.

Federal Trade Commission (FTC) U.S. Federal agency established in 1914 to prevent busi- nesses “from using unfair methods of compe- tition in commerce” and to “protect consum- ers against unfair, deceptive, or fraudulent practices.”

Food and Drug Administration (FDA) U.S. federal agency formed in 1927 for the purpose of carrying out the tasks specified in the Pure Food and Drug Act of 1906.

Guidelines for Consumer Protection Guide- lines established by the United Nations in

1985, which include seven fundamental con- sumer needs that require protection.

loan packing A sales strategy in which loans for a product include charges for additional items—or “add-ons”—that are concealed from the consumer.

loss leader A product that is sold below cost to generate customer traffic, with no pressure put on the customer to buy anything else.

puffery Exaggerated claims in advertising.

puffery legal defense A legal strategy where, when charged with false advertising, a com- pany claims that it was only engaging in puffery.

Pure Food and Drug Act of 1906 U.S. law that aimed to prevent “the manufacture, sale, or transportation of adulterated or misbranded or poisonous or deleterious foods, drugs, medicines, and liquors.”

SaferProducts.gov Web site run by the U.S. Consumer Product Safety Commission where consumers can report unsafe products.

self-regulated advertising The practice in which the advertising industry monitors and corrects false advertising by itself, without reli- ance on government agencies and courts.

target marketing The marketing strategy of breaking the market for one’s product into seg- ments and then focusing marketing activities on one or a few major segments.

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Discrimination in the Workplace

Learning Objectives

After completing this chapter, you should be able to:

• Define the various types of discrimination. • Explain the notions of affirmative action, equal opportunity, preferential treatment, individual and group compensation, and reverse discrimination.

• Explain the different arguments for and against affirmative action. • Describe the different U.S. affirmative action laws and procedures. • Describe the major Supreme Court decisions that have clarified affirmative action laws.

Royalty-free

5

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CHAPTER 5Section 5.1 Introduction

Contents

5.1 Introduction

5.2 Discrimination

Features of Discrimination Social Institutions and Discrimination Types of Discrimination Evidence of Discrimination

5.3 Affirmative Action

Features of Affirmative Action Arguments for Affirmative Action Arguments Against Affirmative Action

5.4 Affirmative Action in U.S. Law

Two Laws and Two Governmental Agencies Compliance Guidelines and Plans Supreme Court Cases

5.5 Conclusion

5.1 Introduction Racial prejudice has been the source of social conflict and personal suffering for as long as there have been human records, and quite possibly for tens of thousands of years before that. Rival ethnic groups wage war upon each other, enslave members of opposing groups, and even try to exterminate them. The concept of racial equality is a comparatively recent one, and it has only been a matter of decades that governments have denounced racial prejudice and made efforts to undo at least some of the damage it has caused.

India is a case in point, with its centuries-old tradition of the caste system, which has splintered the population into a hierarchy of social classes. While the higher castes have been the holders of the country’s wealth and power, at the very bottom are the “untouchables” who are so low that, in the past, upper castes avoided coming into any contact with them. Making up 16% of the coun- try’s population, they historically had no meaningful access to education, respectable employ- ment, or political representation. Millions today live on the streets or in garbage dumps, where they forage for scraps of anything that might have some resale value. While India was a colony, the British government made efforts to elevate the untouchables into mainstream society, one of the first efforts at what we now call affirmative action. After independence in 1947, the government of India continued this policy, even writing into the constitution special protections and opportu- nities for the untouchables. Among these policies is the reservation of 16% of all government jobs for untouchables, in direct proportion to their number in the population. A high percentage of student positions in universities are also reserved for them.

When we look at India’s situation, it is easy to conclude that the country chose the right remedy: Dramatic injustices call for dramatic corrective measures, without which the untouchables would be forever locked into a cycle of the most unimaginable poverty. It is not just India, however, that has

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CHAPTER 5Section 5.2 Discrimination

this problem. Many of the world’s countries have minority groups that are economically suffering because of a history of discrimination. The United States is a case in point. This country has adopted solutions like India’s, though not quite as radical. Businesses in particular are on the cutting edge of social reforms that aim to elevate historically disadvan- taged minority groups. Sometimes companies proactively embrace these efforts, but in most cases, the efforts are backed by government mandates and businesses have no choice but to comply. Discrimina- tion in the workplace is one of the most important ethical and legal issues for businesses. Social con- science urges companies to elimi-

nate discriminatory employment practices, and the law requires them to do so. In this chapter, we will explore many of the issues connected with discrimination in the workplace.

5.2 Discrimination We will begin with a look at the nature of discrimination itself, how it affects businesses and other social institutions, and the evidence for it.

Features of Discrimination

Take this simple case of discrimination: A man and a woman both apply for the same job; the woman’s qualifications are much stronger, but the employer hires the man instead. In essence, the woman was turned down purely because of her gender, and not because of her abilities. Discrimi- nation is the unjust or prejudicial treatment of people on arbitrary grounds, such as race, gender, or age, which results in denial of opportunity, such as in business employment or promotion.

Key to this definition is the idea that the treatment is based on arbitrary grounds. A person’s gender or skin color is irrelevant to his or her job performance as, for example, an accountant, and it would be arbitrary to deny that person an employment opportunity on that basis. Sometimes, though, it is not discriminatory to deny opportunities to people because of some unique feature about them. Suppose that a blind person applied for a job as an air-traffic controller and was turned down for the specific reason of blindness. In this case, having eyesight is a necessary requirement for doing that job, and there is nothing arbitrary about denying that opportunity to blind people.

However, it can be a challenge sometimes to determine whether a particular physical feature is needed to do the job. An interesting case illustrating this is that of a 240-pound woman from San Francisco who was denied work as an aerobics instructor because of her weight. The company

Associated Press/Saurabh Das

This 2011 photo shows an Indian “untouchable” who has pros- pered despite the odds. Hari Kishan Pippal now owns a hospi- tal, a Honda dealership, and a shoe factory (Sullivan, 2011).

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CHAPTER 5Section 5.2 Discrimination

in question was Jazzercise, which advertised itself as the world’s leading dance-fitness program, having 5,000 certified instructors across the country. The company’s stated policy was that their instructors must have a “fit appearance,” and they turned down the woman when seeing her in person. After she complained to the San Francisco Human Rights Commission, the Jazzercise com- pany agreed to drop the “fit appearance” criterion and conceded that “recent studies document that it may be possible for people of varying weights to be fit” (quoted in Ackman, 2002). This case shows that long-standing stereotypes may be grounded in little more than prejudice, and this is precisely what makes discriminatory treatment unfair.

The most commonly acknowledged forms of discrimination today are on the bases of:

• race, • gender, • disability, and • age.

Still others include color, creed, political affiliation, national origin, religion, ancestry, pregnancy, medical condition, mental condition, marital status, sexual orientation, and status as a veteran. The list of discrimination types could be endless: I could discriminate against people who were fans of a rival sports team, or liked a particular type of music, or drove a particular model of car. Whatever differences exist between one human and another could potentially become matters of prejudice.

Social Institutions and Discrimination

In combating discrimination, there are three principal social institutions that are targeted for change: schools, businesses, and governments.

Eliminating discrimination in schools is important because these institutions provide people with the skills to compete for almost everything else in life. If schools at both the K–12 and college levels systematically discriminated against certain groups, those individuals would forever be at a competitive disadvantage and locked into something like a caste system which it would be exceed- ingly difficult to rise above.

Eliminating discrimination in the workplace is important because it is the quality of jobs that determines whether an employee becomes rich or poor. When employers systematically discrimi- nate against certain groups, they thereby turn those groups into a socioeconomic underclass from which, again, it is difficult to break free.

Finally, eliminating discrimination in positions of political power is important because it is the government that shapes social policy regarding the equal treatment of groups. Without proper representation in government, the risk is too great that the interests of White males will prevail over those of other groups.

Types of Discrimination

The type of discrimination that is most relevant to businesses is called employment discrimi- nation and involves the prejudicial treatment of people in hiring, promotion, and termination

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CHAPTER 5Section 5.2 Discrimination

decisions. In the past, employment discrimination was an integral and acceptable part of doing business; that was a reflection of the prevailing social order. Women and ethnic minorities, it was felt, belonged only in specific jobs, typically lower paying ones, and it was just assumed that the better jobs should go to White males. Not so now. The law protects women and minority groups from employment discrimination, and it is a serious blemish on a business’s moral record to be accused of discriminatory practices. Still, some employment discrimination continues today in spite of changing laws and social attitudes.

Sometimes businesses engage in intentional discrimination, when the policies of a company are shaped by overt racial prejudices of its managers or executives. For example, a family restau- rant in a racially divided town had a policy of placing a small letter B on the back of application forms filled out by black applicants. They would then overlook these applications when selecting candidates to interview. The business managers were knowingly and intentionally discriminating against black applicants. Other times, however, businesses engage in unintentional discrimina- tion, when their policies uncritically reflect prejudicial stereotypes. The Jazzercise example from before appears to be of this sort, in that the company wrongly assumed that only people within a certain weight range were athletically fit.

Evidence of Discrimination

When looking for evidence of discrimination within the business world, there are two types: direct and indirect. Direct evidence of discrimination is overt written or oral statements by employers that display their discriminatory intention. The story of the application forms with the small B on the back would be an example. Finding direct evidence, though, is difficult, since employers rarely make explicit discriminatory statements such as “our policy is to not hire black people” either in writing or verbally. It is more likely that there will be indirect evidence of discrimination, where the behavior of the company implies discriminatory conduct. Examples might be withholding training or promotion opportunities from a minority worker that majority workers instead receive.

One strategy for presenting indirect evidence of discrimination in court is called the burden-shift- ing formula, where the burden rests on the employer to show that its behavior was not discrimi- natory (McDonnell Douglas Corp v. Green, 1973). The formula has three steps:

1. The employee makes an initial case that she was treated differently, such as that she was overlooked for promotion because she was female.

2. The employer gives a nondiscriminatory explanation for its conduct, such as that the woman lacked seniority and thus was not qualified for promotion.

3. The employee refutes this explanation as a mere pretext for discrimination, such as by showing that less experienced males in the company had gotten promotions.

The evidence here is still indirect, since there is no explicit statement from the company to the effect of “we did not promote you because you are a woman.” However, through the undermining of the company’s nondiscriminatory explanation, it seems more reasonable that the company’s differential treatment was discriminatory in nature.

There is another type of indirect evidence that suggests the discriminatory treating of minorities within society as a whole, namely income inequality, which involves an analysis of the extent to which income is distributed in an uneven manner among a population. Some income-inequality

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CHAPTER 5Section 5.2 Discrimination

studies focus specifically on race and gender disparities, and much of those data in the United States come from the Census Bureau. The statistics show that race and gender income differences have decreased since 1953, but a sizeable income gap still remains between minority workers and White males, as Figure 5.1 reveals. The statistics themselves show only that major income disparities exist between White males and minority workers. But to use this as evidence for dis- crimination, a person must further show that these differences cannot be reasonably explained by nondiscriminatory factors.

With gender, there are a few possible nondiscriminatory reasons. It is often suggested that women gravitate towards careers that pay lower than those of men, such as education, counseling, and nursing. It is also argued that many women place less value on jobs with long work hours and more value on a flexible schedule that allows for family commitments. In the words of one ana- lyst, “women are less willing to work long hours and relocate, and more eager for part-time work arrangements” (Women in Management, 2002). These explanations are controversial, and perhaps even grounded in stereotypes. However, they suggest that women’s choices may be a source of gender income disparities and, if so, the income-inequality argument for discrimination falls apart.

With racial income inequality, there is also a possible nondiscriminatory explanation: Black and Hispanic people have less access to education, which in turn makes them less competitive for lucrative jobs. Thus, their lower pay may be not the result of employment discrimination, but instead an unfortunate consequence of their sociological background. The educational obstacle is less of a barrier for White women, who first surpassed White men in college enrollment in 1991; since then, the gap has continued to widen (Mather & Adams, 2007).

Pay gaps that begin at the initial acquisition of jobs often continue with promotions within the com- pany. This sometimes leads to a phenomenon called the glass ceiling, where women and minority

Figure 5.1: The U.S. Income Gap, 2009

Source: U.S. Census Bureau. (2009). Historical income tables. Tables P-5 and P-38. Retrieved from http://www.census.gov//hhes/www/ income/data/historical/people/

White male, not Hispanic

White female, not Hispanic

Asian Male

Asian Female

Black Male

Black Female

Hispanic Male

Hispanic Female

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

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CHAPTER 5Section 5.3 Affirmative Action

workers hit a level beyond which they cannot advance, while their White male counterparts continue to prog- ress. In the words of one governmental investigation, it is “the unseen, yet unbreachable barrier that keeps minorities and women from rising to the upper rungs of the corporate ladder, regardless of their qualifica- tions or achievements” (Federal Glass Ceiling Commis- sion, 1995).

The image of a glass ceiling is a telling one: It suggests that as women and minorities compete with others to climb the ladder of success, they bump into a barrier that keeps them from rising higher, while they can see their White male counterparts continue to rise above them. For example, Outback Steakhouse settled a $19 million class-action lawsuit by female employees who maintained that they “hit a glass ceiling and could not get promoted to the higher-level profit-sharing management positions in the restaurants” (Equal Employment Opportunity Commission, 2009). But this concept of the glass ceiling is also controversial, and with gender-based glass ceilings the argument has been put forward that many obstacles to women’s promotion result from personal choices, such as the desire for part-time working arrangements. As one analyst stated, “the only ceiling that exists in corpo- rate America is gender-neutral—it prevents those who choose to devote more time to their personal lives from advancing at the same rate as those who devote more uninterrupted time to the workplace” (Women in Management, 2002).

In short, income-inequality statistics and the phenomenon of the glass ceiling demonstrate that serious pay gaps exist. However, that in and of itself does not constitute compelling indirect evi- dence of systematic employment discrimination. It still may be important to attempt to eliminate the pay gap even if it cannot be demonstrated to result from current discriminatory employment practices. The pay gap that exists still has historical roots in past discrimination, and that alone may justify remedying the inequality.

5.3 Affirmative Action There is no doubt that employment discrimination has taken place in the past and continues today to at least some extent. The question, then, becomes one of finding the best means of combat- ing it. The gentlest public policy for uprooting discrimination in organizations is equal opportu- nity, which is simply the policy of treating employees without discrimination. It involves neutral, nondiscriminatory hiring practices. The hope is that, through the simple removal of discrimina- tory barriers, historically disadvantaged groups may finally be able to compete head-to-head with White males and thereby eventually remove all racial and gender economic disparities. By today’s standards, there is nothing controversial about this neutral, nondiscriminatory notion of equal opportunity, and perhaps only a committed bigot would oppose it.

Associated Press/Charles Dharapak

President Barack Obama signs the Lilly Led- better Fair Pay Act in 2009 with Lily Ledbet- ter (right).

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A much more aggressive mechanism for combating discrimination is affirmative action, which is a policy of improving the opportunities of those within historically disadvantaged groups through positive measures beyond neutral, nondiscriminatory action. We will next look at key features of affirmative action policies and at arguments for and against them.

Features of Affirmative Action

The principal aim of affirmative action policies in the workplace is to increase the representa- tion of women and minority groups in areas of business from which they have been historically excluded. Some of these positive measures include

• active recruiting of minority workers, • elimination of biases in job criteria, • minority training programs for senior positions, and • active promotion of minority workers to senior positions.

The aim of affirmative action is sometimes described as equal results, meaning achieving propor- tional minority representation in a work or economic environment where minorities are presently underrepresented. For example, if 2% of the White male population is wealthy, then 2% of the population of women and minorities should be wealthy. In this sense, affirmative action seeks to achieve an outcome in which women and minorities are proportionally represented in positions of wealth and power. One government agency provides testimonials of employees who have ben- efited from affirmative action programs; here are two:

• Bernadette, of Washington, D.C., works as a carpenter because of a fed- eral affirmative action program. She is an African-American single parent with two children, who says “because the company had an affirmative action program, I got on the job site.”

• Janice became an astronaut with NASA at the Johnson Space Center in July 1991, because of NASA’s affirmative action program. She has since logged over 438 hours in space. She describes the NASA equal employ- ment opportunity policy: “Under NASA’s developing equal opportunity and diversity policies, all hiring and advancement decisions are based on individual qualifications and merit, but recruitment and development programs are structured such that high-quality candidates are available to help achieve a representative workforce.” (Office of Federal Contract Compliance Programs, 2002, Section D.iii)

The point in both of these testimonials is that affirmative action programs through their employ- ers gave these women work opportunities that they would not likely have received otherwise. Affirmative action policies are typically seen as temporary measures to fix problems that exist right now; when equality is achieved, they will no longer be necessary.

Preferential Treatment The most controversial component of affirmative action is preferential treatment, that is, special consideration given in hiring and promotion situations to people from historically disadvantaged groups. Suppose, for example, that a White man and a Black man are applying for the same job,

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and, although their credentials are similar, the White man has more educational experience. Thus, on paper, the White man is the stronger candidate. Since the Black man is a member of a histori- cally underrepresented group, preferential-treatment policies would make him the preferred can- didate over the White man. Sometimes preferential treatment involves a quota system, where a certain number of jobs are set aside for members of minority groups in direct proportion to their numbers in the community. The notions of affirmative action and preferential treatment are often used interchangeably, but they are not identical: Preferential treatment is just one type of affir- mative action policy, and is not necessarily the central component. As one governmental agency stated, “Affirmative action is not preferential treatment. Nor does it mean that unqualified persons should be hired or promoted over other people. What affirmative action does mean is that posi- tive steps must be taken to provide equal employment opportunity” (EEOC, 1993). Nevertheless, preferential treatment has become the focal point for debates about affirmative action policies.

Compensation for Discrimination The strategy of affirmative action programs is group oriented in the sense that every individual who belongs to a designated group will thereby qualify for some special consideration. To explain, there are two ways that we might compensate minority groups for their historical disadvantages:

• There might be individual compensation, where each person is compensated based on his or her individual claim. For example, a Black man might argue that he was discrimi- nated against when he was overlooked for a promotion at his job. He could then sue his company and present his case in court; if he succeeded, his company would then compen- sate him individually. Scenarios like this in fact occur regularly.

• Alternatively, there might be group compensation, where each individual within a disadvan- taged group is compensated based purely on his or her membership in that group. This is the approach that the government takes with affirmative action policy. It identifies a group that has been historically disadvantaged and addresses the situation by compensating each

person within that group.

The benefit of group compensation is that it avoids the impossible task of examining the claims of each person individually within that group. For example, with group compensation, a Black woman would not have to show how she had been personally disadvantaged through the legacy of slavery, Jim Crow laws, and racial prejudice. Those facts have already been established for her minority group as a whole, so she would not have to make her case individually.

There are downsides to group com- pensation, however, which is the source of some of the controversy with affirmative action policies:

Copyright Bettmann/Corbis/AP Images/Ken Yimm

Diane Joyce was a dispatcher in Santa Clara County who won in a Supreme Court case on affirmative action in 1987. The Court upheld her employer’s right to give Joyce a promotion over a male applicant.

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• Some individual members of a minority group may be less deserving of compensation than other individual members but receive the benefit anyway. Take, for example, a Black man who was raised in an affluent family and never personally experienced any prejudice or discrimination. He would still be entitled to the same special consideration as a Black man who has personally experienced discrimination.

• Some members of majority groups may be as deserving of special consideration as mem- bers of a minority group are, yet will not qualify to receive it. Take, for example, a White man whose family has been caught up in a cycle of poverty for generations and who experiences the same socioeconomic disadvantages as a poor Black man. Since he is not a member of the Black minority group, he does not qualify for compensation.

From the government’s standpoint, however, the strengths of group compensation outweigh its weaknesses, so this is the approach that affirmative action policies take.

Arguments for Affirmative Action

Among the many arguments offered in defense of affirmative action policies, here are three com- mon ones.

Helps Create Fairness The first and most important one is that affirmative action is a matter of fairness since it lessens the com- petitive disadvantage of minori- ties, which results from past unjust social treatment. It creates a more equal playing field for employment and promotion, since White males still have many advantages. The rationale behind affirmative action was given in a famous speech by President Lyndon Johnson in 1965:

Equal opportunity is essential, but not enough, not enough. Men and women of all races are born with the same range of abilities. But ability is not just the prod- uct of birth. Ability is stretched or stunted by the family that you live with and the neighborhoods you live in—by the school you go to and the poverty or the rich- ness of your surroundings. It is the product of a hundred unseen forces playing upon the little infant, the child, and finally the man. (paragraph 16)

Johnson’s point was that people’s abilities are often shaped by social factors beyond their control, particularly education and family environment. A member of racial minority who is born into such a disadvantaged situation will not be able to effectively compete for higher level jobs; it is only through affirmative steps that society can help elevate him or her to those positions. President Bill Clinton similarly stated that “the purpose of affirmative action is to give our nation a way to finally

Associated Press/M. Spencer Green

In this 2003 photo, former President Bill Clinton addresses the Rainbow PUSH Coalition on the topic of affirmative action.

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address the systemic exclusion of individuals of talent on the basis of their gender or race from opportunities to develop, perform, achieve and contribute” (1995, p. 1108). His point was that social practices of systematic exclusion have had a long-term negative impact on minority groups that cannot immediately be erased by merely ending discriminatory behavior.

Helps Reduce Poverty A second argument for affirmative action is that it helps reduce poverty. Completely apart from issues of fairness, affirmative action has an important social benefit, since high poverty rates adversely affect society as a whole and not just the poor themselves. Poverty contributes to crime, reduces the educational level of the workforce, and strains the country’s welfare system. Minority discrimination and poverty are correlated, and thus by providing job opportunities to members of those minority groups, poverty within those groups is lessened. This not only reduces poverty for the recipients of affirmative action, but it helps break the cycle of poverty that these recipients would otherwise pass on to their children.

Helps Reduce Racism A third argument is that affirmative action helps reduce racism. Much of the bigotry expressed towards minorities owes to low socioeconomic status, a culture of poverty, and harmful stereo- types that inevitably result from this. Through getting better jobs, the socioeconomic status of members of minority groups is improved and the traditional stereotypes do not apply. These workers thus become positive role models that others within that minority group may be inspired to follow. They also become positive models that others in society can look towards when upgrad- ing their own attitudes about minorities.

Arguments Against Affirmative Action

There are three main arguments against affirmative action, each of which focuses on the contro- versial component of preferential treatment.

Creates Reverse Discrimination The first of these is that preferential treatment is unfair and amounts to reverse discrimination, where a more qualified candidate from the majority group is unfairly denied an opportunity in preference to a less qualified candidate from a minority group. On this view, affirmative action policies work so hard to protect minority groups that they often penalize a member of the majority group, usually a White male. Then California Governor Pete Wilson expressed this sentiment here:

Today the fundamental American principle of equality is being eroded, eroded by a system of preferential treatment that awards public jobs, public contracts, and seats in our public universities, not based on merit and achievement but on membership in a group defined by race, ethnicity, or gender. That’s not right. It’s not fair. It is, by definition, discrimination. (1996, p. 167)

In this quotation, Wilson argued that all discrimination on the basis of race and sex is inher- ently unfair and unequal—and that also applies to preferential treatment. The rights that White

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males have to not be discriminated against are as valid as those of any member of a minority group.

The point is that even if we con- cede that preferential-treatment programs aim to help historically disadvantaged groups, such good intentions alone do not make the policies just. Imagine that, in our efforts to redress the past harms from discrimination, we redistrib- uted half of the wealth of all White males among minorities. One day I have $10,000 in my bank account and the next day I have $5,000, with the missing half going into the bank accounts of members of dis- advantaged minorities. Even if this had a proven benefit to the members of the minority groups, most of us would judge an effort like this to be grossly unfair to White males. While preferential treatment is not as extreme as this, it has the same kind of built-in unfairness. Another way that this unfairness is expressed is that pref- erential treatment essentially takes the view that two wrongs make a right. Some Whites in the past discriminated against some minority groups, even enslaving their members, and that was

undoubtedly wrong. In the present, descendants of those members of minority groups, through preferen- tial-treatment programs, have a right to opportunities over better qualified Whites who had nothing to do with that past discrimination. But these two wrongs do not make preferential treatment right.

Creates Social Tension and Negative Attitudes About Minorities A second argument against pref- erential treatment is that it cre- ates social tension and negative attitudes about minorities who benefit from these programs. If an employer has one job opening and hires a minority applicant to fill it, there may be 50 angry White male applicants, each of whom blames that minority applicant for

What Would You Do?

You are a White employee and are on a list to be considered for a training pro- gram that would lead to career advance- ment and a pay increase. You find out that you were not accepted, but some minority candidates with less seniority and experience than you were.

1. Would you accept the decision? 2. Would you complain to the person

in charge and ask for your candi- dacy to be reevaluated?

3. Would you attempt to negotiate an agreement that you will accept the decision in this case, but that you expect to be accepted into the program the next time?

4. Suppose that you tried to negoti- ate an agreement for the next time the program was offered, but the company did not cooper- ate. Would you get a lawyer and threaten to sue?

Associated Press/Bob Martinez

In this 1995 photo, California Governor Pete Wilson signs an executive order to end affirmative action programs in the state.

Associated Press/Stew Milne

In this 2004 photo, Roger Williams University student Adam Noska (center) is awarded a “whites only” scholarship from College Republicans president Jason Mattera. The award was intended to draw attention to the issue of affirmative action. However, just days after receiving the award, and amid a whirl of controversy at the school, Noska announced that he regret- ted taking the scholarship and was donating the money to char- ity (Carroll, 2004).

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CHAPTER 5Section 5.4 Affirmative Action in U.S. Law

taking the job away from him. The Wilson quote earlier shows the kind of outrage that preferential-treatment programs can generate. Other critics have gone fur- ther and argued that preferential-treatment programs have created an atmosphere in which White males are openly vilified and can do little to stop it. As one opponent of these programs stated, “We have institu- tionalized a counter-white-male bias. We have created a new group who are being discriminated against. . . . [This group has] no access to legal recourse or power. We have institutionalized discrimination against one group. When does it end?” (Lynch, 1989, p. 181). Rather than creating equality and removing social tension, preferential treatment has resulted in a new inequality where there is a hierarchy of the oppressed. Blacks are the primary recipients of preferential treat- ment, followed by women, then Native Americans, then Hispanics, then Asians, then individuals with dis- abilities, and this continues until we finally reach White males at the bottom of the scale. Thus, according to critics, what started out as a policy to reduce social tensions has ended up creating new tensions.

Exceeds Sufficient Nondiscrimination Without Preferential Treatment A third argument is that nondiscrimination without preferential treatment is sufficient for achieving social equality. Society has come a long way since the days of overt racism and sexism, and the laws that we currently have in place are all that we need to elevate the economic status of women and minorities. Government officials continually promise that preferential treatment is only a temporary measure that in time will no longer be necessary, but that time seems to never come. Critics thus contend that programs of preferential treatment are no longer necessary, and now is the time for dismantling them.

5.4 Affirmative Action in U.S. Law Each country has its own history of both discriminatory practices and laws to combat them; we have already examined the situation in India. In this section we will look at the United States’ affirmative action laws and the impact that they have on businesses. The legal issues surround- ing affirmative action policies in the United States are not always the most enjoyable things to explore. There are subtle conceptual distinctions and complex regulations, and emotions run high. However, this is precisely where nondiscrimination in the workplace is put into practice. From the standpoints of both the government and businesses themselves, being ethical in employment nondiscrimination ultimately means following government regulations. All employees in medium to large companies need to be familiar with key aspects of these laws; for many managers, mas- tery of affirmative action policies will be a key part of their job.

males have to not be discriminated against are as valid as those of any member of a minority group.

The point is that even if we con- cede that preferential-treatment programs aim to help historically disadvantaged groups, such good intentions alone do not make the policies just. Imagine that, in our efforts to redress the past harms from discrimination, we redistrib- uted half of the wealth of all White males among minorities. One day I have $10,000 in my bank account and the next day I have $5,000, with the missing half going into the bank accounts of members of dis- advantaged minorities. Even if this had a proven benefit to the members of the minority groups, most of us would judge an effort like this to be grossly unfair to White males. While preferential treatment is not as extreme as this, it has the same kind of built-in unfairness. Another way that this unfairness is expressed is that pref- erential treatment essentially takes the view that two wrongs make a right. Some Whites in the past discriminated against some minority groups, even enslaving their members, and that was

undoubtedly wrong. In the present, descendants of those members of minority groups, through preferen- tial-treatment programs, have a right to opportunities over better qualified Whites who had nothing to do with that past discrimination. But these two wrongs do not make preferential treatment right.

Creates Social Tension and Negative Attitudes About Minorities A second argument against pref- erential treatment is that it cre- ates social tension and negative attitudes about minorities who benefit from these programs. If an employer has one job opening and hires a minority applicant to fill it, there may be 50 angry White male applicants, each of whom blames that minority applicant for

What Would You Do?

You are a White employee and are on a list to be considered for a training pro- gram that would lead to career advance- ment and a pay increase. You find out that you were not accepted, but some minority candidates with less seniority and experience than you were.

1. Would you accept the decision? 2. Would you complain to the person

in charge and ask for your candi- dacy to be reevaluated?

3. Would you attempt to negotiate an agreement that you will accept the decision in this case, but that you expect to be accepted into the program the next time?

4. Suppose that you tried to negoti- ate an agreement for the next time the program was offered, but the company did not cooper- ate. Would you get a lawyer and threaten to sue?

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Two Laws and Two Governmental Agencies

The story of affirmative action regulation in the United States begins with the civil rights movement of the late 1950s and the Civil Rights Act of 1964. This legislation was devised to put an end to a century of racial segregation and discrimination. It was hotly contested in Congress; one Southern senator stated, “We will resist to the bitter end any measure or any movement which would have a tendency to bring about social equality and intermingling and amalgamation of the races in our states” (quoted in Spartacus Educational, n.d.). Fortunately that senator was outvoted. The critical portion of the act that grants equal opportunity for employment appears in Title VII:

It shall be an unlawful employment practice for an employer—

(1) to fail or refuse to hire or to discharge any individual, or otherwise to discrimi- nate against any individual with respect to his compensation, terms, conditions, or privileges of employment, because of such individual’s race, color, religion, sex, or national origin; or

(2) to limit, segregate, or classify his employees in any way which would deprive or tend to deprive any individual of employment opportunities or otherwise adversely affect his status as an employee, because of such individual’s race, color, religion, sex, or national origin. (Section 703)

Title VII allows for some exemptions where discrimination can be permitted, but these must involve bona fide occupational qualifications, that is, qualifications that relate to an essential job duty and are “reasonably necessary to the normal operation of that particular business or enterprise”. (Civil Rights Act [1964] Title VII, Section 703, 3e). An example of this would be dis- qualifying a blind applicant for an air-traffic controller job, as mentioned earlier. Similarly, a theater com- pany could disqualify a male actor who applied for a female role in a play, or an Episcopal church could disqualify an ordained Baptist preacher for a ministe- rial position.

The term affirmative action made its way into law through an executive order by President Kennedy in 1961 requiring any business seeking a federal govern- ment contract to engage in affirmative action. The order stated, “The contractor will not discriminate against any employee or applicant for employment because of race, creed, color, or national origin. The contractor will take affirmative action to ensure that applicants are employed, and that employees are treated during employment, without regard to their race, creed, color, or national origin” (Executive Order No. 10925, 1961). But Kennedy’s conception of affir- mative action was mild, and meant essentially that contractors needed to exhibit an active concern to eliminate discrimination. Four years later, this order was revised by President Johnson to include gender (Executive Order No. 11246, 1965).

Copyright Bettmann/Corbis/AP Images/Anonymous

In this photo, Rosa Parks (left) sits at the front of a Montgomery, Alabama, bus. In 1955, Parks was arrested for refusing to vacate her seat on a Montgomery bus for a White passenger.

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It was in 1968 that the government first required target dates for evaluating a contractor’s affir- mative action program. The regulation stated, “The contractor’s program shall provide in detail for specific steps to guarantee equal employment opportunity keyed to the problems and needs of minority groups, including, when there are deficiencies, the development of specific goals and timetables for the prompt achievement of full and equal employment opportunity” (Affirmative Action Law and Legal Definition, n.d.). This is the basis of the more aggressive notion of affirmative action that includes preferential treatment. In theory, the executive orders for contractors do not require every company in the United States to adopt aggressive affirmative action policies. How- ever, since government contracts are such an important source of revenue throughout the busi- ness world, the executive orders had the practical effect of mandating this uniformly, especially for medium to large corporations.

Enforcing Title VII and Executive Order No. 11246 The task of enforcing Title VII of the Civil Rights Act was assigned to the Equal Employment Opportunity Commission (EEOC), which sets policies for dealing with discrimination complaints, holds hearings on specific complaints, and has the authority to file discrimination suits against employers. The commission’s single mission is “the elimination of illegal discrimination from the workplace” (Equal Employment Opportunity Commission, n.d.). While the EEOC oversees compli- ance with Title VII, the affirmative action executive order for government contractors is under the domain of the Office of Federal Contract Compliance Programs (OFCCP)—a branch of the Depart- ment of Labor. The OFCCP enforces affirmative action compliance in several ways. It offers techni- cal assistance to federal contractors and subcontractors to help them understand the regulatory requirements and review process. It conducts compliance evaluations and complaint investiga- tions of federal contractors’ personnel policies and procedures. The ultimate punishment by the OFCCP for violations is the loss of a company’s federal contracts, and companies may have to pay lost wages to victims of discrimination. Each year, the OFCCP issues an “Opportunity Award” to a contractor who implements outstanding affirmative action programs; recipients have included Raytheon, Texas A&M University, and Dell.

Protected Classes and Minorities The laws and regulations that are jointly enforced by the EEOC and OFCCP are called equal employ- ment opportunity (EEO) laws. From a business’s perspective, EEO laws mandated by the EEOC and OFCCP go hand in hand: While the one agency oversees Title VII, and the other, government con- tracts, medium to large businesses typically need to comply with both. It is beyond the scope of this chapter to give a detailed account of the EEO laws, but there are a few important concepts relating to these laws that are central to compliance for businesses and to the debates surrounding them.

The first is the concept of protected classes, which are the specific groups that are protected from employment discrimination by law. Since the enactment of the Civil Rights Act, the list of legally protected groups in the United States has grown; it currently includes seven groups: (1) women, (2) minorities, (3) veterans, (4) individuals with disabilities, (5) people over 40, (6) pregnant women, and (7) anyone on the basis of genetic information. Technically speaking, every U.S. citizen belongs to some protected class, if only by virtue of being either a man or a woman and having genetic information. However, the EEO laws aim specifically at protecting women and minority groups because of the history of discrimination against them (“Equal Employment Opportunity (EEO) Terminology,” n.d., under “Protected class”). A minority is a subgroup of a population that differs in race, religion, or national origin from the dominant group. The EEOC designates a minority as

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being one of four groups: (1) American Indians or Alaskan Natives, (2) Asians or Pacific Islanders, (3) Blacks, or (4) Hispanics. The EEOC does not technically classify women as a minority. However, women are considered as having “minority status” as far as the law is concerned, since they have experienced the same kind of systematic employment discrimination as the various minorities.

Compliance Guidelines and Plans

The government does not simply trust that employers will embrace nondiscrimination and affir- mative action practices. Rather, employers must follow complex protocols, and compliance places high demands on their personnel resources. Several consulting companies specialize in affirmative action compliance; one advertises that it can help companies successfully navigate “through the complex maze of affirmative action regulations” (AAP Consultants LLC, n.d.).

There are two main government protocols that most medium to large businesses must follow for proper compliance. The first is the Uniform Guidelines on Employee Selection Procedures (UGESP), which are guidelines that require employers to carefully inspect the processes they use to hire, promote, or terminate employees, and assure that those processes are fair and nondiscriminatory. First issued in 1978, the UGESP was designed by several government agencies as a nationwide policy to help achieve the national goal of equal employment opportunity, and it applies to both private and public employers. According to the guidelines, employers need to keep detailed records of applicants for employment and promotion. If a company’s current practices produce a deficiency of women or minority employees, the company must conduct a validity study to show that the imbal- ance was not discriminatory (Uniform guidelines on employee selection procedures, 2010).

Suppose, for example, that you owned a metal-fabrication company and all of the metal-lathe work- ers that you hired were White males. Using a validity study, you might show that your hiring criteria for those employees involved a specialized mathematics test that would legitimately identify work- ers who would be good metal-lathe operators. It then turned out that only White male applicants performed well on that specialized test. This would show that your hiring practice was not inherently discriminatory, and that instead, your choice was dependent on your pool of candidates. If a com- plaint of employment discrimination were ever brought against you, the validity study would be evi- dence in your defense. On the other hand, if the test you gave to job applicants were racially biased, this would be revealed in your validity study and you would need to change your testing procedure.

The UGESP aims at weeding out discriminatory hiring and promotion practices. However, a second government protocol, known as an affirmative action plan (AAP), focuses more aggressively on assuring that employers implement affirmative action in their employment practices. In some cases, affirmative action plans are mandatory; in others, they are voluntary. The OFCCP requires contractors with 50 or more employees and government contracts of $50,000 to develop these plans. However, the EEOC advises all private-sector companies to devise voluntary affirmative action plans as a way of addressing deficiencies in their hiring and promotion procedures, espe- cially as might be revealed by the Uniform Guidelines on Employee Selection Procedures.

It is not enough for businesses to merely create an affirmative action plan; they must also make a good-faith effort to put the plan into practice. According to the OFCCP, “good faith efforts may include expanded efforts in outreach, recruitment, training and other activities to increase the pool of qualified minorities and females” (2002). The government recognizes the controversial nature of preferential-treatment policies and potential accusations of reverse discrimination. Accordingly, the OFCCP has stated that “the actual selection decision [for hiring or promotion] is

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to be made on a nondiscriminatory basis” (2002). The EEOC has stated further that “a voluntary affirmative action plan cannot unnecessarily trammel the rights of non-targeted groups, usually non-minorities or men” (1997).

The required components of an affirmative action plan are listed in the Federal Code of Regula- tions, and the OFCCP provides a sample plan that companies can use as a model (Office of Federal Contract Compliance Programs, n.d.). Each organization is required to devise its own plan, and there is great latitude in how each can arrange its plan’s components. However, certain elements are required, and the plans often fall into two parts: one for minorities and women, and another for veterans and individuals with disabilities. The main components of affirmative action plans regarding women and minorities are:

• Determining whether women and minorities are underrepresented within the company. This involves listing the number of women and minority workers and the various jobs that they hold within a company. This, then, is statistically compared to the availability of women and minority workers in the relevant job market outside the company.

• Establishing goals and programs to address underrepresentation. This may involve more strategic use of recruitment and job-opening advertisements, and EEO training for super- visors and all other employees.

• Conducting an internal audit of hiring, promotion, and termination procedures to detect problem areas. This involves a statistical comparison of, on the one hand, women and minority workers who have been hired, promoted, or terminated and, on the other, men and nonminority workers within the same job groups.

The main components of affirmative action plans regarding veterans and individuals with disabilities are:

• Making a reasonable effort to accommodate the physical or mental limitations of veteran/ disabled employees. When determining the extent of such accommodations, financial cost and organizational necessity are factors that may be considered.

• Disseminating veteran/disability policy information both inter- nally and externally. This may involve communicating EEO policies through job advertise- ments, employee training, and memos to employees.

• Creating an audit and reporting system regarding compliance

with veteran/disability policy. This may involve annually reviewing company hiring and promotion procedures for indications of discrimination or stereotyping.

The plan regarding veterans and individuals with disabilities differs from the plan regarding women and minorities. No statistical comparison is needed between veterans and disabled workers within

Associated Press/Elaine Thompson

In this 2010 photo, a Les Schwab Tire Centers employee fixes a tire. The company was forced to pay $2 million in a suit brought against it by the EEOC, which claimed the company denied certain jobs to women (Foden-Vencil, 2010).

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the company and those in the job market outside the company. Rather, the goal is to improve awareness of the conditions that create a discrimination-free environment for veterans and indi- viduals with disabilities.

Supreme Court Cases

Since the 1970s, the U.S. Supreme Court has heard a series of cases on affirmative action policies, and those rulings have established that some policies are legally permitted under the U.S. Consti- tution while others are not. The court’s decisions, though, are made on a case-by-case basis, and do not always establish clear and uniform policies. One reason is that the makeup of the Supreme Court continually changes, with some justices being more sympathetic to affirmative action than others. Another reason is that the court cases themselves significantly differ in their details, even when on the surface they seem to be about the same issue. We will look at some of the famous Supreme Court cases that have wrestled with the nuances of affirmative action practices of busi- nesses, universities, and government offices. We will consider them chronologically.

The first important case, Regents of the University of California vs. Bakke (1978), involved a White man named Allan Bakke who twice applied to the school of medicine at the University of Cali- fornia, Davis, but was rejected both times, while less qualified minority applicants were admit- ted as part of a racial quota system that reserved 16 places for minorities. The court ruled that universities could take race into account when admitting students, but it was unconstitutional for them to use rigid racial quotas to increase minorities as the University of California had done. The university was required to admit Bakke. While the legal case ended there, the ruling has been con- tinually debated by legal scholars and in the media. A case in point is the following comparison between the medical careers of Bakke and Patrick Chavis, one of the 16 minority candidates against whom Bakke was originally competing:

Bakke . . . ended up with a part-time anesthesiology practice in Rochester, Minnesota. Dr. Patrick Chavis, the African-American who allegedly “took Bakke’s place” in medical school, has a huge OB/GYN practice providing primary care to poor women in predominantly minority Compton. Bakke’s scores were higher, but who made the most of his medical school education? From whom did California taxpayers benefit more? (Rice & Hayden, 1995)

While Chavis’s story has frequently been used as a justification of the University of California’s quota sys- tem, the story flipped when Chavis was found guilty of gross negligence and incompetence in the treatment of three liposuction patients at his clinic, one of whom

Copyright Bettmann/Corbis/AP Images/Anonymous

In this 1977 photo, protestors demonstrate over the Bakke affirmative action case.

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CHAPTER 5Section 5.4 Affirmative Action in U.S. Law

died. The lesson to be learned from this is that a social policy as widespread and complex as affirmative action cannot be judged on the success or failure of any isolated individual. There will always be some examples of great achievement and others of dismal failure, and these can never substitute for systematic and methodologically sound studies of the issue.

In another case, United Steelworkers of America v. Weber (1979), Brian Weber, a young White laboratory assistant at the Kaiser Aluminum and Chemical Corporation, applied for a special train- ing program that would have resulted in a promotion. The company made an agreement with the United Steelworkers of America labor union that for every one White person accepted into such training programs, one Black person would also be accepted. The company had many more Whites than Blacks, and thus accepted some Black employees into the program ahead of White employees with more seniority. When Weber was not accepted into the program, he sued on the grounds that the decision violated Title VII of the Civil Rights Act. The court ruled against Weber and in favor of his company. Affirmative action plans were acceptable, according to the court, when they aimed to correct a statistical imbalance but did not involve quotas. Thus, Kaiser did nothing wrong, since the one-for-one system was not, strictly speaking, based on quotas. The court’s decision was controversial, and one dissenting justice stated the company’s preferential treatment of blacks clearly violated the wording of Title VII, which prohibits discrimination for employment opportunities on the basis of race. The justice continued that, by siding with the Kai- ser company against Weber, the court’s majority decision was reminiscent of “escape artists such as Houdini” insofar is it eluded the clear language of the law in Title VII and wrongly concluded that employers are “permitted to consider race in making employment decisions” (United Steel- workers of America v. Weber, dissenting opn. of J. Rehnquist, 222).

The next case is City of Richmond v. J. A. Croson Co. (1989). In this one, the city of Richmond, Vir- ginia, with a Black population of around 50%, had an affirmative action policy that required 30% of all construction contracts to be awarded to minority-owned companies. One of its projects was for the installation of toilet facilities in the city jail. The J. A. Croson Company applied for the contract, but its bid was denied when it could not comply with the city’s minority requirement. It then sued on the grounds of discrimination. The city of Richmond argued that racial discrimination created a situation in which minority-owned businesses had virtually no access to government contracts, locally or nationally, and that preferential treatment of minority companies was the remedy. The Supreme Court ruled against Richmond, arguing that the city had failed to demonstrate a com- pelling interest in its preferential-treatment policy. According to the court, every disadvantaged group could make a competing claim that preferential treatment was the only corrective remedy that would work. Consequently, the court argued, “the dream of a Nation of equal citizens in a society where race is irrelevant to personal opportunity and achievement would be lost in a mosaic of shifting preferences based on inherently unmeasurable claims of past wrongs” (City of Richmond v. J. A. Croson Co., 505–506).

Another important case regarding affirmative action in universities is Grutter v. Bollinger (2003). Barbara Grutter, a White woman with strong academic credentials, was rejected from the Uni- versity of Michigan’s law school. She sued on the grounds that the school had used race as a predominant factor, thus giving applicants belonging to certain minority groups a significantly greater chance of admission than students with similar credentials from disfavored racial groups. The court ruled in favor of the law school, indicating that the Constitution “does not prohibit the Law School’s narrowly tailored use of race in admissions decisions to further a compelling interest in obtaining the educational benefits that flow from a diverse student body” (Grutter v. Bollinger, 343). The court clarified, though, that preferential-treatment policies cannot go on indefinitely:

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CHAPTER 5Section 5.4 Affirmative Action in U.S. Law

Race-conscious admissions policies must be limited in time. This requirement reflects that racial classifications, however compelling their goals, are poten- tially so dangerous that they may be employed no more broadly than the inter- est demands. Enshrining a permanent justification for racial preferences would offend this fundamental equal protection principle. (Grutter v. Bollinger, 342)

The point is that even though preferential-treatment programs serve an important social purpose, they are potentially damaging and can only be used as temporary mea- sures. The Court explicitly stated, “We expect that 25 years from now the use of racial preferences will no longer be necessary” (Grutter v. Bollinger, 343).

In Ricci v. DeStefano (2009), a fire department in New Haven, Con- necticut, administered a promo- tion exam to 118 applicants for the positions of captain and lieuten- ant. When the results came in, city officials determined that too few minority candidates had scored high enough on the exam, and thus they threw the results out, issuing no promotions. Nineteen firefight- ers, mostly White males, sued on

the grounds of reverse discrimination. The Supreme Court ruled in favor of the firefighters and maintained that the city had violated Title VII of the Civil Rights Act by engaging in “race-based decision making” when discarding the test results (Ricci v. DeStefano, slip op. at 19).

All of these Supreme Court cases specifically involve questions about preferential-treatment poli- cies, and whether they violate the rights of Whites. While the rulings differ in many respects, a consistent pattern emerges regarding the permissibility of quota systems in affirmative action programs. Generally speaking, the court considers quotas discriminatory against whites; however, the government can rightfully order companies to meet gender and minority quotas when they have repeatedly engaged in discriminatory practices.

A final Supreme Court case on affirmative action is not about reverse discrimination against whites, but instead about the ability of women and minority employees to sue their employers for discriminatory practices. The 2011 case, Wal-Mart v. Dukes, was the largest gender-discrimination case to that point in history. Betty Dukes, a 54-year-old Walmart employee, sued the company for sex discrimination when she was denied training that would have led to a promotion. Her suit, though, was a class action on behalf of 1.5 million female employees who, like herself, she claimed, were also denied promotion within the company because of their gender-discriminatory employment practices. Walmart argued that the class-action lawsuit was unjustified, since the 1.5 million female employees had different jobs with different supervisors at 3,400 different stores

Associated Press/Susan Walsh

In this 2003 photo, Barbara Grutter (left), who sued the Uni- versity of Michigan’s law school, leaves the Supreme Court. Grutter sued on the grounds that the school used race as a predominant factor in its admissions. The court ruled in favor of the school.

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CHAPTER 5Section 5.5 Conclusion

nationwide, and did not have enough in common to be combined together into a single suit. The Supreme Court agreed with Walmart and threw out the case. What this means is that it may be more difficult for victims of systematic discrimination to bring class-action lawsuits against their employers; they may only be able to bring suits on an individual basis. That makes a major differ- ence in the deterrence effect that potential lawsuits could have on businesses. A class action suit like Dukes’s, if successful, could have cost Walmart billions of dollars. By contrast, the damages of a lawsuit by a single individual might only be in the thousands of dollars.

5.5 Conclusion We opened this chapter looking at affirmative action in India. There are defenders of India’s radical policy who argue that it is essential for reducing economic differences between its ethnic groups (Deshpande, 2006). But in his book Affirmative Action in India and the United States, economist Thomas Sowell argued that India’s efforts at boosting the social level of untouchables have been a failure: “It is hard to escape the conclusion that affirmative action in India has produced minimal benefits to those most in need and maximum resentments and hostility toward them on the part of others.” According to Sowell, while untouchables have had special positions open to them in universities, businesses, and governments, comparatively few have been able to acquire the skills to move into those positions. For a teenager whose life experience has been salvaging scrap metal from a garbage dump, it makes little difference if law schools have special spots available to stu- dents who are untouchables. The odds are slim that such a teenager will succeed in even getting a high-school diploma.

Sowell’s assessment of affirmative action programs throughout the world was the same, and he argued that people in the United States can learn by observing patterns of failures elsewhere. One such pattern is that every country claims that its problem with discrimination against minori- ties is unique, which justifies its policies of preferential treatment. Further, Sowell wrote, in all of these countries “considerable effort has been made to depict such policies as ‘temporary,’ even when in fact these preferences turn out not only to persist but to grow” (2004, p. 2). The reason, he explained, is that politicians would be blamed for saying no to them, whereas it is much easier to just say yes (Robinson & Sowell, 2004). Another pattern is that when affirmative action poli- cies are set in place, members of majority groups often cheat the system by getting themselves reclassified as members of a minority group—based on very remote minority ancestry—and thus take advantage of special opportunities for minorities. Perhaps most importantly, Sowell argued that there often are not adequate statistical data to show the progress of groups that have been given preferential treatment. Even when such data do exist, it is difficult “to determine how much of that progress was due to preferential policies, rather than to other factors at work at the same time” (Sowell, 2004, p. 19). Nevertheless, Sowell argued, countries push on with their affirmative action programs in the absence of any good data that it works.

Sowell’s point is that the problems of discrimination are not unique to the United States, nor are the problems with preferential treatment. To some extent, many people in the United States share Sowell’s skeptical attitudes about affirmative action policies. Nationwide surveys on this subject are routinely taken, and not surprisingly, the results depend on whether those policies involve preferential treatment. When asked “Do you generally favor or oppose affirmative action pro- grams for racial and ethnic minorities?,” 56% were in favor of such programs, 36% were opposed to them, and 9% were unsure. When asked the same question about affirmative action programs

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CHAPTER 5Summary

for women, 63% were in favor, 29% opposed, and 9% unsure. However, attitudes changed when preferential treatment was a factor. When asked “Do you think members of some racial groups should get preference for jobs in private companies so that the workforce has the same racial makeup as its community?,” only 21% said yes, while 74% said no and 5% were unsure (“Race and Ethnicity,” 2004).

Preferential treatment policies are controversial in the United States and everywhere else in the world where they have been put into practice. Public support might be stronger for these pro- grams if it could be shown with some certainty that they are indeed successful in improving the conditions of historically disadvantaged groups, and they will not continue indefinitely. The prob- lem, though, is that discrimination and its devastating effects on minorities are the consequence of hundreds, and sometimes thousands, of years of prejudicial tradition. It is unrealistic to expect that such a historically rooted problem can be solved with just a few decades of policy changes, and it is understandable that “temporary” policies of preferential treatment have become ongo- ing features of social policy.

Summary We began this chapter looking at different types of discrimination. Employment discrimination is specifically the prejudicial treatment of people in hiring, promotion, and termination decisions. Some discrimination is intentional, in that a company’s policies are shaped by overt racial preju- dices of its managers or executives. Other times it is unintentional, as when a company uncriti- cally perpetuates prejudicial stereotypes. Evidence of discrimination can be direct, when there are overt written or oral statements by employers that display their discriminatory intention. It can also be indirect, when the behavior of the company implies discriminatory conduct. One indi- rect type of evidence for discrimination is income inequality, where statistical analysis shows that income is distributed in an uneven manner among a population. Another type of indirect evidence is the phenomenon of the glass ceiling, where women and minority workers hit a level beyond which they cannot advance, while their White male counterparts continue to progress.

Next we looked at affirmative action, which is a policy of improving the opportunities of those within historically disadvantaged groups through positive measures beyond neutral, nondiscrimi- natory action. This is a more aggressive policy than equal opportunity, which is simply the policy of treating employees without discrimination. The most controversial type of affirmative action policy is preferential treatment, which involves special consideration given to people from historically dis- advantaged groups in hiring and promotion situations. This often involves a quota system, where a certain number of jobs are set aside for members of minority groups in direct proportion to their numbers in the community. Compensating victims of discrimination can be done individually, such as when a person sues her company based on her specific situation. However, governmental affir- mative action policies rest on group compensation, where each individual within a disadvantaged group is compensated based purely on his or her membership in that group. The concept of affir- mative action is a controversial one, and we looked at arguments both for and against it.

From a practical standpoint, nondiscriminatory behavior in the workplace essentially means fol- lowing affirmative action laws that are mandated by the government. The two main affirmative action laws are (1) Title VII of the Civil Rights Act, which grants equal opportunity for employment,

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CHAPTER 5Summary

and (2) the presidential executive order requiring government contractors to take affirmative action measures. The Equal Employment Opportunity Commission (EEOC) oversees compliance with Title VII, and the Office of Federal Contract Compliance Programs (OFCCP) oversees compli- ance with the executive order. These two agencies stipulate two procedures for compliance. The first is laid out in the Uniform Guidelines on Employee Selection Procedures (UGESP), and the second involves the creation of an affirmative action plan (AAP).

Problems routinely arise within the business world with attempts to follow affirmative action laws. Several major Supreme Court rulings have clarified when a business’s affirmative action decision crosses the line and becomes unconstitutional. The Supreme Court’s general view is that quota systems are discriminatory against White males, but companies can still be ordered to use quotas when they have repeatedly engaged in discriminatory practices.

Discussion Questions

Consider the Jazzercize example at the beginning of this chapter and discuss whether the com- pany was discriminating against the instructor.

1. Unintentional discrimination occurs when a company’s policies uncritically reflect preju- dicial stereotypes yet do not involve overt racial prejudices of its managers or execu- tives. Think of examples, either real or imaginary, in which a company might be engaged in unintentional discrimination.

2. Examine the statistical data presented earlier that indicate income inequality throughout the United States. Then discuss how much of that inequality can be attributed to dis- crimination rather than to nondiscriminatory factors.

3. Preferential treatment is just one component of affirmative action, but it is the compo- nent that has caused the most controversy. Suppose that the government banned all preferential-treatment programs throughout the country. Would this make the remain- ing elements of affirmative action ineffective? That is, is affirmative action essentially meaningless without preferential treatment?

4. Governmental affirmative action policies rely on a system of group compensation, rather than individual compensation. Examine the different advantages and disadvantages of the group-compensation approach as listed in the chapter, and discuss whether the gov- ernment did the right thing by adopting the group-compensation approach.

5. Consider the three arguments in favor of affirmative action discussed in the chapter. Indicate which is the weakest and which is the strongest, and discuss why.

6. Consider the three arguments against affirmative action discussed in the chapter. Indi- cate which is the weakest and which is the strongest, and discuss why.

Key Terms

affirmative action The policy of improving the opportunities of those within historically dis- advantaged groups through positive measures beyond neutral, nondiscriminatory action.

affirmative action plan (AAP) U.S. federal requirement for assuring that employers implement affirmative action in their employ- ment practices.

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CHAPTER 5Summary

bona fide occupational qualifications Qualifi- cations that relate to an essential job duty and are reasonably necessary to the normal opera- tion of that particular business or enterprise.

burden-shifting formula The legal strategy for a minority employee where the burden rests on the employer to show that its behavior was not discriminatory.

direct evidence of discrimination Overt written or oral statements by employers that display their discriminatory intention.

discrimination The unjust or prejudicial treat- ment of people on arbitrary grounds, such as race, gender, or age, which results in denial of opportunity, such as in business employment or promotion.

employment discrimination The prejudicial treatment of people in hiring, promotion, and termination decisions.

Equal Employment Opportunity Commis- sion (EEOC) U.S. federal agency responsible for enforcing Title VII of the Civil Rights Act by setting policies for dealing with discrimination complaints, holding hearings on specific com- plaints, and filing discrimination suits against employers.

equal employment opportunity (EEO) laws The laws and regulations that are jointly enforced by the EEOC and OFCCP.

equal opportunity The policy of treating employees without discrimination.

equal results An affirmative action concept of achieving proportional minority representa- tion in a work or economic environment where minorities are presently underrepresented.

glass ceiling A discrimination situation in which women and minority workers hit a level beyond which they cannot advance, while their White male counterparts continue to progress.

group compensation An antidiscrimination policy in which each individual within a disad- vantaged group is compensated based purely on his or her membership in that group.

income inequality Indirect evidence of dis- crimination based on an analysis of the extent to which income is distributed in an uneven manner among a population.

indirect evidence of discrimination Behavior of a company that implies discriminatory conduct.

individual compensation An antidiscrimina- tion policy in which each person is compen- sated based on his or her individual claim.

intentional discrimination Discrimination where the policies of a company are shaped by overt racial prejudices of its managers or executives.

minority A subgroup of a population that differs in race, religion, or national origin from the dominant group.

Office of Federal Contract Compliance Pro- grams (OFCCP) U.S. federal agency (a branch of the Department of Labor) responsible for implementing the affirmative action executive order regarding government contractors.

preferential treatment Special consideration given to people from historically disadvantaged groups in hiring and promotion situations.

protected classes Specific groups that are pro- tected from employment discrimination by law.

quota system An affirmative action concept where a certain number of jobs are set aside for members of minority groups in direct pro- portion to their numbers in the community.

reverse discrimination An aspect of preferen- tial treatment where a more qualified candi- date from the majority group is unfairly denied an opportunity in preference to a less qualified candidate from a minority group.

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CHAPTER 5Summary

Uniform Guidelines on Employee Selection Procedures (UGESP) U.S. federal guidelines that require employers to carefully inspect the processes they use to hire, promote, or terminate employees, and assure that those processes are fair and nondiscriminatory.

unintentional discrimination Discrimination where a company’s policies uncritically reflect prejudicial stereotypes.

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Employees

Learning Objectives

After completing this chapter, you should be able to:

• Understand alternative positions on the nature of employment. • Discuss the ethical problems that arise with hiring and firing people. • Examine the ethics of wages and working conditions. • Discuss the merits of union membership. • Examine the ethics and complexities of whistleblowing.

iStockphoto

6

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CHAPTER 6Section 6.1 Introduction

Contents

6.1 Introduction

6.2 Ethical Theories of Employment

The Capitalist View The Socialist View The Middle Ground: Virtue Ethics Employment and Social Power Conflicts

6.3 Hiring and Firing

Interviews Firing

6.4 Wages

Fair Pay Minimum Wage Salary Caps

6.5 Working Conditions

Occupational Health and Safety Understanding Hazards

6.6 Unions

History of Unions Professional Unions

6.7 Whistleblowing

Types of Whistleblowing Whistleblowing Guidelines Whistleblowing Laws

6.8 Conclusion

6.1 Introduction For many people, the term employee suggests that there is a boss and an underling, and that the worker is subject to the demands and whims of the boss. The cartoon image of an exploited, hum- bled worker readily comes to mind—low wages, poor working conditions, intimidation, and sexual advances. Yet in the world of business, there are many different kinds of employment and there- fore many different kinds of employees. Some we would indeed describe as being oppressed, or at least harassed, and others we would think of as having more power than their bosses.

The issues arising from employment that attract media attention are often legal breaches of con- tract, discrimination, employment of illegal labor, and so on. Contracts are complex, and employ- ment law litigation has escalated since the Civil Rights Act of 1964 and other employment acts. This escalation reflects the change in the law, but there are deeper, ethical, issues too:

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CHAPTER 6Section 6.2 Ethical Theories of Employment

• Do people have a right to a job? • Do employers have ethical responsibilities to

those they employ, and if so, how far do these responsibilities extend?

• What responsibilities do employees have to their employers?

• To what extent should employers be able to find out about employees’ personal lives?

• Should labor unions be allowed? • Should whistleblowers be given legal

protection?

Our thinking can be prejudiced by the presence of com- monly known laws on discrimination and minimum wages. To push on with an ethical frame of mind, we need to put aside legal concepts for the moment. Dis- crimination may be illegal, but is it immoral? Can it ever be right to discriminate between people because of personal prejudice? Although hiring illegal immigrants is illegal, does that make it wrong? If a promotion can be gained by spreading a private truth about a col- league competing for a post, should the information be used? Before hiring someone, should an employer fish around social networking sites for nonrelevant informa- tion? What kind of employer or employee should I be?

Because of the political nature of public sector employment, this chapter discusses the ethical problems of employment in the private sector. We will answer questions like those we just brought up, discussing the ethical responsibilities that employers and employees have to each other, ethical issues related to hiring and firing, and wages, working conditions, and unions. We will conclude by looking at whistleblowers. But let us get started by examining some theories of employment.

6.2 Ethical Theories of Employment In Chapter 2 we introduced the theories of capitalism and socialism. Let us look at how these two distinct theories view employment and its ethics before examining the middle ground between.

The Capitalist View

In the capitalist view of employment, the employer and employee negotiate a contract between themselves for their own benefits, period. This can be called the contractual theory of employ- ment. The terms of the contract may be breached and hence open up either party for a lawsuit, but if one side decides to act unfairly outside the bounds of the contract, then no rights problem occurs. An employee does not have a right to sue against unfriendly or unfair treatment unless there is a breach of contract (Machan, 1988, p. 227). For the capitalist, an employer cannot be

David Hitch

Should work resemble this cartoon of a classic case of the dictatorial manager bawling and whipping people into higher productivity? If not, why do many people believe that we need leaders and people to tell us what to do?

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CHAPTER 6Section 6.2 Ethical Theories of Employment

forced into doing something moral such as acting pleasantly to employees. However, in the capi- talist model, both employers and employees are seen as equals: Both may respect each other or not. Fairness cuts both ways.

For the capitalist, people do not have a right to a job, just as they do not have a right to an income or any product they see on the shelves. A job is a mutual contract between two people, that is all. This can imply that ethics does not even enter employment negotiations or the workplace: If workers are dissatisfied, they can leave; if a manager is dissatisfied with a worker, he or she can fire the worker.

A modified version of this stark view of employment accepts the contractual basis of employment but adds that both employers and employees do have other aspects to them: They can be nice to each other, avoid discrimination, encourage each other to fulfill their potential, provide flexibility. The capitalist world of Adam Smith can be seen as the bare minimum for any free society; once up and running, we can be ethical towards one another (if we choose!).

The Socialist View

According to Marx’s socialism, employees in capitalist systems have to work for employers and are thus slaves to the wage system; inevitably, even by definition, they are exploited. This can be called the exploitation theory of employment. Workers are defined as being without power or the means to sustain their own living. They are dependents whom the capitalist class exploits to make and sell products and services. For Marx, employment is defined by two opposing classes who can only struggle against one another. On the one hand, the capitalists struggle to keep wages low so that they may earn higher profits; on the other hand, the workers struggle to raise their wages so they do not starve. The simplistic duel between employers and employees is compli- cated in 20th-century ethics by notions of justice, fairness, and responsibility, but the image of the boss versus employee has not faded.

These two positions form opposing theories of employment that affect how we view employ- ment ethically. Marx encouraged workers to strive for all the rights and privileges they can get. Otherwise the money will just end up in the capitalists’ pockets. A capitalist sees employment as mutually beneficial and not a “winner takes all” situation where one person’s profit is another person’s loss.

The Middle Ground: Virtue Ethics

The reality for most workers and employers, however, probably lies somewhere in between the capitalist and socialist views. There are exploitative and manipulative bosses as well as lying and thieving employees. There are those who foster fairness and decency in the workplace, and others who prefer an aggressive, competitive atmosphere. There are employers who entrust and encour- age personal development and workers who cooperate, adapt, and innovate. In other words, the workplace is complex, and the ethical problems it generates cannot be fully described by either the capitalist or socialist view. A middle ground emerges in most discussions that seeks to find ethical solutions to the complexities of the workplace in the language of virtue ethics (or virtue theory). Virtue ethics focuses on the good character traits that people acquire. With employers

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CHAPTER 6Section 6.2 Ethical Theories of Employment

and employees, some good character traits would be reputation, morale, loyalty, discipline, pro- ductivity, and respect. These are ethically important qualities that capture aspects of work that we can relate to—Joe is a loyal worker, Shannon is diligent, Manuel is a respectful manager, Kai is flexible to work for, Anya’s firm has an excellent reputation with its workers, Martha’s teams are inspirational, and so on.

Virtue ethics tries to shed light on how we should proceed and act towards one another in the workplace by focusing on good character traits, such as being just, fair, disciplined, hardworking, etc. But such terms are themselves open to criticism. These virtuous character traits themselves have hidden assumptions about power structures in society, which we will look at next.

Employment and Social Power Conflicts

For critics of capitalism and the contractual theory of employment, there is another concern that stems from the observation that social and business relationships often involve power struggles between diverse groups of people. In forming a business contract, for example, the relationship between two people is not always that of two equals. Society is characterized by power relations in which men are generally perceived to have greater power than women; Whites more than eth- nic minorities; large corporations more than small businesses; producers more than consumers. We may not accept the simple two-class war that Marx describes, but we should look for other

kinds of hidden or subtle forms of exploitation in our language and acts.

When we hire another person, we are engaging in something more than just a contract to offer payment in return for skills or time. Inevitably, social relation- ships are implied in the interview and in the work- place, and they are filled with power games. Returning to the cartoon of the boss and employee, what if the boss has much greater economic or social power than the employee? That inevitably alters the potential contract made. In traditionally male-dominated cul- tures, this can be quite obvious—younger men have to trust older men and learn to hold their tongues, and women are further disempowered by their gender. A woman may be hired for various underlying assump- tions governing her weakness in society: She may be less likely to complain or to demand higher pay; she may look attractive to clients and hence gain higher sales. Her mind is less important than the social status she conveys.

In an attempt to produce a better and more ethical atmosphere for workers, some philanthropic employ- ers have created idealistic towns for workers to settle in. These are known as company towns, and we turn to these now as an interesting case study.

Associated Press

In the office, there are both subtle and obvious power structures, as in this exam- ple of a male boss dictating to a female typist while standing over her paternally.

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CHAPTER 6Section 6.2 Ethical Theories of Employment

The Case of Company Towns Historically, company towns were often the product of philanthropic or religious thinking. One of the first company towns was the Scottish village of New Lanark, where the socialist utopian Robert Owen turned a mill town into a centrally run village in which the workers were well provided for. Owen set up the first elementary school in the United Kingdom, and ensured that the workers had good housing and were well fed. Owen’s experiment attracted much attention, and later famous chocolate companies such as Cadbury set up model towns for their workers. While Owen was a socialist, the Cadbury family, of Bournville, were Quakers who believed in the innate equality of men and women and sought to provide better conditions for their working colleagues out of a religious duty.

Owen later traveled to the United States and set up a communal project in New Harmony, Indiana, in 1826. However, the project and other subsequent attempts to reproduce New Lanark failed. Meanwhile, as industrial production followed the migration of European peoples across the Mid- west, company towns based on non-socialist principles flourished for several decades.

The first and most famous, the town of Pullman in Chicago, was reminis- cent of Owen’s idealism, except it was less a socialist experiment than a paternalistically run town. George Pullman, the owner of Pullman Pal- ace Car Company, set up the town, which attracted attention and awards for meeting workers’ needs. Indeed, in contrast to other tene- ments in Chicago, Pullman’s town was initially highly attractive, clean, and modern. Amenities and utili- ties were provided, but when his business took a dive in 1893, Pull- man lowered workers’ wages but kept their rents high. The result was a bitter strike the following year.

The Pullman case provides a useful example of how employer–employee tensions can break out and of the issues that ethicists draw our attention to. On the one side, a powerful company run paternalistically, employing and housing thousands of people, suddenly faces a change in fortune that means it cannot keep up its charitable principles. On the other side, thousands of people and their families who have become accustomed to the higher standard of living the company offers experience their lives being disrupted and changed.

It is not surprising that unions emerged in such situations to help redress perceived and real imbal- ances. Unions, which we will discuss later in this chapter, set up representatives to negotiate better conditions and pay for workers who would otherwise be too weak to voice their demands and con- cerns. Characteristic of many strikes, however, the Pullman Strike brought in federal troops to restore order, essentially forcing workers to give up their strike. This caused political problems between the Illinois governor and President Cleveland, and the union agitator was sentenced to prison.

Snark/Art Resource, NY

Strikers in the Pullman Strike often had deplorable living condi- tions, as shown here.

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CHAPTER 6Section 6.3 Hiring and Firing

While there are many intricacies to the Pullman case, the story pro- vides us with a general descrip- tion of how tensions may erupt: Such tensions may be hidden and go undiscussed—until something sets them off, of course. But to what extent should businesses seek to avoid such tensions? Should they be forced to consider employees’ needs through legisla- tion and greater accountability to municipal, state, or federal agen- cies, or should they be just left to work things out with workers? When an employment contract is made, is it solely about dollars and cents or does it invoke deeper responsibilities?

As we have already learned, employers are subject to regulations concerning how they treat employees, particularly regarding discrimination, but they are also subject to consumer and moral pressure. Previous chapters have discussed whether the latter are sufficient to encourage employers to be scrupulous and fair in their dealings, and while free market proponents may prefer to keep governments out of employment deals, it is nonetheless a reality for all employers that they must deal with regulations concerning hiring and firing, wages, working conditions, and unions. We will now turn our attention to each of these issues.

6.3 Hiring and Firing From the capitalist, free market perspective, if I choose not to buy a certain product, no ethical problem arises: I am exercising my freedom of choice to purchase or not purchase. The same is true for the free market view of employment: Just as I may choose to hire an individual, I may also choose not to hire that individual, or to fire him or her. In both cases, the reasons for not acting are mine alone.

However, the labor market has generally been considered different from the markets for products and services. Marx railed against what he saw as the commoditization of people—the market system’s turning people into economic objects to be bought and sold like soap. Not all free market economists would disagree with him—Adam Smith was highly concerned about the menial nature of mass production, which could reduce a worker’s brain to mush:

The man whose whole life is spent in performing a few simple operations . . . has no occasion to exert his understanding . . . . He naturally loses, therefore, the habit of such exertion, and generally becomes as stupid and ignorant as it is possible for a human creature to become. (1776/1981 p. 782)

Copyright Bettmann/Corbis/AP Images

In the 1890s, President Cleveland called in the United States 15th Infantry, Company C, to break up the Pullman Strike and restore order.

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CHAPTER 6Section 6.3 Hiring and Firing

The virtue ethicist, as you will recall, challenges us to consider the employment contract in more humane terms: Behind the employment contract are people with expectations and emotions that perhaps should be taken into account in hiring. Accordingly, it would be wrong to hire a person under false pretenses con- cerning how much the person was to be paid and what the job description would be, and indeed the law would chastise such practices as breaches of contract.

Yet is it also wrong to hire people knowing that the job may not last as long as projected, or that the job may be much more intricate than explained, or that it would be thoroughly unsuitable for the applicant in other regards? Prejudicial discrimination apart, ethi- cists draw our attention back to the human element. In employing someone, there is an element of promise keeping, a requirement of care and respect for others, and an implication that excellence should be pursued. In turn, this encourages loyalty to the employer (Guy, 1990). In other words, there is an inevitable moral dimension to hiring employees, and mutual respect helps both parties.

It would be difficult to legalize requirements of decency, care, and respect. But what if an employer shows no care for her employee? Should she be ethically con- demned or held legally responsible? Does she have to show care? What would that mean in the workplace? Should an employer have to consider the personal cir- cumstances of a potential applicant for a job? Or should personal life remain private and out-of- bounds in hiring decisions? We address these and other questions in the next section, where we discuss interviews.

What Would You Do?

You work for a decent salary in a field that you enjoy, but the line manager stresses you out every time she enters the office. You talk to colleagues and they are similarly dissatisfied, but in the present economic climate, no one wants to make a fuss in case they might lose their bonus or job.

1. Do you ignore the manager and proceed with your work as profes- sionally as you see fit, or do you ask her to show more respect?

2. Can you think of a situation in which you or someone you know has had to challenge a manager for generating stress? What were the outcomes of highlighting the problem?

3. If you were in a hiring role, what kind of character would you look for in a manager—efficient, pro- ductive, ruthless, competitive, compassionate, decisive, thought- ful? Create of list of values that you think are important and see if you can relate them to the ethical notions you are reading about.

Interviews

Interviews are highly problematic affairs. Inevitably, prejudices may affect an interview; the ethi- cist is quick to warn against personal considerations in favor of a more objective analysis of the candidate (or from the employee’s perspective, of the firm). Explicit discrimination on the grounds of race, gender, and age notwithstanding, personal assessments of a candidate obviously come into play in any interview. For example, the interviewer may find the candidate attractive, or want to find out more about his or her personal life than the job warrants knowledge of. The inter- viewer will also need to assess the candidate’s aptitude for the job: his or her intelligence, reflec- tion on prior experiences, capacity for self-direction, and interpersonal skills. Will the candidate be an asset or a liability in the workplace? Would his or her humor unsettle customers or other employees? Is the job seeker ambitious and trustworthy? What may appear to be a move towards negotiating an employment contract also involves a great deal of personal, subjective evaluation.

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CHAPTER 6Section 6.3 Hiring and Firing

Psychologists explain that we are good at recognizing whether we like or dislike a person immedi- ately. First impressions are often what interviewers rely on to assess an applicant. However, they also offer a warning that we need to be aware of for ethical considerations: First impressions are not always good indicators of how well a person may act in other contexts. That is, just because a would-be employee performs well in an interview does not mean that that person will perform well on the job. This conclusion is at odds with our intuition. Most of the time, we assume that people display the same character traits in different situations. We usually underestimate the large role that context plays in people’s behavior (Gladwell, 2000). Because of the slippery nature of the interview, human resources managers use two basic styles of interviewing: unstructured interviews and structured interviews.

Unstructured Versus Structured Interviews Some psychologists have dismissed the unstructured interview as

“essentially a romantic process, in which the job interview functions as a desexu- alized version of a date. We are looking for someone with whom we have a cer- tain chemistry, even if the coupling that results ends in tears and the pursuer and the pursued turn out to have nothing in common. We want the unlimited promise of a love affair.” (Gladwell, 2000, p. 68)

The unstructured interview is thus ineffective. Ethically, should we be flirting with a candidate as on a date? Can we remove our immediate personal like (or dislike) of a candidate to pursue a more orderly interview? That is where the structured interview comes in.

The structured interview proceeds with each interview using the same questions in the same order for all candidates. Psychologists claim that such interviews are better than unstructured ones when assessing an applicant’s true aptitude. Interestingly, structured interviews are also less likely to become targets for lawyers, as the interviewer is not likely to probe into personal ques- tions when he or she is following a script (OPM, 2008).

But critics of using only structured interviews claim that such interviews do not provide them with all of the information they need to make an employment decision. Some potential employ- ers therefore combine the structured interview with unstructured techniques. Interviewees may be invited to a hotel, for example, where they are interviewed formally. Following the structured interview, they are then observed in a social situation such as a dinner and are judged on their interpersonal skills. Do they tell politically incorrect jokes or drink too much alcohol? Do they get along well with others? The benefit of the unstructured interview and similar unstructured tech- niques is that they are not tied to a script and therefore enable the interviewer to throw curve- ball questions and create more “real world” scenarios to see how the job applicant responds. However, as noted, such interviews may cross the line of propriety, and the decision to hire may become more a subjective evaluation of chemistry than an objective assessment of ability.

From the ethical perspective, is it right to analyze how a candidate acts in a social situation that is unrelated to the workplace? It can be argued that such an interview process would be unethical on the grounds that it intrudes into private areas of the candidate’s life and has no bearing on pro- ductivity. It is thus inappropriate to observe and judge how someone relaxes in a bar or in a hotel environment, as it is none of the firm’s business. Analogously, it would be inappropriate to inquire

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CHAPTER 6Section 6.3 Hiring and Firing

into the candidate’s sexual orientation or to follow the candidate into nightclubs. So why proceed with a behavioral examination in a hotel? The capitalist ethicist here would reject any interview beyond that which is necessary for the job.

The virtue ethicist can reply that a person’s character has many aspects that do not appear in an interview, just as our best abilities are rarely seen in examinations. Rather, it is better for both parties to “get to know each other better” in the informal environments in which deeper layers of the personality emerge. For the virtue theorist, a person’s character is witnessed in the person’s habits, or typical acts during a day or over a few days. How does the person respond to inappro- priate comments, to humor, to a game, to an offer of a drink, to a political headline? To get the most out of an interview, the virtue ethicist suggests being with the candidate for longer and in different situations.

Background Checks Because standard interviews can be hit and miss, in recent years employers have used a variety of other techniques to assess a person’s character. A background check is one of these. Economi- cally, this can be seen as a cost-effective measure to avoid hiring the wrong person, but using background checks also raises some ethical concerns.

From a hirer’s perspective, the cost of employing someone is generally high. Additionally, it is esti- mated that 50% of résumés contain factual errors and that employee theft and fraud cost U.S. busi- nesses $50 billion annually (Jones, Schuckman, & Watson, 2004). It is no mystery that companies want to get it right. But when psychological testing is too expensive for the job, many employers have checked applicants’ Facebook pages and other social networking sites, for instance, to gain a better glimpse of a job applicant’s per- sonal interests and habits. In fact, a recent survey found that 40% of companies said they would check job applicants’ Facebook accounts (Jones et al., 2004).

This has stirred controversy. In some respects, if a person posts her thoughts and pictures of evenings out with friends on public sites, then it can be argued that a potential employer has the right to review her publicly declared deeds and mind- set either before or after screening (Finder, 2006). However, others see such behavior as an unwarranted intrusion into an applicant’s per- sonal life, which, they argue, does not relate to whether the person is competent to do a job or not.

What Would You Do?

You are a human resources manager for a large marketing firm. A job candidate is coming for an interview in the morn- ing. Her résumé is impressive and she seems to be a perfect match for the job.

1. In this situation, would you check the job candidate’s Facebook page? Why or why not?

2. What would you do if you found information on the job candidate’s Facebook page that you did not approve of, such as photos show- ing her partying or at political ral- lies you did not support?

3. To what extent should a candidate’s personal life remain unconnected to his or her application? Are there any personal matters that you think should be considered in hiring a candidate that would justify discov- ering them indirectly?

Associated Press/Ronald Zak

Surprised at what the Internet can hold on you? Austrian stu- dent Max Schrems, shown here, filed a request with Facebook in 2011 to obtain the personal data the company had about him. He received 1,222 pages of information, leading him to start a campaign to force the social networking site to follow data-privacy laws in Europe. Facebook argues that it already follows these laws.

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CHAPTER 6Section 6.3 Hiring and Firing

Do we have a right to enter another person’s private life? Some ethicists say no on grounds of privacy, but this presents an awkward problem. If an employer does discreetly check a blog or a Facebook page of an applicant and finds that it presents a very different pic- ture of the applicant than his résumé or interview did, is it not prudent then to seek another applicant? One example is that of a conservative Christian recruiter going through a pile of applications and rejecting a candidate based on her pro-choice feminist politics (Engler & Tanoury, 2004). This does not seem fair, but on meeting the candidate, the recruiter may very well sum up the candidate’s views and dismiss him or her anyway. Accessing a candidate’s profile online saves both parties the time and money involved. Besides, would the applicant wish to work for a conservative Christian, given her views?

Due Diligence Checking on job candidates’ Facebook pages may reduce the résumé pile on an employer’s desk, but some background checks may be made to avoid hiring a criminal, for instance, for a sensitive job. An inter- viewer may justly employ due diligence—checking a job candidate’s criminal record and employment history, performing a credit check, screening for drugs, and following up on the applicant’s references—if given the candidate’s permission.

This might seem a fair proposal to ensure that employees are not just capable but also honest and not disposed to criminal behavior. However, since that person has given permission to the employer, the information may again be accessed whenever the employer wants to know more about the workers—which raises an important question: For how long should a company continue to monitor an employee’s behavior outside of the workplace? One argument is that by monitoring an employee’s social behavior, a manager can determine whether that employee is losing focus or going through trouble outside work that may affect his productivity. For instance, the manager may become aware of the employee’s inability to keep a long-term relationship, which explains his mood swings in the office; or all night partying on the weekend could start to harm punctuality. Awareness of such pressures and tendencies may help a manager deal with an employee better— or become prepared to fire him for slacking.

Arguably, there comes a point when such research becomes intrusive, even though it may be sanc- tioned by law. Moreover, some research channels, such as the aforementioned social networking sites, can give an interviewer access to information that may not legally be used in judging appli- cability for employment, including the candidate’s age, relationship status, religious or political preference, and sexual orientation. According to the ethicist Michael Jones, companies should not be trawling for information on applicants that, unlike a credit history or a drug screening, could be unfairly taken out of context (Jones, Schuckman, & Watson, 2004). On this view, not peering into a person’s online activity is a matter of fairness. We should treat applicants equally and based on their aptitude for the job and what they do on the job, rather than on what clubs they frequent or whom they spend their weekends with.

into the candidate’s sexual orientation or to follow the candidate into nightclubs. So why proceed with a behavioral examination in a hotel? The capitalist ethicist here would reject any interview beyond that which is necessary for the job.

The virtue ethicist can reply that a person’s character has many aspects that do not appear in an interview, just as our best abilities are rarely seen in examinations. Rather, it is better for both parties to “get to know each other better” in the informal environments in which deeper layers of the personality emerge. For the virtue theorist, a person’s character is witnessed in the person’s habits, or typical acts during a day or over a few days. How does the person respond to inappro- priate comments, to humor, to a game, to an offer of a drink, to a political headline? To get the most out of an interview, the virtue ethicist suggests being with the candidate for longer and in different situations.

Background Checks Because standard interviews can be hit and miss, in recent years employers have used a variety of other techniques to assess a person’s character. A background check is one of these. Economi- cally, this can be seen as a cost-effective measure to avoid hiring the wrong person, but using background checks also raises some ethical concerns.

From a hirer’s perspective, the cost of employing someone is generally high. Additionally, it is esti- mated that 50% of résumés contain factual errors and that employee theft and fraud cost U.S. busi- nesses $50 billion annually (Jones, Schuckman, & Watson, 2004). It is no mystery that companies want to get it right. But when psychological testing is too expensive for the job, many employers have checked applicants’ Facebook pages and other social networking sites, for instance, to gain a better glimpse of a job applicant’s per- sonal interests and habits. In fact, a recent survey found that 40% of companies said they would check job applicants’ Facebook accounts (Jones et al., 2004).

This has stirred controversy. In some respects, if a person posts her thoughts and pictures of evenings out with friends on public sites, then it can be argued that a potential employer has the right to review her publicly declared deeds and mind- set either before or after screening (Finder, 2006). However, others see such behavior as an unwarranted intrusion into an applicant’s per- sonal life, which, they argue, does not relate to whether the person is competent to do a job or not.

What Would You Do?

You are a human resources manager for a large marketing firm. A job candidate is coming for an interview in the morn- ing. Her résumé is impressive and she seems to be a perfect match for the job.

1. In this situation, would you check the job candidate’s Facebook page? Why or why not?

2. What would you do if you found information on the job candidate’s Facebook page that you did not approve of, such as photos show- ing her partying or at political ral- lies you did not support?

3. To what extent should a candidate’s personal life remain unconnected to his or her application? Are there any personal matters that you think should be considered in hiring a candidate that would justify discov- ering them indirectly?

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CHAPTER 6Section 6.3 Hiring and Firing

Negligent Hiring What if after a cursory and legally diligent search, a candidate ends up with the job but turns out to be highly unsuitable and even a danger or embarrassment to the company? Negligent hiring occurs when an employer should have known about an employee’s background that would have revealed his or her dangerous or untrustworthy character. One famous example is the Massa- chusetts court case Ward. v. Trusted Health Resources (1999), in which a health-care employee murdered two of his patients. In cases like this, companies often claim they could not predict that an employee would commit murder or steal from customers. But courts have generally found companies’ defenses wanting. This, in turn, has created strong incentives for businesses to find out more about potential employees before hiring them.

One company that does background checks on applicants has claimed that employers “have not only a right, but a vested interest to know about the people they are hiring” (Hamashige, 2000). However, unsuccessful applicants have a right to ask why they did not get the job, and although they have no right to know the reasons, it would seem inappropriate for an interviewer to respond, “We didn’t like your Internet profile.” Nonetheless, the trend may be for companies to conduct secret checks of applicants. In turn, there is a growing incentive for job seekers to clean up their Facebook pages.

Firing

When it comes to firing an individual, the free market proponent says that the decision to end a contract and hence an employment relationship is really up to both individuals concerned. Either an employer or an employee can terminate a contract, giving the notice required in the contract. The socialist retorts that dismissing workers is easier on the bosses, for they are rarely impover- ished by unemployment, while workers suffer.

The reality once again lies in between: An employer may be relying heavily on an employee to complete a project but suddenly find her employee giving notice. The project cannot be completed, customers are let down, and the business’s reputation suffers. On the other side, a

dismissal can lead to the employ- ee’s being unemployed and los- ing income and self-esteem, as is often portrayed in films and books. It is a sad trend that stock prices tend to rise when listed compa- nies announce layoffs. Sharehold- ers may respond positively to the company’s being seen as cutting costs and making itself more effi- cient: Labor costs are often the highest costs that companies have. Employment is a two-way street highly dependent on mutual trust and dependency—when either fails, the contract may be severed or conditions changed to force a resignation or early retirement.

Associated Press/Ed Andrieski

In this 2011 photo, filmmaker Michael Moore speaks to Occupy Denver protesters.

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CHAPTER 6Section 6.4 Wages

Employment at Will The moral foundation for firing in America rests upon the doctrine of employment at will (EAW), which was accepted by all states until 1959. “At will” means that an employer has the right to hire, promote, demote, or fire an employee at a moment’s notice when the relationship is not covered by a contract, union agreement, public policy, or legal statute. Employers may have their reasons for firing employees, but they do not have to explain their reasons under EAW.

Free market supporters believe that the right to terminate employment is similar to a right to end any personal relationship. Why must a woman provide a reason for no longer dating a man, or vice versa? More controversially, EAW doctrine is said to encourage responsibility and innova- tion in the workplace. If a company has to put up with slow, plodding staff, the threat of layoffs may encourage them to perk up, or firing them may permit the company to compete better with competition.

EAW is also supported on several other grounds:

• Just as a manager can dismiss, so too can an employee leave under EAW. • Employers or companies have a propriety right to hire and fire as they see fit. • In choosing a job, an employee implicitly understands that it is contingent rather than a

job for life. • Intervention into EAW only causes unnecessary interference with commerce and wealth

creation.

These arguments are often used to support EAW against entitlement theories that say workers have a right to a job and a right to know why they were dismissed.

Nonetheless, as one journalist stated twenty years ago, EAW is “on its last leg” (Flynn, 1996, p. 123). The right to fire people arbitrarily has become legally limited and employers restrained as to what they can ask an employee to do. For instance, an employer cannot ask an employee to break a law or violate stated public policy, and hence cannot fire the employee for not doing so. “At will” has its legal limits. But there is also something ethically questionable about treating staff as if they were commodities being thrown into the garbage. Ethicists generally agree that employees are persons deserving respect and deserving reasons for why they may be fired. For critics, EAW also promotes arbitrariness—in a world of employers and employees, the bosses may use their power arbitrarily.

However, EAW supporters would reply that irrational management is not conducive to a healthy, productive workplace, so while whimsical firings may occur, the incentive in the marketplace is to reduce costly whims; and managers who act randomly are not going to retain their employees for long.

6.4 Wages Wages are determined for the most part in the marketplace, in which workers supply their labor and firms demand workers. In this section, we will look at issues involving the ethics of wages. The most common concern is whether the going rates of pay are “fair.”

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CHAPTER 6Section 6.4 Wages

Fair Pay

In the socialist perspective, employees often do not receive fair wages. The call for fair pay is an ancient one and reflects a notion that work somehow has an intrinsic value in itself. Pay should thus reflect the innate value of the work done, regard- less of how other people may value it.

However, free market proponents reject the notion of fair pay in preference for wages set by market con- ditions: When the demand for certain work rises, so too does the wage rate. Should the supply of work- ers expand, from migration or an increase in the birth rate, a downward pressure is put on wages. Demand and supply form an equilibrium wage rate, which is the going rate for work.

The problem with the free market wage rate is that workers are said not to possess sufficient bargaining power or information to negotiate for fair pay. Com- panies may then simply exploit workers’ ignorance to keep wages low. Adam Smith was no fan of com- panies, for he thought they would always conspire to keep wages low. Likewise, the early 19th-century English economist David Ricardo thought that wages for workers would never get above subsistence levels—that is, a wage rate that allowed them to feed themselves and their children but never get richer. Marx developed their ideas to propose that workers were always going to be exploited by capitalists, for workers do not own anything while capitalists exclu- sively own the means of production.

Minimum Wage

As socialism filtered into American liberal politics in the early 20th century, the idea was per- petuated that workers were being constantly exploited and kept on cheap wages. Minimum wage laws were then introduced in the Fair Labor Standards Act (FLSA) of 1938 to ensure that those in work receive a politically agreed-upon minimum. Interestingly, Congress had introduced minimum wages for women prior to the FLSA, but the laws were struck down by the Supreme Court for price fixing and interfering with the right to negotiate over pay (Adkins v. Children’s Hospital, 1923; Gor- man, 2008). Since the enactment of the FLSA, the federal government sets the minimum wage for the nation, while the states may set theirs above that level (Department of Labor, 2011).

Minimum wage laws generate much controversy. For proponents, they ensure that those in work are paid a rate that enables them to keep off the breadline and that may also reflect commu- nity values concerning a basic standard of living. Proponents also champion a living wage, which would also include the right to afford decent housing, child care, and health insurance.

Associated Press/David Zalubowski

In this 2006 photo, workers rally in support of raising the minimum wage in Colorado, calling for fair pay.

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CHAPTER 6Section 6.4 Wages

For opponents, minimum wage laws only protect those who are in work. By introducing a legal minimum, the law separates those who are employed at the minimum wage from those who can- not now gain employment. Consider a young and inexperienced person who is keen to get a job. Employers would like to offer him employment at $3 an hour to see how he gets on, but the law decrees that he should be paid $6 an hour, for example. He remains unemployed. In a sense, his right to compete for work has been removed. He cannot legally offer his services for less than the minimum wage, which means that he either must volunteer and work for free or must remain unemployed. Without experience, it is more difficult to find work.

The evidence on minimum wages is also controversial, with some economists finding that they do not create unemployment and others saying that they do. Even if the law does not intrude, the fair-pay claim does hold our moral attention: It seems only fair and just to treat people as we would be treated, as the principle of the Golden Rule suggests. Accordingly, we should pay people according to how we would wish to be paid.

Salary Caps

Sometimes maximum wages (or salary caps) have been proposed to prevent high earners from earning more money, often because it is considered unfair that some should earn what is consid- ered an exorbitant fee for their work. During one presidential election, the Green Party called for a maximum wage of $100,000. Still, there have been no mandatory maximum wages since colonial times, when the land-owning colonists tried to impose wage rate restrictions in the face of scarce workers and declining currency values.

Nonetheless, there are examples of salary caps in the sports world, with the American professional football, hockey, soccer, and basketball leagues all collectively negotiating maximum salaries for teams and individual players. These are types of voluntary agreements, however, which can be rejected

by teams and by players, who may leave the major associations to form new ones based on free markets for wages (as seen in European soccer, for example). The aim of such sal- ary caps in sports is to ensure that smaller teams are not outcompeted by high-financed larger teams, and that any excesses earned by clubs are returned to the sport.

The caps attract controversy, as the effects are muddied by the leagues’ cartels—which, with the exception of baseball, effectively prohibit competing leagues from being set up. In turn, media companies work with the major leagues to create high barriers to entry for investors wanting to create a new team.

Associated Press/Frank Franklin II

In this 2011 photo, National Basketball Association players- union president Derek Fisher holds a news conference on labor talks. One of the issues in the talks was the salary-cap system.

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CHAPTER 6Section 6.5 Working Conditions

Calls for maximum wages are often made on grounds of fairness. There have been calls to limit bankers’ salaries and bonuses, but the concern is that highly paid executives would just leave to find high-paying jobs elsewhere. If an executive adds several millions to a company’s profits, would it not be right for her to be rewarded proportionately? Free market economists would agree: Salaries are negotiable between individuals and there should be neither a lower minimum nor an upper maximum wage rate. But the ethicist may inquire further and ask what kind of per- son needs to be rewarded in millions of dollars.

6.5 Working Conditions Work takes place in an environment, and that environment can often be as important to work- ers as the wage they are paid. Consider mining. The risk of working underground increases the wages that miners can command in the market relative to those who do surface quarrying, for instance. One thing that all commentators on working conditions agree on is that working condi- tions have improved immensely over the past hundred years—they just disagree on the causes for this improvement.

Occupational Health and Safety

Working conditions as a term in business ethics implies thinking about the welfare, health, and safety of employees in the workplace. However, it can also include the safety of stakeholders such as customers, suppliers, and nearby residents.

The unfortunate reality of work in the past meant that accidents and deaths in the workplace cost companies very little. Workers were expendable, and so there was little incentive to ensure their welfare and safety. Progressively, though, workers combined to reduce obvious risks and lax safety conditions, and legislation began to reflect their concerns, beginning with the railroad and mining industries. In 1970, President Nixon signed the Occupational Safety and Health Act (OSH Act), designed to free workers from unnecessary risk and unhealthy work conditions. The Act sought to

assure safe and healthful working conditions for working men and women; by authorizing enforcement of the standards developed under the Act; by assisting and encouraging the States in their efforts to assure safe and healthful working conditions; by providing for research, information, education, and training in the field of occupational safety and health; and for other purposes. (Occupational Safety and Health Act of 1970, Summary)

Critics claim that the Act caused an increase in companies’ costs, which meant layoffs and a loss of competitive edge against foreign companies. Safe and healthy workplaces are certainly more pref- erable from a third person’s point of view. But if an imposed increase in safety measures meant the loss of jobs, it might not be so welcome to those forced out of work. The free market approach says that as a country gets richer, people tend to want safer workplaces and homes, so it makes sense that competition for workers would also involve offering better workplaces, which would incentivize other companies to follow suit. In other words, if my company offered employees a day care center for their children, I would attract other companies’ employees to my company even if

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CHAPTER 6Section 6.5 Working Conditions

I paid them the same hourly rate. The OSH Act merely intrudes into what the market would cater for anyway—it is an unnecessary intrusion into business life.

Also importantly for critics, the OSH Act was a benefit to large corporations who could swallow the higher costs but it was a death knell for smaller companies faced with mandatory cost increases. The larger corporations could then buy up the smaller firms, or the smaller ones would simply go under. So from the free market perspective, there is no ethical problem as such: Some people may accept working in riskier jobs than others and accept occupational hazards in return for higher pay.

But what kind of corporation or firm would wish to put the lives of its employees at risk? From a moral perspective, it seems extraordinary to seek profits and turnover at the cost of human safety. There may be risk takers in society who enjoy cleaning windows of skyscrapers or climbing, but it would not be professional or diligent to expose the average employee to hazards beyond their understanding or anticipation. Critics raise concerns about the culture of safety both in the workplace and in the nation as a whole: Is it acceptable for employees to take unnecessary or inappropriate risks without proper training, for instance?

Indeed, when the North American Free Trade Agreement came into force in 1994, there were concerns that Canadian and American companies would lose out to competition from Mexico, which was perceived to have lax restrictions for health, safety, and environmental protection. In the long run, it was argued, other countries might catch up with higher U.S. standards, but what if the competing trading partners do not have a so-called safety culture? Would it be right for an American company to lower its safety standards and expect employees to accept a higher level of risk in the workplace?

Supporters of the OSH Act may have a pessimistic or cynical view of people and corporations that echoes Marx’s critique. Workers will be paid a minimum and will be subjected to risks beyond their calling in the capitalist system, so governments must step in to impose minimum require- ments. Otherwise, unsuspecting employees may hazard their health and lives because of lazy or exploitative managers. The capitalist replies that people have a right to take on risks if they so choose: You can ride a bike into a city or take a bus; one carries a higher risk than the other. If you do not understand or know the risks, that is your fault. But the capitalist reply here is an unfair and simplistic understanding of the modern workplace. With new technologies, workers may not know about hidden toxins or radiation in the workplace, for instance, that gradually wear down their health. We need an independent scientific organization to assess the potential threats work- ers face, and in many cases that assessment of facts is not available to workers.

Understanding Hazards

Some jobs carry greater risks than others, and these differences carry over into different popula- tion segments. Men are more likely to make claims for compensation and are more likely to suffer fatalities and severe injuries in the workplace than women (Sarkis, 2000, p. 21). Teenagers are also at high risk, particularly in summer jobs. More than 60 teens a year die in the United States from workplace accidents, and their rate of injury is 75% higher than adults’ (Torres, 2006). This imposes an ethical, legal, and economic burden on companies to do more. However, if youngsters are prohibited from taking employment on the grounds that they may come to harm, the loss of experience would mean that they enter the workforce older but still untrained and liable to cause harm. A stereotype of teenagers is that they are less risk averse than older people, which implies

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CHAPTER 6Section 6.6 Unions

that they are more vulnerable to unknown hazards than are more experienced people. When a young person asks to take on a job, should an employer reduce the risks he faces, or permit him to learn on the job? There is an added, special responsibility towards younger people: The adult is in a position of role model, guide, and teacher, and these are critical responsibilities not to be entered into lightly. It is because workers have felt that their concerns were ignored that some have turned to forming unions to protect workers in the workplace as well as strive for higher wages.

6.6 Unions A union is an organization whose purpose is to protect and enhance workers’ jobs. Since their emergence in the late 19th century, unions have been praised as the saviors of the working class and condemned as disruptive and violent organizations. For socialists, they are useful vehicles to empower the working man and woman and to educate them. For capitalists, unions are impediments to competition and growth. In turn, legislation has permitted them, banned them, allowed them under certain conditions, limited their actions, jailed their leaders, and hailed them as heroes. They are controversial, and even though membership declines and grows, they have played and continue to play a role in the modern economy.

Do you agree with union membership? Do you owe more to unions than you realize, or have they been a blight on American prosperity? A brief review of unions’ aims may help you decide.

History of Unions

Although attempts to protect the interests of a class of producers or artisans go back to medieval European guilds, labor unions only emerged with the industrial revolution. At this time, skilled workers banded together to challenge the technological shift toward mass production that was causing unemployment in rural areas. The industrial revolution shifted much production from the cottage and village into the factory and city. Thousands of workers could end up working for the same company, and unions emerged to become the voice of labor, taking up the demands of oth- erwise voiceless masses submerged in sprawling cities. Members of these early unions paid into a fund to assist members in need and to negotiate for better working conditions and pay.

Initially, labor unions were motivated politically to change not just the workplace but also society and government. By using the power of workers in pursuit of a socialist agenda, late-19th-century union leaders thought they could halt capitalism and what they saw as its inherently exploitative nature. In Europe, the 20th-century union movements maintained that political momentum to rewrite society and politics, but in the United States, the unions shifted motives. Instead of com- bating corporations and “fat cats” with socialism, the unions preferred to gain as much as they could from business turnover for their members in higher wages, fewer hours, better conditions, holiday entitlements, pensions, and so on. Instead of being socialist unions, they became business unions interested in filling their members’ pockets.

The early unions in the United States were small and did not last long. There were too many opportunities for companies to take their production elsewhere and hire people for less pay, or too many migrant workers for a union to grow. Gradually, however, as cities grew up and popula- tions became more stable, unions had a chance to develop and to assert their power. The union’s power rests in its ability to call all members out on a strike: It is a most persuasive bargaining tool.

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CHAPTER 6Section 6.6 Unions

However, this power was often abused. Early unions were often violent, breaking up machinery that they saw as replacing their jobs and intimidating workers who preferred not to cooperate, calling them “scabs” and “blacklegs.” Not surprisingly, property owners turned to government to protect their property and in turn to intimidate the unions.

From a legal standpoint, up until 1840, unions were deemed as “criminal conspiracies in restraint of trade” (Goldberg, 1956, p. 157). However, following the rise of union activity, various prolabor laws were passed in the 20th century, alongside laws that also sought to restrain union activity that spilled over into violence and intimidation.

In Commonwealth v. Hunt (1842), the Massachusetts Supreme Judicial Court allowed that unions were lawful and that members were not collectively responsible for individual members’ acting crim- inally. In 1935, President Franklin Roosevelt signed the National Labor Relations Act (NLRA), or the Wagner Act. This act encouraged collective bargaining, facilitated the formation of the National Labor Relations Board, and made it easier for unions to be created (Reynolds, 2009). Union activism fol- lowing World War II was calmed in 1947 under the Labor–Management Relations Act (Taft-Hartley Act), but unions sidestepped the restrictions in the law to form union shops, in which employment does not have to be based on union membership but employees must join the union within a certain period of time or pay some fees to the union even if they do not wish to become full members.

Historians will champion whichever side they think has the moral right; many free market econo- mists do not mind unions in the abstract. Individuals, they argue, have a right to combine col- lectively. However, when the union imposes a monopoly on workers and says that they have no choice but to join, an ethical problem arises. In a world of choice, the closed-shop union removes choice. If you want to work in a profession and you have no choice but to join a union, your free- dom of choice has been removed.

But is union membership an ethical duty? On the one hand, it can be argued that unions have used up their usefulness. They helped foster a more tolerant and liberal society, but they are now defunct and even act as a brake on economic progress, as they tend to reject change and innovation as much as they reject low wages. Unions cannot do anybody any good in a dynamic marketplace. On the other hand, consider those whose lives have been improved through union action. Would women or Blacks have the same rights and respect they have today if unions had not been used in the cause to promote their dignity and freedoms? Addie Wyatt worked as a meat packer and rose to become the union representative. Her char- acter and intelligence brought her cause fame, and she later worked alongside Martin Luther King Jr. and on the Presidential Commission on the Status of Women. She was the

Copyright Bettmann/Corbis/AP Images

Addie Wyatt (second from right) worked hard to empower underpaid Black women in food processing factories; her intel- ligence and integrity brought her acclaim, and she later worked on the Presidential Commission on the Status of Women.

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CHAPTER 6Section 6.6 Unions

first Black person to be named person of the year by Time magazine. Her civil rights efforts have been saluted. It can be argued that there is a duty of solidarity, especially amongst oppressed workers, to join a union to ensure that progressive measures are continued in corporations and government.

Unions continue to face additional challenges when dealing with questions of gender and racial equality on the job. Consider the following example: In 1993, the New York City Fire Department issued an order that no photos ought to be taken of its female firefighters. The department had been a male preserve for over a century, but women were gradually passing tests to qualify as firefighters. They struggled to gain acceptance and were harassed, intimidated, bullied, and sexu- ally assaulted. The women allied with the Vulcan Society, an organization of Black firefighters, to secure the respect they deserved (MacLean, 1999, p. 44–45).

In a male-dominated profession such as firefighting, the assumption is that women should not be firefighters, as one female captain of the New York Fire Department recalled:

“When I first came on the job 23 years ago, fighting fires was the easiest part of the job for me. Much harder was dealing with the hatred and discrimination that some male firefighters had for me. Now, many of the initial problems [New York City Fire Department] women firefighters encountered have improved.” (Berk- man, n.d.)

While there have been great improvements, the gains are superficial so long as more men, or more white people, are in positions of higher authority and economic power across the country.

Professional Unions

When we think of unions, we generally think of labor unions, but there are also professional unions such as the American Medical Association (AMA). And since unions’ policies are to raise wages, it is not surprising to find critics claiming that the AMA raises doctors’ wages by restricting entry to the profession (through its influence on licensing boards) and by demanding that competing health practitioners such as homeopaths and chiropractors be criminalized by the licensing boards (Cic- chetti, 2008; Peterson & Wiese, 1995, p. 144–147). In fact, at one point the AMA was found guilty of violating the Sherman Antitrust Act in its attempts to prohibit chiropractors from practicing (Wilk v. American Medical Association, 1990). While labor unions call opponents “scabs,” profes- sional unions call the competition “unsafe” or “cults,” yet professional unions have generally been immune to the backlash against unions that arose in the 20th century to control union action.

Generally, economists agree that both labor and professional unions act to restrict the supply of their labor to the market, in order to push wages up. This also implies that to the extent that a union is successful in raising wages for its members, nonmembers will suffer a relative decline in salary. The evidence, however, is unclear: The number of physicians has increased in the past few decades, contrary to this theory. But could the number of physicians have increased further if licensing of doctors were more relaxed? That is a harder question to answer. Milton Friedman and other free market economists have thought the AMA restricts entry (Friedman, 1980, p. 273), whereas the AMA and similar professional unions prefer to claim that their purpose is to ensure patient safety as well as look after physicians’ interests. What fuels the controversy is that over 200,000 Americans die annually from mistakes caused by physicians, and over 100 million Ameri- cans have been adversely affected by medical mistakes (Null, 2010, p. 50–51).

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CHAPTER 6Section 6.7 Whistleblowing

6.7 Whistleblowing A whistleblower is a person who informs the public or someone in authority about illegal activi- ties or some other misconduct that has occurred within an organization. The term is a metaphor based on the use of whistles in law enforcement and sports, where an official draws attention to some infraction by blowing a whistle. In this section, we will review types of whistleblowing, some guidelines for whistleblowers, and some laws that protect whistleblowers.

Types of Whistleblowing

Whistleblowing can be either internal or external. Internal whistleblowing occurs when employ- ees draw attention to a misdeed by a fellow worker or supervisor. The complaint takes place within an organization’s established operational structure, and thus relies on the organization to correct the problem. A famous example of internal whistleblowing occurred at the Firestone Tire and Rubber Company. Its director of development sent a memo to top management regarding flaws in one of its products, stating, “We are making an inferior quality radial tire which will subject us to belt-edge separation at high mileage” (“Forewarnings of Fatal Flaws,” 1979). The company did not correct the problem, and blamed reports of tire failure on consumers’ underinflating their tires. A government investigation determined that the tires were in fact defective and responsible for 34 deaths. Firestone was forced to recall seven million of those tires, the largest tire recall to date.

To deal with such problems, companies sometimes have whistleblower systems or hotlines. These are mechanisms that allow for employees to make complaints within the company struc- ture. Some areas of business, such as accounting, have laws that require the implementation of whistleblower systems to collect and resolve employee complaints or concerns. These might include telephone hotlines or Internet sites where complaints can be registered anonymously. Some companies encourage internal whistleblowing, partly as an effort to eliminate any miscon- duct on the part of employees and managers in the company and partly to avoid potential legal and public relations problems and thereby protect their image as transparent and responsible companies in the eyes of the public. There are also companies that specialize in whistleblower systems and sell their services to organizations, advertising that their systems are more effective and have a lower risk of costly retaliation claims.

Unlike internal whistleblowing, with external whistleblowing the informant goes outside the organization to seek some kind of remedy. Complaints of misconduct may be brought to the atten- tion of authorities outside the organization, such as governmental oversight offices, attorneys, the media, or special interest groups such as watchdog agencies. Here are two dramatic examples:

• In the mid-1990s, Jeffrey Wigand, a former vice president of the Brown and Williamson tobacco company, appeared on the CBS news show 60 Minutes and stated that his com- pany was “a nicotine-delivery business” and had intentionally manipulated its tobacco blend to increase the amount of nicotine in cigarette smoke. He went on to provide evi- dence in a case that resulted in a $246 billion settlement with the tobacco industry. His story is depicted in the feature film The Insider.

• In another case, four employees of the pharmaceutical company Eli Lilly filed lawsuits against their employer for illegally marketing the drug Zyprexa for the treatment of dementia in the elderly, a treatment that was not approved by the Food and Drug Admin- istration. The company pled guilty and was ordered to pay $1.42 billion, which included

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CHAPTER 6Section 6.7 Whistleblowing

a $515 million criminal fine, the largest fine ever imposed on a company in the United States at that time.

Both of these are rather dramatic situations; for the typical whistleblower, appearing on national televi- sion or filing a billion-dollar lawsuit are not options. With many external whistleblowing situations, the employee simply complains to a government agency that oversees a particular area of business.

Suppose, for example, that a company violated a health or safety regulation by not providing proper protective gear for employees who work with hazard- ous material. An employee could bring the situation to the attention of the federal government through the OSH Act. In the case of violation of environmental regulations, such as improper disposal of hazardous waste, the employee could notify the Environmental Protection Agency (EPA). With violations of securi- ties regulations such as insider trading, the employee could contact the Securities and Exchange Commis- sion (SEC). For example, a vice president of Enron, Sherron Watkins, blew the whistle on her company when she informed the SEC of the irregular account- ing activities at her company. The SEC then investi- gated Enron, which ultimately led to the company’s bankruptcy.

Whistleblowing Guidelines

External whistleblowing can cause considerable harm to a company because of fines, lawsuits, and tarnishing of its public image. Consequently, employees who blow the whistle are caught in a conflict between loyalty to the company and loyalty to the public and the law. On the one hand, as members of the company they have a responsibility to look out for the best interest of their employer and avoid causing unnecessary harm. On the other hand, as citizens they have a respon- sibility to the public at large to draw attention to especially harmful activities of their company.

The act of going public with a complaint is not one to take lightly, however, and the argument can be made that in most cases it is not justifiable. Sometimes even well-intentioned whistleblowers get their facts wrong and cause a public spectacle even when the company has not committed an infraction (Tongue & Instone, 2006). Some types of whistleblowing can be unjustifiably con- frontational, such as creating a Web site that boldly states, “My company is dumping toxic waste in your backyard.” Also, some whistleblowing may be the consequence of the employee’s strong ideological convictions, which are disproportionate to the actual harm that a company does. For example, an employee who is especially sensitive over environmental issues may misconstrue a minor environmental infraction as a major one.

Associated Press/Ron Edmonds

Sherron Watkins is sworn in before Con- gress. She blew the whistle on Enron’s dubious accounting practices, and not long afterwards, she feared for her life.

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CHAPTER 6Section 6.7 Whistleblowing

Ultimately, there should be guidelines for when external whistleblowing is appropriate. Of the various suggestions that have been made, here are five valuable ones offered by political philoso- pher Richard T. De George:

1. The firm, through its product or policy, will do serious and considerable harm to the public, whether in the person of the user of its product, an innocent bystander, or the general public.

2. Once an employee identifies a serious threat to the user of a product or to the general public, the person should report it to an immediate superior and make his or her moral concern known.

3. If an employee’s immediate superior does nothing effective about the concern or com- plaint, the employee should exhaust the internal procedures and possibilities within the firm. This usually will involve taking the matter up the managerial ladder, and if neces- sary and possible, to the board of directors.

4. The whistleblower must have, or have access to, documented evidence that would convince a reasonable, impartial observer that one’s view of the situation is correct, and that the company’s product or practice poses a serious and likely danger to the public or to the user of the product.

5. The employee must have good reason to believe that by his or her going public, the nec- essary changes will be brought about. The chance of being successful must be worth the risk one takes and the danger to which one is exposed (2006).

Whistleblowers such as Jeffrey Wigand are sometimes considered folk heroes for exposing great harm. Other times, however, they are depicted as disloyal snitches or emotionally unbalanced com- plainers. In either case, through their efforts, whistleblowers put themselves at risk of employer retaliation through layoffs, pay decreases, hour cutbacks, job reassignments, and even termination. Wigand himself maintained that he was harassed and publicly discredited by Brown and Williamson for whistleblowing. Unable to find a corporate job in the aftermath, he worked for a while as a high school teacher receiving $30,000 a year, which was one tenth of his former salary. The emotional impact on whistleblowers can therefore be very great.

Whistleblowing Laws

Just a few decades ago, whistleblowers had little protection from retaliation by employers, but laws have been passed more recently to safeguard them, and employer retaliation has subsequently been on the decline. We will look at three of the more important laws protecting whistleblowers.

The False Claims Act of 1863 The False Claims Act of 1863 aimed to help the government recover money from companies that defrauded governmental programs. It was signed into law during the Civil War as a mechanism for punishing military contractors who intentionally sold the government faulty weapons and sup- plies. The law was expanded in 1986 to allow citizens to sue on behalf of the government—in essence, to blow the whistle on companies that defraud the government. Most importantly, the law allows for whistleblowers to be rewarded by receiving a percentage of the money recovered. For example, in the Zyprexa case the four employees of Eli Lilly received nearly $80 million in their share of the settlement.

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CHAPTER 6Section 6.8 Conclusion

The Whistleblower Protection Act of 1989 Next, at the urging of President Jimmy Carter, Congress passed the Whistleblower Protection Act of 1989, the purpose of which was to protect employees in government jobs from whistleblower retaliation. As the act itself stated, it sought to “strengthen and improve protection for the rights of Federal employees, to prevent reprisals, and to help eliminate wrongdoing within the Govern- ment” (Whistleblower Protection Act of 1989, §2(b)).

The No FEAR Act of 2002 A final whistleblower protection law is the Notification and Federal Employee Antidiscrimination and Retaliation Act of 2002, more commonly known as the No FEAR Act, which aimed to dis- courage supervisors in government agencies from engaging in discrimination and retaliation. The act was sparked by the case of Marsha Coleman-Adebayo, an employee of the EPA, who alerted the agency that a specific U.S. company was engaged in an environmental violation. When the EPA did not take action, she reported the violation to external organizations. When she was later denied promotion, she filed suit. The EPA was found guilty of civil rights violations and ordered to compensate her with $600,000. In an effort to reduce the occurrence of similar lawsuits against the government, the No FEAR Act was introduced, which required federal employers like the EPA to regularly notify employees of their rights and remedies regarding discrimination and whistle- blower retaliation. The notification must include the following language relating to whistleblowing:

A Federal employee with authority to take, direct others to take, recommend or approve any personnel action must not use that authority to take or fail to take, or threaten to take or fail to take, a personnel action against an employee or appli- cant because of disclosure of information by that individual that is reasonably believed to evidence violations of law, rule or regulation; gross mismanagement; gross waste of funds; an abuse of authority; or a substantial and specific danger to public health or safety. (Office of Personnel Management, n.d.)

Deadlines for retaliation complaints range from a few days to several years, depending on the type of retaliation and the governing federal or state laws. Thus, whistleblowers who wish to complain of retaliation need to be alert to these varying timetables. One resolution for retaliation is a “make whole” remedy, whereby the employee is returned to the position and status that he or she held prior to the complaint.

From an ethical perspective, the whistleblower believes that justice ought to be done—there is a perceived duty to tell the truth because the corporation or government body is acting illegally, fraudulently, or without regard to worker safety. It takes courage to tell the truth and to stand up against one’s peer group and possibly against very powerful political and economic interests. The easier route is to do nothing, say nothing, and hope the problem will go away. But, as the philoso- pher Edmund Burke warned, evil flourishes when good men and women do nothing.

6.8 Conclusion In the marketplace, goods and services are constantly being produced and exchanged. Labor, too, is an economic service offered by people in return for a wage. The contract between two people generates more emotional debate than the buying and selling of cars, though, which reflects our

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CHAPTER 6Summary

moral concern that an employment contract should involve more than just the buying and selling of time, energy, and skills. When two people interact, there is a need for respect, a fair process, and a fair contract. What that means in practice can be difficult to spell out, and even though federal laws have tried to explain what it means, it is up to the courts to decide the interpretation of the laws.

In the last century, we have generally seen a move towards protecting workers from unfair treat- ment and unhealthy working conditions, and a shift of the burden onto corporations to treat their employees with respect and decency. But the relationship goes both ways: As employment costs more in terms of wages, worker-compensation schemes, and health and safety requirements, companies have an incentive to demand more knowledge about the people they intend to hire. So employees can no longer accept that all they have to offer is what is on their résumés and transcripts: Their entire social lives spilling onto the Internet are there for employers to exam- ine (Finder, 2006). In some respect, that captures the problem of seeing employment as more than just an economic transaction—if it’s a “person to person” transaction, then each has a right to demand more knowledge about whom they’re dealing with. But if employment law is overly regulated, then we may risk returning to employment as a commodity transaction. As long as the boxes are properly ticked and the hiring and firing are done according to the letter of the law, employers may overlook important values of decency, politeness, or fairness in the transaction.

Summary In this chapter, we reviewed ethical theories concerning the nature of employment. Capitalists see employment as a simple contract between two people that is generally mutually beneficial and generally needs no other ethical consideration. Socialists see it as a matter of exploitation that will always involve a dominant partner. Virtue theorists prefer to reflect on what kind of virtuous character traits managers or employees have. From the perspective of social power struggles, what is important are the subtle prejudices that may enter the expectations of workers and managers. In hiring people today, one of the greatest temptations is to survey their social networking online; we examined whether it is right to look up or to continue monitoring people’s online activity. In firing people, we considered the right to fire at will versus the recognition that firing people at will is not conducive to a healthy, ethical workplace. Finally, we reviewed whistle- blowers and considered how important they are in bringing ethical issues to the government’s or public’s attention.

Discussion Questions

1. Against due diligence testing and surveying of applicants, an alternative view is to impose a greater role on the diligence of managers in the workplace rather than employ- ing potentially low-quality Internet searches on employees. Through no longer having the temptation to check out online profiles, managers would have to assert greater observational skills at work and ask lawyers to tighten up contractual agreements. Do you agree that putting more responsibility on the people actually hiring is better than asking third parties to do criminal and online assessments of employees and applicants?

2. When reviewing a manager or an employee, to what extent do cultural considerations and stereotypes of people enter into the analysis? Are you aware of any gender or racial biases in your own thinking or in people’s assumptions about work colleagues?

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CHAPTER 6Summary

3. Unions and various workers in big corporations and governments sometimes protest about fair pay. Outline what you think constitute the essentials of fair pay in a given job and then examine the advantages and disadvantages of enacting minimum wages, a fair- pay ethic, and maximum wages in the United States.

4. Unions have been blamed for causing disruption to the advancement of the economy; they have also been praised for their work in drawing attention to and alleviating injus- tice in the workforce. But has their day ended? With union membership on the wane, do you think that unions have a function in the current economy? Why or why not?

5. Examine a particular case of whistleblowing of your choice. What ethical reasons moti- vated the whistleblower and what was the reaction of other employees, friends, and the media? Do you think that whistleblowing should be encouraged or do you think that it would only cause a great deal of crying wolf?

Key Terms

closed-shop union A union association that a worker must join.

commoditization of people A socialist view that employment contracts turn people into commodities to be bought and sold by corpo- rations as they see fit.

company towns Towns that have built up around a single company and in which all the workers’ needs are provided for by the company.

contractual theory of employment The view that employment is just a matter of a contract rather than any other ethical expectations, such as being decent.

due diligence A range of research that a busi- nessperson is expected to make before com- mitting to a contract.

employment at will (EAW) The theory that an employment contract should be instantly terminable by either party.

equilibrium wage rate The wage set by mar- ket conditions.

exploitation theory of employment The socialist view that of the two parties engaged in a job, the boss has more power and the worker possesses little if any power.

external whistleblowing When an employee makes a complaint to an external authority such as the police, the SEC, or another federal agency.

fair pay The idea that a wage should ade- quately reflect a worker’s needs and ability to live in society.

False Claims Act of 1863 U.S. federal law to assist the government in retrieving mon- ies from people and corporations who are defrauding it.

internal whistleblowing When an employee makes a complaint about a fellow worker or corporate procedures and keeps the complaint within the company.

Labor–Management Relations Act of 1947 U.S. federal law that removed the right of unions to used closed shops.

living wage A wage that should reflect an adequate standard of living in a society.

maximum wage The highest wage that may be paid according to a government.

minimum wage law A law that stipulates the minimum wage that can be paid to an employee.

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CHAPTER 6Summary

National Labor Relations Act of 1935 (NLRA) U.S. federal law that encouraged the use of collective bargaining by unions and employers.

negligent hiring When a company hires an inappropriate person and can be ethically cen- sured for not doing its due diligence.

Notification and Federal Employee Antidis- crimination and Retaliation Act of 2002 (No FEAR Act) U.S. federal law designed to stop federal supervisors from threatening or retaliating against federal employees who blow the whistle.

Occupational Safety and Health Act (OSH Act) Introducted by the Nixon administration to regulate the protection and welfare of workers in the workplace.

professional unions White collar unions such as the American Medical Association whose purpose is to protect members’ interests.

safety culture The prevailing ethical view in a company with regards to the health, safety, and welfare of employees.

structured interview An interview that fol- lows a set list of questions.

union An organization set up to protect and advance workers’ safety, work conditions, and wages.

union shop An alternative to the closed shop that mandated union membership upon enter- ing a job contract. In a union shop, workers were still obliged to join a union later or pay fees to the union even if they preferred not to be full members.

unstructured interview An interview that fol- lows the conversation that two people make rather than being prescribed by set criteria.

virtue ethics The view that morality is grounded in the virtuous character traits that people acquire.

whistleblower Someone who divulges to an authority that the company or department he or she is working in is breaking a law.

Whistleblower Protection Act of 1989 U.S. federal law to protect federal employees who blow the whistle on fraudulent or unsafe prac- tices in federal agencies.

whistleblower systems or hotlines Systems within a corporation that allow whistleblowers to make official and sometimes anonymous complaints.

working conditions The health and safety conditions of a workplace.

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Financial Ethics

Learning Objectives

After completing this chapter, you should be able to:

• Describe the common dilemmas that accountants and financial officers face. • Consider how commercial conflicts of interest may arise in preparing accounts and financial reports, and examine whether such conflicts are best dealt with by the government or the marketplace.

• Understand some of the ways companies cheat on financial reports. • Assess the advantages and disadvantages of insider dealing. • Explain the problem of rogue trading. • Describe the various regulations concerning financial practice.

Associated Press/Peter Morgan

7

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CHAPTER 7Section 7.1 Introduction

Contents

7.1 Introduction

7.2 The Ethics of Accounting

Impartiality Berle and Means Versus Henry Manne: Two Views of Corporate Corruption Cooking the Books Transfer Pricing and Costing The Ethics of Deception U.S. Accounting and Reporting History

7.3 Commercial Conflicts of Interest

The Buyer-Beware Principle Complex Products Should Customers Do Their Homework?

7.4 Insider Trading

Insider Trading Defined Examples of Insider Trading The Free Market Perspective An Issue of Fairness Legal Theory of Misappropriation

7.5 Rogue Trading

Example of Rogue Trading: Nick Leeson What Can Be Done?

7.6 Conclusion

7.1 Introduction Recently, a steady stream of major financial scandals have rocked the business world. At one point, Enron (in the United States) was one of the world’s largest utility companies. Within a year, a massive accounting fraud was uncovered, leading to its bankruptcy. The U.S. communications company WorldCom was found to have been covering a $3.8 billion fraud, inflating its asset values to make it look financially healthier than it really was. More recently, the American businessman Bernard Madoff defrauded some 4,800 clients—including many charities—of $65 billion.

Accountants are trained professionals who are accredited and licensed to provide professional services concerning the accounts, audits, and reporting of corporations’ finances. Many are mem- bers of professional organizations, such as the American Institute of Certified Public Accountants, that have ethical principles or codes of professional conduct that members pledge to adhere to. Like medical professionals, they are expected to live up to a professional reputation that has developed over many decades. But innovation in the business world, as well as globalization, has

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put increasing pressures on accountants, auditors, and CEOs that can affect their professional judgment and lead to accounting fraud. Such fraud is costly—in fact, it is estimated to cost the U.S. economy over $300 billion annually.

In the wake of notable fraud cases such as the ones mentioned earlier, the financial profes- sion has been under intense media, regulatory, and internal scrutiny to make sure that financial professionals behave ethically. It even became popular for MBA graduates to swear an oath to uphold ethical conduct, in order to give the financial professions credibility similar to that of health services (MBA, n.d.). Yet so-called white-collar crime continues. It includes various types of financial fraud, such as embezzlement, insider trading, rogue trading, tax evasion, money laun- dering, and more.

This chapter reviews the ethical temptations that sway accountants and other financial officials away from the professionalism expected of them. We will start by taking a brief look at the laws that affect accounting and reporting.

7.2 The Ethics of Accounting Business is run on numbers. The collection, measurement, recording, and communication of finan- cial information is the foundation of accounting; these numbers in turn help owners and investors make financial decisions regarding setting up, expanding, contracting, buying, and selling businesses.

Numbers are supposed to represent objective values. Recall from Chapter 1 that some ethicists believe that moral values are objective, universal, and unchanging. We would normally imagine that numbers are objective and that financial professionals would have no trouble in assigning agreed-upon values. But this is not the case. Turnover and the quantity of sales are objectively measurable, and there can be little argument about them. However, financial professionals also must put values on assets such as property and inventories, as well as offer predictions about future sales and profits. Here is the great dilemma they face: If they stick to reporting what they can know without question, there will be very little to report. However, if they begin to place val- ues on things they do not know with certainty, they can exaggerate or underplay the corporation’s value. This has enormous repercussions on the company’s financial health.

Consider a company that owns a retail unit that it paid $1.5 million for in 2005. The property is an asset that could be sold if the company had to pay a debt. Property values have fallen in the area since 2005, and the accountant knows that the company would not get $1.5 million now, should it sell the company. But what value should be put down? One accountant may suggest $1.2 million, another $1 million. If the company wished to take out a loan, the higher value would be more useful, but if it wanted to reduce its taxable assets, the lower figure would be more useful. There is no right answer here.

Generally, accountants agree to be conservative in making up values, but what conservative means to one accountant may be very different from what it means to another. The problem is that financial numbers are not always objective; there is a great deal of subjectivity involved in producing them. As you can see, accountants can miscommunicate the reality of a company’s financial health through their use of numbers, or even lie about a company’s state of affairs.

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To increase the depth of the problem, many managers who are not financial minded have an “accounting phobia,” which means that financial irregularities, cor- porate problems, and investment opportunities can all be easily missed (Ittelson, 2009, p. 3). If most people are illiterate in the terminology and principles of finance and accounting, it is difficult to judge what is happening, never mind whether the company is acting ethically. Honest mistakes and insidious fraud may develop swiftly without many people knowing.

Not surprisingly, there is therefore a critical element of fiduciary trust that employers and employees, shareholders, and other stakeholders must have in the financial profession. Fiduciary trust implies hav- ing a faith that the accountants, auditors, and finan- cial officers will not lie, cheat, steal, or intentionally misrepresent the company’s financial health. It is this role of trust that the accounting profession is keen to stress. But the problem is that accounting, and hence financial reporting, cannot be precise.

Impartiality

One ethical practice that is often required in the finan- cial professions is impartial oversight. The financial officer dealing with the daily, monthly, and annual reports needs to be removed from any self-interest in assessing the monetary flows. Impartiality involves stepping outside of one’s current position and thinking about what should be reported as if any- one else from the profession were going over the books. However, pressures of the corporate world can undermine professional values such as impartiality as well as due diligence (checking all the key facts properly, rather than assuming that they are correct). When there is pressure to get a deal or to secure a line of funding, self-interest may overwhelm professional codes of conduct, leading to unethical behavior.

Commentators differ on whether the marketplace can look after its own problems or whether government intervention is necessary. We will now look at two theories: one that is very skeptical of businesses’ ability to run without trying to defraud people, and one that sees the marketplace as sufficiently self-regulating.

Berle and Means Versus Henry Manne: Two Views of Corporate Corruption

Two opposing positions on corporate corruption have been offered by, on the one hand, the busi- ness ethicists Adolf Berle and Gardiner Means and, on the other, by their opponent Henry Manne.

What Would You Do?

You are in charge of a company with annual sales of $5 million. You have an opportunity to secure new lend- ing from banks that could propel your company’s sales into the $10 million bracket. Deep down you feel that the company is reaching a plateau in sales, and you are concerned that the future will not be as rosy. Competition is increasing in the industry, and there has been an increase in staff turnover. The new loans could indeed work mir- acles, and if the sales do not actually take place, you could sell the company with its new financing and leave the problem to someone else. Either way, your own reputation would be intact.

1. Given this information, what would you do?

2. Should you discuss your worries that the company has seen its peak, or keep them to yourself until the funding is secured?

3. Do you think that honesty always pays?

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One view favors government regulation, whereas the other favors leaving companies alone, as any mistakes they make will be punished sufficiently in the marketplace through customers’ leaving or other companies’ buying them out.

Berle and Means: We Need Regulation Berle and Means held a cynical point of view that business managers are playing a game to defraud customers and other stakeholders as well as they can. In the absence of good checks and balances, financial managers cannot be trusted to act ethically in how they present themselves and their financial books. They offered three reasons for this:

• The people who run corporations seek to exploit the workers as well as they can to keep costs low, which helps to raise profits.

• They try to reap as much profit for themselves from the company as possible in large bonuses and dividends.

• Their accountants and auditors also get caught up in self-serving behavior and are likely to turn a blind eye to improper procedures (Berle & Means, 1932).

The resulting corrupt corporate culture snares everybody in conflict, as each tries to look after his or her own financial interests. Managers are looking for higher salaries, and accountants are looking for renewed auditing and reporting contracts. There is also the problem that corporate culture is generated from the top. If the executives are acting outside their professional ethics, the ethical tone of the corporation may then be tainted. Junior officers may thus think that cheating or covering up mistakes is acceptable. As each section of the business pursues its own interests, it can produce the kind of sick corporate culture that eventually undermined the utility giant Enron.

For Berle and Means, if business cannot be trusted to regulate itself, and if the financial profession regularly loses the trust people have in it because financial professionals are constantly seeking their own self-interest, then there is a duty for the government to regulate and to control account- ing procedures to ensure transparency and universal auditing principles and rules.

Manne: The Marketplace Can Decide An alternative position was developed by the free-market supporter Henry Manne (2009a). For Manne, businesses cannot hide falsehoods for long without being found out. When self-interested behavior turns to deceiving the public, any chance of profiting from the deception is eventually lost. Manne argued that investors have a vested interest in scrupulously examining the financial statements and cash flows of corporations in which they hold or wish to hold investments. So any fraud or strange accounting procedures are likely—or even bound—to be discovered. He offered two reasons for this:

• Fraudulent reporting is costly to businesses and shareholders, and those guilty of fraud run the risk of long-term lawsuits from aggrieved investors and even the dissolution of the company.

• If managers act against the interests of shareholders, they are likely to drive the share price down. As the share price falls, the self-serving managers have opened their company up for a takeover or merger (Manne, 2009b).

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Manne argued that the threat of being bought out is ever present in the marketplace, so exter- nal regulation beyond normal litigation against criminally fraudulent managers is unnecessary. Although directors can face a personal incentive to camouflage problems or exaggerate incomes, there is also an incentive on the part of investors and shareholders to have the numbers verified as independently as possible. And if CEOs and chief financial officers (CFOs) try to deceive, they may lose not only their reputations, but also their business.

We now turn to the particular methods that financial officers may use in deceiving shareholders, the government, and the public: cooking the books and transfer pricing and costing.

Cooking the Books

Since an element of the financial industry involves using subjective financial values, there is always an incentive to use values that serve particular people. Here we will look at the nature and pos- sible solutions of the most common problem, namely cooking the books. To cook the books is to knowingly falsify a company’s financial statements, which is illegal in the United States. It includes several unethical practices, some of which are identified here:

• Accelerating revenues is when a company brings forward future receipts as if they were earned today.

• Delaying expenses is when a company books its current expenses in the future. • Other income or expense is a term used when a company hides excess incomes or

expenses. • Pension plans are used by companies to deflate or inflate their financial position: If a com-

pany runs a pension plan and the fund is doing well, it can reduce payments into the plan to make its costs look better than they are.

• Off-balance-sheet items are used when a corporation wishes to hide in other corporations it may own liabilities and expenses that it does not want reported.

In each of these examples, the intention is to deceive. Cooking the books is not the same as creative accounting, which is legal and enables accountants and directors to record transactions in different ways for different purposes. With creative accounting, the transactions, assets, and liabilities are real rather than fictitious or sleights of hand.

The world of deceptive accounting is complex, but it often comes down to the simple ideas of falsi- fying income (e.g., by selling a product to yourself), lowering expenses incurred (and thereby mak- ing profits look higher than they are), hiding losses (by calling them profits), or exchanging assets across the company. As with other crimes, there is a belief that the officers will not be caught, that the lie is an intermediate one until things improve, or that it is worth it for the officer’s personal gain or indeed for the benefit of the company and its stakeholders. For example, consider the case of former Computer Associates CEO Sanjay Kumar—which we will examine in detail later—who acted very charitably in other areas of his life but committed fraud, perhaps in order to benefit the company as a whole. This is the ethical position of the utilitarian, who believes that the ends sought may justify the means used, so that a deception or a lie that produces good results is mor- ally acceptable. If deception creates more wealth and jobs, the utilitarian would applaud it.

But this is an argument that does not sit well with professional bodies. Things do not always turn out the way people expect. To act honestly from the beginning makes more sense than to act in the hope that the discrepancies, lies, and fraud will be ignored once great results occur. When

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there is an intention to deceive, it does not matter what results are expected: The problem lies in the intention to do wrong.

In the following two examples, we look at the frauds committed by Computer Associates and Enron. The first company survived, but the second did not.

Example of Cooking the Books: Computer Associates As the CEO of the U.S. software company Computer Associates (now CA Technologies), Sanjay Kumar found out what happens when a manager uses fraudulent financial practices to deceive

others. In 1999 and 2000, Kumar inflated the company’s sales fig- ures by drawing on present quar- terly sales figures and posting them as if they had occurred in the past (a technique known as the “35-day month”). Once an investigation began, Kumar bribed a witness. He was subsequently found guilty of fraud and obstruction of justice and was given a 12-year prison sen- tence. Computer Associates also had to pay shareholders $225 mil- lion for the losses it incurred based on the deception. The short-term gain of appearing to have stronger sales figures was quickly wiped out by Kumar’s act (Merced, 2006). Computer Associates survived, though it rebranded itself as CA Technologies and sought to move on from Kumar’s misconduct.

Example of Cooking the Books: Enron The story of Enron is a complex one. The company grew quickly and fraudulently—it became the United States’ seventh largest company in 15 years, employing 21,000 staff and operating in 40 countries. Following the deregulation of energy markets in the 1990s, Enron extended its busi- ness into different fields. For an economist, deregulation means the removal of legal barriers that inhibit competition, but for Enron it meant the freedom to deceive investors and employees about how it was faring financially. Losses were not properly aired, earnings were misrepresented, and executives embezzled funds and announced an energy crisis that did not occur. The company was heading towards bankruptcy when, in 2001, whistleblower Sherron Watkins penned an anony- mous note to CEO Ken Lay warning that the company would “implode in a wave of accounting scandals” (quoted in Carozza, 2007). Lay apparently sat on the information while the company headed towards bankruptcy. The previous CEO, Jeff Skilling—who had left earlier in the year—sold his Enron stock before the price began to fall. Skilling was indicted on several counts, including insider trading and securities fraud. Lay was later convicted of conspiracy to commit securities fraud, which led to the downfall of the company. He died before being sentenced for his crimes.

Associated Press/Louis Lanzano

In this 2006 photo, the former CEO of Computer Associates, Sanjay Kumar, leaves a federal court after being found guilty of fraud and obstruction of justice. He was given a 12-year prison sentence and fined $8 million for his part in the company’s accounting scandal.

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Enron’s auditing company, Arthur Andersen, also acted as its consultancy firm, which blurred the lines of independent assessment, allowing problems to be overlooked. Even though Arthur Andersen was even- tually acquitted of wrongdoing by the Supreme Court, in 2005, the damage was done. After initially being found guilty of obstructing justice, the company quit operating as a firm and its employees left to work with the other major accountancies.

Transfer Pricing and Costing

A further pair of methods used by companies to alter their financial positions are transfer pricing and trans- fer costing:

• Transfer pricing involves inflating revenues by making it look like the company or parts of it generate higher revenues than is actually happening.

• Transfer costing involves shifting revenues from departments facing high tax rates to those facing lower taxes. Transfer costing is legal but not necessarily ethical.

Transfer pricing is a common problem across the financial world. Let’s say Ford wants some consul- tancy work done with its production-line managers. It can either buy in services from another com- pany or use its own team from its headquarters in Detroit. Either way, it must pay a fee. What fee is

charged depends on what the finan- cial officers wish to report. Charging above the going rate can make the Ford consultants look more profit- able than if they sold their services on the market, thus inflating reve- nues. Using transfer pricing like this becomes a problem if the company is creating the appearance of higher revenues through buying from itself.

Transfer costing, on the other hand, is particularly attractive for multinational corporations seek- ing to minimize their tax burden by sheltering funds. A 2011 sur- vey showed that multinationals were being increasingly targeted for auditing by governments. The audits highlighted the prevalence of transfer costing (Cohen, 2011). In

Associated Press/Michael Stravato

In this 2004 photo, former Enron CEO Ken Lay is led into court. Lay was later con- victed of conspiracy to commit securities fraud, which led to the downfall of the company. He died before being sentenced for his crimes.

Associated Press/Louis Lanzano

In this 2005 photo, Adelphia Communications founder and for- mer CEO John Rigas leaves a federal court. Sentenced to 15 years, Rigas was convicted of hiding billions of dollars of company debt and using company funds for his own personal uses. The com- pany filed for bankruptcy in 2002 as a result of his actions.

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CHAPTER 7Section 7.2 The Ethics of Accounting

fact, the international charity Christian Aid estimated that developing countries are losing $160 billion of tax revenues annually from transfer costing (Sikka, 2009).

A conflict then arises between those who believe that corporations should pay their fair share of taxes and those who believe that companies should seek to minimize their costs, including taxes, for the benefit of shareholders. In a world of different tax brackets, it makes sense that companies seek to minimize their tax burden to improve their earnings; but is it right for them to do so?

The problem of transfer pricing and costing is compli- cated by the international structure of many corpora- tions today. Consider a product that is researched in Switzerland, produced in Japan, and then sold in the United States. Where should the profits be taxed? Tax evasion occurs when an individual or a corporation actively hides or lies about its revenues, whereas tax avoidance is a legal strategy using transfer costing and other accounting tools to minimize tax payments.

Cooking the books and transferring funds to make the company look better or to avoid higher taxes are all about deception. Deceiving people is generally con- sidered wrong, but there are those who argue that deception can play a positive role. We will look at that argument next.

The Ethics of Deception

Deception is a falsification of reality, and ethicists would stress that such falsifications cannot be sus- tained or that they are immoral and must be avoided. Following Henry Manne’s argument from before, investors have an incentive to check companies’ accounts. Therefore, financial irregularities will sooner or later emerge, or whistleblowers will point out what is occurring. Otherwise, to actively deceive someone is an immoral act, for it involves treating other people as a means to an end—it goes against the moral fiber of a civil society.

But could ethics support cooking the books? The ethics of duty would categorically say no. A direc- tor has a duty to stakeholders to be honest, and that honesty is not just the best policy, it is the only policy. Recall from Chapter 1 that the Golden Rule is something that anyone would choose in the same situation—no exceptions. So if a person altered the financial books to make the corpora- tion look better for whatever reason, they would be acting unethically.

On the other hand, a utilitarian who looks to the consequences of an action might take a more flexible approach. If a deception benefits a great number of people, then it could be an excusable strategy. And this is what challenges professional integrity across the financial profession. For

What Would You Do?

Say you are a CFO for a U.S. company earning millions in profits across Africa. You have the choice to employ trans- fer costing to avoid high local taxes and instead send the money back to the United States. There, the tax rate is lower and the profits will pay high dividends to U.S. pension funds. You are aware that Americans will directly benefit from the transfer. In addition, the company will gain extra investment funds if it looks good to U.S. banks. However, the African nations will lose tax revenues, which they could use to maintain their infrastructure and improve their education and health systems. You always complain that the African nations have problems of corruption and poor infrastructure, which higher tax revenues could help to alleviate.

1. Would you express your ideals to help the local economies by con- tributing more taxes, or would you instead look after the interests of U.S. investors?

2. Do you think companies generally should be paying local taxes?

3. Would you be in favor of all com- panies around the world paying the same tax rate?

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instance, if the intention is to secure a deal or to attract more investment that in the long run will pay off with higher profits and more wealth creation, then the utilitarian might accept a short- term deception.

But how long is the short term? In business, all is in flux: Markets change, managers come and go, financial situations alter both within a market and in the broader economy. This provides two strong incentives to exploit short-term deception:

• If a manager moves from company to company, any irregularities he generates to improve his position or department can be hidden for the short term. By the time they are uncov- ered, the manager may be long gone.

• The manager may sincerely believe that inflating revenues now will be sustained by a rise in the market and higher future cash flows.

The first is the immorality of the criminal who tries to get away with fraud and move on before he or she is caught. It is the kind of fraud that credit card thieves perpetrate by moving from state to state. The second is ethically harder to pinpoint, and indeed, expecting future cash flows is what business depends on.

For example, say an auto dealer takes on a dozen new cars in the belief that she will be able to sell them in the next month, earning an income before she has to pay off the supplier. The market has been good and she believes that her revenues will continue to increase. This is an integral element of business planning, but markets can suddenly turn and leave the trader high and dry. It turns out that she is suddenly left with a large outstanding debt and no cash flow to cover her expenses. She has to adapt—perhaps by borrowing for the short term, dropping the prices of the cars on her lot, or advertising aggressively to attract customers—or facing bankruptcy.

In the ever changing marketplace, businesses have to make many assumptions about what will happen as well as about what is happening. The auto dealer’s intention to make future monies can be understood. If she sincerely believed that higher revenues would occur, then she cannot be wholly condemned for acquiring greater stock. She can be chastised for naively assuming that the future will be like the past and for not researching her market better, but that is something all investors can be guilty of.

If she worked alone, we can say that the fault was hers and the pain of struggling to adapt was hers alone, too. But if she employed several people and had made promises to other suppliers, her action has broader effects. When a company employing thousands gets its future expecta- tions wrong, a lot of people can suffer. Some will say that that is the nature of business; others will demand that businesses be more conservative about their behavior because risky ventures harm people.

U.S. Accounting and Reporting History

In response to the stock market crash of 1929, the federal government introduced a series of reforms to the financial, banking, and accounting industries. Since then, the government has tried to calm the excesses of capitalism through regulations, while the accounting profession has pro- duced its own board to oversee professional standards.

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CHAPTER 7Section 7.3 Commercial Conflicts of Interest

Early Reforms In 1934, the Securities Exchange Act set up the Securities and Exchange Commission(SEC) under the chairmanship of U.S. businessman Joseph Kennedy. The SEC was charged with setting up stan- dards to govern accountancy and corporate reporting. It preferred, however, to delegate the task of actually creating accounting standards to the private sector, as long as that sector showed its trustworthiness in its procedures.

In response to mounting concerns, the Financial Accounting Standards Board (FASB) was set up in 1971 by the profession to produce stricter professional standards and codes of conduct. The board’s mission has been to keep full government regulation off the profession and to set independent standards by which accounting and reporting are gov- erned in the United States. These standards are known as generally accepted accounting principles (GAAP).

Sarbox Accounting scandals after 1971 encouraged Congress to introduce more regulation, such as the Sarbanes– Oxley Act of 2002 (SOX or Sarbox). The act was designed to reduce the ability of companies to amend their fig- ures to make them look more appealing to investors. Some have argued that the act provides greater trans- parency in reporting and permits investors to compare different companies on similar grounds (Henry, 2007). Others have complained that the extra rules and pro- cedures hamper American companies in international competition and that the “check-box” mentality of the act has actually distracted businesses from the very ethical principles it was supposed to foster (De Coster, 2002). In fact, in a survey of company directors, over half thought the act should be repealed (Evans, 2006).

Cooking the books and transfer pricing and costing are examples of self-interested behavior specifically in accounting. Next we will look at some other key areas of conflict and ethical problems that arise in the finance profession.

7.3 Commercial Conflicts of Interest A conflict of interest occurs when an agent who must act impartially or loyally to successfully complete a job has a competing financial or other reason not to do so. The agent in this case may be a director, an employee, or a manager who works for one corporation, for example, but has financial ties to a competing organization. Or it can be a person in a position of authority who has

Associated Press/J. Scott Applewhite

In this 2002 photo, President George W. Bush signs the Sarbanes–Oxley Act, a new law changing accounting practices and imposing tough penalties for violators. With Bush are (right to left) Senate major- ity leader Tom Daschle, Senate minority leader Trent Lott, Senator Paul Sarbanes, and Representative Mike Oxley.

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conflicting responsibilities. Additionally, there is also the consideration of who is responsible for acknowledging and resolving the conflict. Should the responsibility fall on the shoulders of corpo- rations or consumers? That is, should professionals disclose their conflicting interests in the ser- vices they offer, or should consumers be expected to work that out? The conflict of interest is the simplest problem that finance officers and accountants face. It is not always apparent, however, when a conflict arises, so this section outlines some of the key points to consider.

The Buyer-Beware Principle

A simple example of a conflict of interest is a salesperson encouraging a customer to buy a service. Obviously, the salesperson gains from the sale. Generally, people would not consider such an obvi- ous self-motivated move as an ethical problem. The job of a salesperson, after all, is to sell, and the customer knows this. But when advice on a product is given that appears impartial but is in fact underpinned by a self-serving desire to sell the product, then there can be a conflict of inter- est if the seller does not express this commercial interest. In the world of business, the principle of “buyer beware”—also known by the adopted Latin expression caveat emptor—is said to rule, and most of the population would be presumed to understand that people who are trying to sell you a product have a financial interest in doing so.

But consider another more complicated scenario. When stock markets are doing well, advice is often given freely—by TV pundits, for example—on what stock and investments to buy. Such pun- dits are not giving impartial advice, for they are generally selling brokerage services, so there is a conflict of interest that is easily spotted. However, when stock prices fall and the pundits’ expecta- tions fail, customers may then feel aggrieved and want some form of compensation. Lawyers then replace the stockbrokers, explaining how they can help clients sue the brokers. In turn, the lawyers are seeking to sell a service and attract clients. For instance, in the boom of 2000, CNBC had rep- resentatives on from the investment companies Merrill Lynch and Morgan Stanley to give advice on stocks. Following the crash, such experts were replaced by lawyers such as Jacob Zamansky, advising on suing the stockbrokers (Sheehan, 2002). Ultimately, the stock advisers and the lawyers were both selling services.

Caveat emptor becomes more intricate here. It is not always obvious that people giving financial advice are in fact speaking impartially. Many advisers are connected to the products that they sell, and a lawyer selling legal services is similar to the clothes retailer advising on clothes. But the connection is not always obvious. For instance, there is the principle of disclosure, which says that an adviser should explain personal or financial interest in the products. This is not required in a transaction as simple as purchasing a pair of jeans from the owner of a store, but it becomes increasingly important with more complex products.

Complex Products

So what if the product offered is complex, such as a mortgage, an insurance policy, or some shares or their derivatives? Accountants and financial advisers offer complex services that are often dif- ficult or even impossible for the general public to understand. That is the reason there are licens- ing bodies guiding professionals on their codes of conduct, to help them avoid conflicts of interest and to act impartially (Brooks, 2001). Indeed, since the 1990s, accountants have increasingly been taught ethics in their courses. They have been encouraged to recognize when an ethical dilemma is occurring and then to consider and evaluate alternatives and propose a solution (Stuart, 2004).

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Ethics teaches us that impartiality is generally good. In educating people, professionals should be advising as if from a third-party perspective rather than from the perspective of their own inter- ests, simplifying the procedures or contract where appropriate and at least explaining what they have to gain from the service. Expert advice is naturally useful, but even if accountants are trained in ethical analysis, how can customers know if they are getting sound, impartial advice?

In recognizing that true impartiality is difficult, some companies have developed options that converge on impartiality. For instance, many Web sites assist people in gaining knowledge about many products and service providers and in cutting through the jargon that often attends complex services. Consider the stock market: Nowadays, some online stock brokerages prefer to offer their clients a range of opinions, drawing on the recommendations of many analysts (averaging a buy or sell recommendation, for instance), or they may sell a higher quality report to subscribers that reflects their own research into the market.

If the complexity of a deal is still baffling, then expert advice can be bought, just as a lawyer’s expertise can be in, for example, creating a will, and the parties’ advice can be compared. Critics could complain that such advice would not come free, and that is true. But then is free advice— freely given by neighbors and friends without any formal training—any good?

Professionally, advisers should disclose any interest they have in providing advice, since that is the honorable, impartial, and honest thing to do for potential clients. Impartiality involves separating advice from any potential for commercial gain, whereas disclosure is admitting that there is a com- mercial interest in what is being offered, such as mortgage or debt advice.

Should Customers Do Their Homework?

But there is another angle that needs to be considered: Are customers always at fault when they fail to do their homework? A free-market proponent would say yes, the buyer should be aware and people should be responsible for their own decisions. After all, only they can learn from their own mistakes, and if they chose to avoid studying a deal or employing an expert, that is their own fault.

However, it can also be recognized that people can be swayed by their emotions and can be easily talked into decisions that they would not enter into in a more rational frame of mind. Consider a medical company offering a treatment to cure cancer. Most people would jump at the chance of saving a loved one’s life, yet they may end up paying thousands in bills for the treatment without being told of alternative, cheaper treatments. Or consider an insurance company offering to pro- tect a family from financial disaster but not explaining the small print that certain issues are not covered. Few people read the small print, and few would assume that they need legal advice on insurance. Unfortunately, the reality of legislation, regulations, and the tax code is that their com- plexity means that companies have to write complex contracts that only specialists can interpret. There is no easy solution to making things simpler.

One solution to the problem, though, is education. Professionals have a duty to explain matters clearly to their clients and to point out potential problems with a contract. Failure to do so is a lapse in professional conduct. Customers can always ask what the jargon means, and they do have a responsibility to read through contracts or employ legal counsel for large financial commit- ments. People may avoid reading the small print or shun professional advice as being expensive, but the costs are generally worth it in the long run: Accountants often say that their fee should cover the taxes that you would have paid if you were doing your own returns.

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CHAPTER 7Section 7.4 Insider Trading

7.4 Insider Trading Another white-collar financial crime that hits the headlines and attracts media attention is insider trading. In this section, we will briefly look at the laws governing insider trading, review famous insider-trading cases, and consider whether insider trading is actually a force for good.

Insider Trading Defined

Insider trading occurs when some- one has information that the rest of the public does not have and then acts on that information to deal in stocks to make a personal gain. Insider trading became well known in the 1980s, with criminal charges being filed against busi- nessmen like Michael Milken and Ivan Boesky and later in the 2000s against corporate officials from Enron. It has remained in the pub- lic eye with famous cases against media magnate Martha Stewart in 2004 and against former hedge- fund manager Raj Rajaratnam, who in 2011, was sentenced to 11 years in prison for conspiracy and securi- ties fraud.

Examples of Insider Trading

The SEC introduced laws against insider trading in 1934 on the basis that insiders had a fiduciary duty to shareholders. Under the laws, any company officer, director, or shareholder owning more than 10% of the company is defined as an insider and is therefore liable if he or she should act to profit from the inside. Examples include advance knowledge of something that would highly benefit the company’s share price, foreknowledge of a dividend cut, and unanticipated expenses.

In 1980, following a Supreme Court ruling, the SEC promoted the principle that insiders should not trade on private information on the grounds that their action is a form of fraud, because insiders have a fiduciary duty (a contractual loyalty) to people buying or selling stock in the company. In other words, they must not trade while the information remains private (Dalley, 1998). Let us look at three examples of insider trading.

Example of Getting Away with Insider Trading: Vincent Chiarella Vincent Chiarella worked in a printing company, setting up sensitive financial reports. From the information he saw—information that was not yet in the public domain—he was able to work out

Associated Press/Jin Lee

In this 2011 photo, Galleon Group founder Raj Rajaratnam leaves court after being found guilty of conspiracy and securi- ties fraud. He was sentenced to 11 years in prison.

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CHAPTER 7Section 7.4 Insider Trading

the identities of corporations involved in takeover bids. He therefore bought shares in the compa- nies before the takeover bids were made public, earning $30,000 from his trades.

The SEC attempted to prosecute him for insider trading, but the Supreme Court supported Chi- arella, arguing that he had no fiduciary duty to any shareholders, nor was he an insider. He had nonpublic information, but that did not necessitate any disclosure (Chiarella v. United States). From the case, the fiduciary duty of insiders was thus highlighted

Example of Insider Trading: Michael Milken and Ivan Boesky The U.S. stock trader Ivan Boesky was the first big fish that the SEC caught for insider trading. Boesky was a trader who dealt based on inside information to become one of Wall Street’s most successful dealers. His reputation for dealing with inside information was known before the SEC moved in. They made a deal with him to continue in his position as long as he informed on others. Eventually he was arrested for his crimes, and he pointed a finger at Michael Milken.

Milken was a prominent whiz-kid investor who had helped finance many well-known U.S. corpora- tions, such as Barnes and Noble, CNN, and Time Warner. His inno- vative techniques earned him mil- lions, but they also attracted the watchful eyes of the SEC. Although Milken was never indicted on insider trading, he spent 22 months in prison for various securities frauds and accounting irregulari- ties. Since leaving prison, Milken has sought to rehabilitate his rep- utation and put his energies and funds into curing prostate cancer, which he suffered from in 1993.

Example of Insider Trading: Martha Stewart Businesswoman Martha Stewart was prosecuted in a high-profile case for selling stock in 2001 based on insider information. Prosecutors argued that Stewart was told by a friend that his com- pany, ImClone, had had its cancer drug rejected by the Food and Drug Administration. Stewart’s stockbroker, Peter Bacanovic, subsequently sold approximately 4,000 ImClone shares for Stew- art, avoiding $45,673 in losses from the stock’s decline the following day. In 2004, Stewart was convicted of lying to investigators looking into the case. She was subsequently imprisoned for 5 months and was forced to pay approximately $195,000 in fines and penalties to the SEC. She was also barred from serving as a director of any public company for 5 years. Nonetheless, since leav- ing prison, Stewart has seen her company, Martha Stewart Living Omnimedia, grow well under her editorial direction.

Associated Press

In this 1987 photo, U.S. stock trader Ivan Boesky leaves court. Boesky was sentenced to 11 years in prison for insider trading.

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CHAPTER 7Section 7.4 Insider Trading

Stewart’s case is interesting. She did not gain from her insider infor- mation; she avoided a loss. This cre- ates a problem for ethical analysis. It is clear to see how trading based on private information before it is released into the public domain is a breach of trust or is simply unfair. However, using that information to avoid losses is a more complex issue. From classical moral theory, we could imagine that Kant would ask whether anyone in the same position as Stewart would have dutifully lost money. It seems a doubtful ethic to support.

Should insider trading be prohib- ited though? Free-market support- ers believe that it should be legal to trade information, while oppo-

nents claim that using privileged information is unfair and enriches some people while others lose out. We will compare those two positions next.

The Free Market Perspective

Free market supporters argue that insiders are doing the public a favor and they should be supported and encouraged. Indeed, the free market economist Mil- ton Friedman proclaimed that you cannot have enough insider trading, on the grounds that insider trading is the very nature of the investment world. If the SEC could ever shut down the insiders, the fear is that an important source of so much finance and investment information would go with it (Murphy, 2011).

From this view, insider trading laws are barriers to trade that should be repealed. In effect, the SEC’s interven- tions and threats upset the free flow of information that permits traders to get a better idea of where the hot deals are. The laws also provide the government with too many powers in trying to regulate dealers. It is far better to permit insider trading and to reward those who dig up useful information, which is inevitably shared quickly once they start buying or selling stock. That is, the market will produce “insider watchers” who trail the stock purchases of the known insiders, just as celebrity gossip columnists may trade tidbits with each other.

What Would You Do?

You hear from an insider that a com- pany in which you hold stock is about to be fined a billion dollars by regula- tors for breaching the country’s envi- ronmental rules. The stock is bound to fall, and you could sell now and buy the stock back cheaper in a few weeks.

1. Should you knowingly accept the loss, or do you think that anyone with that information would try to protect their own interests?

2. Would your decision change if you were told privately that stock you were about to purchase was due for a fall?

3. Can you be guilty of not buying stock today, given that informa- tion, or should you proceed with your original intent, buy the stock, and suffer a fall in values?

Associated Press/Bebeto Matthews

In this 2004 photo, Martha Stewart is shown leaving a federal court. Stewart was convicted of lying to investigators. She was imprisoned for 5 months and forced to pay $195,000 in fines and penalties to the SEC.

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CHAPTER 7Section 7.4 Insider Trading

Instead of laws, companies should look to their own contractual agreements with employees not to disclose or to benefit personally from information generated in their employment. Such nondis- closure contracts are quite common in the security and computer industries, for instance, where clients’ private information and companies’ proprietary knowledge are vital. In such instances, selling or exploiting private data or technical information breaches contractual obligations and the ethical principle of loyalty and trust.

An Issue of Fairness

The common argument against insider trading is that it is immoral on the grounds of fairness (Dal- ley, 1998). Insider trading is like giving a sprinter on the starting blocks a head start. It is not fair that an individual who is privy to some information may profit from knowing something that the rest of the public does not.

Secondly, acting on inside information is a breach of trust, even when there are no contractual agreements on nondisclosure. Even though the party acting on the information may not be legally an insider, someone in the company had to have passed the information along. That agent’s action is unethical, for it breaches professional trust and honesty.

Thirdly, there is evidence that clamping down on insider trading removes some volatility from the stock market, which in turn raises the appeal to proper investors to place their money into the markets (Padilla & Gardiner, 2009).

For many, it remains an issue of fairness plain and simple. However, when looked at closely, insider trading cases can be very complex. Much of the debate that is generated by politicians and lawyers tends to be overly simplistic and ignores economic research on the advantages to insider trading.

Legal Theory of Misappropriation

U.S. law also prohibits insider trading under the legal theory of misappropriation, which lower federal courts have tended to use since the 1980s and which the Supreme Court adopted in the case of United States v. O’Hagan in 1997. James O’Hagan, a partner in a law firm, used private information concerning one of his firm’s clients, Grand Metropolitan, which was considering an acquisition of Pillsbury. Hagan proceeded to purchase stock options without telling his firm; he profited to the tune of $4.3 million. The court ruled that any security trader who fails to dis- close personal profits gained from such exclusive information is acting deceptively by abusing the source of information. In effect, the court ruled that O’Hagan misappropriated information (United States v. O’Hagan). Misappropriation can also occur when a journalist discovers private information concerning the company and then acts on, or passes on, that information for com- mercial gain, a principle that echoes the contract of nondisclosure. However, the O’Hagan case has not completely standardized the issue of insider dealing, as what constitutes misappropria- tion remains a complex issue.

The problem is that profiting on the information is not always a certainty. Any investment car- ries with it a risk that the information used may not turn out to be so profitable after all—the market may discount the new information as it reaches the public’s ears. Alternatively, if the

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CHAPTER 7Section 7.5 Rogue Trading

information is profitable, others may get wind of the private channels of information used and follow the leads assiduously, as gossip magazines follow the lives of celebrities. In other words, if someone is making it rich quickly, others will dig around to find out how he or she is doing it. Indeed, any officers or managers of a company holding more than 10% of its shares must disclose their purchases of the com- pany’s stock to the SEC on Form 4, and their activi- ties can attract investors’ interest. After all, if a director, who has a much better knowledge of the company and its prospects than does a stock analyst in a different state, starts buying the company’s shares, most would believe that the action indicates some good news in the pipeline. But it is not always about buying stock.

Nonetheless, in the meantime the courts continue to work out the relationship of the SEC’s rules on insider trading to create a standard definition. As one legal scholar summed it up, “In so doing, they take their places in the ranks of jurists through the centuries who have wrestled with the question: ‘When is it unlawful to buy or sell a thing when you know some- thing the other party doesn’t?’” (Dalley, 1998).

Insider trading is a slippery eel that lawyers will con- tinue to wrangle over, but rogue trading is a more obvious form of fraud. When a rogue trader is discov- ered, the losses can be in the millions and companies can fall spectacularly. We look at this next.

7.5 Rogue Trading In 1994, Joseph Jett was discovered to have made false trades worth $330 million for Kidder, Peabody, and Co., a subsidiary of General Electric. It was the largest trading loss up to that time. In 1995, Toshihide Iguchi was indicted for rogue trading in the Daiwa Bank of Japan from its Wall Street offices. Over a period of 11 years, he had made over 30,000 unauthorized trades and had lost the bank $1.1 billion. More recently, in late 2011, Kweku Adoboli was arrested and accused of rogue trading after the Swiss bank UBS revealed that it had lost $2.2 billion. But the most “glamor- ous” was Nick Leeson, whose rogue trading brought down a prestigious British banking firm.

Similar to inside dealers, a rogue trader works within a company, usually in an investment com- pany or division. Rather than profiting from using private information held by the company to buy shares and their derivatives, rogue traders abuse the freedom they possess to profit from the company’s resources that they have been entrusted with. In an investment company, an employee can be provided with a trading account and a job to enhance the profits. However, the rogue gets

What Would You Do?

You hear from a good friend news of a tragedy, about to be announced in the morning, involving the listed company that he works for. A gold mine in Peru that was securing several tons of the valuable metal collapsed, killing several people. The mine itself will be closed for a year at least, and compensation claims may end up shutting down the facility completely. You have a chance of making a lot of money on the infor- mation by selling the stock and buying derivative options, which make money as the stock price comes down. The information is being held from the pub- lic until next of kin are informed.

1. Should you act on the information, or would you deem it immoral to earn money on the deaths of the miners?

2. If you chose to sell, on what grounds would you justify your action?

3. Would your decision alter if the disaster involved the deaths of hundreds of people?

4. Is there any kind of information that you believe people should not make money from?

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CHAPTER 7Section 7.5 Rogue Trading

carried away and begins dealing secretly, seeking to cover up mistakes and losses by manipulating deals. The fiduciary trust that exists between the corporation and the employee is then broken.

Rogue trading is exceedingly costly, and corporations have a strong incentive to ensure that their employees do not overstep their bounds. For instance, line managers check their deals and returns and regularly audit the balance book. However, some, perhaps given more trust than others, can run up massive debts.

Example of Rogue Trading: Nick Leeson

One of the most famous rogue traders was the Englishman Nick Leeson, whose actions brought down an old, well-established investment company, Barings Bank, in 1995. Barings was founded in 1792, helped finance the Louisiana Purchase from France in 1803, and rose to prominence with the British establishment. Queen Elizabeth was banking with Barings when Leeson effectively bankrupted the company.

Seen as an innovative whiz kid, Leeson was entrusted by the bank’s managers in London to deal in Japanese futures. Futures are contracts to buy and sell stock or commodities now for a future delivery date. Their prices can fluctuate wildly as trad- ers take positions on whether they believe prices of the stocks or commodities will rise or will fall. In his newly created position as head trader in Singapore, Leeson came across an obscure Barings account named “error account 88888,” into which a previous employee had shifted losses of 20,000 pounds. Rather than report it, Leeson began to use the account to channel the losses that he was incurring from his trading.

His job was to turn over contracts in a very short term, a simple task that would net very little money per trade even on large contracts. But he reasoned that he could net more if the contract were held for a lon- ger period and the market rose at the same time. Lee- son held onto his contracts in the hope that the prices would rise, but the market turned against him, and the Kobe earthquake of January 1995 sealed his fate. He had bet on the Nikkei index rising; it fell (Ball, Chap- man, & Cross, 1999).

As head of his trading team in Singapore, Leeson also had a conflict of interest, since he was in charge of auditing his own position—the managers did not want to incur higher expenses in splitting his position. When he made losses, he was able to report them as profits; as he commented about his supervisors, “peo- ple at the London end of Barings were all so know-all that nobody dared ask a stupid question in case they looked silly in front of everyone else” (Leeson, 1996,

Associated Press/Anat Givon

In this 1995 photo, a bottle of Leeson Lager is displayed, showing Nick Leeson under arrest in Germany after he fled Sin- gapore. The bottle refers to the amount Leeson lost (“US$ 1.4bn Proof”) and the secret account he used to hide his crimes (“88888 Reserve”).

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CHAPTER 7Section 7.6 Conclusion

p. 38). That is, his supervisors failed morally. They preferred to maintain the appearance of profes- sional integrity and banking solidity than to inquire too closely into the daily routines of the com- pany. The losses eventually totaled $1.4 billion—more than the company’s assets and reserves. Barings filed for bankruptcy.

Leeson’s account is instructive. While he was doing well, he was given more trust. But that was not balanced by the removal of the conflict of interest he had as head of his department or by the addition of other auditors. His supervisors failed to hire an auditor for his department, and they preferred not to look stupid through asking relevant questions. The flexibility and trust Leeson initially possessed turned into a greed for beating the market.

What Can Be Done?

Are Leeson and other rogue traders to blame, though? Part of the problem lies with manage- ment. As one commentator has put it: “What makes a rogue trader? The real answer is—a terrible accounting system, reporting system, and lack of internal control. It is actually a management problem” (Hutchinson, 2011). Corporate culture, for such critics, creates the environment in which rogue traders can gamble beyond their official responsibility (Davis, 2011). Employees may feel powerless to stop their rogue gambling when management and reporting are lax, which empha- sizes the need for clarity of purpose and checks and balances in a corporation to ensure that each employee knows the line managers and avenues of complaint or concern.

On the other hand, it can be argued that rogue trading is relatively rare, and the cost of imposing on employees a system of rules and reporting procedures may be the loss of their trust. In financial reporting, accountancy, auditing, and so on, professionals expect to hold the trust of their employ- ers: Their education and professionalism imply a status that should be respected. Accordingly, although there are a few who will abuse their trust—just as there are medics and lawyers who will do so—financial professionals should be allowed to retain the freedom to act as they choose.

7.6 Conclusion Part of the problem concerning the ethics of the finance world is the technical difficulties in understanding whether an unethical action is in fact taking place, and if so, whether it is deeply problematic enough to warrant government or legislative intervention. Companies can legally use creative accounting to shift funds around, to ensure that their tax burden is minimized as well as to increase their funding for asset acquisition, but they morally and legally should not be writing in funds and assets that are not there. While there may be a gray area between creative and fraudu- lent accounting, financial officers retain a duty to be conservative with estimations of value. There are enough ways of making money legally, rather than illegally, and those who do step into illegal procedures fall afoul of the law and potential shareholders and investors.

Professionals can be given freedom and responsibility, but that does not mean that they should go unsupervised and without independent auditing of their positions and accounts. Nick Leeson broke Barings Bank because the bank did not want to pay for supervision. Just as with govern- ment, it is vital to ensure that there are checks and balances against personal greed and incompe- tence, and that always comes at a cost.

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CHAPTER 7Summary

Summary In this chapter we saw that white-collar crime as it relates to financial and accounting practices can be highly expensive. Financial reporting, we noted, is not an objective science, for values allot- ted to corporate assets are ultimately subjective. This means that financial officers often act in a hazy area in which undervaluing or overvaluing a company’s assets and liabilities can have moral as well as market implications. A temptation is always present to represent a company in a good light to secure funding or to advance its interests and profits for a host of reasons.

Financial officers, auditors, and accountants should act conservatively in their evaluations and should note financial discrepancies; but sometimes the temptation or the commands from man- agers can override professional values and legal considerations, as when companies use transfer pricing to enhance their turnover. While it seems reasonable for financial officers to shift funds into countries with lower taxes, we asked whether their actions are ethical. By avoiding tax payments in host countries, they are depriving those countries of sometimes critical funds to help them develop.

The morality of the law in financial and related cases is often confusing, too. There is the ongoing debate on the morality of insider trading, for instance, with proponents claiming that insiders help information flow and opponents arguing that insiders act unfairly.

Finally, we reviewed the problem of rogue traders who break the trust that managers place in them, and who can run up huge debts. While rogue traders are rare, there is a clash between accepting professionalism and an appropriate freedom of action and scrutinizing their every move.

Discussion Questions

1. Henry Manne believed that companies cannot become too incompetent or corrupt, as eventually their share price would fall and they could be taken over by another firm that would get rid of incompetent management. Adolf Berle and Gardiner Means believed that company managers have an incentive to feather their own nests and to undermine share- holder wealth. Using examples, which theory do you think best fits American companies?

2. Financial reporting is a complex procedure that can affect company status and investment opportunities. When a company overstates the value of its assets, it has the potential to tap into new funding or to acquire other businesses. To what extent do you think financial officers should encourage a rosier view of the company, compared to a pessimistic view?

3. Insiders are people who are legally and prominently connected to a listed company; if they act on information that is presently private, they are committing a crime, according to the SEC. Some theorists believe that insider trading laws are illogical and impede the flow of information, making investors wary of police action against them. Outline the SEC rules on insider trading and, using an example of recent insider dealing problems, discuss whether the rules make ethical sense.

4. Rogue trading occurs when an employee takes advantage of financial powers entrusted to him or her. Compare a couple of examples of rogue traders, evaluating whether the blame lies with the corporate culture or with the gambling of the trader. In your evalua- tion, also consider whether traders’ freedom to act should be limited, and, if so, whether such limitations would be an insult to their professionalism.

5. White-collar crime costs the American economy around $300 billion annually. For some, the violation of fiduciary professional trust is a heinous crime that warrants strong

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CHAPTER 7Summary

penalties in order to make an example of people who would break the trust of corpora- tions and the public. Should the professional status of such criminals attract harsher sen- tencing, compared to sentences for other crimes such as robbery and violent assault?

Key Terms

caveat emptor Latin expression meaning “buyer beware,” expressing the theory that consumers are responsible for their purchases.

conflict of interest When a person has two or more conflicting loyalties that can compromise their impartiality in working for a business or preparing a report.

cooking the books A general term describing the use of illegal accounting methods to exag- gerate incomes or to hide losses.

creative accounting Legal use of accounts to shuffle funds around a corporation to make it look stronger or more profitable.

fiduciary trust The trust that nonprofession- als have in the finance and accounting profes- sion that members of that profession will act properly.

Financial Accounting Standards Board (FASB) An independent board set up by the financial industry to promote standards.

Generally Accepted Accounting Principles (GAAP) The standards formed by the finance industry on accounting and financial reporting.

impartial oversight The ethical mindset of tackling a problem or reviewing a business situation without any self-interest involved.

insider According to the SEC, any company officer, director, or shareholder owning more than 10% of the company’s stock.

insider trading This occurs when an insider, as defined by the SEC, trades on information which has not yet been made public. Insider dealing is illegal, although ethicists debate whether it should remain illegal.

rogue trader An employee who abuses the trust given to him or her and uses company funds for personal profit or covers up losses using secret accounts is a rogue trader.

Sarbanes–Oxley Act of 2002 U.S. federal law to encourage greater transparency in corpo- rate financial reporting.

Securities and Exchange Commission (SEC) The Securities and Exchange Commission was set up in 1934 to oversee and regulate the securities and exchanges industry in the after- math of the Great Wall Street Crash of 1929.

Securities Exchange Act of 1934 U.S. federal law that set up the SEC to oversee the financial markets.

tax avoidance The legal use of accounting practices to reduce a tax burden.

tax evasion The illegal hiding of money earned to reduce a tax burden.

transfer costing Shifting funds across a cor- poration, particularly a multinational one, to decrease a tax burden.

transfer pricing A method of making a corpo- ration look more profitable by selling goods or services across the corporation. If a company sells another division a service, this can be booked as revenue, so if the “price” charged is inflated, the company’s revenues can be made to look better than they are.

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International Business and Multinationals

Learning Objectives

After completing this chapter, you should be able to:

• Analyze the reasons why international trade can cause ethical issues for companies and individuals. • Review the role that multinational corporations have in global trade and the ethical standards that they can meet.

• Consider the problem of gift giving and bribery and draw a judgment on corporations engaging in them. • Examine whether child labor and sweatshops are ethically acceptable. • Have an understanding of intellectual property and technological transfer issues as they relate to multina- tional enterprises and doing business around the world.

Ma jian/Imaginechina

8

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CHAPTER 8Section 8.1 Introduction

Contents

8.1 Introduction

8.2 Tax and Environmental Issues

Multinationals and Tax Avoidance Gift Giving and Bribery Environmental Restrictions

8.3 Labor Issues

Child Labor Sweatshops Illegal Immigrant Workers

8.4 Technology Issues

Intellectual Property Theft Technological Transfers

8.5 Ethically Evaluating Multinational Business Activities

Relativism: Western Cultural Norms Affecting Other Cultures Pros and Cons of Multinational Businesses Creating a Global Business Ethic

8.6 Conclusion

8.1 Introduction Some decades ago, the American company International Telephone and Telegraph (ITT) was caught interfering in the political operations of the South American country of Chile. At the time, ITT was the eighth largest Fortune 500 company, with 350,000 employees in 80 countries. Chile was poor but politically stable. A presidential candidate named Salvador Allende campaigned on a communist platform, emphasizing the issue of land reform and indicating his desire to take control of privately owned Chilean telephone companies because of their inefficiency. ITT owned 70% of the stock in one of these, and feared that, if elected, Allende would simply take ownership of it with no compensation, as had happened with private businesses in Cuba and Peru during their communist takeovers. As a result, ITT offered money to the American CIA to help block Allende’s election and support a rival candidate. The scandal surfaced, and critics worldwide attacked ITT for interfering in the activity of a foreign government. Some of ITT’s property was even bombed in protest. Allende was elected anyway, and in retaliation, he nationalized ITT’s Chilean property. Allende did not nationalize other firms, although he required some to sell the government shares of their stock. Allende was assassinated shortly after, and ITT later sued for losses.

While ITT’s concerns were justified, its response was not. The issues that we consider in this chap- ter come from the very nature of dealing with foreign companies and people. When companies cross borders, they must deal with foreign laws and politics, but also with customs and expecta- tions concerning how to act and what is proper and improper in business transactions. This can cause misunderstandings and create clashes of values between the trading partners, since what

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CHAPTER 8Section 8.2 Tax and Environmental Issues

is considered right and proper in one society is not necessarily so in another. In Chapter 1 we encountered the theory of moral relativism, in which moral values are held to be different in dif- ferent cultures. When companies engage in international trade, they certainly encounter exam- ples of laws and cultural behavior that can differ radically from those at home. A tension can then emerge when there are clashes of values, in which American businesses working abroad may have to decide between respecting and abiding by local customs and going by their own ethical culture.

In this chapter, we will examine international trade and the general ethical issues that it creates, especially how it relates to the behavior of U.S. multinational companies. In particular, we exam- ine the problems of child labor, sweatshops, gift giving, and bribery, as well as the complex issues of intellectual property and technological transfers between nations.

8.2 Tax and Environmental Issues When trade stretches beyond the national border, international trade begins. At its simplest, inter- national trade involves importing and exporting. When companies go beyond their national borders to set up factories, warehouses, offices, and shops, they are referred to as multinational corpora- tions or multinationals. World trade has increased massively, with merchant shipping alone rising from 8 billion tons to 32 billions in the past four decades (“Value and Volume,” n.d.). The growth of trade across borders, and its cultural impact, is called globalization. The ethical arguments on glo- balization would require another book, so in this chapter we will examine the main issues that crit- ics bring up concerning corporations dealing in international trade and multinational corporations.

The international business environment is characterized by many different nations with different rules, taxes, and customs as well as opportunities to trade with and enrich both corporations and local peoples. But there are many issues that affect the ability of multinationals and international businesses to work efficiently and even ethically. Sometimes, the problem is not the company’s lack of trying but practices that are widespread and that persist despite attempts to change peo- ple’s thinking and outlook. Or perhaps these things just take time.

In this section, we will look at some specific ethical problems that affect international businesses and multinationals. First we will consider the thorny problem of where multinationals should pay their taxes.

Multinationals and Tax Avoidance

One issue that concerns critics of multinational enterprise is who owns the profits these busi- nesses create, and therefore who should tax them. Currently, U.S. tax policy creates an incentive for multinational enterprises to keep their cash abroad rather than return it to the United States. So-called repatriated income, which is money brought back to the United States from foreign sub- sidiaries, is taxed at 35%. This is one of the highest corporate tax rates in the world.

Not surprisingly, companies like Microsoft, Google, and Hewlett-Packard therefore keep much of their cash abroad, sometimes using it to expand further into other countries or letting it earn interest in foreign banks (Kocieniewski, 2011). In the current economic climate, in which the U.S. government faces enormous debt problems, this poses interesting questions:

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CHAPTER 8Section 8.2 Tax and Environmental Issues

• Should U.S. corporations be forced to bring back money earned abroad to help ease the economic crisis, or should they be free to use their money as they see fit?

• Do companies owe any allegiance to the government or people of their homeland, or should they be free to fly any “flag of convenience” and allocate funds according to the cheapest tax zone?

The ethics of the issue relate to the duties that a homegrown corporation (especially one that grew because of the political or economic climate created by U.S. governments of the past) owes to its home nation. Consider General Electric (GE), which in 2010 reported worldwide profits of $14.2 billion, with $5.1 billion coming from the United States—but had a U.S. federal tax bill of zero, through creative accounting procedures (Kocieniewski, 2011).

GE’s zero tax bill is extraordinary, and represents the clash for a company between accepting the local tax policies and enriching its investors and shareholders. For critics of multinationals, it is ammunition for the case that multinationals are above the law in some respects and that govern- ments must accept what they do to avoid paying taxes. For supporters of multinationals, the issue relates more to corporate financial officers doing their job in minimizing external costs (taxes in this case) so they can plow money back into those who support the company with their funds— and that can include the pension policies and mutual funds of many ordinary Americans.

Gift Giving and Bribery

An integral part of some countries’ commercial culture is the presenting of gifts that are designed to pave the way for easier business. There are two kinds of gifting:

• A voluntary one that can be considered part of public-relations exercises. This can be called gift giving.

• A so-called involuntary act that cannot be avoided and typically involves securing licenses or contracts from public officials. This can be also called bribery and is sometimes viewed by business people as a tax on doing business.

Gift giving can mean different things to different people and is often used to smooth out the prob- lems that international trade can create. Imagine two delegates meeting for lunch to go over some figures. It would not be wrong for the one to offer to pay for lunch, but what about paying for tick- ets to see the Super Bowl? The problem with gift giving comes when it exceeds certain amounts or is intended to financially benefit certain members with preferential treatment. It can easily be confused with a corporate-relations exercise, and needs to be carefully monitored by managers and auditors. Regulators have also begun to clamp down on gift giving to foreign state-owned companies. Employees of these companies are to be regarded as state officials, so an American’s providing gifts to them would fall afoul of Department of Justice and SEC rules on corrupting for- eign governments (Sender, 2011).

The problem with bribery is that it often involves an attempt by a company manager to win over a state official. The state official privately benefits from the deal, which may include cash, tickets, fine art, luxury evenings out, or job positions for family members. Bribing officials to gain licenses or other privileges is corrupt and illegal, but is particularly widespread in civil-engineer- ing projects, which can be worth billions. According to critics, multinationals can engage in cor- ruption without much concern, although indeed, some big companies have been fined recently,

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CHAPTER 8Section 8.2 Tax and Environmental Issues

including IBM, British Aerospace, Halliburton, and Siemens. In 2008, the German company Siemens paid a $1.29 billion settlement to U.S. and German authorities over a bribery scandal in which most of the managers of the company left. They had generated a fund specifi- cally for bribery.

On the other hand, bribery only flourishes when state authorities have discretionary powers. Com- panies are interested in doing busi- ness as effectively as possible: It is not in corporate interests to engage in bribery, as it is an extra cost. But of course individual managers can profit handsomely from winning deals with governments abroad, so corporations need a strong ethic on what is acceptable and what is not. In the Siemens case, the company turned on the managers to sue them for improper practice.

Corruption such as bribery and gift giving is big business and is an ongoing concern for ethicists and lobby groups demanding greater transparency around the world. Any form of corruption dis- torts trade, holds back economic growth, creates unnecessary inefficiencies in commercial trans- actions, runs contrary to the rule of law, and generates an atmosphere of distrust and injustice in which the whimsical decisions of officers can have influential effects on people’s lives (Klitgaard, Maclean-Abaroa, & Lindsey Parris, 2000, p. 4; Mauro, 1997).

A way to reduce corruption going forward is to expand educational opportunities. One economist found that, as the amount spent on education rises, the extent of corruption falls (Mauro, 1997). Usually we turn to governments to educate people, but in the case of the multinationals, they are also in a position to encourage investment in education, both through government channels and through investing in educating their own employees abroad. For those who focus on the social impact of companies, this is a duty that multinationals should take up; the longer term effects of helping to educate, train, and coach employees, rather than leaving them at a low skill level, could outweigh the initial costs. Governments in turn must reduce discretionary powers that encourage officials to accept bribes. As with companies, more checks and balances and independent audit- ing would reduce the temptation faced by officials in powerful positions to gain from company contact.

Environmental Restrictions

In addition to tax issues, multinational corporations must consider environmental regulations in the countries they operate in. For example, other nations may have laxer rules on environmental pollution and standards than the United States has. If American companies choose to work in coun- tries with laxer standards, it may reflect badly on whatever ethical standards the companies are

James Lauritz

Ethicists demand that businesses conduct their transactions in the open, but many deals continue to be made behind the scenes.

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CHAPTER 8Section 8.2 Tax and Environmental Issues

trying to uphold in the home market. And if a poorer nation has weaker environmental standards, is it right for a U.S. company to lower its own standards, or should it set an example in raising local standards—but then run the risk of incurring higher costs? Higher costs may translate into a loss competitive edge in the global market, and poor consumers can end up paying more for products.

For instance, in 2002, Sempra Energy of California attracted criticism from environmentalists for deciding to set up a gas-powered electrical plant 3 miles over the Mexican border to supply San Diego and Los Angeles. The same project would not have met Californian regulations without

incurring higher costs (Ross, 2002).

The issue deepens if the product is to be mined or manufactured for American consumption. If Americans benefit from cheaper products, does it make it right to produce abroad and generate pol- lution and health problems for for- eign populations?

Consider a U.S. company that pays lower wages to a local population than it would pay in the United States. This would seem a proper course of action: The company adapts to the local economy and pays wages accordingly. However, polluting the environment is a dif- ferent problem from that of hiring low-paid workers. Labor is a nec- essary internal cost of production for the company, whereas environ-

mental standards are an imposed social cost affecting others. In the absence of legal or envi- ronmental regulations, the company has no economic incentive to copy U.S. standards while it operates abroad, and to do so would raise costs.

But should we be thinking purely along nationalist lines? Ethically, the health impact on a Mexican citizen should weigh the same as the impact on an American citizen. Accordingly, it is wrong for a U.S. company to pollute abroad when it would not do so back home. Since it is wrong to harm another, and it does not matter who the person is, it follows that it is wrong to pollute another country’s resources. The managers ought to consider citizens of other countries as they would consider their own neighbors.

However, American companies have moved to countries with weaker environmental regulations and have lowered their own standards accordingly. In the search for larger market share or higher profits, the incentive is to seek a looser regulatory environment. Some have claimed that because American companies can enjoy weaker environmental regulations abroad, they are pressuring the U.S. government to make life similarly easy for them in the United States (Perkin, 1996, p. 20). Here there is an example of a moral inversion: companies arguing that weaker ethical guidelines are better than stricter ones.

Associated Press/Sandy Huffaker

This photo from 2005 shows the beginning of construction work on Sempra Energy’s new power station near a small fish- ing village south of Rosarito Beach, in Baja Mexico. Environ- mentalists complained that the plant would not have passed Californian environmental controls.

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CHAPTER 8Section 8.3 Labor Issues

The next example involves the troubling problem of child labor used around the world by local and multinational enterprises.

8.3 Labor Issues Another set of issues with multinationals involves treatment of workers, in particular the prob- lems of child labor, foreign sweatshops, and illegal-immigrant workers. We turn to those next.

Child Labor

One of the most emotional issues that international trade evokes is the use of children in pro- duction. It is estimated that globally, over 250 million children between the ages of 5 and 14 are engaged in some form of work. Some of this work may be considered educationally and culturally beneficial, but some involves dangerous and hazardous conditions, such as working with chemi- cals or machinery, being enrolled in the military, slavery, and child prostitution. Critics have esti- mated that 215 million of these children are working illegally, according to national laws (“Child Labour Guide,” 2011). The use of child labor can occur directly, within a multinational’s own facto- ries, or indirectly, through the supply chains the company uses.

A Historical Perspective Most countries have prohibitions on child labor, but enforcing these laws can be problematic. India and China, for example, have large rural areas where traditional working patterns involve children from an early age. In India, children can be sold into bonded labor, which is a type of slavery, while parents pay off a debt. Even if the children are attracted to working because of the money, they can end up working in hazardous conditions, such as in coal mines or garbage dumps (Magnier, 2011).

America has a tradition of child labor too. In colonial times, chil- dren as young as 8 could be bound to a master to work until the age of 21 in exchange for food, shelter, and clothing. As the industrial era took off, children were routinely found working in mines, facto- ries, and farms, as well as running errands and selling products on the streets. In 1836, Massachusetts passed the first law concerning the employment of children. The law stated that children under 15 years old should attend school for at least 3 months a year. In 1842, the state passed an upper limit of 10 hours of work a day. The rise of

Associated Press/Rajesh Kumar Singh

In this 2010 photo, children in Kanpur, India, are going through recyclable waste looking for rags to sell.

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CHAPTER 8Section 8.3 Labor Issues

the union movement in the late 19th century also witnessed calls to ban children under age 14 from working. In the early 20th century, American children could still be found selling newspapers and working on farms or in factories and mines; their images are captured in photographs by Lewis Hine. (History Place, n.d.).

Charitable organizations continued to support child-welfare reforms and to push for bans on what was considered to be child slavery and exploitation, which culminated in provisions under the Fair

Labor Standards Act of 1938. Later, the Supreme Court finally held that the government had the authority to regulate the actions and treat- ment of children.

For an ethicist, the relevant ques- tion here as it relates to multina- tionals is whether a child should be considered on an equal basis with an adult or whether childhood is a different category of personhood that generates unique responsibili- ties to children and rights that adults do not possess. Should a child be protected from becoming an adult too early, or should children have rights of access to the adult world, including employment?

Protecting Children Many philosophers, such as John Stuart Mill and John Dewey, have argued that children deserve protection from the demands and expectations of the adult world and that they should be pro- tected legally for their own good. But at what age should society consider a person to be a child?

Consider the age of consent, when a young person is legally permitted to engage in sexual activ- ity—a boundary that can be said to separate childhood from adulthood. In Canada and the United Kingdom, it is 16, whereas in the United States it ranges from 16 to 18, depending on the state. In other countries, such as Italy, it is 14, and in Spain it is as low as 13. Some states and countries add that if one of the parties is in a position of trust, such as a doctor or a teacher, the minimum age rises to between 16 and 19. The age of consent encourages us to consider what a child is and, if we place a boundary on childhood, how children should be protected.

The nature of the protection is sometimes confusing and contradictory, however. Up until 1967, children were seen as legally inferior to adults. The landmark U.S. Supreme Court case In re Gault changed that. In that case, the Supreme Court established that juveniles should have the same constitutional rights to due process in courts as adults (Gold, 2008, p. 10). In effect, this acted to protect children from being treated as nonpersons until they passed into legal adulthood.

Copyright Bettmann/Corbis/AP Images

In this 1909 photo, a boy in Augusta, Georgia, changes spindles in the textile factory where he works.

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CHAPTER 8Section 8.3 Labor Issues

In Defense of Children’s Right to Work From an alternative perspective, why can’t a child compete with adults in the workplace? For crit- ics of child-labor laws, the restrictions amount to a deprivation of rights to earn a living, gain an education in a working environment, and compete on an equal level with adults for money.

This may seem a justification for exploitation of children. Children do not know the repercussions of adult work or the complexity of running a house and paying the bills. They should not have to engage in such worries, and their time is better spent learning in school and playing. Yet, as one critic has noted, society wants children to be free to consume but forbidden to produce:

Let’s say you want your computer fixed or your software explained. You can shell out big bucks to the Geek Squad, or you can ask—but you can’t hire—a typical teenager, or even a preteen. Their experience with computers and the online world is vastly superior to that of most people over the age of 30. From the point of view of online technology, it is the young who rule. And yet they are professionally powerless: they are forbidden by law from earning wages from their expertise. (Tucker, 2008)

From this perspective, the law against child labor seems strange. Why not let children earn money for the skills they can offer? Employers in turn complain that young people coming out of high school or college do not have the skills needed to succeed in the workplace, a lack that would be reduced if young people had free access to the employment market from an earlier age.

There certainly seems to be a demand for work-related activi- ties. Consider KidZania, which is an employment-related role-playing theme park for children that is cur- rently expanding its franchise glob- ally. The company claims to provide “children and their parents a safe, unique, and very realistic educa- tional environment that allows kids between the ages of four to twelve to do what comes naturally to them: role-playing by mimicking traditionally adult activities. As in the real world, children perform ‘jobs’ and are either paid for their work (as a fireman, doctor, police officer, journalist, shopkeeper, etc.) or pay to shop or to be entertained” (KidZania, n.d.). Originally set up in Mexico, KidZania is now a multinational corporation (Rathbone, 2011).

Won’t Child Labor Just Disappear? However, there is clearly a difference between playing at work and actually working. From a dif- ferent perspective, what is important to consider is whether a developing nation naturally reduces the number of children in work as it becomes richer. This is what happened across the West: As the

Kyodo

In this 2011 photo, girls play at being beauticians in the pretend cosmetics store at the KidZania theme park in Tokyo. At the park, children can hold “jobs” for which they are paid.

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CHAPTER 8Section 8.3 Labor Issues

economy grew, it became more complex, and that complexity added value to staying in school and getting a deeper and longer education. That is, the richer a country gets and the more opportuni- ties that a family has to increase its income or decrease its dependency on a local factory or farm for work, the less of an incentive there is for children to work. Their education becomes a greater priority (Cigno, 2005, p. 101). According to that argument, it would be better for U.S. corporations to work with foreign companies that use child labor, on the grounds that as the economies of those companies’ countries improve, eventually there will be no economic need for children to work.

The problem with that argument is that it absolves the multinational and its managers from acting as role models or from trying to encourage alternative and less dangerous work for children. Since poverty is synonymous with child labor, if a company pays higher wages, it can have a beneficial effect in raising local living standards and hence reducing the need for children to be employed. Governments, companies, and charities could also help set up schools to attract young people into learning more and enhancing their employment skills. More opportunities generally mean an increased incentive to learn, which in turn often implies an extension of childhood.

In developed countries, childhood can be extended into a person’s 20s as that person contin- ues his or her studies into university. Wealth may bring greater incentives to educate, but critics remind us that waiting for an economy to grow does not alleviate real and serious problems with child labor today.

Sweatshops

An extension of concerns over child labor are the ethical problems that arise in employing adults in sweatshops, which the U.S. Department of Labor defines as com- panies or employers violating more than one federal labor law. Even if they act within the law, sweatshops can have conditions that are hazardous or standards that are below decent for a healthy and safe workplace. They may be crowded with employees working without adequate breaks, or may involve working for abusive managers. Sweatshops are pervasive in poorer coun- tries, but they also exist in the United States, particu- larly in the restaurant, clothing, and meat-processing industries (U.S. General Accounting Office, 1988, 1994).

A Historical Note The term sweatshop was coined in the mid-19th century from sweater, an employer who was a mid- dleman contracting work out for manufacturers. Typi- cally, the sweater employed people desperate to work under any conditions and for minimal pay. Turnover of workers could be high, which meant that there was no incentive for the sweater to improve conditions or pay. Where there were thriving markets, disgruntled employees could move onto better conditions and be replaced by other desperate workers.

Associated Press/Tina Fineberg

In this 2005 photo, demonstrators unfurl a banner at the Niketown store in New York. They are protesting against Nike’s use of sweatshops in its supply chains. Despite the company’s efforts to raise standards, it still gets a great deal of criticism that it is not doing enough.

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CHAPTER 8Section 8.3 Labor Issues

Although the hardship and cruelty of a sweatshop often come to mind, for one cultural historian “the sweatshop is as American as apple pie[,] . . . synonymous with the Singer sewing machine, the hard-driving clothing floor subcontractor, the ingenious immigrant good with the needle, the piecework system” (Hapke, 2004, p. 1–3).

The Benefits of Sweatshops The sweatshop could be seen as a stepping-stone to shelter and work experience that poor people or new immigrants need, or something that is necessary for a poor country while it develops and gains enough money to invest in its safety standards (Maitland, 1997). If workers have the right to leave a sweatshop, it does not seem so right that sweatshops should be summarily condemned and dismissed. Indeed, we must ask, what is the alternative for poor people seeking to better their conditions? For early Americans migrating to the cities, the sweatshops offered higher wages and relatively better conditions than the alternatives. And if consumer pressure encourages an Ameri- can company to shut down a sweatshop in Indonesia, say, the result is that the workers are now unemployed rather than employed. Would the workers prefer to have no job over an uncomfort- able job?

As long as the workers are free to leave, according to supporters of sweatshops, there is no prob- lem, and any intervention to close sweatshops can create more suffering than it prevents. From this perspective, the sweatshop is a relative evil and one that is soon competed out of existence as workers are provided more opportunities for work. As one South African commentator has noted, the problem for the unemployed in South Africa is not ethical policies but the lack of businesses (“Companies Aren’t Charities,” 2010). When the number of businesses increases, more people gain work, and the wealth that is created begins to trickle down to the poorer members of society.

For critics, however, the sweatshop is synonymous with exploitation. In 1995, the Immigration and Naturalization Service raided an illegal sweatshop in El Monte, near Los Angeles. It was run by a family of Thai contractors who kept 72 workers, mainly women, in barracks behind barbed wire and worked them 12 to 18 hours a day. The case was the first in which a federal court held clothing retailers and manufac- turers liable for the actions of the labor contractor (Watanabe, 2008). However, the El Monte sweatshop in effect was an issue of slavery— and of course, slavery is illegal and immoral on most ethical accounts.

Ethically, individuals deserve dignity: No one should aggress against them nor withhold their right of exit from a job or a contract. In the El Monte case, the owners held the women against their will, which is an obvi- ous breach of morality, hence the description of them as slaves. But is it right to create unhealthy work- ing conditions and to demand more than what is fair from workers and to pay them less than a fair amount?

Associated Press/Nick Ut

In this 2005 photo, several women who were used as slave labor- ers in a sweatshop in El Monte, California, are shown about to give a news conference on the 10th anniversary of their release.

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CHAPTER 8Section 8.3 Labor Issues

A corporation has a duty to respect the innate dignity of all people, and that means treating them as moral equals, providing them with conditions that managers would wish to work in, and uphold- ing the expectations of a good life. A manager would presumably not wish to work in sweatshop conditions, so why should he or she expect others to do so? Regarding foreign subsidiaries using sweatshops, rather than excusing the dire local conditions, an American corporation has a duty to offer improved standards and wages. In a sense, when in Rome, do not do as the Romans do, but rather do unto others as you would have them do unto you. In other words, the relative differ- ences between two countries should not matter. The American corporation should employ people on a similar basis abroad as at home.

Illegal-Immigrant Workers

Another concern for international business is whether a company should hire illegal immigrants. Political and economic disturbances around the world push increasing numbers of people over international borders. In 2011, an estimated 47 million were refugees. Many are only temporarily so and return home as soon as it is viable. Others end up in refugee camps for years, while some seek work in host countries both legally and illegally. Up to 4% of the American population is con- sidered to be in the country illegally, constituting 5.4% of the workforce (Passel & Cohn, 2009). That is a sizeable amount. Of an estimated 154 million people in the civilian workforce, that would mean 8 million are working illegally.

For many, illegal immigrants are by definition working illegally and should be returned to their home countries. Politically, immigration is a controversial topic in the United States. There are over 17,000 guards along the U.S.–Mexican border (“Crying Wolf,” 2011), and authorities are try- ing to clamp down on illegal workers.

For critics of immigration laws, the right to engage in any contract with anyone forms the bed- rock of freedom. Indeed, up until 1875, the United States welcomed “the world’s poor, huddled

masses” to give them the chance to realize their potential in a rela- tively free land. The principle of a free society is to provide protec- tion and free migration to any per- son seeking a new life. Two people are free to engage in any contract they wish, and political obstacles such as a required license to work in a country should not exist. A company offers work in return for the services that the workers pro- vide. The transaction is voluntary and victimless. By working, people are contributing to the national economy rather than draining it if through taking government ben- efits. The workers are also invest- ing in their lives, and income would tend to be a positive influence—as

Associated Press/Matt York

In this 2010 photo of the Arizona border between the United States and Mexico, a U.S. border patrol can be seen driving along the route. The entire border now employs 17,000 guards.

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CHAPTER 8Section 8.4 Technology Issues

would employment itself, by keeping people from falling into criminality if they could not find work. They can also learn English while working and thereby become more American than if they avoided or had no chance of finding any work. Legal immigrants contribute an estimated $37 bil- lion to the U.S. gross domestic product; if there are 8 million illegal workers in the country, that means they could contribute billions to that total (Drum Major Institute, n.d.). It is also estimated that illegal immigrants contribute $7 billion in Social Security payments using fake identification cards. They will not be able to access those benefits, though (Porter, 2005).

But the counterarguments are just as strong. By turning a blind eye to illegal workers, govern- ments might tempt companies that are engaged in law breaking to break more laws. There is a deeply felt sense of injustice when citizens are overlooked in favor of illegal immigrants. Illegal immigrants increase the supply of labor to an area and thereby depress wages and opportunities for citizens. Although the immigrants may contribute surreptitiously to Social Security funding, the resulting market for fake identification and Social Security numbers generates income for those who regularly engage in black market activity. That is, there is a transfer of funds and jobs from law-abiding people to criminals and illegal immigrants.

8.4 Technology Issues Another set of issues that multinationals face concerns technology, specifically intellectual-prop- erty theft and technology transfer, which we will consider next.

Intellectual Property Theft

One of the most recent challenges facing businesses operating in a global environment is that their technology or patents are stolen and replicated in other countries. Other companies then reproduce the product at a much lower price and thereby undermine the original company’s profits and innovation. Intellectual property (IP) theft is not the same as employees’ or custom- ers’ stealing physical goods from shops or offices. Rather, it is the appropriation of intangible but legally protected information, including

• copyrights to written, audio, or video materials; • trademarks such as a name, logo, slogan, or package design; • trade secrets; and • patents that cover inventions (BusinessTheft.com, n.d.).

The advance of the Internet has opened up opportunities for IP theft to global as well as national predators. IP theft has been estimated to cost U.S. firms between $100 billion and $1 trillion a year (Burke, 2010, p. 227; Newman, Cai, & Heugstenberg, 2007, p. 693). The federal government has a series of laws against IP theft, and in 2010 introduced a controversial Combating Online Infringement and Counterfeits Act. The Act was designed to modernize IP regulation and to fol- low the path of the United Kingdom and France, who had recently introduced similar updates and would have given the Department of Justice the global power to target piracy Web sites, illegal downloading sites, copyright infringers, and importers of counterfeit goods. However, an online protest campaign drew much attention to the Act, which, in early 2012, does not look as if it will be passed.

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CHAPTER 8Section 8.4 Technology Issues

Despite the estimated economic cost of IP theft, many oppose the enforcement of IP laws. The American Civil Liberties Union, the Center for Democracy and Technology, Human Rights Watch, and other organizations are concerned that moves to censure rogue Web sites will also act to ham- per freedom of speech. This would, for example, affect the social sites that helped the Arab Spring movement of 2010–2012 or the funding of WikiLeaks and other whistle-blower sites (Timm, 2011).

But is there something morally wrong with using other people’s intellectual property? On first thought, the misappropriation of another’s work does seem immoral. However, other cultures do not recognize individual or corporate proprietary rights in the same manner as the West does. For instance, in China innovations are for sharing rather than protecting by legal barriers. Unsurpris- ingly, we find the greatest IP “theft” in China.

Some economists have argued that enforcement of IP laws actually hampers economic growth and the sharing of knowledge that is important if we are to help millions around the world escape poverty. The freedom that the Internet brings permits oppressed people to find a voice, allows people of varying lifestyles to engage in communication (rather than violence), and is a colossal portal for the outpouring of human knowledge. If governments try to crack down on IP theft, they could ruin the Internet and the freedom it brings, and they could also hinder human innovation.

Technological Transfers

On the international market, one fear is that innovation and new products generated in the United States will be transferred across national boundaries without legal protection for the investors and shareholders; hence the calls by various governments for more global action on IP protection. This is known as technological transfer. There is also the concern that exporting some forms of technol- ogy may be detrimental or even dangerous for other, particularly poorer, countries, or may backfire on the United States and cost the country dearly in economic or military terms. For example:

• Military hardware such as the new XM25 grenade launcher could revolutionize infantry combat, and the U.S. Army would not wish it to fall into enemy hands.

• Sometimes a new technology can be pushed into a developing country too quickly and generate more problems than the benefits it brings. For instance, nuclear technology can provide energy to be used in electricity production, but the industry requires a specialized maintenance and research industry behind it to ensure that it is run safely. Without such supporting industries in place, and without a depth of knowledge and expertise in the society to make choices about nuclear energy, the technology and its use remain poten- tially dangerous.

• Transferring technology over to other countries enables those countries to compete against American companies and thereby threaten jobs.

There are two main rebuttals to these fears:

1. Once we step outside the military-political arena, technological transfers can be gener- ally seen as a helpful way of empowering poorer countries to become richer. Technology increases the productivity of workers in all fields of work, which in turn increases produc- tion. As a country becomes richer through technology, it can engage more in world trade and become less dependent on other countries in times of famine or other hardships. So a refusal to share or to export technology abroad in effect keeps the world’s poor in poverty.

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CHAPTER 8Section 8.5 Ethically Evaluating Multinational Business Activities

2. Concerns over IP or technological transfers are reducible to protectionist policies and the nationalist ethic behind them: that American jobs are more important than other coun- tries’ jobs, but also that American consumers should expect to pay more for supporting their country and its unions rather than import cheaper goods from abroad. The falla- cies in such a line of argument are apparent. Protectionists are typically keen to ensure that their self-interest is catered to but not the interests of the majority of their fellow citizens or those of other countries. Self-regard is a powerful motive, but it is not always an ethical one.

8.5 Ethically Evaluating Multinational Business Activities In view of the wide range of ethical issues that multinationals face, we turn next to a more general ethical evaluation of multinational business activities.

Relativism: Western Cultural Norms Affecting Other Cultures

It is easy for ethical thinking and action to get lost in the business world, especially when business crosses borders and cultures. A general concern that ethicists raise is the extent to which countries in the West should be interfering with the norms and values of other coun- tries, especially those of less developed nations whose economic vulnerability may deserve a softer, more respectful approach. This applies especially to nations whose cultural identities are perceived to be untainted by Western culture. Corporations going in to set up factories or offices could have a massive impact on how the culture evolves, which could cause unintended disturbances and violate many local traditions. It is a common complaint of critics of multina- tional corporations that multinationals do not know the extent to which they are affecting local cultures, or if they do, that they possess an arrogance of assuming they are in the right, which to many is offensive.

For instance, an American company may be trying to do business in a culture that is predomi- nantly sexist in the workplace, and to advance competent women over men may cause offense. Here, American values of diversity and sensitivity to gender issues may encounter obstinate refusal and skepticism. Similarly, one commentator noted that for many years, American com- panies avoided employing Black workers in overseas posts, in case doing so would offend local people, but that has recently changed, and in fact there is evidence that people from tradition- ally perceived subcultures in the United States have a greater flexibility in the workforce when they are deployed abroad (Solomon, 1994). Thoughtlessness can also cause problems, as when a security company shipped hardware to Saudi Arabia and wrapped the gadgets in magazines with photos of bikini-clad women. The customs officials were offended and delayed delivery for several weeks (Mailes, 2000).

In many respects, the complaint is now an old one. Ever since Columbus encountered the indig- enous population in 1492, European values have been adopted by or imposed on other peoples. Indeed, Columbus’s first thoughts were of Christianizing and conquering the people: “I could con- quer the whole of them with fifty men, and govern them as I pleased” (Columbus, 1492). In other words, we have power and they do not, so we are right in imposing our values and our systems on these people.

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CHAPTER 8Section 8.5 Ethically Evaluating Multinational Business Activities

Ethical Imperialism Columbus’s sentiment characterizes much of the following 500 years of commercial expansion and globalization. Europeans and then Americans have imposed their will on weaker and less technologically advanced countries through military force. The locals encountered by companies and government officers have been assumed to be backward on religious and moral grounds and hence in need of “correcting.”

In many respects, locals have not been slow to take advantage of trade opportunities either. Where Western explorers went, ports and trading towns developed swiftly, for different cultures have much to offer each other: technology, gold, and silver all in exchange for local skills, labor, and natural

resources. And despite the noise and violence of war that takes up so much of the history books, much com- merce developed and persisted between the peoples of the world. World trade emerged in the 15th century and has continued since. As a recent advertisement by the global bank HSBC commented, “in the future there will be no markets left waiting to emerge.” (HSBC, 2011) Commerce has spread everywhere. Yet there are still ethical issues that a multinational corporation must consider in its overseas operations. For example, should American companies operating abroad have a responsi- bility to local stakeholders and their cultural practices?

When working abroad, sensitivity certainly has to be encouraged. Some companies have very strong eth- ics on how their American team should deal with local people. Others are more lax and leave it up to the managers involved. The former policy—the “ethical” policy—may appear a reasonable move. For example, a brief encounter with a foreign delegation may not cause many problems, as everyone involved will be on their best behavior, and lapses in etiquette will be understood. But when people stay longer and begin to relax in each other’s company, there may be cause for alarm. One commentator on international busi- ness etiquette has noted that the American habits of sprawling in chairs or wearing sunglasses inside may be disconcerting to English people but positively unnerv- ing to Germans; and that while a manager would not send a hard-drinking representative to a Saudi Arabian meeting, that same manager might not be aware that asking after the health of any of the women in the household would be offensive (Lewis, 2006, p. 82).

Leaving managers to adapt to the local cultural climate without any guidelines may thus create problems. If, for instance, corruption is culturally acceptable but is illegal, managers could soon find themselves in legal trouble if they follow the example of local companies

What Would You Do?

You are a manager for a multinational corporation that has started up busi- ness in another country. The resource base is excellent and the local work- force is relatively cheap and willing to work and learn. However, two tribal groups in the country compete with each other for power and wealth. You discover that one group is constantly diminishing the other group’s chances of competing for work, especially their women. Sexism prevails. The women are overlooked for promotion by local managers and are underpaid and over- worked in comparison to their male counterparts. You are concerned that if your company attempts to alter the local presumptions regarding gender, it may offend the local population and cause commercial and employment problems and more trouble for the people who are already disadvan- taged. If your company does nothing, it goes against core American values of respect and equality.

1. If you were the manager, would you advance certain women any- way? Why or why not?

2. Do you think it is better to defer to local sensibilities? Why or why not?

3. Would you encourage bringing in more American female staff mem- bers to show the local managers that they can work just as well? Why or why not?

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CHAPTER 8Section 8.5 Ethically Evaluating Multinational Business Activities

and offer gifts and bribes to officials. Likewise, if managers engage in locally acceptable sexist or racist behavior, they fall afoul of American traditions and law.

Yet many American companies learn to adapt to local conditions quietly and under the radar of media attention. McDonald’s, for instance, has adapted its menu choices for different palates around the world to ensure acceptance of its products; and most companies tend to just get on with the job. Nike was forced to respond to Western criticism of its use of sweatshop suppliers in the 1990s: Local factories were content with driving employees into harsh work- ing conditions, but Western con- sumers were not. Both companies have learned to adapt and even to become role models for local busi- nesses, as one business academic has noted: “I truly believe Western firms have played a significant role in raising standards in [the develop- ing world by demonstrating] how we think, how we do things and how we treat our people” (C. Rob- ertson, as quoted in Dutton, 2008).

In the next section, we look at the main vehicle of international trade, namely multinational corporations and the particular ethics of how they operate.

Pros and Cons of Multinational Businesses

It is at the junction between global business aims, local customs and laws, and American values that many of the ethical issues affecting international trade—and in particular multinationals—arise. For some people, multinationals bring a harmonization to the world: You can purchase compatible Hewlett-Packard printer cartridges anywhere. Likewise, your cellular phone can usually adapt to other countries’ signals quickly, and you can rent a car from Budget in just about any country. Such harmonization of product and service helps markets and smooths trade by creating similarities.

Supporters also claim that multinational corporations are the main causes of economic growth and prosperity for the world’s poor. Such companies bring in new technologies and job opportuni- ties and training for local managers. When an American company opens up a new factory in Indo- nesia, say, the locals can benefit from more employment opportunities and usually higher wages: sometimes up to 40% more (Hijzen & Swaim, 2008).

In turn, without global commerce and multinational enterprises, Americans would miss out on a great deal of opportunities in emerging markets such as India, China, and Brazil. Global trade is mutually beneficial, and to turn our backs on it would take the United States and the world back to the protectionist era of the 1930s, which saw a collapse in world trade volumes and a rise in international aggression that eventually broke out in World War II.

Associated Press/Hasan Jamali

Two worlds meeting: women dressed in traditional niqabs in Saudi Arabia shopping at a restaurant by a very American corporation.

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CHAPTER 8Section 8.5 Ethically Evaluating Multinational Business Activities

But for critics, multinational corporations and their global agendas are exploiters of cheap foreign labor who deplete other countries’ resources and take the profits back to the United States. They give little to their host countries but violate local traditions and cultures by imposing American standards and expectations on commercial life. Moreover, the multinational corporation is a pow- erful, rich, and independent beast that will look after its own interests and tread on domestic and international governments and people to raise its turnover. People point to the Deepwater Horizon oil spill and BP’s laxity with regulations, or to the Bhopal disaster and Union Carbide’s evading safety standards in a foreign land. Some have even seen American multinationals as part

of postwar American foreign policy to control trade and countries around the world (Shearer, 1999). Still others see all multinational corporations as forces to be controlled and highly regulated, or else they would oppress people with poor wages and bad working conditions and undermine union attempts to secure a better life for members. From all the examples that we have considered in this chapter, there are many recurring themes regarding questionable practices of multinationals:

• Improper political influence on foreign govern- ments.

• Pushing for the deregulation of local markets so that they may enter them and undercut local businesses.

• Pursuit of profit over social use such as when multinationals do not have any regard for other stakeholders whom they may be affecting and when they concentrate solely on increasing prof- its and dividends for shareholders to the cost of local people.

• Externalized costs. Multinationals can be particu- larly guilty of ignoring their trade and production’s impact on the environment and local cultures, as they can ultimately cut production and leave the host country reeling from any disasters that they have created (Weissman, 2008).

Debate nonetheless rages on as to the benefits and problems that multinational corporations cre- ate. Indeed, as we have discussed throughout this book, acting ethically within the United States is complicated, and when a U.S. company begins to operate abroad, the ethical intensity increases. A few decades ago, multinationals could operate around the world in relative privacy from national enforcers. But today, the spread of electronic commerce and correspondence means that multi- national operations are never far from scrutiny by the government or consumer activist groups. Today, their products, advertisements, safety standards, wages, and employment are all acces- sible for critics to analyze, which can affect local sales, should those critics choose to publicize a multinational corporation’s ethical misdemeanors.

Despite having a strict set of ethical guidelines on standards and behavior going back to 1992, Nike still managed to fall afoul of consumer activists, who waged an influential war against the

Associated Press/Shuji Kajiyama

In this 2011 photo, the famous American investor Warren Buffett (center), CEO of Berkshire Hathaway, is opening up a Japanese subsidiary factory of one of his companies.

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CHAPTER 8Section 8.5 Ethically Evaluating Multinational Business Activities

company’s use of substandard factories. In 2004, Nike employed 80 corporate social-responsibility and compliance officers, and its factories were inspected weekly, yet even the company admit- ted that standards in 80% of its factories had failed to improve (Hijzen & Swaim, 2008). Victoria’s Secret was also caught using child labor on its organic cotton farms in Burkina Faso (Carpenter, 2011). Perhaps being a perfect ethical multinational is beyond the reach of companies because local conditions are to some extent beyond their control. But it is certainly better to try to change obviously unethical situations and to act as a role model for local companies.

Creating a Global Business Ethic

To relieve the potential for ethical conflict, the philosopher Richard De George created a list of principles regarding operating businesses abroad:

1. Do no intentional harm to the host country. 2. Produce more good than bad for the host country. 3. Contribute to the host country’s development. 4. Respect the human rights of employees. 5. Pay the host country’s taxes. 6. Respect and work with the local culture. 7. Co-operate with reform in the host country, such as in land and tax reforms (De George,

1993).

De George’s principles are useful guides for international businesses, but as we have seen, the reality and complexity of doing business abroad are much more difficult to navigate than the principles imply. Nonetheless, there are moves to form a global business ethic that all companies should subscribe to.

The work of De George and others has helped form the ethical framework of doing work abroad. One of the early executives to pick up the mantle was Sir Geoffrey Chandler, whose actions in 1976 as the CEO of the multinational petroleum company Shell ultimately helped change the moral thinking of multinationals: “To suggest that doing right needs to be justified by its eco- nomic reward is amoral, a self-inflicted wound hugely damaging to corporate reputation,” he com- mented. “Doing right because it is right needs to be the foundation of business” (as quoted in Davison, 2011). Today there are many businesspeople who try to emulate the moral stance of Chandler and others, who believe in setting an example within the companies they run and also for the people they deal with.

Indeed, one New York institute, Ethisphere, attempts to monitor ethical performance around the world and to score companies on their actions. According to the institute, acting ethically also translates into profitability. The criteria that the institute looks for are in line with what ethicists look for in corporate behavior, including

• corporate citizenship and responsibility, • innovation contributing to public well-being, • industry leadership, • executive leadership, • legal, regulatory, and reputation track record, and • internal systems and ethics-compliance programs (Ethisphere, n.d.).

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CHAPTER 8Section 8.5 Ethically Evaluating Multinational Business Activities

Of the top five U.S. companies on Forbes’s list of the 10 largest multinationals in the world, Ethi- sphere included only General Electric for 2011. Nonetheless, many other U.S. companies do appear on the list, including Rockwell Collins, eBay, Gap, Timberland, Ford Motor Company, Microsoft, Colgate-Palmolive, Xerox, PepsiCo, General Mills, Caterpillar, and Cisco Systems. What Ethisphere calls the world’s most ethical companies are said to outperform the S&P 500 index in the United States (“World’s Biggest Public Companies,” 2011).

But critics of Ethisphere’s system ask, can companies and their ethical outlook actually be scored?1 If a company seeks to eradicate sexism in its foreign subsidiary, does it get points? Utilitarians, who are interested in cost-benefit analyses, may nod in agreement, since they see ethical life as adding up the good things and subtracting the bad things. Other ethicists do not agree. For them, doing the right thing is not about scoring points; it is about doing the right thing because it is the right thing to do, or because it reflects the innate ethical culture and principles of the company. Also, the fact that the ethical com- panies have done well compared to the S&P 500 may not mean much. Ethisphere’s companies come in and out of its tables more than companies exit the S&P Index, since they lose points one year and gain them back the next, which can cause problems in comparing like with like. Nonetheless, Ethisphere’s objective is quite clear: When a company seeks to run itself ethi- cally, respecting stakeholders and contributing to public welfare and corporate transparency, it should be publicly applauded.

Supporting a global business ethic assumes, though, that there are objective or common values by which communities all live by. And while most communities do have similar levels of respect for issues like birth and death, the sanctity of holy places, and the responsibility to care for the vulner- able, there are also a host of issues that people differ on. Relativism is the ethical theory that says that people’s values differ on many things, which implies that it would be wrong for one group to impose an ethical standard on another.

1 There are critics of the institute who note that those scoring well tend to advertise with Ethisphere or use its partner company—a conflict of interest that the institute’s director is seeking to resolve (Evans, 2010)—but the more important point remains.

PR Newswire/Anonymous

In this 2011 photo, Ethisphere’s director, Alex Brigham (right), is presenting an award to Paul Arnos of Aflac for winning the 2011 World’s Most Ethical Company award.

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CHAPTER 8Summary

8.6 Conclusion The world is moving increasingly towards greater commercial integration as multinationals spread in both numbers and jurisdictions. Because of the Internet and the growth of social networking sites, consumer activists also can keep a better eye on world news and what multinationals are up to. The power of boycotting or of raising awareness of ethical issues and corporate disasters is such now that companies will find it very difficult to hide their problems. Ethisphere and other organizations are actively working on a global ethics standard that companies can subscribe to and in turn be judged by, and companies are listening. Many now employ specialists who work internally to make sure that managers are not bribing local officials, employing sweatshops and child labor in the supply chain, or otherwise undermining the corporate image.

In business, image and reputation mean a lot, so when a company is tarnished by a disaster any- where around the world, such as BP following the Deepwater Horizon explosion or the Siemens bribery scandal, it must work hard to rehabilitate its name. Ethical analysis is helping: more and more managers become aware of the risks of acting unethically and of the heightened scrutiny they now face.

Large international firms have an incentive to tighten their standards, as Nike is trying to do, and they can act as role models for smaller companies in other countries (Baker, n.d.). Nonethe- less, businesses work in a legal and moral framework, and while they can help form the moral framework, they cannot affect the legal framework so well. Some of the problems that we have discussed in this chapter, such as child labor, IP theft, illegal immigrant workers, and especially bribery, reflect national government failings. Companies will have a great incentive to bribe offi- cials if governments have discretionary powers. Once the regulatory framework is impenetrable and state dealings more transparent, corruption in its various forms should dwindle.

Summary In this chapter, we discussed issues relating to doing business around the world, including gift giv- ing and bribery. The American and European governments are acting together to clamp down on such corrupt practices, but such practices are not likely to disappear until governments change the way that they do business. A grave problem for lawyers is intellectual-property (IP) theft. Some argue that IP theft results from the way Americans and Europeans view intellectual property and that other cultures do not see IP as capable of being stolen—it is merely recycled. Finally, we looked at the issue of technological transfer, which can be highly sensitive in the military industry, and we considered whether it is wrong to halt such transfers, since most of them improve living standards in poorer countries.

We also reviewed how ethics deals with international trade and multinational companies. The initial problem was whether companies should abide by local customs or by a global standard of corporate behavior. If companies subscribe to an overarching ethical agenda, they run the risk of being arrogant—entering foreign nations with American ways of doing things and expecting the local people to change their behavior accordingly. But business is ultimately about adaptation, and while some companies try to uphold noble ethical standards, others bend to local rules and customs. This becomes a problem when corporations engage in practices that Americans find immoral or even illegal back home, such as the use of child labor. Sweatshops are a more complex

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CHAPTER 8Summary

case: As long as people are free to leave them, the ethical problem is diminished, although it does not look good for a company to be seen driving workers hard in poor conditions for low pay. So too with the issue of employing illegal immigrants: For some people, their illegal status is sufficient for them to be arrested and sent back home, but many recognize that illegal immigrants contribute to the U.S. economy and, strangely enough, to Social Security funds.

Discussion Questions

1. International trade brings with it international customs and different ways of living and doing business. There are many books on how to do business in different parts of the world; but should U.S. companies and their agents feel obliged to support local customs, regardless of how they reflect on home values? Why or why not?

2. Environmental standards differ across nations. Poorer countries tend to have weaker regulations that are less well enforced than richer nations. If there is a chance of improv- ing profits by setting up in a country with laxer restrictions, do American companies have a duty not to set up production there? Why or why not?

3. Child labor is endemic to the poorer countries of the world, and for many children it is seen as way of keeping their families out of poverty. Critics point out that if the govern- ments were to invest more in educating children, the children could be more produc- tive and create more wealth for their nations when they grew older. In the meantime, multinational enterprises often secure suppliers who use children. In your opinion, what is the best way to reduce child labor for multinational corporations?

4. Bribery and corruption have gone on in the business world for centuries and remain a staple of doing business not only in transitional and poor countries, but also in well- developed economies. Should companies have a strict rule on bribing and gift giving to public officials and members of other large corporations, or should they accept that sometimes the only way to get business is to offer “incentives”?

5. Intellectual property involves a range of products and services that are sold around the world. But some cultures do not recognize IP as being anything special, so when people download a movie from an illegal Web site, they may not feel that they are stealing. Does IP law have any ethical basis, or is it just an attempt to secure monopoly earnings by large corporations?

Key Terms

bribery The giving of money, vouchers, goods, or services to public officials in the hope of securing a license or contract.

gift giving The presentation of money, vouch- ers, goods, or services to another in business; this may be a normal part of business eti- quette in dealing with other business people or public officials, but when used to encour- age the signing of a contract or when the gifts become relatively large, ethical issues arise.

globalization The expansion of international trade; the term also implies a movement towards a similar global culture and, by impli- cation, ethics.

intellectual property (IP) Intangible assets protected by law such as copyrights, trade- marks, packaging designs, and trade secrets.

intellectual property theft The illegal misap- propriation of intellectual property that has been secured by a company or individual.

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CHAPTER 8Summary

multinational corporation A corporation that has production centers and offices in more than one country.

repatriated income Money earned by an American multinational that is transferred back to the United States; it is subject to cor- porate tax.

sweatshops Factories whose workplace stan- dards on health and safety and pay fall below a legal minimum, or whose standards are below what is commonly acceptable in a community.

technological transfer Selling or distributing technology from one country to another; often concerned with the transfer of sensitive com- mercial or military technology.

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Environmental Issues

Learning Objectives

After completing this chapter, you should be able to:

• Explain why environmental issues have become important. • Describe different ethical perspectives concerning environmental issues. • Describe the impact of several key environmental topics, namely pollution, habitat destruction, resource depletion, and global warming.

• Explain the conflict between environmental values and commercial freedom and the various ways govern- ments and businesses try to resolve that conflict.

Associated Press/Prakash Hatvalne

9

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CHAPTER 9Section 9.1 Introduction

Contents

9.1 Introduction

9.2 Environmentalist Ethics

Economic Growth and Environmental Damage Varieties of Environmentalist Positions

9.3 Pollution

The Right to Trade in Emissions Does Emissions Trading Work?

9.4 Habitat Destruction

The Environmentalist Critique The Regulatory Response Privatizing Government Lands

9.5 Resource Depletion and Sustainability

Peak Oil Should Consumers Change Their Behavior?

9.6 Global Warming/Climate Change

Problems with the Science Alternative Energy Sources

9.7 Environmental Restrictions Versus Economic Freedom

U.S. Laws on Restricting Access Private Trusts Restricting Access The Problem of the Beautiful Valley Cost-Benefit Analysis of Environmental Responsibility Social and Private Costs

9.8 Conclusion

9.1 Introduction In Chapter 1, we read that in 1984, a storage tank exploded at the Union Carbide pesticide fac- tory in Bhopal, India, releasing 40 tons of toxic gas into surrounding slums, killing thousands of people. It is one of the worst environmental disasters in human history and worth recalling for our purposes here. Safety regulations were lower in Bhopal than they were in the United States, and Union Carbide took advantage of these laxer regulations. Over the years, the death toll reached 20,000, and today the pollution continues to affect the water supply, causing serious ongoing health problems. The disaster cost Union Carbide $470 million in compensation payments. More recently, in 2010, the Deepwater Horizon oil platform off the coast of Louisiana exploded, killing 11 people and unleashing 200 million gallons of oil into the sea, affecting over 300 miles of Louisi- ana coastline and its wildlife habitats. As of 2011, BP, which owned the rig, has paid out over $3.8 billion in claims. And in 2011, the Fukushima nuclear reactors went into meltdown after in the hours following a tsunami that hit the Japanese coastline. The reactors bled radioactive waste into

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CHAPTER 9Section 9.2 Environmentalist Ethics

the seas and air, and some of the radioactive substances have been detected on the west coast of the United States. The effects of the disaster are still being cataloged.

Stories like these are sadly common. Industrial spillages from agricultural waste to nuclear radia- tion capture our attention on a daily basis. Indeed, the greatest challenge that humanity faces is how we should interact with the environment. Environmentalist ethics is now a staple in ethics courses. In this chapter, we will examine some of the key issues that businesses face today: pol- lution, habitat destruction, resource depletion and sustainability, and global warming. To gain a deeper appreciation of these issues, we will first review environmentalist ethics and the concerns it raises about how we are living and what we can do about it.

9.2 Environmentalist Ethics Campaigners across the environmentalist spectrum have raised important points that are having an increasing impact on how we live and do business at home and around the world. In this sec- tion, we will look at their major concerns and the criticisms they have encountered in describing our relationships with nature and with economic growth and our impact on the planet.

Economic Growth and Environmental Damage

In considering the environment, we need to think about our relationship with economic growth. Growth can bring prosperity, but it can also create environmental problems.

Mastering the Planet The technological advances that have accumulated following the industrial revolution have enabled us to increase our population and produce more energy and products than ever before. In the aftermath of World War II, there was a rush to employ the enormous breadth of technol- ogy that had been unleashed by science. Chemical companies proliferated, and states invested in nuclear power. Big projects such as dams, extended harbors, airports, and highway systems were seen as symbols of postwar prosperity and as necessary for economic growth. Indeed, eco- nomic growth became the guiding principle that governments primarily focused on. Growth, it was argued, would enrich the world’s poor and lift millions out of poverty. In the rush to new riches, corporations set out to earn profits by setting up large-scale enterprises both at home and abroad. The postwar ideology was very much led by the primary importance of growth over any environmental concerns.

Underpinning the rush to growth after the World War II was the deeply ingrained argument that nature must be controlled. Just as people had waged war on tyrannical governments, so too would the war continue for man’s mastery over the planet. Nature would be tamed and turned to serve humanity using new technologies. Industrial chemicals would ensure that humanity could feed and clothe itself, and nuclear fusion would be used to power the grids that would light up the world and bring heat (or air conditioning) to the world’s billions. Civil engineering would enable the world’s resources to be dug out more effectively and in greater quantities. The petrochemi- cals industry would bring forth new materials and cheap fuel for transport, while the computer industry would enable scientists to gain better knowledge of the planet, and people and medical

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CHAPTER 9Section 9.2 Environmentalist Ethics

science would wage global warfare on disease and ailments. The postwar period was filled with such optimism, and the United States was the main power to take the helm and pilot the world to riches through its multinational corporations.

Destroying the Planet However, in the rush to economic growth, several key factors were overlooked or ignored, the most prominent one being the effects on the world’s habitats and environments. As resources were depleted, indigenous peoples were displaced and lost their homes and natural habitats. Chemicals used in production were wantonly discarded into the air or into rivers, lakes, and seas, leading to negative local and global effects. Swaths of forests were cut down, destroying animals’

habitats and landing many species on endangered lists. Petrochemi- cals used for fuels were considered by some to contribute to global warming. Medical interventions produced unintended side effects, such as superbugs resilient to anti- biotics, while pharmaceutical pol- lution of the waters was evident in the dispersal of medicines in a variety of flora and fauna. Air pollu- tion caused an estimated 3% of all deaths annually in America (“Med- scape,” 2000).

Consider the farming business. Like with any business, farmers want to increase their yields and prof- its; then along came agrochemical companies, offering them efficient means to rid their crops of pests and diseases. The results were

immediate and visible: Yields rose as farmers sprayed the land and crops in their war on the envi- ronmental threats to their livelihood. However, scientists now know that fertilizers and other agro- chemicals sprayed onto agricultural land seep into the waterways, causing oxygen starvation for fish and other animals. The application of chemicals began to take its toll on other species but also on humanity, as health effects from the chemicals were noted. Ethical questions were now raised about the priorities that were being followed by corporations, governments, and end users alike.

Varieties of Environmentalist Positions

Against the backdrop of environmental damage caused by businesses, the environmental move- ment emerged. Environmentalism is a social and political movement that works toward protect- ing the natural environment from destruction or pollution. Early influences on environmentalism were the 19th-century writers Ralph Waldo Emerson, Henry David Thoreau, and John Muir, who emphasized the importance of returning to nature and preserving wilderness areas. The movement

Chuck Keeler

In this photo, a crop sprayer is spraying a pesticide, which can have secondary effects on the land and other animals and plants. Critics are concerned that such spraying is reducing the honey- bee population and building up toxins in the water supplies.

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CHAPTER 9Section 9.2 Environmentalist Ethics

took its modern form in the 1970s, inspired in part by several books whose titles are telling: Rachel Carson’s Silent Spring (1962); Paul R. Ehrlich’s The Population Bomb (1968); The Limits to Growth (1972) by Donnella Meadows, Dennis Meadows, Jørgen Randers, and William Behrens III; and E. F. Schumacher’s Small Is Beautiful (1973). All of these books are still in print and have had an enormous impact on reading generations since. Indeed, Carson’s work led to the banning of the pesticide DDT and to the creation of the Environmental Protection Agency (EPA). Organizations defending the environment have also proliferated, including the Sierra Club, Greenpeace, Earth First!, and the Earth Liberation Front, with some of these being more radical than others.

The main ethical position of the environmental movement can be encapsulated in the following points:

• Current economic growth is not environmen- tally sustainable, and we are undermining our own habitat and health.

• Resources are being depleted at worrying rates and population growth is out of control.

• People and companies are arrogant in assum- ing that we could tame nature for our pur- poses and for our own short-term gains.

• We have responsibilities toward other spe- cies and must acknowledge that some animals might possess rights similar to those of humans.

• The earth and its vast range of habitats and living creatures deserve respect and protec- tion from humanity’s greed for resources.

Within the environmental movement, though, there is a wide variety of thought on how we should por- tray nature, how we should interact with it, and how companies should behave towards it. There are two extreme positions this debate:

• Those who believe humanity has a right to do what it wishes to the environment and other species, because we are the primary species whose destiny is to master the world and other animals. If we are to be concerned about our use of the environment, it is only because some of our actions may be harming us.

• Those who believe that humanity is an evil blight, a cancer on the earth, which can only do evil and cause wanton destruction that will inevitably destroy the planet and ourselves. Humans get what they deserve, and life was better when there were fewer people alive or even before human beings emerged.

Between the two extremes are many theorists whose arguments range from stressing the role of our guardianship over the planet to a deep pessimism regarding our ability to do anything positive for the planet. Here are some of the less extreme positions:

Copyright Bettmann/Corbis/AP Images/Anonymous

Emerson believed that we cannot separate ourselves from the environment: We are an intimate part of nature—connected and at one with the land. If we act to harm the environment, we only hurt ourselves (Brewton, 2003).

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CHAPTER 9Section 9.2 Environmentalist Ethics

• Socialists who believe that the world would be greener if the means of production were handed over to the people, which usually means nationalized by governments. Critics counter that much of the planet’s pollution has been created by governments and their agencies.

• Anarchists who believe that governments are the main culprits behind environmental destruction and that a return to small, self-regulating societies is the only path to a better relationship with the planet. Critics counter that anarchic societies only work for small numbers of people and are not practical for the billions currently living on earth: Millions would starve if we tried to live the life they think we should.

• Capitalists who look upon governments skeptically but nonetheless believe that cor- porations and people pursuing their own self-interests will be guided by Adam Smith’s “invisible hand” to protect the environment through the proper application of property rights. Critics complain that companies’ self-regard has caused many of the environ- mental problems we have today through cost cutting and use of the cheapest rather than the greenest fuels. These critics do not believe that companies can be trusted to do the right thing.

• Liberals who accept that capitalism produces wealth but who believe that corporations would continue to act without regard for the environment unless they were controlled by strict laws and regulatory agencies. Skeptics fear that the agencies just end up being controlled by companies or pursue their own agendas and forget what their original func- tion was.

There are also lobbying groups, environmental-protection societies, and government agencies with different beliefs on environmental protection. Some groups focus on single campaigns, such as saving a particular animal or environment from human destruction, whereas others present philosophical views on how we should live. In addition, there are millions of individuals who believe that something ought to be done about the environment but whose beliefs do not fall readily into a political or ethical philosophy. In turn, there are green businesses that sell environ- mentally friendly products and farm organically, as well as businesses that are eager to reduce their carbon footprint and invest in alternative energies. The founders of such companies believe that entrepreneurs can make a positive impact on nature by adjusting their behavior or by looking for new ways to create the goods and services we want.

Free Market Response to Environmentalism On the opposing side are free market economists, such as George Reisman, who argue that environmentalism attacks our fundamental right to live and pursue happiness. “The environ- mentalists,” Reisman wrote, “view man as evil, because, in the pursuit of his well-being, man sys- tematically destroys the wildlife, jungles, and rock formations that the environmentalists hold to be intrinsically valuable” (Reisman, 1990, p.82). Reisman thinks that environmentalism is illogical and unethical and that all environmentalist proposals are contrary to human needs and desires. In turn, capitalist enterprises should know no restrictions except those created by private property arrangements.

Indeed, some of the environmental laws can cause unintended effects and create much human misery and confusion. For instance, in 1993, homeowners in Riverside, California, were told not to clear-cut the overgrown brush around their homes, in order to protect the kangaroo rats living there. However, when a wildfire broke out, that brush burned swiftly; the fire destroyed many homes as well as the rats. In 2011, oil companies were fined $6.8 million for not mixing a certain

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CHAPTER 9Section 9.3 Pollution

biofuel into their gasoline and diesel fuels, but the “required” compound did not even exist (Heyes, 2012). For some critics, it is individuals and small businesses who bear the brunt of a growing envi- ronmentalist crusade against common sense and fair practice (Wollstein, 1999).

In the next sections, we will look at specific issues of concern and how environmentalists and busi- nesses respond to them. We begin with a look at pollution.

9.3 Pollution In 1979, a nuclear reactor on Three Mile Island in Pennsylvania endured a partial meltdown, caus- ing the release of 13 million curies of radioactive gases into the neighborhood. In 1989, the Exxon Valdez struck a reef and released over 10 million gallons of crude oil into Prince William Sound (Stephanie Rogers, 2011). In 2003, the Missouri-based multinational company Monsanto was fined $700 billion for dumping millions of pounds of polychlorinated biphenyl (PCBs) into open- pit landfills. In 2008, 80 acres of coal slurry containing a billion gal- lons of toxic sludge broke through a containing wall owned by the Ten- nessee Valley Authority in Roane County, Tennessee, onto 300 acres of land, destroying homes and con- taminating the area with arsenic, mercury, and lead.

Further, according to environmen- tal campaigners, 40% of the United States’ rivers and 46% of its lakes are too polluted for swimming. The Mississippi River drains 1.5 million tons of nitrogen products into the Gulf of Mexico, creating an infa- mous “dead zone” the size of Mas- sachusetts each summer. Annually, a quarter of American beaches are closed because of water pollution. Factories emit 3 million tons of toxic chemicals into the environment. Each American produces annually over 3,200 pounds of hazardous waste. Together, the American population produces 10 times more toxic chemicals than the agricultural industry and uses 30 billion foam cups and 1.8 billion disposable diapers annually, which can take 500 years to decompose. Some 80% of American streams are polluted from pharmaceutical products, which in turn contaminate drinking water (“11 Facts About Pollution,” n.d.; Adams, 2010; “Our Pollution,” n.d.; Hearn, 2011).

When we talk of pollution, the statistics are grim. Of course, nobody is for pollution—the problem is how pollution should be dealt with. For some, the solution lies with the free market and the proper recognition and defense of property rights. For other economists and ethicists, the solu- tion lies with governments and regulations.

Associated Press/Wade Payne

This 2008 photo shows a home that was destroyed by coal slurry containing toxic sludge that broke through a containing wall owned by the Tennessee Valley Authority in Roane County, Tennessee. Cleanup has been estimated to cost $1 billion and will take at least 6 years.

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CHAPTER 9Section 9.3 Pollution

The Right to Trade in Emissions

One scheme that has proved popular with governments and companies is the creation of a market in emissions rights, which seeks to embrace both market and regulatory solutions. A government body sets a national limit on a certain emission and then shares out the “rights” to emit that pol- lution across various companies. Those rights to pollute may then be traded, with companies sell- ing rights to pollute to those who pollute more and need the extra licenses. The tradable licenses cover a variety of emissions and pollutants and are generally called cap-and-trade rights.

Emissions Regulations The Clean Air Act Amendments of 1990 capped sulfur dioxide emissions and reduced overall output by 50% between 1980 and 2007. The Cross-State Air Pollution Rule, enacted by the EPA in 2011, was a further move to reduce interstate pollution and health effects on Americans by targeting power- plant emissions and other fine particle emissions (U.S. Environmental Protection Agency, n.d.). While there is no national law, individual states have created programs to cap and trade emissions in a variety of pollutants. For example, in 2011, California—whose cities suffer from smog causing

$193 million in annual health-care costs—made intentions to create a cap-and-trade market to reduce emissions by 15% by 2020 (Romley, Hackbarth, & Goldman, 2010).

Internationally, since the 1997 Kyoto Protocol, governments have set up trading schemes in carbon pollution, permitting countries to purchase the right to pollute the world from others who do not pro- duce enough (“Emissions Trading,” n.d.). The scheme was designed to ensure a more level playing field between nation-states but also to encourage nations to begin reduc- ing global carbon emissions as a whole. However, although 191 other nations have ratified the pro-

tocol, the United States, while a signatory to the intentions of the conventions that led to the protocol (the protocol enacts the ideas of reducing carbon emissions), has yet to ratify the agree- ment. London, England, has become the prominent trading market for carbon emissions.

Does Emissions Trading Work?

Emissions trading has its critics. Cap-and-trade programs still permit the earth to be polluted and hence let corporations off the hook: They can continue to harm the planet and its people by buy- ing the right to do so, which critics see as unethical. Arguing from an absolutist position, critics claim that all pollution is an act of aggression against innocent people and that there should be

Associated Press/Kim D. Johnson

Because of the smog that affects many of its cities, California has sought to impose strict regulations on pollution output.

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CHAPTER 9Section 9.4 Habitat Destruction

zero toleration. People’s health and the quality of the environment are more important than com- pany profits.

Some have argued for a carbon tax as simpler and more direct, as well as for a complete ban on hazardous industrial by-products. A carbon tax would be a simple tax on all carbon-based gas emissions, such as carbon monoxide and carbon dioxide from cars and factories. (California, Mary- land, and Colorado have implemented carbon taxes.)

For free market economists, the issue is whether there is indeed a provable case against polluters. If a plaintiff can substantiate that a corporation or individual does in effect cause harm, then that corporation or individual can be rightly sued, but there must be evidence of a crime taking place (Rothbard, 1982). So for the free market thinker, the problem lies in seeing the evidence of harm done. If there is no objective evidence of harm being caused, companies can continue to release their pollutants. But if there is evidence, the companies should rightly be sued.

However, environmentalists will reject this theory, since they believe that the evidence is accumu- lating slowly from so many different angles that it is difficult to say that this company is causing this pollution. Consider the death of a person who smoked, drank copious alcohol, ate unhealthy foods, never exercised or got out in the fresh air, was clinically depressed, and eventually died relatively young: What was the cause of death? A coroner may justly reply, “All of the above.” So trading in the right to pollute causes controversy. Environmentalists complain that it removes responsibility for halting pollution, and even free market economists would admit that companies are being given a right to pollute when they are causing great harms.

9.4 Habitat Destruction Corporations are often guilty of massive habitat destruction. The lists are readily catalogued in environmentalist publications, but even prominent business magazines list the ever-expanding disasters:

• Three quarters of the world’s genetic material in plants may have been lost, and water tables are plummeting (“No Easy Fix,” 2011).

• The world’s coastlines are suffering from an increase in slime due to overfishing and habi- tat destruction (“The Rise of Slime,” 2009).

• Some 20,000 species may be lost each year (Bird, 2011). • In the last four decades, over 232,000 square miles of the Amazon rain forest was cut

down (Haluzan, 2010).

The Environmentalist Critique

The destruction of the rain forests and the “dead zone” in the Gulf of Mexico are potent reminders that all is not well on the planet. The sociologist E. O. Wilson wrote of the “mindless horsemen of the apocalypse” who were overharvesting and were bringing foreign species, disease, and habitat alteration to the environment (1992, p. 253). For environmentalists there are several reasons why companies destroy habitats:

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CHAPTER 9Section 9.4 Habitat Destruction

• People are self-interested and shortsighted, and so too are companies that act to maximize this year’s profits. Companies are not interested in the long-term effects of their actions, so they deplete resources and destroy habitats wantonly.

• Companies do not care for people’s property rights compared to the money they could earn, so land is cleared of people who hap- pen to be in the way.

• Animal activists within the movement say the same with regard to species: Companies do not care to consider the effects of their actions on local species.

• Population growth adds pressures on habitats as urbanization spreads outward and the demand for food and meat grows.

• End users are also to blame: Few consumers consider where their produce comes from and the potential environmental impact they are directly having.

For environmentalists, the shortsightedness of corporations and consumers needs balancing by activism to remind people of their responsibilities of care toward the planet and its people and animals. Similarly, because animals are speechless and cannot understand why their lives are being

disrupted, it is also up to activists to raise concerns and to try to stop habitat destruction.

There are arguments about how this may be best brought about. Some demand that governments impose stricter controls on com- panies’ actions, whereas others are skeptical of using political pro- cesses and prefer instead to aim at educating people, especially the young, to change their lifestyle. If people are taught about the cri- ses affecting the many habitats in the United States and around the world, politicians and companies will then have to listen to consum- ers’ demands and expectations that they act responsibly.

Associated Press/Hall Anderson

Many view clear-cutting as an example of unrestricted violence against the landscape. But for loggers and their communities, cutting timber provides important jobs, and for consumers, it provides paper and wood products.

PR Newswire/Kate Davison

In this 2009 photo, activists from Greenpeace unfurl a banner urging politicians to stop global warming.

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CHAPTER 9Section 9.4 Habitat Destruction

Others, like the activists from Greenpeace, prefer direct action that draws media attention to their antics. In 2008, activists locked logging equipment and used a plow to carve “CLIMATE CRIME” in the grass next to a deforestation project in New Zealand. In 2009, they scaled Mount Rushmore in a stunt to draw attention to global warming. In 2011, they gate-crashed a climate summit in Denmark and stormed several French nuclear power stations in a nonviolent attempt to show how vulnerable the stations were. In the United Kingdom that year, they targeted Volkswagen dealer- ships, placing their own advertisements over the company’s in a campaign to get the German company to stop opposing talks on carbon dioxide emissions.

Such activism attracts media attention, but the activists also run the risk of imprisonment and fines, so Greenpeace trains its activists to stick to nonviolent action to frustrate government attempts to punish them. More extreme groups push the boundaries, and various acts of Con- gress now prohibit doing malicious damage to property and harm to people in the name of envi- ronmental or animal rights.

Can ethics support such activism? Many environmentalists see an imbalance of politics and jus- tice in favor of corporations, and their intention is to redress the imbalance so the voices of mil- lions of concerned but politically powerless people can be heard. The big companies raise millions from stock markets, have massive advertising budgets, and easily attract newspaper headlines; environmentalists, by contrast, do not have the resources to continually put their message out around the world. Against corporations’ huge budgets, environmentalists who wish to raise con- sciousness concerning habitat destruction have to use cheap methods that gain high leverage: hence their antics.

The Regulatory Response

In response to the environmentalist criticism of habitat destruction, supporters of regulation pre- fer to focus on the incentives that companies face. Regulators accept that companies seek to max- imize profits, so they believe that through tweaks of the incentives in the right direction, the mass destruction of habitats can be avoided. For instance, to avoid deforestation, timber companies can be forced to plant new trees for every one they cut. Or the license fees allowing companies to exploit habitats could be used to set up more national parks.

Regulators have to strike a balance between ensuring that habitats are managed well and provid- ing local jobs. When regulators get the balance wrong, they can upset of lot of people dependent on the timber or quarrying industries; if the companies exploit too much, that in turn upsets envi- ronmentalists. Let us look at the effects of federal legislation on the timber industry.

The Organic Act of 1897 The Organic Act of 1897, signed by President McKinley, was the first law designed to adminis- ter and protect the government’s forestry reserves and to strike a balance between industrial needs, conservation, and public access. However, in 1922, the Izaak Walton League, a conserva- tion group, claimed that the act was not protecting the timberlands at all and that clear-cutting was being used to switch land use over to sheep grazing. It took 51 years for the group to success- fully sue the government for permitting clear-cutting, and this in turn encouraged a new look at habitat conservation.

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CHAPTER 9Section 9.4 Habitat Destruction

The National Forest Management Act of 1976 When land is controlled by the government (the U.S. government runs 131 million acres, which is about the size of France), there are many competing pressures on its use, from vocal environ- mentalists and equally vocal company and union lobbyists seeking to protect jobs. The Organic Act had failed to secure a balance, so it was replaced by the National Forest Management Act of 1976, which provided guidelines on where, when, and how trees could be harvested. For Senator Hubert Humphrey, the new act reflected a shift in philosophy:

The days have ended when the forest may be viewed only as trees and trees viewed only as timber. The soil and the water, the grasses and the shrubs, the fish and the wildlife, and the beauty of the forest must become integral parts of the resource manager’s thinking and actions. (as quoted in “National Forest Manage- ment Act (NFMA),” n.d.)

The act stressed the importance of the wider habitat and permitted logging only when the soil, slopes, and water flows would not be permanently damaged. In turn, the act sought to avoid the short-term thinking that had led to clear-cutting under the Organic Act and instead to create a pro- gram of multiple and sustainable use that would last. However, pressure from timber companies has, according to environmentalists, led to a watering down of the act, which leaves the problem that there will be increasing pressures by corporations to permit exploitation.

As noted before, the goal for regulators is to maintain a balance between these competing needs. Yet for critics, it is an impossible task. The problem for them lies with the presumption of gov- ernment ownership. If the government owns land, there will inevitably be conflict over use, and habitats will be either overexploited or underexploited, leaving all stakeholders unhappy. We will next consider the argument for privatizing government lands.

Privatizing Government Lands

Corporations tend to respond to the legal and political framework that they work in. If the land is owned by the government, and the corporations have a chance of exploiting resources and clear- cutting forests with the full support of the law, they will do so. It is in their interests to maximize their returns from their efforts. Regulators and environmental groups then have an incentive to challenge companies, but it can take many years and millions of dollars in legal fees to change what companies do. In the meantime, the habitats continue to suffer.

So for free market proponents, the greatest leverage that the environmental lobby can have is to change the framework that businesses work in, by privatizing the land and giving companies the incentive to look after what they own. The problem with government-owned land is that com- panies may have no incentive to act responsibly if the law itself is unclear or does not support property rights. This is what happened to the dodo: A flightless bird on Mauritius was exploited to extinction by passing sailors hungry for food. No one owned the dodos, so they were all eaten. This would not have happened to chickens owned by farmers.

If there are no clear private rights controlling a habitat, or if the land is subject to political choices, economists point out that the land is effectively held in common (or by none). It is thus open to

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CHAPTER 9Section 9.4 Habitat Destruction

each and every user to exploit as he or she sees fit, leaving the land’s resources to be potentially over- exploited. It is the same problem as the students’ dormitory refrig- erator: You leave a gallon of milk in there and overnight most of it dis- appears, as other people assume it is in a common fridge for their use too. A company may be permitted to release its pesticides, toxic by- products, and other wastes into the surrounding environment, and no affected individual can, in the absence of well-defined property rights, properly sue the company. According to this argument, turn- ing common lands over to pri- vate ownership would produce an immediate incentive to sustain the land’s values. For example, com- mercial forestry owners actively add more trees to the stock than they remove, as they have an incentive to grow their capital stock. Each year, the companies add 31 percent to their investments, which has accumulated to an additional 28 million cubic feet of wood since 1977 (“Appalachian Forestry,” n.d.).

The only other route is for victims or activists to lobby local governments for changes in the law. This, however, is costly and dependent on fragile collective action and political maneuvers. The indirectness of such protests often leaves them with no results. In contrast, to be able to sue a neighbor for polluting your land is much more direct and effective.

Currently, however, much of the land that is threatened by exploitation is not under private owner- ship. Yet governments are not in a hurry to encourage private ownership, since they can earn high rents from licensing timberland and quarries out to corporations. This, in turn, poses a problem for the free market advocates who may wish to support environmentalist goals: Ideally, the land should be sold off to private owners, who would take better care of it than government agencies. But that is not on the political agenda of many political parties around the world: In the United Kingdom, a proposal to privatize ancient forestry was quickly thrown out after a public outcry. So much land may, in the eye of the free market economist, remain in inept government hands. And that helps to explain why environmentalists also target consumers and encourage them to change their buying behavior to support sustainably managed resources and buy organic.

The next problem involves the finite nature of resources. Even if resources are owned privately, there are some resources that are nonrenewable. Timber can be replaced, but oil is not renew- able, and the more we use up now, the less there will be in the future. We turn to this next.

Copyright Bettmann/Corbis/AP Images/Anonymous

The now-extinct dodo bird reveals the problem with government- owned land: Companies may have no incentive to act responsibly if the law itself is unclear or does not support property rights. The dodo was a flightless bird on Mauritius that was exploited to extinction. No one owned the dodos, so they were all eaten.

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CHAPTER 9Section 9.5 Resource Depletion and Sustainability

9.5 Resource Depletion and Sustainability As the population of the world continues to grow, there are concerns not just for the habitats that are destroyed by humanity’s encroachment but also for the resources that we are exploiting. Similar principles to those discussed before, regarding habitat destruction, can guide our think- ing here: If resources are held by governments, there is an incentive on the part of companies to exploit and remove as much as they can while the getting is good. Nonetheless, there is the differ- ence between depleting a renewable source such as timber and a nonrenewable resource such as oil that generates much concern.

Peak Oil

For many decades, the notion of peak oil has haunted discussions of the oil industry. The argu- ment is as follows: As the population expands, humanity’s use of oil increases. But the amount of oil in the ground is essentially fixed, and so as we consume more of it, we must be exhausting its stock. Eventually, there will come a point when we are using more oil than we are discovering or pumping to the surface. This is peak oil. After that, the price of oil will rise, causing untold eco- nomic misfortune for the entire global economy, since so many products from industrial chemicals and transportation to clothing are dependent on oil.

The United States began oil production in 1859 and hit a peak of 10 million barrels a day in 1970. Production has since fallen to 5 million barrels a day, with an estimated 20 billion barrels of crude left in the ground. Three quarters of U.S. oil is now imported, much of it subtly subsi- dized, according to the National Defense Council Foundation, to the tune of over $300 billion annually (Copulos, 2003). As global oil production hits its peak and then begins to dwindle, the United States may find itself struggling to maintain its oil-dependent economy: “We are in for an epochal period of contraction and strife around the world” (Kunstler, 2005). Doomsayers believe that the “Age of Oil” will end with a collapse of civilization, since so much depends on continuing production.

On the other hand, optimists believe that alternative energy sources will be discovered or exploited better by our advancing technologies, sources that will have fewer detrimental side effects. As the resource is depleted, its price will begin to rise, which in turn encourages people to cut back on their consumption as well to purchase automobiles and engines that use oil more effectively. There is also the added incentive for companies to expand into other sources of energy production.

Should Consumers Change Their Behavior?

Corporations and individuals certainly respond to price signals, but some environmental ethi- cists suggest that there should be more than just prices governing or encouraging our acts. If an individual knows that continued use of a product leads to a diminished use in the future, then ethically, they argue, the individual should avoid consuming that product and start invest- ing in renewable energy sources anyway. In the case of oil, this will reduce present consump- tion and divert customers’ money into greener and more sustainable projects, such as solar or wind energy.

What Would You Do?

As the CEO of a medium-size company, you are concerned with the impact of the company’s production on the broader environment. Your factory uses several hundred thousand dollars of electricity annually, and you have permit rights to release waste into the local river. Your predecessors have not had to worry about energy costs, and the attitude of the company towards pollution has always been one of “out of sight, out of mind.” If you engage in greener production, profits may fall and shareholders may lose dividends. If the share price falls, you know that in the current environment, you would be making the company and all of its employees vulnerable to a potential aggressive takeover.

1. Should you go green and invest in relatively more expensive lighting and photovoltaic panels on the roof? Why or why not?

2. Should you keep the company financially secure from predatory takeovers and maintain an envi- ronmentally “dirtier” corporation? Why or why not?

3. Do you consider your position to be determined by the interests of the shareholders alone—and your maxim therefore to look after financial affairs only—or do you see yourself as someone with a vision of a better world, one that would attract alternative investors and green consumers?

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CHAPTER 9Section 9.5 Resource Depletion and Sustainability

However, the logic of shifting consumption is not so straightforward. Let us consider gas. If I stop using gas, I may have to give up driving a car altogether or use a more expensive alternative. If I give up driving a car, that should also imply that I give up rides offered by friends. But that can have an enormous effect on my choice to partake in modern society and such simple tasks as com- muting to work, taking my children to school, and shopping for groceries. While in many European cities bicycling is popular for commuting as well as for leisure, that does not translate so well to the larger, sprawling cities of the United States. Similarly, if I avoid gas in favor of another fuel, such as electrically driven motors, I may have to pay more, which may not be very economical for my budget or for other people who are poorer. Also, in driving a hybrid or electric car, my choice may not be that environmentally friendly as the electricity still has to be produced: It may come from coal- and oil- burning power plants.

For those who do not wish to give up the convenience of driving, rising energy prices will hit home harder than ethical appeals to turn off lights, use alternative energies, and recycle. The problem is that state gov- ernments have capped price rises in electricity, which causes further distortions in the market for energy (Reisman, 2000). This has meant that Americans have been sheltered from the burgeoning oil crisis, as they have not experienced the real cost of oil over the past three decades thanks to different governments’ con- tinuing that artificial dependency. The only indications that something may be wrong in the energy markets are felt when there are blackouts; and blackouts are on the increase, up 124% between 1991 and 2005 (Patterson, 2010).

The complicated mess of intervention and market forces in the energy sector muddies the waters dread- fully for an ethicist, too. For free market supporters, the principle is to release energy markets from state and federal control, so that small power companies can set up in competition with the larger suppliers and rising oil prices will encourage a huge change in life greater than moral appeals. Others who are wary of the free market emphasize consumer responsibility to seek alternative ways of living. For example, in Aus- tin, Texas, Austin Energy has a program for volunteers to have their home thermostats remotely controlled by the power company: If there is a surge in energy consumption because of a heat wave, the company has the ability to alter air-conditioning units. Similarly, some power companies are deploying smart meters designed to educate consumers about electricity use around the home as well as to let the power compa- nies know of local power cuts (Patterson, 2010).

9.5 Resource Depletion and Sustainability As the population of the world continues to grow, there are concerns not just for the habitats that are destroyed by humanity’s encroachment but also for the resources that we are exploiting. Similar principles to those discussed before, regarding habitat destruction, can guide our think- ing here: If resources are held by governments, there is an incentive on the part of companies to exploit and remove as much as they can while the getting is good. Nonetheless, there is the differ- ence between depleting a renewable source such as timber and a nonrenewable resource such as oil that generates much concern.

Peak Oil

For many decades, the notion of peak oil has haunted discussions of the oil industry. The argu- ment is as follows: As the population expands, humanity’s use of oil increases. But the amount of oil in the ground is essentially fixed, and so as we consume more of it, we must be exhausting its stock. Eventually, there will come a point when we are using more oil than we are discovering or pumping to the surface. This is peak oil. After that, the price of oil will rise, causing untold eco- nomic misfortune for the entire global economy, since so many products from industrial chemicals and transportation to clothing are dependent on oil.

The United States began oil production in 1859 and hit a peak of 10 million barrels a day in 1970. Production has since fallen to 5 million barrels a day, with an estimated 20 billion barrels of crude left in the ground. Three quarters of U.S. oil is now imported, much of it subtly subsi- dized, according to the National Defense Council Foundation, to the tune of over $300 billion annually (Copulos, 2003). As global oil production hits its peak and then begins to dwindle, the United States may find itself struggling to maintain its oil-dependent economy: “We are in for an epochal period of contraction and strife around the world” (Kunstler, 2005). Doomsayers believe that the “Age of Oil” will end with a collapse of civilization, since so much depends on continuing production.

On the other hand, optimists believe that alternative energy sources will be discovered or exploited better by our advancing technologies, sources that will have fewer detrimental side effects. As the resource is depleted, its price will begin to rise, which in turn encourages people to cut back on their consumption as well to purchase automobiles and engines that use oil more effectively. There is also the added incentive for companies to expand into other sources of energy production.

Should Consumers Change Their Behavior?

Corporations and individuals certainly respond to price signals, but some environmental ethi- cists suggest that there should be more than just prices governing or encouraging our acts. If an individual knows that continued use of a product leads to a diminished use in the future, then ethically, they argue, the individual should avoid consuming that product and start invest- ing in renewable energy sources anyway. In the case of oil, this will reduce present consump- tion and divert customers’ money into greener and more sustainable projects, such as solar or wind energy.

What Would You Do?

As the CEO of a medium-size company, you are concerned with the impact of the company’s production on the broader environment. Your factory uses several hundred thousand dollars of electricity annually, and you have permit rights to release waste into the local river. Your predecessors have not had to worry about energy costs, and the attitude of the company towards pollution has always been one of “out of sight, out of mind.” If you engage in greener production, profits may fall and shareholders may lose dividends. If the share price falls, you know that in the current environment, you would be making the company and all of its employees vulnerable to a potential aggressive takeover.

1. Should you go green and invest in relatively more expensive lighting and photovoltaic panels on the roof? Why or why not?

2. Should you keep the company financially secure from predatory takeovers and maintain an envi- ronmentally “dirtier” corporation? Why or why not?

3. Do you consider your position to be determined by the interests of the shareholders alone—and your maxim therefore to look after financial affairs only—or do you see yourself as someone with a vision of a better world, one that would attract alternative investors and green consumers?

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CHAPTER 9Section 9.6 Global Warming/Climate Change

9.6 Global Warming/Climate Change One of the most potent fears to emerge in the past 20 years is of the apparent effect of human activity on global temperatures. Since the 1980s, scientists have been worried about the effects that industrial and chemical production are having on the planet generally, rather than on a par- ticular coastline, river, or landscape. First, there were concerns that fluoride compounds were affecting the ozone layer, as a hole in the ozone over Antarctica was apparently opening up. This led to an international agreement to reduce and ban certain fluoride compounds. Then came fears that our carbon emissions were having a global effect on world temperatures and accordingly on climate and sea levels. The two terms associated with this issue are global warming and climate change, which are commonly used interchangeably for the view that world temperatures are ris- ing. In more scientific discussions, however, each term has a more precise definition.

Governments and businesses, political parties, lobby groups, and citizens have all chimed in with their opinions and recommendations to avoid global warming and climate change. The secretary- general of the United Nations, Ban Ki-moon, stressed to businesses, “As business leaders, you must make it clear to your [political] leaders that doing the right thing for the climate is also the smart thing for global competitiveness and long-term prosperity” (as quoted in Wirth, 2009). There have been many international meetings and treaties, including the Kyoto Protocol in 1997

and, most recently, a summit in December 2011 in Durban, South Africa, at which the United Nations issued a new protocol to bring all nations (including India and China) into acting on climate change.

But international treaties do not always meet expectations. As men- tioned earlier in the chapter, the United States is one of the few countries in the world not to have ratified the Kyoto Protocol, and fol- lowing the Durban summit, one commentator noted that business leaders were simply waiting to see what their respective governments would do (J. A., 2011). That is, cor- porations would act in response to what their national governments enacted rather than on the idealism set out in an international treaty.

Problems with the Science

Most people know about global warming and the tremendous impact it could have on life around the world. The gravest problem in trying to understand what ought to be done, though, is that the science is complex. In addition, the scientific jury (rather than the media or political jury) is out on the extent to which human action causes global climate change.

Associated Press/Luiz Vasconcelos

In the 2000s, scientists grew increasingly concerned at the apparent rise in extreme weather conditions and effects. This 2005 photo shows the effect of a drought on part of the Ama- zon River. The drought disrupted travel and trade.

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CHAPTER 9Section 9.6 Global Warming/Climate Change

For a decade it was assumed that carbon dioxide emissions caused global warming, and govern- ments sponsored much research into the science, a crusade that former Vice President Al Gore picked up and ran with and which American taxpayers are now funding with $4 billion each year (Horn, 2011). A decade later, the science is still ambiguous. Debate still rages between those who put the blame squarely onto human actions and those who claim that climate cycles are natural and humanity’s guilt is minimal (e.g., “Are Humans Definitely Causing Global Warming?,” 2010; Rose, 2011; Singer, 2011).

Unfortunately, it’s also not easy to follow the intentions of either side of the debate. Skeptics who believe there are no or little effects may be funded by oil companies, while climate change lob- byists may be funded by government grants. Both may thus be following their own self-interest in advertising the stance of their sponsors. The actual science is, of course, independent of the money, but few are honest in disclosing their sources, with whistle-blowers claiming that research- ers often distort data for political purposes (O’Sullivan, 2011). We can pessimistically assume that this happens on all sides of the debate, which makes ethical debate foggy and therefore makes it more difficult to explain to companies how they should be acting.

Environmentalist Claims While the public debate continues, environmentalists remind us of the explicit effects of pollution: Habitats are being destroyed, and in the long run, we are only harming ourselves. Therefore, they add, if there is some chance that we are heating up our planet, we have a duty to stop, even if the evidence is ambiguous and the causation not fully understood. It is far better to avoid caus- ing further harm while we are debating the nuances of causation. The natural world may create some of the carbon dioxide emissions, but there is a primary duty not to pollute in the first place. Therefore, businesses are in a position to take a leading role in avoiding adding anything that could cause climate change or global warming.

Free Market Response On the other hand, free market advocates can argue that there should be objective evidence that we are causing global climate change before we act politically or commercially. Some insist there should be noncontroversial evidence that some people and corporations are actually causing harm before they are punished or cajoled into changing their behavior through fines, taxes, and regulations. Criminal law is underpinned by the principle of a crime having been committed before someone can be blamed and charged (the principle of nulla poena sine lege) (Rothbard, 1978). If there is no evidence, companies and people cannot be blamed. Other critics of global warming refer to the weak and contradictory evidence that is sometimes used to scare people rather than to allow them to consider the facts scientifically.

Could Businesses Lead the Way? Yet if corporations are more adaptable than governments, perhaps they can lead the way by tak- ing ethical stands on global warming. When we think of Steve Jobs, the late CEO of Apple, we think of a man who could innovate and challenge our expectations in the computer industry. Body Shop founder Anita Roddick shifted thinking on cosmetics, and Ray Kroc of McDonald’s did so with regard to burgers. If these business people could shift our thinking on consumer products, then

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CHAPTER 9Section 9.6 Global Warming/Climate Change

business can take up the mantle to become the proper vanguard for shifting our thinking on the environment. And in many respects, companies are leading the way. Forbes magazine presents a list of America’s greenest companies, where we find Intel at the top of the 2011 list for having shifted electricity consumption to renewable sources by 75% (Dolan, 2011).

Alternative Energy Sources

One of the biggest areas of commercial activity has been the search for alternative and preferably renewable energy sources. Companies have responded to fears of peak oil but also government and consumer pressure to find alternatives. One of those has been nuclear energy.

Nuclear Energy Another trend following World War II was to encourage investment into nuclear energy as well as to continue mining for coal and drilling for oil and gas. By the 1960s, nuclear reactors were seen as offering a clean and efficient method for keeping up with growing demand for electricity. However, much of the investment in the technology was advanced beyond what commerce would stand acting alone.

For instance, in 1979, the Three Mile Island nuclear plant in Dauphin Country, Pennsylvania, suf- fered a meltdown in one reactor that led to 40,000 gallons of radioactive coolant’s being poured into the local river. The incident has been used by various parties to proclaim that nuclear power is not safe and that the nuclear industry was too tied up with local officials, who turned a blind eye to safety issues (Keisling, 2011). But there are also those who believe that lessons from such disasters have been learned and that nuclear power is a viable option. Tellingly, however, the free market had not been interested in nuclear power: “Utilities considering building nuclear power stations discovered their investments could not be insured. [Lloyd’s] of London, known for taking risks on just about anything, would not write a policy protecting a nuclear power plant” (Keisling, 2011).

If insurance companies do not wish to underwrite a venture, the message is clear: The risks are too high. When private insurance companies refused to underwrite Three Mile Island, even before the disaster happened, the U.S. government stepped in to subsidize the insurance bill with taxpayers’ money. This was, in effect, an admission that the industry could not go it alone and that a hazard had to be subsidized. From both an economic and an ethical point of view, a potential hazard was being given a subsidy. This is analogous to subsidizing a commodity such as tobacco, which gener- ates health costs for others as well as the consumer. Such an action is difficult to defend, except on the possible argument that it is worth permitting suffering today in order to create a cleaner future technology, even if insurers cannot support them. This would mean encouraging suffering today in order to benefit more people in the future. However, this defense presumes that govern- ments are in a better position to know what the future will bring (and thereby have a political duty to advance present technology accordingly) than are businesses, who are only interested in maximizing profit, and consumers, who are too interested in their daily lives.

The argument that governments know best has been a popular one during the 20th century. The New Deal and the postwar expansion of government into the market and into the social lives of Americans was based on the assumption that government officials could use scientific knowledge

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CHAPTER 9Section 9.7 Environmental Restriction Versus Economic Freedom

and social statistics to engineer the country for the better: This is known as social engineering (Johnson, 2001). Critics complain that the argument for using government to better people’s lives is weak on several grounds:

• Governments are plagued by self-interested groups and are just as near sighted as they claim businesses to be.

• Historically, governments have been notoriously bad at predicting the future. • Governments may not be affected by profit-maximization concerns, but the main players

are certainly affected by elections, and so they may adjust their policies to get reelected. • And why should government officials possess deeper insights into the world just because

they are paid from the public purse?

In economics, this is known as the problem of government failure, as opposed to market failure (Buchanan, 1962).

In hindsight, the nuclear industry can be seen as too much too soon, or, more pessimistically, as an unmitigated human and environmental disaster that continues to unroll down to the present and into the future. Proponents, however, are optimistic that the way ahead still lies with nuclear power: It has the potential to produce most of the nation’s electricity, and the technology and hence safety have improved in the wake of problems.

But the problems do weigh heavily on people’s minds, reply the environmentalists. In 1986, the Soviet plant at Chernobyl went into meltdown, as did three of the Fukushima Daiichi plant’s reac- tors in Japan following the dreadful tsunami in 2011. Indeed, there is a catalogue of 33 serious nuclear disasters around the world (Simon Rogers, 2011). Nonetheless, the nuclear industry is still being heavily subsidized by taxpayers around the world. In 2010, direct subsidies to nuclear power amounted to over $3 billion (“Energy Subsidies and External Costs,” n.d.).

9.7 Environmental Restriction Versus Economic Freedom In living in a habitat such as a city, a town, or the deep countryside, we can usually see the impact of littering in or destroying our immediate vicinity, and we learn to avoid harming the environ- ment when doing so also harms us. But when the effects of our actions are not visible, and may be hundreds or even thousands of miles away, our diligence is reduced. Consider taking a shower and using regular soap. Many personal products have a range of chemicals in them that are washed down the drains, into the sewers, and out into the rivers to the sea. Along the way, main ingre- dients such as sodium laureth sulfate have cumulative effects on plants and animals and on the quality of water. Consumers do not usually think about the impact their shampoo may be having on aquatic animals living several hundred miles away, and following self-interested behavior, they have no incentive to change.

Ethically, though, the effects do need to be considered, and so we have a conflict between pur- suing personal freedom (to wash in chemicals) and the environmentalist desire to restrict that freedom (because of its unseen effects). Interestingly, although the United States was founded on the principle of human freedom, successive U.S. governments have instituted laws prohibiting commercial exploitation of various landscapes that they deemed intrinsically worth protecting.

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CHAPTER 9Section 9.7 Environmental Restriction Versus Economic Freedom

U.S. Laws Restricting Access

In 1832, President Andrew Jackson encouraged the passing of the first Congressional laws on areas of natural beauty deserving federal protection. The first area protected was the Hot Springs Res- ervation (now National Park) in Arkansas. This was followed by Lincoln’s securing of the Yosemite Valley and the Mariposa Grove. In 1872, Yellowstone National Park was formed by Ulysses S. Grant to secure its protection. In 1916, Woodrow Wilson formed the National Park Service to oversee the management of the national parks, which now number 58 and cover 84 million acres of land (National Park Service, 2011). Yosemite, Yellowstone, the Grand Canyon, and many other sites also became UNESCO World Heritage sites following an international ratification of their special status to humanity as a whole. The United States played a leading role in developing World Heritage sites following a White House conference in Washington, DC, in 1965, and its proposals were eventually ratified in 1972 by the general conference of UNESCO (“The World Heritage Convention,” n.d.).

Private Trusts Restricting Access

Normally, we consider safeguarding key areas of outstanding beauty to be a role of government, but private owners also create legal trusts to protect the landscapes they love. There are currently over 37 million acres that have been voluntarily protected in the United States (“History,” n.d.). Critics complain that governments tend not to manage property well and that the national parks should be turned over to private trusts. The argument is less with the impact of a potential indus- trialization of the parks than with the efficiency of their management (Lora, 2007).

Private individuals, lobbyists, and governments show their concern with protecting the environ- ment from industry, but does this run counter to the economic freedom of present or future gen- erations to enjoy a cash flow from beautiful areas?

The Problem of the Beautiful Valley

Consider a valley with a flowing river and ancient woodland surround- ing it, inhabited by a wide variety of flora and fauna; the views are breathtaking and the air is fresh. The river is swimmable and has a broad range of fish; fruit grows well in the autumn, and the valley protects its inhabitants from the ravages of win- ter. It is an idyllic place to settle.

From the environmentalist posi- tion, the pristine nature of the val- ley gives it a primary objective value that trumps all other human inter- ests: It should be left as is, with only a few people being able to savor the rural paradise. From an alterna- tive, commercial perspective, the

Simon Russell

A pristine landscape untainted by human interference: Is it bet- ter left alone, or should it be developed so more people can have access to its resources?

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CHAPTER 9Section 9.7 Environmental Restriction Versus Economic Freedom

land offers excellent possibilities for a tourist resort or a rural retreat for families or retired folk. If power and roads were brought to the area, the valley could provide hundreds of jobs and transform a zero-economic-value area into a multimillion-dollar complex of businesses and supporting indus- tries. Where there is nothing but wilderness, the business investor sees the potential to serve other people through job creation and the building of accommodation and recreational units. It may be acknowledged that the environment suffers, but the benefits brought forward are for people. And corporations are in the business of serving people, not squirrels and fish. But should there be any restrictions on what they can do? And who should for- mulate those restrictions, and on what grounds?

The two opposing visions of exploiting the landscape and leaving it alone can merge into green business projects. These attempt to develop pristine wilder- ness for human enjoyment while not losing any of the ecological breadth and natural beauty found there. Imagine off-grid wooden cabins where environmen- talists come to study and research the area and fami- lies come to get away from the urban sprawl, enjoy fresh air, and get closer to nature. If a middle path is attempted, sometimes well-meaning people fall afoul of laws that restrict environmentally friendly develop- ment. After all, corporations have to respond to the legal framework that they operate in.

Sometimes, however, the legal framework is not as objective and impartial to human and environmen- tal interests as it may appear. Much legislation is the product of lobbying and of politicians’ trying to garner votes rather than stick to principles. Such actions may or may not reflect the values that the general popu- lation would support or that would reflect the envi- ronment’s needs. In the great emotional debate that sometimes affects environmental issues, governments and corporations haggle over what is known as a cost- benefit analysis of actions.

Cost-Benefit Analysis of Environmental Responsibility

As the size of the federal government, and thereby its jurisdiction, expanded following the New Deal of the 1930s, the justification for government projects took on a more scientific, or eco- nomic, approach. Rather than just proceed with a flood control project, a dam, a power station, or a road through the woods, for example, government agencies were told to check whether the benefits outweighed the costs. After World War II, there was a global pressure on governments to ensure that they were acting efficiently and spending taxpayers’ money wisely on large infrastruc- ture projects such as dams and roads (“Executive Summary,” 2006). Agencies and the economists they employed had found a fruitful ground to proceed with seemingly scientific studies that would be used to explain the balance of merits to taxpayers. Cost-benefit analysis became increasingly popular with agencies and later with lobbying groups and corporations, who would come up with opposing numbers to justify their own positions.

What Would You Do?

Imagine that you inherit an idyllic valley from a distant family member and you set eyes on it for the first time. Several thoughts rush through your mind. As a business venture, it could bring thousands a year into your account from renting cabins around the water’s edge and selling hunting rights. However, it could instead be left alone for you to pass on to the next family member, and in your lifetime, you and your family could enjoy peace- ful evenings by the campfire.

1. What do you envision—a thriving business venture or a valley to keep as it is? Why?

2. Would your mind change if a geol- ogist informed you of rare miner- als that had been detected along the shore? Why or why not?

3. Do people have rights over such landscapes or, as some thinkers hold, do such landscapes have rights over us?

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CHAPTER 9Section 9.7 Environmental Restriction Versus Economic Freedom

However, in the past two decades, cost-benefit analysis has come under increasing criticism on philosophical and methodological grounds (Adler & Posner, 1999). For supporters, cost-benefit analysis has many advantages over simply plowing ahead with a project regardless of the effects on human and environmental welfare. The social benefits must be seen to outweigh the social costs across society. The analyst proceeds by adding up the willingness of people to pay for the benefits that come from the project, or their willingness to be compensated for any negative impacts. The benefits are then discounted over time, as present benefits are held to have a higher value than future benefits. In the adding up of values, society is held to be the sum of individuals, and each individual’s financial status should be accounted for. But rather than assuming that each person counts for one (as utilitarianism holds), cost-benefit studies typically assume that lower income or disadvantaged people should gain more than the rich when infrastructure projects are planned. This means that a short-term project can have a greater beneficial flow than a long-term project, and one that brings more jobs to a disadvantaged area has a higher worth than one that brings jobs to an already booming area.

Criticism of cost-benefit analysis comes from several areas:

• The methodology can be questioned. The studies assume that poor people will enjoy higher benefits than the rich when projects create jobs, for instance. This is not necessar- ily the case as (a) an outsider cannot judge what is valuable to other people and (b) the jobs that are created may be geared mainly towards the rich.

• The weightings provided by the analysis can be criticized. People are generally given more weighting than animals, but conservationists and environmentalists would argue that this is wrong and that land should count as much as people, mountains as much as towns, wolves as much as children.

• Most importantly, the entire enterprise can be rejected on the grounds that the values imposed on companies and people are basically made up.

Social and Private Costs

In a market, the price reflects the private valuation that both the buyer and the seller place on the good or service. But for critics, what the market price does not reflect is the social value, or the social costs incurred in the production or consumption of the good or service. These social costs provide critics with a rationale for intervention and hence for the imposition of taxes and regulations on trade. The distinction arises between the costs as assessed by the accountants of the firm and the costs that are incurred by other stakeholders and by the environment but are not accounted for by the producers.

For instance, a timber company cuts down trees that are then used by the paper industry. The products in turn are used by book producers and read by consumers. At each stage of production, a certain profit is made, and the consumers exhibit their valuation of the books produced by either buying them or not.

But now consider the same scenario from an environmentalist viewpoint. The cutting of timber removes the natural habitat of several species and in turn has a follow-on effect on other species through the food chain. This produces an irreversible alteration that in turn affects the ecologi- cal health of the environment. The trees become more susceptible to disease and the diseases spread, leaving the timberland weaker. At this point, the companies may react and alter their

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CHAPTER 9Section 9.8 Conclusion

production methods because their financial health is also being threatened. But imagine that the company is only interested in reaping profits from the landscape once and that it possesses no incentive to alter its methods.

Accordingly, environmentalists note the difference between the private costs of doing business and the social costs:

• The effects on the environment are not accounted for by the companies; • nor is the pollution that is a byproduct of all the machinery cutting down the timber and

hauling it back to the mills; and • nor are the externalities imposed on other people whose lives are affected for good and

ill by the companies’ actions, such as the impact of logging roads and the industrial traf- fic around mills. Externalities are the costs incurred by other people rather than by the company.

The argument is then proposed that instead of the company charging the market price for the tim- ber, a surcharge should be added to reflect the extra costs borne by the environment and people affected by the logging industry. This surcharge (typically a tax) forces the corporation to include the externalities in its own accounting; this can, depending on consumers’ responses, reduce the overall profits of the trade and discourage timber companies from proceeding carelessly. How- ever, if consumers’ demand is unaffected by the higher after-tax price, then the company’s profits can indeed expand, which may be contrary to what the environmentalists expected. That, in turn, may encourage further logging.

Between the two groups (corporations and environmental lobbyists), advisers sit and consider the nature and extent of the externalities. Each side may come up with wildly differing results, and so a government official may then have to choose between the different reports. (Imagine the pros and cons of building an airport in a small town.) The official may then try for a compromise to appease both sides and the voters. To supportive commentators, this is what politics are about: finding a working solution between different interest groups. To critics, the attempt at formulat- ing a set of values in the absence of market prices is ludicrous, since all cost-benefit analyses are academic exercises that are a waste of money in themselves but that also, when implemented, can generate more harm than good.

Despite decades of environmental laws and cost-benefit studies, pollution and habitat destruction continue, and in the wake of the Deepwater Horizon oil spill and the nuclear pollution pouring out of the Fukushima Daiichi nuclear power plant, the evidence of our impact on the world is growing.

9.8 Conclusion Despite the confusion that surrounds the incentives prompting environmental projects, programs, and visions, ethics can still play a role in the economic fog that is created by subsidies and regula- tions. Each individual has a choice to support environmental projects with posttax income. Envi- ronmentalists would remind us that the duty to care for the earth is as important as the duty to respect one another. However, other ethicists would reject putting inanimate objects or other spe- cies ahead of the needs and desires of sentient, conscious, rational folk—us. Cost-benefit analysis can play a role in sorting out which projects should be funded and which environments protected,

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CHAPTER 9Summary

but it is also subject to criticism that the designers of such studies are merely imposing subjective values on land and resources, and such evaluations are prone to politicization. Ultimately, the choice to respect the environment or not lies with our individual choices. We can decide to ignore the long-term or distant impacts resulting from the products we consume, or we can take a prin- cipled stance in reducing those possible effects.

Summary Pollution is a global as well as a national problem, and it is not always clear who is polluting what, particularly with carbon emissions: We are all guilty. For politicians, the solution lies in agree- ments and accords on reducing emissions, such as the agreements coming from the Kyoto and Durban conferences. For some economists, the problem lies in the lack of property rights or the lack of enforcement of known rights. Either way, an awkward problem remains: Ethically, should we each try to purchase greener technology, reduce our own waste into sewers, and buy electric- ity generated from renewable resources; or should we put our individual, family, and social needs first and turn away from problems over which there is so much disagreement? Subsidizing forms of energy production comes with many problems and acts to muddy the ethical debate. Taxpayer money may be spent on the wrong forms of production, which may in turn cause more danger- ous environmental damage. The enthusiasm for nuclear power, for instance, has diminished after several disasters whose true impact may not be known for generations. Most Western countries subsidize renewable energy to some extent, and thus the market for energy is politicized. Govern- ment incentives distort the market and thereby people’s choices, making it difficult to assess the ethical impact of choosing the greener option or reducing a carbon footprint.

Discussion Questions

1. Our thinking about the world around us has an effect on how we relate to and behave towards it. We are increasingly aware that many of our industrial and chemical pro- cesses have an impact on the world we live in. To what extent does learning about the environment have an effect on your personal choices and the purchases you make from businesses?

2. A power station is planned in your area and you have been requested to submit a primary cost-benefit analysis of the potential economic and environmental impact that the station could have. Prepare a list of pros and cons and a preliminary judgment on whether the project should go ahead.

3. The federal government manages millions of acres of forest land across the country, but there are increasing pressures on the agencies to permit varying levels of commercial access to the timber, other resources, and water flows. Should the government have an absolute prohibition on commercial access or should there be a working compromise with companies?

4. Free market supporters believe that many pollution and habitat issues could be resolved if the lands in question were turned over to private individuals and companies who would have an incentive to look after them better and even to help add value to them. Do you think that all environmental problems could be solved if the land, rivers, and coastline were privately held, or do you think there would be other problems to contend with?

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CHAPTER 9Summary

5. When we flick a switch on a device, we consume electricity, and often it is difficult to know what the source of that energy is: nuclear, wind, solar, coal, water, or oil. Do you think electricity companies have a duty to inform customers how their electricity is pro- duced, and would you be interested if they did?

Key Terms

cap and trade The term describing the right of companies to pollute up to a maximum and then trade any unused rights on the market.

carbon tax A tax on any carbon-emitting fac- tory or product, such as cars.

climate change The theory that pollution of the air is causing the earth’s weather systems to become more erratic.

cost-benefit analysis The economic model- ing of a project to check whether the benefits outweigh the costs.

emissions rights The legal ownership, which companies can trade with other companies, of the right to pollute up to a maximum.

environmentalism A social and political move- ment characterized by the belief that people have a duty of care to the planet or that environmental values should come first over people’s value.

externalities A term used by economists to express the costs imposed on stakeholders and the environment but not accounted for on a company’s books.

global warming The theory that pollution of the air is causing the earth’s average tempera- ture to rise.

government failure A term from economics that describes the conflicting interests, short- sightedness, and incompetency of government officials.

Kyoto Protocol of 1997 An international declaration that sought to reduce carbon emis- sions around the world and reduce the threat of global warming.

peak oil The notion that there will come a time when humanity has exacted a maximum amount of oil from the ground, after which oil supplies will deplete quickly.

private costs Costs incurred by a corporation which are accounted for on its books.

social costs Costs incurred by other people outside a corporation which hence are not accounted for on the company’s books.

social engineering The theory that govern- ments can organize society along lines that will promote the greatest welfare for citizens.

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Investments

Learning Objectives

After completing this chapter, you should be able to:

• Describe various ethical investments. • Describe which investments are criticized by ethicists. • Explain the basic ethics of saving and investing. • Outline the problems involved in corporate investments.

iStockphoto/Thinkstock

10

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CHAPTER 10Section 10.1 Introduction

Contents

10.1 Introduction

10.2 Ethical Investing

Features of Ethical Investing Sustainable Investing Community-Development Financing Impact Investing Socially Responsible Investing Funds and Green Funds

10.3 Potentially Unethical Investments

Environmentally Damaging Products Genetically Modified Foods Pharmaceutical Products Military Weapons

10.4 Investing Versus Spending

The Economic Harm of Hoarding Does Investment Harm Recession Recovery?

10.5 Conclusion

10.1 Introduction Ethically minded investors throughout the ages have been concerned about where their money is invested and from where they make their returns. John Wesley (1703–1791), the founder of Methodism, argued that Christians should not invest in anything that could harm people, such as the slave trade. Later, religiously motivated campaigns also targeted alcohol, tobacco, and drug companies. There have been several notable campaigns in the 20th century:

• In the 1930s, the Nazis waged a racist campaign against German Jewish businesses. In retaliation, Jews around the world boycotted German products.

• In the 1960s, Martin Luther King Jr. instigated a campaign against the Montgomery City Lines bus company for its treatment of Black riders.

• In the 1970s and 1980s, antiapartheid groups encouraged boycotting of companies involved in trade with South Africa.

• Since the 1980s, consumer activists have led boycotts against Nestlé for its aggressive marketing of infant formula in developing countries and the use of bonded and child labor in some of its cocoa plantations.

In each of these cases there is a choice:

1. We can invest in goods and services that reflect our ethical considerations, or 2. We can simply aim for high rates of return with our investments and ignore ethics.

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CHAPTER 10Section 10.2 Ethical Investing

In letting ethics influence their choices, investors hope to send a moral message to the market. Consumers today are more aware of commercial scandals, unethical marketing, and misleading adver- tising than ever before (Bibb, 2010, pp.158–159). We can now search the Internet for product reviews from customers and professional groups and make better decisions about our purchases and invest- ments. With just a little research, the opportunities are there for anyone to make ethics a factor in investment decisions.

At first, the idea of ethical invest- ments was met with a good deal of skepticism about how well they would perform financially. However, ethical investments have done reasonably well on average, holding their own against traditional investments. This chapter will explain types of ethical investments and how ethics factors into even the most basic invest- ment decisions.

10.2 Ethical Investing Investing is a thoroughly capitalist enterprise, since capitalism involves investing in a given busi- ness to improve its productivity. An investor channels his or her money into what will hopefully be a productive enterprise: a business, a real estate investment, stocks and commodities, or valu- able items such as fine art or gold. A profitable investment either earns the investor immediate income, such as through dividend payments, or goes up in price.

We begin by looking at various types of ethical investing. The need for ethical investments emerged from a broader movement to encourage corporations to become more ethical and to satisfy inves- tors’ consciences that they were putting their money into good practices. There are several terms used to describe ethical investments, which we discuss here.

Features of Ethical Investing

Ethical investing involves using an ethical model to screen companies to invest in. The model may be influenced by religious considerations, such as supporting one’s denomination, or by politi- cal considerations, such as supporting liberal or conservative causes. Ethical investing commonly involves avoiding stocks related to armaments, tobacco, the sex industry, and alcohol, as well as incorporating stocks in ethical companies such as alternative energy companies. Ethical investing also draws on the more particular ethical convictions that the individual investor has, such as not

Pat Roque/AP

In this 2009 photo, a Filipina worker encourages boycotting Nestlé products, including a variety of milk substitutes.

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CHAPTER 10Section 10.2 Ethical Investing

investing in mining stocks or agrochemical companies. A benefit of ethical investing is that the investment can truly reflect the beliefs of the investor. For instance, an investment manager may avoid putting money into governments that do not respect human rights or into companies that habitually pollute. Ethical investing has the potential for elevating moral priorities within the busi- ness world. Businesses are more likely to be ethical if they attract investors who are seeking ethi- cally minded corporations; in turn, ethically minded investors can have an influence on corporate culture and ethics.

A major challenge for ethical investing involves the issue of relativism: An ethical investment to one person may be an unethical investment to another. Recall that moral relativism is the theory that one person’s notion of good can differ from another’s. For example, a religious-minded inves- tor may encourage making certain investments that a secular-minded investor would not touch. Ethicists want to create some common moral standards that we all accept, such as one that says it is wrong to invest in companies that have poor safety records or whose products cause ill health. But the ethical status of some business activities is not entirely clear. Take genetically modified foods, for example, which are widely criticized for potentially harmful effects on human health and the environment. The two sides in this dispute may agree to disagree, but the average inves- tor may be confused as to the right course of action.

Another major challenge in ethical investing involves difficulties in detecting morally questionable practices of businesses that might be hidden from public view. An ethical investor may easily avoid so-called sinful stocks, such as tobacco companies, whose very products are morally question- able. But many activities in the business world are less open to public scrutiny. For instance, an otherwise good company may move revenues into low-tax countries and hence avoid paying high rates of tax in host countries. The average investor may not have the proper data to make the right investment decision.

Sustainable Investing

Another type of ethical investing is sustainable investing, which occurs when investments are made to encourage socially responsible businesses to engage in environmentally sustainable proj- ects. Investors might, for example, fund efforts to support local organic farming or help a business shift away from nonrenewable fossil fuels. Too often, venture capital can be withdrawn from an investment before a worthwhile project has truly got going. Sustainable investing seeks to remove that fear. Loans for sustainable investing typically go through cooperatives, credit unions, social banks, and microfinance institutions whose missions are to serve local communities better than large multinational or national banks would.

The problem for critics is that such projects may not produce great returns, and they can verge on being acts of charity. Second, it is not always apparent how long the investment is required. For instance, when investing in forestry development, the return from timber can be several decades out.

Community-Development Financing

Community-development financing (CDF) invests where traditional banks and investing organi- zations fail to reach. The businesses or individuals may be in deprived areas, whose social and

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CHAPTER 10Section 10.2 Ethical Investing

economic statistics do not encourage large firms to invest there. CDF provides loans to people who would not otherwise have the correct credit score, or people with business plans but no experience. The sources of CDF can be charities or governments, and their investments tend not to be for profit. The great benefit of CDF is that the loans reach out into areas and peoples that would not otherwise get a loan. For many ethically minded investors, this can be seen as an act of justice and of empowering poor people or areas.

Since it is not for profit, CDF investment or financing is more of an act of charity and so is not usu- ally going to generate good returns for investors. If such businesses or individuals do not score

well, then they are likely to prove poor recipients of investment funds. Nonetheless, there are ele- ments of CDF that can be profit- able. Consider the individuals who would not otherwise get a regular bank loan, but whose sincerity and financial ability do translate into a good investment in a start-up busi- ness. Investments in CDF may aver- age out losses from people who do not do as well as expected, but there can be many who do provide good returns on the loans. In that respect, averaging out the good with the bad is like any investment portfolio, but CDF invokes the ethic that everybody deserves a chance to do better in life, and many recipi- ents would otherwise remain poor.

Impact Investing

Impact investing is a recently coined term that invokes using investment finance to make an impact for the better across communities and environments (Bugg-Levine & Emerson, 2011). Impact investors are pro-business and support the role of market forces in the economy, so they certainly seek to maximize their returns. However, they wish to balance their returns by having a definable impact on social or environmental issues. Supporters argue that impact investors are optimistic about the role that business and investment can have, rather than relying on govern- ments to lend to ethically minded people or projects. They believe that markets and businesses can be vehicles for good when they are blended with ethical values (Bugg-Levine & Emerson, 2011, line 472).

In many respects, impact investing reflects the general thrust of other forms of ethical investing, but with the added element that the investors are generally pro-market rather than skeptical of market forces and corporations. However, because of this pro-market bias, impact investors face regulatory hurdles and skepticism from other ethically minded investors. This is because impact investors would prefer to loan money to poor people struggling to make a go of a business than simply give them money. Impact investing also falls between definitions. Investors believe

Associated Press

This 2011 photo shows bracelets that Starbucks gave to custom- ers who donated more than $5 into a fund that provided money to community-development financing institutions, which in turn offered loans to those who would ordinarily not have qualified.

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CHAPTER 10Section 10.2 Ethical Investing

that they are acting charitably by extending funds where regular banks would not invest, but gov- ernments find it difficult to accord them charity or nonprofit status, even if the investors do not intend to make a profit. If they borrow money on the market, rather than just raise it in a charity drive, this causes further confusion. As pro- ponents complain, the regulatory system has yet to catch up with this dynamic form of ethical investing.

Socially Responsible Investing Funds and Green Funds

In the past decade, a special type of ethical investing has become popular that involves seeking out a group of ethical companies and compiling shares of their stock into investment funds. Socially respon- sible investing (SRI) funds, as they are called, are stock funds that invest in companies attempting to do good to more than just their shareholders. SRI funds tend to invest in companies that seek to help stakeholders gain a voice in company activities, are transparent and uphold good working conditions, and maintain good environmental standards and safe products. Broadly speaking, SRI fund managers screen their investments to

• avoid some and include other companies that reflect their particular ethical model, • invest in companies that invoke and encourage shareholder advocacy, and • invest in communities and local nonprofit ventures.

SRI funds have grown to make up $3 trillion of the $25 trillion invested in the United States. These funds are supported by individuals as well as corporations, pension funds, nonprofit groups, and religious institutions with wealth to invest (“Sustainable and Responsible Investing,” n.d.). SRI funds typically do not invest in companies that make weapons, pollute the environment, test on animals, or use child labor. But they do try to invest in businesses that make a positive impact on the world, such as those creating green technologies and community-development schemes.

Carlos Osorio/AP

Sports star Earvin “Magic” Johnson (back left) is seen here in 2011 with the mayor of Detroit, Dave Bing (back right), and (front row, from left) Detroit Venture Partners’ Brian Hermelin, Quicken Loans founder Dan Gilbert, and Josh Linkner, also of Detroit Venture Partners. Johnson said in a news conference that he wanted to have a positive impact on Detroit’s down- town area by joining Detroit Venture partners to help channel millions of dollars into the city.

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CHAPTER 10Section 10.3 Potentially Unethical Investments

The rise of SRI funds coincided with the rise of what are called green funds, which aim to attract environ- mentally conscious investors. At first, green and SRI funds were generally lumped together, but as con- sumer groups and activists rummaged through what their money was buying, investment companies became more specific. Just because some investors held a very aggressive environmental position, this did not mean that an SRI fund had to echo that particular environmental preference (Harvey, 2008).

Ethical investment managers tend to begin with filter- ing out companies that do not match the fund’s ethi- cal criteria. This is called negative filtering. They may filter out negatives such as companies connected with alcohol, gambling, the military, pornography, human- rights abuses, health and safety problems, animal testing, genetically modified foods, intensive farming, nuclear power, pesticides, and exploitation of people and resources in developing nations. Then the fund managers may use positive filtering to gather other companies into the funds, companies that they know are socially responsible or green in their credentials. The managers may rank investments by commu- nity involvement, environmental improvement and management, equal opportunity, and positive envi- ronmental and humanrights procedures (“Ethical Preferences Questionnaire,” n.d.).

10.3 Potentially Unethical Investments In this section, we look at the kinds of companies that are of particular concern for ethical inves- tors—both individual investors and fund managers. These include those relating to the environ- ment, genetically modified foods, pharmaceutical products, and military weapons.

Environmentally Damaging Products

In recent years, public concern for the environment has focused on the notion of a “carbon foot- print” to examine how much carbon production our individual and national lives generate. In 2010, carbon emissions saw their largest increase in output in the United States since 1988, according to the U.S. Energy Information Administration, with 5,638 million metric tons of carbon dioxide emissions. Since 1990, American carbon dioxide emissions have grown at an annual rate of 0.6% (Pentland, 2011). For investors who are conscious of the potential effects of carbon emissions on climate change or global warming, the corporate producers of carbon dioxide emissions are chief among the companies to be avoided.

What Would You Do?

You would like to invest in a fund or a stock. A basic fund could gain 6% annually, whereas an ethical fund could gain 5% annually. If you invest $10,000, that’s the difference between $500 and $600, or the fund’s doubling in 11 years versus 14 years. A $100 difference a year may not seem much, but a 3-year difference in how quickly the fund doubles may be more unattractive.

1. As an investor, is it important for you to grow your wealth as quickly as possible, or are you comfortable giving up some of the potential returns in favor of a conscientious investment?

2. Based on a $100 difference in returns over the course of a year, would you invest in the ethical fund? Why or why not?

3. If the difference in returns were $1,000 a year, would your answer remain the same? Why or why not?

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CHAPTER 10Section 10.3 Potentially Unethical Investments

But an issue arises here as to what constitutes envi- ronmentally destructive products. For instance, many would argue that oil and gas companies pollute the environment once the hydrocarbons are burned to produce carbon dioxide, but some oil companies can be found in ethical and green funds because their research and drilling procedures pass many environ- mental tests. Consider BP, which was implicated in the Deepwater Horizon oil spill in the Gulf of Mexico in 2010. For many, the company (which is listed on the New York Stock Exchange) would certainly be one to avoid. Yet Mark Robertson, an ethical-funds adviser, has said that BP actually passes lots of ethical tests for its openness (as quoted in Pennells, 2010).

BP has also captured attention for investing millions in green technologies, which is favored by green inves- tors, but it has been found guilty of other spills and invests heavily in lobbying American politicians, con- tributing over $2 million to Republicans and Democrats alike in the years 2004 to 2010 (“Opensecrets,” n.d.). This can put off ethically minded investors who do not wish their money to fall into political games. Some eth- ical funds prefer to avoid investing in the oil business or industrial chemicals altogether, while others prefer a more pragmatic stance on companies like BP that are simultaneously striving to invest in future fuels.

Genetically Modified Foods

Other environmentally questionable products that ethical and green-minded investors may wish to avoid

include genetically modified (GM) foods. Critics believe that GM foods should be avoided for the environmental and health effects they allegedly cause.

A case in point for many ethical investors is the multinational company Monsanto, which is one of the three largest GM seed producers in the world and spends millions on lobbying the federal gov- ernment (Associated Press, 2011). Critics accuse Monsanto of only appearing ethical and open; they believe that the company’s biotech products, including GM crops and herbicides, generate health disorders and unintentional consequences such as weeds’ evolving a resistance against the com- pany’s popular herbicide Roundup (Gucciardi, 2011). They also complain that the artificial sweet- ener aspartame, which is found in many sugarless drinks, is made from GM bacteria (Woolf, 1999).

Environmentalists such as the international group Greenpeace see GM food crops as a disaster threatening biodiversity and human health. Their stance is that science is useful for expanding our knowledge, but that does not mean it should be used in commercially motivated genetic experi- ments. In effect, corporations should not be deploying GM food because it quickly contaminates other crops around it and is in effect a form of pollution, whose results are not understood or even

Photodisc/Thinkstock

For many environmentally conscious inves- tors, channeling money into renewable energy is an ethical investment, and one that generates a good return. The down- side is that many people consider wind tur- bines ugly. Critics also point out that until the electricity generated can be harnessed by batteries, turbines are useless when the wind is not blowing.

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CHAPTER 10Section 10.3 Potentially Unethical Investments

controllable (“Say No to Genetic Engineering,” n.d.). For environmentalists, the intention of companies like Monsanto is to make money rather than to improve the health and well-being of the environment, and the results are at best unknown, and at worst harmful.

For defenders of investing in companies that produce GM foods, those companies could secure humanity’s food supply by producing weed- and pest-resistant crops. Not only would the investment reap great prof- its as the seeds were sold and propagated around the world, but humanitarian disasters would be avoided and people living on the margin of famine and death would be saved. GM crops require less use of pesti- cides and act to reduce greenhouse emissions (Bright Hub, 2011). What could be a better ethical invest- ment? Critics reply that the evidence is not forthcom- ing (J. Smith, 2011):

• In India, GM cotton has cost two states over $80 billion because of inconsistent crop perfor- mance. Shepherds have lost 25% of their herds grazing on GM crops. Cotton-gin workers have had to resort to antihistamines to go to work.

• Mice eating GM corn had fewer and smaller babies, and half of the babies died within three weeks.

• Cross contamination with non-GM food crops could last decades.

• There are no human clinical trials of the effects of GM foods; the American Academy of Environmental Medicine urges doctors to prescribe non-GM diets for patients.

• Since the introduction of GM foods in 1996, American health has been affected with increases in reported food allergies, chronic illnesses, and reproductive and digestive disorders.

GM-food corporations are thus targeted for exclusion by ethical investors on the grounds that their products cause more harm than good, or that we do not know what the long-term conse- quences of using GM seeds will be. For many, that is sufficient to avoid investing in those compa- nies. If we do not know whether the product will be harmful or not, it is better to avoid supporting it until we know more.

Pharmaceutical Products

Initially, it would seem strange to raise moral questions about pharmaceutical companies. But just as environmentalists see oil companies as being in cahoots with politicians and covering up scandals and the true cost of burning fossil fuels, natural health advocates similarly complain of the pharmaceutical industry’s power, influence, and unethical activities. For one, pharmaceutical companies are under increasing criticism for the effects that their drugs have both on people and

Polka Dot/Thinkstock

A symbol of genetically modifying the foods we eat: a hypodermic syringe about to inject an ordinary apple with a modify- ing substance. The picture captures our attention, but the science is more indirect: Monsanto and other companies alter the genetic codes of the seeds that are then planted, rather than inject harvested foods.

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CHAPTER 10Section 10.3 Potentially Unethical Investments

on the environment (Desai, 2007). In fact, research has shown that more than 100,000 deaths are caused by drug reactions each year in the United States (Null, 2010). This implies that an invest- ment in pharmaceuticals could cause more suffering than an investment in an armaments com- pany. Drug companies are also a source of misery, pain, and death, and attracted $3.1 billion in claims through the Justice Department for fraud and false claims in 2010 (Harris & Wilson, 2010).

Defenders of pharmaceutical companies argue that the intention behind drugs is that they will be used to help people. A right intention holds a good claim for many ethicists—as long as the inves- tor intended to do the right thing, and the right thing is something that people would agree on as being right, then the investor cannot be in the wrong. But the response is simple: The road to hell is paved with good intentions. That is, it is not sufficient for people to merely claim that they were trying to do the right thing; they actually need to be doing the right thing, and the right thing involves not just possessing a good intent but also generating benefits through the action.

Defenders of pharmaceutical companies also insist that drugs save the lives of thousands of peo- ple each day around the world, and for the most part that is true. To relieve suffering and to help save lives is noble. But, according to critics, the same argument could be made for the oil industry too: The intention is to help people get around, and the side effect is pollution. The presence of a good does not necessarily cancel out the presence of an evil.

Critics of pharmaceutical companies also see the size and stature of the corporations as a threat to health and security: Indeed, some speak of the military-industrial-pharmaceutical complex that works to secure huge contracts from the government, including experimental drugs in the mili- tary and unethical experiments on children and minority citizens in the United States and abroad (Veracity, 2006). For example:

• Jacklyn Hoerger was employed to treat HIV-positive children in a New York children’s home. She was not informed that the children were being given a secret and experimen- tal drug. She was also told that if the children showed any serious health effects, this was because of their HIV infection. Moreover, if she or any other caregiver tried to take the children off the drugs, social work authorities threatened, the children would be taken away. This case, along with others, has caused international concern at the way pharma- ceutical companies use children and minority citizens for experimentation (Doran, n.d.).

• In 2005 the American Chemical Society (funded by pharmaceutical companies) proposed investigating the effects of inhaling, ingesting, and absorbing chemicals by exposing children to them, specifically children from a poor, predominantly Black neighborhood in Duval County, Florida. Consumer activist groups protested until the experiment was dropped (“EPA & Chemical Industry,” n.d.).

Pharmaceutical companies’ intention is also to make money, and not necessarily to pursue science and health: This sometimes comes as a shock to scientists who work for the medical and pharma- ceutical industries. One pharmaceutical sales representative turned health activist and recipient of a humanrights award commented that she felt used and that her participation in the company she had worked for had been put toward harming people: “I had been used in the game, I liter- ally was the one at the front lines, harming people—unintentionally—but I was responsible, and I carry a burden for that now.” The sales representative became a whistleblower in the industry, saying that she believed she had a moral obligation to educate others on the use of harmful phar- maceutical drugs (Luisa, 2011).

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CHAPTER 10Section 10.3 Potentially Unethical Investments

Medical- and pharmaceutical-research institutions and journals have been criticized for not being scien- tific, including recently by the prestigious BMJ, and for instead focusing on expanding profits regardless of side effects in the population. The published lit- erature has often underestimated drug efficacy and not given enough information to clients to consider the risks (Chan, 2012). Evidence from whistleblow- ers at the large pharmaceutical companies has given health activists a reason to shun investing in pharma- ceutical companies:

• A federal court awarded whistleblower James Marchese $1.6 million for advising federal prose- cutors that Cell Therapeutics was engaged in ille- gally promoting unapproved uses of the cancer drug, Trisenox (Gutierrez, 2008).

• The multinational pharmaceutical company GlaxoSmithKline was fined $750 million for knowingly selling tainted drugs. Whistleblower Cheryl Eckard had been fired after warning the company of problems with its plant in Puerto Rico, but still the company went on to sell the drugs (Harris & Wilson, 2010).

Other ethical issues arise for those who oppose abor- tion out of conscience and religious beliefs and would prefer not to invest in pharmaceutical companies that are linked to contraceptive pills and abortion drugs or that use aborted fetal tissue to produce vaccines (Catholic News Agency, 2009; McGovern, n.d.). Simi- larly, campaigners for alternative medicine have noted the connections between the pharmaceutical industry

and legal attempts to outlaw a variety of complementary health products, ranging from vitamin supplements and herbs to raw milk (Adams, 2011).

Some pharmaceutical products do wonders: Painkillers and antibiotics have certainly made pain and disease more containable. But pharmaceutical companies’ quest to make money sometimes overwhelms their good intentions.

Military Weapons

The American armaments trade is enormous: In 2006, U.S. companies exported $11.6 billion worth of weaponry and associated military materials—45.6% of the world’s total (Plumer, 2007). In 2009, the U.S. government approved $40 billion in private arms sales around the world (“Quick Facts,” 2011). The ethical problem with investing in armaments is that we have to consider not just the production of arms themselves, but also their use.

Creatas/Thinkstock

What is in a pill? Some ethical investors avoid putting money into pharmaceutical companies, which they believe regularly ignore ethical standards by selling prod- ucts that have not been thoroughly tested, not being explicit enough concerning the potential side effects of their products, or experimenting on vulnerable sections of the populations.

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CHAPTER 10Section 10.3 Potentially Unethical Investments

If a company produces weapons for home defense, there can hardly be any complaints except from pacifists who wish to avoid any type of weapon and violence and so would not invest even in weapons of self-defense. Most ethicists subscribe to the right to defend the nation-state, but not all accept the right of individuals to defend their own lives with arms. Of course, guns can be used for other purposes, such as hunting and pest control, which complicates matters somewhat, but with production of weaponry designed solely for the military, there can be a clearer description of end use.

Military arms can either be used for defense of the nation or be exported to other countries to earn profits for American companies and create jobs. In 2007, the American arms industry, employing lobby groups such as the Aerospace Industries Association, was looking for fewer con- trols on whom it sold products to around the world. American companies wanted more of that market, and these companies were complaining that federal licensing procedures were bureau- cratic and needed streamlining (Plumer, 2007).

But this runs contrary to a general government policy not to sell certain kinds of military hardware abroad, or at least to control carefully who is buying what. In recent years, the U.S. government has tried to impose laws against companies aiding foreign nations at war or companies seeking to sell U.S. military technology without license. For example:

• Boeing was fined $15 million in 2006 for breaking the Arms Export Control Act of 1976 by selling commercial aircraft that contained chips with military applications (Associated Press, 2006).

• In 2007, ITT was fined $100 million for transferring night-vision goggles and technical data to Singapore (Ahlers, 2007).

Critics point out that even with the Foreign Assistance Act of 1961 and the Arms Export Control Act, which ban the sale of arms to countries that are at war or guilty of human rights violations, Congress has permitted the sale of weapons to many countries engaged in active conflict. This means that Congress has failed to generate an ethical framework for businesses to operate in. Nonetheless, businesses can, and do, make decisions independently of politicians and have the power to make the right choices about whom to sell to.

There is a chance that military hardware produced by corporations may be sold abroad for other countries to use for criminal purposes. This causes a problem in that the end use is contrary to national interests. Political ethics stresses that it would be immoral (and often illegal) to sell hard- ware for illicit use abroad and that national interest and law should trump any interest that par- ticular individuals or companies have in investing in illicit arms dealing. Not surprisingly, many ethical funds altogether avoid investing in armament producers. But if it can be guaranteed that the end use is solely for the protection of the United States, then a concerned investor can relax, as investing in home protection reflects the basic right of a nation to defend itself. If, on the other hand, the arms are to be sold abroad or to countries whose record on human rights is suspect, then the ethical investor may justly have qualms.

Consider: Is it right to invest in armament production in the knowledge that the weapons could be used by tyrannical regimes around the world, or even against American troops in a future war? The latter is harder to predict of course, but the former can be examined on how the country has recently behaved towards its citizens or how it acts in war. If the country has no intention against the United States, corporations should be still concerned about the end use of ammunition, mis- siles, tanks, and jet fighters.

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CHAPTER 10Section 10.3 Potentially Unethical Investments

It can be countered that the produc- tion orders can generate jobs and profits for the United States, and that the end use of the weaponry is not of any concern to the United States. Its use may be for self- defense purposes only, or it may be for political games that Ameri- cans do not need to know anything about. Instead, the focus should be on creating a good return for Amer- ican citizens. But a response like this merely turns a blind eye to the staggering amount of bloodshed that has resulted from the export of American military weapons:

• In the 1990s, the United States aided and supplied the Rwandan Patriotic Army, which, according to the Washington Post, later used the weapons in the horrendous genocide that took place in 1994 (Duke, 1998).

• In 2011, American companies were accused of selling arms to countries seeking to sup- press democracy across the Middle East. Critics noted that arms sales were going to be used to put down dissenters, perhaps people fighting for democracy (“Obama Administra- tion Approved,” n.d.).

Weapons manufacturers are inter- ested in expanding turnover and increasing profits like any other company, but the end-product is used to create injuries, suffering, and death in places around the world. This is what many ethicists find objectionable (Stohl, 2008). In the aftermath of the attacks of Sep- tember 11, 2001, President Bush permitted the sale and transfer of military technologies to countries who were up until then banned from buying from the United States. As long as a country pledged to fight terrorism globally, it could purchase arms. Since then, human rights violations in those countries have worsened (Stohl, 2008). Inves- tors may have made good money from the corporations selling the arms, but their investments have

Khalil Hamra/AP

In this photo, a tank is used to threaten protestors in Egypt during the Arab uprisings in early 2011. The Egyptian army had been sold many Western products over the previous decade, and it was feared that they would be used in repressing a revolt by the people that demanded political change.

Paul White/AP

In 2011, a news conference was called by Greenpeace, Amnesty International, Intermón Oxfam, and other charities involved with supporting human and environmental rights. Esteban Bel- trán, the director of Amnesty International Spain, is seen here protesting against Spanish arms sales to North African and Mid- dle Eastern countries that had records of human rights abuses.

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CHAPTER 10Section 10.4 Investing Versus Spending

helped to cause suffering and bloodshed around the world. Because of the intimate connection between military products and human suffering, ethical fund managers avoid armament producers.

More disturbing are the connection between political establishments and what President Eisen- hower called the military-industrial complex, which ethical investment-fund managers seek to avoid supporting. Politicians around the world have discovered that weapons companies are good at securing higher orders from governments when they need them, according to Andrew Fein- stein, a South African politician turned journalist (as quoted in Lloyd, 2011). For critics such as Feinstein, investing in armaments companies—while it may provide high returns—is also investing in what many see as a corrupt and deceitful world.

10.4 Investing Versus Spending Throughout this chapter we have examined the nature of ethical investing and the types of com- panies that ethical investors avoid. In this final section, we will look at the nature of investment more generally, and whether we have special social obligations to spend our money rather than invest it.

The Economic Harm of Hoarding

Suppose that you take all the money that you have and put it into a safe-deposit box. You neither spend it nor invest it; it simply sits there untouched. This is the action of hoarding money,that is, money that is kept out of circulation. Hoarding money is traditionally seen as harmful to the community, since it restricts the flow of income and spending, which are necessary for keeping the economy going (Clark, 2009). Indeed, President Hoover lambasted hoarders in 1932: “The battlefront today is against the hoarding of currency, which began about 10 months ago, and with its growing intensity became a national danger” (as quoted in G. F. Smith, 2009). The hoarder is thus condemned for acting unethically by not sharing his or her wealth and by helping to prolong recessions and mass unemployment.

Let us grant that hoarding money does hurt the national economy, just as Hoover argued. Does this mean that people have a social obligation to not hoard their money? Not necessarily. Peo- ple hold onto their money for a variety of reasons, the biggest of which is uncertainty. If people believe that the nation will soon be at war, they will tend to stash cash away. Entering a recession, people tend to hoard because they fear they may lose their jobs and will need to hold back on luxury expenses such as vacations, alcohol, and cigarettes. To some, hoarding cash can even be considered a virtuous action of being prudent and safe with money and making sure that there is cash ready in case of hard times (Levin, 2000; G. F. Smith, 2009).

The choice to withhold money from circulation is a personal one, not a social one. It belongs to the sphere of personal ethics, like friendship, and respect must be given to other people’s deci- sions to save their money. To demand that consumers spend their money in troublesome times is, according to this view, comparable to asking them to sacrifice their goals and prudence to make the economy look better for politicians.

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CHAPTER 10Section 10.4 Investing Versus Spending

The same is true of companies. When demand falls for their products, there is only so much money available that can be used to stimulate purchases through advertising, say, before the pot runs out. When troubled times are upon companies, it is far wiser to increase cash holdings, in order to protect present employees and maintain financial health, than to deplete them.

Thus, even if hoarding money does hurt the economy, there may be good personal reasons for an individual to hoard money anyway.

Does Investment Harm Recession Recovery?

The anti-hoarding argument is often adapted into an anti-investing argument. According to this view, investing money is almost like hoarding money, and what we really need to do help the national economy is to spend our money, not invest it. Barely a week goes by without an econo- mist arguing that spending money will help the nation recover from recession. Thanks to spend- ing, retail outlets will demand more supplies from wholesalers, who will in turn demand more from manufacturers. If people increase their consumption, this argument goes, they will be doing everyone a favor by encouraging an expansion of trade and hence employment. Rather than save money to invest, people should be encouraged to spend their money. In turn, companies should spend what profits they earn to expand their factories, hire more people, and advertise their products widely. This will create jobs and help economic growth or help the nation recover from a recession. Thus, investing takes money and productivity out of the economy, and what we need instead is for people to buy products.

There are two main problems with this argument. First, each of us has a personal responsibility to look after our own accounts and to save and invest wisely. If people spend all they earn, they are not acting pru- dently by putting some aside for the unexpected. And if they do not invest, they are relying on earning an income for the rest of their lives rather than having a pension or other retirement fund. Indeed, to spend money at the malls in the hope of getting an economy out of a recession would be financial suicide for many people who live on the margin of debt.

The second problem is with the very idea of spend- ing for immediate gratification. Part of being a respon- sible person is refraining from enjoying immediate pleasures in favor of putting something aside for the future. We face this challenge every day: The cake is tempting, but what about our health? The new car is attractive, but what about the payments we will have to make if we buy it? Ethicists have long discussed the arguments for and against living a pleasure-seeking life. Most have argued that a critical element of liv- ing a civilized existence is that we learn to contain

What Would You Do?

Imagine that your neighbor works for a troubled local car plant and that the recession is threatening her job. You know that if you purchase one of the local company’s cars, it may help save your friend’s job. However, you could also choose to invest your money into something that would bring you and your family a higher return.

1. Would you buy the car or invest your money elsewhere? Explain your response.

2. One of the companies you could choose to invest in is a competing auto company. Would you invest in a competitor’s company? Why or why not?

3. Would you tell your friend of your decision? Why or why not?

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CHAPTER 10Summary

our immediate instincts in favor of cultivating patience, prudence, and foresight. We should give thought to the future when our incomes may fall and our needs may increase; we should learn habits of abstention, self-control, and wisdom.

The same is true of companies. In business, money can be spent before it is even earned, a prob- lem that causes many businesses to fail. Similarly, profits can be squandered on impressive build- ings, private jets, and five-star hotels: Money is used up to help the current management team look good rather than put aside to invest for tomorrow’s needs. When appearances are more important than growing the corporation, trouble is usually brewing.

Thus, even if it is true that spending money will help the country recover from a recession, that is only one consideration. This must be balanced against personal economic stability and the need to resist a purely pleasure-seeking lifestyle.

10.5 Conclusion Ethical investing involves idealistic thinking. Business ethics requires thinking above the dollars and cents and making policy changes for the better on such issues as employment, environmental effects, and corporate culture. Ethical and environmental idealism can of course be expensive, as it may cost a company or an individual more to live a greener lifestyle, for instance. But for invest- ments it may mean giving up a potentially higher return from relatively unethical or less green corporations. Nonetheless, there is evidence that the demand for ethical investments has grown enormously, and their returns are holding up well: The cost for being ethical may not be so pain- ful. Suppose that some ethical investments do not match other fund returns; still, the fact that they exist and have grown also attracts attention from fund managers, investors, and the media. In turn, as investments are channeled into ethical ventures, they can start to earn similar returns.

Summary This final chapter brought together the various ethical strands of this book and summarized a few of them in the problem of investing. As soon as people save money, they may be acting unethi- cally, according to some economists; others believe that saving is the leverage people and soci- eties need to progress and to gain wealth. The act of investing is not so clear-cut, though: Legal barriers keep poorer investors out of potentially lucrative markets.

We then noted that there are several kinds of ethical investing; they range from supporting com- munities or individuals who would not get traditional bank loans to investing in a manner that can have an ethical impact on life and the world. We then worked through several of the key indus- tries that ethical investment managers may avoid: environmentally harmful products, genetically modified foods, drugs, and arms. In each example, debate rages over the balance to be made between making a return on the investment and investing in the right product that will not cause intentional harm to people or the environment.

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CHAPTER 10Summary

Discussion Questions

1. A village in the north of England has turned over unused land to planting vegetables and herbs, which anyone can then take for free (Huff, 2011; “Incredible Edible Todmorden,” n.d.). In giving up time, energy, and money to buy the plants and seeds, the people pro- vide for the town’s needs and for the future of their community, reducing the need to import as much food. As one of the writers on the Web site Incredible Edible Todmorden wrote, “The ethos is not about me me me. It is about us us us, thru the shared medium of food and towards a sustainable, survivable future” (Nick, 2009). The proponents believe that if we move from the self-seeking individualism of the market place, we will in fact create a more harmonious and environmentally friendly life. In thinking about investing, should we consider not just our own immediate and future needs, but those of our community, our nation, and even our planet?

2. After years of hard work and study that has paid off well, do you believe that you have a duty to engage in impact investing or setting up community development financing to help the neighborhood that you came from?

3. Reviewing the investments in your portfolio, you realize that the carbon footprint con- nected to your investments is relatively large, but your oil company stock also pays for the family holidays each year. The company’s Web site says that it uses a high proportion of its profits to invest in green and renewable fuels of the future. Do you keep the stock or sell?

4. A friend is excited about a new stock opportunity with a medical company whose prod- ucts could sell well around the world; having reviewed some of the stories in this chap- ter, you are no longer certain about the benefits that companies say will emerge from their products, and you are concerned that the company’s history includes using animals and vulnerable people in experiments. Do you ignore the company’s past and research the current product, digging around for alternative ethical viewpoints, or do you accept the possibility of earning a simple profit?

5. A local American weapons company whose stock you invest in employs thousands of peo- ple in the neighborhood, but you become aware that its products are being used against civilians fighting for human rights in other countries. Should you sell your investment?

Key Terms

community-development financing (CDF) Ethical investments in community projects using nonprofit status or charitable funds to encourage growth and development in run- down communities.

ethical investing Investing according to an ethical model or the particular ethics of an individual investor.

genetically modified (GM) foods Seeds that have been genetically altered to remove a weakness or to improve a strength in a crop.

green funds Refers to a pool of investment funds designated for environmental projects rather than just ethical funds.

hoarding money The act of stashing money away rather than investing in something productive.

impact investing A pro-market, pro-ethical approach to investments designed to have a good impact on the world.

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CHAPTER 10Summary

negative filtering Taking certain companies or industries out of a portfolio of ethical investments.

positive filtering Adding certain compa- nies or industries into a portfolio of ethical investments.

socially responsible investing (SRI) A general term that describes the intention to invest in ethical investments.

sustainable investing An ethical investment vehicle that intends to maintain investments in worthwhile community or environmental projects over a period of time rather than pull out capital on short notice.

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acquisition  When a larger company buys a smaller company, which is then swallowed up and loses its identity within the larger one.

affirmative action plan (AAP)  U.S. federal requirement for assuring that employers implement affirmative action in their employ- ment practices.

affirmative action  The policy of improving the opportunities of those within historically dis- advantaged groups through positive measures beyond neutral, nondiscriminatory action.

alienated labor  Labor that a worker is forced to give away to a factory owner.

bait and switch  An illegal sales strategy where customers are attracted into a store to buy an artificially low-priced product and then are persuaded to buy a more expensive one.

bid rigging  When competing businesses agree that one of them will place a bid on a contract at a predetermined price.

board of directors  Group of individuals elected by corporation stockholders to manage the corporation.

bona fide occupational qualifications  Qualifi- cations that relate to an essential job duty and are reasonably necessary to the normal opera- tion of that particular business or enterprise.

bourgeoisie  Karl Marx’s term for a class of large-scale business owners that oppresses workers.

bribery  The giving of money, vouchers, goods, or services to public officials in the hope of securing a license or contract.

burden-shifting formula  The legal strategy for a minority employee where the burden rests on the employer to show that its behavior was not discriminatory.

cap and trade  The term describing the right of companies to pollute up to a maximum and then trade any unused rights on the market.

capitalism  The economic theory that main- tains that (1) personal self-interest, not community interest, motivates economic development, (2) the major sources of soci- ety’s economic production should be privately owned, not governmentally owned, and (3) economic planning should be decentralized through market competition, not centralized through government policy.

carbon tax  A tax on any carbon-emitting fac- tory or product, such as cars.

care ethics  The theory that women see moral- ity as the need to care for people who are in situations of vulnerability and dependency.

Glossary

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GLOSSARY

categorical imperative  The moral principle proposed by Immanuel Kant that we should treat people as an end, and never merely as a means to an end.

caveat emptor  Latin expression meaning “buyer beware,” expressing the theory that consumers are responsible for their purchases.

child advertising  The marketing strategy of directing an advertisement toward either a young child under age 8 or an older child between ages 8 and 12.

class struggle  The socialist view that through- out history, societies have evolved through conflicts between the social classes of those who do the work and those who are in charge and benefit from that work.

Clayton Antitrust Act of 1914  U.S. federal law that restricts specific types of business prac- tices that might potentially lead to anticom- petitiveness, such as mergers and acquisitions that aim to create monopolistic power.

climate change  The theory that pollution of the air is causing the earth’s weather systems to become more erratic.

closed-shop union  A union association that a worker must join.

commoditization of people  A socialist view that employment contracts turn people into commodities to be bought and sold by corpo- rations as they see fit.

communism  A radical form of socialism that aims to abolish all social classes, private prop- erty, and government.

community-development financing (CDF)  Ethical investments in community projects using nonprofit status or charitable funds to encourage growth and development in run- down communities.

community-service order  A corporate punish- ment where a company must participate in some project that benefits the community in some way.

company towns  Towns that have built up around a single company and in which all the workers’ needs are provided for by the company.

conflict of interest  When a person has two or more conflicting loyalties that can compromise their impartiality in working for a business or preparing a report.

consumer advocacy  An organized effort to protect consumers against dangerous prod- ucts, unfair pricing, deceptive advertising, and manipulative sales practices.

consumer autonomy  The notion that consum- ers should be in charge of determining what to purchase after being supplied with relevant information.

Consumer Bill of Rights  Four consumer rights articulated in a 1962 speech by President John F. Kennedy: (1) the right to safety, (2) the right to be informed, (3) the right to choose, and (4) the right to be heard.

consumer boycott  When a group of people act together to abstain from buying from or dealing with a business.

Consumer Product Safety Commission (CPSC)  U.S. federal agency founded in 1972 for the purpose of protecting the public “against unreasonable risks of injuries and deaths asso- ciated with consumer products.”

consumer retaliation  When individual con- sumers or consumer groups express dis- satisfaction with a company through some effort that harms it financially, e.g., boycotts, complaints to government agencies, or civil lawsuits.

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GLOSSARY

Consumers Union  Nonprofit consumer- advocacy organization founded in 1936, pub- lisher of Consumer Reports magazine.

contractual theory of employment  The view that employment is just a matter of a contract rather than any other ethical expectations, such as being decent.

cooking the books  A general term describing the use of illegal accounting methods to exag- gerate incomes or to hide losses.

corporate codes of ethics  Detailed accounts of the principles of conduct within organiza- tions that guide decision making and behavior.

corporate death penalty  A corporate punish- ment where a company is forced to go out of business, such as by the revocation of its corporate charter.

corporate incapacitation  A corporate punish- ment where a court issues an order to restrain the activities of a corporation in some area of business.

corporate moral agency  The concept that businesses are morally responsible for their actions, similar to how individual people are morally responsible for theirs.

corporate shaming  A corporate punish- ment where the government requires a guilty company to make a public announcement that threatens its reputation and social standing.

corporate social responsibility (CSR)  A cor- poration’s efforts to take responsibility for its effects on the environment and its impact on social welfare.

Corporate Social Responsibility Index  An index created by the Center for Corporate Citizenship at Boston College that ranks com- panies based on public perceptions of their citizenship, governance, and workplace.

corrective advertising  A punishment that requires companies to publish notices that cor- rect consumers’ mistaken impressions created by deceptive advertisements in the past.

cost benefit analysis  The economic model- ing of a project to check whether the benefits outweigh the costs.

creation by statute  The legal concept that corporations come into existence through the creation of a legal document called a charter.

creative accounting  Legal use of accounts to shuffle funds around a corporation to make it look stronger or more profitable.

deceptive advertising  Advertising that inten- tionally misleads or confuses consumers.

default opt-in  A feature of sales contracts where the customer is automatically enrolled in some unnecessary and costly secondary service, typically without knowing about it.

deterrence  A justification of punishment where an offender is punished to set an example that might discourage others from committing similar crimes.

direct evidence of discrimination  Overt written or oral statements by employers that display their discriminatory intention.

direct governmental regulation  When specific regulatory policies are established by an actual branch or agency of the government, such as Congress or the SEC.

direct-to-consumer advertising  An advertis- ing strategy, used especially by pharmaceutical companies, where patients are targeted rather than health-care professionals.

discrimination  The unjust or prejudicial treat- ment of people on arbitrary grounds, such as race, gender, or age, which results in denial of opportunity, such as in business employment or promotion.

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GLOSSARY

divine-command theory  The view that moral standards are created by God’s will.

due diligence  A range of research that a busi- nessperson is expected to make before com- mitting to a contract.

duty theory  The view that moral standards are grounded in instinctive obligations, that is, duties.

emissions rights  The legal ownership, which companies can trade with other companies, of the right to pollute up to a maximum.

employment at will (EAW)  The theory that an employment contract should be instantly terminable by either party.

employment discrimination  The prejudicial treatment of people in hiring, promotion, and termination decisions.

environmentalism  A social and political move- ment characterized by the belief that people have a duty of care to the planet or that environmental values should come first over people’s value.

Equal Employment Opportunity Commis- sion (EEOC)  U.S. federal agency responsible for enforcing Title VII of the Civil Rights Act by setting policies for dealing with discrimination complaints, holding hearings on specific com- plaints, and filing discrimination suits against employers.

equal employment opportunity (EEO)  laws  The laws and regulations that are jointly enforced by the EEOC and OFCCP.

equal opportunity  The policy of treating employees without discrimination.

equal results  An affirmative action concept of achieving proportional minority representa- tion in a work or economic environment where minorities are presently underrepresented.

equilibrium wage rate  The wage set by mar- ket conditions.

equity fine  A corporate punishment where a fine payment is made in shares of the com- pany, not in money.

ethical investing  Investing according to an ethical model or the particular ethics of an individual investor.

ethics  An organized analysis of values relating to human conduct, with respect to their right- ness and wrongness.

ethics officer  An administrator within a com- pany who holds workers accountable to the company’s ethical standards.

exploitation theory of employment  The socialist view that of the two parties engaged in a job, the boss has more power and the worker possesses little if any power.

externalities  A term used by economists to express the costs imposed on stakeholders and the environment but not accounted for on a company’s books.

external whistleblowing  When an employee makes a complaint to an external authority such as the police, the SEC, or another federal agency.

fair pay  The idea that a wage should ade- quately reflect a worker’s needs and ability to live in society.

False Claims Act of 1863  U.S. federal law to assist the government in retrieving mon- ies from people and corporations who are defrauding it.

Federal Sentencing Guidelines for Organiza- tions (FSGO)  U.S. government guidelines for sentences imposed by federal judges, which include restitution, remedial orders, commu- nity service, fines, and jail terms.

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GLOSSARY

Federal Trade Commission (FTC)  U.S. Federal agency established in 1914 to prevent busi- nesses “from using unfair methods of competi- tion in commerce” and to “protect consum- ers against unfair, deceptive, or fraudulent practices.”

Federal Trade Commission (FTC)  U.S. federal agency established to prevent unfair methods of competition in commerce.

fiduciary duty  A legal obligation to manage a company in a way that protects the owners’ investment.

fiduciary trust  The trust that nonprofession- als have in the finance and accounting profes- sion that members of that profession will act properly.

Financial Accounting Standards Board (FASB)  An independent board set up by the financial industry to promote standards.

fine  A payment of money imposed as a pen- alty for an offense.

Food and Drug Administration (FDA)  U.S. federal agency formed in 1927 for the purpose of carrying out the tasks specified in the Pure Food and Drug Act of 1906.

Foreign Corrupt Practices Act  A U.S. Federal law regulating the operation of U.S. companies in foreign countries, which includes an anti- bribery provision.

free market economics  The view that busi- nesses should be governed by the laws of supply and demand, not restrained by govern- ment interference.

free trade  The concept that trade across national boundaries should take place without interference from the respective governments.

Generally Accepted Accounting Principles  (GAAP)  The standards formed by the finance industry on accounting and financial reporting.

genetically modified (GM) foods  Seeds that have been genetically altered to remove a weakness or to improve a strength in a crop.

gift giving  The presentation of money, vouch- ers, goods, or services to another in business; this may be a normal part of business eti- quette in dealing with other business people or public officials, but when used to encour- age the signing of a contract or when the gifts become relatively large, ethical issues arise.

glass ceiling  A discrimination situation in which women and minority workers hit a level beyond which they cannot advance, while their white male counterparts continue to progress.

globalization  The expansion of international trade; the term also implies a movement towards a similar global culture and, by impli- cation, ethics.

global warming  The theory that pollution of the air is causing the earth’s average tempera- ture to rise.

government failure  A term from economics that describes the conflicting interests, short- sightedness, and incompetency of government officials.

government-mandated self-regulation  When, in lieu of direct government involvement, the government mandates that a private self- regulatory organization set policies in a given market and defers to that organization.

government regulation  Rules and poli- cies imposed by the government on various aspects of commerce within a country.

greed is good  The view that, in the business world, the human drive of self-interest directs our energy and creativity.

green funds  Refers to a pool of investment funds designated for environmental projects rather than just ethical funds.

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GLOSSARY

greenwashing  A term referring to pretended efforts at environmental responsibility and, more broadly, at corporate responsibility.

group compensation  An antidiscrimination policy in which each individual within a disad- vantaged group is compensated based purely on his or her membership in that group.

groupthink  The practice of thinking or making decisions as a group in a way that discourages creativity or individual responsibility.

Guidelines for Consumer Protection  Guide- lines established by the United Nations in 1985, which include seven fundamental con- sumer needs that require protection.

harm principle  The view that governments may restrict our conduct when it harms other people.

hoarding money  The act of stashing money away rather than investing in something productive.

human rights  Rights that are not created by government, but held by all people around the world regardless of the country in which they live.

impact investing  A pro-market, pro-ethical approach to investments designed to have a good impact on the world.

impartial oversight  The ethical mindset of tackling a problem or reviewing a business situation without any self-interest involved.

incapacitation  A justification of punishment where removing an offender from society prevents the offender from committing similar crimes.

income inequality  Indirect evidence of dis- crimination based on an analysis of the extent to which income is distributed in an uneven manner among a population.

indirect evidence of discrimination  Behavior of a company that implies discriminatory conduct.

individual compensation  An antidiscrimina- tion policy in which each person is compen- sated based on his or her individual claim.

insider  According to the SEC, any company officer, director, or shareholder owning more than 10% of the company’s stock.

insider trading  This occurs when an insider, as defined by the SEC, trades on information which has not yet been made public. Insider dealing is illegal, although ethicists debate whether it should remain illegal.

intellectual property (IP)  Intangible assets protected by law such as copyrights, trade- marks, packaging designs, and trade secrets.

intellectual property theft  The illegal misap- propriation of intellectual property that has been secured by a company or individual.

intentional discrimination  Discrimination where the policies of a company are shaped by overt racial prejudices of its managers or executives.

internal whistleblowing  When an employee makes a complaint about a fellow worker or corporate procedures and keeps the complaint within the company.

invisible hand  The view proposed by Adam Smith that, by pursuing our self-interest, we indirectly promote the good of society as if directed by an invisible hand.

Kyoto Protocol of 1997  An international declaration that sought to reduce carbon emis- sions around the world and reduce the threat of global warming.

Labor–Management Relations Act of  1947  U.S. federal law that removed the right of unions to used closed shops.

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GLOSSARY

laissez faire  French term; literally “leave it alone,” expressing the free market idea that governments should stay out of the market place.

legal moralism  The view that governments may restrict conduct that is especially sinful or immoral.

legal paternalism  The view that governments can restrict the conduct of an individual who harms him- or herself.

legal person  A nonhuman entity regarded by law as having the status of a person.

legal rights  Rights that are created by governments.

legal standing  The legal concept that a person can sue others and be sued by others, own property, and make contracts with others.

limited liability  The legal concept that a stock- holder cannot lose more than the amount that he or she invested.

living wage  A wage that should reflect an adequate standard of living in a society.

loan packing  A sales strategy in which loans for a product include charges for additional items—or “add-ons”—that are concealed from the consumer.

loss leader  A product that is sold below cost to generate customer traffic, with no pressure put on the customer to buy anything else.

market socialism  Socialist economic systems where governments own and control major economic enterprises yet incorporate some capitalist policies, such as relying on supply and demand in the market to set prices.

maximum wage  The highest wage that may be paid according to a government.

merger  When two companies of roughly the same size agree to combine as equals to form a new company.

minimum wage law  A law that stipulates the minimum wage that can be paid to an employee.

minority  A subgroup of a population that differs in race, religion, or national origin from the dominant group.

mission statement  A short account of a company’s fundamental purpose, which may include a statement of ethical standards.

monopoly  Control by a single company of all or nearly all of the market for a given type of product or service.

moral objectivism  The theory that moral stan- dards are not created by human beings, are unchanging, and are universal.

moral relativism  The theory that moral stan- dards are created by human beings, change from society to society, and are not universal.

multinational corporation  A corporation that has production centers and offices in more than one country.

National Labor Relations Act of 1935 (NLRA)  U.S. federal law that encouraged the use of collective bargaining by unions and employers.

negative filtering  Taking certain companies or industries out of a portfolio of ethical investments.

negligent hiring  When a company hires an inappropriate person and can be ethically cen- sured for not doing its due diligence.

Notification and Federal Employee Antidis- crimination and Retaliation Act of 2002   (No FEAR Act)  U.S. federal law designed to stop federal supervisors from threatening or retaliating against federal employees who blow the whistle.

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GLOSSARY

Occupational Safety and Health Act (OSH Act)  Introducted by the Nixon administration to regulate the protection and welfare of workers in the workplace.

offense principle  The view that governments may keep us from offending others.

Office of Federal Contract Compliance Pro- grams (OFCCP)  U.S. federal agency (a branch of the Department of Labor) responsible for implementing the affirmative action executive order regarding government contractors.

officers  Individuals designated by a corpora- tion’s board of directors to operate the busi- ness, with the chief executive officer (CEO) at the top and various levels of managers below.

oligopoly  Market domination by a small num- ber of businesses that collectively exert control over that market’s supply and prices.

organizational schizophrenia  Tension between competing goals or values within a corporation.

peak oil  The notion that there will come a time when humanity has exacted a maximum amount of oil from the ground, after which oil supplies will deplete quickly.

perpetual existence  The legal concept that corporations can continue indefinitely and independently of the temporary lives of their managers and shareholders.

positive filtering  Adding certain companies or industries into a portfolio of ethical investments.

preferential treatment  Special consider- ation given to people from historically dis- advantaged groups in hiring and promotion situations.

price fixing  When business competitors con- spire to set their prices at a fixed point.

price gouging  When a business sells a product for a price that is much higher than is consid- ered reasonable or fair or sustainable in a truly competitive environment.

private costs  Costs incurred by a corporation which are accounted for on its books.

professional unions  White collar unions such as the American Medical Association whose purpose is to protect members’ interests.

profit motive  The view that the ultimate purpose of a commercial enterprise is to earn a profit.

protected classes  Specific groups that are pro- tected from employment discrimination by law.

psychological altruism  The theory that human beings are at least occasionally capable of act- ing selflessly.

psychological egoism  The theory that human conduct is selfishly motivated and we cannot perform actions from any other motive.

puffery  Exaggerated claims in advertising.

puffery legal defense  A legal strategy where, when charged with false advertising, a com- pany claims that it was only engaging in puffery.

Pure Food and Drug Act of 1906  U.S. law that aimed to prevent “the manufacture, sale, or transportation of adulterated or misbranded or poisonous or deleterious foods, drugs, medicines, and liquors.”

quota system  An affirmative action concept where a certain number of jobs are set aside for members of minority groups in direct pro- portion to their numbers in the community.

rehabilitation  A justification of punishment where, through reform techniques, changes are made to an offender’s future behavior.

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GLOSSARY

reparation  A justification of punishment where an offender must repay the victim for the injury that the offense caused.

repatriated income  Money earned by an American multinational that is transferred back to the United States; it is subject to cor- porate tax.

retribution  A justification of punishment where punishment balances the scales of jus- tice; a crime requires a punishment.

reverse discrimination  An aspect of preferen- tial treatment where a more qualified candi- date from the majority group is unfairly denied an opportunity in preference to a less qualified candidate from a minority group.

right  A justified claim against another person’s behavior.

rogue trader  An employee who abuses the trust given to him or her and uses company funds for personal profit or covers up losses using secret accounts is a rogue trader.

SaferProducts.gov  Web site run by the U.S. Consumer Product Safety Commission where consumers can report unsafe products.

safety culture  The prevailing ethical view in a company with regards to the health, safety, and welfare of employees.

Sarbanes–Oxley Act of 2002  U.S. federal law to encourage greater transparency in corpo- rate financial reporting.

Securities and Exchange Commission  (SEC)  Agency of the federal government that regulates stocks.

Securities and Exchange Commission (SEC)  The Securities and Exchange Commission was set up in 1934 to oversee and regulate the securities and exchanges industry in the after- math of the Great Wall Street Crash of 1929.

Securities Exchange Act of 1934  U.S. federal law that set up the SEC to oversee the financial markets.

self-regulated advertising  The practice in which the advertising industry monitors and corrects false advertising by itself, without reli- ance on government agencies and courts.

shell corporations  Corporations that exist on paper but have no active business operations or significant assets.

Sherman Antitrust Act of 1890  First U.S. federal law to outlaw price fixing and restrict monopolies.

social-contract theory  The moral and political theory that, to preserve our individual lives, we agree to set aside our hostilities towards each other in exchange for the peace that a civilized society offers.

social costs  Costs incurred by other people outside a corporation which hence are not accounted for on the company’s books.

social engineering  The theory that govern- ments can organize society along lines that will promote the greatest welfare for citizens.

socialism  The economic theory that (1) com- munity interest, not personal self-interest, should motivate economic development, (2) the major sources of society’s economic production should be governmentally owned, not privately owned, and (3) economic planning should be centralized through government policy, not decentralized through market competition.

socially responsible investing (SRI)  A general term that describes the intention to invest in ethical investments.

stakeholder  Any party who is affected by, or who has a stake in, a business practice, includ- ing employees, suppliers, customers, creditors, competitors, governments, communities, and stockholders.

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GLOSSARY

stockholders  Those who own a corporation by obtaining shares of stock in it.

strategic misrepresentation  The intentional and systematic distortion or misstatement of facts for the purpose of gaining a financial advantage.

structured interview  An interview that fol- lows a set list of questions.

survival of the fittest  The evolutionary notion that species with the best adaptations will win out over rival species that are less well adapted.

sustainable investing  An ethical investment vehicle that intends to maintain investments in worthwhile community or environmental projects over a period of time rather than pull out capital on short notice.

sweatshops  Factories whose workplace stan- dards on health and safety and pay fall below a legal minimum, or whose standards are below what is commonly acceptable in a community.

target marketing  The marketing strategy of breaking the market for one’s product into seg- ments and then focusing marketing activities on one or a few major segments.

tax avoidance  The legal use of accounting practices to reduce a tax burden.

tax evasion  The illegal hiding of money earned to reduce a tax burden.

technological transfer  Selling or distributing technology from one country to another; often concerned with the transfer of sensitive com- mercial or military technology.

Ten Planks of Communism  Karl Marx’s set of 10 policies to transition into socialism.

transfer costing  Shifting funds across a cor- poration, particularly a multinational one, to decrease a tax burden.

transfer pricing  A method of making a corpo- ration look more profitable by selling goods or services across the corporation. If a company sells another division a service, this can be booked as revenue, so if the “price” charged is inflated, the company’s revenues can be made to look better than they are.

triple bottom line (3BL)  The view that suc- cessful companies must pursue three distinct values: people, the planet, and profit.

Uniform Guidelines on Employee Selection  Procedures (UGESP)  U.S. federal guidelines that require employers to carefully inspect the processes they use to hire, promote, or terminate employees, and assure that those processes are fair and nondiscriminatory.

unintentional discrimination  Discrimination where a company’s policies uncritically reflect prejudicial stereotypes.

union  An organization set up to protect and advance workers’ safety, work conditions, and wages.

union shop  An alternative to the closed shop that mandated union membership upon enter- ing a job contract. In a union shop, workers were still obliged to join a union later or pay fees to the union even if they preferred not to be full members.

unstructured interview  An interview that fol- lows the conversation that two people make rather than being prescribed by set criteria.

utilitarianism  The theory that an action is mor- ally right if the consequences of that action are more favorable than unfavorable to everyone.

virtue ethics  The view that morality is grounded in the virtuous character traits that people acquire.

virtues  Good habits of character that result in morally proper behavior.

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GLOSSARY

virtue theory  The view that morality is grounded in the virtuous character traits that people acquire.

welfare capitalism  Social programs in market economies that the government runs, such as national health care and government-run child care.

whistleblower  Someone who divulges to an authority that the company or department he or she is working in is breaking a law.

Whistleblower Protection Act of 1989  U.S. federal law to protect federal employees who blow the whistle on fraudulent or unsafe prac- tices in federal agencies.

whistleblower systems or hotlines  Systems within a corporation that allow whistleblowers to make official and sometimes anonymous complaints.

working conditions  The health and safety conditions of a workplace.

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