Finish answer questions

Chapter 2  Strategic Management of Stakeholder Relationships 71

The Reactive–Defensive–Accommodative–Proactive Scale provides a method for assessing a company’s strategy and performance with one stakeholder. The reactive approach involves denying responsibility and doing less than is required. The defensive approach acknowledges only reluctantly and partially the responsibility issues that may be raised by the firm’s stakeholders. The accommodative strategy attempts to satisfy stakeholder demands. The proactive approach accepts and anticipates stakeholder interests. Results from this stakeholder assessment should be included in the social audit, which assesses and reports a firm’s perfor- mance in fulfilling the economic, legal, ethical, and philanthropic social responsibilities expected of it by its stakeholders.

Responsible Business Debate

Prioritizing Stakeholder Concerns

Issue: A stakeholder or shareholder orientation—whose company is it?

For decades, the question of “Whose company is it?” has permeated discussions of the role of business in society. Famously, some economists have long argued for the primacy of profit, noting that without eco- nomic stability and prospects for growth, a firm cannot continue to pay employees, buy from suppliers, pay taxes, and meet other economic and legal expectations. Adam Smith made this point succinctly, “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.” In the United States and United Kingdom, the belief is that shareholders are the owners of firms and managers have a fiduciary responsibility to act in the interests of shareholders. The shareholder orientation is dominant in most business and invest- ment communities, although this mind-set is shifting.

In other countries, a stakeholder, not shareholder, orientation is the norm. Several European countries oper- ate under a system of “co-determination,” where both employees and shareholders in large companies hold seats on the oversight board and are required to con- sider multiple interests in decision making. In Denmark,

employees in firms with more than 35 workers elect one- third of the firm’s board members, with a minimum of two. In Sweden, companies with more than 25 employees have two labor representatives appointed to the board. In large German corporations, employees and sharehold- ers hold an equal number of seats. Finally, in Japan, exec- utives can be liable for managerial negligence, but do not have fiduciary duties to shareholders and are expected to meet an array of stakeholder expectations.

There Are Two Sides to Every Issue 1. Defend the belief that companies exist first and fore-

most for the benefit of shareholders and investors. For what reasons should the maximization of share- holder value be the accepted corporate paradigm?

2. Defend the belief that companies, in addition to shareholders and investors, have equally important stakeholders, such as employees, customers and suppliers. What about responsibilities to the com- munity, society, and the natural environment?

Sources: “Whose Company Is It?: New Insights into the Debate over Shareholders vs. Stakeholders,” http://knowledge.whar- ton.upenn.edu/article.cfm?articleid=1826 (accessed July 7, 2016). Tibor R. Machan, “Stakeholder vs. Shareholder Theory of the Ethics of Corporate Management,” International Journal of Economics and Business Research 1 (2009): 12–20.

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72 Business and Society

DISCUSSION QUESTIONS

KEY TERMS

THAI DIE…ENVIRONMENTAL EXPLOITATION OR ECONOMIC DEVELOPMENT: WHAT WOULD YOU DO? Literally hundreds of buildings dotted the ground below and the thousands of cars on highways looked like ants on a mission. The jet airliner made its way to the Bangkok International Airport and eased into the humid afternoon. The group of four passed through customs control and looked for the limousine provided by Suvar Corporation, their Thai liaison in this new business venture. Representing Global Amusements were the vice-president of corporate development, director of Asian operations, vice-president of global relations, and director of governmental relations for Southeast Asia.

Global Amusements, headquartered in London, was considering the development of a Thai cultural amusement center on the island of Phuket. Phuket is a tourist destination known for its stunning beaches, fine resorts, and famous Thai hospitality. Both Global Amusements and Suvar Corporation believed Phuket was a great candidate for a new project. The amuse- ment center would focus on the history of Thailand and include a variety of live performances, rides, exhibits, and restaurants. Domestic and international tourists who visited Phuket would be the primary target market.

?

primary stakeholders (p. 46) secondary stakeholders (p. 46) stakeholder interaction model

(p. 48)

stakeholder orientation (p. 49) power (p. 51) legitimacy (p. 52) urgency (p. 53)

reputation management (p. 54) crisis management (p. 59) social capital (p. 62) social audit (p. 68)

1. Define stakeholder in your own terms. Compare your definition with the definition used in this chapter.

2. What is the difference between primary and secondary stakeholders? Why is it important for companies to make this distinction?

3. How do legitimacy, urgency, and power attributes positively and negatively affect a stakeholder’s ability to develop relationships with organiza- tions?

4. What is reputation management? Explain why companies are concerned about their reputation and its effects on stakeholders. What are the four

elements of reputation management? Why is it important to manage these elements?

5. Define crisis management. What should a com- pany facing a crisis do to satisfy its stakeholders and protect its reputation?

6. Describe the process of developing stakeholder relationships. What parts of the process seem most important? What parts seem most difficult?

7. How can a stakeholder orientation be imple- mented to improve social responsibility?

8. What are the differences between the reac- tive, defensive, accommodative, and proactive approaches to stakeholder relationships?

EXPERIENTIAL EXERCISE Choose two companies in different industries and visit their respective websites. Peruse these sites for informa- tion that is directed at three company stakeholders: employees, customers, and the media. For example, a company that places its annual reports online may be

appealing primarily to the interests of investors. Make a list of the types of information that are on the site and indicate how the information might be used and perceived by these three stakeholder groups. What differences and similarities did you find between the two companies?

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Chapter 2  Strategic Management of Stakeholder Relationships 73

Global Amusements had been in business for nearly 20 years and currently used a joint venture approach in establishing new properties. Suvar was its Thai partner, and the two firms had been successful two years ago in developing a water amusement park outside Bangkok. Phuket could hold much promise, but there were likely to be questions about the poten- tial destruction of its beauty and the exploitation of this well-preserved island and cultural reserve. These concerns had been heightened as the island slowly recovered from the 2004 tsunami and set a course for managing future development.

Following a day to adjust to the time zone and refine the strategy for the visit, the next three days would be spent in Bangkok, meeting with various

company and governmental officials who had a stake in the proposed amusement facility. After a short flight to Phuket, the group would be the guest of the Southern Office of the Tourism Authority of Thailand for nearly a week. This part of the trip would involve visits to pos- sible sites as well as meetings with island government officials and local interest groups.

After arriving at the hotel, the four employees of Global Amusement agreed to meet later that evening to discuss their strategy for the visit. One of their main con- cerns was the development of an effective stakeholder analysis. Each member of the group was asked to bring a list of primary and secondary stakeholders and indicate the various concerns or “stakes” that each might have with the proposed project. What would you do?

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74

CHAPTER THREE

Corporate Governance

Chapter Objectives

●● To define corporate governance

●● To describe the history and practice of corporate governance

●● To examine key issues to consider in designing corporate governance systems

●● To describe the application of corporate governance principles around the world

●● To provide information on the future of corporate governance

Chapter Outline

Corporate Governance Defined

History of Corporate Governance

Corporate Governance and Social Responsibility

Issues in Corporate Governance Systems

Corporate Governance Around the World

Future of Corporate Governance

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75

Credit Suisse is the first bank in more than a decade to admit to a crime in the United States. The company was charged with conspiring to aid American clients in tax evasion. Government officials claim that hundreds of Credit Suisse employees, including managers, helped American clients evade taxes to the Internal Revenue Service by concealing funds, destroying records, and failing to accurately disclose financial information. Approximately 22,000 Americans had accounts with Credit Suisse, owning assets worth between $10 and $20 billion.

The crime was discovered through an investiga- tion involving 100,000 internal documents. Some of the documents revealed that Credit Suisse bankers had helped Americans evade taxes through such entities as secret offshore accounts. Such systemic misconduct demonstrates that Credit Suisse not only lacked effec- tive risk management but was also deficient in its over- sight responsibilities.

Credit Suisse maintains that its internal investi- gation did not discover any leadership failures that led to the scandal. However, the Federal Sentencing Guidelines for Organizations (FSGO) clearly places the burden of knowledge on the company’s leadership. According to the FSGO, the board of directors and company leaders are responsible for maintaining an effective ethics and compliance program with internal

control measures. This scandal seems to indicate a fail- ure to have strong values and enforce the spirit of the laws of the customers’ home countries.

The U.S. government believes this guilty plea will help demonstrate that nobody, even MNCs, is above the law. However, the impact this will have on Credit Suisse is questionable. In addition to its guilty plea, Credit Suisse must pay a fine of $2.6 billion and agree to independent monitoring for two years. Although a guilty plea would generally mean that Credit Suisse would have to give up its investment-adviser license, the Securities and Exchange Commission (SEC) has granted the bank a temporary exemption.

Some have called for the resignation of Credit Suisse’s American CEO for corporate governance fail- ures. Others point to the fact that Credit Suisse is not being forced to disclose the names of American tax evaders. Credit Suisse claims that this is due to Swiss law, which has traditionally valued the privacy of cli- ents. This brings up the issue of corporate governance in Switzerland. The laws of Switzerland regarding this issue are different than those in the United States, which makes it more difficult to effectively prosecute a Swiss company. Finally, critics have also accused U.S. law enforcement of a lack of governance controls, as they appeared less than eager to pursue the matter for many years.1

Credit Suisse: A Case of Bankrupt Leadership

Opening Vignette

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76 Business and Society

Business decisions today are increasingly placed under a microscope by stakeholders and the media, especially those made by high-level person-nel in publicly held corporations. Stakeholders are demanding greater transparency in business, meaning that company motives and actions must be clear, open for discussion, and subject to scrutiny. Recent scandals and the associated focus on the role of business in society have highlighted a need for systems that take into account the goals and expectations of vari- ous stakeholders, as the example of Credit Suisse’s guilty plea illustrates. To respond to these pressures, businesses must effectively implement policies that provide strategic guidance on appropriate courses of action. This focus is part of corporate governance, the system of checks and balances that ensures that organizations are fulfilling the goals of social responsibility.

Governance procedures and policies are typically discussed in the context of publicly traded firms, especially as they relate to corporations’ responsibilities to investors.2 However, the trend is toward discussing gover- nance within many industry sectors, including nonprofits, small businesses, and family-owned enterprises. Corporate governance deserves broader con- sideration because there is evidence of a link between good governance and strong social responsibility. Corporate governance and accountability are key drivers of change for business in the twenty-first century. The corporate misconduct at firms such as Credit Suisse, J.P. Morgan, and Walmart rep- resent fundamental failures in corporate governance systems that provide oversight. Investors and other stakeholders must be able to trust manage- ment while boards of directors oversee managerial decisions. In the most recent recession, some of the nation’s oldest and most respected financial institutions teetered on the brink of failure and were either bailed out or acquired by other firms. Many problems in the financial sector come from boards of directors allowing excessive risk taking.

In this chapter, we define corporate governance and integrate the concept with the other elements of social responsibility. Then, we examine the corpo- rate governance framework used in this book. Next, we trace the evolution of corporate governance and provide information on the status of corporate gov- ernance systems in several countries. We look at the history of corporate gover- nance and the relationship of corporate governance to social responsibility. We also examine primary issues that should be considered in the development and improvement of corporate governance systems, including the roles of boards of directors, shareholder activism, internal control and risk management, and executive compensation. Finally, we consider the future of corporate gover- nance and indicate how strong governance is tied to corporate performance and economic growth. Our approach in this chapter is to demonstrate that corporate governance is a fundamental aspect of social responsibility.

CORPORATE GOVERNANCE DEFINED In a general sense, the term governance relates to the exercise of oversight, control, and authority. For example, most institutions, governments, and businesses are organized so that oversight, control, and authority are

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Chapter 3  Corporate Governance 77

clearly delineated. These organizations usually have an owner, president, chief executive officer, and a board of directors that serves as the ulti- mate authority on decisions and actions. The board of directors should have final authority on decisions, including the ability to approve cor- porate strategy, provide financial oversight, and even remove the CEO. Nonprofit organizations, such as homeowners associations, have a presi- dent and a board of directors to make decisions in the interest of a com- munity of homeowners. A clear delineation of power and accountability helps stakeholders understand why and how the organization chooses and achieves its goals. This delineation also demonstrates who bears the ultimate risk for organizational decisions. Legally, Sarbanes-Oxley and the FGSO places responsibility and accountability on top officers and the board of directors. Although many companies have adopted decentralized decision-making, empowerment, team projects, and less hierarchical structures, governance remains a required mechanism for ensuring accountability to regulatory authorities. Even if a company has adopted a consensus approach for its operations, there has to be author- ity for delegating tasks, making tough and controversial decisions, and balancing power throughout the organization. Governance also provides oversight to uncover and address mistakes, risks, as well as ethical and legal misconduct. Consider the failure of boards at Enron and AIG to address risks and provide internal controls to prevent misconduct. More recently, boards at J.C. Penney and J.P. Morgan have been criticized for issues such as failing to have a solid succession plan in place and not exerting enough oversight to prevent misconduct. On the other hand, corporate governance consultants have praised the boards of Eaton Corporation and Abbott Laboratories for strong benchmarking and incentive pay systems.3

We define corporate governance as the formal system of oversight, accountability, and control for organizational decisions and resources. Oversight relates to a system of checks and balances that limit employees’ and managers’ opportunities to deviate from policies and codes of con- duct. Accountability relates to how well the content of workplace deci- sions is aligned with a firm’s stated strategic direction. Control involves the process of auditing and improving organizational decisions and actions. The philosophy that is embraced by a board or firm regarding oversight, accountability, and control directly affects how corporate governance works. Table 3.1 describes some examples of important corporate gover- nance decisions.

Corporate Governance Framework The majority of businesses and many courses taught in colleges of busi- ness operate under the belief that the purpose of business is to maximize profits for shareholders. In 1919, the Michigan Supreme Court in the case of Dodge v. Ford Motor Co.4 ruled that a business exists for the profit of shareholders, and the board of directors should focus on that objective. On the other hand, the stakeholder model places the board of directors

corporate governance Formal system of oversight, accountability, and control for organizational decisions and resources.

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78 Business and Society

in the central position to balance the interests and conflicts of the various constituencies. As we will see, there should be no conflict between maxi- mizing profits and maintaining a stakeholder orientation. External con- trol of the corporation includes government regulation but also includes key stakeholders such as employees, consumers, and communities, who exert pressures for responsible conduct. Many of the obligations to bal- ance stakeholder interest have been institutionalized in legislation that provides incentives for responsible conduct. It is not correct to assume that it is necessary to take advantage of or ignore stakeholders to maximize profits. There is much evidence that a stakeholder orientation maximizes profits in the long run. By taking preventive action against misconduct, a company may avoid onerous penalties should a violation occur. Top officers and the board of directors are legally responsible for accurate financial reporting, as well as providing oversight to manage ethical decision-making. Today, most companies understand that ethical decision-making supports the firm’s reputation and the cooperation of stakeholders.

Therefore, the failure to balance stakeholder interests can result in a failure to maximize shareholders’ wealth. Sometimes the issue is so major that fines and serious penalties occur as a result. For instance, the man- ager of a home health-care company was convicted of Medicare fraud for directing employees to visit patients who were physically capable of leaving their homes and having them bill at the highest level. This lack of ethical leadership demonstrated a true failure in corporate governance.5 Most firms are moving more toward a balanced stakeholder model, as they see that this approach will sustain the relationships necessary for long-run success.

Both directors and officers of corporations are fiduciaries for the shareholders. Fiduciaries are persons placed in positions of trust who use due care and loyalty in acting on behalf of the best interests of the orga- nization. There is a duty of care, also called a duty of diligence, to make informed and prudent decisions.6 Directors have an obligation to avoid ethical misconduct in their role and to provide leadership in decisions to

TABLE 3.1 Corporate Governance Decisions

Decisions Examples Ethical and legal risks Approve ethics and compliance program

Regulatory financial reporting Audit committee oversees financial reporting

Compensation Committee approves compensation for top officers

Strategic Approves decisions related to strategies, mergers, and acquisitions

Financial Major decisions related to the use of financial assets, including issuing stocks and bonds

Stakeholder Decisions regarding employee benefits, shareholder rights, and contributions to society

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Chapter 3  Corporate Governance 79

prevent ethical misconduct in the organization. Directors are not held responsible for negative outcomes if they are informed and diligent in their decision-making. For example, the directors of General Motors (GM) must remain diligent in ensuring that financial reporting is accurate to the best of their knowledge. Manufacturing cars that lose market share is a serious concern, although it is not a legal issue. On the other hand, if the directors know that the firm is covering up a safety concern, then they can be held responsible. This means directors have an obligation to request information, research, and use accountants, attorneys, and obtain the services of consultants in matters where they need assistance or advice.

The duty of loyalty means that all decisions should be in the interests of the corporation and its stakeholders. Conflicts of interest exist when a director uses the position to obtain personal gain, usually at the expense of the organization. Two hedge funds opposed United Continental Holdings Inc.’s decision to appoint the CEO the additional role of Chairman and questioned the amount of compensation he received. The hedge funds asked shareholders to consider six new directors for the board. Many corporate governance experts have criticized appointing the same person as both CEO and Chairman, although it is common occurrence in U.S. companies.7

Officer compensation packages challenge directors, especially those on the board who are not independent. Directors have an opportunity to vote for others’ compensation in return for their own increased compen- sation. Opportunities to know about the investments, business ventures, and stock market information create issues that could violate the duty of loyalty. Insider trading of a firm’s stock is illegal and violations can result in serious punishment. A probe of Samsung involving several employees, including president-level executives, was launched to investigate whether the employees used insider trading tips to profit from an upcoming purchase. The employees allegedly purchased $43 million in a Samsung de facto holding company before it disclosed plans to purchase an affiliate firm. This knowledge would have provided them with an unfair advantage that other shareholders did not have. If found guilty, employees could face fines and jail time.8 The ethical and legal obligations of directors and officers interface with their fiduciary relationships to the company. Ethical values should guide decisions and buffer the possibility of illegal conduct. With increased pressure on directors to provide oversight for organizational ethics and compliance, there is a trend toward director training to increase their competence in ethics program development as well as other areas, such as accounting.

Corporate governance establishes fundamental systems and processes for oversight, accountability, and control. This requires investigating, disciplining, and planning for recovery and continuous improvement. Effective corporate governance creates compliance and values so that employees feel that integrity is at the core of competitiveness.9 Even if a company has adopted a consensus approach to decision-making, there

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80 Business and Society

should be oversight and authority for delegating tasks, making difficult and sometimes controversial decisions, balancing power throughout the firm, and maintaining social responsibility. Governance also provides mechanisms for identifying risks and planning for recovery when mistakes or problems occur.

The development of a stakeholder orientation should interface with the corporation’s governance structure. Corporate governance is also part of a firm’s corporate culture that establishes the integrity of all relationships. A governance system that does not provide checks and balances creates opportunities for top managers to put their own self- interests before those of important stakeholders. Medical products dis- tributor McKesson Corp. announced changes in corporate governance at the behest of stakeholders. CEO John H. Hammergren’s compensa- tion has been called into question for reaching unprecedented levels, and the restructuring addressed these issues. The company reevaluated other aspects of governance and plans to implement more changes in phases.10 Concerns about the need for greater corporate governance are not limited to the United States. Reforms in governance structures and issues are occurring all over the world.11 In many nations, companies are being pressured to implement stronger corporate governance mecha- nisms by international investors; by the process of becoming privatized after years of unaccountability as state companies; or by the desire to imitate successful governance movements in the United States, Japan, and the European Union (EU).12 As the business world becomes more global, standardization of governance becomes important in order for multinational and international companies to maintain standards and a level of control.

Table 3.2 lists examples of major corporate governance issues. These issues normally involve strategic-level decisions and actions taken by boards of directors, business owners, top executives, and other managers

TABLE 3.2 Corporate Governance Issues Shareholder rights

Executive compensation

Composition and structure of the board of directors

Auditing and control

Risk management

CEO selection and termination decisions

Integrity of financial reporting

Stakeholder participation and input into decisions

Compliance with corporate governance reform

Role of the CEO in board decisions

Organizational ethics programs

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Chapter 3  Corporate Governance 81

with high levels of authority and accountability. Although these people have often been relatively free from scrutiny, changes in technology, con- sumer activism, government attention, recent ethical scandals, and other factors have brought new attention to such issues as transparency, execu- tive pay, risk and control, resource accountability, strategic direction, stockholder rights, and other decisions made for the organization.

HISTORY OF CORPORATE GOVERNANCE In the United States, a discussion of corporate governance draws on many parallels with the goals and values held by the U.S. Founding Fathers.13 As we mentioned earlier in the chapter, governance involves a system of checks and balances, a concept associated with the distribution of power within the executive, judiciary, and legislative branches of the U.S. govern- ment. The U.S. Constitution and other documents have a strong focus on accountability, individual rights, and the representation of broad interests in decision-making and resource allocation.

In the late 1800s and early 1900s, corporations were headed by such familiar names as Carnegie, DuPont, and Rockefeller. These “captains of industry” had ownership investment and managerial control over their businesses. Thus, there was less reason to talk about corporate gover- nance because the owner of the firm was the same individual who made strategic decisions about the business. The owner primarily bore the consequences—positive or negative—of decisions. During the twentieth century, however, an increasing number of public companies and inves- tors brought about a shift in the separation of ownership and control. By the 1930s, corporate ownership was dispersed across a large number of individuals. This raised new questions about control and accountability for organizational resources and decisions.

One of the first known anecdotes that helped shape our current under- standing of accountability and control in business occurred in the 1930s. In 1932, Lewis Gilbert, a stockholder in New York’s Consolidated Gas Company, found his questions repeatedly ignored at the firm’s annual shareholders’ meeting. Gilbert and his brother took the problem to the federal government and pushed for reform, which led to the creation of the U.S. Securities and Exchange Commission, which requires corporations to allow shareholder resolutions to be brought to a vote of all stockholders. Because of the Gilbert brothers’ activism, the SEC formalized the process by which executives and boards of directors respond to the concerns and questions of investors.14

Since the mid-1900s, the approach to corporate governance has involved a legal discussion of principals and agents to the business rela- tionship. Essentially, owners are “principals” who hire “agents,” the executives, to run the business. A key goal of businesses is to align the interests of principals and agents so that organizational value and viability are maintained. Achieving this balance has been difficult, as evidenced

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82 Business and Society

by these business terms coined by media—junk bonds, empire building, golden parachute, and merger madness—all of which have negative conno- tations. In these cases, the long-term value and competitive stance of orga- nizations were traded for short-term financial gains or rewards. The results of this short-term view included workforce reduction, closed manufactur- ing plants, struggling communities, and a generally negative perception of corporate leadership. In our philosophy of social responsibility, these long- term effects should be considered alongside decisions designed to generate short-run gains in financial performance.

The Sarbanes-Oxley Act was the most significant piece of corporate governance reform at the time since the 1930s. Under these rules, both CEOs and CFOs are required to certify that their quarterly and annual reports accurately reflect performance and comply with the requirements of the SEC. Among other changes, the act also required more independence of boards of directors, protected whistle-blowers, and established a Public Company Accounting Oversight Board. The New York Stock Exchange (NYSE) and NASDAQ also overhauled the governance standards required for listed firms. Business ethics, director qualifications, unique concerns of foreign firms, loans to officers and directors, internal auditing, and many other issues were part of the NYSE and NASDAQ reforms.15

Despite the implementation of Sarbanes-Oxley, corporate misconduct and the quest for short-term profits led the U.S. financial system to a near collapse during the last recession. The cause was a pervasive use of instru- ments like credit default swaps, risky debt like subprime lending, and cor- ruption in major corporations. The government was forced to step in and bail out many financial companies. Later on, because of the weak financial system and reduced consumption, the government also had to step in to help major automotive companies GM and Chrysler. The U.S. govern- ment became a majority shareholder in GM, an unprecedented move (it has since divested itself of its final shares). Not since the Great Depression and President Franklin Delano Roosevelt has the United States seen such widespread government intervention and regulation—something that most deem necessary but is nevertheless worrisome to free market capitalists. The basic assumptions of capitalism are under debate as countries around the world work to stabilize markets and question those that managed the money of individual corporations and nonprofits. The latest recession caused many to question government institutions that provide oversight and regulation. As changes are made, there is a need to address issues related to law, ethics, and the required level of compliance necessary for government and business to serve the public interest.

Finance Reforms The lack of effective control and accountability mechanisms prompted a strong interest in corporate governance. In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed to protect consum- ers from overly complex financial instruments, better regulate the financial

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Chapter 3  Corporate Governance 83

industry, and prevent too-big-to-fail financial institutions. (One of the reasons why the government had to intervene during the financial meltdown was that allowing large institutions such as Bank of America or AIG to fail would devastate the economy at a much higher rate.) The Dodd- Frank Act established a Consumer Financial Protection Bureau (CFPB), among other agencies. The CFPB is similar to the Bureau of Consumer Protection in that its purpose is to protect consumers from being deceived by institutions selling high-risk financial products. The Dodd-Frank Act will be discussed in detail in the following chapter. Boards of directors have the responsibility to provide oversight and compliance with regulation.

Beyond the legal issues associated with governance, there has also been interest in the board’s role in social responsibility and stakeholder engagement. Table 3.3 pro- vides a list of companies with good corporate governance. The board of directors should provide leadership for social responsibility initiatives. It is apparent that some boards have been assuming greater responsibility for strategic decisions and have decided to focus on building more effec- tive social responsibility.

CORPORATE GOVERNANCE AND SOCIAL RESPONSIBILITY Corporate social responsibility can be a difficult concept to define. While there is broad agreement among professionals, academics, and policy makers that being socially responsible does pay, corporate social responsibility always involves trade-offs, and most businesses have yet to formulate an idea of what social responsibility really entails for their organization.16 Interpreted narrowly, a company can consider itself socially responsible if it generates returns for shareholders and provides jobs for employees (called the shareholder model). A broad definition of social responsibility interprets the corporation as a vehicle for stakehold- ers and for public policy (called the stakeholder model). A company that takes the latter view would be more concerned with the public good as well as with profitability and shareholder return. Because most firms have so many potential stakeholders, a key to developing a socially responsible agenda involves determining which of these groups are most important for your business. Social responsibility should seek to help a firm’s prin- cipal stakeholders. For example, a line of high-end organic soaps might seek to source its ingredients from sustainable sources, avoid products that have been tested on animals, and hire workers at living wages.

To understand the role of corporate governance in business today, it is also important to consider how it relates to fundamental beliefs about

TABLE 3.3 Companies with Good Corporate Governance

The Allstate Corporation

AMN Healthcare

CVS Health Corporation

General Electric

Graybar

Lockheed Marting

Marsh & McLennan Companies

Microsoft

Splunk

Westpac Banking Corporation

Source: IR Media Group Ltd., “Corporate Governance Awards 2015,” Corporate Secretary, November 4, 2015, http://www.corporatesecre- tary.com/events/corporate-governance-awards/ corporate-governance-awards-2015/research/ (accessed June 17, 2016).

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84 Business and Society

the purpose of business organizations. Some people believe that as long as a company is maximizing shareholder wealth and profitability, it is fulfilling its core responsibility. Although this must be accomplished in accordance with legal and ethical standards, the primary focus is on the economic dimension of social responsibility. Thus, this belief places the philanthropic dimension beyond the scope of business. Other people, however, take the view that a business is an important mem- ber, or citizen, of society and must assume broad responsibilities. This view assumes that business performance is reflexive, meaning it both affects and is influenced by internal and external factors. In this case, performance is often considered from a financial, social, and ethical perspective. From these assumptions, we can derive two major concep- tualizations of corporate governance: the shareholder model and the stakeholder model.

The shareholder model of corporate governance is founded in classic economic precepts, including the maximization of wealth for investors and owners. For publicly traded firms, corporate governance focuses on developing and improving the formal system of performance account- ability between top management and the firms’ shareholders.17 Thus, the shareholder orientation should drive management decisions toward what is in the best interests of investors. Underlying these decisions is a classic agency problem, where ownership (i.e., investors) and control (i.e., managers) are separate. Managers act as agents for investors, and their primary goal is to generate value for shareholders. However, investors and managers are distinct parties with unique insights, goals, and values with respect to the business. Managers, for example, may have motivations beyond shareholder value, such as market share, personal compensation, or attachment to particular products and projects. Because of these potential differences, corporate governance mechanisms are needed to ensure an alignment between investor and management interests.

For example, Deutsche Bank was investigated for questionable prac- tices including possible manipulation of worldwide benchmark interest rates and legality of payment processing in various countries. These activi- ties generated profits and raised the company’s stock price. As a result of alleged misconduct, numerous employees have been fired, at least $6.9 billion has been paid in fines and penalties, and former senior executive William Broeksmit committed suicide apparently owing to the pressure and stress of the investigations. In addition, regulators have indicated that these investigations will continue for an unforeseen amount of time. The investigations have forced the bank to set aside billions of dollars for legal fees and more potential fines. This is now causing harm to investors as these costs are driving down the stock price.18 The shareholder model has been criticized for its somewhat singular purpose and focus because there are other ways of “investing” in a business. Suppliers, creditors, custom- ers, employees, business partners, the community, and others also invest their resources in the success of the firm.

shareholder model of corporate governance Founded in classic economic precepts, it focuses on improving the formal system of performance accountability between the top management and the shareholders.

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In the stakeholder model of corporate governance, the purpose of business is conceived in a broader fashion. Although a company has a responsibility for economic success and viability, it must also answer to other parties, including employees, suppliers, government agencies, communities, and groups with which it interacts. This model presumes a collaborative and relational approach to business and its constituents. Because management time and resources are limited, a key decision within the stakeholder model is to determine which stakeholders are pri- mary. Once primary groups have been identified, appropriate corporate governance mechanisms are implemented to promote the development of long-term relationships.19 As we discussed in Chapter 2, primary stakeholders include stockholders, suppliers, customers, employees, the government, and the community. Governance systems that consider stakeholder welfare in tandem with corporate needs and interests char- acterize this approach. For instance, several companies including Google, Inc., J. Crew Group, Inc., and Deere & Co. have discovered that some of their materials have been supplied through suppliers that may have engaged in unethical and illegal conduct. Questionable market channels can damage a firm’s reputation and social responsibility agenda. Conflict minerals, sourced from the Congo whose profits benefit armed militias, may have been used to make some of the companies’ products. While determining the origin of all materials is a difficult and sometimes even impossible process, it is important for companies to do everything in their power to most positively impact all stakeholders. This discovery came as a result of one of the mandates of the 2010 Dodd-Frank Act that requires companies to fully understand their supply chains.20

Although these two approaches seem to represent ends of a con- tinuum, the reality is that the shareholder model is often a precursor to the stakeholder model. Many businesses have evolved into the stake- holder model as a result of government initiatives, consumer activism, industry activity, and other external forces. In the aftermath of corporate scandals, it became clear how the economic accountability of corpora- tions could not be detached from other responsibilities and stakeholder concerns. Although this trend began with large, publicly held firms, its aftereffects are being felt in other types of organizations and industries as well. Figure 3.1 illustrates a continuum of stakeholder concerns. One end demonstrates the shareholder model. The other end demonstrates a stake- holder model with concern for various company stakeholders.

The shareholder model focuses on a primary stakeholder—the investor—whereas the stakeholder model incorporates a broader phi- losophy toward internal and external constituents. According to the World Bank, a development institution whose goal is to reduce poverty by promoting sustainable economic growth around the world, corporate governance is defined by both internal (i.e., long-term value and efficient operations) and external (i.e., public policy and economic development) factors.21 We are concerned with the broader conceptualization of corpo- rate governance in this chapter.

stakeholder model of corporate governance A model where the business is accountable to all its stakeholders, not just the shareholders.

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FIGURE 3.1 Stakeholder Continuum

Shareholder Model Stakeholder Model

Shareholder profits Focus on selected stakeholders

Employees Customers

Shareholders Suppliers Regulators

Communities

In the social responsibility model that we propose, governance is the organizing dimension for keeping a firm focused on continuous improve- ment, accountability, and engagement with stakeholders. Although finan- cial return, or economic viability, is an important measure of success for all firms, the legal dimension of social responsibility is also a compulsory consideration. The ethical and philanthropic dimensions, however, have not been traditionally mandated through regulation or contracts. This represents a critical divide in our social responsibility model and associ- ated governance goals and systems because there are some critics who challenge the use of organizational resources for concerns beyond finan- cial performance and legalities. This view was summarized in an editorial in National Journal, a nonpartisan magazine on politics and government: “Corporations are not governments. In the everyday course of their busi- ness, they are not accountable to society or to the citizenry at large.… Corporations are bound by the law, and by the rules of what you might call ordinary decency. Beyond this, however, they have no duty to pursue the collective goals of society.”22 This type of philosophy, long associated with the shareholder model of corporate governance, prevailed through- out the twentieth century. However, as the consequences of neglecting the stakeholder model of corporate social responsibility have become clearer, fewer firms persist in adhering to such a narrow view.

ISSUES IN CORPORATE GOVERNANCE SYSTEMS Organizations that strive to develop effective corporate governance sys- tems consider a number of internal and external issues. In this section, we look at four areas that need to be addressed in the design and improve- ment of governance mechanisms. We begin with boards of directors, which have the ultimate responsibility for ensuring governance. Then,

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SodaStream: Bubbling Up with Socially Responsible Products

Daniel Birnbaum, CEO of SodaStream, sees plastic bottles as a thing of the past. SodaStream manufac- tures home carbonation systems that allow consum- ers to make their own sodas. The home carbonation systems include a reusable bottle, which cuts back on plastic ending up in landfills. Although SodaStream controls less than 1 percent of the global soda market, Birnbaum hopes that one day SodaStream will become its leader. The company sells its products through retail- ers ranging from Sears and Walmart to Bloomingdale’s and Williams-Sonoma.

The first rendition of SodaStream was introduced in 1903 and became a big hit in Europe. After several acquisitions over a period of time, SodaStream began selling products globally. SodaStream became a public corporation in 2010 with an initial public offering of $109 million in the United States. Its share price has fluctuated greatly as the firm continues to be the underdog in a fierce competition between the two heavyweight corporations—PepsiCo and Coca-Cola.

SodaStream’s success is the result of CEO Daniel Birnbaum’s promotion of the product as a healthier and greener alternative to prepackaged sodas. As consumers become increasingly concerned about their health and about the firm’s impact on the environ- ment, SodaStream is becoming a household name. As SodaStream has grown in recent years, it has had to increase its corporate governance efforts to maintain its position as an ethical and sustainable company. The firm has established a corporate governance commit- tee for its board of directors to ensure adherence to its responsibilities. Additionally, it has a number of gover- nance documents to provide guidelines for managers

and employees, including a conflict minerals policy, a social media policy, a code of ethics for executives, and a code of conduct for employees.

The company’s promotion efforts focus on the amount of plastic, glass, and aluminum bottles that are thrown away every year. SodaStream continues to be vis- ibly critical of the amount of waste created by beverage companies and was even given a cease-and-desist order by Coca-Cola regarding one of its marketing campaigns. The campaign featured a cage full of discarded plastic and canned sodas collected from dumpsites—which included Coca-Cola products. Birnbaum’s response was to point to the massive amounts of litter Coca-Cola has produced worldwide. He also hinted that if Coke wants to claim any of its discarded trademark waste, it should be forced to claim all of it.

Some might question whether it is a smart corpo- rate move to challenge such major competitors. Yet, because SodaStream is governed by sustainable values and practices, it seems appropriate to challenge firms it believes are violating these values. This does not always mean SodaStream receives support. In 2013, SodaStream created an ad to be aired on Super Bowl Sunday. It was estimated that over 500 million plastic bottles would be discarded on that day alone. The television networks refused to air the ad as many of their sponsors and advertisers were large beverage companies, but SodaStream posted the ad online and received over 2 million views on YouTube. In 2014, a censored SodaStream advertisement with endorser Scarlett Johansson aired during the Super Bowl. Again, the commercial was edited to remove a barb at Coke and Pepsi but remained popular on the internet.

Earth in the Balance

Source: Michal Lev-Ram, “SodaStream’s Bubbly Rise,” CNN Money, March 21, 2013, http://fortune.com/2013/03/21/sodastreams-bubbly- rise/ (accessed July 12, 2016); Emily Jane Fox, “Super Bowl Showdown: SodaStream vs. Pepsi and Coke,” CNN Money, February 3, 2013, http://money.cnn.com/2013/02/03/news/companies/sodastream-coke-pepsi-super-bowl/ (accessed July 12, 2016); SodaStream website, http://www.sodastream.com/ (accessed July 12, 2016), http://sodastream.investorroom.com/index.php?s=116#.U58iAXnQe70 (accessed July 12, 2016); “Governance Documents,” SodaStream, http://sodastream.investorroom.com/index.php?s=116#.U58ncXnQe73 (accessed July 12, 2016).

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TABLE 3.4 Challenges in Corporate Governance

Challenge Example Independence Increasing the percentage of independent directors who do

not own shares or otherwise have a material interest in the company

Quality Tracking quality control issues and ensuring that the organization meets benchmarks for product quality

Performance Ensuring that performance meets shareholder expectations

Shareholder Activism Dealing with shareholder demands such as calls for limiting executive compensation

Internal Controls Appointing an ethics officer to oversee the company’s ethics and compliance program

Audits Periodically auditing different areas of the company to determine areas of improvement

Risk Management Understanding major risks the company faces and developing controls to limit these risks

we discuss shareholder activism, internal control and risk management, and executive compensation within the governance system. These issues affect most organizations, although individual businesses may face unique factors that create additional governance questions. For example, a com- pany operating in several countries will need to resolve issues related to international governance policy. Table 3.4 discusses major areas of risk in corporate governance that organizational leaders are facing across various corporations.

Boards of Directors A company’s board of directors assume responsibility for the firm’s resources and legal and ethical compliance. The board appoints top execu- tive officers and is responsible for overseeing their performance. This is also true of a university’s board of trustees, and there are similar arrange- ments in the nonprofit sector. In each of these cases, board members have a fiduciary duty, which was discussed earlier in this chapter. These respon- sibilities include acting in the best interests of those they serve. Thus, board membership is not designed as a vehicle for personal financial gain; rather, it provides the intangible benefit of ensuring the success of the organization and the stakeholders affected and involved in the fiduciary arrangement.

In the case of public corporations, boards of directors hold the ultimate responsibility for their firms’ ethical culture and legal compli- ance. This governing authority is held responsible by the 2004 and 2007 amendments to the Federal Sentencing Guidelines for creating an ethical culture that provides leadership, values, and compliance. The members of a company’s board of directors assume legal responsibility for the firm’s resources and decisions, and they appoint its top executive officers. In an

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effort to revamp the company after the last recession, Citigroup appointed new directors to its board. This overhauled board now includes financial experts from government, the banking industry, and academia—all in an effort to increase transparency and accountability.23

The traditional approach to directorship assumed that board members managed the corporation’s business. Research and practical observation have shown that boards of directors rarely, if ever, perform the manage- ment function.24 Because boards usually meet four to six times a year, there is no way that time allocation would allow for effective management. In small nonprofit organizations, the board may manage most resources and decisions. The complexity of large organizations requires full atten- tion on a daily basis. Today, boards of directors are concerned primarily with monitoring the decisions made by managers on behalf of the com- pany. This includes choosing top executives, assessing their performances, helping to set strategic direction, evaluating company performance, devel- oping CEO succession plans, communicating with stakeholders, maintain- ing legal and ethical practices, ensuring that control and accountability mechanisms are in place, and evaluating the board’s own performance. In sum, the board members assume the ultimate authority for organizational effectiveness and subsequent performance.

Independence Just as social responsibility objectives require more employ- ees and executives, boards of directors are also experiencing increasing accountability and disclosure mandates. The desire for independence is one reason that a few firms have chosen to split the powerful roles of chair of the board and CEO. Although the practice is common in the United King- dom and activists have called for this move for years, the idea is newer to the United States and is sometimes met with resistance. The past couple of years have placed pressure on J.P. Morgan Chase Chairman and CEO James Dimon. After a number of regulatory hearings concerning the Lon- don Whale Fiasco, lack of oversight in the Bernard Madoff Ponzi scheme incident, and risky loans before the Great Recession, shareholders at J.P. Morgan requested that the chairman and CEO roles be divided. The request was met with resistance and did not pass a board vote, but Dimon did relinquish his role as chairman of the bank business. Some think this is an acknowledgement of responsibility and a step in the right direction concerning better corporate governance.25

Traditionally, board members were retired company executives or friends of current executives, but the trend since the corporate scandals associated with Enron, WorldCom, and more recently Countrywide Financial and J.P. Morgan has been toward independent directors who have valuable expertise yet little vested interest in the firm before assuming the director role. According to Rule 303A.01 of the NYSE corporate gov- ernance guidelines, the boards of listed companies must be comprised of a majority of independent directors.26 However, a listed company in which more than 50 percent of the voting power for the election of directors is held by a group or individual does not have to abide by Rule 303A.01.27

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Thus, directors today are more likely chosen for their competence, motivation, and ability to bring enlightened and diverse perspectives to strategic discussions. Outside directors are thought to bring more inde- pendence to the monitoring function because they are not bound by past allegiances, friendships, a current role in the company, or some other mat- ter that may create a conflict of interest. However, independent directors who sit on a board for a long time may eventually lose some of the out- sider perspective. While they are more likely to be impartial, independent directors are not always guaranteed to avoid conflict of interest issues. For example, hedge fund management firm The Galleon Group had indepen- dent directors on its board, but this did not stop massive misconduct at the firm. Founder Raj Rajaratnam was convicted of insider trading and was sentenced to 11 years in prison, the longest sentencing to date for the crime. Directors have to avoid ‘groupthink’ and be competent enough to understand risks. They must also be willing to ask for information relevant to avoiding organizational misconduct.

Quality Finding board members who have some expertise in the firm’s industry or who have served as chief executives at similar-sized organiza- tions is a good strategy for improving the board’s overall quality. Directors with competence and experiences that reflect some of the firm’s core issues should bring valuable insights to bear on discussions and decisions. Direc- tors without direct industry or comparable executive experience may bring expertise on important issues, such as auditing, executive compensation, succession planning, and risk management, to improve decision-making. Board members must understand the company’s strategy and operations; this suggests that members should limit the number of boards on which they serve. Directors need time to read reports, attend board and commit- tee meetings, and participate in continuing education that promotes strong understanding and quality guidance. For example, directors on the board’s audit committee may need to be educated on new accounting and audit- ing standards. Experts recommend that fully employed board members sit on no more than four boards, whereas retired members should limit their memberships to seven boards. Directors should be able to attend at least 75 percent of the meetings. Thus, many of the factors that promote board quality are within the control of directors.28

Performance An effective board of directors can serve as a type of insur- ance against the business cycle and the natural highs and lows of the econ- omy. A company with a strong board free from conflicts of interest and clearly stated corporate governance rules will be more likely to weather a storm if something bad does happen.29 As federal regulations increase and the latitude afforded boards of directors shrinks, boards are going to be faced with greater responsibility and transparency.

Board independence, along with board quality, stock ownership, and corporate performance, are often used to assess the quality of corporate boards of directors. Many CEOs have lost their jobs because the board of

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directors is concerned about performance, ethics, and social responsibility. The main reason for this is the boards’ fear of losing their personal assets. This fear comes from lawsuits by shareholders who sued the directors of financial firms over their roles in the collapse on Wall Street. These events make it clear that board members are accountable for oversight.

Just as improved ethical decision-making requires more of employees and executives, so too are boards of directors feeling greater demands for ethics and transparency. Directors today are increasingly chosen for their proficiency and ability to bring different perspectives to strategic discus- sions. As mentioned earlier, outside directors are thought to bring more independence to the monitoring function because they are not bound by past allegiances and other issues that may create a conflict of interest. The chair of the board audit committee must be an outside independent direc- tor with financial expertise.

Many of the corporate scandals uncovered in recent years might have been prevented if each of the companies’ boards of directors had been bet- ter qualified, more knowledgeable, and less biased. The institution of the Volcker Rule, one component of the Dodd-Frank Wall Street Reform and Consumer Protection Act, provides stricter rules on financial management and controls on hedge funds and money-market mutual funds. The aim is to ensure that banks will have more liquid assets than before. It also aims to provide increased openness and transparency, greater oversight and enforcement, and clearer, more common-sense language in the financial sys- tem.30 Board members are being asked to understand changes in regulations and participate in providing better oversight on risk-taking in their firms.

Rules promulgated by the Sarbanes-Oxley Act and various stock exchanges now require a majority of independent directors on the board with no material relationship to the firm; regular meetings between non- management board members; audit, compensation, governance, and nomi- nating committees either fully made up of or with a majority of independent directors; no more than $120,000 in compensation for independent direc- tors per year; and a financial expert on the audit committee. The gover- nance area will continue to evolve as corporate scandals are resolved and the government and companies begin to implement and test new policies and practices. Regardless of the size and type of business for which boards are responsible, a system of governance is needed to ensure effective control and accountability. As a corporation grows, matures, enters international markets, and takes other strategic directions, it is likely that the board of directors will evolve to meet its new demands. Sir Adrian Cadbury, former president of the Centre for Board Effectiveness at the Henley Business School in Reading, England, and an architect of corporate governance changes around the world, outlined responsibilities of strong boards:

Boards are responsible for developing company purpose statements that cover a range of aims and stakeholder concerns.

Annual reports and other documents include more nonfinancial information.

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Boards are required to define their role and implement self-assessment processes better.

Selection of board members will become increasingly formalized, with less emphasis on personal networks and word of mouth.

Boards need to work effectively as teams. Serving on boards will require more time and commitment than in the

past.31

These trends are consistent with our previous discussion of social responsi- bility. In all facets of organizational life, greater demands are being placed on business decisions and people. Many of these expectations emanate from those who provide substantial resources in the organization— namely, shareholders and other investors.

Shareholder Activism Shareholders, including large institutional ones, have become more active in articulating their positions with respect to company strategy and execu- tive decision-making. Activism is a broad term that can encompass engag- ing in dialog with management, attending annual meetings, submitting shareholder resolutions, bringing lawsuits, and other mechanisms designed to communicate shareholder interests to the corporation. Table 3.5 lists characteristics of effective shareholder activism campaigns.

TABLE 3.5 Characteristics of a Successful Shareholder Activism Campaign Alliances Alliances with social movements or public

interest groups, where shareholder concerns and activity mesh with and play a part in a larger, multifaceted campaign

Grass-roots pressure Letter writings or phone-ins to public investors to generate support for the resolution

Communications Media outreach, public and shareholder education, etc.

High-level negotiations with senior decision-makers

Company executives and directors

Support and active involvement from large institutional investors

Financial firms such as Goldman Sachs and JP Morgan

A climate that makes it difficult for the company not to make the “right decision”

If you have a plainly compelling financial argument, you have a better chance of getting company management and other shareholders on board with your proposal.

Persistence Shareholders don’t go away. They own the company and have a right to be heard. Often shareholder activists stick with issues for years.

Source: “Characteristics of a Successful Shareholder Activism Campaign,” Friends of the Earth, http:// www.foe.org/international/shareholder/characteristics.html (accessed April 25, 2006). Courtesy Friends of the Earth © 2006.

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Shareholder resolutions are nonbinding, yet important, statements about shareholder concerns. A shareholder that meets certain guidelines may bring one resolution per year to a proxy vote of all shareholders at a corporation’s annual meeting. Recent resolutions brought forth relate to auditor inde- pendence, executive compensation, independent directors, environmental impact, human rights, and other social responsibility issues. In some cases, the company will modify its policies or practices before the resolution is ever brought to a vote. In other situations, a resolution will receive less than a majority vote, but the media attention, educational value, and other stake- holder effects will cause a firm to reconsider, if not change, its original posi- tion to meet the resolution’s proposal. The accounting scandals prompted many resolutions about executive compensation among shareholders who believe that improper compensation structures are often a precursor to accounting mismanagement.32 The resolution process is regulated by the SEC in the United States and by complementary offices in other countries; some claim this to be more favorable to the corporation than to shareholders.

Although labor and public pension fund activists have waged hun- dreds of proxy battles in recent years, they rarely have much effect on the target companies. Now shareholder activists are attacking the process by which directors themselves are elected. After a poor performance leading up to the latest recession, Bank of America shareholders voted to oust six board members. The move got rid of entrenched directors with possible conflicts of interest and replaced them with qualified financial experts.33 Although shareholders and investors want their resources used efficiently and effectively, they are increasingly willing to take a stand to encourage companies to change for reasons beyond financial return.

Investor Confidence Shareholders and other investors must have assurance that their money is being placed in the care of capable and trustworthy organizations. These primary stakeholders are expecting a solid return for their investment, but as illustrated earlier, they have additional concerns about social responsi- bility. When these fundamental expectations are not met, the confidence that investors and shareholders have in corporations, market analysts, investment houses, stockbrokers, mutual fund managers, financial plan- ners, and other economic players and institutions can be severely tested. In Chapter 1, we discussed the importance of investor trust and loyalty to organizational and societal performance. Part of this trust relates to the perceived efficacy of corporate governance. Table 3.6 shows the charac- teristics of a well-governed board of directors.

Internal Control and Risk Management Controls and a strong risk management system are fundamental to effective operations, as they allow for comparisons between the actual performance and the planned performance and goals of the organization. Controls are

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used to safeguard corporate assets and resources, protect the reliability of organizational information, and ensure compliance with regulations, laws, and contracts. Risk management is the process used to anticipate and shield the organization from unnecessary or overwhelming circumstances while ensuring that executive leadership is taking the appropriate steps to move the organization and its strategy forward.

Internal and External Audits Auditing, both internal and external, is the linchpin between risk and controls and corporate governance. Boards of directors must ensure that the internal auditing function of the company is provided with adequate funding, up-to-date technol- ogy, unrestricted access, independence, and authority to carry out its audit plan. To ensure these characteristics, the internal audit executive should report to the board’s audit committee and, in most cases, the chief executive officer.34

TABLE 3.6 Attributes of a Highly Functioning Board

Attributes A Highly Functioning Board Exhibits the Following Skills and knowledge

The board understands the attributes of successful leaders and how to apply them to the organization and its strategic plans; has experience developing leadership pipelines in organizations of similar size and scale; understands the mechanics of the company’s compensations plans and the risks inherent in the plans.

Process Appoints the CEO and oversees the CEO’s development, goal-setting, and compensation

Approves and monitors compensation performance metrics for the CEO Oversees CEO compensation and transparent disclosure of executive

compensation to stakeholders Ensures development of executive succession plans that contemplate

various scenarios Collaborates with management to develop and adopt a compensation

philosophy for the organization Meets periodically with executive leadership, including risk and HR, to

understand organizational compensation plans, talent pipeline, and underlying risks

Monitors external stakeholder considerations related to executive management and compensation

Information Obtains independent views and peer company benchmarks of compensa- tion plans proposed by management; has access to and receives periodic reports related to compensation plans, including internal audit and other reports; monitors marketplace developments.

Behavior Board leadership takes responsibility for the development of the CEO; appropriately supports and mentors the CEO; develops and maintains relationships with other key executives, especially those with potential to succeed the CEO.

Source: “Framing the Future of Corporate Governance,” Deloitte, 2015, http://www2.deloitte. com/content/dam/Deloitte/us/Documents/risk/us-aers-framing-the-future-of-corporate-gover- nance-09262014.pdf (accessed June 17, 2016).

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The external auditor should be chosen by the board and must clearly identify its client as the board, not the company’s chief financial officer. Under Sarbanes-Oxley, the board audit committee should be directly responsible for the selection, payment, and supervision of the company’s external auditor. The act also prohibits an external auditing firm from performing some non-audit work for the same public company, includ- ing bookkeeping, human resources, actuarial services, valuation services, legal services, and investment banking. However, even with regulations in place, many auditors failed to do their jobs properly. For example, trustees of New Century Financial Corporation sued its auditor, KPMG, for “reckless and grossly negligent audits” that hid the company’s finan- cial problems and sped its collapse. New Century was one of the early casualties of the subprime mortgage crisis but was once one of the coun- try’s largest mortgage lenders to those with poor credit histories. After it disclosed accounting errors not discovered by KPMG, the company col- lapsed.35 Part of the problem relates to the sheer size and complexity of organizations, but these factors do not negate the tremendous responsibil- ity that external auditors assume.

Control Systems The area of internal control covers a wide range of company decisions and actions, not just the accuracy of financial state- ments and accounting records. Controls also foster understanding when discrepancies exist between corporate expectations and stakeholder interests and issues. Internal controls effectively limit employee or man- agement opportunism or the use of corporate assets for individualistic or nonstrategic purposes. Controls also ensure the board of directors has access to timely and quality information that can be used to determine strategic options and effectiveness. For these reasons, the board should have ultimate oversight of the integrity of the internal control system.36 Although board members do not develop or administer the control sys- tem, they are responsible for ensuring that an effective system exists. The need for internal controls is rarely disputed, but implementation can vary. The CEO or chair appears to be the key decision-maker relating to public and political debates that have an impact on shareholder value. Thus, internal control represents a set of tasks and resource commit- ments that require high-level attention. See Table 3.7 for an integrated framework for implementing internal controls.

Although most large publicly traded corporations have designed inter- nal controls, smaller private companies and nonprofit organizations are less likely to have invested in a complete system. For example, electric car company Green Tech Automotive came under investigation by the SEC for questionable practices in recruiting foreign investors. The claims that the company overstated guaranteed returns on investment and accepted investment from investors that may compromise national security are highlighted in the investigation.37 Such questionable behaviors are com- mon in private businesses because they often lack effective internal con- trols. The framework in Table 3.7, while developed for large corporations,

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TABLE 3.7 Integrated Framework for Internal Control Control Environment

The organization demonstrates a commitment to integrity and ethical values

The board of directors demonstrates independence from management and exercises oversight of the development and performance of internal control

Management establishes, with board oversight, structures, reporting lines, and appropriate authorities and responsibilities in the pursuit of objectives

The organization demonstrates a commitment to attract, develop, and retain competent individuals in alignment with objectives

The organization holds individuals accountable for their internal control responsibilities in the pursuit of objectives

Risk Assessment The organization specifies objectives with sufficient clarity to enable the identification and assessment of risks relating to objectives

The organization identifies risks to the achievement of its objectives across the entity and analyzes risks as a basis for determining how the risks should be managed

The organization considers the potential for fraud in assessing risks to the achievement of objectives

The organization identifies and assesses changes that could significantly impact the system of internal control

Control Activities

The organization selects and develops control activities that contribute to the mitigation of risks to the achievement of objectives to acceptable levels

The organization selects and develops general control activities over technology to support the achievement of objectives

The organization deploys control activities through policies that establish what is expected and procedures that put policies into action

Information and Communication

The organization obtains or generates and uses relevant, quality infor- mation to support the functioning of internal control

The organization internally communicates information, including objec- tives and responsibility for internal control, necessary to support the functioning of internal control

The organization communicates with external parties regarding matters affecting the functioning of internal control

Monitoring Activities

The organization selects, develops, and performs ongoing and/or sepa- rate evaluations to ascertain whether the components of internal control are present and functioning

The organization evaluates and communicates internal control deficiencies in a timely manner to those parties responsible for taking corrective action, including senior management and the board of directors, as appropriate

Source: “Internal Control—Integrated Framework Executive Summary,” Committee of Sponsoring Organizations of the Treadway Commission, May 2013, http://www.coso.org/documents/coso%20 2013%20icfr%20executive_summary.pdf (accessed June 17, 2016).

can be used in all types of organizations. These techniques are not always costly, and they conform to best practices in the prevention of ethical and legal problems that threaten the efficacy of governance mechanisms.

Amendments to the Federal Sentencing Guidelines for Organizations make it clear that a corporation’s governing authority must be well

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informed about its control systems with respect to implementation and effectiveness. This places the responsibility squarely on the shoulders of the firm’s leadership, usually the board of directors. The board must ensure that there is a high-ranking officer accountable for the day-to-day opera- tional responsibility of the control systems. The board must also provide for adequate authority, resources, and access to the board or an appropri- ate subcommittee of the board. The guidelines further call for confidential mechanisms whereby the organization’s employees and agents may report or seek guidance about potential or actual misconduct without fear of retaliation. Finally, the board is required to oversee the discovery of risks and to design, implement, and modify approaches to deal with those risks. Thus, the board of directors is clearly accountable for discovering risks associated with a firm’s specific industry and assessing the firm’s ethics program to ensure that it is capable of uncovering misconduct.38

Risk Management A strong internal control system should alert decision- makers to possible problems, or risks, that may threaten business opera- tions, including worker safety, company solvency, vendor relationships, proprietary information, environmental impact, and other concerns. As we discussed in Chapter 2, having a strong crisis management plan is part of the process for managing risk. The term risk management is normally used in a narrow sense to indicate responsibilities associated with insurance, liability, financial decisions, and related issues. Kraft General Foods, for example, has a risk management policy for understanding how prices of commodities, such as coffee, sugar, wheat, and cocoa, will affect its rela- tionships throughout the supply chain.39

Most corporate leaders’ greatest fear is discovering serious miscon- duct or illegal activity somewhere in their organization. The fear is that a public discovery can immediately be used by critics in the mass media, competitors, and skeptical stakeholders to undermine a firm’s reputation. Corporate leaders worry that something will be uncovered outside their control that will jeopardize their careers and their organizations. Fear is a paralyzing emotion. Of course, maybe even organizational leaders such as Raj Rajaratnam experienced fear as they participated in misconduct. The former chairman of Satyam Computer Services, Ramalinga Raju, said it was a terrifying experience to watch a small act of fudging some numbers snowball out of control. He compared knowingly engaging in misconduct for years to “riding a tiger, not knowing how to get off without being eaten.”40 These leaders were the captains of their respective ships, and they made a conscious decision to steer their firms into treacherous waters with a high probability of striking an iceberg.41

Corporate leaders do fear the possibility of damage to reputation, financial loss, or a regulatory event that could potentially end their careers and even threaten their personal lives through fines or prison sentences. Indeed, the whole concept of risk management involves recognizing the possibility of a misfortune that could jeopardize or even destroy the cor- poration.42 Organizations face significant risks and threats from financial

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misconduct. There is a need to identify potential risks that relate to mis- conduct that could devastate the organization. If risks and misconduct are discovered and disclosed, they are more likely to be resolved before they become front page news.

Risk is always present within organizations, so executives must develop processes for remedying or managing its effects. A board of directors will expect the top management team to have risk management skills and plans in place. There are at least three ways to consider how risk poses either a potentially negative or positive concern for organi- zations.43 First, risk can be categorized as a hazard. In this view, risk management is focused on minimizing negative situations, such as fraud, injury, or financial loss. Second, risk may be considered an uncertainty that needs to be hedged through quantitative plans and models. This type of risk is best associated with the term risk management, which is used in financial and business literature. Third, risk also creates the opportunity for innovation and entrepreneurship. Just as management can be criti- cized for taking too much risk, it can also be subject to concerns about not taking enough risk. All three types of risk are implicitly covered by our definition of corporate governance because there are risks for both control (i.e., preventing fraud and ensuring accuracy of financial state- ments) and accountability (i.e., innovation to develop new products and markets). For example, the internet and electronic commerce capabilities have introduced new risks of all types for organizations. Privacy, as we discuss in Chapter 10, is a major concern for many stakeholders and has created the need for policies and certification procedures. A board of directors may ensure that the company has established privacy poli- cies that are not only effective but can also be properly monitored and improved as new technology risks and opportunities emerge in the busi- ness environment.44

Executive Compensation Executive compensation has been a topic rife with controversy. In the midst of government bailouts of corporations and financial institutions and loss of jobs and life savings, top executives continued to receive incredibly high bonuses. This brought attention to the manner in which executives are paid, which had largely been left uninvestigated until this point. The Dodd-Frank Act included measures to rein in overcompensation including a “say-on-pay” mandate requiring shareholders to vote on their compa- ny’s compensation policies, and “compensation committee independence” requiring board members in charge of determining compensation to be independent from the company’s management. Other mandates, which have been proposed by the SEC, but are not yet approved, include requir- ing companies to disclose the ratio between CEO and employee pay, the disclosure of pay as it relates to performance, the process of recovering of compensation that was wrongly awarded, and disclosure of any hedging activities conducted by directors or employees.45

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Executive compensation is such an important matter that many boards spend more time deciding how much to compensate top executives than they do perhaps in ensuring the integrity of the company’s financial report- ing systems. Because of the large government bailouts during the last reces- sion, many people became enraged because they felt that the government was sponsoring corporate excess with taxpayer money. This was a major contributor to the Occupy Wall Street protests of 2011. Even many boards of directors—which are responsible for setting executive pay—feel that the United States has a problem in that executive pay is not in line with perfor- mance or demonstration of stewardship to the company.46 According to the AFL-CIO, average executive pay is $13.5 million, which is 373 times the pay of the average U.S. worker.47

An increasing number of corporate boards are imposing performance targets on the stock and stock options they include in their CEOs’ pay package. The SEC proposed that companies disclose how they compen- sate lower-ranking employees as well as top executives. This was part of a review of executive pay policies that addresses the belief that many financial corporations have historically taken on too much risk. The SEC believes that compensation may be linked to excessive risk-taking.48 Another issue is whether performance-linked compensation encourages executives to focus on short-term performance at the expense of long-term growth.49 Shareholders today, however, may be growing more concerned about transparency than short-term performance and executive compensation.

Some people argue that executives deserve the rewards that follow from strong company performance, because they assume so much risk on behalf of the company. In addition, many executives’ personal and professional lives meld to the point that they are “on call” 24 hours a day. Because not everyone has the skill, experience, and desire to become an executive, with the accompanying pressure and responsibility, market forces dictate a high level of compensation. When the pool of qualified individuals is limited, many corporate board members feel that offer- ing large compensation packages is the only way to attract and retain top executives and thereby ensure that their firms are not left without strong leadership. In an era when top executives are increasingly willing to “jump ship” to other firms that offer higher pay, potentially lucrative stock options, bonuses, and other benefits, such thinking is not without merit.50

Executive compensation is a difficult but important issue for boards of directors and other stakeholders to consider because it receives much atten- tion in the media, sparks shareholder concern, and is hotly debated in dis- cussions of corporate governance. One area for board members to consider is the extent to which executive compensation is linked to company per- formance. Corporate plans that base compensation on the achievement of several performance goals, including profits and revenues, are intended to align the interests of owners with management. For example, General Electric CEO Jeff Immelt missed his five-year performance target and lost out on a stock award that was valued at more than $3 million.51

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Table 3.8 shows CEO compensation at some of the world’s largest companies. While still hundreds of times higher than what the average worker makes, overall CEOs’ compensation is decreasing, indicating a possible change in the way executives are compensated. On the other hand, critics still believe there is a mismatch between the compensa- tion of Wall Street CEOs and performance. In 2015 Wall Street CEOs saw their pay rise about 10 percent even though shares of major banks fell.52

CORPORATE GOVERNANCE AROUND THE WORLD Increased globalization, enhanced electronic communications, economic agreements and zones, and the reduction of trade barriers have created opportunities for firms around the world to conduct business with both international consumers and industrial partners. These factors propel the need for greater homogenization in corporate governance principles. Standard & Poor’s has a service called Corporate Governance Scores, which analyzes four macro-forces that affect the general governance climate of a country, including legal infrastructure, regulation, information infrastructure, and market infrastructure. On the basis of these factors, a country can be categorized as having strong, moderate, or weak support for effective governance practices at the company level. Institutional inves- tors are very interested in this measure, as it helps determine possible risk.53 As financial, human, and intellectual capital cross borders, a num- ber of business, social, and cultural concerns arise. Institutional investors in companies based in emerging markets claim to be willing to pay more

TABLE 3.8 Examples of Chief Executive Officer Compensation

Executive Company Pay ($millions) Dara Khosrowshahi Expedia 94.6

Robert Iger Walt Disney 43.5

AT&T Randall L. Stephenson 22.6

James Gorman Morgan Stanley 22.1

Kenneth I. Chenault American Express 21.7

Virginia Rometty IBM 19.8

Meg Whitman Hewlett-Packard 17.1

Muhtar Kent Coca-Cola 14.6

Jeff Bezos Amazon 1.7

Larry Page Alphabet 1

Source: Equilar Inc., “Equilar/Associated Press S&P 500 CEO Pay Study 2016,” Equilar, 2016, http:// www.equilar.com/reports/37-2-associated-press-pay-study-2016.html (accessed June 17, 2016).

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for shares in companies that are well governed. Global shareholders also would like companies in their countries to disclose more financial data, to adopt CEO pay plans that reward only strong performance, and to use independent boards with no ties to management.

In response to this business climate, the Organisation for Economic Co-operation and Development (OECD), a forum for governments to discuss, develop, and enhance economic and social policy, issued a set of principles intended to serve as a global model for corporate gover- nance.54 After years of discussion and debate among institutional inves- tors, business executives, government representatives, trade unions, and nongovernmental organizations, 30 OECD member governments signaled their agreement with the principles by signing a declaration to integrate them within their countries’ economic systems and institutions. The purpose of the OECD Corporate Governance Principles (see Table 3.9) is to formulate minimum standards of fairness, transparency, account- ability, disclosure, and responsibility for business practice. The principles

TABLE 3.9 OECD Principles of Corporate Governance

Principle Explanation 1. Ensuring the basis for an effective corporate governance framework

The corporate governance framework should promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibil- ities among different supervisory, regulatory and enforce- ment authorities.

2. The rights of shareholders and key ownership functions

The corporate governance framework should protect and facilitate the exercise of shareholders’ rights.

3. The equitable treatment of shareholders

The corporate governance framework should ensure the equitable treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.

4. The role of stakeholders in corporate governance

The corporate governance framework should recognize the rights of stakeholders as established by law and encourage active cooperation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.

5. Disclosure and transparency The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company.

6. The responsibilities of the board

The corporate governance framework should ensure the strategic guidance of the company, the effective moni- toring of management by the board, and the board’s accountability to the company and the shareholders.

Source: ComplianceOnline.com, “OECD Principles of Corporate Governance,” 2014, http://www. complianceonline.com/dictionary/OECD_Principles_of_Corporate_Governance.html (accessed June 17, 2016).

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focus on the board of directors, which the OECD says should recognize the impact of governance on the firm’s competitiveness. In addition, the OECD charges boards, executives, and corporations with maximizing shareholder value while responding to the demands and expectations of their key stakeholders.

The OECD Corporate Governance Principles cover many specific best practices, including (1) (ensuring) the basis for an effective corporate governance framework; (2) rights of shareholders to vote and influence corporate strategy; (3) greater numbers of skilled, independent members on boards of directors; (4) fewer techniques to protect failing management and strategy; (5) wider use of international accounting standards; and (6) better disclosure of executive pay and remuneration. Although member governments of the OECD are expected to uphold the governance prin- ciples, there is some room for cultural adaptation.

Best practices may vary slightly from country to country because of unique factors such as market structure, government control, role of banks and lending institutions, labor unions, and other economic, legal, and historical factors. Both industry groups and government regulators moved quickly in the United Kingdom after the Enron crisis. Because some British bankers were indicted in the scandal, corporate governance concerns increased. Several British reforms resulted, including annual shareholders’ votes on board compensation policies and greater supervision of invest- ment analysts and the accounting profession.

Corporate governance, or lack of it, was one of the reasons for the financial crisis that occurred in Southeast Asia in the late 1990s. For example, the government structure of some Asian countries created greater opportunities for corruption and nepotism. Banks were encouraged to extend credit to companies favored by the government. In many cases, these companies were in the export business, which created an imbalance in financing for other types of businesses. The concentration of business power within a few families and tycoons reduced overall competitiveness and transparency. Many of these businesses were more focused on size and expanded operations than profitability. Foreign investors recognized the weakening economies and pulled their money out of investments. India has experienced a decrease in foreign investment for this reason. Despite the government’s maneuvers to improve the economy, by easing restrictions on joint ventures in certain sectors, foreign firms decided against investing as this was not enough incentive in light of the nation’s weakening currency.55

FUTURE OF CORPORATE GOVERNANCE As the issues discussed in the previous section demonstrate, corporate gover- nance is primarily focused on strategic-level concerns for accountability and control. Although many discussions of corporate governance still revolve around responsibility in investor-owned companies, good governance is fundamental to effective performance in all types of organizations. As you

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have gleaned from history and government classes, a system of checks and balances is important for ensuring a focus on multiple perspectives and con- stituencies; proper distribution of resources, power, and decision authority; and the responsibility for making changes and setting direction.

To pursue social responsibility successfully, organizations must con- sider issues of control and accountability. As we learned earlier, the con- cept of corporate governance is in transition from the shareholder model to one that considers broader stakeholder concerns and inputs to financial performance. A number of market and environmental forces, such as the OECD and shareholder activism, have created pressures in this direction. This evolution is consistent with our view of social responsibility. Although some critics deride this expanded focus, a number of external and internal forces are driving business toward the stakeholder orientation and the for- malization of governance mechanisms. One concern centers on the cost of governance. Companies like Nike have had problems in the past and have implemented strong ethics and compliance systems. However, many of the largest firms on Wall Street, which were overleveraged and did not have strong ethics and compliance programs in place, either failed or had to be bailed out to prevent failure.56

Most businesspeople and academicians agree that the benefits of a strong approach to corporate governance outweigh its costs. However, the positive return on governance goes beyond organizational performance to benefit the industrial competitiveness of entire nations, something which was discussed in Chapter 1. For example, corrupt organizations often fail to develop competitiveness on a global scale and can leave behind finan- cial ruin, thus negating the overall economic growth of the entire region or nation. At the same time, corrupt governments usually have difficulty sustaining and supporting the types of organizations that can succeed in global markets. Thus, a lack of good governance can lead to insular and selfish motives because there is no effective system of checks and balances. In today’s interactive and interdependent business environment, most orga- nizations are learning the benefits of a more cooperative approach to com- merce. It is possible for a company to retain its competitive nature while seeking a “win-win” solution for all parties to the exchange.57 Furthermore, as nations with large economies embrace responsible governance principles, it becomes even more difficult for nations and organizations that do not abide by such principles to compete in these lucrative and rich markets. There is a contagion effect toward corporate governance among members of the global economy, much like peer pressure influences the actions and decisions of individuals. Portugal is a good example of this effect.

Because governance is concerned with the decisions made by boards of directors and executives, it has the potential for far-reaching positive—and negative—effects. A recent study by the OECD found that stronger finan- cial performance is the result of several governance factors and practices, including (1) large institutional shareholders that are active monitors of company decisions and boards, (2) owner-controlled firms, (3) fewer mergers, especially between firms with disparate corporate values and

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business lines, and (4) shareholders’, not board of directors’, decisions on executive remuneration.58 The authors of the study note that these practices may not hold true for a strong performance in all countries and economic systems. However, they also point out that a consensus view is emerging, with fewer differences among OECD countries than among all other nations. Similarities in organizational-level accountability and con- trol should lead to smoother operations between different companies and countries, thereby bolstering competitiveness on many levels.

The future of corporate governance is directly linked to the future of social responsibility. Because governance is the control and accountability process for achieving social responsibility, it is important to consider who should be involved in the future. First and most obviously, business lead- ers and managers will need to embrace governance as an essential part of effective performance. Some of the elements of corporate governance, particularly executive pay, board composition, and shareholder rights, are likely to stir debates for many years. However, business leaders must rec- ognize the forces that have brought governance to the forefront as a pre- condition of management responsibility. Thus, they may need to accept the “creative tension” that exists among managers, owners, and other primary stakeholders as the preferable route to mutual success.59

Second, governments have a key role to play in corporate governance. National competitiveness depends on the strength of various institu- tions, with primacy on the effective performance of business and capital markets. Strong corporate governance is essential to this performance, and thus, governments will need to be actively engaged in affording both protection and accountability for corporate power and decisions. Just like the corporate crises in the United States, the Asian economic crisis discussed earlier prompted companies and governments around the world to consider tighter governance procedures. Finally, other stakeholders may become more willing to use governance mechanisms to influence corporate strategy or decision-making. Investors—whether shareholders, employees, or business partners—have a stake in decisions and should be willing to take steps to align various interests for long-term benefits. There are many investors and stakeholders willing to exert great influence on underper- forming companies.

Until recently, governance was one area in the business literature that had not received the same level of attention as other issues, such as environmental impact, diversity, and sexual harassment. Over the next few years, however, corporate governance will emerge as the operational centerpiece to the social responsibility effort. The future will require that business leaders have a different set of skills and attitudes, including the ability to balance multiple interests, handle ambiguity, manage complex systems and networks, create trust among stakeholders, and improve pro- cesses so that leadership is pervasive throughout the organization.60

In the past, the primary emphasis of governance systems and theory was on the conflict of interests between management and investors.61 Governance today holds people at the highest organizational levels

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accountable and responsible to a broad and diverse set of stakeholders. Although top managers and boards of directors have always assumed responsibility, their actions are now subject to greater accountability and transparency. A Wall Street Journal writer put the shift succinctly, indi- cating, “Boards of directors have been put on notice.” A key issue going forward will be the board’s ability to align corporate decisions with vari- ous stakeholder interests.62 Robert Monks, the activist money manager and leader in corporate governance issues, wrote that effective corporate governance requires understanding that the “indispensable link between the corporate constituents is the creation of a credible structure (with incentives and disincentives) that enables people with overlapping but not entirely congruent interests to have a sufficient level of confidence in each other and the viability of the enterprise as a whole.”63 We will take a closer look at some of these constituents and their concerns in the next few chapters.

SUMMARY To respond to stakeholder pressures for companies to be more accountable for organizational decisions and policies, organizations must implement policies that provide strategic guidance on appropriate courses of action. Such policies are often known as corporate governance, the formal system of accountability and control for organizational decisions and resources. Accountability relates to how well the content of workplace decisions is aligned with the firm’s stated strategic direction, whereas control involves the process of auditing and improving organizational decisions and actions.

Both directors and officers of corporations are fiduciaries for the shareholders. Fiduciaries are persons placed in positions of trust who are loyal and take due care in acting on behalf of the best interests of the organization. There is a duty of care, also called a duty of diligence, to make informed and prudent decisions. As directors, they too have a duty to avoid ethical misconduct and to provide leadership in decisions to prevent ethical misconduct in the organization. Directors are not held responsible for negative outcomes if they are informed and diligent in their decision-making. The duty of loyalty means that all decisions should be in the interests of the corporation and its stakeholders. Conflicts of interest exist when a director uses the position to obtain personal gain, usually at the expense of the organization.

There are two major conceptualizations of corporate governance. The shareholder model of corporate governance focuses on developing and improving the formal system of performance accountability between the top management and the firm’s shareholders. The stakeholder model of corporate governance views the purpose of business in a broader fashion in which the organization not only has a responsibility for economic suc- cess and viability but also must answer to other stakeholders. The share- holder model focuses on a primary stakeholder—the investor—whereas

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the stakeholder model incorporates a broader philosophy that focuses on internal and external constituents.

Governance is the organizing dimension that keeps a firm focused on continuous improvement, accountability, and engagement with stake- holders. Although financial return, or economic viability, is an important measure of success for all firms, the legal dimension of social responsibility is also a compulsory consideration. The ethical and philanthropic dimen- sions, however, have not been traditionally mandated through regulation or contracts. This represents a critical divide in our social responsibility model and associated governance goals and systems because there are some critics who challenge the use of organizational resources for concerns beyond financial performance and legalities.

In the late 1800s and early 1900s, corporate governance was not a major issue because company owners made strategic decisions about their businesses. By the 1930s, ownership was dispersed across many indi- viduals, raising questions about control and accountability. In response to shareholder activism, the Securities and Exchange Commission required corporations to allow shareholder resolutions to be brought to a vote of all shareholders. Since the mid-1900s, the approach to corporate governance has involved a legal discussion of principals (owners) and agents (manag- ers) in the business relationship. The lack of effective control and account- ability mechanisms in years past has prompted a current trend toward boards of directors playing a greater role in strategy formulation than they did in the early 1990s. The board of directors assumes legal responsibility and a fiduciary duty for organizational resources and decisions. Boards today are concerned primarily with monitoring the decisions made by managers on behalf of the company. The trend today is toward boards composed of external directors who have little vested interest in the firm. Shareholder activism is helping to propel this trend, as they seek better representation from boards that are less likely to have conflicts of interest.

Another significant governance issue is internal control and risk man- agement. Controls allow for comparisons between actual performance and the planned performance and goals of the organization. They are used to safeguard corporate assets and resources, protect the reliability of organi- zational information, and ensure compliance with regulations, laws, and contracts. Controls foster understanding when discrepancies exist between corporate expectations and stakeholder interests and issues. A strong inter- nal control system should alert decision-makers to possible problems or risks that may threaten business operations. Risk can be categorized (1) as a hazard, in which case risk management focuses on minimizing negative situations, such as fraud, injury, or financial loss; (2) as an uncertainty that needs to be hedged through quantitative plans and models; or (3) as an opportunity for innovation and entrepreneurship.

How executives are compensated for their leadership, service, and performance is another governance issue. Many people believe the ratio between the highest paid executives and median employee wages in the company should be reasonable. Others argue that because executives

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assume so much risk on behalf of the organization, they deserve the rewards that follow from strong company performance. One area for board members to consider is the extent to which executive compensation is linked to company performance.

The Organisation for Economic Co-operation and Development has issued a set of principles from which to formulate minimum standards of fairness, transparency, accountability, disclosure, and responsibility for business practice. These principles help guide companies around the world and are part of the convergence that is occurring with respect to corporate governance.

Most businesspeople and academicians agree that the benefits of a strong approach to corporate governance outweigh its costs. Because governance is concerned with the decisions taken by boards of directors and executives, it has the potential for far-reaching positive, and nega- tive, effects. The future of corporate governance is directly linked to the future of social responsibility. Business leaders and managers will need to embrace governance as an essential part of effective performance. Governments also have a role to play in corporate governance. National competitiveness depends on the strength of various institutions, with pri- macy on the effective performance of business and capital markets. Other stakeholders may become more willing to use governance mechanisms to affect corporate strategy or decision-making.

Responsible Business Debate

Issue: Should pharmacies sell harmful products?

CVS is discontinuing sales of cigarettes and other tobac- co products. In a risky move that cost it $2 billion, CVS claimed that selling cigarettes was incompatible with its intention to position itself as a healthcare provider. By the end of 2014, it was estimated that the num- ber of insured Americans increased by 11–13 million. Pharmacies are competing with one another to capture a share of this growing market, and they are attempt- ing to move away from their position as drugstores toward becoming healthcare providers.

CVS believes that the move, although costly in the short-term, will provide it with a long-term advantage. It has partnered with about two dozen health systems in its quest toward gaining leadership in healthcare

services. CVS believes discontinuing sales of its tobacco products will increase its standing with its healthcare partners, providing it with a competitive advantage over rival pharmacies that continue to sell cigarettes.

This creates an ethical dilemma for CVS’s rivals. Walgreen’s has argued that selling cigarettes is neces- sary for remaining competitive. Rite Aid has stated it will continue selling cigarettes based on the demands of its customers. Both firms offer smoking-cessation products and clinics.

From a stakeholder orientation, this issue can be examined a variety of ways. Those that believe Walgreen’s, Rite Aid, and other pharmacies should fol- low CVS’s lead feel that it is the most ethical response if they want to position themselves as health services com- panies since it is hypocritical to offer customers access

Corporate Governance at CVS

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to harmful products while promoting that they care about consumer health. Possible advantages also exist for pharmacies choosing to discontinue tobacco-related product sales. For instance, it is possible that healthcare partners will be more inclined to do business with CVS over other pharmacies who continue to sell cigarettes.

On the other hand, there are potential downsides for companies that follow CVS’s lead. One of the most obvious would be loss of profits. CVS acknowledges that it will lose revenue from cigarette sales, and other com- panies too would face similar losses should they choose to discontinue tobacco products. In fact, CVS’s stock went down after the announcement that it was eliminating cig- arette sales. Conversely, the stock of Walgreen’s and Rite Aid increased. This shows that investors believe selling

cigarettes is more beneficial financially in the short-term. From a stakeholder perspective, it is necessary to consider the needs of investors as well as customers because the firm also has a duty to work toward profitability. Finally, tobacco products might be harmful, but they are not ille- gal. While many customers might applaud CVS for taking a stand, cigarette smokers lose out.

There Are Two Sides to Every Issue: 1. Major pharmacies should stop selling cigarettes

because they are harmful products that are not con- sistent with their healthcare focus.

2. Major pharmacies should not stop selling cigarettes because they are legal, highly profitable for the company, and offer consumers choice.

DISCUSSION QUESTIONS

Sources: Marilyn Alva, “Walgreen, Rite Aid Rise as CVS Falls on Tobacco Ban,” Investors.com, http://news.investors.com/business/020514- 688934-walgreen-and-rite-aid-rise-as-cvs-falls.htm (accessed July 12, 2016); Aaron Blake, “Obama praises CVS’s Decision to Stop Selling Cigarettes,” The Washington Post, February 5, 2014, https://www.washingtonpost.com/news/post-politics/wp/2014/02/05/obama-praises- cvss-decision-to-stop-selling-cigarettes/ (accessed July 12, 2016); Peter Frost, “CVS Cigarette Move urges Action by Walgreens, Rivals,” Chicago Tribune, February 5, 2014, http://articles.chicagotribune.com/2014-02-05/business/chi-walgreen-cigarettes-20140205_1_tobacco- sales-cvs-caremark-walgreen-co (accessed July 12, 2016); Timothy W. Martin and Mike Esterl, “CVS to Stop Selling Cigarettes,” The Wall Street Journal, February 5, 2014, http://online.wsj.com/news/articles/SB10001424052702304851104579363520905849600 (accessed July 12, 2016); Staff, “Rite Aid Gives Generic Response to Decision by CVS to Stop Selling Cigarettes,” MEDCity News, February 6, 2014, http:// medcitynews.com/2014/02/rite-aid-gives-generic-response-decision-cvs-stop-selling-cigarettes/ (accessed February 6, 2014).

KEY TERMS

corporate governance (p. 77) shareholder model of corporate

governance (p. 84)

stakeholder model of corporate governance (p. 85)

1. What is corporate governance? Why is it an important concern for companies pursuing the social responsibility approach? How does it improve or change the nature of executive and managerial decision-making?

2. Compare the shareholder and stakeholder models of corporate governance. Which one seems to pre- dominate today? What implications does this have for businesses in today’s complex environment?

3. What role does executive compensation play in risk taking and accountability? Why do some people partially blame compensation for the

failures of the subprime mortgage and financial industries in 2008–2009?

4. What is the role of the board of directors in cor- porate governance? What responsibilities does the board have?

5. What role do shareholders and other investors play in corporate governance? How can investors effect change?

6. Why are internal control and risk management important in corporate governance? Describe three approaches organizations may take to man- age risk.

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EXPERIENTIAL EXERCISE Visit the website of the Organisation for Economic Co-operation and Development (http://www.oecd.org). Examine the origins of the organization and its unique role in the global economy. After visiting the site, answer the following questions:

1. What are the primary reasons that OECD exists? 2. How would you describe OECD’s current areas

of concern and focus?

3. What role do you think OECD will play in the future with respect to corporate governance and related issues?

CORE-TEX CREATES A VORTEX AROUND AGGRESSIVE ACCOUNTING: WHAT WOULD YOU DO? The statewide news carried a story about Core-Tex that evening. There were rumors swirling that one of the largest manufacturers in the state was facing seri- ous questions about its social responsibility. A former accountant for Core-Tex, whose identity was not revealed, made allegations about aggressive accounting methods and practices that overstated company earn- ings. He said he left Core-Tex after his supervisor and colleagues did not take his concerns seriously. The for- mer accountant hinted that the company’s relationship with its external auditor was quite close, since Core- Tex’s new CFO had once been on the external auditing team. Core-Tex had recently laid off 270 employees—a move that was not unexpected given the turbulent financial times. However, the layoffs hit some parts of the site’s community pretty hard. Finally, inspectors from the state environmental protection agency had just issued a series of citations to Core-Tex for improper disposal methods and high emissions at one of its larger manufacturing plants. A television station had run an exposé on the environmental citations a week ago.

CEO Kelly Buscio clicked off the television set and thought about the company’s next steps. Core-Tex’s attorney had cautioned the executive group earlier that

week about communicating too much to the media and other constituents. The firm’s vice president for marketing countered the attorney by insisting that Core-Tex needed to stay ahead of the rumors and assumptions that were being made about the company. He said that suppliers and business partners were starting to question Core-Tex’s financial viability. The vice president of information technology and the vice president of operations were undecided on the next step, while the vice president of manufacturing had not attended the meeting. Buscio wondered what tomor- row could bring.

To her surprise, the newspapers had gone easy on Core-Tex the next day, owing to a shift in the media attention on a major oil spill, the retirement of a Fortune 500 CEO, and a major league baseball championship game the night before. The company’s stock price, which averaged around $11.15, was down $0.35 by midmorning. The vice-president of marketing suggested that employees needed to hear from the CEO and be reassured about Core-Tex’s strong future. Her first call after lunch came from a member of the board asking Buscio what the board could do to help the situation. What would you do?

7. Why is the issue of executive compensation controversial? Are today’s corporate executives worth the compensation packages they receive?

8. In what ways are corporate governance practices becoming standardized around the world? What differences exist?

9. As corporate governance becomes a significant aspect of social responsibility, what new skills and characteristics will managers and executives need to possess? Consider how pressures for gov- ernance require managers and executives to relate and interact with stakeholders in new ways.

?

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CHAPTER FOUR

Legal, Regulatory, and Political Issues

Chapter Objectives

●● To understand the rationale for government regulation of business

●● To examine the key legislation that structures the legal environment for business

●● To analyze the role of regulatory agencies in the enforcement of public policy

●● To compare the costs and benefits of regulation

●● To examine how business participates in and influences public policy

●● To describe the government’s approach for legal and ethical compliance

Chapter Outline

Government’s Influence on Business

The Contemporary Political Environment

The Government’s Strategic Approach for Legal and Ethical Compliance

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111

In the technology industry, protecting one’s intellectual property through patents is crucial to the survival of a company. A patent gives an organization such as Microsoft a temporary monopoly over a new technol- ogy. Patents are intended to reward firms for the risks they take in developing new products. They not only allow the firms to recoup their investment but also give them the chance to earn a significant profit. This prompts technology firms to constantly innovate and stay ahead of the competition by patenting new items.

Companies will often file lawsuits seeking dam- ages from those they believe violated their intellectual property rights. One well-publicized case occurred between two titans of the cell phone industry, Apple and Samsung. After Apple introduced its iconic iPhone, Samsung came out with its own smartphone called Galaxy S. Apple filed a lawsuit against Samsung, accus- ing it of violating its iPhone patent by copying many components of the iPhone, including the rectangular shape; the black color of the phone; the tap to zoom, the flip to rotate, the slide to scroll features; and so on. It also claimed that Samsung copied features of its iPad product.

Samsung countersued, claiming that many of these components had already been patented by Samsung; thus, Samsung—and not Apple—held the intellectual property rights. The lawsuit soon snow- balled, with suits being filed in the United States, South Korea, Germany, Japan, and other areas. Many of these countries came to different conclusions. For instance, the United States found Samsung guilty of intellectual

property violations and ordered Samsung to pay Apple $1 billion in damages (this was later reduced). However, South Korea determined that Apple violated two of Samsung’s patents, while Samsung violated one of Apple’s. The United Kingdom ruled in favor of Samsung, while Germany banned sales of the Galaxy Tab 2.0 because of its similarities to Apple’s iPad 2.

The different court rulings demonstrate the com- plexities of international regulations. The ethical and legal standards of intellectual property vary from coun- try to country, making it difficult for firms to protect their intellectual property. Samsung appealed the rul- ing in the United States. In 2012, Apple filed another lawsuit against Samsung in the United States alleging that it had violated another five of its patents. The United States ordered Samsung to pay Apple $119.6 million. Apple requested that Samsung be banned from sales in the United States, but this was not granted, and legal experts say a direct ban is unlikely.

With so many different verdicts, it can be hard to determine which, if any, of the companies is at fault. Samsung has encountered price-fixing allegations in the past and has been accused by more than one com- petitor of copying its technology. However, Apple has also been involved in lawsuits. Apple recently paid to settle a lawsuit that it engaged in no-hiring agreements with competitors in the tech industry. Both companies have had to deal with past issues of legal misconduct. Whoever is at fault, the current ruling on intellectual property will have a major impact on the technology industry as a whole.1

Apple vs Samsung: Which Came First…the Chicken or the Egg?

Opening Vignette

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112 Business and Society

The government has the power through laws and regulations to struc-ture how businesses and individuals achieve their goals. The purpose of regulating firms is to create a fair competitive environment for businesses, consumers, and society. All stakeholders need to demonstrate a commitment to social responsibility through compliance with relevant laws and proactive consideration of social needs. The law is one of the most important business subjects in terms of its effect on organizational practices and activities. Thus, compliance with the law is a fundamental expectation of social responsibility. Because the law is based on principles, norms, and values found within society, the law is the foundation of responsible decision-making.

This chapter explores the complex relationship between business and government. First, we discuss some of the laws that structure the environ- ment for the regulation of business. Major legislation relating to compe- tition and regulatory agencies is reviewed to provide an overview of the regulatory environment. We also consider how businesses can participate in the public policy process through lobbying, political contributions, and political action committees. Finally, we offer a framework for a strategic approach to managing the legal and regulatory environment.

GOVERNMENT’S INFLUENCE ON BUSINESS The government has a profound influence on business. Most Western countries have a history of elected representatives working through demo- cratic institutions to provide the structure for the regulation of business conduct. For example, one of the differences that have long characterized the two major parties of the U.S. political system involves the govern- ment’s role with respect to business. In general terms, the Republican Party tends to favor smaller central government with less regulation of business, while the Democratic Party is more open to government oversight, fed- eral aid program, and sometimes higher taxes. From the start, President Obama worried some businesspeople, as he has promised more oversight of many different areas of the economy. For example, he promised to be tough on antitrust violations and has followed through by reversing a Bush-era policy that made it more difficult for the government to pursue antitrust violations.2

President Obama has brought U.S. policy regarding antitrust cases more in line with Europe’s model.3 Third-party and independent candi- dates typically focus on specific business issues or proclaim their distance from the two major political parties. However, the power and freedom of big business have resulted in conflicts among private businesses, govern- ment, private interest groups, and even individuals as businesses try to influence policy makers.

In the United States, the role that society delegates to government is to provide laws that are logically deduced from the Constitution and the Bill of Rights and to enforce these laws through the judicial system. Individuals

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and businesses, therefore, live under a rule of law designed to protect society and support an acceptable quality of life. Ideally, by limiting the influence and force by some parties, the overall welfare and freedom of all participants in the social system will be protected.

The provision of a court system to settle disputes and punish crimi- nals, both organizational and individual, provides for justice and order in society. Both Google (renamed Alphabet) and Microsoft have come under numerous ongoing investigations for alleged antitrust activity in Europe, where the companies have been accused of engaging in behavior that prevents smaller companies from competing. In just over a year, the EU’s antitrust regulator filed four charges against Alphabet that, among other allegations, Google favors its search functions more than rival sites, it restricts how a website can show advertisements from other companies, and it forces smartphone makers into pre-installing its search engine as the default on mobile devices.4 The European Union is famous for being tough on companies suspected of antitrust cases, igniting the ire of many multinational corporations that feel as if they are being punished for being successful. Being aware of antitrust laws is important for all large corporations around the world, because judicial systems can punish businesses that fail to comply with laws and regula- tory requirements.

The legal system is not always accepted in some countries as insur- ance that business will be conducted in a legitimate way. For example, after generations of being known for its top-secret bank accounts, Swiss banks were ordered by the United States Internal Revenue Service to dis- close information about some of their clients because of concerns over illegal activities. In many places around the world, the business climate has become less tolerant of illegal and immoral actions, and countries like Switzerland, Liechtenstein, and Luxembourg now are being pressured to share information on potential tax dodgers with government agencies like the IRS. Credit Suisse pleaded guilty to aiding wealthy Americans in tax evasion and was ordered to give the Justice Department all records concerning American clients and was charged a fine of $2.6 billion for criminal misconduct.5 This case illustrates the complexity of complying with international business laws.

While many businesses may object to regulations aimed at maintain- ing ethical cultures and preserving stakeholder welfare, businesses’ very existence is based on laws permitting their creation, organization, and dissolution. From a social perspective, it is significant that a corporation has the same legal status as a “person” who can sue, be sued, and be held liable for debts. Laws may protect managers and stockholders from being personally liable for a company’s debts, but individuals as well as organi- zations are still responsible for their conduct. Because corporations have a perpetual life, larger companies like ExxonMobil, Ford, and Sony take on an organizational culture, including social responsibility values, that extends beyond a specific time period, management team, or geographi- cal region. Organizational culture plays an important role in the ability of

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114 Business and Society

corporations to outlive individual executives—it sets the tone for the busi- ness and allows for continuity even during times of leadership turnover.

Most, generally smaller, companies are owned by individual propri- etors or operated as partnerships. However, large incorporated firms like those just mentioned often receive more attention because of their size, visibility, and impact on so many aspects of the economy and society. In a pluralistic society, diverse stakeholder groups such as business, labor, consumers, environmentalists, privacy advocates, and others attempt to influence public officials who legislate, interpret laws, and regulate busi- ness. The public interest is served through open participation and debate that result in effective public policy. Because no system of government is perfect, legal and regulatory systems are constantly evolving and changing in response to changes in the business environment and social institutions. For example, increasing use of the internet for information and business created a need for legislation and regulations to protect the owners of creative materials from unauthorized use and consumers from fraud and invasions of privacy. The line between acceptable and illegal activity on the internet is increasingly difficult to discern and is often determined by judges and juries and discussed widely in the media.

In response, the Better Business Bureau (BBB), a self-regulatory asso- ciation supported by businesses, offers an Online Accredited Business certification to retailers, which certifies their high ethical standards and safety for online shoppers. The BBB lists the companies on its website and directs consumers to approved businesses’ websites.6 Over a million times a month, web users click on the BBBOnline seals to check a firm’s cred- ibility and high standards.7

Like the companies that have pursued and received the BBB accredi- tation, firms that adopt a strategic approach to the legal and regulatory system develop proactive organizational values and compliance programs that identify areas of risks and include formal communication, training, and continuous improvement of responses to the legal and regulatory environment.

In the next section, we take a closer look at why and how the govern- ment affects businesses through laws and regulation, the costs and benefits of regulation, and how regulation may affect companies doing business in foreign countries.

The Rationale for Regulation The United States was established as a capitalist system, but the prevailing capitalistic theory has changed over time. Adam Smith published his criti- cal economic ideas in The Theory of Moral Sentiments and Inquiry into the Nature and Causes of the Wealth of Nations during the late 1700s, which are still considered important today. Smith observed the supply and demand, contractual efficiency, and division of labor of various companies within England. Smith’s writings formed the basis of modern economics.

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Chapter 4  Legal, Regulatory, and Political Issues 115

Smith’s idea of laissez faire, or “the invisible hand,” is critical to capitalism in that it assumes the market, through its own inherent mechanisms, will keep commerce in equilibrium.

A second form of capitalism gained support at the beginning of the Great Depression. During the 1930s, John Maynard Keynes argued that the state could stimulate economic growth and improve stability in the private sector—through, for example, controlling interest rates, taxation and public projects.8

Keynes argued that government policies could be used to increase aggregate demand, thus increasing economic activity and reducing unem- ployment and deflation. He argued that the solution to depression was to stimulate the economy through some combination of a reduction in inter- est rates or government investment in infrastructure. President Franklin D. Roosevelt employed Keynesian economic theories to pull the United States out of the Great Depression.

The third and most recent form of capitalism was developed by Milton Friedman and represented a swing to the right on the political spec- trum. Friedman had lived through the Great Depression but rejected the Keynesian conclusion that the market sometimes needs some intervention in order to function most efficiently. Friedman instead believed in deregu- lation because he thought that the system could reach equilibrium without government intervention.9 Friedman’s ideas were the guiding principles for government policy making in the U.S., and increasingly throughout the world, starting in the second half of the twentieth century, especially dur- ing the presidencies of Ronald Reagan, George H.W. Bush, Bill Clinton, and George W. Bush. However, President Barack Obama’s policies moved back in the direction of Keynesian capitalism with higher taxes and more spending on healthcare, as well as other public projects related to stabiliz- ing the economy after the financial crisis.

Many communist countries too are adopting components of capi- talism. State capitalism occurs when the government runs commercial activity in a capitalist manner. In China, for instance, many of the largest for-profit firms are owned in some capacity by the government. Despite this ownership, the day-to-day workings of the companies operate in a capitalist manner. This gives them the ability to compete against global firms. Table 4.1 gives a brief overview of the different forms of capitalism.

Although the opinions of which form of capitalism is the better option has changed over time, the federal and state governments in the United States have always stepped in to enact legislation and create regulations to address particular issues and restrict the behavior of business in accor- dance with society’s wishes. Many of the issues used to justify business regulation can be categorized as economic or social.

Economic and Competitive Reasons for Regulation A great number of regulations have been passed by legislatures over the last 100 years in an effort “to level the playing field” on which businesses operate. When the

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United States became an independent nation in the eighteenth century, the business environment consisted of many small farms, manufacturers, and cottage industries operating on a primarily local scale. With the increas- ing industrialization of the United States after the Civil War, “captains of industry” like John D. Rockefeller (oil), Andrew Carnegie (railroads and steel), Andrew Mellon (aluminum), and J.P. Morgan (banking) began to consolidate their business holdings into large national trusts.

Trusts are organizations generally established to gain control of a product market or industry by eliminating competition. Such organiza- tions are often considered detrimental because, without serious competi- tion, they can potentially charge higher prices and provide lower quality products to consumers. Thus, as these firms grew in size and power, public distrust of them likewise grew because of often-legitimate concerns about unfair competition. This suspicion and the public’s desire to require these increasingly powerful companies to act responsibly spurred the first antitrust legislation. If trusts are successful in eliminating competition, a monopoly can result.

A monopoly occurs when just one business provides a good or service in a given market. Utility companies that supply electricity, natural gas, water, or cable television are recent examples of monopolies, but that is starting to change. The government tolerates these monopolies because the cost of supplying the good or providing the service is so great that few companies would be willing to invest in new markets without some protec- tion from competition. Monopolies may also be allowed by patent laws that grant the developer of a new technology a period of time (usually 20 years) during which no other firm can use the same technology without the patent holder’s consent. Patent protections are permitted to encourage businesses to engage in riskier research and development by allowing them time to recoup their research, development, and production expenses and to earn a reasonable profit.

trusts Organizations established to gain control of a product market or industry by elimi- nating competition.

monopoly A market type in which just one business provides a good or service in a given market.

TABLE 4.1 Forms of Capitalism

Type of Capitalism Description Example Adam Smith’s laissez faire

The market, through its own inherent mechanisms, will keep commerce in equilibrium

Popular in the United States during the nineteenth century

Keynesian capitalism Government policies could be used to stimulate growth

Popular in the United States after the Great Depression

Friedman capitalism Emphasizes deregulation and significantly less government intervention

Popular in the second half of the twentieth century

State capitalism Major organizations are owned by the government but run in a capitalist manner

China’s economic system

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Because trusts and monopolies lack serious competition, there are concerns that they may either exploit their market dominance to restrict their output and raise prices or lower quality to gain greater profits. This concern is the primary rationalization for their regulation by the government. Public utilities, for example, are regulated by state public utility commissions and, where they involve interstate commerce, are subject to federal regulation as well. In recent years, some of these industries have been deregulated with the idea that greater competi- tion will police the behavior of individual firms. However, in areas like utilities it is difficult to develop perfect competition because of the large sunk costs required. Oftentimes, deregulation has led to increased costs to stakeholders. For example, Maryland deregulated the state’s residen- tial energy market in the late 1990s, and when rate caps came off in 2004, residences were hit with skyrocketing utilities costs. The problem has been market prices—when petroleum costs are high, so are the costs to generate energy. In a deregulated privatized market, these costs are passed on to consumers. The governor has tried numerous tactics to relieve the burden, including a one-time handout, but stakeholders remain concerned.10

Related to the issue of regulation of trusts and monopolies is the soci- ety’s desire to restrict destructive or unfair competition. What is consid- ered unfair varies with the standard practice of the industry, the impact of specific conduct, and the individual case. When one company dominates a particular industry, it may engage in destructive competition or employ anticompetitive tactics. For example, it may slash prices in an effort to drive competitors out of the market and then raise prices later. It may con- spire with other competitors to set, or “fix,” prices so that each firm can ensure a certain level of profit. Other examples of unfair competitive trade practices are stealing trade secrets or obtaining confidential information from a competitor’s employees, trademark and copyright infringement, false advertising, and deceptive selling methods such as “bait and switch” and false representation of products.

Regulation is also intended to protect consumers from unethical business practices. For instance, the government has been scrutinizing large-scale increases in the price of pharmaceuticals. Although businesses generally have freedom to determine their pricing strategies, pharmaceuti- cals are a hot-button issue because of their impact on people’s health. The nation was outraged when Turing Pharmaceuticals raised the price of an old generic drug 5,000%. Even though most pharmaceutical firms do not implement such massive price increases, many are increasing their prices. There is some concern among drug makers that Congress might implement controls on the amount that pharmaceutical companies can raise the prices of their drugs.11

Social Reasons for Regulation Regulation may also occur when market- ing activities result in undesirable consequences for society. Many manu- facturing processes, for example, create air, water, or land pollution.

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Such consequences create uncounted “costs” in the form of contamina- tion of natural resources, illness, and so on that neither the manufacturer nor the consumer “pays” for directly, although consumers may end up paying for these costs nevertheless. Because few companies are willing to shoulder these costs voluntarily, regulation is necessary to ensure that all firms within an industry do their part to minimize damages and pay their fair share. Likewise, regulations have proven necessary to protect natural (e.g., forests, fishing grounds, and other habitats) and social resources (e.g., historical and architecturally or archeologically significant struc- tures). We will take a closer look at some of these environmental protec- tion regulations and related issues in Chapter 11 on sustainability.

Other regulations have come about in response to social demands for equality in the workplace, especially after the 1960s. Such laws and regulations require that companies ignore race, ethnicity, gender, religion, and disabilities in favor of qualifications that more accurately reflect an individual’s capacity for performing a particular job. Likewise, deaths and injuries because of employer negligence resulted in regula- tions designed to ensure that people can enjoy a safe working environ- ment. The airline industry has become a prime example of how tough economic times result in overworked, under-trained employees. Many pilots receive low compensation, poor health benefits, and are forced to work long hours—all factors that contribute to a weak and careless organizational culture. It is thought that the crash of a FlyDubai plane might have occurred partially due to overwork. Although there may have other factors involved, colleagues claim the pilot was going to leave the airline because of fatigue. Crew members have claimed acute fatigue is common in the industry.12

Still other regulations have resulted from special-interest group cru- sades for safer products. For example, Ralph Nader’s Unsafe at Any Speed, published in 1965, criticized the automobile industry as a whole, and General Motors specifically, for putting profit and style ahead of lives and safety. Nader’s consumer protection organization, popularly known as Nader’s Raiders, successfully campaigned for legislation that required automakers to provide safety belts, padded dashboards, stronger door latches, head restraints, shatterproof windshields, and collapsible steering columns in automobiles. As we will see in Chapter 8, consumer activists also helped secure passage of several other consumer protection laws, such as the Wholesome Meat Act of 1967, the Clean Water Act of 1972, and the Toxic Substance Act of 1976.

Issues arising from the increasing use of the internet have led to demands for new laws protecting consumers and business. Laws such as the Stop Online Piracy Act (SOPA) and the Protect Intellectual Property Act (PIPA) were proposed to prevent copyright infringement over the internet. Under these provisions companies could be penal- ized for posting pirated content over the internet. However, Google, Yahoo, and other internet companies protested the bills, saying that

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it gave the government too much power to shut down websites and infringe on freedom of speech.13 Wikipedia, Google, and other websites underwent a service blackout for an entire day to protest the bills. The proposed laws were defeated, much to the frustration of content provid- ers who hoped the bills would help protect their intellectual property. Intellectual property protection versus freedom of speech is a tricky balance that requires legislators to research solutions that respects both of these rights.

As we shall see in Chapter 10, the technology associated with the internet has generated a number of issues related to privacy, fraud, and copyrights. For instance, creators of copyrighted works such as movies, books, and music are calling for new laws and regulations to safeguard their ownership of these works. In response to these concerns, Congress enacted the Digital Millennium Copyright Act in 1998, which extended existing copyright laws to better protect “digital” recordings of music, movies, and the like. While other countries have implemented similar measures, copyright violations continue to plague many global indus- tries, which to some critics calls into question the effectiveness of legal action. A team of security specialists recommends technological, not legal, solutions as most effective in the fight against piracy and copyright infringement.14

Concerns about the collection and use of personal information, especially regarding children, resulted in the passage of the Children’s Online Privacy Protection Act of 2000 (COPPA). The Federal Trade Commission (FTC) enforces the act by levying fines against non-comply- ing website operators. For example, Singapore-based mobile advertising firm InMobi paid $950,000 in civil penalties for tracking the locations of hundreds of millions of consumers, many of them children, for the geo-targeting of ads.15

Internet safety among children is a major topic of concern. This is true for children of all ages. Studies have shown that approximately 50 percent of children between the ages of six and nine use social media, and over 90 percent of children under the age of two have accessible information online, including photos and other personal information. Many are urging parents to encourage their children to practice safe online behaviors such as using privacy restrictions and not posting information or photos that contain too much personal information.16

Another major concern is online fraud. According to the Internet Crime Complaint Center (IC3), online fraudsters are becoming more and more creative by making use of over 20 listed types of scams. These scams are designed to target all age groups and together contribute to the loss of nearly $200 million a year. While online fraud is a major concern, it is only a small portion of the entirety of online crimes com- mitted. It is estimated that there are 25 million fraudulent log-in attempts per month.17

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Ethical Responsibilities in Marketing

Ackman vs. Herbalife: It’s Multilevel War! Herbalife International is the third largest direct-selling company in the world, with independent contractors in 90 countries. Its product line consists of weight- management and nutrition products. Like many direct selling companies, Herbalife employs a multilevel mar- keting compensation system. Multilevel marketing is a compensation system wherein contractors earn income from their own sales of products as well as commissions from sales made by those they have recruited. However, sales are never forced, and independent contractors do not receive additional compensation unless their recruits make sales.

Multilevel marketing is a legal activity. However, pyramid schemes are illegal. These schemes occur when investors are promised large profits based primarily on recruiting others to join their program. The promise is not based on profits from any real investment or sale of goods. The reason why this scheme is illegal is because it is unsustainable—the scheme falls apart once new recruits dry up, and investors often lose their investments.

Because of the similarities between the two, many people mistake legal multilevel marketing with illegal pyramid schemes. China, in fact, has banned multilevel marketing in the belief that it too closely resembles a pyramid scheme. However, U.S. courts have determined multiple times that multilevel marketing is a legitimate way of doing business.

Like other direct selling companies, Herbalife has faced accusations of operating pyramid schemes. However, one of its biggest challenges occurred when a famous hedge fund manager tried to discredit the com- pany. In 2012, Herbalife was accused of being an elabo- rate pyramid scheme by hedge fund manager William Ackman. Ackman had bet $1 billion in a short sale off

Herbalife’s stock. Short selling occurs when an investor sells shares borrowed from a lender in the belief that the stock will decrease. If the stock decreases, the inves- tor profits.

Ackman’s accusations against Herbalife included the following: (1) the majority of contractors for Herbalife lose money, (2) Herbalife pays more for recruiting new contractors than selling actual products, and (3) only the top 1 percent of contractors earn most of the money. Herbalife defended its business model and pointed out that many people become contractors to get a 25 percent discount on their purchases. Often they are not trying to make money. Also, indepen- dent contractors who decide not to sell products have the option of returning merchandise to Herbalife. A respected Nielsen survey found that 7.9 million con- sumers, or 3.3 percent of the U.S. population, had purchased a Herbalife product in the last three months. This supports the fact that Herbalife uses a valid and successful business model, which is producing profits directly related to product sales.

Although Herbalife’s stock initially dropped due to the allegations, it has now recovered. Many have criticized Ackman, claiming that his short against the company created an incentive for him to try to dis- credit Herbalife. In 2014 the Federal Trade Commission claimed they were investigating Herbalife’s operations. It believed Herbalife was misrepresenting opportuni- ties as “get-rick-quick” schemes and did not have adequate disclosures. Herbalife disagreed with the FTC but paid $200 million to settle and promised to improve disclosures with distributors. The main issue involved accurately reporting retail sales. However, the FTC did not rule that the firm was a pyramid scheme, a great victory for Herbalife and a blow for Ackman.

Sources: Adapted from the case “Multilevel Marketing Under Fire: Herbalife Defends Its Business Model,” developed by Michelle Urban and Jennifer Sawayda for the UNM Daniels Fund Ethics Initiative; David Benoit, “Herbalife to Pay $200 Million Over Claims of Misrepresentation,” The Wall Street Journal, July 15, 2016, http://www.wsj.com/articles/herbalife-to-pay-200-million-over-claims-of- misrepresentation-1468584397 (accessed July 15, 2016).

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Laws and Regulations As a result of business abuses and social demands for reform, the federal government began to pass legislation to regulate business conduct in the late nineteenth century. In this section, we will look at a few of the most significant of these laws. Table 4.2 summarizes many more laws that affect business operations.

TABLE 4.2 Major Federal Legislation Regulating Business Sherman Antitrust Act, 1890 Prohibits monopolies

Clayton Act, 1914 Prohibits price discrimination, exclusive dealing, and other efforts to restrict competition

Federal Trade Commission Act, 1914 Created the Federal Trade Commission (FTC) to help enforce antitrust laws

Robinson-Patman Act, 1936 Prohibits price discrimination between retailers and wholesalers

Wheeler-Lea Act, 1938 Prohibits unfair and deceptive acts regardless of whether competition is injured

Lanham Act, 1946 Protects and regulates brand names, brand marks, trade names, and trademarks

Celler-Kefauver Act, 1950 Prohibits one corporation from controlling another when the effect substantially lessens competition

Consumer Goods Pricing Act, 1975 Prohibits price maintenance agreements among manufacturers and resellers in interstate commerce

Antitrust Improvements Act, 1976 Strengthens earlier antitrust laws; gives Justice Department more investigative authority

Federal Corrupt Practices Act, 1977 Makes it illegal to pay foreign government officials to facilitate business or to use third parties such as agents and consultants to provide bribes to such officials

Trademark Counterfeiting Act, 1984 Provides penalties for individuals dealing in counterfeit goods

Trademark Law Revision Act, 1988 Amends the Lanham Act to allow brands not yet introduced to be protected through patent and trademark registration

Federal Trademark Dilution Act, 1995 Provides trademark owners the right to protect trademarks and requires them to relinquish those that match or parallel existing trademarks

Digital Millennium Copyright Act, 1998

Refines copyright laws to protect digital versions of copyrighted materials, including music and movies

Sarbanes-Oxley Act, 2002 Made securities fraud a criminal offense; stiffened penalties for corporate fraud; created an account- ing oversight board; and instituted numerous other provisions designed to increase corporate transpar- ency and compliance

(Continued )

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122 Business and Society

Sherman Antitrust Act The Sherman Antitrust Act, passed in 1890, is the principal tool employed by the federal government to prevent busi- nesses from restraining trade and monopolizing markets. Congress passed the law, almost unanimously, in response to public demands to curtail the growing power and abuses of trusts in the late nineteenth century. The law outlaws “every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce.”18 The law also makes a violation a felony crime, punishable by a fine of up to $10 million for corporate violators and $350,000 and/or 3 years in prison for individual offenders.19

The Sherman Antitrust Act applies to all firms operating in interstate commerce as well as to U.S. firms engaged in foreign commerce. The law has been used to break up some of the most powerful companies in the United States, including the Standard Oil Company (1911), the American Tobacco Company (1911), and AT&T (1984). There was also an attempt to break up Microsoft. In the Microsoft case, a U.S. district court judge ruled that the software giant inhibited competition by using unlawful tactics to protect its Windows monopoly in computer operat- ing systems and by illegally expanding its dominance into the market for internet Web-browsing software. However, the ruling to break up Microsoft was appealed, and the order overturned. Microsoft agreed to adhere to a consent decree, where it complied with stricter rem- edies to prevent non-competitive business practices through 2010. The Sherman Act remains the primary source of antitrust law in the United States, although it has been supplemented by several amendments and additional legislation.

Clayton Antitrust Act Because the provisions of the Sherman Antitrust Act were vague, the courts have interpreted the law in different ways. To rectify this situation, Congress enacted the Clayton Antitrust Act in 1914 to limit mergers and acquisitions that have the potential to stifle compe- tition.20 The Clayton Act also specifically prohibits price discrimination,

Controlling the Assault of Non- solicited Pornography and Marketing Act (CAN-SPAM), 2003

Bans fraudulent or deceptive unsolicited commercial email and requires senders to provide information on how recipients can opt out of receiving additional messages

Fraud Enforcement and Recovery Act, 2009

Strengthens provisions to improve the criminal enforcement of fraud laws, including mortgage fraud, securities fraud, financial institutions fraud, and fraud related to the federal assistance relief program

Dodd-Frank Wall Street Reform and Consumer Protection Act (2010)

Increases accountability and transparency in the financial industry, protects consumers from deceptive financial practices, and establishes the Consumer Financial Protection Bureau

TABLE 4.2 (Continued)

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tying agreements (when a supplier furnishes a product to a buyer with the stipulation that the buyer must purchase other products as well), exclusive agreements (when a supplier forbids an intermediary to carry products of competing manufacturers), and the acquisition of stock in another corpo- ration where the effect may be to substantially lessen competition, or tend to create a monopoly. In addition, the Clayton Act prohibits members of one company’s board of directors from holding seats on the boards of com- peting corporations. The law also exempts farm corporations and labor organizations from antitrust laws.

Federal Trade Commission Act In the same year the Clayton Act was passed, Congress also enacted the Federal Trade Commission Act to further strengthen the antitrust provisions of the Sherman Act. Unlike the Clayton Act, which prohibits specific practices, the Federal Trade Commission Act more broadly prohibits unfair methods of competition. More significantly, this law created the Federal Trade Commission (FTC) to protect consumers and businesses from unfair competition. Of all the federal regulatory agen- cies, the FTC has the greatest influence on business activities.

When the FTC receives a complaint about a business or finds rea- son to believe that a company is engaging in illegal conduct, it issues a formal complaint stating that the firm is in violation of the law. If the company continues the unlawful practice, the FTC can issue a cease-and-desist order, which requires the offender to stop the specified behavior. The weight loss industry has been a target for complaints in recent years. Lunada Biomedical, Inc. and three of its principals settled with the FTC after it filed a lawsuit over misleading claims regarding its dietary supplement Amberen. According to the FTC, the health and efficacy claims of Amberen, a dietary supplement for women over 40, were unsubstantiated.21

Although a firm can appeal to the federal courts to have the order rescinded, the FTC can seek civil penalties in court, up to a maximum penalty of $10,000 a day for each infraction, if a cease-and-desist order is ignored. The commission can also require businesses to air corrective advertising to counter previous ads the commission considers misleading. For example, Lasik surgery providers were required by the FTC to run corrective advertising to inform consumers of the risks of undergoing the irreversible surgery along with the benefits.22

In addition, the FTC helps to resolve disputes and makes rulings on business decisions. The FTC ruled that POM Wonderful LLC, maker of a pomegranate juice product, made unsubstantiated claims about the prod- uct’s health benefits. The FTC mandated that POM could not claim its product helped fight disease unless backed up by two pharmaceutical clini- cal trials. A federal appeals court upheld the FTC’s finding but questioned whether the need for two clinical trials in order to make health claims could be a free speech violation.23 In this case, the FTC helped to reinforce truthfulness in advertising, but some question whether its requirements for POM are too stringent.

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Proposed Financial Reforms In response to the 2008–2009 financial cri- sis, government leaders proposed sweeping reforms to increase consumer protection. This proposed legislation has been a step away from the dereg- ulation practices of the last several decades, instead giving government a freer hand in regulating the financial industry. The Obama administra- tion has given the Federal Reserve more power over the financial indus- try and established a new Consumer Financial Protection Bureau that aids in regulating banks and other financial institutions. More specifically, the agency monitors financial instruments like subprime mortgages and other high-risk lending practices. The problems leading up to the financial crisis included inaction on the part of federal regulators to protect consumers from fraud and predatory lending practices, lack of responsibility on the part of mortgage brokers taking large risks, conflicts of interest among credit rating industries, and complex financial instruments that investors did not understand.

To prevent these problems from leading to future financial crises, the Obama administration proposed legislation that would include the follow- ing reforms among others: removing some of the FTC’s powers and creat- ing a Consumer Financial Protection Bureau; creating a Financial Stability Oversight Council to identify and address key risks to the financial indus- try; requiring loan bundlers to retain a percentage of what they sell (a proposal also being considered by the EU); providing new powers for the Securities and Exchange Commission to monitor credit rating industries for objectivity; and requiring complex financial instruments to be traded on a regulated exchange.

Enforcement of the Laws Because violations of the Sherman Antitrust Act are felony crimes, the Antitrust Division of the U.S. Department of Justice enforces it. The FTC enforces antitrust regulations of a civil, rather than criminal, nature. There are many additional federal regulatory agen- cies (see Table 4.3) that oversee the enforcement of other laws and regu- lations. Most states also have regulatory agencies that make and enforce laws for individuals and businesses. In recent years, cooperation among state attorneys general, regulatory agencies, and the federal government has increased, particularly in efforts related to the control of drugs, orga- nized crime, and pollution.

The 2008–2009 financial meltdown revealed the need for better enforcement of the financial industry. Institutions took advantage of loopholes in the regulation system to make quick profits. For example, some adjustable mortgage rates offered low “teaser” rates that did not even cover the monthly interest on loans. This ended up increasing the principal balances on mortgages, resulting in debt that many consum- ers could not pay off. Unethical actions such as these led to the financial crisis. However, since these institutions were not as carefully monitored as other institutions, such as banks, regulators did not catch them until it was too late.24

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TABLE 4.3 Federal Regulatory Agencies Food and Drug Administration, 1906

Enforces laws and regulations to prevent distribution of adulterated or misbranded foods, drugs, medical devices, cosmetics, veterinary products, and potentially hazardous consumer products

Federal Reserve Board, 1913 Regulates banking institutions; protects the credit rights of consumers; maintains the stability of the financial system; conducts the nation’s monetary policy; and serves as the nation’s central bank

Federal Trade Commission, 1914 Enforces laws and guidelines regarding business practices; takes action to stop false and deceptive advertising and labeling

Federal Deposit Insurance Corporation, 1933

Insures deposits in banks and thrift institutions for at least $250,000; identifies and monitors risks related to deposit insurance funds; and limits the economic effects when banks or thrift institutions fail

Federal Communications Commission, 1934

Regulates communication by wire, radio, and television in interstate and foreign commerce

Securities and Exchange Commission, 1934

Regulates the offering and trading of securities, including stocks and bonds

National Labor Relations Board, 1935

Enforces the National Labor Relations Act; investigates and rectifies unfair labor practices by employers and unions

Equal Employment Opportunity Commission, 1970

Promotes equal opportunity in employment through administrative and judicial enforcement of civil rights laws and through education and technical assistance

Environmental Protection Agency, 1970

Develops and enforces environmental protection standards and conducts research into the adverse effects of pollution

Occupational Safety and Health Administration, 1971

Enforces the Occupational Safety and Health Act and other workplace health and safety laws and regulations; makes surprise inspections of facilities to ensure safe workplaces

Consumer Product Safety Commission, 1972

Ensures compliance with the Consumer Product Safety Act; protects the public from unreasonable risk of injury from any consumer product not covered by other regulatory agencies

Commodity Futures Trading Commission, 1974

Regulates commodity futures and options markets. Protects market users from fraud and abusive trading practices

Federal Housing Finance Industry, 2008

Combined the agencies of the Office of the Federal Housing Enterprise Oversight, the Federal Housing Finance Board, and the GSE mission office of the Department of Housing and Urban Development to oversee the country’s secondary mortgage markets

Consumer Financial Protection Bureau, 2010

Created as part of the Dodd-Frank Act to educate consumers and protect them from deceptive financial products

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126 Business and Society

New enforcement aims to require brokers to display a greater fiduciary duty to their clients, requiring them to put their clients’ interests above their own and eliminating any conflicts of interest. This could cause them to offer products that are less costly and more tax-efficient for consum- ers rather than promoting products that would benefit their companies at consumers’ expense.25

In addition to enforcing stricter regulations for financial institutions, the Obama administration has taken steps to protect consumers. This includes encouraging consumers to manage credit cards, savings, and mortgages more carefully; providing cardholders with warnings about how long it will take to pay off their debt if they only pay the minimum on their credit cards each month; and preventing certain credit card issuers from offering credit cards to people under the age of 21.

In addition to enforcement by state and federal authorities, lawsuits by private citizens, competitors, and special-interest groups are used to enforce legal and regulatory policy. Through private civil actions, an individual or organization can file a lawsuit related to issues such as anti- trust, price fixing, or unfair advertising. An organization can even ask for assistance from a federal agency to address a concern. For example, broad- casting companies gained the assistance of the Department of Justice in fighting the start-up service Aereo, which used equipment to stream local television content to consumers for a fee. The case was eventually taken to the Supreme Court, where it was ruled that Aereo needed to secure permis- sion from content providers.26

Apple has been under an antitrust investigation for fixing prices on elec- tronic books as a means to block competition with Amazon. A U.S. District Court Judge ruled that the company colluded with five e-book publishers on pricing. Apple denies any wrongdoing and claims its pricing is due to natural competitive pressures that resulted as they entered the market. The company filed an appeal to the ruling that was denied. Apple was forced to pay $400 million in compensation. Consumers who purchased e-books from the New York Times bestseller lists received $6.93 credit for every purchase.27

Global Regulation The twentieth century brought a number of regional trade agreements that decreased the barriers to international trade. The North American Free Trade Agreement (NAFTA) and the EU are two such agreements that were formed with the intention of enhancing regional competitive- ness and decreasing inequalities. NAFTA, which eliminates virtually all tariffs on goods produced and traded between the United States, Canada, and Mexico, makes it easier for businesses of each country to invest in the other member countries. The agreement also provides some coor- dination of legal standards governing business transactions among the three countries. NAFTA promotes cooperation among various regulatory agencies to encourage effective law enforcement in the free trade area. Within the framework of NAFTA, the United States and Canada have

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developed many agreements to enforce each other’s antitrust laws. The agreement provides for cooperation in investigations, including requests for information and the opportunity to visit the territory of the other nation in the course of conducting investigations.

The European Union was established in 1958 to promote free trade among its members and now includes 28 European nations, with more expected to join in coming years.28 However, in 2016 the United Kingdom voted to leave the EU. If the separation takes place, it will some years for it to occur. These changes will likely have a profound impact on both the U.K. and the EU economy. To facilitate trade among its members, the EU standardized business laws and trade barriers, eliminated customs checks among its members, and introduced the euro as a standard currency. Moreover, the Commission of the European Communities has entered into an agreement with the United States, similar to NAFTA, regarding joint antitrust laws. The European Union is in favor of tighter financial- market regulation in the wake of the financial crisis. Proposals discussed by the European Commission include laws restricting proprietary trading at large banks, revisions on rules regulating occupational pension funds, and improving benchmarks used as reference prices for financial instru- ments.29 However, not all countries in the EU agree on which reforms to adopt. Citizens in the United Kingdom disagreed on certain policies such as immigration and disliked the impact the EU’s financial struggles were having on the economy. This likely contributed to the vote to leave the EU. It is noteworthy that the vote only won by a slim margin.30

A company that engages in commerce beyond its own country’s borders must contend with the potentially complex relationship among the laws of its own nation, international laws, and the laws of the nation in which it will be trading, as well as various trade restrictions imposed on international trade. International business activities are affected to varying degrees by each nation’s laws, regulatory agencies, courts, the political environment, and special-interest groups. The European Union, for example, has been tough on large businesses, leaving some critics in the United States to call the EU anti-competitive and anti-innovative. However, as regulations in the United States and the EU continue to be modified as a result of the 2008–2009 financial crisis, incongruences from each side can be seen. For example, as part of the Dodd-Frank Act, the United States mandated that large banks rely more upon liquid capital for financing rather than debt. While this mandate seems to reduce risks in the financial industry, those banks in the EU see this mandate as creating a competitive disadvantage. Financial firms have historically been held to local standards of the country where busi- ness is conducted. EU regulators fear that this new capital requirement will restrict economic growth and give U.S. firms an advantage over those in the EU. They also cite potential issues regarding international trade.31

This example demonstrates how companies can experience major barriers when doing business in foreign countries. In addition to stricter regulations, countries can also establish import barriers, including tariffs, quotas, minimum price levels, and port-of-entry taxes that affect the

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importation of products. Other laws govern product quality and safety, distribution methods, and sales and advertising practices.

Although there is considerable variation in focus among different nations’ laws, many countries have laws that are quite similar to those in the United States. Indeed, the Sherman Act has been copied throughout the world as the basis for regulating fair competition. Antitrust issues, such as price fixing and market allocation, have become a major area of inter- national cooperation in the regulation of business.32 Table 4.4 provides a list of situations and signs indicating that antitrust may become a concern.

Costs and Benefits of Regulation Costs of Regulation Regulation results in numerous costs for businesses, consumers, and society at large. Although many experts have attempted to quantify these costs, it is quite difficult to find an accurate measurement tool. To generate such measurements, economists often classify regulations as eco- nomic (applicable to specific industries or businesses) or social (broad regula- tions pertaining to health, safety, and the environment). One yardstick for the direct costs of regulation is the administrative spending patterns of federal regulatory agencies. The 2013 estimated cost of regulatory activities was over $58 billion, which was up by approximately 8 percent from 2011. Many peo- ple in the business world and beyond are concerned about the upward trajec- tory of regulatory costs. Another way to measure the direct cost of regulation is to look at the staffing levels of federal regulatory agencies. The expenditures

TABLE 4.4 Signs of Possible Antitrust Violation Any evidence that two or more competing sellers of similar products have agreed to price

their products a certain way, to sell only a certain amount of their product or to sell only in certain areas or to certain customers;

Large price changes involving more than one seller of very similar products of different brands, particularly if the price changes are of an equal amount and occur at about the same time;

Suspicious statements from a seller suggesting that only one firm can sell to a particular customer or type of customer;

Fewer competitors than normal submit bids on a project;

Competitors submit identical bids;

The same company repeatedly has been the low bidder on contracts for a certain product or service or in a particular area;

Bidders seem to win bids on a fixed rotation;

There is an unusual and unexplainable large dollar difference between the winning bid and all other bids; or

The same bidder bids substantially higher on some bids than on others, and there is no logical cost reason to explain the difference.

Source: U.S. Department of Justice, “Antitrust Enforcement and the Consumer,” http://www.justice .gov/atr/public/div_stats/antitrust-enfor-consumer.pdf (accessed June 17, 2016).

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and staffing of state and local regulatory agencies also generate direct costs to society. Federal regulatory agency jobs have been on the rise in recent years, growing to 290,690 full-time jobs in 2013, indicating a 2.5 percent increase or approximately 7,000 new employees each year.33

Still another way to approach the measurement of the costs of regulation is to consider the burden that businesses incur in complying with regulations. Various federal regulations, for example, may require companies to change their manufacturing processes or facilities (e.g., smokestack “scrubbers” to clean air and wheelchair ramps to make facilities accessible to customers and employees with disabilities). Companies also must keep records to document their compliance and to obtain permits to implement plans that fall under the scope of specific regulatory agencies. Again, state regulatory agencies often add costs to this burden. Regulated firms may also spend large amounts of money and other resources to prevent additional legislation and to appear responsible. Of course, businesses generally pass these regulatory costs on to their consumers in the form of higher prices, a cost that some label a “hidden tax” of government. Additionally, some businesses contend that the financial and time costs of complying with regulations stifle their ability to develop new products and make investments in facilities and equipment. Moreover, society must pay for the cost of staffing and operating regulatory agencies, and these costs may be reflected in federal income taxes. Table 4.5 describes the primary drivers to the cost of regulation, including those associated with administering, enforcing, and complying with the regulation.

Benefits of Regulation Despite business complaints about the costs of regulation, it provides many benefits to business, consumers, and society as a whole. These ben- efits include greater equality in the workplace, safer workplaces, resources

TABLE 4.5 Cost of Regulation

Type of Cost Description 1. Administration and

Enforcement Expenditures by government to develop and administer regulatory requirements, including the salaries of government workers, hiring inspectors, purchasing office supplies, and other overhead expenses

2. Compliance Expenditures by organizations, both private and public, to meet regulatory requirements, such as reporting activities and establishing an ethics and compliance program

3. Costs of Legal Consultants Expenditures by organizations for company or outside legal consultants to deal with legal accusations or issues associated with regulation

4. Additional Costs to Operation

Additional costs to the operations of an organization related to improved safety, sustainability, communication, product requirements, and more

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for disadvantaged members of society, safer products, more information about and greater choices among products, cleaner air and water, and the preservation of wildlife habitats to ensure that future generations can enjoy their beauty and diversity.

Companies that fail to respond to consumer desires or that employ inefficient processes are often forced out of the marketplace by more effi- cient and effective firms. Truly competitive markets also spur companies to invest in researching and developing product innovations as well as new, more efficient methods of production. These innovations benefit consum- ers through lower prices and improved goods and services. For example, companies such as Apple, Samsung, and Lenovo continue to engineer smaller, faster, and more powerful computers and mobile devices that help individuals and businesses to be more productive.

Regulatory Reform Many businesses and individuals believe that the costs of regulation outweigh its benefits. They argue that removing regulation will allow Adam Smith’s “invisible hand of competition” to more effec- tively and efficiently dictate business conduct. Some people desire complete deregulation, or removal of all regulatory authority. Proponents of deregu- lation believe that less government intervention allows business markets to work more effectively. For example, many businesses want their industries deregulated to decrease their costs of doing business. Many industries have been deregulated to a certain extent since the 1980s, including trucking, airlines, telecommunications (long-distance telephone and cable televi- sion), and more recently, electric utilities. In many cases, this deregulation has resulted in lower prices for consumers as well as in greater product choice.

However, the onset of the 2008–2009 financial crisis slowed the call for deregulation. After the economy plummeted, the United States and other countries around the world saw the need for greater regulation, par- ticularly of the financial industry, and began to reverse the deregulatory trend of the previous two or three decades. Although the economic crisis stemmed from a variety of factors, many perceived that much of it stemmed from a lack of appropriate governmental oversight and a lack of ethical leadership in businesses. However, governments’ reactions and plans have many worrying that governments will assume too much control. There has always been considerable debate on the relative merits and costs of regula- tion, and these new changes resulting from the worst financial crisis since the Great Depression are not likely to lessen this controversy.

Self-Regulation Many companies attempt to regulate themselves in an effort to demonstrate social responsibility, to signal responsibility to stake- holders, and to preclude further regulation by federal or state government. Many firms choose to join trade associations that have self-regulatory programs, often established as a preventative measure to stop or delay the development of laws and regulations that would restrict the associations’ business practices. Some trade associations establish codes of conduct by

deregulation Removal of all regulatory authority.

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which their members must abide or risk discipline or expulsion from the association. The Direct Marketing Association in the United Kingdom expelled Reactiv Media from its membership after its own investigation upheld consumer complaints regarding the company’s telemarketing prac- tices.34

Perhaps the best-known self-regulatory association is the Better Business Bureau. Founded in 1912, today there are more than 110 bureaus in the United States, parts of Canada, Puerto Rico, and the Caribbean territories. The bureaus have accredited over 375,000 local and national businesses and charities and resolve problems for millions of consumers and businesses each year.35 Each bureau also works to champion good business practices within a community, although it usually does not have strong tools for enforcing its business conduct rules. When a company violates what the BBB believes to be good business practices, the bureau warns consumers through local newspapers or broadcast media.

If the offending organization is a member of the BBB, it may be expelled from the local bureau. For example, the Better Business Bureau revoked accreditation for two Texas businesses for not adhering to BBB standards. One firm agreed to arbitration with the customer but failed to honor the arbitrator’s decison.36

Self-regulatory programs like the Better Business Bureau have a number of advantages over government regulation. Establishment and implementation of such programs are usually less costly, and their guidelines or codes of conduct are generally more practical and realis- tic. Furthermore, effective self-regulatory programs reduce the need to expand government bureaucracy. However, self-regulation also has sev- eral limitations. Nonmember firms are under no obligation to abide by a trade association’s industry guidelines or codes. Moreover, most asso- ciations lack the tools or authority to enforce their guidelines. Finally, these guidelines are often less strict than the regulations established by government agencies.

THE CONTEMPORARY POLITICAL ENVIRONMENT During the 1960s, a significant “antiestablishment” movement manifested in the form of hostile protests toward businesses. These efforts spurred a 15-year wave of legislation and regulation to address a number of issues of the day, including product safety, employment discrimination, human rights, energy shortages, environmental degradation, and scandals related to bribery and payoffs. During the 1980s, the pendulum swung back in favor of business, and the economic prosperity of the 1990s was driven by technological advances and the self-regulation of business. In addition, business priorities were beginning to be focused on protecting competition and the natural environment. These policies continued through 2008, with

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continued self-regulation of industries and the rolling back of environmen- tal laws that businesses deemed detrimental. However, the regulatory cli- mate changed again in 2009 toward more regulation of environmental and health issues, resulting in higher taxes and increased social services. The onset of the financial crisis created an even greater need for stricter legisla- tion, such as the Troubled Assets Recovery Program (TARP) that autho- rized the U.S. Treasury to purchase up to $700 billion of troubled assets like mortgage-backed securities. It has also resulted in support for entirely new regulation and regulatory agencies like the Consumer Financial Protection Bureau. These new regulations have had wide-sweeping effects over the financial industry. Other organizations such as the Environmental Protection Agency and the Food and Drug Administration also began to regulate with the aim of protecting stakeholders with renewed vigor.

Such changes in the political environment over the last 50 years shaped the political environment in which businesses operate and created new avenues for businesses to participate in the political process. Among the most significant factors shaping the political environment were changes in Congress and the rise of special-interest groups. As the Obama administra- tion sought to revive and increase oversight of the finance industry, more companies became interested in hiring lobbyists to campaign on behalf of their interests in Washington.

Changes in Congress Among the calls for social reform in the 1960s were pressures for changes within the legislative process of the U.S. Congress itself. Bowing to this pressure, Congress enacted an amendment to the Legislative Reorganization Act in 1970, which ushered in a new era of change for the political process. This legislation significantly revamped the procedures of congressional committees, most notably stripping commit- tee chairpersons of many of their powers, equalizing committee and chair assignments, and requiring committees to record and publish all roll-call votes taken in the committee. By opening up the committee process to public scrutiny and reducing the power of senior members and commit- tee leaders, the act reduced the level of secrecy surrounding the legislative process and effectively brought an end to an era of autonomous committee chairs and senior members.37

Another significant change occurred in 1974 when Congress amended the Federal Election Campaign Act to limit contributions from individuals, political parties, and special-interest groups organized to get specific can- didates elected or policies enacted.38 Around the same time, many states began to shift their electoral processes from the traditional party caucus to primary elections, further eroding the influence of the party in the political process. These changes ultimately had the effect of reducing the importance of political parties by decreasing members’ dependence on their parties. Many candidates for elected offices began to turn to special-interest groups to raise enough funds to mount serious campaigns and reelection bids.

In 2002, Congress passed the Bipartisan Campaign Reform Act (BRCA), sponsored by Senators John McCain and Russell Feingold.

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This new act limited the amount of contributions parties could donate to political campaigns, and it implemented rules for how corporate and labor treasury funds could be used in federal elections. The act also for- bade national party committees from raising or spending unregulated funds. Though the act outraged certain legislators, who appealed to the Supreme Court over its constitutionality, the Supreme Court upheld it.39

However, the Supreme Court decision popularly referred to as Citizens United grants more powers to organizations regarding corporate contri- butions. Citizens United gives corporations the right to spend as much as they want in independent political expenditures to support governmental candidates. These independent political expenditures are provided through political action committees. Political action committees (PACs) are orga- nizations that solicit donations from individuals and then contribute these funds to candidates running for political office. Companies can organize PACs to which their executives, employees, and stockholders can make significant donations as individuals. PACs operate independently of busi- ness and are usually incorporated. Labor unions and other special-interest groups, such as teachers and medical doctors, can also establish PACs to promote their goals.

The Citizens United decision enabled the creation of what has been termed Super PACs. Before Citizens United, individuals were able to con- tribute $2,500 to PACs, and unions and corporations were not allowed to contribute. The Supreme Court ruled that these prohibitions violated the First Amendment. After the Supreme Court decision, many PACs were dubbed Super PACs because of what is seen as their unlimited abil- ity to receive political donations.40 The Federal Election Committee has rules to restrict PAC donations to $5,000 per candidate for each election. However, many PACs exploit loopholes in these regulations by donating so-called soft money to political parties that do not support a specific can- didate for federal office. Under the current rules, these contributors can make unlimited donations to political parties for general activities.

Rise of Special-Interest Groups The success of activists’ efforts in the 1960s and 1970s marked the rise of special-interest groups. The move- ments to promote African American and women’s rights and to protest the Vietnam War and environmental degradation evolved into well-organized groups working to educate the public about significant social issues and to crusade for legislation and regulation of business conduct they deemed irresponsible. These progressive groups were soon joined on Capitol Hill by more conservative groups working to further their agendas on issues such as business deregulation, restriction of abortion and gun control, and promotion of prayer in schools. Businesses joined in by forming industry and trade associations. These increasingly powerful special-interest groups now focused on getting candidates who could further their own political agendas elected. Common Cause, for example, is a nonprofit, nonpartisan organization working to fight corrupt government and special interests backed by large sums of money. Since 1970, Common Cause, with nearly

political action committees (PACs) Organizations that solicit donations from individuals and contribute these funds to candidates running for political office.

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475,000 members, has campaigned for greater openness and accountabil- ity in government. Some of its self-proclaimed “victories” include reform of presidential campaign finances, tax systems, congressional ethics, open meeting standards, and disclosure requirements for lobbyists. Table 4.6 lists the dates and subject matter of Common Cause’s major accomplish- ments over the past three decades.

TABLE 4.6 Accomplishments of Common Cause 1971: Helps pass the Twenty-Sixth Amendment, giving 18-year olds the right to vote

1974: Leads efforts to pass presidential public financing, contribution limits, and disclosure requirements

1974–1975: Helps pass Freedom of Information Act (FOIA) and open meetings laws at federal, state, and local levels

1978: Leads efforts to pass the historic Ethics in Government Act of 1978, requiring financial disclosure for government officials and restricting the “revolving door” between business and government

1982: Works to pass extension of the Voting Rights Act

1989: Successfully lobbies for passage of the Ethics in Government Act

1990: Works to help pass the Americans with Disabilities Act, guaranteeing civil rights for the disabled

1995: Lobbies for limits on gifts in the House and Senate and for passage of the Lobby Reform Act, providing disclosure of lobbyists’ activity and spending

2000: Successfully works for legislation to unmask and require disclosure of “527” political groups

2001: Lobbies successfully with a coalition for the Help America Vote Act, which provided funding to states for improvement of the nation’s system of voting

2002: Leads successful multiyear campaign to enact the Bipartisan Campaign Reform Act, banning soft money in federal campaigns. In 2003, in a landmark decision, the U.S. Supreme Court upheld the law

2004: Launches major voter mobilization and election monitoring programs for presidential election

2005: Wins the fight against efforts to cut federal funding for the Corporation for Public Broadcasting, and gathers 150,000 petition signatures calling for the resignation of CPB Chairman Ken Tomlinson for partisan and unethical behavior

2005/2006: Leads the charge against disgraced Majority Leader Tom DeLay and fights for major ethics reform

2007: Fights successfully for passage of the Honest Leadership and Open Government Act of 2007, making major improvements in ethics and lobby laws and rules

2008: Leads successful campaign to create the first-ever independent ethics commission in the U.S. House of Representatives

2010: Spurred by the U.S. Supreme Court’s Citizens United decision that lifted the decades-old ban on corporate and union spending around elections, Common Cause redoubles efforts to pass the Fair Elections Now Act, which would allow candidates to run competitive campaigns on small donations and fair elections funds

Source: Common Cause, “History and Accomplishments,” http://www.commoncause.org/site/ pp.asp?c=dkLNK1MQIwG&b=4860205 (accessed June 11, 2014).

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Corporate Approaches to Influencing Government Although some businesses view regulatory and legal forces as beyond their control and simply react to conditions arising from those forces, other firms actively seek to influence the political process to achieve their goals. In some cases, companies publicly protest the actions of legislative bodies. More often, companies work for the election of political candidates who regard them positively. Lobbying, political action committees, and cam- paign contributions are some of the tools businesses employ to influence the political process.

Lobbying Among the most powerful tactics business can employ to par- ticipate in public policy decisions is direct representation through full-time staff who communicate with elected officials. Lobbying is the process of working to persuade public and/or government officials to favor a particu- lar position in decision-making. Organizations may lobby officials either directly or by combining their efforts with other organizations.

Many companies concerned about the threat of legislation or regula- tion that may negatively affect their operations employ lobbyists to com- municate their concerns to officials on their behalf. Google, for example, has recently expanded its Washington office to one the size of the White House. Less than a decade ago, the company had a small presence in Washington but today they are within the top five of the companies with the largest lobbying activities. With all of the controversy over data col- lection and privacy concerns, both of which are core aspects of Google’s business, the company has learned to be an active member in shaping the political conversation.41 Table 4.7 provide examples of organizations that spend money on lobbying.

lobbying The process of working to persuade public and/ or government officials to favor a particular position in decision-making.

TABLE 4.7 Organizations that Engage in Lobbying

Lobbying Organization Total U.S. Chamber of Commerce $1,248,040,680

National Association of Realtors $363,246,628

American Medical Association $338,642,500

General Electric $336,680,000

American Hospital Association $301,548,726

Pharmaceutical Research and Manufacturers of America $294,890,300

Blue Cross/Blue Shield $277,811,849

AARP $257,951,064

Northrop Grumman $236,102,213

Boeing Co. $230,403,310

Source: The Center for Responsive Politics, “Top Spenders,” Open Secrets, 2016, https://www.opensecrets. org/lobby/top.php?showYear=a&indexType=s (accessed June 17, 2016).

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The financial industry has long employed lobbyists to push for increased deregulation so that it can pursue riskier and more profitable avenues. However, changes in regulation and compensation practices in the financial sector are making this a more difficult task. In the past, bank officials have often been awarded for the quantity of business they do, rather than the quality, which encouraged employees to engage in riskier business practices to increase their compensation packages. Some changes in bank compensation packages include adjusting pay to account for any risks taken in the process of generating profits and changing the system of awarding bonuses from a more individualistic focus to one that is more encompassing of the entire organization. Additionally, new Treasury rules mandate banks to better inform borrowers about the costs of certain loans, create greater supervision of bank practices, and even establish a capital surcharge for certain banks. Banks and other financial organizations voiced their opinions on these financial reforms through discreet lobbying and industry groups.42

Companies may attempt to influence the legislative or regulatory process more indirectly through trade associations and umbrella organiza- tions that represent collective business interests of many firms. Virtually every industry has one or more trade associations that represent the interests of their members to federal officials and provide public edu- cation and other services for their members. Examples of such trade associations include the National Association of Home Builders, the Tobacco Institute, the American Booksellers Association, and the Pet Food Institute. Additionally, there are often state trade associations, such as the Hawaii Coffee Association and the Michigan Beer and Wine Wholesalers Association, which work on state- and regional-level issues. Umbrella organizations such as the National Federation of Independent Businesses and the U.S. Chamber of Commerce also help promote business interests to government officials. The U.S. Chamber of Commerce takes positions on many political, regulatory, and economic questions. With more than 3 million member companies, its goal is to promote its members’ views of the ideal free enterprise marketplace. The cozy relationship between cor- porations and the government has been a growing concern for years, and was a topic of serious discussion after the 2008–2009 financial industry meltdown. For example, 48 members of the House Energy and Commerce Committee that were at the forefront of climate change legislation owned stock in energy, oil, and natural gas companies. This was a concern to some citizens as these investments could create a conflict of interest among legislators. However, House and Senate ethics do not forbid Congress from having a stake in companies unless they pass a law that would benefit only their own interests.43

Campaign Contributions Corporate money can also be channeled into candidates’ campaign coffers as corporate executives’ or stockholders’ per- sonal contributions. A sizable contribution to a candidate may carry with it an implied understanding that the elected official will perform some favor,

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such as voting in accordance with the contributor’s desire on a particular law. Occasionally, some businesses find it so important to ensure favor- able treatment that they make illegal corporate contributions to campaign funds. As mentioned earlier, it is also common for businesses and other organizations to make donations to political parties through PACs. Critics are concerned that decisions such as Citizens United will give organiza- tions unfettered power to allow large corporations to effectively “buy” elections.44

THE GOVERNMENT’S STRATEGIC APPROACH FOR LEGAL AND ETHICAL COMPLIANCE Thus far, we have seen that, although legal and regulatory forces have a strong influence on business operations, businesses can also affect these forces through the political process. In addition, socially responsible firms strive to comply with society’s wishes for responsible conduct through legal and ethical behavior. Indeed, the most effective way for businesses to man- age the legal and regulatory environment is to establish values and policies that communicate and reward appropriate conduct. Most employees will try to comply with an organization’s leadership and directions for respon- sible conduct. Therefore, top management must develop and implement a highly visible strategy for effective compliance. This means that top manag- ers must take responsibility and be accountable for assessing legal risks and developing corporate programs that promote acceptable conduct.

Federal Sentencing Guidelines for Organizations Companies are increasingly establishing organizational compliance pro- grams to ensure that they operate legally and responsibly, as well as to generate a competitive advantage based on a reputation for responsible citizenship. There are also strong legal incentives to establish such pro- grams. The Federal Sentencing Guidelines for Organizations (FSGO) was developed by the U.S. Sentencing Commission and approved by Congress in November 1991. These guidelines streamline sentencing and punish- ment for organizational crimes and holds companies, as well as their employees, responsible for misconduct. The guidelines codified into law incentives to reward organizations for implementing controls to prevent misconduct, such as developing effective internal legal and ethical compli- ance programs.45 The commission describes seven steps that companies must implement to demonstrate due diligence. These steps are discussed in Table 4.8.

The assumption underlying the FSGO is that good, socially respon- sible organizations maintain compliance systems and internal governance controls that deter misconduct by their employees. Thus, these guidelines provide guidance for both organizations and courts regarding program

Federal Sentencing Guidelines for Organiza- tions (FSGO) Developed by the U.S. Sentencing Commission and approved by Congress in November 1991 to streamline sentencing and punishment for organizational crimes and holds companies and employees responsible for misconduct.

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effectiveness. Organizations have flexibility about the type of program they develop; the seven steps are not a checklist requiring that legal procedures be followed to gain certification of an effective program. Organizations implement the guidelines through effective core practices that are appro- priate for their firms. The programs they put into effect must be capable of reducing the opportunity for organizational misconduct.

The guidelines pertain to all felonies and class A misdemeanors com- mitted by employees regarding their work. Organizations demonstrating due diligence in developing effective compliance programs can avoid or reduce organizational penalties if an employee commits a crime.46 When it was discovered that bribery had occurred at Ralph Lauren’s Argentine operations, the company took immediate action. Its thorough investigation generated praise from the Securities and Exchange Commission (SEC). Although the company paid $882,000 in penalties to the Department of Justice and $735,000 to the Securities and Exchange Commission, for the first time the SEC entered into a non-prosecution agreement with Ralph Lauren. This was a clear demonstration that the company was being rewarded for its due diligence in handling the misconduct.47

Overall, the spirit behind the FSGO is that legal violations can be prevented through organizational values and a commitment to ethical conduct. The law develops new amendments almost every year. Table 4.9 shows all of the amendments made to date.

In 2004, an amendment to the FSGO placed responsibility on the busi- ness’s governing authority, requiring them to be knowledgeable about the company’s ethics program regarding content, implementation, and effec- tiveness. Usually the governing authority in an organization is the board of directors. The board must make certain there is a high-ranking manager responsible for the daily oversight of the ethics program; provide for suffi- cient authority, resources, and access to the board or an appropriate board subcommittee; and ensure that there are confidential mechanisms so the organization’s employees and agents may ask questions or report concerns without fear of retaliation. The board is also required to oversee the dis- covery of risks and to design, apply, and modify approaches to deal with

TABLE 4.8 Seven Steps to Effective Compliance and Ethics Programs 1. Establish codes of conduct (identify key risk areas).

2. Appoint or hire high-level compliance manager (ethics officer).

3. Take care in delegating authority (background checks on employees).

4. Institute a training program and communication system (ethics training).

5. Monitor and audit for misconduct (reporting mechanisms).

6. Enforce and discipline (management implementation of policy).

7. Revise program as needed (feedback and action).

Source: U.S. Federal Sentencing Guidelines for Organizations.

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TABLE 4.9 Institutionalization of Ethics through the U.S. Sentencing Guidelines for Organizations

1991 Laws: U.S. Sentencing Guidelines for Organizations were created for federal prosecutions of organizations. These guidelines provide for just punishment, adequate deterrence, and incentives for organizations to prevent, detect, and report misconduct. Organizations need to have an effective ethics and compliance program to receive incentives in the case of misconduct.

2004 Amendments: The definition of an effective ethics program now includes the development of an ethical organizational culture. Executives and board members must assume the responsibility of identifying areas of risk, providing ethics training, creating reporting mechanisms, and designating an individual to oversee ethics programs.

2007–2008 Additional definition of a compliance and ethics program: Firms should focus on due diligence to detect and prevent misconduct and to promote an organizational culture that encourages ethical conduct. More details are provided, encouraging the assessment of risk and outlining appropriate steps in designing, implementing, and modifying ethics programs and training that will include all employees, top management, and the board or governing authority. These modifications continue to reinforce the importance of an ethical culture in preventing misconduct.

2010 Amendments: Chief compliance officers are directed to make their reports to their firm’s board rather than to the general counsel. Companies are encour- aged to create hotlines, perform self-audit programs, and adopt controls to detect misconduct internally. More specific language has been added to the word prompt in regards to what it means to promptly report misconduct. The amendment also extends operational responsibility to all personnel within a company’s ethics and compliance program

2014 The Commission investigated how the sentencing guidelines could be used by regulatory and law enforcement agencies to recommend effective ethics and compliance programs. The Commission assessed its efforts to encourage corporations, nonprofits, government agencies, and other organizations to form institutional cultures that discourage misconduct.

Sources: “U.S. Sentencing Guidelines Changes Become Effective November 1,” FCPA Compliance and Ethics Blog, November 2, 2010, http://fcpacompliancereport.com/2010/11/us-sentencing-guide- lines-changes-become-effective-november-1/ (accessed June 17, 2016). United States Sentencing Commission, “Amendments to the Sentencing Guidelines,” April 30, 2012, http://www.ussc.gov/Legal/ Amendments/Reader-Friendly/20120430_RF_Amendments.pdf (accessed June 17, 2016); Paula Desio, Deputy General Counsel, An Overview of the Organizational Guidelines, http://www.ussc.gov/sites/ default/files/pdf/training/organizational-guidelines/ORGOVERVIEW.pdf (accessed June 17, 2016).

those risks. If board members do not understand how to execute an ethics program, the organization risks insufficient oversight and misconduct that can snowball into a crisis.48

In 2005, the Supreme Court held that the federal sentencing guidelines were not mandatory but would act as recommendations for judges to use in their decisions. Some legal experts thought that this might weaken the effectiveness of the FSGO, but the majority of federal sentences have remained similar to what they had been before the Supreme Court deci- sion. Thus, the guidelines are important in developing a successful ethics and compliance program.49

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The 2007–2008 amendments to the FSGO extend the necessary ethics training to board members or the governing authority, managers, employ- ees, and the organizations’ agents. This change pertains to mandatory training at all organizational levels. Simply disseminating a code of ethics is not enough to meet training requirements. The new amendments com- pelled most governmental contractors to implement ethics and compliance training.

In 2010, the FSGO adopted four new amendments. The first amend- ment simplified reporting relationships by recommending that chief com- pliance officers report misconduct directly to the board or to a board committee, rather than simply to the general counsel. The second amend- ment encouraged organizations to strengthen internal controls through hotlines, self-auditing programs, and other mechanisms to increase the chances that misconduct will be detected internally instead of externally. The third amendment adopted more specific wording to clarify what it means to report an ethical violation promptly. Finally, a fourth amend- ment extended operational responsibility to all personnel within a com- pany’s ethics and compliance program. This means that everyone in an organization has a responsibility to ensure ethical conduct.50

In 2014, the Federal Sentencing Commission reiterated the impor- tance of best practices in organizations. The commission advocated the sharing of best practices among regulatory and law enforcement agencies. Agencies such as the Department of Justice’s Antitrust Division are using the FSGO’s seven steps for ethics programs to develop their own compli- ance programs. The Commission also encourages the sharing of best prac- tices among industry associations. The FSGO does not believe this sharing of best practices should be limited to for-profit organizations, however. It also assessed the success of nonprofit organizations, businesses, regula- tors, and other organizations in creating effective organizational cultures that will work toward preventing misconduct. The emphasis of the FSGO is increasingly geared toward best practices, principles, and values over formal regulations in which organizations do the bare minimum to comply with the law.51

The Department of Justice also recommended general principles to apply in cases of corporate misconduct. Ethics and compliance programs are essential in discovering the types of misconduct common in a particu- lar organization’s industry. If an organization does not have an effective ethics and compliance program in place, a firm convicted of misconduct will likely not be treated lightly, particularly as the prosecutor has a large amount of freedom in determining when, whom, and whether to prosecute illegal conduct. Even minor misconduct could result in significant penalties if committed by a large number of employees or approved by upper man- agement. Without an effective ethics and compliance program to identify misconduct, a firm can face severe consequences from legal issues, enforce- ment, and sentencing.52 Legal and administrative policies mostly agree that an effective ethics and compliance program is required to prevent miscon- duct and reduce legal repercussions should it occur.

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Sarbanes-Oxley (SOX) Act The Sarbanes-Oxley Act was enacted to restore stakeholder confidence and provide a new standard of ethical behavior for U.S. businesses in the wake of Enron and WorldCom in the early 2000s. During probes into financial reporting fraud at many of the world’s largest companies, investigators learned that hundreds of public corporations were not reporting their financial results accurately. Accounting firms, lawyers, top corporate officers, and boards of directors had developed a culture of deception in an attempt to gain investor approval and competitive advantage. The downfall of many of these companies resulted in huge losses to thousands of investors, and employees even lost much of their savings from 401ks.

The Sarbanes-Oxley Act (SOX) legislation protects investors by improving the accuracy and reliability of corporate disclosures. The act had almost unanimous support by Congress, government regulatory agencies, and the general public. When President Bush signed the act, he emphasized the need for the standards it provides, especially for top management and boards of directors responsible for company oversight. Table 4.10 details the requirements of the act.

Sarbanes-Oxley Act Enacted to restore stake- holder confidence and provide a new standard of ethical behavior for U.S. businesses in the wake of Enron and WorldCom in the early 2000s.

TABLE 4.10 Major Provisions of the Sarbanes-Oxley Act 1. Requires the establishment of an Independent Accounting Oversight Board in charge of

regulations administered by the Securities and Exchange Commission.

2. Requires CEOs and CFOs to certify that their companies’ financial statements are true and without misleading statements.

3. Requires that corporate board of directors’ audit committees consist of independent members with no material interests in the company.

4. Prohibits corporations from making or offering loans to officers and board members.

5. Requires codes of ethics for senior financial officers; code must be registered with the SEC.

6. Prohibits accounting firms from providing both auditing and consulting services to the same client.

7. Requires company attorneys to report wrongdoing to top managers and, if necessary, to the board of directors; if managers and directors fail to respond to reports of wrongdoing, the attorney should stop representing the company.

8. Mandates “whistle-blower protection” for persons who disclose wrongdoing to authorities.

9. Requires financial securities analysts to certify that their recommendations are based on objective reports.

10. Requires mutual fund managers to disclose how they vote shareholder proxies, giving investors information about how their shares influence decisions.

11. Establishes a ten-year penalty for mail/wire fraud.

12. Prohibits the two senior auditors from working on a corporation’s account for more than five years; other auditors are prohibited from working on an account for more than seven years; in other words, accounting firms must rotate individual auditors from one account to another from time to time.

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The section of SOX that initially caused the most concern for com- panies was compliance with section 404. Section 404 comprises three central issues: (1) it requires that management create reliable internal financial controls; (2) it requires that management attest to the reli- ability of those controls and the accuracy of financial statements that result from those controls; and (3) it requires an independent auditor to further attest to the statements made by management. Because the cost of compliance was so high for many companies, some publicly traded companies considered de-listing themselves from the U.S. Stock Exchange. However, although compliance costs were high after Sarbanes–Oxley, they have decreased over the years. Compliance costs have decreased 50 percent from their level when the laws were put into effect. The current costs of compliance range from between $100,000 and $500,000.53

To address fraudulent occurrences, SOX required the creation of the Public Company Accounting Oversight Board, which provides oversight of the accounting firms that audit public companies and sets standards for the auditors in these firms. The board has investigatory and disciplin- ary power over accounting firm auditors and securities analysts who issue reports about companies. Specific duties include: (1) registration of public accounting firms; (2) establishment of auditing, quality control, ethics, independence, and other standards relating to preparation of audit reports; (3) inspection of accounting firms; (4) investigations, disciplinary proceed- ings, and imposition of sanctions; and (5) enforcement of compliance with accounting rules of the board, professionals standards, and securities laws relating to the preparation and issuance of audit reports and obligations and liabilities of accountants.

SOX also requires corporations to take more responsibility and to provide principles-based ethical leadership. Enhanced financial disclosures are required, including certification by top officers that audit reports are complete and that nothing has been withheld from auditors. For example, registered public accounting firms are now required to identify all mate- rial correcting adjustments to reflect accurate financial statements. Also, all material off-balance sheet transactions and other relationships with unconsolidated entities that affect current or future financial conditions of a public company must be disclosed in each annual and quarterly financial report. In addition, public companies must also report “on a rapid and current basis” material changes in the financial condition or operations. Section 201 of SOX prohibits registered public accounting firms from providing both audit and non-audit services to a public company, a major issue with the now defunct accounting firm Arthur Andersen in its rela- tionship with Enron.

Other provisions of the act include whistle-blower protection and changes in the attorney-client relationship so that attorneys are now required to report wrongdoing to top managers or to the board of directors. Employees of public companies and accounting firms, in gen- eral, are also accountable to report unethical behavior. SOX intends to

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motivate employees through “whistle-blower” protection that would prohibit the employer from taking certain actions against employees who lawfully disclose private employer information to, among others, parties in a judicial proceeding involving a fraud claim. Whistle-blowers are also granted a remedy of special damages and attorney’s fees. This pro- tection is designed to encourage whistleblowers to come forward when detecting business misconduct, as much of the fraud that eludes audits or other controls may be detected by employees. According to a 2008 report published by the Association of Certified Fraud Examiners, data compiled on 959 cases of occupational fraud between 2006 and 2008 revealed that 46 percent of the cases were detected by tipsters such as employees or vendors.54 Acts of retaliation that harm informants, includ- ing interference with the lawful employment or livelihood of any person, shall result in fines and/or imprisonment for ten years. Table 4.11 lists the benefits of the act.

Dodd-Frank Wall Street Reform and Consumer Protection Act In 2010, the Dodd–Frank Wall Street Reform and Consumer Protection Act was passed. The act was hailed as “a sweeping overhaul of the finan- cial regulatory system. . .on a scale not seen since the reforms that fol- lowed the Great Depression.”55 Dodd-Frank seeks to prevent financial crisis through improved financial regulation, additional oversight of the industry, and preventative measures to reduce the types of risk-taking, deceptive practices, and lack of oversight that led to the financial fallout in 2007–2008.56 Its provisions include increasing the transparency of finan- cial institutions, creating a bureau to educate consumers about financial

Dodd–Frank Wall Street Reform and Consumer Protection Act Passed in 2010 to prevent financial crisis by increased financial deregulation, additional oversight of the industry, and preventative measures against unhealthy risk-taking and deceptive practices.

TABLE 4.11 Benefits of Sarbanes-Oxley 1. Greater accountability by top management and board of directors to employees, commu-

nities, and society. The goals of the business will be to provide stakeholders with a return on their investment rather than providing a vehicle for management to reap excessive compensation and other benefits.

2. Renewed investor confidence providing managers and brokers with the information they need to make solid investment decisions, which will ultimately lead to a more stable and solid growth rate for investors.

3. Clear explanations by CEOs about why their compensation package is in the best interest of the company. It eliminates certain traditional senior management perks, including com- pany loans, and requires disclosures about stock trades, thus making executives more like other investors.

4. Greater protection of employee retirement plans. Employees can develop greater trust that they will not lose savings tied to such plans.

5. Improved information from stock analysts and rating agencies.

6. Greater penalties and accountability of senior managers, auditors and board members. The penalties now outweigh the rewards of purposeful manipulation and deception.

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products and protect them from deceptive financial practices, implement- ing added incentives for whistle-blowers, increasing oversight of the finan- cial industry, and regulating the use of derivatives.

Unlike Sarbanes-Oxley, there was not a clear consensus on the Dodd- Frank Act. Opponents of the act expressed many concerns, asserting that the rules on derivatives would be too difficult to follow, the changes would create chaos in the financial system, and the government could gain too much power.57 J.P. Morgan claimed that they supported the law but were against certain provisions.58 Included in these provisions was the creation of new financial regulatory agencies that would increase government over- sight of the financial system.

The Office of Financial Research was developed with the responsibility to improve the quality of financial data accessible to government officials and construct an improved system of analysis for the finance industry.59 The Financial Stability Oversight Council (FSOC) has been given the responsibility to keep the financial system stabilized through market monitoring, threat identification, the promotion of market discipline among public constituents, and responses to risks that threaten stability.60 FSOC can limit or supervise financial risks, create more stringent rules for banking and nonbanking financial organizations, and break up financial organizations that present major risks to market stability.61 The purpose of these two new agencies is to eliminate loopholes that allowed financial companies to commit risky and deceptive actions leading up to the finan- cial crisis.

The Dodd-Frank Act also developed the Consumer Financial Protection Bureau (CFPB). The CFPB is an independent agency within the Federal Reserve System that “regulate[s] the offering and provision of consumer financial products or services under the Federal consumer financial laws.”62 A major problem leading up to the financial meltdown was that average investors usually did not understand the complex financial products in which they were trading. The federal government has granted the CFPB supervisory power over credit markets and the ability to monitor lenders to ensure they are in legal compliance.63 The CFPB also has authority to restrict unfair lending and credit card practices, enforce consumer financial protection laws, and ensure the safety of financial products before their release onto the market.64

Some have major concerns about the extent of the agency’s powers. For instance, critics are concerned that this increased power could lead to severe sanctions or heavy regulations.65 Goldman Sachs was one financial organization affected by the regulation. In order to comply with part of the Dodd-Frank Act, it was forced to limit investing in its own private- equity funds. This provision restricts financial organizations from using their own money to make large bets.66 The CFPB has oversight powers over organizations that tend to be accused of questionable conduct, such as payday lenders and debt collectors.67 The CFPB’s goal is to maintain a more transparent financial environment for consumers.

Consumer Financial Protection Bureau (CFPB) Established by the Dodd– Frank Act to regulate banks and other financial institutions by monitoring financial instruments like subprime mortgages and high-risk lending practices.

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Finally, the Dodd–Frank law created a whistle-blower bounty pro- gram. Whistle-blowers who report financial fraud to government agencies are eligible to receive 10–30 percent of fines and settlements if their reports result in convictions of more than $1 million in penalties.68 In 2012, the government awarded its first payout of $50,000 to a whistleblower who assisted regulators in convicting a company of fraud.69

SUMMARY In a pluralistic society, many diverse stakeholder groups attempt to influence the public officials who legislate, interpret laws, and regulate business. Companies that adopt a strategic approach to the legal and regulatory system develop proactive organizational values and compliance programs that identify areas of risks and include formal communication, training, and continuous improvement of responses to the legal and regula- tory environment.

Economic reasons for regulation often relate to efforts to level the playing field on which businesses operate. These efforts include regulating trusts, which are generally established to gain control of a product market or industry by eliminating competition, and eliminating monopolies, which occur when just one business provides a good or service in a given market. Another rationale for regulation is society’s desire to restrict destructive or unfair competition. Social reasons for regulation address imperfections in the market that result in undesirable consequences and the protection of natural and social resources. Other regulations are created in response to social demands for safety and equality in the workplace, safer products, and privacy issues.

The Sherman Antitrust Act is the principal tool used to prevent busi- nesses from restraining trade and monopolizing markets. The Clayton Antitrust Act limits mergers and acquisitions that could stifle competition and prohibits specific activities that could substantially lessen competi- tion or tend to create a monopoly. The Federal Trade Commission Act prohibits unfair methods of competition and created the Federal Trade Commission (FTC). Legal and regulatory policy is also enforced through lawsuits by private citizens, competitors, and special-interest groups.

A company that engages in commerce beyond its own country must contend with the complex relationship among the laws of its own nation, international laws, and the laws of the nation in which it will be trading. There is considerable variation and focus among different nations’ laws, but many countries’ antitrust laws are quite similar to those of the United States.

Regulation creates numerous costs for businesses, consumers, and society at large. Some measures of these costs include administrative spending patterns, staffing levels of federal regulatory agencies, and costs businesses incur in complying with regulations. The cost of regulation is passed on to consumers in the form of higher prices and may stifle product

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innovation and investments in new facilities and equipment. Regulation also provides many benefits, including greater equality in the workplace, safer workplaces, resources for disadvantaged members of society, safer products, more information about and greater choices among products, cleaner air and water, and the preservation of wildlife habitats. Antitrust laws and regulations strengthen competition and spur companies to invest in research and development. Many businesses and individuals believe that the costs of regulation outweigh its benefits. Some people desire complete deregulation, or removal of regulatory authority.

Because government is a stakeholder of business (and vice versa), busi- nesses and government can work together as both legitimately participate in the political process. Business participation can be a positive or negative force in society’s interest, depending not only on the outcome but also on the perspective of various stakeholders.

Changes over the last 40 years have shaped the political environment in which businesses operate. Among the most significant of these changes were amendments to the Legislative Reorganization Act and the Federal Election Campaign Act, which had the effect of reducing the importance of political parties. Many candidates for elected offices turned to increasingly powerful special-interest groups to raise funds to campaign for elected office. Until the Citizens United decision, corporations were restricted in giving contributions to political action committees. However, the Supreme Court decision gives corporations the right to spend as much as they want in political independent expenditures to support governmental candidates.

Some organizations view regulatory and legal forces as beyond their control and simply react to conditions arising from those forces; other firms seek to influence the political process to achieve their goals. One way they can do so is through lobbying, the process of working to persuade public and/or government officials to favor a particular position in deci- sion-making. Companies can also influence the political process through political action committees, which are organizations that solicit donations from individuals and then contribute these funds to candidates running for political office. Corporate funds may also be channeled into candi- dates’ campaign coffers as corporate executives’ or stockholders’ personal contributions, although such donations can violate the spirit of corporate campaign laws. It is also common for businesses and other organizations to make donations to political parties.

More companies are establishing organizational compliance programs to ensure that they operate legally and responsibly as well as to gener- ate a competitive advantage based on a reputation for good citizenship. Under the Federal Sentencing Guidelines for Organizations (FSGO), a company that wants to avoid or limit fines and other penalties as a result of an employee’s crime must be able to demonstrate that it has imple- mented a reasonable program for deterring and preventing misconduct. To implement an effective compliance program, an organization should develop a code of conduct that communicates expected standards, assign

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oversight of the program to high-ranking personnel who abide by legal and ethical standards, communicate standards through training and other mechanisms, monitor and audit to detect wrongdoing, punish individuals responsible for misconduct, and take steps to continuously improve the program. A strong compliance program acts as a buffer to keep employees from committing crimes and to protect a company’s reputation should wrongdoing occur despite its best efforts.

Enacted after many corporate financial fraud scandals, the Sarbanes- Oxley Act created the Public Company Accounting Oversight Board to provide oversight and set standards for the accounting firms that audit public companies. The board has investigatory and disciplinary power over accounting firm auditors and securities analysts. The act requires cor- porations to take responsibility to provide principles-based ethical leader- ship and holds CEOs and CFOs personally accountable for the credibility and accuracy of their company’s financial statements.

However, the 2008–2009 recession, collapse of the subprime mort- gage market, and troubles on Wall Street all pointed to systemic flaws and gaps in the regulatory system. In 2010, the Obama administration passed the Dodd-Frank Wall Street Reform and Consumer Protection Act. Dodd-Frank seeks to prevent financial crisis through the improvement of financial regulation, the increase in oversight of the industry, and preven- tative measures to reduce types of risk-taking, deceptive practices, and lack of oversight. It established several new agencies, including the Consumer Financial Protection Bureau to protect consumers from complex finan- cial instruments. It also established a whistle-blower bounty program, in which whistle-blowers are eligible to receive 10–30 percent of fines and settlements if their reports result in convictions of more than $1 million in penalties

Responsible Business Debate

The Legality of Marijuana Advertising Issue: Should marijuana be advertised where it is legally sold?

Marketers in any vice industry face political, legal, and sociocultural challenges when communicating the message of their brand or product. Marijuana is no exception. The legalization of cannabis for recreational use in Colorado and Washington has created both opportunities in a new market as well as uncertainties associated with advertising to this market. The media industry as a whole is averse to promoting recreational

marijuana use due to its controversial nature. While two states have legalized this activity and others are planning on putting the issue to a vote, federal law still considers it to be illegal. Marijuana retailers are technically considered to be narcotics traffickers, and marketers for the substance can be held as accomplices to criminal activity.

Google, one of the main online advertising outlets, has long restricted searches related to drugs out of its own conviction. Other advertising channels, such as newspapers and billboards, are legally restricted from

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KEY TERMS

accepting advertising money related to drugs. This is true in cities where the substance is legal for both recreational and medicinal use. These laws work to protect underage individuals from seeing the adver- tisements and sparking their interest in drug use. For example, Colorado laws state that any kind of mass media advertising that has the potential to reach 30 percent or more individuals under the age of 21 is restricted. Online content that does not block minors’ access cannot contain marijuana advertising. Signage, flyers, and leaflets are also restricted as their reach can- not be controlled. Similar advertising regulations apply in Washington as well.

However, some startup advertising agencies are emerging to help marijuana retailers with their adver- tising. Seattle-based Mirsky Media is one such company, whose services include search engine optimization, Web page design, marketing consulting, and obtaining advice on how to get good feedback on the review website Yelp. There are other methods that marijuana retailers use to promote themselves as well. Sponsoring charity walks, sporting events, and live concerts have been an effective means of public relations for some dispensaries.

Despite these legal restrictions in advertising, the question as to whether marijuana dispensaries should advertise their products remains. On the one hand, they are a legal business in Colorado and Washington, and it is their legal right to generate a profit. But is this profit generated to the detriment of society? Some argue that the legality of the issue does not mean that it should be promoted. The use of marijuana is linked to side effects, including memory loss, a tendency

toward depression, and a lack of motivation. It is also linked to more positive side effects such as slowing the progression of Alzheimer’s, reducing the spread of cancer, and controlling epileptic seizures. Despite these linkages, research has not been adequate to make any definitive claims.

There Are Two Sides to Every Issue: 1. Advertising for recreational marijuana should be

legal in states where its use has been legalized. 2. Because recreational marijuana use can be a det-

riment to society, advertising for recreational marijuana should be prohibited.

Sources: Bruce Kennedy, “Ad Agencies Prepare for the Legal Marijuana Market,” CBS News, January 6, 2014, http:// www.cbsnews.com/news/ad-agencies-prepare-for-the-legal- marijuana-market/ (accessed July 15, 2016); Eleazar David Melendez, “Marijuana Doesn’t Just Sell Itself, as Marketers Face Resistance from Google, Media Companies,” The Huffington Post, August 30, 2013, http://www.huffington- post.com/2013/08/30/marijuana-marketers_n_3832448.html (accessed July 15, 2016); Melanie Williamson, “Legalized Weed Means Changes for Digital Marketing Strategies,” Josic, January 14, 2014, http://www.josic.com/legalized-weed- means443-changes-for-digital-marketing-strategies (accessed July 15, 2016); Anne Holland, “Recreational Marijuana Retailers to Face Major Advertising Restrictions in Colorado,” Marijuana Business Daily, September 17, 2013, http://mmj- businessdaily.com/recreational-marijuana-retailers-to-face- significant-advertising-constrictions-in-colorado/ (accessed July 15, 2016); Jacob Sullum, “6 Ways Washington’s Marijuana Rules Are Looser Than Colorado’s,” Reason, July 5, 2013, http://reason.com/blog/2013/07/05/6-ways-washingtons-mari- juana-rules-are-l (accessed July 15, 2016) Jennifer Welsh, Dina Spector, and Randy Astaiza, “The Positives and Negatives: How Marijuana Affects Your Brain and Body,” thejournal.ie, January 11, 2014, http://www.thejournal.ie/marijauan-health- effects-legalised-medical-negative-positve-1256236-Jan2014/ (accessed July 15, 2016).

trusts (p. 116) monopoly (p. 116) deregulation (p. 130) political action committee (PAC)

(p. 133) lobbying (p. 135)

Federal Sentencing Guidelines for Organizations (FSGO) (p. 137)

Sarbanes-Oxley Act (SOX) (p. 141) Dodd-Frank Wall Street Reform

and Consumer Protection Act (p. 143)

Consumer Financial Protection Bureau (CFPB) (p. 144)

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DISCUSSION QUESTIONS 1. Discuss the existence of both cooperation and

conflict between government and businesses con- cerning the regulation of business.

2. What is the rationale for government to regulate the activities of businesses? How is our economic and social existence shaped by government regu- lations?

3. What was the historical background that encour- aged the government to enact legislation such as the Sherman Antitrust Act and the Clayton Act? Do these same conditions exist today?

4. What is the role and function of the Federal Trade Commission in the regulation of business? How does the FTC engage in proactive activities to avoid government regulation?

5. How do global regulations influence U.S. busi- nesses operating internationally? What are the major obstacles to global regulation?

6. Compare the costs and benefits of regulation. In your opinion, do the benefits outweigh the costs or do the costs outweigh the benefits? What are the advantages and disadvantages of deregula- tion?

7. Name three tools that businesses can employ to influence government and public policy. Evaluate the strengths and weaknesses of each of these approaches.

8. How do political action committees influence society, and what is their appropriate role in a democratic society?

9. Why should an organization implement the Federal Sentencing Guidelines for Organizations (FSGO) as a strategic approach for legal compliance?

10. What is the significance of Sarbanes-Oxley and the Dodd-Frank Act to business operations in the United States?

EXPERIENTIAL EXERCISE Visit the website of the Federal Trade Commission (FTC) (http://www.ftc.gov/). What is the FTC’s current mission? What are the primary areas for which the FTC

is responsible? Review the press releases of the last two months: on the basis of these releases, what appear to be major issues of concern at this time?

THE TAXING ROLE OF BEING A POLITICIAN: WHAT WOULD YOU DO? ? The election of a new governor brings many changes to any state capital, including the shuffling of a variety of appointed positions. In most cases, political appointees have contributed a great deal to the governor’s election bid and have expertise in a specific area related to the appointed post. Joe Barritz was in that position when he became assistant agricultural commissioner in January 2010. He was instrumental in getting the governor elected, especially through his fundraising efforts. Joe’s family owned thousands of acres in the state and had been farming and ranching since the 1930s. Joe earned a bachelor’s degree in agricultural economics and policy and a law degree from one of the state’s top institutions. He worked as an attorney in the state’s capital city for over 18 years and represented a range of clients, most of whom were involved in agriculture. Thus, he possessed many characteristics that made him a strong candidate for assistant commissioner. After about six months

on the job, Joe had lunch with a couple of friends he had known for many years. During that June lunch, they had a casual conversation about the fact that Joe never did have a true “celebration” after being named assistant agricultural commissioner. His friends decided to discuss with others and plan a celebration in a few months. Before long, eight of Joe’s friends were busy planning to hold a reception in his honor on October 5. Two of these friends were currently employed as lob- byists. One represented the beef industry association, and the other worked for the cotton industry council. They asked Joe if they could hold the celebration at his lake home in the capital city. Joe talked with the commission’s ethics officer about the party and learned that these types of parties, between close friends, were common for newly appointed and elected officials. The ethics officer told Joe that the reception and location were fine, but only if his lobbyist friends paid for the

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reception with personal funds. The state’s ethics rules did not allow a standing government official to take any type of gift, including corporate dollars, that might influence his or her decision-making. Joe communicated this information to his friends.

During the next few months, Joe was involved in a number of issues that could potentially help or harm agriculture-based industries. Various reports and policy statements within the Agricultural Commission were being used to tailor state legislation and regulatory proposals. The beef and cotton councils were actively supporting a proposal that would provide tax breaks to farmers and ranchers. Staff on the Agricultural Commission were mixed on the proposal, but Joe was expected to deliver a report to a legislative committee on the commission’s preferences. His presentation was scheduled for October 17.

On October 5, nearly 60 of Joe’s friends gathered at the catered reception to reminisce and congratulate him on his achievements. Most were good friends and acquaintances, so the mood and conversation were relatively light that evening. A college football game

between two big rivals drew most people to the big- screen TV. By midnight, the guests were gone. Back at the office the following week, Joe began working on his presentation for the legislative committee. Through a series of economic analyses, long meetings, and electronic discussions, he decided to support the tax benefits for farmers and ranchers. News reports carried information from his presentation.

It was not long before some reporters made a “con- nection” between the reception in Joe’s honor and his stand on the tax breaks for agriculture industries. An investigation quickly ensued, including reports that the beef and cotton industry associations had not only been present but also financially supported the reception on October 5. The small company used to plan and cater the party indicated that checks from the cotton indus- try council and beef industry association were used to cover some of the expenses. A relationship between the “gift” of the reception and Joe’s presentation to the legislative committee would be a breach of his oath of office and state ethics rules. If you were Joe, what would you do?

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CHAPTER FIVE

Business Ethics and Ethical Decision-Making

Chapter Objectives

●● To define and describe the importance of business ethics

●● To understand the diverse and complex nature of existing and emerging ethical issues

●● To discuss the individual factors that influence ethical or unethical decisions

●● To explore the effects of organizational relationships on ethical decision-making

●● To evaluate the role of opportunity in ethical or unethical decisions

●● To understand how to implement an ethical culture

Chapter Outline

The Nature of Business Ethics

Foundations of Business Ethics

Ethical Issues in Business

Understanding the Ethical Decision-Making Process

Developing an Ethical Culture

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153

As concerns about the environment grow among con- sumers and stakeholder groups, more companies are trying to portray themselves in an eco-friendly light. This can lead to a form of deception called greenwash- ing, which occurs when companies market products as environmentally friendly when they are actually not. It is a way for companies to appeal to green consumers while avoiding the costs of developing truly “green” products.

Businesses accused of greenwashing can be exposed as misguiding the public and face the possi- bility of negative publicity and resulting sales declines. In the United States, firms that label or advertise products as organic or environmentally friendly are supposed to abide by the Federal Trade Commission’s revised “Green Guides,” which provides guidelines to help companies make sure that their green claims are truthful. Those found to be misleading consumers risk fines, negative publicity and the possibility of con- sumer reimbursement.

Both the Federal Trade Commission and consumer advocates are beginning to hold companies to stricter standards. The FTC levied a $450,000 fine against AJM Packaging Corporation for violating a 1994 order not to represent its products or packaging as being bio- degradable without reliable evidence to back it up. A lawsuit was filed against PepsiCo because critics found synthetic vitamins in the drink despite its claims to be all-natural. PepsiCo paid to settle the lawsuit and agreed not to use the all-natural label.

The problem is that terms such as “natural” and “green” can be hard to define. Is a product eco- friendly if most, but not all, of its components are made from sustainable materials? What about compa- nies that still give off carbon emissions but which have improved their products over the years? The automo- bile industry faces this problem as vehicles continue to negatively impact the environment. Even hybrids, electric vehicles, and fuel-efficient cars impact the environment. Norway actually banned all green claims in car advertising after concerns about greenwashing in the auto industry.

To not become a victim of greenwashing, ask the right questions. When buying green, investigate what materials the products use and how the company obtained those materials. Always look for evidence to back up a green product’s claims. Also, beware of ambiguous claims. For instance, the phrase “lower car- bon emissions” in and of itself does not explain much if it does not have a point of comparison. Third-party certification including the Forest Stewardship Council and Green Globes offer some assurance that certified products adhere to certain green guidelines. However, consumers must exert caution with certification firms as well. The FTC sent warning letters to five marketers of green certifications and seals warning them that their criteria for the certifications fail to meet the guidelines set forth in its “Green Guides.” With greenwashing incidents increasing, consumers need to use caution and verify that the products they buy are truly eco-friendly.1

Greenwashing: Don’t Be ‘Taken to the Cleaners’

Opening Vignette

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154 Business and Society

Key business ethics concerns relate to questions about whether vari-ous stakeholders consider specific business practices acceptable. A reputation as an ethical firm takes a long time to earn but just min- utes to lose. Once lost, it can take considerable time to restore goodwill with stakeholders. For example, banks and financial institutions have had major reputational damage. The financial services industry ranks the low- est in consumer and investor trust. However, the financial services industry has begun to rebound slowly. About 51 percent of the global population claims they trust the financial services industry.2 Business ethics is impor- tant to build trust and create an organizational culture that establishes a good reputation.

By its very nature, the field of business ethics is complex because orga- nizational issues often require subject matter knowledge. For example, accounting ethics is embedded with principles, rules, and regulatory requirements. Most businesses are establishing initiatives that include the development and implementation of ethics programs designed to deter misconduct. Raytheon Company, a long-established defense and security company employing 63,000 people worldwide, has a comprehensive ethics and compliance program. The company’s ethics education program has been ranked by 82 percent of employees as relevant and useful in making ethical decisions. The strength of the program has contributed to a strong organizational culture of integrity. Employees engage in annual peer meet- ings called “Ethics Checkpoint” sessions where all have an opportunity to reflect on and provide solutions to real life ethical dilemmas. Video vignettes and other online educational materials on supplier relations, product integrity, and labor issues are also utilized. The company displays an outward focus on ethics by supporting education and proper conduct in defense and university programs.3

The definition of social responsibility that appears in Chapter 1 incorporates society’s expectations and includes four levels of concern: economic, legal, ethical, and philanthropic. Because ethics is becoming an increasingly important issue in business today, this chapter and Chapter 6 are devoted to exploring this dimension of social responsibility. First, we define business ethics, examine its importance from an organizational perspective, and review its foundations. Next, we define ethical issues in business to help understand areas of risk. We then look at the individual, organizational, and opportunity factors that influence ethical decision- making in the workplace. We conclude by examining requirements for developing an ethical organizational culture.

THE NATURE OF BUSINESS ETHICS Business decisions can be both acceptable and beneficial to society. It is necessary to examine business ethics to understand decisions made in the context of an organizational culture. The term ethics relates to choices and judgments about acceptable standards of conduct that guide the behavior

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Chapter 5  Business Ethics and Ethical Decision-Making 155

of individuals and groups. These standards require both organizations and individuals to accept responsibility for their actions and to comply with established principles, values, and norms. Without a shared view of which values and norms are appropriate and acceptable, companies will not have consistency in decisions, with individuals differing in how they resolve issues. Building an ethical culture results in shareholder loyalty and can contribute to success that supports even broader social causes and concerns. Director of Sustainability at the Verdigris Group, Garratt Hasenstab, has stated regarding its corporate social responsibility initia- tives that “the true value we receive from our ongoing initiatives is that of social good will—we believe that setting a good example is the greatest benefit.”4 Society has developed rules—both legal and implied—to guide companies in their efforts to earn profits through means that do not bring harm to individuals or to society at large.

Business ethics comprises the principles and standards that guide the behavior of individuals and groups in the world of business. Most defini- tions of business ethics relate to rules, standards, and principles regarding what is right or wrong in specific situations. Principles are specific and per- vasive boundaries for behavior that are universal and absolute. Principles often become the basis for rules. Some examples of principles include freedom of speech, principles of justice, and equal rights to civil liberties. Values are used to develop norms that are socially enforced. Integrity, accountability, and trust are examples of values. Investors, employees, customers, interest groups, the legal system, and the community often determine whether a specific action is right or wrong, ethical or unethical. Although these groups are not necessarily “right,” their judgments influ- ence society’s acceptance or rejection of a business and its activities.

Managers, employees, consumers, industry associations, government regulators, business partners, and special interest groups all contribute to these conventions, and they may change over time. The most basic of these standards have been codified as laws and regulations to encourage companies to conform to society’s expectations of business conduct. As we said in Chapter 4, public concerns about accounting fraud and conflicts of interest in the securities industry led to the passage of the Sarbanes-Oxley Act to restore the public’s trust in the stock market.

It is vital to recognize that business ethics goes beyond legal issues. Ethical business decisions foster trust in business relationships, and as we discussed in Chapter 1, trust is a key factor in improving productivity and achieving success in most organizations. When companies deviate from the prevailing standards of industry and society, the result is customer dis- satisfaction, lack of trust, and lawsuits.

Some businesspeople choose to behave ethically because of enlight- ened self-interest, or the expectation that “ethics pays.” They want to act responsibly and assume that the public and customers will reward the company for its ethical actions. For example, Patagonia began donating one percent of their sales to environmental causes and encourages cus- tomers not to buy their products if they do not need them. While these

business ethics The principles and standards that guide the behavior of individuals and groups in the world of business.

principles Specific and pervasive boundaries for behavior that are universal and ab- solute and often form the basis for rules.

values Norms that are socially enforced, such as integrity, accountability, and trust.

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activities have the potential to negatively affect the company’s sales, con- sumers value Patagonia’s responsible message and opt to support them over other outdoor retailers, which could increase long-run profitability.5

FOUNDATIONS OF BUSINESS ETHICS Because all individuals and groups within a company may not have embraced the same set of values, there is always the possibility of ethical conflict. Most ethical issues in an organizational context are addressed openly whenever a policy, code, or rule is questioned. Even then, it may be hard to distinguish between the ethical issue and the legal means used to resolve it. Because it is difficult to draw a boundary between legal and ethical issues, all questionable issues need an organizational mechanism for resolution.

The legal ramifications of some issues and situations may be obvi- ous, but questionable decisions and actions more often result in disputes that must be resolved through some type of negotiation or even litigation. Companies that sell e-cigarettes, for instance, may be subject to such risks similar to traditional tobacco firms. The FDA has issued tough new rules for e-cigarettes that bans selling to minors, requires warning labels on packaging, and having all e-cigarette products undergo government approval. Some argue that these restrictions are too cumbersome in terms of cost for businesses, particularly in light of the fact that many tobacco users have reduced or eliminated their dependence on the drug as a result of switching to e-cigarettes. On the other hand, many say these devices are targeted toward youth since they offer flavors such as chocolate and bubblegum, which are likely to attract this demographic and get them dab- bling with tobacco products.6 Such highly publicized issues strengthen the perception that ethical standards in business need to be raised.

When ethical disputes wind up in court, the costs and distractions associated with litigation can be devastating to a business. In addition to the compensatory or nominal damages actually incurred, punitive damages may be imposed on a company that is judged to have acted improperly to punish the firm and to send an intimidating message to others. The legal system, therefore, provides a formal venue for businesspeople to resolve ethical as well as legal disputes; in fact, many of the examples we cite in this chapter had to be resolved through the courts. To avoid the costs of litigation, companies should develop systems to monitor complaints, sug- gestions, and other feedback from stakeholders. In many cases, issues can be negotiated or resolved without legal intervention. Strategic responsibil- ity entails systems for listening to, understanding, and effectively managing stakeholder concerns.7

A high level of personal morality may not be sufficient to prevent an individual from violating the law in an organizational context in which even experienced attorneys debate the exact meaning of the law. Because it is impossible to train all the members of an organization as lawyers,

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Chapter 5  Business Ethics and Ethical Decision-Making 157

the identification of ethical issues and the implementation of standards of conduct that incorporate both legal and ethical concerns are the best approaches to preventing crime and avoiding civil litigation. Codifying ethical standards into meaningful policies that spell out what is and is not acceptable gives businesspeople an opportunity to reduce the probability of behavior that could create legal problems. Without proper ethical train- ing and guidance, it is impossible for the average business manager to understand the exact boundaries for illegal behavior in the areas of prod- uct safety, price fixing, fraud, collusion, copyright violations, and so on. For example, the largest technology companies, including Google, Apple, Intel, and Adobe, were charged in a class-action suit regarding collusion on employee wages. The claim stated that the executives of all companies agreed not to recruit the others’ employees for a number of years, the effect of which was a suppression of wages. The companies settled the lawsuit for $415 million.8

Although the values of honesty, respect, and trust are often assumed to be self-evident and universally accepted, business decisions involve complex and detailed discussions in which correctness may not be so clear-cut. Both employees and managers need experience within their specific industry to understand how to operate in gray areas or to handle close calls in evolving areas. Warren Buffett and his company Berkshire Hathaway command significant respect from investors because of their track record of financial returns and the integrity of their organizations. Buffett says, “I want employees to ask themselves whether they are willing to have any contemplated act appear the next day on the front page of their local paper—to be read by their spouses, children and friends—with the reporting done by an informed and critical reporter.” The high level of accountability and trust Buffett places in employees translates into investor trust and confidence.9

Many people with limited business experience suddenly find them- selves required to make decisions about product quality, advertising, pricing, sales techniques, hiring practices, privacy, and pollution control. For example, how do advertisers know when they are making mislead- ing statements in advertising versus “puffery”? Bayer is “the world’s best aspirin,” Snapple “made from the best stuff on earth,” and Firestone (before recalling 6.5 million tires) promised “quality you can trust.”10 The personal values learned through non-work socialization from family, religion, and school may not provide specific guidelines for these complex business decisions. In other words, a person’s experiences and decisions at home, in school, and in the community may be quite different from the experiences and the decisions he or she has to make at work. Moreover, the interests and values of individual employees may differ from those of the company in which they work, from industry standards, and from the society in general. When personal values are inconsistent with the con- figuration of values held by the work group, ethical conflict may ensue. It is important that a shared vision of acceptable behavior develop from an organizational perspective to cultivate consistent and reliable relationships

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158 Business and Society

with all concerned stakeholders. A shared vision of ethics that is part of an organization’s culture can be questioned, analyzed, and modified as new issues develop. However, business ethics should relate to work environ- ment decisions and should not control or influence personal ethical issues.

Recognizing an Ethical Issue Although we have described a number of relationships and situations that may generate ethical issues, it can be difficult to recognize specific ethical issues in practice. Failure to acknowledge ethical issues is a great danger in any organization, particularly if business is treated as a game in which ordinary rules of fairness do not apply. Sometimes, people who take this view do things that are not only unethical but also illegal to maximize their own position or boost the profits or goals of the orga- nization.

Figure 5.1 identifies the frequency of misconduct observed by employees in different countries. In the 2016 global survey on workplace misconduct, 30 percent of U.S. employees noted observing misconduct at work. This is down from 55 percent in 2007. This figure shows how important it is to have a comprehensive ethics and compliance program in place to assess risk and to reduce instances of personal misconduct. These data provide evidence that the institution of an ethical organizational culture has a posi- tive impact on business.

However, just because an unsettled situation or activity is an ethical issue does not mean the behavior is necessarily unethical. An ethical issue

FIGURE 5.1 Employee Observed Misconduct in the Workplace

Source: Ethics and Compliance Initiative, 2016 Global Business Ethics SurveyTM: Measuring Risk and Promoting Workplace Integrity (Arlington, VA: Ethics and Compliance Initiative, 2016), p. 31-43.

0%

5%

10%

15%

20%

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30%

35%

40%

45%

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ly

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ico

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a

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at es

Observed Misconduct

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Chapter 5  Business Ethics and Ethical Decision-Making 159

may relate to a situation, a problem, or even an opportunity that requires thought, discussion, or investigation to determine the potential impact of the decision. Because the business world is dynamic, new ethical issues are emerging all the time.

One way to determine whether a specific behavior or situation has an ethical component is to ask other individuals in the business for feed- back and guidance, or approval/disapproval of your decision. Another way is to determine whether the organization has adopted specific poli- cies or whether there are legal ramifications. An activity approved of by most members of an organization, if it is also customary in the industry, is probably ethical. An issue, activity, or situation that can withstand open discussion between many stakeholders, both inside and outside the organization, and survive untarnished probably does not pose a threat. For instance, it is a common legal practice for medical device manufacturers to have close relationships with medical practitioners, which often include monetary transactions. However, the nature of these relationships may concern outside stakeholders, especially when devices are found to malfunction and cause patients harm. Johnson & Johnson had such an experience with one of their medical devices, and it was found that some internal conversations about the language of marketing materials were changed to increase sales, potentially mislead- ing physicians.11

ETHICAL ISSUES IN BUSINESS An ethical issue is a problem, situation, or opportunity requiring an individual, group, or organization to choose among several actions that must be evaluated as right or wrong, ethical or unethical. Surveys can render a useful overview of the many unsettled ethical issues in business. A constructive step toward identifying and resolving ethical issues is to classify the issues relevant to most business organizations. In this section, we examine ethical issues related to abusive behavior, misuse of company resources, conflict of interest, bribery, discrimination and sexual harass- ment, fraud, and privacy issues.

Although not all-inclusive or mutually exclusive, these classifications provide an overview of some major ethical issues that business decision- makers face. Table 5.1 provides statistics on organizational misconduct in the United States. Putting one’s own interests ahead of the organization, abusive behavior, and lying to employees are all personal in nature. Abusive behavior, lying to employees, and conflict of interest are three major issues that directly relate to the firm’s agenda.

Although Table 5.1 documents some ethical issues that exist in global organizations, due to the almost infinite number of ways that misconduct can occur, we cover only the major organizational ethical issues. Any type of manipulation, deceit, or the absence of transparency in decision-making can create harm to others.

ethical issue A problem, situation, or opportunity requiring an individual, group, or orga- nization to choose among several actions that must be evaluated as right or wrong, ethical or unethical.

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TABLE 5.1 Organizational Misconduct in the United States

Misconduct Facts Percentages Observed misconduct 30%

Abusive behavior 22%

Lying to stakeholders 22%

Conflict of interest 19%

Pressure to compromise standards 22%

Report observed misconduct 76%

Experience retaliation for reporting 53%

Source: Ethics and Compliance Initiative, 2016 Global Business Ethics SurveyTM: Measuring Risk and Promoting Workplace Integrity (Arlington, VA: Ethics and Compliance Initiative, 2016), p. 43.

Abusive or Intimidating Behavior Abusive or intimidating behavior is the most common ethical problem for employees, but what does it mean to be abusive or intimidating? The con- cepts can mean anything from physical threats, false accusations, annoying a coworker, profanity, insults, yelling, harshness, and ignoring someone to the point of being unreasonable, and the meaning of these words are sub- jective and can vary from person to person. It is important to understand that each term falls along a continuum. For example, what one person may define as yelling might be another’s definition of normal speech. Civility in our society has been a concern, and the workplace is no exception. The productivity level of many organizations has declined on account of the time spent unraveling abusive relationships.

Within the concept of abusive behavior, intent should be a consid- eration. If the employee was trying to convey a compliment when the comment was considered abusive, then it was probably a mistake. The way a word is spoken (voice inflection) can be important. Add to this the fact that we now live in a multicultural environment doing business and working with many different cultural groups and the businessperson soon realizes the depth of the ethical and legal issues that may arise. There are problems of word meanings across different age-groups and cultures. For example, an expression such as, “Did you guys hook up last night?” can have various meanings, including some that could be considered offensive in a work environment.

Misuse of Company Time and Resources Theft of time is estimated to cost companies hundreds of billions of dol- lars annually. It is estimated that the average employee “steals” more than ten hours per week with late arrivals, long lunch breaks, leaving early, daydreaming, excessive socializing, engaging in personal activities, and using social networking sites such as Facebook.12 The misuse of time and

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Chapter 5  Business Ethics and Ethical Decision-Making 161

resources has been identified by the Ethics Resource Center as a major form of observed misconduct. In one survey, 31 percent of respondents observed others misusing company time, and 17 percent observed com- pany resource abuse such as theft of office supplies. Therefore, nearly 50 percent noted misconduct related to resource issues. When enforcement is lax or non-existent, employees may get the impression that they are entitled to certain company resources.

Using company computer equipment for personal business is a common way employees engage in time theft. While employees might recognize that spending the workday talking with friends and relatives is unacceptable, they might not hesitate to go online and do the same thing. Typical examples of misusing company computers include sending personal emails, socializing on Facebook, shopping on Amazon or eBay, downloading music, doing personal banking, or watching sporting events online. Many employees, for instance, engage in time theft during March Madness during the NCAA basketball tournament. As a result, many organizations block websites where employees can watch sports events. Some even block sites such as Netflix and Pandora to prevent employees from watching video clips or streaming music.

To deter this type of misconduct, many organizations implement poli- cies describing the acceptable use of such resources. For example, Boeing’s code of ethics states that resource use is acceptable when it does not result in “significant added costs, disruption of business processes, or any other disadvantage to the company.” The policy states that use of company resources for non-company purposes is only acceptable when an employee receives permission to do so.13

Conflict of Interest A conflict of interest exists when an individual must choose whether to advance his or her own interests, those of his or her organization, or those of some other group. Investment manager BlackRock agreed to pay $12 million after failing to report a conflict of interest. One of its portfolio managers was running an energy company that partnered with a coal firm. The coal firm eventually became the largest holding in a fund the manager ran for BlackRock. BlackRock also agreed to allow an independent com- pliance consultant to conduct a review of its policies.14

To avoid conflicts of interest, employees must be able to separate their private interests from their work roles. Organizations, too, must avoid potential conflicts of interest in providing goods or services. Environmental organization Sierra Club requested documents from the U.S. State Department regarding the hiring of Environmental Resources Management, a contractor set to work on the Keystone XL pipeline. The documents reveal several conflicts of interest as many of its consultants also work for companies that benefit greatly from the completion of the pipeline. It was found that the company did not disclose these issues nor did it appear that the U.S. government investigated them.15

conflict of interest An issue that arises when an individual must choose whether to advance his or her own interests, those of his or her organization, or those of some other group.

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Bribery Bribery is the practice of offering something, such as money, gifts, enter- tainment, and travel, in order to gain an illicit advantage from someone in authority. The definition of bribery depends upon whether the illicit payment or favor is used to gain an advantage in a relationship. In many developed countries, society generally recognizes that employees should not accept bribes or special favors from people who could influence the outcome of a decision. However, bribery is an acceptable way of doing business in other countries. The U.S. Securities and Exchange Commission has cracked down on cases of bribery involving hundreds of companies. One investigation resulted in pharmaceutical firm Novartis agreeing to pay $25 million to settle allegations that it bribed health care providers in China.16

Bribery can be considered an unlawful act, but in some cultures bribing business or government officials with fees is considered standard practice. In this case, bribery becomes a business ethics issue. Bribes have led to the downfall of many managers, legislators, and government officials. The World Bank estimates that more than $1 trillion is paid annually in bribes.17

When a government official accepts a bribe, it is usually from a busi- ness that seeks some advantage, perhaps to obtain business or the oppor- tunity to avoid regulation. Giving bribes to legislators or public officials, then, is both a legal and a business ethics issue. It is a legal issue in the United States under the U.S. Foreign Corrupt Practices Act (FCPA). This act maintains that it is illegal for individuals, firms, or third parties doing business in American markets to “make payments to foreign government officials to assist in obtaining or retaining business.”18 Companies have paid billions of dollars in fines to the Department of Justice for bribery violations. The law applies not only to American firms but to all firms transacting business with operations in the United States. This also means that firms do not necessarily have to commit bribery in the United States to be held accountable.

The United Kingdom Bribery Act passed in 2010 is similar to the FCPA but more encompassing. For instance, while the FCPA applies to bribing foreign government officials, the U.K. Bribery Act holds people or businesses responsible for commercial bribery as well. The first cases con- victed under the U.K. Bribery Act were acts of commercial bribery commit- ted largely by individuals, such as a student who tried to bribe a professor to pass him. The Act also does not allow for facilitation payments or small payments to get normal services performed. Like the FCPA, any organiza- tion is subject to the U.K. Bribery Act if it has operations in the United Kingdom, no matter where the bribery occurred.

Discrimination and Sexual Harassment Discrimination remains a significant ethical issue in business despite nearly 50 years of legislation to outlaw it. Once dominated by white men, today’s

bribery The practice of offering something, such as money, gifts, entertainment, and travel, in order to gain an illicit advantage from some- one in authority.

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U.S. workforce includes significantly more women, African Americans, Hispanics, and other minorities, as well as workers with disabilities and older workers. Experts project that within the next 30 years, Hispanics will represent 30 percent of the population, while African Americans and Asians/Pacific Islanders will make up 15 and 9.2 percent, respectively.19 These groups have traditionally faced discrimination and higher unem- ployment rates and have been denied opportunities to assume leadership roles in corporate America.

The most significant piece of legislation against discrimination is Title VII of the Civil Rights Act of 1964, which prohibits employment discrimi- nation on the basis of race, national origin, color, religion, and gender, and applies to employers with 15 or more employees, including state and local governments. This law is fundamental to employees’ rights to join and advance in an organization according to merit rather than one of the characteristics just mentioned. As a result of racial discrimination class- action settlements, some companies, such as Coca-Cola, were required to establish an independent task force to monitor and modify company practices to combat racial discrimination.

Additional laws passed in the 1970s, 1980s, and 1990s were designed to prohibit discrimination related to pregnancy, disabilities, age, and other factors. The Americans with Disabilities Act, for example, prohibits companies from discriminating on the basis of physical or mental disabil- ity in all employment practices and requires them to make facilities acces- sible to and usable by persons with disabilities. The Age Discrimination in Employment Act specifically outlaws hiring practices that discriminate against people ages 40 or older, but it also bans policies that require employees to retire before the age of 70. Despite this legislation, charges of age discrimination persist in the workplace. Currently, about half of the United States workforce is 40 or older. This is a large segment of the workplace, and naturally age discrimination lawsuits are prevalent. In a 5-4 split ruling, the U.S. Supreme Court ruled to make it more difficult for workers to claim age discrimination in lawsuits. Now employees must be able to prove that their employers terminated them for age-related reasons. Because this is a difficult thing to prove for certain, the ruling sig- naled a major coup for employers. The ruling was part of a case brought to trial by Jack Gross, who at 54 was demoted from a director position by his employer FBL Financial Group.20 Given that more than 25 percent of the nation’s workers will be 55 years old or over by 2020, many com- panies need to change their approach toward older workers.21

Sexual harassment is a form of sex discrimination that violates Title VII of the Civil Rights Act of 1964. Sexual harassment can be defined as any repeated, unwanted behavior of a sexual nature perpetrated upon one individual by another. It may be verbal, visual, written, or physical and can occur between people of different genders or those of the same gender. Displaying sexually explicit materials “may create a hostile work environment or constitute harassment, even though the private posses- sion, reading, and consensual sharing of such materials is protected under

sexual harassment Any repeated, unwanted behavior of a sexual nature perpetrated upon one in- dividual by another; it may be verbal, visual, written, or physical and can occur between people of different genders or those of the same gender.

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the Constitution.”22 The Equal Employment Opportunity Commission (EEOC), the institution that monitors compliance with Title VII, in one year received 6,822 charges of sexual harassment, of which men filed over 17 percent. In the same year, the EEOC resolved 7,289 sexual harassment charges and recovered $46 million in penalties.23

To establish sexual harassment, an employee must understand the definition of a hostile work environment, for which three criteria must be met: (1) the conduct was unwelcome; (2) the conduct was severe, pervasive, and regarded by the claimant as so hostile or offensive as to alter his or her conditions of employment; and (3) the conduct was such that a reasonable person would find it hostile or offensive. To assert a hostile work environment, an employee need not prove that it seriously affected his or her psychological well-being or that it caused an injury; the decisive issue is whether the conduct interfered with the claimant’s work performance.24

Fraud When an individual engages in deceptive practices to advance his or her own interests over those of the organization or some other group, charges of illegal fraud may result. In general, fraud is any false communication that deceives, manipulates, or conceals facts to create a false impression when others are damaged or denied a benefit. It is considered a crime, and convictions may result in fines, imprisonment, or both. Employee expense fraud alone is estimated to cost businesses more than $2.8 billion annually.25 Among the most common fraudulent activities reported by 40 percent of employees are embezzlement, offshore financial accounts, and stealing money or products.26 Table 5.2 indicates what fraud examiners view as the biggest risks to companies. In recent years, accounting fraud has become a major ethical issue, but fraud can also relate to marketing and consumer issues as well. Online fraud is also a large concern and is growing as internet use expands.27

Privacy The final category of ethical issues relates to privacy, especially within the health-care and internet industries. Some privacy issues that busi- nesses must address include the monitoring of employees’ use of avail- able technology, consumer privacy, and online marketing. Companies often use cookies or other devices to engage in online tracking, and many websites use consumer information to improve services. Although this can benefit consumers in the form of better marketing and tailored searches, it is also controversial because many consumers do not want their information being tracked. Others are still willing to provide per- sonal information despite the potential risks.28

The challenge for today’s firms is balancing their need for con- sumer or employee information with the desire for privacy. In terms of

hostile work environment A kind of work environ- ment where the conduct is: unwelcome; severe and hostile as to affect condi- tions of employment; and offensive to a reasonable person.

fraud Any false communication that deceives, manipulates, or conceals facts to create a false impression when oth- ers are damaged or denied a benefit.

privacy issues Issues that businesses must address that include the monitoring of employees’ use of available technol- ogy, consumer privacy, and online marketing.

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employees, there are few legal protections for their right to privacy, giving businesses flexibility in establishing policies regarding employee privacy while using company equipment on company property. Some common ways that an employer might track employee use of equipment is through computer monitoring, telephone monitoring, video surveillance, and GPS satellite tracking. Although employers have the right to make sure their resources are being used for appropriate purposes, the ability to gather and use data about employee behavior creates the need for trust and responsibility.

There are two issues involving consumer privacy: consumer awareness of information collection and a growing lack of consumer control with respect to how organizations use their personal information. For exam- ple, many are not aware that Google, Inc., reserves the right to track each time you click on a link from one of its searches.29 Online purchases and random web surfing can be tracked without a consumer’s knowledge. The Progress and Freedom Foundation found that 96 percent of popular commercial websites collect personally identi- fying information from visitors.30

However, consumer information is valuable not only to businesses but to criminals as well. An identity is sto- len approximately once every three seconds.31 Criminals may try to steal personal consumer information and sell it online. Some of this information comes from publicly accessible sources such as social networking profiles, but poorly protected corporate files are another major source for criminals. In one year, 90 percent of large U.K. organi- zations reported security breaches.32

To reassure consumers that their information will be protected, an increasing number of companies are display- ing an online seal from the Better Business Bureau avail- able to sites that subscribe to certain standards. A similar seal is provided through TRUSTe, a nonprofit global initiative. These seals assure customers that the websites adhere to certain policies meant to protect their privacy.

UNDERSTANDING THE ETHICAL DECISION-MAKING PROCESS To grasp the significance of ethics in business decision-making, it is impor- tant to understand how ethical decisions are made within the context of an organization. Understanding the ethical decision-making process can help individuals and businesses design strategies to deter misconduct. Our

TABLE 5.2 Greatest Fraud Risk to Companies

Source: Association of Certified Fraud Examiners, Report to the Nations on Occupational Fraud and Abuse, 2016, https://s3-us-west-2.amazonaws.com/ acfepublic/2016-report-to-the-nations.pdf (accessed June 17, 2016). .

Corruption 35.4%

Conflicts of interrest

Purchasing schemes

Sales schemes

Bribery

Invoice kickbacks

Bid rigging

Illegal gratuities

Economic Extortion

Asset Misappropriation 83.5%

Theft of cash on hand

Theft of cash receipts

Skimming

Cash larceny

Fraudulent disbursements

Billing schemes

Payroll schemes

Expense reimbursement schemes

Expense reimbursement schemes

Check tampering

Register disbursements

Inventory and all other assets

Misuse

Larceny

Financial Statement Fraud 9.6%

Net worth/net income overstatements

Net worth/net income understatements

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descriptive approach to understanding ethical decision-making does not prescribe what to do but, rather, provides a framework for managing ethi- cal behavior in the workplace. Figure 5.2 depicts this framework, which shows how individual factors, organizational relationships, and opportu- nities interact to determine ethical decisions in business.

Individual Factors Individuals make ethical choices on the basis of their own concepts of right or wrong, and they act accordingly in their daily lives. Studies sug- gest that individual ethics are reaching a new low. A Josephson Institute Center for Youth Ethics survey of teens showed that 95 percent feel trust and honesty are necessary in the workplace. In addition to this, 36 percent of those surveyed feel it is sometimes necessary to lie and cheat in order to succeed. More than one-fourth of the respondents confessed to cheat- ing on a test more than once. While this survey indicates teens are more concerned about ethics when compared with a similar survey from two years prior, these results show that more needs to be done to teach teens about the importance of ethical decision-making.33 If today’s students are tomorrow’s leaders, there is likely to be a correlation between acceptable behavior today and tomorrow, adding to the argument that the leaders of today must be prepared for the ethical risks associated with acceptance of unethical behavior.

Significant factors that affect the ethical decision-making process include an individual’s personal moral philosophy, motivation, and other personal factors such as gender, age, and experience.

Ethical Theories Many people have justified difficult decisions by citing the golden rule (“Do unto others as you would have them do unto you”) or some other principle. Such principles, or rules, which individuals apply in deciding

FIGURE 5.2 Factors That Influence the Ethical Decision-Making Process

Individual Factors

Organizational Relationships

Opportunity

Ethical or Unethical Decisions

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Chapter 5  Business Ethics and Ethical Decision-Making 167

what is right or wrong, are often referred to as moral philosophies. Mor- als refers to the individuals’ philosophies about what is right or wrong. It is important to understand the distinction between moral philosophies and busi- ness ethics. A moral philosophy is a person’s principles and values that define what is moral or immoral. Moral philosophies are person-specific, whereas business ethics is based on decisions in groups or those made when carrying out tasks to meet business objectives. In the context of business, ethics refers to what the group, firm, or strategic business unit (SBU) defines as right or wrong actions pertaining to its business operations and the objective of prof- its, earnings per share, or some other financial measure of success. Socializa- tion by family members, social groups, religion, and formal education teaches moral philosophies. This concept is particularly important to the concept of social exchange theory, which states that social behavior is determined by social exchanges between different parties. Most moral philosophies can be classified as consequentialism, ethical formalism or deontology, or justice.

Consequentialism is a class of moral philosophy that considers a deci- sion right or acceptable if it accomplishes a desired result, such as career growth, the realization of self-interest, or utility in a decision. This looks at the moral outcome based on the consequences associated with decision- making. Egoism and utilitarianism are two important consequentialist philosophies that often guide decision-making in business.

Egoism is a philosophy that defines right or acceptable conduct in terms of the consequences for the individual. Egoists believe they should make decisions that maximize their own self-interest, which, depending on the individual, may be defined as career success, power, fame, a satisfying career, a good family life, wealth, and so forth. In a decision-making situ- ation, the egoist will probably choose the alternative that most benefits his or her self-interest. Many people feel that egoists are inherently unethical, that they focus on the short term, and that they will take advantage of any opportunity to exploit consumers or employees.

Utilitarianism is another consequentialist philosophy that is concerned with seeking the greatest good for the greatest number of people. Using a cost-benefit analysis, a utilitarian decision-maker calculates the utility of the consequences of all possible alternatives and then chooses the one that achieves the greatest utility.

In contrast with consequentialism, ethical formalism or deontology is a class of moral philosophy that focuses on the rights of individuals and on the intentions associated with a particular behavior rather than on its con- sequences. This theory falls under what is known as the rights-based ethics. Deontologists regard certain behaviors as inherently right, and their deter- mination of rightness focuses on the individual actor, not on society. Thus, these perspectives are sometimes referred to as nonconsequentialism and the ethics of respect for persons. Contemporary ethical formalism has been greatly influenced by German philosopher Immanuel Kant, who developed the so-called categorical imperative: “Act as if the maxim of thy action were to become by thy will a universal law of nature.”34 Unlike utilitarians, ethi- cal formalists contend that there are some things that people should not do,

moral philosophies Principles, or rules, which individuals apply in deciding what is right or wrong; morals refers to the indi- viduals’ philosophies about what is right or wrong.

social exchange theory This concept is particularly important to the concept of social exchange theory, which states that social behavior is determined by social exchanges between different parties.

consequentialism A class of moral philosophy that considers a decision right or acceptable if it ac- complishes a desired result, such as career growth, the realization of self-interest, or utility in a decision.

egoism A philosophy that defines right or acceptable conduct in terms of the consequenc- es for the individual.

utilitarianism A consequentialist philoso- phy that is concerned with seeking the greatest good for the greatest number of people.

ethical formalism A class of moral philosophy that focuses on the rights of individuals and on the intentions associated with a particular behavior rather than on its consequences.

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even to maximize utility. For example, an ethical formalist would consider it unacceptable to allow a coalmine to continue to operate if some work- ers became ill and died of black lung disease. A utilitarian, however, might consider some disease or death an acceptable consequence of a decision that resulted in large-scale employment and economic prosperity.

Justice theory is a class of moral philosophy that relates to evaluations of fairness, or the disposition to deal with perceived injustices of others. Justice demands fair treatment and due reward in accordance with ethical or legal standards. A similar concept is the Principle of Equal Freedom, which asserts that all persons must have equality under the law. In business, this requires that the rules an individual uses to determine justice be based on the perceived rights of individuals and on the intentions associated with a business interaction. Justice, therefore, is more likely to be based on non- consequentialist moral philosophies than on consequentialist philosophies. Justice primarily addresses the issue of what individuals feel they are due based on their rights and performance in the workplace. For example, the U.S. Equal Employment Opportunity Commission exists to help employees who suspect the injustice of discrimination in the workplace.

There are three types of justice that can be used to assess fairness in different situations. Distributive justice evaluates the outcomes or results of a business relationship. For example, if an employee feels that she is paid less than her coworkers for the same work, she has concerns about distributive justice. Procedural justice assesses the processes and activities employed to produce an outcome or results. Procedural justice concerns about compensation would relate to the perception that salary and benefit decisions are consistent and fair to all categories of employees. Procedural justice is associated with group cohesiveness and helping behaviors.35 Interactional justice evaluates the communication processes used in the business relationship. Being untruthful about the reasons for missing work is an example of an interactional justice issue.36

It is important to recognize that there is no one “correct” moral philos- ophy to apply in resolving ethical and legal issues in the workplace. It is also important to acknowledge that each philosophy presents an ideal perspec- tive and that most people seem to adapt a number of moral philosophies as they interpret the context of different decision-making situations. Each philosophy could result in a different decision in a situation requiring an ethical judgment. And depending on the situation, people may even change their value structure or moral philosophy when making decisions.37

Strong evidence shows that individuals use different moral philoso- phies depending on whether they are making a personal decision outside the work environment or making a work-related decision on the job.38 Two possible reasons may explain this. First, in the business arena, some goals and pressures for success differ from the goals and pressures in a per- son’s life outside of work. As a result, an employee might view a specific action as “good” in the business sector but “unacceptable” in the non- work environment. Business has two variables that are absent from other situations: the profit motive and the influence of managers and coworkers

justice theory A class of moral philosophy that relates to evaluations of fairness, or the disposi- tion to deal with perceived injustices of others.

Principle of Equal Freedom A similar concept is the Principle of Equal Free- dom, which asserts that all persons must have equality under the law.

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(corporate culture). The weights on the various factors that make up a person’s moral philosophy are shifted in a business (profit) situation. The statement “it’s not personal, it’s just business” demonstrates the conflict businesspeople can have when their personal values do not align with util- itarian or profit-oriented decisions. In extreme cases, this mentality could become Machiavellian in nature. Machiavellianism in business is the use of duplicity or cunning to achieve business goals. The second reason peo- ple change moral philosophies could be the corporate culture where they work. When a child enters school, for example, he or she learns certain rules such as raising your hand to speak or asking permission to use the restroom. So it is with a new employee. Rules, personalities, and historical precedence exert pressure on the employee to conform to the new firm’s culture. As this occurs, the individual’s moral philosophy may change to be compatible with the work environment. The employee may alter some or all of the values within his or her moral philosophy as he or she shifts into the firm’s different moral philosophy. There are many examples of people who are known for their goodness at home or in their communities making unethical decisions in the workplace.

Ethical Diversity It is obvious that not everyone holds the same ethical val- ues. One person may have values that another person does not have, or that person might value a certain trait more highly than another. Additionally, individuals can have significantly different values than those of the organiza- tion.39 This concept is referred to as ethical diversity. Ethical diversity refers to the fact that employee values often differ from person to person. Every employee has developed his or her personal values over a lifetime, and these values are not likely to disappear just because they differ from others or the organization. However, it also means that employees cannot be allowed to bring their individual values to the workplace as they see fit. Imagine the chaos that would happen if each employee acted in a way that was appro- priate in his or her eyes. Instead, members need to accept that some values are superior to others and handle the organizational need to develop con- sensus among employees. This may result in possible tensions and conflicts that must be figured out between individual and organizational values.40 However, it is best to follow a consensus approach rather than just having managers assign and enforce their own individual values to the organiza- tion. There should be group discussions, negotiations, and modifications to determine how organizational values are implemented.41

Organizational Relationships Although individuals can and do make ethical decisions, they do not oper- ate in a vacuum.42 Ethical choices in business are most often made jointly in committees and work groups or in conversations with coworkers. Moreover, people learn to settle ethical issues not only from their indi- vidual backgrounds but also from others with whom they associate in the business environment. The outcome of this learning process depends on

machiavellianism In extreme cases, this mentality could become Machiavellian in nature. Machiavellianism in business is the use of duplicity or cunning to achieve business goals.

ethical diversity Refers to the fact that employee values often differ from person to person.

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the strength of each individual’s personal values, opportunity for unethi- cal behavior, and exposure to others who behave ethically or unethically. Consequently, the culture of the organization, as well as superiors, peers, and subordinates, can have a significant impact on the ethical decision- making process.

Organizational Culture Organizational, or corporate, culture can be defined as a set of values, norms, and artifacts shared by members or employees of an organization. It answers questions such as “What is important?” “How do we treat each other?” and “How do we do things around here?” Culture may be conveyed formally in employee hand- books, codes of conduct, memos, and ceremonies, but it is also expressed informally through dress codes, extracurricular activities, and anecdotes. A firm’s culture gives its members meaning and offers direction as to how to behave and deal with problems within the organization. The corporate culture at American Express, for example, includes numerous anecdotes about employees who have gone beyond the call of duty to help custom- ers out of difficult situations. This strong tradition of customer service might encourage an American Express employee to take extra steps to help a customer who encounters a problem while traveling overseas.

Organizational culture depends on company strategy because it priori- tizes stakeholders. For example, Marriott prioritizes employees to provide exceptional service for customers. Therefore, its strategic priority is keeping Marriott as one of the best companies to work for. Walmart, on the other hand, values customers and therefore places a priority on a low cost, effi- cient operating environment. Amazon has developed a culture that focuses on competitors and is making extreme inroads into traditional markets for durable goods sold in stores. Therefore, the company strategy will help shape stakeholder relationships and the ethical culture.

On the other hand, an organization’s culture can also encourage employ- ees to make decisions that others may judge as unethical, or it can encourage actions that may be viewed as socially irresponsible. Some misconduct comes from employees trying to attain the performance objectives of the firm. ethicaWhile high performance objectives are not a bad thing, it is impor- tant for managers to ensure these objectives can be reached without cutting corners or engaging in questionable conduct. Derivatives used in financial markets to transfer risk are so complex, difficult to value, poorly regulated, and have been so widely used that they can bring down a company. They also contributed a great deal to the severity of the most recent recession, challenging our financial systems. To make ethical decisions when using derivatives, one requires a great deal of transparency, financial expertise and competence, and responsibility.43 Because of their complexity, derivatives provide openings for manipulation and misconduct. When a corporation uses certain compensation systems, employees striving for financial success could be inadvertently rewarded for their sales of dangerous derivatives. The corporate culture may drive decisions on developing and selling derivatives because of the difficulty in applying moral reasoning.

organizational, or corporate, culture A set of values, beliefs, and artifacts shared by members or employees of an organization.

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Earth in the Balance

Sources: Paul Sonne, “Unilever Takes Palm Oil in Hand,” The Wall Street Journal, April 24, 2012, http://online.wsj.com/article/SB100014240 52702303978104577362160223536388.html (accessed August 4, 2016); “How It Works,” Green Palm Sustainability, http://www.greenpalm. org/en/what-is-greenpalm/how-it-works (accessed July 1, 2014); “Unilever’s Europe-wide Palm Oil Covered Sustainably,” Unilever, July 4, 2010, http://www.unilever.com/mediacentre/pressreleases/2010/UnileversEuropewidepalmoilcoveredsustainably.aspx (accessed July 1, 2014); Samantha Neary from Triple Pundit, “Unilever Reaches Sustainable Palm Oil Goal Three Years Early,” TodayEco, August 2, 2012, http:// www.triplepundit.com/2012/08/unilever-reaches-sustainable-palm-oil-goal-three-years-early/ (accessed August 4, 2016); Unilever, “Working with Suppliers,” http://www.unilever.com/sustainable-living-2014/reducing-environmental-impact/sustainable-sourcing/sustainable-palm-oil/ working-with-suppliers/index.aspx (accessed July 1, 2014); Voices for Biodiversity, “Consumer Group Slams Greenwashing in Sustainable Palm Oil Marketing,” National Geographic, August 8, 2013, http://newswatch.nationalgeographic.com/2013/08/08/consumer-groups-slam-

Unilever is working toward full sustainability when it comes to palm oil production. The process of extracting palm oil has gained global attention because of unsus- tainable practices such as deforestation, which has led to the destruction of native animal habitats. Because Unilever is a large company that works with an extensive supply chain, maintaining ethical sourcing practices can be a bit of a burden and are hard to track. Yet as the buyer, Unilever is responsible for any unethical sourcing practices in its supply chain.

Unilever is attempting to monitor its supply chain in two ways. First, it has invested $100 million to build a palm oil processing plant in Indonesia, the source of much of its palm oil, to ensure responsible practices. This plant represents a $130 million investment on Unilever’s part. Second, Unilever is purchasing GreenPalm certificates from the Roundtable on Sustainable Palm Oil (RSPO) when it purchases palm oil from other processing compa- nies. Unilever helped to found the RSPO, which monitors the practices of palm oil processing companies and issues them certificates when they meet sustainable, environ- mentally-responsible standards. Belonging to the RSPO is a signal to consumers that Unilever is adhering to a set of strict environmental standards. These certificates can then be purchased by companies like Unilever in an attempt to ensure ethically sourced supply chains. This alleviates some of the skepticism about the origins of the palm oil.

Unilever announced that it had reached its target of purchasing all palm oil from credible sustainable sources by the end of 2012. Unilever was three years ahead of schedule on this projection. The certification was issued

through GreenPalm Certificates. However, this method is not entirely dependable because the processing of all palm oil is not completely traceable. Additionally, some have criticized GreenPalm certificates for their confus- ing language, calling them a type of greenwashing.

However, Unilever is still determined to improve its palm oil sourcing practices. It has developed a Sustainable Palm Oil Sourcing Policy based on three principles: (1) halt deforestation, (2) protect peat land, and (3) drive economic and social impact. It also announced a few sustainability goals it aims to attain in the near future. By 2019 Unilever plans to have all its palm oil and derivatives physically certified. The company has announced that by 2020 all Unilever palm oil will come from sustainable, traceable, and certified sources.

To continue achieving the company’s sustainability goals, Unilever is working directly with producers to purchase segregated supplies of sustainable palm oil to ensure customers they are delivering a sustainable product. The company also wants to ensure that its sup- pliers are being ethical in other ways. For instance, the company has partnered with leading Asian agribusiness group Wilmar International in an agreement to ensure that the company’s farming efforts are free from defor- estation and human rights abuses. With such a large global supply chain, it is important for Unilever to make certain that their suppliers are following other ethical practices as well, such as treating farmers fairly. Despite the difficulty in tracking the sustainability of its palm oil, Unilever’s initiative demonstrates a commitment toward reducing its environmental impact.

Unilever Opens Opportunity in Sustainability Initiatives

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Whereas a firm’s overall culture establishes ideals that guide a wide range of behaviors for members of the organization, its ethical climate focuses specifically on issues of right and wrong. We think of ethical climate as the part of a corporate culture that relates to an organiza- tion’s expectations about appropriate conduct. To some extent, ethi- cal climate is the character component of an organization. Corporate policies and codes, the conduct of top managers, the values and moral philosophies of coworkers, and opportunity for misconduct all contrib- ute to a firm’s ethical climate. When top managers strive to establish an ethical climate based on responsibility and citizenship, they set the tone for ethical decisions.

New Belgium Brewing (NBB) is an example of a company in which the top leaders set the tone for the rest of the organization. Former CEO and current Executive Chair Kim Jordan helped co-found the company with her former husband Jeff Lebesch. Before starting the company, the two carefully considered the values they wanted to use as the founda- tion for the company. These values included sustainability and employee empowerment. Under Jordan’s leadership, New Belgium’s ethical climate placed a great deal of emphasis on these two values. Among a number of sustainability initiatives, New Belgium became the first brewery to use 100 percent wind power. Over the years, NBB has become a 100 percent employee-owned company, giving employees the ability to make crucial decisions regarding company operations. Ethical climate also determines whether an individual perceives an issue as having an ethical component. Recognizing ethical issues and generating alternatives to address them are manifestations of ethical climate.

Significant Others Significant others include superiors, peers, and sub- ordinates in the organization who influence the ethical decision-making process. Although people outside the firm, such as family members and friends, also influence decision-makers, organizational structure and cul- ture operate through significant others to influence ethical decisions. Ethics and Compliance Initiative, 2016 Global Business Ethics SurveyTM: Mea- suring Risk and Promoting Workplace Integrity (Arlington, VA: Ethics and Compliance Initiative, 2016), p. 43.44 Reporting misconduct is most likely to come from upper levels of management compared to lower level supervi- sors and non-management employees. Employees in lower level positions have a greater tendency to not understand misconduct or to be complacent about the misconduct they observe. While other options like ethics officers

ethical climate That part of the firm’s culture that focuses specifi- cally on issues of right and wrong.

significant others Include superiors, peers, and subordinates in the organization who influence the ethical decision-making process.

greenwashing-in-sustainable-palm-oil-marketing/ (accessed August 4, 2016); Unilever, “Roundtable on Sustainable Palm Oil,” http://www.unilever.com/sustainable-living-2014/reducing-environmental-impact/ sustainable-sourcing/sustainable-palm-oil/roundtable-on-sustainable-palm-oil/index.aspx (accessed July 1, 2014); Unilever, “Sustainable Palm Oil,” http://www.unilever.com/sustainable-living-2014/reducing-envi- ronmental-impact/sustainable-sourcing/sustainable-palm-oil/ (accessed July 1, 2014); Unilever, “Unilever Sustainable Palm Oil Sourcing Policy -- 2016,” https://www.unilever.com/Images/unilever-palm-oil-poli- cy-2016_tcm244-479933_en.pdf (accessed August 4, 2016).

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Chapter 5  Business Ethics and Ethical Decision-Making 173

and ethics hotlines exist, the vast majority of employees surveyed prefer to report to supervisors and other higher management.

Most experts agree that the CEO establishes the ethical tone for the entire firm. This can be problematic when managers are more likely to engage in certain forms of misconduct. For instance, Figure 5.3 shows that managers are more likely to engage in bribery globally than lower-level employees. Lower level managers obtain their cues from top managers, and they in turn impose some of their personal values on the company. This interaction between corporate culture and executive leadership helps determine the ethical value system of the firm. However, obedience to authority can also explain why many people resolve workplace issues by following the directives of a superior. An employee may feel obligated to carry out the orders of a superior even if those orders conflict with the employee’s values of right and wrong. If that decision is later judged to have been wrong, the employee may justify it by saying, “I was only car- rying out orders” or “My boss told me to do it this way.”

Coworkers’ influence on ethical decision-making depends on the person’s exposure to unethical behavior in making ethical decisions. The more a person is exposed to unethical activity by others in the organiza- tion, the more likely it is that he or she will behave unethically, especially in (ethically) “gray” areas. Thus, a decision maker who associates with others who act unethically is more likely to behave unethically as well. Within work groups, employees may be subject to the phenomenon of “groupthink,” going along with group decisions even when those decisions run counter to their own values. They may rationalize the decision with

FIGURE 5.3 Employees Most Likely to Engage in Bribery Globally

Top manager(s)

Middle manager(s)

First line supervisor(s)

Non-management employee(s)

Public official(s)

Individual(s) outside the organization

23%

32%

19%

16%

5% 4%

SOURCE: Ethics and Compliance Initiative, 2016 Global Business Ethics SurveyTM: Measuring Risk and Promoting Workplace Integrity (Arlington, VA: Ethics and Compliance Initiative, 2016), p. 17.

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“safety in numbers” when everyone else appears to back a particular deci- sion. Most businesspeople take their cues or learn from coworkers how to solve problems—including ethical dilemmas.45 Close friends at work exert the most influence on ethical decisions that relate to roles associated with a particular job.

Superiors and coworkers can create organizational pressure, which plays a key role in creating ethical issues. Although power differences will exist between supervisors and their employees, ethical leaders attempt to reduce these differences when communicating with employ- ees. It is not uncommon for leaders within the organization to adopt the habit of viewing employee information as unimportant.46 However, employees who feel that they are not being heard are less likely to report concerns and more likely to ignore questionable conduct in the workplace. Ethical leaders can help to reduce these perceived power differences through frequent employee communication. This interac- tion creates more beneficial relationships with employees, making them more comfortable in bringing up issues of concern to their supervisors. Leader–follower congruence occurs when leaders and followers share the same organizational vision, ethical expectations, and objectives. A crucial way to communicate ethical values to employees is through codes of ethics and training to familiarize employees with the ethical decision-making process.

Nearly all businesspeople face difficult issues where solutions are not obvious or where organizational objectives and personal ethical values may conflict. For example, a salesperson for a Web-based retailer may be asked by a superior to lie to a customer over the telephone about a late product shipment. A study by the Ethics Resource Center found that 22 percent of U.S. employees said they felt pressure from other employees or managers to compromise standards. In addition, 76 percent of employ- ees reported misconduct after they observed it and 53 percent of these were met with some type of retailiation.47

Opportunity Together, organizational culture and the influence of coworkers may foster conditions that either hinder or permit misconduct. Opportunity is a set of conditions that limits barriers or provides rewards. When these conditions provide rewards—be it financial gain, recognition, promo- tion, or simply the good feeling from a job well done—the opportunity for unethical conduct may be encouraged or discouraged. For example, a company policy that fails to specify the punishment for employees who violate the rules provides an opportunity for unethical behavior because it allows individuals to engage in such behavior without fear of consequences. Thus, company policies, processes, and other factors may create opportunities to act unethically. Advancing technology associated with the internet is challenging companies working to limit opportunities to engage in unethical and illegal behavior. Individual factors as well as

opportunity A set of conditions that limits barriers or provides rewards.

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Chapter 5  Business Ethics and Ethical Decision-Making 175

organizational relationships may influence whether an individual becomes opportunistic and takes advantage of situations in an unethical or even illegal manner.

Opportunity usually relates to employees’ immediate job con- text—where they work, with whom they work, and the nature of the work. This context includes the motivational “carrots and sticks,” or rewards and punishments, that superiors can use to influence employee behavior. Rewards, or positive reinforcers, include pay raises, bonuses, and public recognition, whereas repri- mands, pay penalties, demotions, and even firings act as negative reinforcers. For example, a manager who decides to sell customers’ personal data may be confident that such behavior is an easy way to boost revenue because other companies sell customer account information. Even if this activity violates the employee’s personal value system, it may be viewed as acceptable within the organiza- tion’s culture. This manager may also be motivated by opportuni- ties to thereby improve his or her performance standing within the organization. A survey by Kessler International indicates that 52 percent of employees take office supplies for personal use. As Table 5.3 shows, many employees pilfer office supply rooms for matters unrelated to the job. It is possible that the opportunity is provided for small-scale theft in the company; in some cases, there are no concerns if employees take pens, Post-its, envelopes, notepads, and paper. Printing large documents at work for their own or spouse’s use, or even for their children’s school assignments, is a common form of misconduct. Additionally, some indicated that they take more expensive items such as USB drives, blank disks, and computer accessories.48 If there is no policy against this practice, employees will not learn where to draw the line and will get into the habit of taking even more expensive items for personal use.

Often, opportunity can arise from someone whose job is to create opportunities for others. Barbara Toffler, an ethics consultant and profes- sor, learned firsthand how difficult it can be to follow one’s own moral compass when she worked as a consultant at Arthur Andersen creating ethics programs for Andersen clients (the firm itself had no internal eth- ics program). After charging a client $1 million for developing an ethics program that should have cost $500,000, the praise Toffler earned from Andersen “was the only day in four years that I felt truly valued by Arthur Andersen.” Despite her expertise, she learned that “unethical or illegal behavior happens when decent people are put under the unbearable pres- sure to do their jobs and meet ambitious goals without the resources to get the job done right.”49

General Electric has taken steps to place itself at the head of the ethical pack. Its “ecomagination” campaign is designed to “build innovative solutions for today’s environmental challenges while driv- ing economic growth.” It also has an initiative called “healthymagina- tion,” which aims to improve the quality of healthcare. As part of its

TABLE 5.3 Most Common Office Supplies Stolen by Employees

Source: Bryan Johnston, “Top 10 Most Stolen Office Supplies,” CareerAddict, October 10, 2015, http://www.careeraddict.com/ top-10-most-stolen-office-supplies (accessed June 17, 2016).

1 Post-It notes

2 Paper clips

3 Toilet paper

4 Copier paper

5 Scissors

6 Tape

7 Notepads

8 Staplers

9 Highlighters

10 Pens and pencils

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investment, GE focuses on investigating clean-tech research, releas- ing products that are more eco-friendly, partnering with community health organizations, and continuing employee healthcare efforts.50

If an employee takes advantage of an opportunity to act unethically and is rewarded or suffers no penalty, he or she may repeat such acts as other opportunities arise. Dov Charney, founder and former CEO of American Apparel, was pushed out of his position by the board after allegations con- cerning sexual misconduct and sexual harassment. These allegations had persisted for more than a decade before he was eventually terminated.51 His removal as CEO demonstrates the effectiveness of good corporate gover- nance and the duty of the board of directors to maintain an ethical organi- zational culture. When company managers get away with unethical conduct, their behavior is reinforced and a culture of manipulation and misconduct can develop. Indeed, the opportunity to engage in unethical conduct is often a better predictor of unethical activities than personal values.52

In addition to rewards and the absence of punishment, other elements in the business environment tend to create opportunities. Professional codes of conduct and ethics-related corporate policies also influence opportunity by prescribing what behaviors are acceptable. Compliance programs are neces- sary to provide internal controls to prevent situations just discussed. The larger the rewards and the milder the punishment for unethical behavior, the greater is the probability that unethical behavior will be practiced.

DEVELOPING AN ETHICAL CULTURE Organizational ethics and compliance initiatives are developed to establish appropriate conduct and core values. The term ethical culture refers to the character of the decision-making process employees use to determine if their responses to ethical issues are right or wrong. Ethical culture is that part of corporate culture that encompasses the values and norms an organization defines as appropriate conduct. The goal of an ethical culture is to curtail the need for enforced compliance of rules and amplify the use of principles that contribute to ethical reasoning in complex or new situations. Ethical culture is positively related to orga- nizations with hotlines and with employees who confront ethics issues in the workplace and/or report observed misconduct to management.53 Developing an ethical culture involves communicating organizational values and norms to employees throughout the organization, developing effective ethics programs, and appointing ethics officers to run them. An ethical culture creates shared values and managerial commitment for ethical decisions.

Organizational Values Organizational values are abstract ideals distinct from individual values. Values can evolve over time. They are more subjective and are viewed

ethical culture Refers to the character of the decision-making process employees use to determine if their responses to ethical issues are right or wrong.

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Chapter 5  Business Ethics and Ethical Decision-Making 177

by societal members as ethical or unethical. Values-based practices become the end results and are separate from organizational prac- tices based on technical or efficiency considerations.54

Both stakeholders and the organizational culture impact the development of organizational values. As mentioned earlier, New Belgium Brewing has adopted sustainability as an organizational value. The organizational culture strongly supports this value through initiatives aimed at reducing energy, recycling, and provid- ing employees with mountain bikes after one year of employment. Because values are more subjective, they are influenced by firm, industry, country, and global specific factors.55 For instance, firms from countries that stress individualism might encourage the abil- ity to work independently, whereas firms from more collectivist nations might place more value on teamwork. Additionally, core values might differ depending upon the industry. Although safety is a core value of many firms, it is more likely to be emphasized in a factory environment than in an office environment. For instance, organizations from countries that value risk may value innovative risk taking, while organizations from countries more averse to risk may have a different opinion. Table 5.4 provides an example of the organizational values of Marriot. From its organizational values one can determine that Marriot tries to deliver exceptional customer service and operate with high ethi- cal standards. Marriott’s values reinforce its vision “to be the #1 hos- pitality company in the world.”56 These types of organizational values are critical to organizational ethical decision-making. Organizations that have ethics programs based upon values tend to make a greater contribu- tion than those based simply on compliance, or obeying rules.57

Normative Considerations of Ethical Decision-Making Earlier in the chapter, we described how ethical decision-making occurs in an organization. Understanding what impacts the ethical decision- making process is necessary for developing and managing an ethical culture within an organization. However, understanding how ethical decisions are made is different from determining what ought to guide ethical decisions. Normative approaches are concerned with how organizational decision-makers should approach an ethical issue. It is concerned with providing a vision and recommendations for improv- ing ethical decision-making. Concepts like fairness, justice, and moral philosophies such as deontology and utilitarianism are important to a normative approach. Strong normative approaches in organizations have a positive relationship to ethical decision-making. Besides val- ues, norms provide more specific beliefs about expected behaviors in a specific context. Norms may exist about expected behavior in work groups and teams throughout the organization. Examples of norms could relate to expected professionalism and how to resolve a reoccur- ring ethical issue.

normative approaches Provide a vision and recom- mendations for improving ethical decision-making; they are concerned with how organizational decision-makers should approach an ethical issue.

TABLE 5.4 Organizational Values of Marriott

1. Put people first

2. Pursue excellence

3. Embrace change

4. Act with integrity

5. Serve our world

Source: Marriott, “Core Values & Heritage,” http://www.marriott. com/culture-and-values/core-values. mi (accessed June 17, 2016).

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Managing the Ethical Culture: Variations of Employee Conduct Despite the creation and implementation of shared organizational val- ues, organizations must recognize that employee behavior will still vary. Overall, it is up to the organization to take responsibility for an ethical cul- ture and implementation. However, research indicates that there are major differences in the values and philosophies influencing how individuals that comprise organizations make ethical decisions.58 Due to ethical diversity, employees will often interpret situations differently and will vary in their responses to an ethical issue.

Table 5.5 reflects a study that measures variation in employee con- duct. It demonstrates that approximately 10 percent of employees will take advantage of situations to further their own personal interests. These employees are often referred to as “bad apples” and are more likely to manipulate, cheat, or be self-serving when the benefits gained from mis- conduct are greater than the penalties. These employees are more likely to steal office supplies or engage in other forms of misconduct. The lower the risk of penalties, the higher the likelihood that these 10 percent of employ- ees will commit unethical activities.

Approximately 40 percent of workers go along with the work group on most decisions. These employees are most concerned about the social implications of their actions and desire to be accepted in the organization. They have their own personal opinions but are easily impacted by other employees around them. For instance, they might be well aware that using office supplies for personal use is improper. However, if it is common for other employees to take office supplies for personal use, than these employ- ees are likely to do the same just to fit in. These employees tend to rational- ize, claiming that the use of office supplies is one of the benefits and that because there is no company policy prohibiting it, then it must be accept- able. Coupled with this is the belief of safety in numbers. These employees feel that they will not get into trouble since everybody is doing it.

On the other hand, approximately 40 percent of a company’s employ- ees always try to follow company policies and rules. These workers have

TABLE 5.5 Variation in Employee Conduct

10 Percent 40 Percent 40 Percent 10 Percent Follow their own values and beliefs; believe that their values are superior to those of others in the company

Always try to follow company policies

Go along with the work group

Take advantage of situ- ations if the penalty is less than the benefit— the risk of being caught is low

Source: These percentages are based on a number of studies in the popular press and data gath- ered by the authors. The percentages are not exact and represent a general typology that may vary by organization. The 10 percent that will take advantage is adapted from John Fraedrich and O. C. Ferrell, “Cognitive Consistency of Marketing Managers in Ethical Situations,” Journal of the Academy of Marketing Science 20 (Summer 1992): 243–252.

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Chapter 5  Business Ethics and Ethical Decision-Making 179

a strong understanding of how their corporate culture defines acceptable behavior and try to comply with organizational codes of ethics, ethics training, and other communications about ethical conduct. In the office supply example, if the company has a policy that prohibits taking office supplies from work for personal use, these employees would most likely obey the policy. However, they probably would not tell anyone about the 40 percent who go along with the work group, for these employees prefer to focus on their jobs and avoid any conflicts or organizational misconduct. These employees rely heavily on organizational communica- tion and expectations. If the organization fails to communicate standards for ethical conduct, then members of this group will devise their own.

The final 10 percent of employees attempt to uphold formal ethical standards focusing on rights, duties, and rules. They adopt values that support certain inalienable rights and actions. From their perspective, these actions are always ethically correct if they protect inalienable rights. Overall, these employees believe that their values are correct and superior to the values of other employees in the organization, or even to the organization’s own value system, when an ethical issue arises. These employees tend to report observed misconduct or report when they view activities within the organization that they believe are unethical. As a result, these employees would most likely report coworkers who steal office supplies.

It should be clear by now that employees use different approaches when making ethical decisions. Because of the probability that a large per- centage of employees will take advantage of a situation or go along with the rest of employees, it is important that companies provide communica- tion and internal controls to support an ethical culture. Organizations that do not monitor activities and enforce ethical policies provide a low-risk environment for employees inclined to take advantage of situations to accomplish their own personal objectives.

Although the percentages in Table 5.5 are only estimates, the specific percentages are not as important as the fact that research has identi- fied these employee variations as existing within most organizations. Organizations should pay particular attention to managers who monitor the daily operations of employees. They should also provide ethics train- ing and communication to make certain that the business operates in an ethical manner, misconduct is caught before it becomes a major issue, and risk to stakeholders is eliminated or minimized.

Maintaining ethical conduct is a business goal that should be no dif- ferent from increasing profits. If progress in maintaining an ethical culture stalls, then the organization must determine the reason and take corrective action through the enforcement of existing standards or setting higher standards. If the code of ethics is strongly enforced and becomes part of the corporate culture, it can lead to strong improvements in the ethical conduct within the organization. On the other hand, if the code of ethics and managerial commitment are merely window-dressing and not truly a part of the corporate culture, it will not be effective.

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SUMMARY Business ethics comprises principles and standards that guide individual and work group behavior in the world of business. Principles are specific and pervasive boundaries that are absolute, while values are used to develop norms that are socially enforced. Stakeholders determine these conventions, and they may change over time. The most basic of these standards have been codified as laws and regulations. Business ethics goes beyond legal issues.

Because individuals and groups within a company may not have embraced the same set of values, ethical conflict may occur. An ethi- cal issue is a problem, situation, or opportunity requiring an individual, group, or organization to choose among several actions that must be eval- uated as right or wrong, ethical or unethical. Questionable decisions and actions may result in disputes that must be resolved through some type of negotiation or even litigation. Codifying ethical standards into meaningful policies that spell out what is and is not acceptable gives businesspeople an opportunity to reduce the possibility of behavior that could create legal problems. Business decisions involve complex and detailed discussions in which correctness may not be clear-cut. It is important that a shared vision of acceptable behavior develops from an organizational perspective to cre- ate consistent and reliable relationships with all concerned stakeholders. Common ethical issues faced by businesses include abusive or intimidat- ing behavior, misuse of company time and resources, conflicts of interest, bribery, discrimination and sexual harassment, fraud, and privacy issues.

Understanding the ethical decision-making process can help individu- als and businesses design strategies to prevent misconduct. Three of the important components of ethical decision-making are individual factors, organizational relationships, and opportunity.

Significant individual factors that affect the ethical decision-making process include personal moral philosophy, stage of moral development, motivation, and other personal factors such as gender, age, and experi- ence. Moral philosophies are the principles or rules that individuals apply in deciding what is right or wrong. Most moral philosophies can be clas- sified as consequentialism, ethical formalism, or justice. Consequentialist philosophies consider a decision to be right or acceptable if it accomplishes a desired result such as pleasure, knowledge, career growth, the realization of self-interest, or utility. Consequentialism may be further classified as egoism and utilitarianism. Ethical formalism focuses on the rights of indi- viduals and on the intentions associated with a particular behavior rather than on its consequences. Justice theory relates to evaluations of fairness or the disposition to deal with perceived injustices of others.

The culture of the organization, as well as superiors, peers, and subor- dinates, can have a significant impact on the ethical decision-making pro- cess. Organizational, or corporate, culture can be defined as a set of values, beliefs, goals, norms, and rituals shared by members or employees of an organization. Whereas a firm’s overall culture establishes ideals that guide a wide range of behaviors for members of the organization, its ethical climate focuses specifically on issues of right and wrong. Significant others include

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Chapter 5  Business Ethics and Ethical Decision-Making 181

superiors, peers, and subordinates in the organization who influence the ethical decision-making process. Interaction between corporate culture and executive leadership helps determine the ethical value system of the firm, but obedience to authority can also explain why many people resolve workplace issues by following the directives of a superior. The more exposed a person is to unethical activity in the organization, the more likely it is that he or she will behave unethically. Superiors and coworkers can create organizational pressure, which plays a key role in creating ethical issues.

Opportunity is a set of conditions that limit barriers or provide rewards. If an individual takes advantage of an opportunity to act unethi- cally and escapes punishment or gains a reward, that person may repeat such acts when circumstances favor them.

To develop an ethical culture, it is crucial for the organization to develop strong organizational values to guide the organization. The values often form the basis of a normative structure. A normative approach is concerned with how organizational decision makers should approach an ethical issue.

Finally, studies have shown that employee ethical behavior in the workplace tends to vary. While 10 percent are bad apples who will take advantage of the organization, 40 percent of employees are estimated to go along with the majority in ethical decision-making. Another 40 percent are likely to obey policies and procedures themselves but will not often report the misconduct of others. The final 10 percent view their values as superior to others. They adhere to their high ethical values and will report those employees that they consider to be unethical. Organizations should pay particular attention to managers who monitor the daily operations of employees.

Responsible Business Debate

Should the FDA Protect Consumers from the Potential Harm Caused by Antibacterial Soap?

Issue: Are Consumers Being Harmed by Antibacterial Soap?

The Food and Drug Administration (FDA) has proposed that antibacterial soap and body wash manufacturers provide additional evidence that their products are more effective than other soap products and safe for long-term use. A chemical commonly found in antibac- terial products has raised concerns. It is estimated that approximately 75 percent of liquid antibacterial soaps contain triclosan. Studies have revealed the presence

of triclosan in urine samples of a shocking 75 percent of respondents.

If the proposal of the FDA passes, it will have signifi- cant implications for soap manufacturers. Antibacterial soap is a strong business within the United States. If antibacterial soap manufacturers cannot prove their claims of effectiveness, they might have to relabel their products, reformulate them, or even remove them completely once they are deemed unsafe.

There are three major concerns over triclosan. First, there is the question of whether triclosan is actu-

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182 Business and Society

KEY TERMS

ally effective in killing more bacteria than other soap products. If it is not more effective, then the benefits of antibacterial soap are untrue. Secondly, consumer advocates are concerned that triclosan might inter- fere with hormones, making long-term use harmful. Finally, there is the possibility that too much use of triclosan could lead to bacteria that are not only resis- tant to triclosan but to other antibiotics as well.

Since 2005, some scientists have been calling for the FDA to get involved. Tests on animals have suggested that prolonged triclosan use could act as endocrine dis- rupters, negatively impacting a person’s hormone sys- tem. So far these tests have been performed largely on animals, so there is still the question of how this would affect humans. Research has also revealed the presence of triclosan in breast milk and umbilical cord blood. Canada has requested that companies within the coun- try voluntarily phase out triclosan from products.

The American Cleaning Institute counteracts these claims, stating that triclosan has helped fight against bac- teria for decades. More than 600 firms support this claim, citing studies that have revealed there are fewer microbes on the hands of those who use antibacterial soap than on those who do not. There is not much evidence sug- gesting that triclosan-resistant bacteria exist outside of labs. Many studies have found that relationships between antibiotic-resistant bacteria and triclosan are not statisti- cally significant. Even the FDA admits there is no evidence suggesting that triclosan is harmful to humans.

The soap industry amounts to about $5.5 billion in sales of soaps, shower products, and body washes. Forcing the industry to reformulate or relabel their products would be highly costly. Additionally, many other industries, including cosmetics, use triclosan in

products as well. Growing concern is causing some firms to voluntarily remove triclosan. Johnson and Johnson and Reckitt Benckiser have already begun phasing out triclosan from their products.

There Are Two Sides To Every Issue: 1. There is enough evidence to support the FDA’s con-

cerns about the negative impacts of antibacterial soap. 2. There is not enough evidence to support the FDA’s

concerns about the effects of antibacterial soap.

Source: Thomas M. Burton and Serena Ng, “FDA Seeks Stricter Rules on Antibacterial Soaps,” The Wall Street Journal, December 16, 2013, http://www.nytimes.com/2011/08/20/busi- ness/triclosan-an-antibacterial-chemical-in-consumer-products- raises-safety-issues.html?pagewanted=all&_r=0 (accessed August 4, 2016); Brian Clark Howard, “Avoid Antibacterial Soaps, Say Consumer Advocates,” National Geographic, http://news.nationalgeographic.com/news/2013/12/131217- a n t i b a c t e r i a l - s o a p s - t r i c l o s a n - f d a - h y g i e n e - s a f e t y - health/?rptregcta=reg_free_np&rptregcampaign=20131016_ rw_membership_r1p_us_se_w# (accessed December 18, 2013); Allison E. Aiello, Bonnie Marshall, Stuart B. Levy, Phyllis Della-Latta, and Elaine Larson, “Relationship between Triclosan and Susceptibilities of Bacteria Isolated from Hands in Community,” Antimicrob Agents Chemother 48 (8), American Society for Microbiology, 2004, pp. 2973– 2979; Elizabeth Weise, “FDA: Antibacterial Soaps Could Pose Health Risks,” USA Today, December 16, 2013, http://www .usatoday.com/story/news/nation/2013/12/16/fda-antibacterial- soap/4038907/ (accessed August 4, 2016); Andrew Martin, “Antibacterial Chemical Raises Safety Issues,” The New York Times, August 19, 2011, http://www.nytimes.com/2011/08/20/ business/triclosan-an-antibacterial-chemical-in-consumer- products-raises-safety-issues.html?pagewanted=all&_r=0 (accessed August 4, 2016). Laura Landro, “Are Antibacterial Soaps Safe?” The Wall Street Journal, February 15, 2016, http:// www.wsj.com/articles/are-antibacterial-soaps-safe-1455592023 (accessed August 4, 2016); Alexandra Sifferlin, “The Case Against Antibacterial Soap Is Getting Stronger,” Time, May 18, 2016, http://time.com/4339866/triclosan-antibacterial-soap- safety/ (accessed August 4, 2016).

business ethics (p. 155) principles (p. 155) values (p. 155) ethical issue (p. 159) conflict of interest (p. 161) bribery (p. 162) sexual harassment (p. 163) hostile work environment (p. 164) fraud (p. 164)

privacy issues (p. 164) moral philosophies (p. 167) social exchange theory (p. 167) consequentialism (p. 167) egoism (p. 167) utilitarianism (p. 167) ethical formalism (p. 167) justice theory (p. 168) Principle of Equal Freedom (p. 168)

machiavellianism (p. 169) ethical diversity (p. 169) organizational, or corporate,

culture (p. 170) ethical climate (p. 172) significant others (p. 172) opportunity (p. 174) ethical culture (p. 176) normative approaches (p. 177)

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Chapter 5  Business Ethics and Ethical Decision-Making 183

DISCUSSION QUESTIONS 1. Why is business ethics a strategic consideration in

organizational decisions? 2. How do individual, organizational, and opportu-

nity factors interact to influence ethical or unethi- cal decisions?

3. How do moral philosophies influence the individual factor in organizational ethical decision-making?

4. How can ethical formalism be used in organiza- tional ethics programs and still respect diversity and the right for individual values?

5. What are the potential benefits of an emphasis on procedural justice?

6. Describe the importance of normative approaches to ethical decision making.

7. How do organizations create an ethical climate? 8. Why are we seeing more evidence of widespread

ethical dilemmas within organizations? 9. Describe the importance of organizational values

to the development of an ethical culture. 10. Why is it important for managers to take ethical

diversity into account?

EXPERIENTIAL EXERCISE Visit www.bbb.org, the home page for the Better Business Bureau. Locate the International Marketplace Ethics award criteria. Find recent winners of the award

and summarize what they did to achieve this recogni- tion. Describe the role of the BBB in supporting self- regulatory activities and business ethics.

On Sunday, Armando went to work to pick up a report he needed to review before an early Monday meeting. While at work, he noticed a colleague’s light on and went over to her cubicle for a short visit. Monica was one of the newest systems designers on the department’s staff. She was hired six weeks ago to assist with a series of human resources (HR) projects for the company. Before joining the firm, she had worked as an independent consultant to orga- nizations trying to upgrade their HR systems that track payroll, benefits, compliance, and other issues. Monica was very well qualified, detail oriented, and hard working. She was the only female on the systems staff.

In his brief conversation with Monica, Armando felt that he was not getting the full story of her reason for being at work on a Sunday. After all, the systems team completed the first HR systems proposal on Thursday and was prepared to present its report and recommenda- tions on Monday. Monica said she was “working on a few parts” of the project but did not get more specific. Her face turned red when Armando joked, “With the beautiful sunshine outside, only someone hoping to earn a little extra money would be at work today.”

Armando and another coworker, David, presented the systems team’s report to the HR staff on Monday. The HR team was generally pleased with the recommen- dations but wanted a number of changes in specifications. This was normal and the systems designers were prepared

for the changes. Everyone on the team met that afternoon and Tuesday morning to develop a plan for revamping the HR system. By Tuesday afternoon, each member was working on his or her part of the project again.

On Friday afternoon, David went up and down the hall, encouraging everyone to go to happy hour at the pub down the street. About ten people, including Monica and Armando, went to the pub. The conversation was mainly about work and the new HR project. On several occasions, Monica offered ideas about other systems and companies with which she was familiar. Most of the sys- tems designers listened, but a few were quick to question her suggestions. Armando assumed her suggestions were the result of work with previous clients. Over the weekend, however, Armando began to wonder whether Monica was talking about current clients. He remembered their con- versation on Sunday and decided to look into the matter.

On Monday, Armando asked Monica directly whether she still had clients. Monica said yes and that she was finishing up on projects with two of them. She went on to say that she worked late hours and on the weekends and was not skimping on her company responsibilities. Armando agreed that she was a good colleague but was not comfortable with her use of com- pany resources on personal, moneymaking projects. He was also concerned that the team’s intellectual capital was being used. What would you do?

MOONLIGHTING MONICA: WHAT WOULD YOU DO? ?

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184

CHAPTER SIX

Strategic Approaches to Improving Ethical Behavior

Chapter Objectives

●● To provide an overview of the need for an organizational ethics program

●● To consider crucial keys to development of an effective ethics program

●● To demonstrate the elements of a corporate culture.

●● To examine leadership and its importance to an ethical corporate culture.

●● To discuss the requirements for ethical leadership.

Chapter Outline

Scope and Purpose of Organizational Ethics Programs

Codes of Conduct

Ethics Officers

Ethics Training and Communication

Establishing Systems to Monitor and Enforce Ethical Standards

Continuous Improvement of the Ethics Program

Institutionalization of Business Ethics

Ethical Leadership

Requirements for Ethical Leadership

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185

For NiSource, social responsibility involves actively living its four core values: fairness, honesty, integrity, and trust. NiSource is a Fortune 500 company that owns a portfo- lio of energy businesses. Headquartered in Merrillville, Indiana, NiSource is involved in natural gas and electric transmission, storage, generation, and distribution in seven states.

The company’s mission reflects its emphasis on social responsibility. It seeks to deliver “safe, reliable, clean and affordable energy” that benefits all stake- holders. As a profitable company complying with all applicable laws, NiSource achieves the economic and legal levels of social responsibility. It also exhibits strong ethical and philanthropic initiatives, leading it to be named one of the “World’s Most Ethical Companies”. Its code of ethics encourages employees to take respon- sibility for the company’s success and ethical conduct.

NiSource demonstrates a strong commitment to employees, customers, the environment, and communi- ties. For instance, NiSource has taken a strong stance on improving employee safety and has become an industry leader in this area. NiSource incentivizes employees by offering them rewards for safe behavior. As a result, vehicle and safety-related accidents have decreased.

NiSource also recognizes the dangers that consum- ers might face, especially in situations such as poten- tially hitting an underground utility line when digging in their yards. NiSource invests $3.2 million on public and safety awareness programs for consumers. As part of its awareness campaign, it created the mascot Digger Dog to appeal to children and educate them about call- ing the number 811 to receive information about the location of utility lines before digging.

Environmental sustainability is a strong component of NiSource’s corporate culture. In 2014 the company completed a project estimated to reduce harmful sulfur dioxide emissions significantly. The company maintains a Board of Directors’ Environmental Health and Safety Committee that evaluates and approves NiSource’s environmental policy, including policies concerning climate change. NiSource also helps its customers save energy by developing energy efficiency programs such as its Customer CHOICE® program. This program allows customers to reduce energy costs by purchasing natural gas from non-utilities suppliers.

Finally, NiSource recognizes its responsibilities toward communities. It has established the NiSource Charitable Foundation to provide funds to nonprofits who it believes contribute toward its mission to help create “strong and sustainable communities.” NiSource has contributed more than $5 million toward nonprofit organizations.

NiSource invests resources in social responsibil- ity and has been recognized for its many benefits. Because of its sustainability initiatives, NiSource was named to the Dow Jones Sustainability Index in 2012. It was also named among the top 25 Socially Responsible Dividend Stocks by the Dividend Channel. These awards are beneficial in attracting investors interested in investing in socially responsible compa- nies. This has significantly impacted NiSource’s bottom line—its stock experienced a 19 percent annual return at a time when the average return in the utilities sec- tor of the Standard and Poor’s index was -8. NiSource clearly proves that social responsibility helps stake- holders and the bottom line.1

NiSource—A Top Firm in Social Responsibility

Opening Vignette

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186 Business and Society

Astrategic approach to ethical decisions will contribute to both busi-ness and society. This chapter provides a framework that is con-sistent with research, best practices, and regulatory requirements for improving ethical conduct within the organization. Some companies have not implemented effective business ethics programs, but they should because ethics and compliance programs create good systems to manage organizational misconduct. Our framework for developing effective ethics programs is consistent with the ethical decision-making process described in Chapter 5. In addition, the strategic approach to an ethics program presented here is consistent with the Federal Sentencing Guidelines for Organizations, the Sarbanes-Oxley Act, and the Dodd-Frank Act described in Chapter 4. These legislative reforms require managers to assume responsibility and ensure that ethical standards are implemented properly on a daily basis. Ethics programs include not only the need for top executive leadership but also responsibility by boards of directors for corporate governance.

Unethical and illegal business conduct occurs, even in organizations that have ethics programs. For example, although Enron had a code of ethics and was a member of the Better Business Bureau, the company was devastated by unethical activities and corporate scandal. Many business leaders believe that personal moral development and character are all that is needed for corporate responsibility. There are those who feel that ethics initiatives should arise inherently from a company’s culture and that hiring good employees will limit unethical behavior within the organization. Many executives and board members do not understand how organizational ethical decisions are made nor how to develop an ethical corporate culture. Customized ethics programs may help many organizations provide guidance for employees from diverse backgrounds to gain an understanding of acceptable behavior within the organization. Many ethical issues in business are complex and include considerations that require organizational agreement regarding appropriate action. Top executives and boards of directors must provide leadership, a system to resolve these issues, and support for an ethical corporate culture.

In this chapter, we provide an overview of why businesses need to develop an organizational ethics program. Next, we consider the fac- tors that are crucial for the development of such a program: a code of conduct, an ethics officer and appropriate delegation of authority, effec- tive ethics training, a system to monitor and support ethical compliance, and continual efforts to improve the ethics program. Next we discuss the institutionalization of business ethics through mandated and voluntary programs. We discuss the importance of ethical leadership to a company’s ethics program. Finally, we examine the requirements of ethical leadership and its impact on organizational culture, including the different forms of communication an ethical leader must master.

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Chapter 6  Strategic Approaches to Improving Ethical Behavior 187

SCOPE AND PURPOSE OF ORGANIZATIONAL ETHICS PROGRAMS Usually, an organization is held accountable for the conduct of its employ- ees. Companies must assess their ethical risks and develop values and compliance systems to avoid legal and ethical mistakes that could damage the organization. The Federal Sentencing Guidelines for Organizations hold corporations responsible for conduct engaged in as an entity. Some corporate outcomes cannot be tied to one individual or even a group, and misconduct can result from a collective pattern of decisions supported by a corporate culture. Therefore, corporations can be held accountable, fined, and even ordered to close their doors when they are operating in a manner inconsistent with major legal requirements. Organizations are sensitive to avoid infringing on employees’ personal freedoms and ethical beliefs. In cases where an individual’s personal beliefs and activities are inconsistent with company policies on ethics, conflict may develop. If the individual feels that ethics systems in the organization are deficient or directed in an inappropriate manner, some type of open conflict resolution may be needed to deal with the differences.

Understanding the factors that influence how individuals make deci- sions to resolve ethical issues, as discussed in Chapter 5, can help com- panies encourage ethical behavior and discourage undesirable conduct. Fostering ethical decisions within an organization requires eliminating unethical behavior and improving the firm’s ethical standards. Some people will always do things in their own self-interest regardless of organizational goals or accepted standards of conduct. For example, professional athletes know that use of steroids is prohibited, yet some players still choose to use them in order to gain an edge. Professional tennis star Maria Sharapova, who had been selected to participate in the Rio de Janeiro Olympics, was banned for two years from the sport after failing a drug test.2 Eliminating inappropriate or abnormal behavior through screening techniques and enforcement of the firm’s ethical standards can help improve the firm’s overall ethical conduct.

Organizations can foster unethical corporate cultures not because individuals within them are bad but because the pressures to succeed create opportunities that reward unethical decisions. In the case of an unethical corporate culture, the organization must redesign its ethical standards to conform to industry and stakeholder standards of accept- able behavior. Most businesses attempt to improve ethical decision mak- ing by establishing and implementing a strategic approach to improving organizational ethics. Companies such as Texas Instruments, Starbucks, and Levi’s take a strategic approach to organizational ethics but moni- tor their programs on a continuous basis and make improvements when problems occur.

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188 Business and Society

To be socially responsible and promote legal and ethical conduct, an organization should develop an organizational ethics program by establish- ing, communicating, and monitoring ethical values and legal requirements that characterize its history, culture, industry, and operating environment. Without such programs and uniform standards and policies of conduct, it is difficult for employees to determine what behaviors are acceptable within a company. As discussed earlier, in the absence of such programs and stan- dards, employees generally will make decisions based on their observations of how their coworkers and managers behave. A strong ethics program includes a written code of conduct, an ethics officer to oversee the program, careful delegation of authority, formal ethics training, auditing, monitoring, enforce- ment, and periodic revision of program standards. Without a strong custom- ized program, problems are much more likely to arise. Figure 6.1 outlines what employees identified as the causes of organizational misconduct.

Trust in top management and business is low. An analysis of trustwor- thy companies revealed three characteristics that CEOs have implemented that resulted in trust and confidence in business. These include involving those directly affected by company decisions in the decision-making pro- cess, being transparent and consistent in actions, and nurturing relation- ships.3 This is a recurring theme among primary stakeholders. Consumers are looking for clear, creative, and constructive leadership from CEOs that demonstrates trust is a priority.

Source: “Integrity Survey 2013,” KPMG, 2013, p. 13, http://www.kpmg.com/CN/en/IssuesAndInsights/ArticlesPublications/ Documents/Integrity-Survey-2013-O-201307.pdf (accessed June 21, 2016).

0% 10% 20% 30% 40% 50% 60% 70%

49%

59%

59%

59%

60%

Are seeking to bend the rules or steal for their own personal gain

Believe policies and procedures are easy to bypass or override

Lack resources to get the job done without cutting corners

Lack understanding of the standards that apply to their jobs

Fear losing their jobs if they do not meet targets

Believe they will be rewarded for results, not the means used to achieve them

Believe that the code of conduct is not taken seriously

Feel pressure to do "whatever it takes" to meet business targets 64%

57%

57%

FIGURE 6.1 Employee Assessment of the Causes of Misconduct

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Chapter 6  Strategic Approaches to Improving Ethical Behavior 189

No universal standards exist that can be applied to organizational ethics programs in all organizations, but most companies develop codes, values, or policies for guidance about business conduct. The majority of companies that have been in ethical or legal trouble usually have stated ethics codes and programs. Often, the problem is that top manage- ment, as well as the overall corporate culture, has not integrated these codes, values, and standards into daily decision making. For example, Priceline CEO Darren Huston resigned after it was discovered that he had a personal relationship with an employee in violation of the com- pany’s ethics policies.4 If a company’s leadership fails to provide the vision and support needed for ethical conduct, then an ethics program will not be effective. Ethics is not something to be delegated to lower- level employees while top managers break the rules. Excellent leaders must lead by example and reinforce the integrity of the organizational culture.

No matter what their specific goals, ethics programs are developed as organizational control systems, the aim of which is to create pre- dictability and consistency in employee behavior. There are two types of organizational control systems. A compliance orientation creates order by requiring that employees identify with and commit to specific required conduct. It uses legal terms and statutes that teach employees the rules and penalties for noncompliance. The other type of system is a values orientation, which strives to develop shared values. Although penalties are attached, the focus is more on an abstract core of principles such as respect and responsibility. The goal is to create an environment where employees are compelled and willing to support an ethical orga- nizational culture. More than half of employees in the KPMG Forensic Ethics Survey stated that they had observed misconduct that could cause ‘a significant loss of public trust if discovered.’ The industries in which this type of misconduct increased the most include electronics, chemi- cals and diversified industrials, consumer markets, and aerospace and defense.5 The goal of an effective ethics program is to get employees to report wrongdoing when they become aware of it and seek guidance when they are uncertain as to how to respond in ambiguous circum- stances.

Research into compliance- and values-based approaches reveals that both types of programs can interact or work toward the same end, but a values orientation tends to have a stronger influence on employees. Values-based programs increase employees’ awareness of ethics at work, their integrity, their willingness to deliver bad news to supervisors, and the perception that better decisions are made. Compliance-based programs are linked to employees’ awareness of ethical issues at work and their perception that decision making is better because of the expectations of its employees.

To meet the public’s escalating demands for ethical decision mak- ing, companies need to develop plans and structures for addressing ethical considerations. Some directions for the improvement of ethics

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190 Business and Society

have been mandated through regulations, but companies must be will- ing to have a values and ethics implementation system in place that exceeds the minimum regulatory requirements. In addition, companies that have experienced reputational damage in the past are much further along compared to their peers in establishing ethics and compliance programs.6

CODES OF CONDUCT Because people come from diverse family, educational, and business back- grounds, it cannot be assumed that they know how to behave appropri- ately when they enter a new organization or job. Most companies begin the process of establishing organizational ethics programs by developing codes of conduct (also called codes of ethics), which are formal statements that describe what an organization expects of its employees. Table 6.1 depicts elements of an effective ethics and compliance program (such as codes and training). Codes of ethics address risk areas that organizations face and which employees may experience in the workplace.

A code of ethics has to reflect the board of directors’ and senior management’s desire for organizational compliance with the values and

codes of conduct Formal statements that describe what an organization expects of its employees; also called codes of ethics.

TABLE 6.1 Elements of an Effective Ethics Program 1 Standards and

Codes Used to prevent and detect criminal conduct by expressing what the right thing is, how it can be accomplished, and the expecta- tions to which the employee is held. They should be communicated and written in a concise, clear language in codes of ethics.

2 Leadership and the Ethics Officer

The company’s board of directors usually oversees the implementa- tion of the program, and a senior executive or committee of execu- tives should be given overall responsibility for its compliance. Many ethics officers report to the chief executive and interact with the board of directors on a regular basis.

3 Communication and Effective Training

The company must effectively implement the program through education and training. Training should be focused on industry- specific areas of risk, and should not merely recite the law, but should explicitly explain the company’s policies and ask employees to think through complex “gray areas” they may encounter in their day-to-day tasks.

4 Monitoring and Disclosure

The ethics and compliance program should be implemented. Employees should be asked about the “unwritten rules” within the company to determine whether the program’s goals match its actual operation. Employees must be provided with effective mechanisms through which to anonymously or confidentially report potential misconduct or seek guidance on compliance issues, pro- tect such individuals against retaliation, and adequately follow up on their reports.

(Continued )

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Chapter 6  Strategic Approaches to Improving Ethical Behavior 191

TABLE 6.2 Developing and Implementing a Code of Ethics 1. Consider areas of risk and state values as well as conduct necessary to comply with laws

and regulations. Values and principles are an important buffer in preventing serious misconduct.

2. Identify values and principles that specifically address current ethical issues.

3. Consider values and principles that link the organization to a stakeholder orientation. Attempt to find overlaps in organizational and stakeholder values.

4. Make the code understandable by providing examples that reflect values.

5. Communicate the code frequently and in language that employees can understand.

6. Revise the code every year with input from organizational members and stakeholders.

5 Observation and Reinforcement

Appropriate incentives must be provided to encourage employees to comply with the program and impose appropriate disciplinary measures if audits reveal that employees fail to do so. It is impor- tant for the company to enforce these rules consistently to maintain the credibility of the program.

6 Corrective Action Misconduct must be addressed after it occurs including, at times, self-reporting to the authorities. Reasonable steps must be taken to prevent similar misconduct in the future. In addition, the company’s board or audit committee must receive regular and meaningful reports on audit results and the status of corrective action.

Source: Adapted from U.S. Federal Sentencing Guidelines, Chapter 8; 2012 Amendments to the U.S. Federal Sentencing Guidelines; Kristin Graham Koehler and Brian P. Morrissey, “Seven Steps for Developing an Effective Compliance and Ethics Program,” Chain Store Age, January 3, 2013, http://chainstoreage.com/article/seven-steps-developing-effective-compliance-and-ethics-program (accessed June 21, 2016).

principles, mission, rules, and policies that support an ethical climate. Development of a code of ethics should involve the board of directors, president, ethics officer, and senior managers who will be implement- ing the code. Legal staff should be called on to ensure that the code has correctly assessed key areas of risk and that potential legal problems are buffered by standards in the code. A code of ethics that does not address specific high-risk activities within the scope of daily operations is inadequate for maintaining standards that can prevent misconduct. Table 6.2 shows considerations in developing and implementing a code of ethics.

A large multinational firm, Texas Instruments (TI), manufactures computers, calculators, and other high-technology products. Its code of ethics has some of the elements listed in the table above as its base. The code addresses issues relating to policies and procedures; government laws and regulations; acceptance of gifts, travel, and entertainment; handling of proprietary information and trade secrets; and more.7 To ensure that its

TABLE 6.1 (Continued )

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employees understand the nature of business ethics and the ethical stan- dards they are expected to follow, TI provides the “Ethics Quick Test” to help employees when they have doubts about the ethics of specific situations and behaviors. It urges employees to reflect upon the following questions and statements:

Is the action legal?

Does it comply with our values?

If you do it, will you feel bad?

How will it look in the newspaper?

If you know it’s wrong, don’t do it!

If you’re not sure, ask.

Keep asking until you get an answer.8

Texas Instruments explicitly states what it expects of its employees and what behaviors are unacceptable. When such standards of behavior are not made explicit, employees sometimes base ethical decisions on their observations of the behavior of peers and management. The use of rewards and punishments to enforce codes and policies controls the opportunity to behave unethically and increases employees’ acceptance of ethical standards.

As we stated, codes of conduct may address a variety of situations, from internal operations to sales presentations and financial disclosure practices. Research has found that corporate codes of ethics often have five to seven core values or principles, in addition to more detailed descrip- tions and examples of appropriate conduct.9 The six values that have been suggested as desirable to appearing in the codes of ethics include: (1) trustworthiness, (2) respect, (3) responsibility, (4) fairness, (5) caring, and (6) citizenship. These values will not be effective without distribution, training, and the support of top management in making the values a part of the corporate culture. Employees need specific examples of how the values can be implemented and guide ethical decision making.

Codes of conduct will not resolve every ethical issue encountered in daily operations, but they help employees and managers deal with ethical dilemmas by prescribing or limiting specific actions. Many companies have a code of ethics, but is it communicated effectively? According to the Ethics Resource Center, the number of companies developing and implementing effective ethics and compliance programs is increasing each year.10 A code that is placed on a website or in a training manual is useless if it is not reinforced on a daily basis. By communicating to employees both what is expected of them and what punishments they face if they violate the rules, codes of conduct curtail opportunities for unethical behavior and thereby improve ethical decision making. Wells Fargo Bank offers a comprehensive code of conduct that specifies: “If you violate any provision of the Code

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Chapter 6  Strategic Approaches to Improving Ethical Behavior 193

or fail to cooperate fully with any inquiries or investigations, you will be subject to corrective action, which may include termination of your employment.”11 Codes of conduct do not have to be so detailed that they take into account every situation, but they should provide guidelines and principles that are capable of helping employees achieve organizational ethical objectives and address risks in an accepted manner.

ETHICS OFFICERS Organizational ethics programs also must have oversight by a high-rank- ing person known to respect and understand legal and ethical standards. This person is often referred to as an ethics officer but can also be the general counsel, the vice-president of human resource management, or any other officer. Corporate wrongdoings and scandal-grabbing headlines have a profound negative impact on public trust. To ensure compliance with state and federal regulations, many corporations are now appointing chief compliance officers and ethics and business conduct professionals to develop and oversee corporate compliance programs.

Consistent enforcement and necessary disciplinary action are essential to a functional ethics and compliance program. The ethics or compliance officer is usually responsible for companywide disciplinary systems, implementing all disciplinary actions the company takes for violations of its ethical stan- dards. Many companies are including ethics and compliance in employee performance appraisals. During performance appraisals, employees may be asked to sign an acknowledgment that they have read the company’s current guidelines on its ethics policies. The company must also promptly investigate any known or suspected misconduct. The appropriate company official, often the ethics officer, needs to make a recommendation to senior manage- ment on how to deal with a particular ethics infraction.

The Ethics and Compliance Association consists of front line manag- ers of ethics programs in dozens of industries worldwide.12 Ethics and compliance officers are instrumental in managing ethics programs and have the attention of top managers and boards of directors.13 The eth- ics officer position has existed for decades, but its importance increased tremendously when the Federal Sentencing Guidelines for Organizations were passed in 1991. The guidelines gave companies that faced federal charges for misconduct the incentive of fine reductions up to 95 percent if they had an effective comprehensive ethics program in place. The financial reporting requirements of the Sarbanes-Oxley Act put more pressure on ethics officers to monitor financial reporting, as well as reporting of sales and inventory movements, to prevent fraud in reporting revenue and prof- its. While not always deemed to be most effective, it is recommended that ethics officers report directly to the board of directors.

Building an ethics program and hiring an ethics officer to avoid fines alone will not be effective. Only with the involvement of top management and the board can an ethics officer earn the trust and cooperation of all

ethics officer A high-ranking person known to respect and understand legal and ethical standards.

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key decision makers. Ethics officers should be knowledgeable about the industry’s laws and regulations as well as adept at communicating and reinforcing values that build an ethical corporate culture.

ETHICS TRAINING AND COMMUNICATION Instituting a training program and a system of communication to dissemi- nate the firm’s ethical standards is a major step in developing an effective ethics program. Such training can educate employees about the firm’s policies and expectations, relevant laws and regulations, and general social standards. Training programs can make employees aware of available resources, support systems, and designated personnel who can assist them with ethical and legal advice. Training also can help empower employees to ask tough questions and make ethical decisions.

Ethics officers provide the oversight and management of most ethics training. Although training and communication should reinforce values and provide learning opportunities about rules, risks, and acceptable behavior, it is only one part of an effective ethics program. The employee’s capacity to exercise judgments that result in ethical decisions must be rein- forced and developed. Ethics training should be customized to the specific risk areas they face. If ethical evaluations are not a part of regular perfor- mance appraisals, the message employees will receive is that ethics is not an important component of decision making. For ethics training to make a difference, employees must understand why it is conducted, how it fits into the organization, and what their role is in its implementation.

Top corporate executives must communicate with managers at the operations level (e.g., in production, sales, and finance) and enforce over- all ethical standards within the organization. Table 6.3 lists the factors crucial to successful ethics training. It is most important to help employees identify ethical issues and give them the means to address and resolve such

TABLE 6.3 Factors Crucial to Ethics Training 1. Identify the key ethical risk areas.

2. Relate ethical decisions to the organization’s values, principles, and culture.

3. Communicate company codes, policies, and procedures regarding ethical business conduct.

4. Provide leadership training to model desired behavior.

5. Provide directions for internal questions and non-retaliatory reporting mechanisms.

6. Engage in regular training events using a variety of educational tools.

7. Establish manuals, websites, social media, and other communication to reinforce ethics training.

8. Evaluate and use feedback to improve training.

Source: © O. C Ferrell 2018.

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Chapter 6  Strategic Approaches to Improving Ethical Behavior 195

issues in ambiguous situations. In addition, employees must be offered direction on seeking assistance from managers or other designated person- nel in resolving ethical problems. An effective ethics program can reduce criminal, civil, and administrative consequences, including fines, penal- ties, judgments, debarment from government contracts, and court control of the organization. An ineffective ethics program that results in many unethical acts may cause negative publicity, a decrease in organizational financial performance, and lowered stakeholder trust. An ethical disaster can be more damaging to an organization than a natural disaster because of the damage that occurs to organizational reputation.

Companies can implement ethical principles in their organizations through training programs. Discussions conducted in ethics training pro- grams sometimes break down into personal opinions about what should or should not be done in particular situations. To be successful, business ethics programs need to educate employees about how to identify and deal with business ethics issues. Employees are then able to base ethical deci- sions on their knowledge of appropriate actions, from an organizational perspective, rather than on emotions.

Training and communication initiatives should reflect the unique char- acteristics of an organization: its size, culture, values, management style, and employee base. It is important for the ethics program to differentiate between personal and organizational ethics. If ethics training is to be effec- tive, it must start with a foundation, a code of ethics, commitment from all levels of the organization, and executive priorities on ethics that are communicated to employees. Managers from every department must be involved in the development of an ethics training program.

Most experts agree that one of the most effective methods of ethics training involves resolving ethical dilemmas that relate to actual situa- tions employees may encounter while performing their jobs. For example, Lockheed Martin developed a training game called Gray Matters. This training device includes dilemmas that can be resolved by teams. Each member of the team can offer his or her perspective and understand the ramifications of the decision for coworkers and the organization.

Another training device is the behavioral simulation or role-play exer- cise in which participants are given a short hypothetical ethical issue sce- nario to review. The participants are assigned roles within the hypothetical organization and are provided with varying levels of information about the issue. They then must interact to provide recommended courses of action representing short-term, midrange, and long-term considerations. The simulation recreates the complexities of organizational relationships and of having to address a situation without complete information. Learning objectives of the simulation exercise include (1) increased awareness by participants of the ethical, legal, and social dimensions of business decision making; (2) development of analytical skills for resolving ethical issues; and (3) exposure to the complexity of ethical decision making in organi- zations. Simulations help teach students about why ethics is important as well as how to handle ethics conflict situations.14

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A growing number of small businesses deliver “learning-management” systems software and content to train and certify employees on a variety of topics. In addition to streamlined training, the systems provide real-time records of instruction that increasingly are the first line of defense for com- panies facing litigation or questions about whether they are accountable for an employee’s actions. The e-learning market is growing very rapidly both in education and business. For multinational companies, the computerized train- ing elements of such systems provide consistency of content and delivery to all locations and allow for customization of languages and to cultures. Some of the goals of an ethics training program might be to improve employee under- standing of ethical issues and the ability to identify them, to inform employees of related procedures and rules, as well as to identify the contact person who could help in resolving ethical problems. In keeping with these goals, the pur- pose of Boeing’s Code of Ethics and Business Conduct program is to:

Communicate the Boeing Values and standards of ethical business con- duct to employees.

Inform employees of company policies and procedures regarding ethical business conduct.

Establish company-wide processes to assist employees in obtaining guidance and resolving questions regarding compliance with the com- pany’s standards of conduct and the Boeing Values.

Establish company-wide criteria for ethics education and awareness programs.15

Ethical decision making is influenced by organizational culture, by coworkers and supervisors, and by the opportunity to engage in unethical behavior. All three types of influence can be affected by ethics training. Full awareness of the philosophy of management, rules, and procedures can strengthen both the organizational culture and the ethical stance of peers and supervisors. Such awareness also arms employees against oppor- tunities for unethical behavior and reduces the likelihood of misconduct. Thus, the existence and enforcement of company rules and procedures limit unethical practices in the organization. The primary goals of ethics train- ing are to make employees aware of the risks associated with their jobs, industry, and stakeholders; provide an understanding of the culture and expectations within the organization; create accountability for individual actions; and inform employees not only of the behavior that is unaccept- able but also that which is acceptable and supported in the organization.

ESTABLISHING SYSTEMS TO MONITOR AND ENFORCE ETHICAL STANDARDS Ethics and compliance programs also involve comparing employee ethical performance with the organization’s ethical standards. Ethics programs can be measured through employee observation, internal audits, surveys, reporting systems, and investigations. An effective ethics program uses

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a variety of resources to effectively monitor ethical conduct. Sometimes, external auditing and review of company activities are helpful in develop- ing benchmarks of compliance and identifying areas for improvement.

Systems to Monitor and Enforce Ethical Standards Many companies set up ethics assistance lines, also known as ‘hotlines’, to provide support and give employees the opportunity to ask ques- tions or report concerns. The most effective ethics hotlines operate on an anonymous basis and are supported 24 hours a day, 365 days a year. Approximately 52 percent of the employees who report concerns indicated using their company’s hotline to do so. In addition, 15 percent use the company’s website to report misconduct and 32 percent use other tradi- tional methods such as face-to-face reporting to supervisors or managers, email, fax, and direct mail.16

It is interesting that most of the issues reported do not relate to serious ethical and legal issues. Nearly 70 percent of the issues raised on help lines relate to human resources and complaints such as coworker abuse, failure of management to intervene in such abuse, and inappropriate language. Other top issues reported include business integrity at 17 percent; environ- ment, health, and safety at 7 percent; misuse or misappropriation of assets at 6 percent; and accounting, auditing, and financial reporting at 3 percent.17

A help line or desk is characterized by ease of accessibility and simple procedures, and it serves as a safety net that facilitates monitoring and reporting. Companies such as Global Compliance provide automated case management systems which collect, categorize, and provide alerts to the appropriate manager for dealing with ethics issues in the organization. Companies are increasingly using case management services and software to track employees and issues throughout their entire organization. These programs provide reports of employee concerns, complaints, or observa- tions of misconduct. Systems such as these allow the company to track investigations, analysis, resolutions, documentation, emerging/declining issues, and the time required for resolution.

Observation and Feedback To determine whether a person is performing his or her job adequately and ethically, observation might focus on how the person handles an ethically charged situation. For example, during role-plays in the training sessions of salespeople and managers, ethical issues can be introduced into the discussion, and the decisions can be videotaped and outcomes evaluated by managers.

Questionnaires that survey employees’ ethical perceptions of their com- pany, their superiors, their coworkers, and themselves, as well as ratings of ethical or unethical practices within the firm and industry, can serve as bench- marks in an ongoing assessment of ethical performance. Then, if unethical behavior is perceived to increase, management will have a better understand- ing of what types of unethical practices may be occurring and why. A change

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in the ethics training within the company may be necessary. In addition, organization-wide risk management systems identify new and emerging risks employees face and to which management must respond.

Appropriate action involves rewarding employees who comply with company policies and standards and punishing those who do not. When employees comply with organizational standards, their efforts may be acknowledged and rewarded through public recognition, bonuses, raises, or some other means. Conversely, when employees deviate from organi- zational standards, they may be reprimanded, transferred, docked, sus- pended, or even fired.

Whistle-blowing Interpersonal conflict ensues when employees think they know the right course of action in a situation, yet their work group or company pro- motes or requires a different, possibly unethical decision. In such cases, employees usually follow the organizational values. If they conclude that they cannot discuss what they are doing or what should be done with their coworkers or immediate supervisors, these employees may go outside the organization to publicize and correct the unethical situation. Whistle-blowing means exposing an employer’s wrongdoing to outsiders, such as the media or government regulatory agencies.

Whistle-blowers have provided pivotal evidence documenting corpo- rate wrongdoing at a number of companies. Since the institution of the Whistleblower Protection Act, many employees are coming forward to reveal company misdeeds to government authorities. Bradley Birkenfeld of UBS reported a tax evasion scheme to the Internal Revenue Service and was awarded $104 million for the revelation. The SEC awarded one whisteblower $17 million, the second largest award under the Dodd-Frank whistleblower bounty program, because his information was a substan- tial help to the SEC in its investigation.18 Another whistleblower, Keith Edwards, was awarded over $63 million for providing information regard- ing J. P. Morgan’s plan to hide findings from internal reviews about faulty mortgage loans from the government. It is estimated that the SEC paid out $37 million to whisteblowers in the security industry in 2015.19 Despite these large monetary rewards, the fortunes of whistleblowers are peppered with negative pushback. Most are labeled traitors, many lose their jobs, and some find it difficult to gain new employment afterward.

Critics have stated that the potential for large monetary sums related to whistleblowing encourage employees to come forward regardless of whether their claims are valid. However, a survey by the Ethics Resource Center showed that only 14 percent of employees are motivated by such incentives. Rather, the majority of external reporting is a result of other factors such as lack of trust in company authorities, experience of retali- ation from prior internal reporting, and the fear of losing one’s job.20 Because of the risks involved in being a whistleblower, Table 6.4 provides a checklist of questions an employee should ask before blowing the whistle.

whistle-blowing Exposing an employer’s wrongdoing to outsid- ers such as the media or government regulatory agencies.

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TABLE 6.4 Questions to Ask Before Engaging in External Whistle-Blowing 1. Have I exhausted internal anonymous reporting opportunities within the organization?

2. Have I examined company polices and codes that outline acceptable behavior and violations of standards?

3. Is this a personal issue that should be resolved through other means?

4. Can I manage the stress that may evolve from exposing potential wrongdoing in the organization?

5. Can I deal with the consequences of resolving an ethical or legal conflict within the organization?

Source: © O. C. Ferrell 2016.

CONTINUOUS IMPROVEMENT OF THE ETHICS PROGRAM Improving the system that encourages employees to make more ethical decisions is not very different from implementing other types of busi- ness strategies. Implementation means putting strategies into action. Implementation in ethics and compliance means the design of activities to achieve organizational objectives using available resources and given existing constraints. Implementation translates a plan for action into operational terms and establishes a means by which organizational ethical performance will be monitored, controlled, and improved.

A firm’s ability to plan and implement ethical business standards depends in part on the organization’s structuring of resources and activi- ties to achieve its ethical objectives in an effective and efficient manner. Some U.S. companies are setting up computer systems that encourage whistle-blowing. For instance, Marvin Windows (one of the world’s larg- est custom manufacturers of wood windows and doors) was concerned about employees feeling comfortable reporting violations of safety con- ditions, bad management, fraud, or theft. It established an anonymous system that allows for reporting in native country languages. This system is used to alert management to potential problems in the organization and facilitate an investigation.21 Systems such as these help alleviate employee concerns when reporting observed misconduct.

Once a company determines that its ethical performance has not been satisfactory, the company’s management may want to reorganize the way certain ethical decisions are made. For example, a decentralized organi- zation may need to centralize key decisions, if only for a time, so that top-level managers can ensure improved organizational decision-making. Centralization may reduce the opportunity for lower-level managers and employees to make unethical decisions. Top management can then focus on improving the corporate culture and infusing more ethical values throughout the organization. Dell Computer is an example of a centralized organization, possibly because of its focus on manufacturing processes.

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In other companies, decentralization of important decisions may be a bet- ter way to attack ethical problems so that lower-level managers, familiar with the forces of the local business environment and local culture and val- ues, can make more decisions. Coca-Cola is a more decentralized company due to its use of independent distributors and unique localized cultures. Whether the ethics function is centralized or decentralized, the key need is to delegate authority in such a way that the organization can achieve ethical performance.

INSTITUTIONALIZATION OF BUSINESS ETHICS22 To successfully implement an ethics program, managers should be aware of the core, legally mandated, and voluntary elements of organizational busi- ness practices. All three should be incorporated into an organization’s ethics program. This generates an ethical culture that successfully controls and manages ethical risks. Institutionalization involves the legal and social forces that provide organizational rewards and punishments based upon stake- holder assessments of an organization’s behavior. In business ethics, institu- tionalization is associated with the establishment of laws, regulations, norms, and organizational programs. A refusal to conform to what is believed to be ethical conduct is often perceived to be an ethical issue and a concern to stakeholders. Institutions involve obligations, structures, and social expecta- tions that reward and limit ethical decisions. Federal agencies, for instance, are institutions that mandate laws for appropriate conduct. They may even recommend core practices for developing an ethical organizational culture.

Voluntary, Core Practices, and Mandatory Dimensions of Ethics Programs23 Table 6.5 summarizes the three elements of institutionalization. Voluntary practices are the beliefs, values, and voluntary responsibilities of an orga- nization. All organizations engage in some level of voluntary activities to

voluntary practices The beliefs, values, and voluntary responsibilities of an organization.

TABLE 6.5 Voluntary Boundary, Core Practices, and Mandated Boundaries of Ethical Decisions

Voluntary boundary A management-initiated boundary of conduct (beliefs, values, volun- tary polices, and voluntary responsibilities)

Core practice A highly appropriate and common practice that helps ensure compli- ance with legal requirements, industry self-regulation, and societal expectations

Mandated boundary An externally imposed boundary of conduct (laws, rules, regulations, and other requirements)

Source: Adapted from the “Open Compliance Ethics Group (OCEG) Foundation Guidelines,” v1.0, Steering Committee Update, December 2005, Phoenix, AZ.

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Chapter 6  Strategic Approaches to Improving Ethical Behavior 201

help different stakeholders. These responsibilities often manifest them- selves through philanthropy, which occurs when businesses give back to communities and causes. Home Depot strongly supports the nonprofit organization Habitat for Humanity and encourages employees to vol- unteer. Evidence suggests that a sense of the law and ethical behavior increases voluntary responsibility activities. Research has also confirmed that when a company’s core practices support ethical and legal responsi- bilities, they enhance economic performance.24

Core practices are recognized best practices that are often encouraged by regulatory forces and industry trade associations. As we mentioned in the previous chapter, the Better Business Bureau provides guidance for managing customer conflicts and reviewing advertising disputes. Core practices are appropriate practices often common to the industry. They guarantee compliance with legal requirements and social expectations. Core practices align the expectations of the consumer with a business to create satisfying exchanges.25

Although core practices are not enforced on a legal basis, businesses can face consequences for not engaging in them when misconduct occurs. For example, the Federal Sentencing Guidelines for Organizations provide incen- tives for firms that effectively implement core practices. If misconduct occurs, firms that have demonstrated best practices may be able to avoid serious penalties. However, if the board took no initiative to oversee ethics and com- pliance in the organization, its failure could increase the level of punishment the company experiences. In institutionalizing core practices, the government allows organizations to structure their own methods and takes action only if violations occur. Mandated boundaries are externally imposed boundaries of conduct, such as laws, rules, regulations, and other requirements. Laws regulating business competition are examples of mandated boundaries.

Organizations manage stakeholder expectations for ethical conduct through corporate governance mechanisms, compliance, risk management, and voluntary activities. Government initiatives and stakeholder demands have helped to institutionalize these drivers of an ethical organizational culture. For instance, the governing authority of an organization structures corporate governance to provide oversight, checks, and balances to ensure the organization meets its ethical objectives. Compliance represents areas that must follow laws and regulations. Risk management examines the chance that misconduct may occur based on the type of business and the risk areas it commonly faces. Voluntary activities often involve the values and responsibilities organizations adopt in contributing to stakeholder expectations.

ETHICAL LEADERSHIP26 A company’s leaders provide the blueprint for an organization’s corporate culture.27 If organizational leaders do not display ethical conduct, the corpo- rate culture will evolve on its own to exhibit the organization’s norms and

philanthropy The act of businesses giving back to communities and causes.

core practices Recognized best practices that are often encouraged by regulatory forces and industry trade associations.

mandated boundaries Externally imposed bound- aries of conduct, such as laws, rules, regulations, and other requirements.

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Ethical Responsibilities in Accounting

Integrated Financial Reporting Paints an Accurate Picture

Most people believe that financial statements such as income statements and balance sheets provide the entire picture of a firms’ financial standing. In reality, however, this is not the case. It has been estimated that about 80 percent of a firm’s value is not found on the balance sheet. One of the least understood areas involves sustainability. For instance, how much does violating an environmental law truly cost a firm, not only monetarily but also in terms of its reputation? Some socially responsible businesses have adopted a triple bottom line approach in which the organization reports its financial results, its impact on society, and its impact on the planet. Yet even these companies find it difficult to take three different dimensions and add them up to provide an overall report.

A pilot program consisting of about 100 global companies in 25 countries is investigating ways to over- come these challenges. This program, monitored by the International Integrated Reporting Council, seeks to create an integrated reporting model giving investors the opportunity to gain a holistic view of the com- pany’s operations and business strategies. Integrated reporting combines both financial and non-financial information. According to the Chartered Institute of Management Accountants, integrated reporting is meant to examine how organizations “really cre- ate value.” Companies testing this program include Microsoft, Unilever, Clorox, and Coca-Cola. Although most of these firms already develop sustainability or

social responsibility reports, these reports are separate from the company’s financial information. Such an endeavor requires the active participation of both com- pany financial officers and accountants.

Companies in the pilot program have different ways of reporting, but all focus on the true cost of capital and resources. For instance, U.K. global support and construction firm Interserve developed an integrated report focused upon four dimensions, including finan- cial, natural/environmental, knowledge, and social capital. This reporting system recognizes the value of intangible assets such as knowledge as well as the firm’s societal impact. The point of such reports is not to report more information, but to provide more thorough information so both investors and consum- ers receive a more complete view of the company. Whereas financial reports focus on short-term num- bers, it is hoped that integrated reporting will allow firms to adopt a more long-term orientation by taking an in-depth look at their resources and their impacts.

Proponents of integrated reporting hope that inte- grated reports will become the primary reports of the organization. In other words, integrated reporting may become the new norm for investor reports such as the annual report. Additionally, the demand for integrated reporting metrics seems to be growing. For instance, stock exchanges such as the Nasdaq are beginning to require more information on a firm’s corporate gover- nance and environmental activities.

Sources: “Integrated Reporting,” http://www.theiirc.org/ (accessed August 4, 2016); Kathleen Hoffelder, “What Does Sustainability Really Cost?” CFO, August 28, 2012, http://ww2.cfo.com/cash-flow/2012/08/what-does-sustainability-really-cost/ (accessed August 4, 2016); “Triple Bottom Line,” The Economist, November 17, 2009, http://www.economist.com/node/14301663 (accessed August 4, 2016); IIRC Pilot Programme Yearbook, Business and Investors Explore the Sustainability Perspective of Integrated Reporting, 2013, http://www. theiirc.org/wp-content/uploads/2013/12/IIRC-PP-Yearbook-2013_PDF4_PAGES.pdf (accessed August 4, 2016); “Integrated Reporting,” The Prince’s Accounting for Sustainability Project, http://www.accountingforsustainability.org/connected-reporting (accessed August 4, 2016); Chartered Institute of Management Accountants, “Integrated Reporting <IR>,” http://www.cimaglobal.com/Thought-leadership/ Integrated-reporting/ (accessed August 4, 2016).

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values. Consider the infamous accounting firm Arthur Andersen, once one of the “Big Five” accounting firms (they were reduced to the “Big Four” after Arthur Andersen’s demise). Arthur Andersen, who founded the company, valued ethical behavior. In one situation, he refused to improperly record an accounting entry for a major client.28 Contrast this to the firm Arthur Andersen a few years before its demise and you can see what could happen when an organization strays from ethical leadership. Without ethical leader- ship, an organizational culture cannot be maintained for long periods of time.

Organizational leaders are important to ethical decision making because they have the ability to motivate employees and enforce the orga- nization’s norms, policies, and procedures. Ethical leaders make certain that operational goals are achieved in an ethical manner. They do not simply allow employees to follow their individual moral codes, but enforce shared organizational values to support an ethical organizational culture. Ethical leaders also take the responsibility to model acceptable conduct for employees.29 Ethical leadership is positively related to employee organiza- tional citizenship; conversely, it is negatively related to employee miscon- duct. In other words, ethical leaders are more likely to have employees that support the organization’s ethical culture and less likely to have employees that deviate from organizational values.30

In addition to CEOs and managers, the board of directors is important in whether the organization displays ethical leadership. Legally, the board has a fiduciary duty to stakeholders to manage in the best interests of the organization. However, it is not always easy to determine what is in the best interests of the organization. A good example would be whether to engage in a risky activity that would result in short-term gains but which could cost the organization significantly in the long-run. To determine the appropriate course of action, board members must consider the impact a decision will have on different stakeholders.31

So far we have discussed individuals in a position of authority within an organization. However, ethical leadership is not limited to authority figures. It should also be practiced by employees at all levels of the orga- nization. Often, the actions of fellow employees significantly influence the ethical decision making of an individual.32 Thus, both leaders as well as employees within an organization have the responsibility to demonstrate ethical leadership characteristics when making decisions.

If stakeholders are dissatisfied with an organizational leader, the leader will not remain in that position. Ethical leaders must have the trust and respect of their followers. For instance, Martin Winterkorn, former CEO of Volkswagen, stepped down after it was discovered that Volkswagen had installed defeat devices into its diesel vehicles to fool regulators. Although initially is was unclear whether Winterkorn knew about the misconduct, as the leader of the company, the misconduct occurred during his watch.33 The nature of the relationship was found to violate Best Buy ethical policies. Ineffective tone at the top generates the perception that managers do not care about the organization’s ethics program or that they feel they are above the ethical requirements that everyone else in the organization must follow.

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Just as strong ethical leadership plays a key role in guiding employee behavior, so does a strong corporate culture of support. A KPMG Forensic Integrity Survey asked employees whether the leaders of their companies displayed personal integrity and ethical leadership traits. Approximately 68 percent of employees indicated that leaders emphasized ethics and integrity in the organization.34 These types of responses are becoming more common as organizations continue strengthening their ethics programs. The results of having an ethical focus are proving to be beneficial toward business operations. Challenges persist, however, and ethical leaders must be vigilant in nurturing the corporate culture of their organizations.

Leadership Power As we have shown, organizational leaders use their power and influence to shape corporate culture. Power refers to the influence that leaders and managers have over the behavior and decisions of subordinates. An individual has power over others when his or her presence causes them to behave differently. Exerting power is one way to influence the ethical decision-making framework we described in Chapter 5 (especially signifi- cant others and opportunity).

The status and power of leaders are directly related to the amount of pressure they can exert on employees to conform to their expectations. A superior in a position of authority can put strong pressure on employees to comply, even when their personal ethical values conflict with the supe- rior’s wishes. For example, a manager might say to a subordinate, “I want the confidential data about our competitor’s sales on my desk by Monday morning, and I don’t care how you get it.” A subordinate who values his or her job or who does not realize the ethical questions involved may feel pressured to do something unethical to obtain the data.

There are five power bases from which one person may influence another: (1) reward power, (2) coercive power, (3) legitimate power, (4) expert power, and (5) referent power.35 These five bases of power can be used to motivate individuals either ethically or unethically.

Reward Power Reward power refers to a person’s ability to influence the behavior of others by offering them something desirable. Typical rewards might be money, status, or promotion. Consider, for example, a retail salesperson who has two watches (a Timex and a Casio) for sale. Let us assume that the Timex is of higher quality than the Casio but is priced about the same. In the absence of any form of reward power, the salesper- son would logically attempt to sell the Timex watch. However, if Casio gave him an extra 10 percent commission, he would probably focus his efforts on selling the Casio watch. This “carrot dangling” and incentives have been shown to be very effective in getting people to change their behavior in the long run. In the short run, however, it is not as effective as coercive power.

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Coercive Power Coercive power is essentially the opposite of reward power. Instead of rewarding a person for doing something, coercive power penalizes actions or behavior. As an example, suppose a valuable client asks an industrial salesperson for a bribe and insinuates that he will take his business elsewhere if his demands are not met. Although the salesper- son believes bribery is unethical, her boss has told her that she must keep the client happy or lose her chance at promotion. The boss is also impos- ing a negative sanction if certain actions are not performed. Every year, 20 percent of Enron’s workforce was asked to leave because they were ranked as “needs improvement,” or because of other issues. Employees not want- ing to fall into the bottom 20 percent engaged in corruption or exhibited complacency toward corruption.36

Coercive power relies on fear to change behavior. For this reason, it has been found to be more effective in changing behavior in the short run than in the long run. Coercion is often employed in situations where there is an extreme imbalance in power. However, people who are continually subjected to coercion may seek a counterbalance by aligning themselves with other more powerful persons or simply by leaving the organization. In firms that use coercive power, relationships usually break down in the long run. Power is an ethical issue not only for individuals but also for work groups that establish policy for large corporations.

Legitimate Power Legitimate power stems from the belief that a certain person has the right to exert influence and that certain others have an obligation to accept it. The titles and positions of authority that organiza- tions bestow on individuals appeal to this traditional view of power. Many people readily acquiesce to those who wield legitimate power, sometimes committing acts that are contrary to their beliefs and values. Betty Vin- son, an accountant at WorldCom, objected to her supervisor’s requests to produce improper accounting entries in an effort to conceal WorldCom’s deteriorating financial condition. She finally gave in to their requests, how- ever, after being told that this was the only way to save the company. She and other WorldCom accountants eventually pleaded guilty to conspiracy and fraud charges.37

Such loyalty to authority figures can also be seen in corporations that have strong charismatic leaders and centralized structures. In business, if a superior tells an employee to increase sales “no matter what it takes” and that employee has a strong affiliation to legitimate power, the employee may try anything to fulfill that order.

Expert Power Expert power is derived from a person’s knowledge (or the perception that the person possesses knowledge). Expert power usually stems from a superior’s credibility with subordinates. Credibility, and thus expert power, is positively related to the number of years a person has worked in a firm or industry, the person’s education, or the honors he or she has received for performance. Expert power can also be conferred on a person by others who perceive him or her as an expert on a specific topic.

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A relatively low-level secretary may have expert power because he or she knows specific details about how the business operates and can even make suggestions on how to inflate revenue through expense reimbursements.

Expert power may cause ethical problems when it is used to manipu- late others or to gain an unfair advantage. Physicians, lawyers, or con- sultants can take unfair advantage of uninformed clients, for example. Accounting firms may gain extra income by ignoring concerns about the accuracy of financial data they are provided in an audit.

Referent Power Referent power may exist when one person perceives that his or her goals or objectives are similar to another’s. The second person may attempt to influence the first to take actions that will lead both to achieve their objectives. Because they share the same objectives, the person influenced by the other will perceive the other’s use of referent power as beneficial. For this power relationship to be effective, however, some sort of empathy must exist between the individuals. Identification with others helps to boost the decision maker’s confidence when making a decision, thus increasing his or her referent power.

Consider the following situation: Lisa Jones, a manager in the accounting department of a manufacturing firm, has asked Michael Wong, a salesper- son, to speed up the delivery of sales contracts, so the revenue can be reported in the current quarter. Michael protests that he is not to blame for the slow process. In this case, Lisa makes use of referent power. She invites Michael to lunch, and they discuss some of their work concerns. They agree to speed up document processing, and Lisa suggests that Michael start asking for con- tracts that he expects in the next quarter. He agrees to give it a try, and within several weeks, the contracts are moving faster and revenue has increased in the current quarter. Lisa’s job is made easier, and Michael gets his commis- sion checks a little sooner. (On the other hand, they may be engaging in chan- nel stuffing, which in some cases can be considered revenue fraud.)

The five bases of power are not mutually exclusive. People typically use several power bases to effect change in others. Although power in itself is neither ethical nor unethical, its use can raise ethical issues. Sometimes, a leader uses power to manipulate a situation or a person’s values in a way that creates a conflict with the person’s value structure. For example, a manager who forces an employee to choose between staying home with his sick child and keeping his job is using coercive power, which creates a direct conflict with the employee’s values.

The Role of an Ethical Corporate Culture Top management sets the tone for the ethical culture of an organization. If executives and CEOs do not explicitly address ethics issues, a culture may emerge where unethical behavior is sanctioned and rewarded. To be most successful, ethical standards and expected behaviors should be integrated throughout every organizational process from hiring, training, compensat- ing, and rewarding to firing. This requires ethical leadership.

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An ethical organizational culture is important to employees. A fair, open, and trusting organizational climate supports an ethical culture and can be attributed to lower turnover and higher employee satisfac- tion. Southwest Airlines has a very strong organizational culture that has remained consistent from the days of its key founder Herb Kelleher. All Southwest employees have heard the stories of Kelleher engaging employ- ees and emphasizing loyalty, teamwork, and the creation of a fun environ- ment. Kelleher strove to treat employees like family. Today, Southwest continues that legacy and culture. Pilots willingly support the ‘Adopt a Pilot’ program that allows students in classrooms countrywide to adopt a Southwest pilot for its four-week educational and mentoring program.38

Some leaders assume that hiring or promoting good, ethical managers will automatically produce an ethical organizational climate. This ignores the fact that an individual may have limited opportunity to enforce his or her own personal ethics on management systems and informal deci- sion making that occurs in the organization. The greatest influence on employee behavior is that of peers and coworkers.39 Many times, workers do not know what constitutes specific ethical violations such as price fix- ing, deceptive advertising, consumer fraud, and copyright violations. The more ethical the culture of the organization is perceived to be, the less likely it is that unethical decision making will occur. Over time, an orga- nization’s failure to monitor or manage its culture may foster questionable behavior. FedEx maintains a strong ethical culture and has woven its val- ues and expectations throughout the company. FedEx’s open-door policy specifies that employees may bring up any work issue or problem with any manager in the organization.40

REQUIREMENTS OF ETHICAL LEADERSHIP41 Ethical leaders develop their skills through years of training, experience, and learning. In identifying what makes an effective leader, there is no clear con- sensus of the exact skills needed. However, there are certain skills that seem to be common to ethical organizational leaders. To be an ethical organizational leader, individuals should model corporate values, place the organization’s own interests above their own, understand their employees, develop tools for reporting, and recognize the limitations of organizational rules and values.42 Additionally, ethical leaders should never ignore issues of misconduct.

Ethical leaders do not live in a vacuum but are constantly interacting with others to encourage them to develop ethical leadership skills. Perhaps the best ethical leaders recognize their own limitations and establish strong support networks within the organization to help them in the decision making process. In so doing, they motivate employees toward reaching their full potential and emphasize their importance to the organization.43 They also establish incentives for those in the organization who train new leaders.44 Developing effective ethical leaders should be a never-ending process within an organization.

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Archie Carroll developed a list of characteristics called the “7 Habits of Highly Moral Leaders,” based on Stephen Covey’s The 7 Habits of Highly Effective People.45 We have adapted Carroll’s work46 to develop “The 7 Habits of Strong Ethical Leaders.” These characteristics include (1) hav- ing a strong personal character, (2) having a passion to do what is right, (3) being proactive, (4) considering stakeholder interests, (5) modeling the organization’s values, (6) being transparent and actively involved in organi- zational decision making, and (7) being a competent manager who takes a holistic view of the firm’s ethical culture. Ethical leadership requires holistic thinking—one that is willing to take on the challenging issues organizations face every day. Strong ethical leaders have the knowledge and courage to put together important information in order to make the most ethical deci- sion. Various stakeholder demands and conflicts make this a major chal- lenge, but ethical leaders are up to the task. Above all, ethical leaders abide by their principles. This might even require the leader to leave the organiza- tion if he or she feels that the culture is too unethical to change.

Additionally, effective ethical leaders are so passionate about the orga- nization and its success that they place the organizations’ interests above their own.47 It also requires them to align employees behind a shared vision.48 Ethical leaders are concerned with the legacy of their companies, desiring for the company’s success to continue long after they are gone. For example, Milton Hershey’s legacy has continued at Hershey Foods long after his death, and the firm’s ethical culture remains a role model for other companies.

Ethical leaders must be proactive in anticipating, planning, and acting to avoid potential ethical crises.49 They shoulder the important responsibility of developing effective ethics programs to guide employees in their ethical decision making. Ethical leaders understand social needs and develop core practices of ethical leadership. Vice Chairman Tom Mendoza at NetApp tells managers to let him know when an employee is “doing something right.” Mendoza then calls the employees to thank them. His personal “thank you” calls average approximately 10–20 calls per day.50 Recognizing employee accomplishments in promoting ethical conduct is a great way to make employees feel appreciated and reinforce an ethical organizational culture.

Finally, ethical leaders should be role models. If leaders do not model the values that they advocate, then those values become little more than window dressing. Behavioral scientist Brent Smith claims that leaders act- ing as role models are the primary influence on individual ethical behavior. On the other hand, leaders whose decisions go against the organization’s values signal to employees that the organization’s ethical values are mean- ingless.51 Whole Foods is an example of a company that strongly supports its core values. In addition to providing quality products, Whole Foods establishes employee well-being through the creation of a transparent workplace. To reduce the power gap between executives and employees, a salary cap has been placed on executive compensation. Each Whole Foods store donates at least 5 percent of profits to its communities.52 Table 6.6 displays Whole Foods’ core values.

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TABLE 6.6 Whole Food’s Core Values Sell the highest quality natural and organic products Satisfy, delight, and nourish our customers Support team member happiness and excellence Create wealth through profits and growth Serve and support our global and local communities Practice and advance environmental stewardship Create ongoing win-win partnerships with our suppliers Promote the health of our stakeholders through healthy eating education

Source: “Our Core Values,” Whole Foods Markets, http://www.wholefoodsmarket.com/company/cor- evalues.php (accessed June 21, 2016).

Benefits of Ethical Leadership53 Perhaps the most important influence of ethical leadership is its impact on organizational culture. Because ethical leaders communicate and oversee the implementation of an organization’s values, they make certain that employees are familiarized with core beliefs.54 Some may provide incen- tives for ethical conduct, such as rewards for making ethical decisions. These incentives have a positive impact on ethical conduct among employ- ees.55 Teaching employees to value integrity is a key component in creating an ethical organization.

Research has shown that ethical leadership tends toward higher employee satisfaction and commitment.56 Employees seem to like work- ing for ethical companies and are more likely to stay with ethical orga- nizations.57 This saves the firm money and leads to higher productivity. Employees at The Container Store are provided with 263 hours of train- ing, receive higher pay than at competing stores, and are shown appre- ciation through events like We Love Our Employees Day. This strong organizational culture has resulted in a turnover rate of 10 percent for The Container Store. This is compared to 100 percent for other retailers in the industry.58

In addition to employee satisfaction and productivity, ethical leader- ship also creates strong connections with stakeholders external to the organization. Studies have revealed that customers are willing to pay higher prices for products from companies they consider to be ethical.59 Consumer trust for businesses still has a long way to go after the latest recession, and organizations that can establish trust are likely to receive a large and loyal customer following.

Ethical leadership also impacts an organization’s long-term value. Evidence shows that the ethical commitment of organizational members is positively associated with the organization’s value on the stock market.60 This is because reputation has a profound influence on whether an investor will even invest. Investors consider the risk of an investment as a major

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factor in their decision, and because social responsibility programs are negatively related to long-term risks,61 ethical conduct is likely to improve reputation and consequently lower the risks of investment. As we already discussed in the previous chapters, from a regulatory standpoint, organiza- tions demonstrated as having strong ethics programs are more likely to see reduced penalties if misconduct should happen.62 By creating strong rela- tionships with a variety of stakeholders, ethical leaders are able to develop major competitive advantages for their organizations.

Leadership Styles63 Leadership styles impact not only how a leader leads but also how employ- ees accept and/or adhere to organizational norms and values. Clearly, leadership styles that reinforce the development of organizational values are beneficial. These styles of leadership affect the organization’s commu- nication and oversight of values, norms, and ethics codes.64 The challenge that leaders face is earning employee trust. This trust is imperative if a leader hopes to guide employees into ethical decision making. Trustworthy leaders tend to be seen as ethical stewards.65 Employees often look to their organizational leaders to determine how to respond to a situation, even when that response may be ethically questionable.

Effective ethical leadership requires the leader to understand the orga- nization’s vision and values, ethical challenges, and the risks involved in accomplishing organizational objectives. One of the biggest assumptions is that those who fail in ethical leadership do not have an ethical character. This is a fallacy. In reality, there are a number of examples of people impli- cated in misconduct who appeared to have good character. Rajat Gupta, who was convicted for passing on insider trading tips, has been recognized for his strong philanthropic endeavors and exceptional kindness.66

Ethical leaders must learn from their experiences and gain knowledge about appropriate practices. They display transparency in their leadership and have the ability to understand both current ethical issues as well as to anticipate future issues. These leaders often adopt a stakeholder orienta- tion approach to management. It is also important to note that even the most ethical leaders are human; they will make ethical mistakes, but how they acknowledge these mistakes is what often separates them from other leaders.

One important characteristic that many ethical leaders appear to pos- sess is emotional intelligence, or the skills to manage themselves and their relationships with others effectively. Emotionally intelligent leaders are characterized by self-awareness, self-control, and relationship building. They see their efforts as achieving “something greater than themselves.”67 Warren Buffett and Howard Schultz are examples of emotionally intel- ligent leaders. These leaders are able to motivate employees to support a common vision, making them feel that their efforts matter in the success- ful operation of the organization.68 Because emotionally intelligent leaders exhibit self-control and self-awareness, they are more proficient in tackling

emotional intelligence An important characteristic possessed by ethical leaders referring to the skills to manage themselves and their relationships with others effectively.

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stressful and challenging situations. Because of the impact of emotional intelligence on the success of the organization, some employers have begun viewing emotional intelligence as more important than IQ.69

Daniel Goleman examined leadership styles based upon emotional intelligence. He came up with the following six styles:70

1. The coercive leader requires complete obedience and focuses on achieve- ment, initiative, and self-control. This style can be highly effective during times of crisis but tends to be detrimental to long-term performance.

2. The authoritative leader motivates employees to follow a shared vision, embraces change, and creates a strongly positive performance climate.

3. The affiliative leader values people and their needs. This leader depends upon friendship and trust to encourage flexibility and innovation.

4. The democratic leader values participation and teamwork to develop collaborative decisions. This style focuses heavily on communication and creating a positive work climate.

5. The pacesetting leader sets high standards of performance. This style works well for achieving quick results from motivated, achievement- oriented employees but can have negative results due to its stringent performance standards.

6. The coaching leader creates a positive work climate by developing skills to promote long-term success, delegating responsibility, and assigning challenging assignments.

Using Goleman’s research, Richard Boyatzis and Annie McKee came up with the idea of a resonant leader. Resonant leaders are mindful of their emotions, believe that goals can be achieved, and display a caring attitude toward other employees. This leads to resonance within the organization, enhancing collaboration and the ability of employees to work toward shared goals.71 Resonant leaders are highly effective in creating an ethical corporate culture as well as strong relationships with employees.

The most successful leaders tend to adapt their styles based upon the situation. Leadership style relies heavily on how the leader measures risks as well as his or her desire to attain a positive corporate culture. Like other leadership characteristics, many emotional intelligence skills can be learned. Starbucks places great importance on emotional intelligence. New employees at the company undergo a training program called the “Latte Method” to learn how to detect negative emotions from their customers and the best ways of responding to them.72

Two dominant leadership styles in an organization are transactional and transformational. Transactional leadership attempts to create employee satisfaction through negotiating for levels of performance or “bartering” for desired behaviors. Transformational leadership, in contrast, tries to raise the level of commitment of employees and creates greater trust and motivation.73 Transformational leaders attempt to promote activities and behavior through a shared vision and common learning experiences. Both transformational and transactional leaders can positively influence the organizational climate.

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Transformational leaders communicate a sense of mission, stimulate new ways of thinking, and enhance as well as generate new learning expe- riences. Transformational leadership considers the employees’ needs and aspirations in conjunction with organizational needs. Therefore, transfor- mational leaders have a stronger influence on coworker support and the building of an ethical culture than transactional leaders. Transformational leaders also build a commitment and respect for values that provide agreement on how to deal with ethical issues. Transformational ethical leadership is best suited for higher levels of ethical commitment among employees and strong stakeholder support for an ethical climate. A number of industry trade associations, such as the American Institute of Certified Public Accountants, Defense Industry Initiative on Business Ethics and Conduct, and the Ethics and Compliance Officer Association, are assisting companies in providing transformational leadership.74 Research suggests that organizations with transformational leadership are more likely to be involved in corporate social responsibility (CSR) activities.75

Transactional leadership focuses on ensuring that the required conduct and procedures are implemented. The “barter” aspects of negotiations to achieve the desired outcomes result in a dynamic relationship between lenders and employees where reactions, conflicts, and crises influence the relationship more than ethical concerns. Transactional leaders produce employees who achieve a negotiated level of required ethical performance or compliance. As long as employees and leaders find the exchange mutu- ally rewarding, the compliance relationship is likely to be successful. However, transactional leadership is best suited to quickly changing ethi- cal climates or reacting to ethical problems or issues. After a major leader- ship scandal at Tyco resulted in the conviction of CEO Dennis Kozlowski and the removal of its board members, the need for quick action to pull up the struggling company was apparent. Without a quick turnaround—both in leadership and in the company’s ethical conduct—Tyco may not have survived. Eric Pillmore was hired to be the senior vice president of cor- porate governance at Tyco. Pillmore had to institute ethics and corporate governance decisions quickly to aid in the turnaround. He helmed a new ethics program that changed leadership policies and gave him direct com- munications with the board of directors.76

Other leadership experts are classifying leaders into a new category based on how they model organizational values. Authentic leadership includes individuals who are passionate about the organization, display corporate values in their daily behavior at work, and establish enduring relationships with stakeholders. Kim Jordan, former CEO of craft brewery New Belgium Brewing (NBB), is an example of an authentic leader. Jordan constantly attempts to embody NBB’s mission to “operate a profitable company which makes our love and talent manifest.”77 Jordan has also successfully aligned employees at NBB toward a shared goal of providing high quality products, improving sustainability, and embracing a stake- holder orientation.

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Authentic leadership can also be learned. In fact, authentic leaders often learn by observing the successful leadership habits of other strong leaders.78 Authentic leaders possess principle-centered power, meaning that they can handle difficult situations and are extremely dedicated toward their organizations.79 They also exhibit organizational core values and incorporate these values into daily operations. This type of leadership should be the aim for all ethical leaders in an organization.

Leader-Follower Relationships80 Communication is the key toward establishing strong relationships between organizational leaders and employees. Leader–follower congru- ence takes place when leaders and their followers (employees) share the same organizational vision, ethical expectations, and objectives. It is important for ethical leaders to get employees to adopt shared organiza- tional goals and values. If employees feel that the organizational leaders are unapproachable, this will create a major obstacle toward the achieve- ment of the organization’s vision and objectives.

On the other hand, leaders may take the opposite approach by micro- managing employees. Managing employees too closely will make them feel stifled and give them the feeling that the management does not trust them. Micromanagement in organizations is associated with lower morale, decreased productivity, and greater tendency to leave the company.81 These disadvantages can be avoided when ethical leaders use communication to develop respectful relationships with employees. These more positive rela- tionships tend to increase job satisfaction and employee commitment.82

Because organizational leaders are often managers or executives, they may not work very much with lower-level employees. This could create a sense of isolation in which the leader feels cut off from other employees. The more isolated organizational leaders are, the less connected they will be with employees—and the less likely they will be to detect organizational miscon- duct. Instead, ethical leaders must frequently interact with employees. This takes the form of not only speaking with employees but also listening to them and encouraging them to provide feedback. Often employees tend to want to avoid discussing ethical issues in the workplace. To get past this hesitation, ethical leaders must proactively communicate the firm’s ethical values and develop a transparent workplace in which employees can feel comfortable expressing concerns.83 We discuss communication in more detail in the next section. When organizational leaders and employees are on the same page, they are able to advance the organization’s goals and culture more effectively.

Ethical Leadership Communication84 The development of an ethical culture is impossible without strong com- munication in the organization. If an organizational leader communicates through highly controlling speech that tolerates little criticism, employees will be reluctant to bring up any ethical issues or problems. However,

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TABLE 6.7 Communication Skills for Becoming an Ethical Leader 1. Tell employees the truth about their conduct.

2. Listen to employee concerns about ethical issues they observe.

3. Engage in direct personal communication about appropriate conduct.

4. Use coaching to provide expectations about behavior.

5. Include performance feedback on ethical evaluations.

6. Be sure your feedback on ethical conduct is correct.

7. Always ask for feedback from employees.

8. Continue to develop your leadership skills.

ethical leaders understand the importance of frequent communication and interaction with employees. Table 6.7 shows how leaders can use commu- nication to become better leaders.

An ethical culture must contain both transparency and strong mecha- nisms for reporting. Ethical leaders in the organization must create a transparent environment where ethics is frequently discussed. This helps remove the idea that discussing issues is a “taboo” topic. Reporting occurs when organizational leaders and their employees communicate. Most of the time, employees report to the leaders. However, ethical leaders should also be responsible for reporting crucial information to employees to pro- mote an ethical workplace and advance organizational goals.

Reporting can be either formal or informal. Formal reports occur in contexts such as conferences and meetings. An important tool for formal reporting is an anonymous ethics hotline employees can use to report concerns. Informal reporting is no less important. It happens when ethical leaders interact with their employees on a less formal basis to keep them apprised of organizational policies, expectations, and decisions.85 Informal discussions are incredibly important in identifying ethical risk areas as concerns are frequently expressed through casual conversations. Ethical leaders must recognize the importance of both formal and informal com- munication mechanisms.

Just as individuals can learn leadership skills, they can also learn how to communicate effectively. Effective communication skills are often devel- oped and honed through training and experience. Organizational com- munication necessary for the establishment of an ethical culture includes the following: interpersonal communication, small group communication, nonverbal communication, and listening. Table 6.8 summarizes the four categories of communication.

Interpersonal Communication. Interpersonal communication is the most common form of communication. It occurs when two or more people communicate with one other.86 A meeting between an employee and her supervisor is an example of interpersonal communication. Interpersonal communication (versus small group communication) is more intimate because fewer people are involved. This type of communication should

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TABLE 6.8 Four Categories of Communication

Communication Description Interpersonal When two or more people communicate with one another

Small Group Communication that occurs in small groups

Nonverbal Expressed through body language, actions, expressions, tone of voice, proximity, volume, rhythm, or any other way that is not oral or written

Listening Actively listening to the other person’s verbal or nonverbal behavior

occur often within an organization because it gives ethical leaders a greater chance to uncover ethical risk areas, create better employee relationships, and encourage feedback about the organization’s ethical climate. For inter- personal communication to be effective, ethical leaders must show the employee respect and dignity to maintain a positive relationship—even during disciplinary procedures. Respecting the employee demonstrates that the leader cares about what the employee has to say. On the other hand, this does not mean that ethical leaders should ignore or compromise uneth- ical employee conduct. It is less about placating an employee and more about showing him or her dignity as a person.

It is not uncommon for employees to feel intimidated by their supe- riors due to power differences.87 An ethical leader can use communica- tion to reassure employees as well as balance the interests of all relevant stakeholders.88 A good way to reduce perceived power distances is for the ethical leader to be open and respectful to the employee instead of judg- mental. This approach helps make employees feel more comfortable about bringing up ethical concerns.89

Communication is not always black-and-white. Like many ethical issues, there are times when the ethical leader will have different options on what to communicate, with some being more or less ethical than oth- ers. For instance, lying to a customer is clearly unacceptable, but white lies that do not damage stakeholders (such as complimenting an employee on a haircut despite the fact that it looks awful) may be permissible in some instances. Additionally, as the Rajat Gupta example from earlier demon- strates, communication that is not thought out carefully can have serious consequences. For Rajat Gupta, giving his friend Raj Rajaratnam from The Galleon Group nonpublic information directly violated the law. Ethical leaders will encounter numerous situations in which they must consider the ethical consequences of communication with stakeholders. Ethical leaders who strongly support ethical interpersonal communication can empower employees while promoting the organization’s ethical objectives.

Small Group Communication. Small group communication is becoming increasingly important to ethical decision making.90 Because ethical deci- sion making does not occur in a silo, small group communication is often necessary to investigate and select the most ethical course of action. Small

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group communication has an advantage over interpersonal communica- tion because it increases collaboration, explores more options, and allows employees to participate more in ethical decision making. Small groups generate a variety of perspectives on a particular issue, enabling ethical leaders to look at an issue from a number of different angles. This diversity of perspectives can lead to better solutions than if the leader had tried to arrive at the outcome individually.

Small groups also help to create checks and balances through accountability. An effective team holds individual members accountable for their contributions. For effective small group communication to take place, all small group members should feel comfortable with contributing input, understand the organization’s ethical values, be trained in ethical communication, know how to listen to the input of other members, try to understand the other person’s point of view, demonstrate a readiness to seek common agreement, investigate different alternatives, and commit to choosing the most ethical solution.91

However, ethical leaders should also recognize the limitations of small group communication. Sometimes routine group decision making can cause the group to overlook possibilities. It is also not uncommon for teams to expe- rience groupthink or group polarization. Group polarization is the tendency to decide on a more extreme solution than an individual might choose on his or her own. A small group, for instance, might choose to pursue a riskier decision than would normally be chosen.92 Groupthink is when group mem- bers feel pressured to conform to the group consensus, even if they personally disagree with it. This could result in a less-than-optimal ethical decision.

Nonverbal Communication. Non-spoken communication is a dimen- sion of ethical communication that is just as important as spoken forms. Nonverbal communication is expressed through body language, actions, expressions, tone of voice, proximity, volume, rhythm, or any other way that is not oral or written. Nonverbal communication is important because it provides clues to an individual’s emotional state.93 Paralanguage, which includes the way we talk, can indicate whether a person is angry, sad, happy, etc. Often nonverbal communication is more trustworthy than spo- ken communication. For instance, although a person might say one thing, if his or her body language communicates something else, then the non- verbal communication is often a better indicator of what the person really means. This is because nonverbal communication is harder to control than the spoken word as it occurs in the subconscious.

Nonverbal communication helps to clarify ambiguous or confusing language, alerting the communicator about whether the recipient under- stands the communication. Because nonverbal communication provides important insights into a person’s feelings, ethical leaders should pay care- ful attention to their employees’ nonverbal cues. Sometimes permission to engage in unethical activities is granted by an expression or nodding of the head. They should also be careful to monitor their own nonverbal cues so they do not give off the wrong impression to employees.

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Listening. Ethical communication is not limited to speaking or communi- cating nonverbally. It also involves actively listening to the other person’s verbal or nonverbal behavior.94 Communication between stakeholders cannot occur without listening. Organizational leaders who fail to listen can overlook ethical issues and fail to stop them before they snowball into a crisis. In fact, many employees have cited the failure to listen as one of their top complaints in the workplace,95 so listening to employee concerns is crucial in advancing an ethical organizational culture. Without listening ethical leaders cannot learn important information from employee reports necessary in understanding the ethical climate of the firm.

On the other hand, listening to employees increases morale as well as their willingness to participate in the ethical decision making process. Effective listening skills create a sense of credibility and trustworthiness.96 This supports a transparent organizational culture in which ethical con- cerns can be discussed freely. Because ethical leaders act as role models, their ability to listen encourages employees to do the same, further pro- moting the acceptance of the organization’s ethical values.

SUMMARY A strategic approach to ethical decisions will contribute to both business and society. To be socially responsible and promote legal and ethical con- duct, an organization should develop an organizational ethics program by establishing, communicating, and monitoring ethical values and legal requirements that characterize its history, culture, industry, and operat- ing environment. Most companies begin the process of establishing an organizational ethics program by developing a code of conduct, a formal statement that describes what the organization expects of its employees. A code should reflect senior management’s desire for organizational compli- ance with values, rules, and policies that support an ethical climate. Codes of conduct help employees and managers address ethical dilemmas by prescribing or limiting specific activities.

Organizational ethics programs must be overseen by high-ranking persons reputed for their legal and ethical standards. Often referred to as ethics officers, these persons are responsible for assessing the needs and risks to be addressed in an organization-wide ethics program, develop- ing and distributing a code of conduct, conducting training programs for employees, establishing and maintaining a confidential service to answer questions about ethical issues, making sure the company is in compliance with government regulations, monitoring and auditing ethical conduct, taking action on possible violations of the organization’s code, and review- ing and updating the code. Instituting a training program and a system to communicate and educate employees about the firm’s ethical standards is a major step in developing an effective ethics program.

Ethical compliance involves comparing the employee’s ethical perfor- mance with the organization’s ethical standards. Ethical compliance can be measured through employee observation, internal audits, reporting

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systems, and investigations. An internal system for reporting misconduct is especially useful. Employees who conclude that they cannot discuss cur- rent or potential unethical activities with co-workers or superiors and go outside the organization for help are known as whistle-blowers.

Consistent enforcement and necessary disciplinary action are essential to a functional ethical compliance program. Continuous improvement of the ethics program is necessary. Ethical leadership and a strong corporate culture in support of ethical behavior are required to implement an effec- tive organizational ethics program.

Ethical leadership is particularly important to the organization’s ethi- cal culture. The most effective leaders are able to adapt their leadership styles—reward, coercive, legitimate, expert, and referent power—to the type of situation. These styles also have a major impact on the organiza- tion’s corporate culture. Emotional intelligence is also an important com- ponent of ethical leadership.

There are many requirements for ethical leadership, including a pas- sion for doing right, being competent and proactive, taking a holistic view of the ethics program, considering stakeholder interests, and acting as a role model. Ethical leadership leads to several benefits for the organiza- tion, including higher employee satisfaction and productivity as well as the promotion of ethical values. Leaders have different methods of leading. These methods, including transactional, transformational, and authentic, have different impacts on the organization’s ethical culture. To promote an ethical culture, it is necessary for leaders to have strong positive rela- tionships with the employees. An important way of maintaining these relationships is through communication. Ethical leaders should master interpersonal, small group, and nonverbal communication as well as listen- ing. Being an effective communicator helps the ethical leader to develop positive employee relationships, uncover ethical issues, address employee concerns, and include employees in the ethical decision-making process.

Responsible Business Debate

Enron: The Capitalist Manifesto? Issue: Was it greed, corporate culture, or something else that caused the downfall of Enron?

“Greed is good,” said Gordon Gekko in the movie Wall Street—a mind-set that permeated the financial firms of Wall Street for decades. If this phrase is the capitalist manifesto, Enron is the archetype of this philosophy. The company marked both the height and the begin- ning of the end of that kind of corporate mentality.

Ken Lay, former CEO of Enron, has become the ultimate symbol of unethical conduct. He was the key executive involved in a massive fraud that destroyed thousands of jobs, life savings, as well as billions in shareholder value. Lay was put on trial and found guilty of “consciously avoiding knowing about wrongdoing” at Enron. Yet even after his conviction, Lay maintained that “with 30,000 employees in 30 countries and 200 executives at the vice president level,” the corruption

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had existed without his knowledge. Most experts believe that ethical corporate cultures are a top-down phenomenon, and after the fall of Enron, most people felt Lay had to be held responsible.

Enron whistle blower Sherron Watkins asserted that Lay was indeed some distance from the fraud, and that Jeff Skilling, also CEO for a short time, was the one who had created a strong culture of greed where bad behavior was rewarded as long as it delivered profits for the company. Aggressive business practices included finding loopholes in regulation, extreme pressure to perform, periodic firing of the lowest performing employees, paying huge salaries and bonuses to those who did perform well (regardless of what ethical cor- ners they may have cut), and bribing lawyers, bankers, accountants, and other so-called gatekeepers.

A culture of greed evolved where everyone took risks and expected a big reward. And yet, until his death Key Lay claimed the firm had strong values of respect, integrity, communication, and excellence, including a detailed code of ethics. How could these two corpo- rate cultures—the greedy one created by Skilling and the ethical one Lay believed Enron had—exist in the same company? In the end, Lay stated internal controls

were not effective and that he believed the frauds of Andy Fastow, the former CFO, were what brought down the company. Sherron Watkins, although a key whistleblower, did not blame Lay. She thought that Jeff Skilling’s charismatic and intimidating leadership had been the central problem. Watkins believes that if Skilling had been out of the picture, the fraud would not have happened. The Enron disaster created more new regulatory legislation and incited an ongoing debate about the nature of capitalism and what is an effective business ethics program.

There Are Two Sides To Every Issue: 1. Ethical misconduct was caused by the corporate

culture at Enron. 2. Ethical misconduct at Enron was caused by Ken Lay’s

and Jeff Skilling’s leadership.

Sources: Gerard Beenen and Jonathan Pinto, “Resisting Organizational Level Corruption: An Interview with Sherron Watkins,” Academy of Management Learning and Education 8, no. 2 (June 2009): 275–289; O. C Ferrell and Linda Ferrell, “The Responsibility and Accountability of CEOs: The Last Interview with Ken Lay,” Journal of Business Ethics 100, no. 2 (May 2011): 209–219; Fareed Zakaria, “Greed is Good (to a point),” Newsweek, June 22, 2009, p.41.

codes of conduct (p. 190) ethics officer (p. 193) whistle-blowers (p. 198)

voluntary practices (p. 200) philanthropy (p. 201) core practices (p. 201)

mandated boundaries (p. 201) emotional intelligence (p. 210)

KEY TERMS

DISCUSSION QUESTIONS 1. How can an organization be socially responsible

and promote legal and ethical conduct? 2. What are the elements that should be included in

a strong ethics program? 3. What is a code of conduct and how can a code be

communicated effectively to employees? 4. How and why are a training program and a com-

munications system important in developing an effective ethics program?

5. What does ethical compliance involve and how can it be measured?

6. What role does leadership play in influencing organizational behavior?

7. Describe some of the skills needed to be an ethical leader.

8. List some of the benefits of ethical leadership. 9. Compare transformational leadership and trans-

actional leadership. 10. Describe the four different types of communication.

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Robert Rubine flipped through his messages and won- dered which call he should return first. It was only 3:30 p.m., but he felt as though he had been through a week’s worth of decisions and worries. Mondays were normally busy, but this one was anything but normal. Robert’s employer, Medic-All, is in the business of selling a wide array of medical supplies and equip- ment. The company’s products range from relatively inexpensive items, like bandages, gloves, and syringes, to more costly items, such as microscopes, incubators, and examination tables. Although the product line is broad, it represents the “basics” required in most healthcare settings. Medic-All utilizes an inside sales force to market its products to private hospitals, elder care facilities, government healthcare institutions, and other similar organizations. The company employs 275  people and is considered a small business under government rules.

The inside sales force has the authority to negotiate on price, which works well in the highly competitive market of medical supplies and equipment. The sales- people are compensated primarily on a commission basis. The sales force and other employees receive legal training annually. All employees are required to sign Medic-All’s code of ethics each year and attend an ethics training session. Despite the importance of the inside sales force, Medic-All has experienced a good deal of turnover in its sales management team. A new lead manager was hired about four months ago. Robert oversees the sales division in his role as vice president of marketing and operations.

Late Friday afternoon last week, Robert received word that two employees in the company’s headquarters

were selling products to the government at a higher price than they were selling them to other organiza- tions. Both employees have been on the job for over two years and seem to be good performers. A few of their sales colleagues have complained to the lead sales manager about the high quarterly commissions that the two employees recently received. They insinuated that these commissions were earned unfairly by charging government-run hospitals high prices. A cursory review of their accounts showed that, in many instances, the government was paying more than other organizations. Under procurement rules, the government is supposed to pay a fair price, one that other cost-conscious cus- tomers would pay. When asked about the situation, the two employees said that the price offered was based on volume, so the pricing always varied from customer to customer.

Robert took the information to his boss, the presi- dent. The two of them discussed how these employees received legal and ethics training, signed the company code of ethics, and should have been knowledgeable about rules related to government procurement. The president said that these two salespeople sounded like “rogue employees,” who committed acts without the approval of the management to increase their commis- sions. They also discussed many issues and scenarios, such as how to deal with the two salespeople, whether to continue the investigation and inform the govern- ment, what strategies to put in place for preventing similar problems in the future, how to protect the firm’s good name, whether the company could face suspension from lucrative government business, and others. What would you do?

EXPERIENTIAL EXERCISE Visit the website of the Ethics and Compliance Officer Association (http://www.theecoa.org). What is the asso- ciation’s current mission and membership composition? Review the website to determine the issues and concerns

that comprise the ECOA’s most recent programs, pub- lications, and research. What trends do you find? What topics seem most important to ethics officers today?

UP-CHARGING THE GOVERNMENT: WHAT WOULD YOU DO? ?

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CHAPTER SEVEN

Employee Relations

Chapter Objectives

●● To discuss employees as stakeholders

●● To examine the economic, legal, ethical, and philanthropic responsibilities related to employees

●● To describe an employer of choice and the employer of choice’s relationship to social responsibility

Chapter Outline

Employee Stakeholders

Responsibilities to Employees

Strategic Implementation of Responsibilities to Employees

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In 1991 a few executives from Circuit City decided to test-launch a new business idea for a used car company termed Project X. Two years later CarMax was offi- cially launched. CarMax makes it a priority to develop satisfied employees. The company has a decentralized structure where employees are encouraged to submit recommendations and develop leadership skills. Over the past 20 years, CarMax has grown to 150 stores with 22,000 employees. CarMax has been listed as one of Fortune magazine’s “Best Companies to Work For” for over a decade.

CarMax uses RFID technology to track how long cars sit in the lot, extensive sales data to determine inventory needs accurately, and a flat commission com- pensation system so salespeople will promote the cars that best meet customer needs rather than trying to sell the most expensive car. Unlike other dealerships, CarMax offers no-haggle prices to consumers in order to simplify the car-buying process. It also reduces pres- sure on the salesperson. Employees at CarMax receive many benefits, including health benefits, paid time off, life insurance, and retirement savings plans. They also offer more non-traditional benefits, including smoking cessation assistance, tuition assistance, weight loss pro- grams, and discounts on company products. CarMax’s time away policy allows salaried associates to take as much time off as they deem necessary to meet work/ life obligations.

Tom Folliard, the CEO of CarMax, learned that developing a decentralized corporate culture focusing on teamwork and employee empowerment generates

positive results. CarMax uses teams to implement corporate strategies. It has a Consumer Insights team that focuses on improving customer experiences, an Operations Team that focuses on repair work, and an Inventory Strategy Team to focus on using data to improve purchasing in car auctions. CarMax also encourages teams for volunteerism. Its Volunteer Team- Builders who volunteer at nonprofits make those organizations eligible for grants from the CarMax Foundation.

CarMax prides itself on being founded on fun- damental principles by which every store must abide. Values include respect, communication, customer focus, and teamwork. CarMax believes that employees who work together are able to place the customer first and serve their best interests. CEO Folliard stays accessible for employees through town hall meetings. He also visits sites that meet their sales goals and rewards them with steak dinners. Approximately 95 percent of employees claim that their workplace is friendly, 87 per- cent claim that management is easy to approach with concerns or other issues, and 80 percent say that they consistently look forward to going to work.

This type of culture enables employees to feel a sense of ownership in the company. Employees hold themselves to higher standards, resulting in higher work performance. In an industry that has a certain stigma about car salespeople and tactics, CarMax’s focus on empowering employees to provide quality customer service and take ownership of the company has revolutionized the used car industry.1

Beep Beep: CarMax is an Admired ‘Road Runner’

Opening Vignette

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CarMax illustrates the extent to which some firms consider the needs, wants, and characteristics of employees and other stakeholders in designing various business processes and practices. Although it is widely understood that employees are of great importance, beliefs about the extent and types of responsibilities that organizations should assume toward employees are likely to vary. For example, some managers are pri- marily concerned with economic and legal responsibilities, whereas propo- nents of the stakeholder interaction model would advocate for a broader perspective. As this chapter will show, a delicate balance of power, respon- sibility, and accountability resides in the relationships a company develops with its employees.

Because employee stakeholders are so important to the success of any company, this chapter is devoted to the employer-employee relationship. We explore the many issues related to the social responsibilities employ- ers have to their employees, including the employee-employer contract, workforce reduction, wages and benefits, labor unions, health and safety, equal opportunity, sexual harassment, whistle-blowing, diversity, and work/life balance. Along the way, we discuss a number of significant laws that affect companies’ human resources programs. Finally, we look at the concept of employer of choice and what it takes to earn that reputation and distinction.

EMPLOYEE STAKEHOLDERS Think for a minute about the first job or volunteer position you held. What information were you given about the organization’s strategic direction? How were you managed and treated by supervisors? Did you feel empowered to make decisions? How much training did you receive? The answers to these questions may reveal the types of responsibilities that employers have toward employees. If you worked in a restaurant, for example, training should have covered safety, cleanliness, and other health issues mandated by law. If you volunteered at a hospital, you may have learned about the ethical and economic considerations in providing healthcare for the uninsured or poor and the philanthropic efforts used to support the hospital financially. Although such issues may have seemed subtle or even unimportant at the time, they are related to the responsibili- ties that employees, government, and other stakeholders expect of employ- ing organizations.

RESPONSIBILITIES TO EMPLOYEES In her book The Working Life: The Promise and Betrayal of Modern Work, business professor Joanne B. Ciulla writes about the different types of work, the history of work, the value of work to a person’s self-concept, the relationship between work and freedom, and as the title implies,

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the rewards and pitfalls that exist in the employee-employer relationship. Ciulla contends that two common phrases—“Get a job!” and “Get a life!”—are antithetical in today’s society, meaning they seem diametrically opposed goals or values.2 For the ancient Greeks, work was seen as the gods’ way of punishing humans. Centuries later, Benedictine monks, who built farms, church abbeys, and villages, were considered the lowest order of monks because they labored. By the eighteenth century, the Protestant work ethic had emerged to imply that work was a method for discovering and creating a person.3 Today, psychologists, families, and friends lament how work has become the primary source of many individuals’ fulfill- ment, status, and happiness. Just as in the complicated history of work, the responsibilities, obligations, and expectations between employees and employers are also fraught with challenges and debates. In this section, we review the four levels of corporate social responsibilities as they relate to employees. Although we focus primarily on the responsibilities of employ- ers to employees, we also acknowledge the role that employees have in achieving strategic social responsibility.

Economic Issues The significance of the economic realm of employment is evidenced in the story of Malden Mills Industries. In 1995, just a few weeks before the winter holidays, the factory and office space at Malden Mills burned to the ground, injuring many workers. In an unusual move, CEO Aaron Feuerstein paid full wages, year-end bonuses, and benefits to employees while the buildings were reconstructed. Human resource managers set up a temporary job-training center, collected Christmas gifts for employees’ children, and worked with community agencies to support employees and their families.4 When economic factors forced Malden Mills through several employee layoffs in the late 1990s, employees were offered jobs at another plant and received career transition assistance. Feuerstein believed in an unwritten contract that considers the economic prospects of both employer and employees.

Several years later, Malden Mills filed for bankruptcy protection. Malden Mills’ assets were sold and the company name was changed to Polartec, LLC. Polartec started with the original synthetic fleece developed by Malden and today offers 300 different fabrics. Customers include the U.S. military, L.L. Bean, Patagonia, and a number of small businesses. While Feuerstein is no longer at the company, his original product inven- tion and commitment to social responsibility continues to exist at Polartec.5

Employee-Employer Contract As we discussed in Chapter 1, the recent history of social responsibility has brought many changes to bear on stakeholder relationships. One of the more dramatic shifts has been in the “contract” and mutual understanding that exist between employee and employer. At the beginning of the twenty-first century, many companies had to learn and accept new rules for recruiting, retaining, and compensating

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employees. For example, although employers held the position of power for many years, the new century brought record employment rates and the tightest job market in years. Huge salaries, signing bonuses, multiple offers, and flexible, not seniority-based, compensation plans became commonplace throughout the late 1990s. However, the first decade of the 2000s reversed this trend. Business scandals in the early 2000s, the World Trade Center attacks, and the latest recession brought a decline in lucrative employment opportunities and forced many firms to implement layoffs and other cost- cutting measures. At one point unemployment in the United States reached 10 percent. Pay raises, healthcare benefits, mental health coverage, retire- ment funding, paid maternity leave, and other benefits were reduced or costs were shifted to employees.6 The Affordable Care Act shifted aspects of healthcare to the government.

Regardless of salary, perks, and specific position, a psychological contract exists between an employee and employer. This contract is largely unwritten and includes the beliefs, perceptions, expectations, and obligations that make up the agreement between individuals and the orga- nizations that employ them.7 Details of the contract develop through com- munications, via interactions with managers and coworkers, and through perceptions of the corporate culture often formed by watching manage- ment and leadership. These interactions are especially important for new employees, who are trying to make sense of their new roles.8 This contract, though informal, has a significant influence on the way employees act. When promises and expectations are not met, a psychological contract breach occurs, and employees may become less loyal, less trusting, inatten- tive to work, or otherwise dissatisfied with their employment situation.9 On the other hand, when employers present information in a credible, competent, and trustworthy manner, employees are more likely to be sup- portive of and committed to the organization. Therefore, employers and employees are the two groups that contribute to the development, main- tenance, and evolution of the psychological contract at work. Table 7.1 provides an overview of what is needed for employee commitment to the firm and employer promises to the employee.

psychological contract Largely unwritten, it includes beliefs, perceptions, expec- tations, and obligations that make up the agreement between individuals and the organizations that employ them.

TABLE 7.1 Psychological Contract between Employee and Employer

Employee Commitment Employer Promises Loyalty to the company Respect from management

Teamwork and cooperation Training opportunities

Compliance with policies Opportunity to advance

Ethical leadership Adequate benefits

Protection of company resources Fairness in work assignments

Volunteer to address challenges Ethical culture

Solve problems independently Financial rewards

Trust and confidentiality Work and family balance

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An employee’s perception of how well employer promises are kept provides for an ongoing psychological assessment of the employment relationship, including whether the employee will choose to leave the organization. The promises, or inducements, made by the organiza- tion are valuable to nearly all employees, but one study of over 5,000 employees indicates this rank order for their importance to employees: (1) social atmosphere, (2) career development opportunities, (3) job content, (4) work/life balance, and (5) financial rewards. This same sample ranked the organizational fulfillment of these promises as: (1) job content, (2) social atmosphere, (3) work/life balance, (4) career development oppor- tunities, and (5) financial rewards. Based on these results, it is clear that career development opportunities deserve more attention from managers to strengthen the psychological contract and provide incentives for employee retention. Organizations that are able to implement the key promises so that employees view them as fulfilled reap rewards in terms of increased employee loyalty and decreased intentions to leave and/or search for a new employer.10 Strong employee commitment is then revealed through their positive interactions with key stakeholders, especially customers, and ulti- mately has a positive influence on organizational success, as we discussed in Chapter 1.11

Just as in other stakeholder relationships, expectations in the employ- ment psychological contract are subject to a variety of influences. This section discusses how the contract has ebbed and flowed over the last 100 years. Table 7.2 describes some examples of ways companies fulfill the psychological contract.

Until the early 1900s, the relationship between employer and employee was best characterized as a master-servant relationship.12 In this view, there was a natural imbalance in power that meant employment was viewed as a privilege that included few rights and many obligations. Employees were expected to work for the best interests of the organiza- tion, even at the expense of personal and family welfare. At this time,

TABLE 7.2 Examples of Psychological Contracts

Company Employee Promise Google Child care

Starbucks Two years of college tuition

The Container Store Extensive employee training and higher pay

SAS Free on-site healthcare clinic

REI Provides annual surveys to employees to get feedback on employee engagement

Salesforce.com Employee recognition and reward programs for the company’s salespeople

Wegman’s Market Strong growth opportunities in the company

W.L. Gore and Associates Flat non-hierarchical business structure

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most psychologists and management scholars believed that good leader- ship required aggressive and domineering behavior.13 Images from Upton Sinclair’s novel The Jungle, which we discuss briefly in the next chapter, characterized the extreme negative effects of this employment contract.14

In the 1920s and 1930s, employees assumed a relationship with an employer that was more balanced in terms of power, responsibilities, and obligations. This shift meant that employees and employers were coequals, and in legal terms, employees had many more rights than under the mas- ter-servant model.15 Much of the employment law in the United States was enacted in the 1930s, when legislators passed laws related to child labor, wages, working hours, and labor unions.16 Throughout the twentieth cen- tury, the employee-employer contract evolved along the coequals model, although social critics began to question the influence large companies had on employees.

In the 1950s, political commentator and sociologist C. Wright Mills criticized white-collar work as draining on employees’ time, energy, and even personalities. He also believed that individuals with business power were apt to keep employees happy in an attempt to ward off the develop- ment of stronger labor unions and unfavorable government regulations.17 A few years later, the classic book The Organization Man by William H. Whyte was published. This book examined the social nature of work, including the inherent conflict between belonging and contributing to a group on the job while maintaining a sense of independence and identity.18 Organizational researchers and managers in the 1960s began to question authoritarian behavior and consider participatory management styles that assumed employees were motivated and eager to assume responsibility for work. A study by the U.S. Department of Health, Education, and Welfare in the early 1970s confirmed that employees wanted interesting work and a chance to demonstrate their skills. The report also recommended job redesign and managerial approaches that increased participation, free- dom, and democracy at work.19 By the 1980s, a family analogy was being used to describe the workplace. This implied strong attention to employee welfare and prompted the focus on business ethics that we explored in previous chapters. At the same time, corporate mission statements touted the importance of customers and employees, and In Search of Excellence, a best-selling book by Thomas J. Peters and business consultant Robert H. Waterman Jr., profiled companies with strong corporate cultures that inspired employees toward better work, products, and customer satisfac- tion.20 The total quality management (TQM) movement increased empow- erment and teamwork on the job throughout the 1990s and led the charge toward workplaces simultaneously devoted to employee achievement at work and home.21

Although there were many positive initiatives for employees in the 1990s, the confluence of economic progress with demands for global competitiveness convinced many executives of the need for cost cutting. For individuals accustomed to messages about the importance of employ- ees to organizational success, workforce reduction was both unexpected

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and traumatic. These experiences effectively ended the loyalty- and commitment-based contract that employees had developed with employ- ers. A study of young employees showed that their greatest psychological need in the workplace is security but that they viewed many employers as “terminators.”22 By the time Barack Obama became President of the United States in 2009, his administration was facing an economy in ter- rible condition. By mid-2009, over 8 million employees had been laid off and recessionary effects loomed large. The Conference Board, which publishes the Employment Trend Index (ETI) monthly, announced the index was declining faster than at any other time in the 35-year history of the ETI. Eight indicators contribute to the index, including claims for unemployment insurance, number of part-time workers due to economic reasons, consumer confidence, industrial production, manufacturing and trade sales, among others.

Although unemployment went as high as 10 percent during the last recession, the economy slowly began to recover. In 2015, unemployment had decreased to 5.3 percent, and the number of long-term unemployed individuals had been reduced. According to economists, it had been the slowest recovery in 55 years.23 Unfortunately, recovery has proven slower for minorities and individuals between the ages of 18 and 29 years old. In the same year, unemployment for younger adults was 12.2 percent, more than double the national average.24 There are concerns that the opportu- nities for employment based on education and skills has diminished. For example, many college graduates are underemployed in their first job.

Workforce Reduction At different points in a company’s history, there are likely to be factors that beg the question, “How can we decrease our overall costs?”25 In a highly competitive business environment, where new companies, customers, and products emerge and disappear every day, there is a continuous push for greater organizational efficiency and effectiveness. This pressure often leads to difficult decisions, including ones that require careful balance and consideration for the short-run survival and long-term vision of the company. This situation can create the need for workforce reduction, the process of eliminating employment positions. This process places considerable pressure on top management, causes speculation and tension among employees, and raises public ire about the role of business in society.26

There are several strategies that companies use to reduce overall costs and expenditures. For example, organizations may choose to reduce the number of employees, simplify products and processes, decrease quality and promises in service delivery, or develop some other mechanism for eliminating resources or nonperforming assets. Managers may find it dif- ficult to communicate about cost reductions, as this message carries both emotional and social risk. Employees may wonder, “What value do I bring to the company?” and “Does anyone really care about my years of ser- vice?” Customers may inquire, “Can we expect the same level of service and product quality?” Governments and the community may ask, “Is this

workforce reduction The process of eliminating employment positions.

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really necessary? How will it affect our economy?” For all of these ques- tions, company leadership must have a clear answer. This response should be based on a thorough analysis of costs within the organizational system and how any changes are likely to affect business processes and outcomes. Intel reduced its global workforce by 11 percent. This is a decision many large technology companies are facing as newcomers in the industry gain more market share.27

In the last two decades, many firms chose to adopt the strategy that also creates the most anxiety and criticism—the reduction of the work- force. Throughout the 1990s, the numbers were staggering, as Sears elimi- nated 50,000 jobs and Kodak terminated nearly 17,000 people. Economic decline and financial scandals in the first decade of the twenty-first century also created a wave of layoffs. General Motors cut thousands of jobs and needed government assistance just to stay afloat. These actions effectively signaled the “end of the old contract” that employees had with employ- ers.28 This strategy, sometimes called downsizing or rightsizing, usually entails employee layoffs and terminations. In other cases, a company freezes new hiring, hopes for natural workforce attrition, offers incentives for early retirement, or encourages job sharing among existing employees. There are three different tactics for downsizing. We have already discussed workforce reduction through layoffs, retirement incentives, buyout pack- ages, transfers, etc. Another tactic is organization redesign to eliminate organizational layers or functions and/or merge units. The third tactic is systemic redesign, which necessitates a major culture change, the simplifi- cation of processes, an emphasis on continuous improvement, and changes in employee responsibility.29 The reality is that some employees will lose their current positions one way or another. Thus, although workforce reduction may be the strategy chosen to control and reduce costs, it may have profound implications for the welfare of employees, their families, and the economic prospects of a geographical region and other constitu- ents, as well as for the corporation itself.

As with other aspects of business, it is difficult to separate financial considerations for costs from other obligations and expectations that develop between a company and its stakeholders. Depending on a firm’s resource base and current financial situation, the psychological contract that exists between an employer and employee is likely to be broken through layoffs, and the social contract between employers, communi- ties, and other groups may also be threatened. Downsizing makes the private relationship between employee and employer a public issue that affects many stakeholders and subsequently draws heavy criticism.30 Fundamentally, top managers must recognize the many different types of “costs” that occur through workforce reduction. These include costs asso- ciated with future talent and leadership, company morale, perceptions on Wall Street, and rehiring needs.31

The impact of the workforce reduction process depends on a host of factors, including corporate culture, long-term plans, and creative cal- culations on both quantitative and qualitative aspects of the workplace.

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Because few human resource directors and other managers have extensive experience in restructuring the workforce, there are several issues to con- sider before embarking on the process.32 First, a comprehensive plan must be developed that takes into account the financial implications and quali- tative and emotional toll of the reduction strategy. This plan may include a systematic analysis of workflow so that management understands how tasks are currently completed and how they will be completed after restruc- turing. Second, the organization should commit to assisting employees who must make a career transition as a result of the reduction process. To make the transition productive for employees, this assistance should begin as soon as management is aware of possible reductions. Through the Worker Adjustment and Retraining Notification Act (WARN), U.S. employers are required to give at least 60 days’ advance notice if a layoff will affect 500 or more employees or more than one-third of the work- force.33 Offering career assistance and other services is beneficial over the long term, as it demonstrates a firm’s commitment to social responsibility.

External factors also play a role in how quickly employees find new work and affect perceptions of a firm’s decision to downsize. Michigan launched an initiative called Community Ventures to connect the long- term unemployed with jobs. The initiative worked with individuals for up to one year, providing services such as literacy training, networking connections, and transportation. Since its beginning, the initiative has linked 3,000 hard-core unemployed to new jobs.34 Those unemployed for long periods of time are likely to experience feelings of discouragement and low morale. On the other hand, individuals who are reemployed quickly, whether through company efforts or market circumstances, expe- rience fewer negative economic and emotional repercussions. In addition, employees who are kept well informed of the downsizing decision process are more likely to retain positive attitudes toward the company, even if they experience job loss.35

Companies must be willing to accept the consequences of terminating employees. Although workforce reduction can improve a firm’s finan- cial performance, especially in the short run, there are costs to consider, including the loss of intellectual capital.36 The years of knowledge, skills, relationships, and commitment that employees develop cannot be eas- ily replaced or substituted, and the loss of one employee can cost a firm between $50,000 and $100,000.37 So although workforce reduction low- ers costs, it often results in lost intellectual capital, strained customer rela- tionships, negative media attention, and other issues that drain company resources. Employees who retain their jobs may suffer guilt, depression, or stress as a result of the reduction in the workforce. Thus, a long-term understanding of the qualitative and quantitative costs and benefits should guide downsizing decisions.38

Although workforce reduction is a corporate decision, it is also important to recognize the potential role of employees in these decisions. Whereas hiring and job growth reached a frantic pace by the late 1990s, a wave of downsizings in the early 1990s and 2000s meant that some

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individuals had embraced the reality of having little job security. Instead of becoming cynical or angry, employees may have reversed roles and began asking, “What is this company doing for me?” and “Am I getting what I need from my employer?” Employees of all types began taking more responsibility for career growth, demanding balance in work and personal responsibilities, and seeking opportunities in upstart firms and emerging industries. Thus, although workforce reduction has negative effects, it has also shifted the psychological contract and power between employee and employer. The following suggestions examine how individuals can poten- tially mitigate the onset and effects of downsizing.

First, all employees should understand how their skills and compe- tencies affect business performance. Not recognizing and improving this relationship makes it more difficult to prove their worth to managers faced with workforce reduction decisions. Second, employees should strive for cost-cutting and conservation strategies regardless of the employer’s cur- rent financial condition. This is a workforce’s first line of defense against layoffs—assisting the organization in reducing its costs before drastic mea- sures are necessary. Third, today’s work environment requires that most employees fulfill diverse and varying roles. For example, manufacturing managers must understand the whole product development and intro- duction process, ranging from engineering to marketing and distribution activities. Thus, another way of ensuring worth to the company, and to potential employers, is through an employee’s ability to navigate different customer environments and organizational systems. It is now necessary to “cross-train,” show flexibility, and learn the entire business, even if a com- pany does not offer a formal program for gaining this type of experience and exposure. Although this advice may not prevent workforce reduction, it does empower employees against some of its harmful effects. Through laws and regulations, the government has also created a system for ensur- ing that employees are treated properly on the job. The next section covers the myriad of laws that all employers and employees should consider both in daily and strategic decisions.

Legal Issues Employment law is a very complex and evolving area. Most large compa- nies and organizations employ human resource managers and legal special- ists who are trained in the detail and implementation of specific statutes related to employee hiring, compensation, benefits, safety, and other areas. Smaller organizations often send human resource managers to workshops and conferences to keep abreast of legal imperatives in the workplace. Table 7.3 lists the major federal laws that cover employer responsibili- ties with respect to wages, labor unions, benefits, health and safety, equal opportunity, and other areas. Until the early 1900s, employment was primarily governed by the concept of employment at will, a common-law doctrine that allows either the employer or the employee to terminate the relationship at any time as long as it does not violate an employment

employment at will A common-law doctrine until the early 1900s that allows either the employer or the employee to ter- minate the relationship at any time as long as it does not violate an employment contract.

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TABLE 7.3 Major Employment Laws

Act (Date Enacted) Purpose National Labor Relations Act (1935)

Established the rights of employees to engage in collective bargaining and to strike.

Fair Labor Standards Act (1938) Established minimum wage and overtime pay standards, recordkeeping, and child labor standards for most private and public employers.

Equal Pay Act (1963) Protects women and men who perform substantially equal work in the same establishment from gender-based wage discrimination.

Civil Rights Act, Title VII (1964) Prohibits employment discrimination on the basis of race, national origin, color, religion, and gender.

Age Discrimination in Employment Act (1967)

Protects individuals aged 40 or older from age-based discrimination.

Occupational Safety and Health Act (1970)

Ensures safe and healthy working conditions for all employees by providing specific standards that employers must meet.

Employee Retirement Income Security Act (1974)

Sets uniform minimum standards to assure that employee benefit plans are established and maintained in a fair and financially sound manner.

Americans with Disabilities Act (1990)

Prohibits discrimination on the basis of physical or mental disability in all employment practices and requires employ- ers to make reasonable accommodation to make facilities accessible to and usable by persons with disabilities.

Family and Medical Leave Act (1993)

Requires certain employers to provide up to 12 weeks of unpaid, job-protected leave to eligible employees for certain family and medical reasons.

Uniformed Services Employment and Reemployment Rights Act (1994)

The pre-service employer must reemploy service members returning from a period of service in the uniformed services if those service members meet five criteria.

Patient Protection and Affordable Care Act (2010)

Makes healthcare affordable and universal so all employees can have access to it.

Source: U.S. Department of Labor, “Employment Law Guide,” http://www.dol.gov/compliance/guide/ index.htm (accessed June 21, 2016).

contract. Today, many states still use the employment-at-will philosophy, but laws and statutes may limit total discretion in this regard.39 The fol- lowing discussion highlights employment laws and their fundamental con- tribution to social responsibility.40

Wages and Benefits After the Great Depression, the U.S. Congress enacted a number of laws to protect employee rights and extend employer respon- sibilities. The Fair Labor Standards Act (FLSA) of 1938 prescribed mini- mum wage and overtime pay, recordkeeping, and child labor standards for most private and public employers. The minimum wage is set by the federal government and is periodically revised, although states have the option to adopt a higher standard. For example, the federal minimum wage was

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raised from $6.55 per hour to $7.25 per hour in 2009. In 2013, the Fair Minimum Wage Act was introduced and it proposed that the minimum wage be raised to $10.10 per hour but has not been passed yet. Various members of Congress, including the U.S. Chamber of Commerce, have pro- posed a $15 per hour minimum wage. On the other hand, Republicans in Congress and other opponents are worried that a substantial minimum wage increase would lead to job loss or higher prices for consumers. The nonprofit Empire Center for New York State Policy has concerns that increasing the minimum wage too much will lead to increased costs for businesses, therefore having a major detrimental impact on smaller busi- nesses.41

As demonstrated, minimum wage remains a highly debated topic. Many workers are not earning enough to make ends meet. Critics of the proposal say that it is not the most effective way to address the plight of those workers living in poverty. The bill did not receive enough votes from Congress, and the debate continues.42 The majority of states abide by the federal standard, although Alaska, California, Oregon, Vermont, Washington, and several others have adopted a higher minimum wage. Most employees who work more than 40 hours per week are entitled to overtime pay in the amount of one and a half times their regular pay. There are exemptions to the overtime pay provisions for four classes of employees: executives, outside salespeople, administrators, and profes- sionals.43

The FLSA also affected child labor, including the provision that indi- viduals under the age of 14 are allowed to do only certain types of work, such as delivering newspapers and working in their parents’ businesses. Children under age 16 are often required to get a work permit, and their work hours are restricted so that they can attend school. Persons between the ages of 16 and 18 are not restricted in terms of number of work hours, but they cannot be employed in hazardous or dangerous positions. Although passage of the FLSA was necessary to eliminate abusive child labor practices, its restrictions became somewhat problematic during the booming economy of the late 1990s, when unemployment rates were extremely low in the United States. Some business owners may have even considered lobbying for relaxed standards in very restrictive states so that they could hire more teens. In addition, general FLSA restrictions have created problems in implementing job-sharing and flextime arrangements with employees who are paid on an hourly basis.44

Two other pieces of legislation relate to employer responsibilities for benefits and job security. The Employee Retirement Income Security Act (ERISA) of 1974 set uniform minimum standards to assure that employee benefit plans are established and maintained in a fair and financially sound manner. ERISA does not require companies to establish retirement pen- sion plans; instead, it developed standards for the administration of plans that management chooses to offer employees. A key provision relates to vesting, the legal right to pension plan benefits. In general, contributions an employee makes to the plan are vested immediately, whereas company

vesting The legal right to pension plan benefits.

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contributions are vested after five years of employment. ERISA is a very complicated aspect of employer responsibilities because it involves tax law, financial investments, and plan participants and beneficiaries.45

The Family and Medical Leave Act (FMLA) of 1993 requires certain employers to provide up to 12 weeks of unpaid, job-protected leave to eligible employees for certain family and medical reasons. However, if the employee is paid in the top 10 percent of the entire workforce, the employer does not have to reinstate him or her in the same or compa- rable position.46 Typical reasons for this type of leave include the birth or adoption of a child, personal illness, or the serious health condition of a close relative. The FMLA applies to employers with fifty or more employ- ees, which means that its provisions do not cover a large number of U.S. employees. In addition, employees must have worked at least one year for the firm and at least 25 hours per week during the past year before the FMLA is required.

Labor Unions In one of the earliest pieces of employment legislation, the National Labor Relations Act (NLRA) of 1935 legitimized the rights of employees to engage in collective bargaining and to strike. This law was originally passed to protect employee rights, but subsequent legisla- tion gave more rights to employers and restricted the power of unions. Before the NLRA, many companies attempted to prohibit their employees from creating or joining labor organizations. Employees who were mem- bers of unions were often discriminated against in terms of hiring and retention decisions. This act sought to eliminate the perceived imbalance of power between employers and employees. Through unions, employees gained a collective bargaining mechanism that enabled greater power on several fronts, including wages and safety.47 For example, in a series of strikes against Walmart, members of the Organization for United Respect at Walmart (OUR Walmart), founded by the United Food and Commer- cial Workers (UFCW) union, called for the retailer to offer employees $25,000 per year, plenty of hours for workers to support their families, no more retaliation against those making these requests, and fair treatment to pregnant workers. When the strikes were ongoing, they had the following results: Walmart agreed to a $21 million settlement regarding wages in one of its warehouses, the U.S. government initiated prosecutions regarding illegal firing of workers, and the city of Portland cut ties with the retailer. In order to avoid continuous labor strikes, the company will have to address employees’ needs more completely.

Health and Safety In 1970, the Occupational Safety and Health Act (OSHA) sought to ensure safe and healthy working conditions for all employees by providing specific standards that employers must meet. This act led to the development of the Occupational Safety and Health Administration, also known as OSHA, the agency that oversees the regu- lations intended to make U.S. workplaces the safest in the world. In its more than 40 years of existence, OSHA has made great strides to improve

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and maintain the health and safety of employees. For example, since the 1970s, the workplace death rate in the United States has been reduced by more than 65 percent, and the agency’s initiatives in cotton dust and lead standards have reduced disease in several industries. The agency continues to innovate and uses feedback systems for improving its services and stan- dards. As more Spanish-speaking workers entered the workforce, officials were concerned about their understanding of the agency and their rights in the workplace. In response, OSHA translated a variety of its documents into Spanish and posted them onto a prominent place on its website.48 OSHA has the authority to enter and make inspections of most employ- ers. Because of its far-reaching power and unwarranted inspections made in the 1970s, the agency’s relationship with business has not always been positive. For example, OSHA proposed rules to increase employer respon- sibility for ergonomics, the design, arrangement, and use of equipment to maximize productivity and minimize fatigue and physical discomfort. Without proper attention to ergonomics, employees may suffer injuries and long-term health issues as a result of work motion and tasks. Many busi- ness and industry associations opposed the proposal, citing enormous costs and unsubstantiated claims. A federal ergonomics rule was established under the Clinton presidency but was repealed by President George W. Bush. However, the issue continues to be raised on the regulatory agenda. OSHA has focused its ergonomics efforts by developing guidelines for each industry, while individual states, such as Alaska, Washington, and Califor- nia, have implemented their own ergonomics rules.49 Despite differences between this federal agency and some states and companies on a number of regulations, most employers are required to display the poster shown in Figure 7.1 or one required by their state safety and health agency. Gil- dan Activewear Inc., a manufacturer and marketer of clothing, developed a program to improve ergonomic practices and reduce injuries. This is par- ticularly important since repetitive actions in the sewing industry are com- mon and prolonged repetitive actions can lead to injury over time.50

An emerging issue in the area of health and safety is the increasing rate of violence in the workplace. According to OSHA, 2 million workers are assaulted and over 400 are murdered in the workplace every year.51 A recent survey of Fortune 1000 companies indicates that workplace vio- lence is one of the most important security issues they face, costs up to $36 billion annually, and results in three deaths daily and thousands of injuries each year. The fourth leading cause of all occupational fatalities is homicide.52

The Society for Human Resource Management (SHRM) has identified four types of workplace violence: (1) crimes committed by strangers and intruders in the workplace; (2) acts committed by nonemployees, such as customers, patients, students, and clients; (3) violence committed by coworkers; and (4) incidences involving those with a personal relationship with an employee.53 Taxi drivers and clerks working late-night shifts at convenience stores are often subject to the first type of violence. Airline attendants are increasingly experiencing the second category of workplace

ergonomics The design, arrangement, and use of equipment to maximize productivity and minimize fatigue and physi- cal discomfort.

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Source: Occupational Safety and Health Administration, “OSHA’s Free Workplace Poster,” http://www .osha.gov/Publications/osha3165low-res.pdf (accessed June 28, 2014).

FIGURE 7.1 Job Safety and Health Protection Poster

violence when passengers become unruly, drunk, or otherwise violent while in flight. Nurses and customer service associates also experience ver- bal and sometimes physical violence from angry patients and customers.

Many instances abound of employee-related workplace violence. A worker at a lawn care company in Kansas opened fire, killing three people and injuring an additional 16. The shooter himself was shot by a policeman.54 Today, many organizations are conducting workplace shooter trainings in order to decrease the number of fatalities in these types of violent situations. Although crimes reflect general problems in society, employers have a responsibility to assess risks and provide secu- rity, training, and safeguards to protect employees and other stakeholders

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from such acts. Companies often purchase insurance policies to cover the costs of workplace violence, including business interruption, psychological counseling, informant rewards, and medical claims related to injuries. One expert suggests that all organizations publish and communicate an anti- violence policy and make employees and managers aware of antecedents to workplace violence.55

Equal Opportunity Title VII of the Civil Rights Act of 1964 prohibits employment discrimination on the basis of race, national origin, color, religion, and gender. This law is fundamental to employees’ rights to join and advance in an organization according to merit rather than one of the characteristics just mentioned. For example, employers are not permitted to categorize jobs as only for men or women unless there is a reason gender is fundamental to the tasks and responsibilities. Addi- tional laws passed in the 1970s, 1980s, and 1990s were also designed to prohibit discrimination related to pregnancy, disabilities, age, and other factors. The Americans with Disabilities Act prohibits companies from discriminating on the basis of physical or mental disability in all employ- ment practices and requires them to make facilities accessible to and usable by persons with disabilities. The Pregnancy Discrimination Act, now 30 years old, was created to help protect the rights of mothers and mothers-to-be in the workplace. The act has been modified many times since its inception. As a result, the number of pregnancy discrimination complaints filed with the Equal Employment Opportunity Commission (EEOC) has continually decreased over the years.56 Figure 7.2 depicts the number of complaints and resolutions on pregnancy discrimination cases from 2012 through 2015.

These legal imperatives require that companies formalize employment practices to ensure that no discrimination is occurring. Thus, managers must be fully aware of the types of practices that constitute discrimination and work to ensure that hiring, promotion, annual evaluation, and other procedures are fair and based on merit. The spread of HIV and AIDS has prompted multinational firms with operations in Africa to distribute educational literature and launch prevention programs. Some companies work with internal and external stakeholders and even fund medical facili- ties that help prevent the disease and treat HIV/AIDS patients. Another component to their initiatives involves education on fair treatment of employees with the disease. Multinational companies in Mexico produced a written commitment to eliminate the stigma and discrimination often surrounding HIV/AIDS in the workplace.57

To ensure that they build balanced workforces, many companies have initiated affirmative action programs, which involve efforts to recruit, hire, train, and promote qualified individuals from groups that have traditionally been discriminated against on the basis of race, sex, or other characteristics. Coca-Cola established a program to create a level foundation for all employees to have access to the same information and

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Source: U.S. Equal Employment Opportunity Commission, “Pregnancy Discrimination Charges,” http:// www.eeoc.gov/eeoc/statistics/enforcement/pregnancy_new.cfm (accessed June 21, 2016).

0

500

1000

1500

2000

2500

3000

3500

4000

4500

Receipts Resolutions

2012

2013

2014

2015

FIGURE 7.2 Growth in Filings and Resolutions of Pregnancy Discrimination Act Complaints to the EEOC

development opportunities.58 A key goal of these programs is to reduce any bias that may exist in hiring, evaluating, and promoting employees. A special type of discrimination, sexual harassment, is also prohibited through Title VII.

Sexual Harassment The flood of women into the workplace during the last half of the twentieth century brought new challenges and opportuni- ties for organizations. Although harassment has probably always existed in the workplace, the presence of both genders in roughly equal numbers changed norms and expectations of behavior. When men dominated the workplace, photos of partially nude women or sexually suggestive mate- rials may have been posted on walls or in lockers. Today, such materials could be viewed as illegal if they contribute to a work environment that is intimidating, offensive, or otherwise interferes with an employee’s work performance. The U.S. government indicates the nature of this illegal activ- ity: unwelcome sexual advances, requests for sexual favors, and other ver- bal or physical conduct of a sexual nature constitutes sexual harassment when submission to or rejection of this conduct explicitly or implicitly affects an individual’s employment, unreasonably interferes with an indi- vidual’s work performance, or creates an intimidating, hostile, or offensive work environment.59

sexual harassment Unwelcome sexual advances, requests for sexual favors, and other verbal or physical conduct of a sexual nature which when submitted to or rejected explicitly or implicitly affects an individual’s employment, unreasonably interferes with an individual’s work performance, or creates an intimidating, hostile, or offensive work environment.

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Prior to 1986, sexual harassment was not a specific violation of fed- eral law in the United States. In Meritor Savings Bank v. Vinson, the U.S. Supreme Court ruled that sexual harassment creates a “hostile environ- ment” that violates Title VII of the Civil Rights Act, even in the absence of economic harm or demand for sexual favors in exchange for promotions, raises, or related work incentives.60 In other countries, sexual harass- ment in the workplace is considered an illegal act, although the specific conditions may vary by legal and social culture. Until recently, Mexican sexual harassment law protected public sector employees only if their jobs were jeopardized on the basis of the exchange of sexual favors or rela- tions. A bill proposed by former President Felipe Calderon expanded the parameters of such an offense to include private businesses. Employees of Mexican public and private entities will be fired if found guilty of the offending behavior.61 In the European Union (EU), sexual harassment legislation focuses on the liability that employers carry when they fail to promote a workplace culture free of harassment and other forms of discrimination. The EU has strengthened its rules on sexual harassment, including definitions of direct and indirect harassment, the removal of an upper limit on victim compensation, and the requirement that businesses develop and make “equality reports” available to employees.62

There are two general categories of sexual harassment: quid pro quo and hostile work environment.63 Quid pro quo sexual harassment is a type of sexual extortion where there is a proposed or explicit exchange of job benefits for sexual favors. For example, telling an employee, “You will get the promotion if you spend the weekend with me in Las Vegas,” is a direct form of sexual harassment. Usually, the person making such a statement is in a position of authority over the harassed employee, and thus, the threat of job loss is real. One incident of quid pro quo harassment may create a justifiable legal claim. Hostile work environment sexual harassment is less direct than quid pro quo harassment and can involve epithets, slurs, nega- tive stereotyping, intimidating acts, graphic materials that show hostility toward an individual or group, and other types of conduct that affect the employment situation. For example, at one automobile manufacturing plant, male employees drew inappropriate sexually explicit pictures on cars before they were painted. This was found to be sexual harassment. An e-mail message containing sexually explicit jokes that is broadcast to employees could be viewed as contributing to a hostile work environment. Some hostile work environment harassment is nonsexual, meaning the harassing conduct is based on gender without explicit reference to sexual acts. For example, in Campbell v. Kansas State University (1991), the courts found repeated remarks about women “being intellectually inferior to men” to be part of a hostile environment. Unlike quid pro quo cases, one incident may not justify a legal claim. Instead, the courts will examine a range of acts and circumstances to determine if the work environment was intolerable and the victim’s job performance was impaired.64 From a social responsibility perspective, a key issue in both types of sexual harass- ment is the employing organization’s knowledge and tolerance for these

quid pro quo sexual harassment A type of sexual extortion where there is a proposed or explicit exchange of job benefits for sexual favors.

hostile work environment sexual harassment Less direct than quid pro quo harassment, it involves epithets, slurs, negative stereotyping, intimidating acts, graphic materials that show hostility toward an individual or group, and other types of conduct that affect the employment situation.

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types of behaviors. A number of court cases have shed more light on the issues that constitute sexual harassment and organizations’ responsibility in this regard.

In Harris v. Forklift Systems (1993), Teresa Harris claimed that her boss at Forklift Systems made suggestive sexual remarks, asked her to retrieve coins from his pants pocket, and joked that they should go to a motel to “negotiate her raise.” Courts at the state level threw out her case because she did not suffer major psychological injury. The U.S. Supreme Court overturned these decisions and ruled that employers can be forced to pay damages even if the worker suffered no proven psychological harm. This case brought about the “reasonable person” standard in evaluating what conduct constitutes sexual harassment. From this case, juries now evaluate the alleged conduct with respect to commonly held beliefs and expectations.65

Several firms have been embroiled in sexual harassment suits. For example, Sterling Jewelers, parent company of Kay Jewelers and Jared the Galleria of Jewelry, is being accused of discrimination and sexual harass- ment for a period of over ten years. If the class-action suit involving over 40,000 women is approved, the company may have to pay thousands in punitive damages and fines. At least 12 women claim they were underpaid in comparison to men and faced lewd harassment that became unbear- able.66 In another case, a jury awarded the victim $95 million in damages due to years of experiencing severe sexual harassment by a manager at fur- niture rent-to-own store, Aarons Inc. The manager’s behavior encouraged other male employees to harass the victim, creating a hostile workplace. To make matters worse, the company neglected to respond to the victim when she left a message on their hotline.67

U.S. Supreme Court decisions on sexual harassment cases indicate that (1) employers are liable for the acts of supervisors; (2) employers are liable for sexual harassment by supervisors that culminates in a tangible employ- ment action (loss of job, demotion, etc.); (3) employers are liable for a hostile environment created by a supervisor but may escape liability if they demonstrate that they exercised reasonable care to prevent and promptly correct any sexually harassing behavior and that the plaintiff employee unreasonably failed to take advantage of any preventive or corrective measures offered by the employer; and (4) claims of hostile environment sexual harassment must be severe and pervasive to be viewed as actionable by the courts.68

Much like the underlying philosophy of the Federal Sentencing Guidelines for Organizations that we discussed in earlier chapters, these decisions require top managers in organizations to take the detection and prevention of sexual harassment seriously. To this end, many firms have implemented programs on sexual harassment. To satisfy current legal standards and set a higher standard for social responsibility, employees, supervisors, and other close business partners should be educated on the company’s zero-tolerance policy against harassment. Employees must also be educated on the policy prohibiting harassment, including the types of

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behaviors that constitute harassment, how offenders will be punished, and what employees should do if they experience harassment. Just like an organizational compliance program, employees must be assured of confi- dentiality and no retaliation for reporting harassment.

Training on sexual harassment should be balanced in terms of legal definitions and practical tips and tools. Although employees need to be aware of the legal issues and ramifications, they also may need assistance in learning to recognize and avoid behaviors that may constitute quid pro quo harassment, create a hostile environment, or appear to be retalia- tory in nature. In fact, retaliation claims have more than doubled since the early 1990s, prompting many companies to incorporate this element into sexual harassment training. Finally, employees should be aware that same-sex conduct may also constitute sexual harassment.69 Sexual harassment from women to their male subordinates is yet another issue. One law enforcement officer in Texas won a lawsuit against his female boss after claiming that she frequently wanted sexual favors and touched him inappropriately.70 Table 7.4 lists facts about sexual harassment that should be used in company communication and training on this work- place issue.

TABLE 7.4 Sexual Harassment in the Workplace Sexual harassment is a form of sex discrimination that violates Title VII of the Civil Rights Act of 1964.

Unwelcome sexual advances, requests for sexual favors, and other verbal or physical conduct of a sexual nature constitute sexual harassment when submission to or rejection of this conduct explicitly or implicitly affects an individual’s employment, unreasonably interferes with an indi- vidual’s work performance, or creates an intimidating, hostile, or offensive work environment.

Sexual harassment can occur in a variety of circumstances including but not limited to the following:

The victim as well as the harasser may be a woman or a man. The victim does not have to be of the opposite sex.

The harasser can be the victim’s supervisor, an agent of the employer, a supervisor in another area, a coworker, or a nonemployee.

The victim does not have to be the person harassed but could be anyone affected by the offensive conduct.

Unlawful sexual harassment may occur without economic injury to or discharge of the victim.

The harasser’s conduct must be unwelcome.

It is helpful for the victim to inform the harasser directly that the conduct is unwelcome and must stop. The victim should use any employer complaint mechanism or grievance system available. When investigating allegations of sexual harassment, the Equal Employment Opportunity Commission looks at the whole record: the circumstances, such as the nature of the sexual advances, and the context in which the alleged incidents occurred. A determination of the allegations is made from the facts on a case-by-case basis.

Source: U.S. Equal Employment Opportunity Commission, “Facts About Sexual Harassment,” http:// www.eeoc.gov/eeoc/publications/fs-sex.cfm (accessed June 21, 2016).

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Whistle-blowing An employee who reports individual or company wrong- doing to either internal or external sources is considered a whistle-blower.71 Whistle-blowers usually focus on issues or behaviors that need corrective action, although managers and other employees may not appreciate reports that expose company weaknesses, raise embarrassing questions, or otherwise detract from organizational tasks. Although not all whistle-blowing activity leads to an extreme reaction, whistle-blowers have been retaliated against, demoted, fired, and subject to even worse consequences as a result of their actions.72 For example, Eddie Garcia, energy specialist at Santa Fe County in New Mexico, was accused of grand larceny and was fired from his job after pointing out improper conduct on the part of an exclusive government contractor. Garcia revealed to his supervisors that the contractor had double billed the county and was failing to obtain required permits for work. When they did not respond, he expressed his concerns to the media, which spurred retaliation from his employer. In the end, the charges against Garcia were dropped and he was awarded $180,000 in settlement fees, but he suffered personal and professional hardship for five years as a result.73

As discussed in Chapter 4, whistle-blowers have legal protections. The federal government and most state governments in the United States have enacted measures to protect whistle-blowers from retaliation. If you recall, the Whistleblower Protection Act of 1986 shields federal employees from retaliatory behavior; the Sarbanes-Oxley Act provides solid protection to whistle-blowers and strong penalties for those who retaliate against them; and other legislation such as the Dodd-Frank Act has provisions to reward whistle-blowers for revealing illegal behavior. Even with this protection, most reported misconduct to the government does not result in an inves- tigation. Most internal and external whistle-blowers are not legal experts and use their own judgment about an issue. Therefore, it is important to know the facts and conduct research before reporting.

Ethical Issues Laws are imperative for social responsibility. The ethical climate of the workplace, however, is more values-driven and dependent on top manage- ment leadership and corporate culture. In this section, we examine several trends in employment practices that have not fully reached the legal realm. Company initiatives in these areas indicate a corporate philosophy or cul- ture that respects and promotes certain ethical values.

Training and Development As discussed in the business ethics chapter, organizational culture and the associated values, beliefs, and norms operate on many levels and affect a number of workplace practices. Organizations should value employees as individuals, not just functional units to do work. Firms with this ethical stance fund initiatives to develop employees’ skills, knowledge, and other personal characteristics. Although this development is linked to business strategy and aids the employer, it also demonstrates a commitment to the future of the employee and his or her interests. Jiffy

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Lube has been listed as number one for Training Magazine’s list of top 125 employee training programs. It was selected for focused approach on train- ing on topics including customer service, leadership, and new services. Its training program is credited with helping the organization increase stores by 900 percent and approval ratings by 93 percent.74

Professionals also appreciate and respect a training and development focus from their employers. For example, the University of California, Berkeley incorporates an Individual Development Plan (IDP) component to their professional employee training program. The IDP is a one-on-one mentoring process between the employee and supervisor in which they dis- cuss setting specific goals, how to reach them, and overcoming obstacles.75 These organizations are finding many benefits from employee training and development, including stronger employee recruitment and retention strategies. Indeed, there is a link between investments in employees and the amount of commitment, job satisfaction, and productivity demonstrated by them. Happier employees tend to stay with their employer and to bet- ter serve coworkers, customers, and other constituents, which has a direct bearing on the quality of relationships and financial prospects of a firm. Leadership training is also critical, as the main reason employees leave a company is because of poor or unskilled management and leadership, not salary, benefits, or related factors. In exit interviews, departing employees often mention their desire for more meaningful feedback and steady com- munication with managers.76

Employees recognize when a company is diligently investing in programs that not only improve operations but also increase empower- ment and provide new opportunities to improve knowledge and grow professionally. Through formal training and development classes, workers get a better sense of where they fit and how they contribute to the overall organization. This understanding empowers them to become more responsive, accurate, and confident in workplace decisions. Training also increases ethical decision-making skills, accountability, and responsibility, a situation most employees prefer to micromanag- ing or “hand-holding.” All these effects contribute to the financial and cultural health of an organization.77 Thus, a commitment to training enables a firm to enhance its organizational capacity to fulfill stake- holder expectations.

Training and development activities require resources and the com- mitment of all managers to be successful. For example, a departmental manager must be supportive of an employee using part of the workday to attend a training session on a new software package. At the same time, the organization must pay for the training, regardless of whether it uses inside or outside trainers and develops in-house materials or purchases them from educational providers. A study by the American Society for Training and Development indicates that, on average, employers in the U.S. spend about $1,182 per employee on training every year, and employees engaged in approximately 31 hours of annual learning. The survey also tracked the major topics offered to employees. Over 35 percent of material accounted

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for three main topics: managerial and supervisory; industry or profes- sion; and processes, procedures, and business practices.78 Another area that has received much attention in the United States involves support for outside education. For example, Starbucks partnered with Arizona State University to offer tuition coverage for eligible employees to earn their bachelor’s degrees.79

Diversity Whereas Title VII of the Civil Rights Act grants legal protection to different types of employees, initiatives in workplace diversity focus on recruiting and retaining a diverse workforce as a business imperative.80 With diversity programs, companies assume an ethical obligation to employ and empower individuals regardless of age, gender, ethnicity, physical or mental ability, or other characteristics. These firms go beyond compliance with government guidelines to develop cultures that respect and embrace the unique skills, backgrounds, and contributions of all types of people. Thus, legal statutes focus on removing discrimination whereas diversity represents a leadership approach for cultivating and appreciating employee talent.81 Firms with an effective diversity effort link their diversity mis- sion statement with the corporate strategic plan, implement plans to recruit and retain a diverse talent pool, support community programs of diverse groups, hold management accountable for various types of diversity per- formance, and have tangible outcomes of the diversity strategy. Each firm must tailor its diversity initiative to meet unique employee, market, and industry conditions.82

Many firms embrace employee diversity to deal with supplier and customer diversity. Their assumption is that to effectively design, market, and support products for different target groups, a company must employ individuals who reflect its customers’ characteristics.83 Organizations and industries with a population-wide customer base may use national demo- graphics for assessing their diversity effort. Kaiser Permanente uses a dash- board to assess the links between its senior-executive compensation and diversity. It is mandatory for company recruiters to have diversity slates that are viewed by human resources. Kaiser Permanente’s strong empha- sis on diversity began in 1989 after the company developed the Minority Recruitment and Development Task Force to address racial inequalities.84 As demographics in the United States continue to shift, companies are faced with reconsidering their marketing and hiring strategies, including the link between employee and customer characteristics. The sharp growth in the Hispanic population is one of the most important shifts recorded. This has prompted firms to hire Hispanic employees and consultants and tailor their offerings to this demographic. Clorox and General Mills, for instance, are appealing to Hispanics with bilingual advertisements via mobile applications.85

As we discussed in Chapter 1, there are opportunities to link social responsibility objectives with business performance, and many firms are learning the benefits of employing individuals with different backgrounds and perspectives. For example, at New York Life, diversity is treated like

workplace diversity Focuses on recruiting and retaining a diverse workforce as a business imperative.

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all other business goals. The company employs a chief diversity officer to create accountability and inclusion strategies with employees, sup- pliers, community members, and other stakeholders.86 Hewlett-Packard (HP), a multinational information technology company, is committed to including people with disabilities into the workplace. The company was recently named Private-Sector Employer of the Year by CAREERS & the disABLED magazine, a publication that provides career advice for people with disabilities. HP was chosen by readers for providing a positive envi- ronment in which to work. The company values diversity and believes that this component of their culture allows them to innovate in ways that less diverse companies are not able. In addition, HP designs goods and services that are informed by its diverse workforce.87

Conflicting views and voices of different generations abound in the workplace, and this is the first time in history that the workforce has been composed of so many generations at one time. Generations have worked together in the past, but these groups were usually divided by organiza- tional stratification. Many workplaces now include members of multiple generations working shoulder to shoulder. The result may be greater dissension among the age groups than when they were stratified by the organizational hierarchy. Because employees serve an important role in the social responsibility framework, managers need to be aware of gen- erational differences and their potential effects on teamwork, conflict, and other workplace behaviors. Table 7.5 lists the three generations in today’s workplace as well as their key characteristics.

Baby boomers are service oriented, good team players, and want to please. However, they are also known for being self-centered, overly sensitive to feedback, and not budget minded. People in Generation X are adaptable, technologically literate, independent, and not intimidated by authority. However, their liabilities include impatience, cynicism, and inexperience. The latest generation to enter the workforce, Generation Y, or the Millennials, is technologically savvy. They also bring the assets of collective action, optimism, multitasking ability, and tenacity to the work- place. However, they bring the liabilities of inexperience, especially with difficult people issues, and a need for supervision and structure.

Although generational issues existed in the workforce in the 1920s and the 1960s, there are some new twists today. The older generations no

TABLE 7.5 Profiles of Generations at Work

Generation Name Birth Years Key Characteristics Baby boomers 1946–1964 Rejection of traditional values, optimistic,

achievement-oriented

Generation X 1965–1983 Family-oriented, impatient, individualistic

Millennials (Generation Y) After 1983 Technologically savvy, greater expectations for workplace, optimistic

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longer have all the money and power. Times of anxiety and uncertainty can aggravate differences and generational conflict, and these conflicts need to be handled correctly when they occur. Understanding the dif- ferent generations and how they see things is a crucial part of handling this conflict. The authors of Generations at Work: Managing the Clash of Veterans, Boomers, Xers, and Nexters in Your Workplace developed the ACORN acronym to describe five principles that managers can use to deal with generational issues. Accommodating employee differences entails treating employees as customers and giving them the best service that the company can give. Creating workplace choices as to what and how employees work can allow for change and satisfaction. Operating from a sophisticated management style requires that management be direct but tactful. Respecting competence and initiative assumes the best from the different generations and responds accordingly. Nourishing retention means keeping the best employees. When combined with effective com- munication skills, the ACORN principles can help managers mend genera- tional conflicts for the benefit of everyone in the company.88

Although workplace diversity reaps benefits for both employees and employers, it also brings challenges that must be addressed. For example, diverse employees may have more difficulty communicating and working with each other. Although differences can breed innovation and creativ- ity, they can also create an atmosphere of distrust, dissatisfaction, or lack of cooperation.89 Today many companies are seizing the opportunity for discussing diversity and creating stronger bonds among employees of different ethnicities, religions, beliefs, and experiences. Other firms engage employees in community service projects and similar initiatives that pro- mote teamwork and cohesion and help to minimize any negative effects of diversity.

Finally, the diversity message will not be taken seriously unless top management and organizational systems fully support a diverse workforce. After Home Depot settled a gender-discrimination lawsuit, it developed an automated hiring and promotion computer program. Although the Job Preference Program (JPP) was originally intended as insurance against dis- crimination, the system opens all jobs and applicants to the companywide network, eliminates unqualified applications, and enables managers to learn employee aspirations and skills in a more effective manner. JPP has also brought a positive change to the number of female and minority man- agers within Home Depot.90 On the other hand, Silicon Valley has been highly criticized for its apparent lack of diversity. Although many tech firms are setting more diversity goals, companies like Facebook have made only minimal gains. Facebook claims that there is simply not enough available talent.91 In addition, some employees of companies with diversity training programs have viewed such training as intended to blame or change white men only. Other training has focused on the reasons diversity should be important, though not the actual changes in attitudes, work styles, expecta- tions, and business processes that are needed for diversity to work.92

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Work/Life Balance Just as increasing numbers of women in the work- place have changed the norms of behavior at work and prompted attention to sexual harassment, they have also brought challenges in work/life bal- ance. This balance is not just an issue for women, as men also have multiple roles that can create the same types of stress and conflict.93 The work/life balance may be described otherwise, such as people who are torn between work and home on a regular basis. An employee thinking about work (or actually working) when he is at home and vice versa is ultimately strug- gling with multiple responsibilities.94

Because employees have roles within and outside the organization, there is increasing corporate focus on the types of support that employ- ees have in balancing these obligations. Deloitte & Touche (now part of Deloitte Touche Tohmatsu), an international professional services firm, was forced to address issues of work/life balance when it discovered the alarming rate at which women were leaving the firm. In the early 1990s, only four of the 50 employees being considered for partner status were women, despite the company’s heavy recruitment of women from busi- ness schools. The company convened the Initiative for the Retention and Advancement of Women task force and soon uncovered cultural beliefs and practices that needed modification. The task force found that younger employees—both male and female—wanted a balanced life, were willing to forgo some pay for more time with family and less stress, and had simi- lar career goals. Therefore, Deloitte & Touche developed a major work/ life balance initiative that included reduced travel schedules and flexible work arrangements to benefit both men and women employed at the firm. According to a survey, issues related to work/life balance such as telecom- muting, flexible scheduling, and assistance with child care and elder care are almost equally important to male and female employees. Whereas men rarely utilized these benefits in the past, this is no longer the case. Many midlevel executives, both male and female, are part of dual-earner couples “sandwiched” between raising children and caring for aging parents.95

Such work/life programs assist employees in balancing work responsi- bilities with personal and family responsibilities. A central feature of these programs is flexibility so that employees of all types are able to achieve their own definition of balance. For example, a single parent may want child care and consistent work hours, whereas another employee may need assistance in finding elder care for a parent with Alzheimer’s disease. A working mother may need access to “just-in-time” care when a child is sick or school is out of session. Employees of all types appreciate flextime arrangements, which allow them to work 40 hours per week on a sched- ule they develop within a range of hours specified by the company. Other employees work some hours at home or in a location more conducive to their personal obligations. SAS Institute, the world’s largest private soft- ware company, has been recognized by Glassdoor.com for its exceptional work/life balance program. The company offers employees and their families many perks supporting a balanced life, such as free access to a gymnasium, a healthcare clinic on company grounds, discounted child

work/life programs Assist employees in balanc- ing work responsibilities with personal and family responsibilities.

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care, free “work-life” counseling, and more.96 Work/life balance not only enhances employee productivity, but it is also an imperative to attracting and maintaining a healthy workforce.

More than 80 million Americans suffer from symptoms of stress at work, including headaches, sleeplessness, and other physical ailments.97 To remedy these concerns, Americans spend more than $20 billion per year on stress-reducing goods, services, and strategies.98 Compared to Japanese and Chinese workers, however, the U.S. figures are moderate. The term “karoshi,” which means, “death from overwork,” became widely used in Japan. Thousands of deaths per year are attributed to overwork, such as brain hemorrhages, heart attacks, suicides, etc. The Japanese government passed legislations to establish support centers, assist businesses in reduc- ing the number of deaths, and conduct more research into the phenom- enon. China, as its economy continues to grow, is beginning to experience the same issue. The death toll is estimated at 600,000 employees per year, or 1,600 per day.99

Managers must become sensitive to cues that employees need to cre- ate a stronger work/life balance. Frustration, anger, moodiness, a myopic focus, and physiological symptoms are often present when an employee needs to take vacation, work fewer hours, utilize flexible scheduling, or simply reduce his or her workload. One manager of a telecommunications firm in California returned to the workplace around 11:30 p.m. every night to send people home. Otherwise, she knew many of them would sleep on the floor in the office. Not only do some employees work too many hours, but they may largely ignore nutrition and fitness, friendships, community involvement, and other aspects of work/life balance.100

There is no generic work/life program. Instead, companies need to consider their employee base and the types of support their employees are likely to need and appreciate. James Goodnight, SAS’s founder, believes that dinnertime should be spent with family and friends, not in the office. Most employees leave by 5:00 p.m., and others participate in flextime or job-sharing arrangements. This, among other characteristics listed earlier, have resulted in the company receiving honors such as its high ranking on Fortune magazine’s annual list of the 100 Best Companies to Work For and one of Working Mother magazine’s 100 Best Companies for Working Mothers.101

Successful work/life programs, like that developed by the SAS Institute, are an extension of the diversity philosophy so that employees are respected as individuals in the process of contributing to company goals. Thus, connecting employees’ personal needs, lives, and goals to stra- tegic business issues can be fruitful for both parties. This perspective is in contrast to the “employee goals versus business goals” trade-off mentality that has been pervasive. IBM implemented a work/life strategy over two decades ago and periodically conducts employee surveys to see if changes or additions are needed.102

The Silk Road Survey found that 55 percent of all applicants consider work/life balance the most important consideration in identifying potential employers and considering job offers.103 For this reason, companies have

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become quite innovative in their approach to work/life balance. Agilent Technologies, for example, not only offers flexible work schedules and employee discounts, but also has organized sports teams, massages on location, and yoga sessions.104 Nokia is known for making employees feel cared for. Employees have noted that beyond flexible work schedules and the ability to work from home, the company encourages them to take time off and recharge.105 Such efforts demonstrate the company’s willingness to accommodate employee needs and concerns beyond the workplace.

Philanthropic Issues In later chapters, we examine the philanthropic efforts of companies and the important role that employees play in the process of selecting and implementing projects that contribute time, resources, and human activity to worthy causes. In social responsibility, philanthropic responsibilities are primarily directed outside the organization, so they are not directly focused on employees. However, employees benefit from participating in volunteerism and other philanthropic projects. Employee volunteerism increases the level of engagement the employee feels, which not only con- tributes to their performance but also to the company’s performance. The engagement is a result of many factors including gaining a sense of purpose through volunteering, having the ability to work in positions of leadership, and gaining new skills. In addition, engaged employees are more likely to stay with the company for longer periods of time.106

Many employers help organize employees to participate in walkathons, marathons, bikeathons, and similar events. For example, Blue Cross Blue Shield companies hold an annual event called National Walk@Lunch Day. The event challenges employees and community members to put on their shoes and walk at lunch. Over a six-week period, participants log their steps on the company’s Facebook page. At the end of the event, Blue Cross Blue Shield donates up to $1 per mile reported to the American Diabetes Association.107 Thus, the benefits of corporate philanthropy in the com- munity reflect positively on the organization. There are many strategies for demonstrating community involvement and care. CA Technologies holds a month-long volunteer program in which employees from all over the world spend time volunteering at nonprofits in their local communities.108

STRATEGIC IMPLEMENTATION OF RESPONSIBILITIES TO EMPLOYEES As this chapter has demonstrated, responsibilities toward employees are varied and complex. Legal issues alone require full-time attention from lawyers and human resource specialists. These issues are also emotional because corporate decisions have ramifications on families and communi- ties as well as on employees. In light of this complexity, many companies

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For employees at Alphabet’s Google, it pays to be green. In addition to the extensive benefits Google offers, the company provides incentives for employees to increase their sustainability habits. Google recognizes that becoming a sustainable company requires support both from external and internal stakeholders. As a result, the company takes great pains to make being sustainable easy for employees. Google employees can save money, donate to charities, and receive discounts on eco-friendly technology by taking advantage of the company’s green incentives. For instance, employees can save fuel costs by riding to work on Google’s bio- diesel shuttles. Approximately 6,400 Google employees use the company’s shuttles to commute to work.

Google’s GFleet car-sharing program, a car sharing program employees can use to get around on Google’s campus, consists of electric vehicles including Nissan LEAFs and Chevrolet Volts. To power these vehicles Google has installed the largest electric vehicle charging station in the country. Approximately 1,000 charging ses- sions occur every day at Google headquarters. Together Google’s shuttle and GFleet programs save 29,000 met- ric tons of carbon dioxide emissions. Google has also invested in car sharing programs Sidecar and Uber.

Employees can also use Google’s bike-sharing pro- gram to get around campus. The company encour- ages employees to bike to work and holds an annual Google Bike to Work Day. Approximately 3,700 Google employees at 26 offices participated in the event.

Others have been known to adopt more unusual ways to get around campus, including pogo jumping. For employees who choose to bike, walk, or pogo to work, the company provides them with digital stamps. These stamps can be redeemed for company donations to the employee’s favorite charity.

Many of Google’s green initiatives help both employees and society. For example, Google developed a $300 million fund for SolarCity in a partnership to support the installation of solar panels on residential homes. While it may be difficult to convince the aver- age consumer to adopt solar technology, Google offers its employees discounts on SolarCity products. This encourages employees to adopt sustainable practices outside of work. Google has also invested in additional solar companies as well as wind power.

It appears that Google’s concerns with sustain- ability are successfully catching on with employees. At Google’s EMEA Engineering facility in Zurich, Google surveyed employees on ways to redesign a local brewery building into office space for the company. The result was a uniquely designed work space that emphasizes innovation, creativity, and sustainability. One major feature in the construction was the use of transpar- ent glass to section space in the building. This design increases daylighting, which cuts back on the build- ing’s energy consumption. It is clear that Google seeks to make a difference in the field of sustainability— starting with its employees.

Sources: Brian Dumaine, “Google’s Zero-Carbon Quest,” Fortune Tech, http://fortune.com/2012/07/12/googles-zero-carbon-quest/ (accessed July 18, 2016); Bill Weihl, “Reducing Our Carbon Footprint,” Google, May 6, 2009, http://googleblog.blogspot.com/2009/05/ reducing-our-carbon-footprint.html#!/2009/05/reducing-our-carbon-footprint.html (accessed July 18, 2016); Taflin Laylin, “Gallery: Google Employees in Zurich (Zooglers) Have the World’s Coolest Re-Purposed Office,” September 27, 2011, http://inhabitat.com/ google-employees-in-zurich-zooglers-have-the-worlds-coolest-re-purposed-office/emea-engineering-hub-zurich-camenzind-evolution- 1/?extend=1 (accessed July 18, 2016); Joseph Stomberg, “Google’s Rick Needham is Feeling Lucky About the Future of Sustainable Energy,” Smithsonian, September 2, 2013, http://www.smithsonianmag.com/innovation/googles-rick-needham-is-feeling-lucky-about- the-future-of-sustainable-energy-3415041/?page=1 (accessed July 18, 2016); Robert McMillan, “Inside the Cycleplex: The Weird, Wild World of Google Bikes,” Wired, April 25, 2013, http://www.wired.com/2013/04/google-bikes/ (accessed July 18, 2016); Google, “Campus Operations,” Google Green, https://www.google.com/green/efficiency/oncampus/ (accessed July 18, 2016); SolarCity Creates Fund to Finance $750 Million in Residential Solar Projects with Investment from Google,” February 26, 2015, http://www.solarcity.com/ newsroom/ press/solarcity-creates-fund-finance-750-million-residential-solar-projects-investment (accessed July 18, 2016). Alison van Diggelen, “Working @ Google: Green Carrots & Pogo Sticks,” Fresh Dialogues, August 23, 2011, http://www.freshdialogues.com/2011/08/23/ working-google-green-carrots-pogo-sticks/ (accessed July 18, 2016).

Earth in the Balance

Google to Employees: Go Green!

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have chosen to embrace these obligations to benefit both employee and organizational goals. This philosophy stands in stark contrast to the master-servant model popular more than 100 years ago. Today, compa- nies are using distinctive programs and initiatives to set themselves apart and to become known as desirable employers. Low unemployment levels before the last recession, along with diversity, work/life balance, outsourc- ing, and generational differences, prompted companies to use marketing strategy and business insight normally applied to customer development in the employee recruitment and retention realm. Even in a time of economic downturn, employers will need to be mindful of keeping top talent and maintaining employee satisfaction. For example, Patagonia encourages its employees to stay physically fit. It places so much emphasis on employee satisfaction and physical fitness, in fact, that employees are allowed to go surfing in the middle of the workday.109

An employer of choice is an organization of any size in any industry that is able to attract, optimize, and retain the best employee talent over the long term. ENSR, a European environmental consulting firm, created a cross-functional and geographically diverse committee to provide guid- ance for maintaining and strengthening the company’s positive culture. The committee focuses on ways in which ENSR’s top management can ensure that integrity, respect, open communications, flexibility and bal- ance are the key values and defining qualities of every ENSR career.110 Advertising, websites, and other company communications often use the term to describe and market the organization to current and potential employees. These messages center on the various practices that compa- nies have implemented to create employee satisfaction. Firms with this distinction value the human component of business, not just financial considerations, ensure that employees are engaged in meaningful work, and stimulate the intellectual curiosity of employees. These businesses have strong training practices, delegate authority, and recognize the link between employee morale, customer satisfaction, and other performance measures.111 Thus, becoming an employer of choice is an important

manifestation of strategic social responsibility. Potential employees may look for signs that social responsibility is a top concern. College graduates often evaluate a potential employer’s socially responsible and ethical behavior when deciding on a career path. Table 7.6 shows the percentage of college graduates who indicated the top characteristics of a job they considered to be the most important. The table provides results from college graduates and demonstrates the kind of culture companies should cultivate to attract employees.

Despite the negative effects that certain actions may have on perceptions of a company’s social responsibility, there are strategies and programs

employer of choice An organization of any size in any industry that is able to attract, optimize, and retain the best employee talent over the long term.

TABLE 7.6 What Graduates Consider Most Important for Employment

Employer Action Graduates (%) 1. Opportunity for personal growth 60.7%

2. Job security 46.0%

3. Friendly coworkers 43.7%

4. Good benefits package 39.2%

5. Ability to improve community 34.7%

Source: National Association of Colleges and Employers, “Student Survey: The Job/Employer Preferences of the Class of 2014,” July 23, 2014, http://www.naceweb.org/s07232014/ job-preferences-graduating-class-2014.aspx (accessed June 21, 2016).

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that demonstrate a proactive approach to employee relations. One tradi- tional way to strengthen trust is through employee stock ownership plans (ESOPs), which provide the opportunity both to contribute to and gain from organizational success. Such programs confer not only ownership but also opportunities for employees to participate in management planning, which foster an environment that many organizations believe increases profits. Several studies of companies with ESOPs cast a positive light on these plans. ESOPs appear to increase sales by about 2.3–2.4 percent over what would have been expected without an ESOP. ESOP companies were also found to pay better benefits, higher wages, and provide nearly twice the retire- ment income for employees than their non-ESOP counterparts. Under these plans, employees must take on an ownership perspective, work as a team in an environment that forges trust, and provide excellent interactions and service to customers. Some of the 7,000 “employee-owned” firms include Dunn-Edwards Paints, Publix Supermarkets, and Round Table Pizza.112 Of Fortune magazine’s 100 Best Companies to Work For, more than half are employee-owned.113 Research has shown that the decision to become an employee-owned company enhances company performance and provides higher wealth accumulation for employee owners. Despite the advantages of ESOPs, experts also warn that some plans are potentially risky for employ- ees, as in the case of Enron.114 Just like any other company initiative, man- agement must take responsibility for managing an ESOP well.

Becoming an employer of choice has many benefits, including an enhanced ability to hire and retain the best people, who in turn offer strong commitment to the company mission and its stakeholders. The expectations of such businesses are very high because employee stakehold- ers often have specific criteria in mind when assessing the attractiveness of a particular employer. Some people may be focused on specific envi- ronmental issues, whereas others may be searching for a company that markets healthy and helpful products. Although top managers must decide on how the firm will achieve strategic social responsibility with employ- ees, Table 7.7 provides guidance on eight key principles that are typically exhibited and managed by employers of choice. Although most companies have long understood the importance of attracting and keeping customers through strong branding efforts, many are relatively new to the idea and implementation of similar strategies to create an employer brand.115

Finally, the global dimensions of today’s workplace shape an organiza- tion’s ability to effectively work with employee stakeholders and to become an employer of choice. Firms with offices and sites around the world must deal with a complexity of norms and expectations, all of which can affect its reputation at home. For example, when Nike was first accused of deal- ing with suppliers that used child labor in the mid-1990s, the company claimed that it was not in the business of manufacturing shoes and that it could therefore not be blamed for the practices of Asian manufactur- ers. Following media criticism, Nike publicized a report claiming that the employees of its Indonesian and Vietnamese suppliers were living quite well. The veracity of this report was tarnished by contradictory evidence

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TABLE 7.7 Key Principles of Employers of Choice

Principle Explanation 1. Organizational reputation Employees desire to work in an organization that maintains a

good reputation among stakeholders.

2. Organizational culture Employees want to work in an ethical organizational culture that maintains integrity and encourages employee contributions.

3. Strong leadership Employees want to work in an environment that has strong ethical leaders who care passionately about the company.

4. Interesting work Employees want their jobs to be challenging and rewarding, not mundane or too difficult.

5. Opportunities for Growth Employees want to work in a job or industry where there are significant opportunities for career advancement.

6. Employee recognition Employees appreciate being recognized for their contributions to the company and are encouraged to continue serving.

7. Employee well-being Employees expect fair compensation, appropriate benefits, and an adequate work/life balance from their employers.

8. Social Responsibility Studies have demonstrated that employees enjoy working for a company that considers the needs of stakeholders and contrib- utes toward improving society.

Sources: Barbara J. Bowen, “Being an Employer of Choice has Bottom-Line Benefits,” CMA Management 82 (November 2008): 14–15; “Main Page,” Employer of Choice.net, http://www .employerofchoice.net/ (accessed July 1, 2014); Roger E. Herman and Joyce L. Gioia, How to Become an Employer of Choice (Winchester, VA: Oakhill Press, 2000); Jody Ordioni, “How to Become an Employee of Choice,” ere.net, July 15, 2013, http://www.eremedia.com/ere/how-to-become-an- employer-of-choice/ (accessed June 21, 2016).

produced by activists. Next, Nike started introducing workers’ rights and environmental guidelines for its suppliers. Yet some company representa- tives explained that any additional social responsibility initiative would damage the competitive position of the firm.

In the late 1990s, Nike designed a suppliers’ auditing process that invited student representatives along with other activists to visit manufac- turing plants and provide recommendations for better practice. Before the company’s shift, many media reports discussed Nike’s manufacturing prac- tices, and it is likely that some consumers and potential employees turned their attention away from Nike. Nike actually settled the legal case that rose all the way to the Supreme Court. Nike agreed to pay $1.5 million to the Fair Labor Association to help fund worker development programs. In this case, Nike’s relationships with its manufacturing suppliers and their employees affected its ability to achieve strategic social responsibility.116 Today, Nike’s supply chain practices have improved considerably. The company has been awarded the Corporate Register Reporting Award for excellence in global reporting, demonstrating that its auditing and ethical programs for supply chains have significantly increased the transparency and accountability of the company.117

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SUMMARY Throughout history, people’s perceptions of work and employment have evolved from a necessary evil to a source of fulfillment. The relationship between employer and employee involves responsibilities, obligations, and expectations as well as challenges.

On an economic level, many believe there is an unwritten, informal psychological contract that includes the beliefs, perceptions, expectations, and obligations that make up the agreement between individuals and their employers. This contract has evolved from a primarily master-servant relationship, in which employers held the power, to one in which employ- ees assume a more balanced relationship with employers. Workforce reduction, the process of eliminating employment positions, breaches the psychological contract that exists between an employer and employee and threatens the social contract among employers, communities, and other groups. Although workforce reduction lowers costs, it often results in lost intellectual capital, strained customer relationships, negative media atten- tion, and other issues that drain company resources.

Employment law is a complex and ever-evolving area. In the past, employment was primarily governed by employment at will, a common- law doctrine that allows either the employer or employee to terminate the relationship at any time as long as it does not violate an employment contract. Many laws have been enacted to regulate business conduct with regard to wages and benefits, labor unions, health and safety, equal employment opportunity, sexual harassment, and whistle-blowing. Title VII of the Civil Rights Act, which prohibits employment discrimination on the basis of race, national origin, color, religion, and gender, is fun- damental to employees’ rights to join and advance in an organization according to merit. Sexual harassment is defined as unwelcome sexual advances, requests for sexual favors, and other verbal or physical con- duct of a sexual nature when submission to or rejection of this conduct explicitly or implicitly affects an individual’s employment, unreason- ably interferes with an individual’s work performance, or creates an intimidating, hostile, or offensive work environment. Sexual harassment may take the form of either quid pro quo harassment or hostile work environment harassment. An employee who reports individual or cor- porate wrongdoing to either internal or external sources is considered a whistle-blower.

Although legal compliance is imperative for social responsibility, the ethical climate of the workplace is more subjective and dependent on top management support and corporate culture. Companies with a strong ethical stance fund initiatives to develop employees’ skills, knowledge, and other personal characteristics. With diversity programs, companies assume an ethical obligation to employ and empower individuals regardless of age, gender, physical and mental ability, and other characteristics. Work/ life programs assist employees in balancing work responsibilities with per- sonal and family responsibilities.

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Employees may play an important role in a firm’s philanthropic efforts. Employees benefit from such initiatives through participation in volunteerism and other projects.

In light of the complexity of and emotions involved with respon- sibilities toward employees, many companies have chosen to embrace these obligations to benefit both employee and organizational goals. An employer of choice is an organization of any size in any industry that is able to attract, optimize, and retain the best employee talent over the long term. One traditional way to strengthen trust is through ESOPs, which provide the opportunity both to contribute to and gain from organiza- tional success. Finally, the global dimensions of today’s workplace shape an organization’s ability to effectively work with employee stakeholders and to become an employer of choice.

Responsible Business Debate

The Usefulness of Performance Reviews Issue: Should companies get rid of the performance review?

The beginning of the year brings with it something dread- ed by employees: the performance review. Performance reviews are meant to measure employees’ progress over the year and determine whether their performance meets job expectations. The theory behind performance reviews is that they help employees enhance their strengths and improve on their weaknesses. Performance reviews are often used in promotion or compensation decisions.

Performance reviews act as an important benchmark for employees. Supporters argue that it helps employ- ees realize how they are doing compared to others in the company. The ability to measure an employee’s per- formance is essential in determining how he or she fits in with the firm. Performance reviews also provide the manager with the ability to help employees improve on their strengths and weaknesses, improving employee skill sets and giving them more of an opportunity to advance in their careers. Managers who genuinely care about their subordinates can work with employees more closely to enhance their performance.

However, organizations including Adobe, Juniper, and Kelly Services have begun to scrap the traditional

performance review due to perceived weaknesses. Critics of performance reviews believe they have so many flaws that the time it takes to implement a review in no way equals the benefits. Instead, it creates tension between employees and supervisors. There are many disadvan- tages to performance reviews that could hinder their usefulness. For instance, managers are not unbiased. It has been shown that managers tend to give higher ratings to employees that they have hired and lower rat- ings to employees who are different from them.

Critics suggest that the performance review harms employee relations with their managers because they have different intentions. Employees are more con- cerned with compensation or promotion, while employ- ers are more interested in employee improvement. Also, because the performance review is a one-way form of communication, it places the boss in a power- ful position. Additionally, many performance reviews have criteria that may or may not be specific to that employee’s job. Opponents argue that employees can- not possibly be fit into a box of predetermined criteria.

A recent study suggests that it is often a company’s best employees that dislike criticism the most. Additionally, high achievers who are rated below the highest rating are

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often crushed, even if they receive a high score. Contrary to popular opinion, this research study seems to demon- strate that those who want to improve do not like the negative feedback given in a performance review and— like many people—will often zone out once a supervisor begins providing negative feedback.

Some alternatives to the traditional performance review have been suggested. One alternative is to make the performance review more of a two-way form of com- munication. Instead of the manager simply evaluating the employee’s performance, employees could also be pro- vided with the opportunity to share their thoughts about their superiors or the company. This would help keep the managers accountable in working toward employee prog- ress. REI, for instance, has an independent firm conduct an annual employee survey to gather employee feedback about the company, its benefits, engagement, and more.

There Are Two Sides to Every Issue 1. Traditional performance reviews act as important

indicators of employee progress and productivity.

2. Traditional performance reviews should be com- pletely eliminated due to their disadvantages.

Sources: Josh Bersin, “Time to Scrap Performance Appraisals?” Forbes, May 6, 2013, http://www.forbes.com/sites/joshber- sin/2013/05/06/time-to-scrap-performance-appraisals/ (accessed July 18, 2016); Samuel A. Colbert, “Get Rid of the Performance Review!” The Wall Street Journal, October 20, 2008, http:// online.wsj.com/news/articles/SB122426318874844933 (accessed July 18, 2016); Rose Johnson, “Advantages & Disadvantages of Performance Evaluation,” Chron, http://smallbusiness.chron. com/advantages-disadvantages-performance-evaluation-21143. html (accessed July 18, 2016); Jena McGregor, “Study Finds That Basically Every Single Person Hates Performance Reviews,” The Washington Post, January 27, 2014, https://www.wash ingtonpost.com/news/on-leadership/wp/2014/01/27/study- finds-that-basically-every-single-person-hates-performance- reviews/ (accessed July 18, 2016); REI, “Employee Engagement & Retention,” https://www.rei.com/stewardship/report/2013/ workplace/employee-engagement-retention.html (accessed July 18, 2016); Derek Thompson, “The Case Against Performance Reviews,” The Atlantic, January 29, 2014, http://www.theatlantic. com/business/archive/2014/01/the-case-against-performance- reviews/283402/ (accessed July 18, 2016).

KEY TERMS psychological contract (p. 226) workforce reduction (p. 229) employment at will (p. 232) vesting (p. 234) ergonomics (p. 236)

sexual harassment (p. 239) quid pro quo sexual harassment

(p. 240) hostile work environment sexual

harassment (p. 240)

workplace diversity (p. 245) work/life programs (p. 248) employer of choice (p. 252)

DISCUSSION QUESTIONS 1. Review Table 7.1, Psychological Contract

between Employee and Employer. Indicate the positive effects associated with the contract’s characteristics. For example, what is positive about an employee’s ability to solve problems independently?

2. What is workforce reduction? How does it affect employees, consumers, and the local community? What steps should a company take to address these effects?

3. What responsibilities do companies have with respect to workplace violence? Using the three categories of violence presented in the chapter,

describe the responsibilities and actions that you believe are necessary for an organization to dem- onstrate social responsibility in this area.

4. Describe the differences between workplace diver- sity and equal employment opportunity. How do these differences affect managerial responsibilities and the development of social responsibility pro- grams?

5. Why is it important to understand the profiles of different generations at work? How can manag- ers use the ACORN principles to develop a strong sense of community and solidarity among all employee groups?

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6. What trends have contributed to work/life pro- grams? How do work/life programs help employ- ees and organizations?

7. What is an employer of choice? Describe how a firm could use traditional marketing concepts and strategies to appeal to current and potential employees.

8. Review the best practices in Table 7.7 for becom- ing an employer of choice. What are some poten- tial drawbacks to each practice? Rank the eight practices in terms of their importance to you.

EXPERIENTIAL EXERCISE Develop a list of five criteria that describe your employ- er of choice. Then, visit the websites of three companies in which you have some employment interest. Peruse each firm’s website to find evidence on how it fulfills your criteria. On the basis of this evidence, develop a

chart to show how well each firm meets your descrip- tion and criteria of your employer of choice. Finally, provide three recommendations on how these com- panies can better communicate their commitment to employees and the employer of choice criteria.

X, Y, & MILLENIAL: WHAT WOULD YOU DO? ? Dawn Burke, director of employee relations, glanced at her online calendar and remembered her appointment at 3:00 p.m. today. She quickly found the file labeled “McCullen and Aranda” and started preparing for the meeting. She recalled that this was essentially an employee-supervisor case, where the employee had been unwilling or unable to meet the supervisor’s requests. The employee claimed that the supervisor was too demanding and impatient. Their conflict had escalated to the point that both were unhappy and uncomfortable in the work environment. Other employees had noticed, and overheard, some of the conflict.

In her role, Dawn was responsible for many pro- grams, including a new mediation initiative to resolve workplace conflict. The program was designed to help employees develop stronger communication and con- flict resolution skills. In this case, the program was also providing an intermediary step between informal and formal discipline. Today, she was meeting with both parties to discuss mediation guidelines, a time line, their goal, and their general points of conflict.

John McCullen, 51, a buyer in the facilities depart- ment, and Terry Aranda, the director of facilities pro- curement, arrived separately. John had been with the company for 32 years and had started his career with the company right out of high school. Terry, 31, was hired from another firm to oversee the procurement area a year ago and had recently graduated from a prestigious M.B.A. program. Dawn started the meeting

by reviewing the mediation guidelines and time line. She reminded John and Terry that their goal was to develop a workable and agreeable solution to the current situa- tion. Dawn then asked for each party to explain his or her position on the conflict.

John began, “Ms. Aranda is a very smart lady. She seems to know the buying and procurement area, but she knows less about the company and its history. I am not sure she has taken the time to learn our ways and values. Ms. Aranda is impatient with our use of the new software and computer system. Some of us don’t have college degrees, and we haven’t been using computers since we were young. I started working at this company about the time she was born, and I am not sure that her manage- ment style is good for our department. Everything was going pretty well until we starting changing our systems.”

Terry commented, “John is a valuable member of the department, as he knows everyone at this company. I appreciate his knowledge and loyalty. On the other hand, he has not completed several tasks in a timely manner nor has he asked for an extension. I feel that I must check up on his schedule and proof all of his work. John has attended several training classes, and I asked that he use an electronic calendar so that projects are completed on time. He continues to ignore my advice and deadlines. We’ve had several conversations, but John’s work has not substantially improved. We have many goals to achieve in the department, and I need everyone’s best work in order to make that happen.”

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Dawn thanked them for their candor and told them she would meet with them next week to start the media- tion process. As she contemplated what each had said, she remembered an article that discussed how people

born in different generations often have contrasting per- ceptions about work. Dawn started to jot a few notes about the next steps in resolving their conflict. What would you do?

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CHAPTER EIGHT

Consumer Relations

Chapter Objectives

●● To describe customers as stakeholders

●● To investigate consumer protection laws

●● To examine six consumer rights

●● To discuss the implementation of responsibilities to consumers

Chapter Outline

Consumer Stakeholders

Responsibilities to Consumers

Strategic Implementation of Responsibilities to Consumers

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261

It is not uncommon to see long lines stretching out the door during lunchtime at the Protein Bar. Protein Bar specializes in healthy, high-protein food options that appeal to busy consumers on the go. The Protein Bar was founded in Chicago by Matt Matros. Although it was founded in 2009, Matros got the idea for the restaurant two years earlier while working as an associ- ate brand manager for Kraft Foods. Matros used his life savings to open his original restaurant, which at first focused solely on protein shakes. The restaurant was later expanded to include healthy burritos, salads, and breakfast items. Today Protein Bar locations can be found in Chicago, Washington D.C., Denver, and Boulder, Colorado.

Matros’s journey to healthy living was not easy. After losing his father to a sudden heart attack at a young age, Matros struggled with his weight through- out his youth. At 22, he decided to drastically change his lifestyle. He adopted an exercise regimen and a high-protein diet. He lost 50 pounds and from then on became committed toward living healthy. Matros learned that trying to eat healthy on the go was expen- sive, requiring him to bring some of his own ingredients to make high-protein shakes. He began to recognize that other consumers were having similar problems.

It was then he conceived of a convenient casual dining restaurant that would offer healthy options. Two years later, he founded Protein Bar. Protein Bar offers bar-ritos (burritos), gluten-free food bowls, blended drinks, chilis and side dishes, breakfast items, salads, and raw juices. Common ingredients include

quinoa, a grain high in protein, tofu, chicken, and kale. Protein Bar was founded with the mission “to change the way people eat on the go.” Service is an important principle at Protein Bar, and employees aim to serve high-quality, healthy food quickly so consumers can resume their busy lives.

Protein Bar is concerned with consumer satisfaction and uses this as a competitive advantage. Restaurants that compete on health are increasingly popular and Protein Bar knows it must cater to the customers’ right to choose to remain competitive. Customers choose to patronize the restaurant due to its quality service and unique mix of high-protein food options. Additionally, they know they will not be misled, as Protein Bar is transparent about the nutrition of its products. Under each menu item listed on its website, information is provided regarding carbohydrates, protein, calorie, and fat content. This allows consumers to make informed choices, meeting their right to be informed.

Because service is so important at Protein Bar, the restaurant takes any concerns consumers may have seriously. Protein Bar urges any dissatisfied customer to contact the restaurant and promises that a member of its corporate team will respond to any complaints within 48 hours. This emphasizes the consumers’ right to be heard and demonstrates how Protein Bar is living its values of service and quality. Protein Bar’s actions demonstrate the importance it places on consumer relations. As for Matt Matros, he went on to found another company Limitless High Definition Coffee and Tea. However, he remains on Protein Bar’s board.1

Not Your Grandparents’ Bar: The Protein Bar

Opening Vignette

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Protein Bar illustrates how organizations are able to meet customer needs and satisfy stakeholder groups. From a social responsibility perspective, the key challenge is how an organization assesses its stakeholders’ needs, integrates them with company strategy, reconciles dif- ferences between stakeholders’ needs, strives for better relationships with stakeholders, achieves mutual understandings with them, and finds solu- tions for problems. In this chapter, we explore relationships with consum- ers and the expectations of the economic, legal, ethical, and philanthropic responsibilities that must be addressed by business.

CONSUMER STAKEHOLDERS For the past 20 years, “green marketing,” the promotion of more environ- mentally friendly products, has become a much-discussed strategy in the packaged goods industry. Procter & Gamble (P&G), the venerable manu- facturer of soap, paper goods, and other household products, feared that increasing environmental consciousness among consumers would lead to a resurgence in the use of cloth diapers, which would have had a negative effect on its disposable diaper business. P&G launched a marketing cam- paign touting the benefits of disposables, including the fact that their use does not require hot water for laundering or fuel for diaper service trucks. P&G also initiated a pilot project for composting disposable diapers. Today, the debate over cloth versus disposables has largely faded, and the P&G marketing campaign has disappeared.

The dawn of the twenty-first century brought many new products, including disposable tableware, food containers that can be used repeat- edly or thrown away, and electrostatic mops with cloths that are disposed of after one use. Although these product introductions suggest a decline in environmental consciousness among consumers, other initiatives counter this assumption. Whole Foods Markets, a grocery chain that specializes in organic and environmentally friendly items, reports $940 of sales per square foot versus the $496 of sales per square foot earned by Kroger.2 Today, the company utilizes a wide variety of approaches to reinforce its green philosophy, including blogs, store projects, loans for local produc- ers, selling organic foods, and the use of biodiesel for its trucks.3 Indeed, environmental and related social initiatives have become a global con- cern. One goal of the annual International Buy Nothing Day, sponsored by consumer associations around the world, is to encourage consumers to consider the environmental consequences of their buying habits. The event’s organizers remind consumers that the richest 20 percent of people consume 80 percent of the world’s resources.4

Although the future of different marketing strategies can be debated, the real test of effectiveness lies in the expectations, attitudes, and ultimate buying patterns of consumers. The preceding examples illustrate that there is no true consensus around issues such as environmental responsibility and companies therefore face complex decisions about how to respond

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to them. This is true for all types of expectations, including the ones we explore in this chapter. In the sections that follow, we examine the eco- nomic, legal, ethical, and philanthropic responsibilities that businesses have to consumers, those individuals who purchase, use, and dispose of products for themselves and their homes.

RESPONSIBILITIES TO CONSUMERS Not too long ago, the emphasis of marketing was on investors and com- petitors. However, as marketers began to develop a stakeholder orientation, the importance of consumers as a primary stakeholder became apparent. Consumers are necessary for the success of a business; any business that does not consider the impact its operations will have on consumers will likely not be in business very long. As such, organizations must consider their respon- sibilities to meet consumer needs. The following sections illustrate how the different components to social responsibility are applied to consumers.

Economic Issues As discussed in Chapter 2, consumers are primary stakeholders because their awareness, purchase, use, and repurchase of products are vital to a company’s existence. Fundamentally, therefore, consumers and businesses are connected by an economic relationship. This relationship begins with an exchange, usually of a good or service for money, which often leads to deeper attachments or affiliation. A well-known advertising campaign slogan, “Delivering Happiness,” typifies the close relationship that Zappos customers develop with the shoes they purchase. Other consumers may choose to shun particular brands or opt for the environmentally sensi- tive products described earlier. In all of these cases, however, consum- ers expect the products they purchase to perform as guaranteed by their sellers. Remember from our opening example, a member of Protein Bar’s executive team responds to dissatisfied customers within 48 hours. Thus, a firm’s economic responsibilities include following through on promises made in the exchange process. Although this responsibility seems basic today, business practices have not always been directed in this way. In the early part of the 1900s, the caveat “Let the buyer beware” typified the power that business—not consumers—wielded in most exchange relation- ships.5 In some parts of the world, this phrase often accurately describes the consumer marketplace. For example, although Indonesia has consumer protection laws, consumers often feel like they have to test products in stores before purchasing them. It is not uncommon for them to take elec- tronics out of the packaging and plug them in to see if they work. Many Indonesian consumers do not appear to be fully aware of their rights in the exchange process.6

Fulfillment of economic responsibilities depends on interactions with the consumer. However, there are situations in which the consumer does

consumers Those individuals who purchase, use, and dispose of products for themselves and their homes.

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not act as a fair participant in the exchange.7 Consumer fraud involves intentional deception to derive an unfair economic advantage over an organization. Examples of fraudulent activities include shoplifting, collu- sion or duplicity, and guile. Collusion typically involves an employee who assists the consumer in fraud. For example, a cashier may not scan all merchandise or may give an unwarranted discount. Duplicity may involve a consumer staging an accident in a grocery store and then seeking dam- ages against the store for its lack of attention to safety. A consumer may purchase, wear, and then return an item of clothing for a full refund. In other situations, the consumer may ask for a refund by claiming a defect that either is nonexistent or was caused by consumer misuse.8 Although some of these acts warrant legal prosecution, they can be very difficult to prove, and many companies are reluctant to accuse patrons of a crime when there is no way it can be verified. Businesses that operate with the “customer is always right” philosophy have found that some consumers will take advantage of this promise and have therefore modified return policies to curb unfair use. REI, for instance, modified its 100 percent satisfaction guarantee so consumers now have a year to return defective or unwanted products (previously there was no limit). Other companies, especially electronic firms, charge a “restocking fee” if goods are not returned within a specified time period. Table 8.1 describes different types of consumer fraud.

Because of the vague nature of some types of consumer fraud, its full financial toll is somewhat difficult to tally. However, rough estimates indi- cate that the average inventory shrinkage—which occurs when inventory is lost through shoplifting, vendor fraud, employee error, or other means— costs U.S. businesses more than $45 billion per year globally.9 While shrinkage is most often considered in the context of brick-and-mortar establishments, companies in many industries have problems with fraud and related issues that raise costs and lower profitability. The internet has complicated matters as it can be harder for consumers to determine which

consumer fraud Intentional deception to derive an unfair economic advantage over an organization.

TABLE 8.1 Types of Consumer Fraud

Motivation Example Shoplifting A teenager steals a flash drive from an office supply store

Collusion An employee provides a consumer with substantial company discounts because of their friendship

Duplicity A consumer stages an accident with the intent to file false claims against a retailer

Tag switching A customer switches the tags of a higher priced item with that of a lower priced item

Credit card fraud A consumer uses a credit card he or she got through fraudulent means

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TABLE 8.2 Ways to Avoid Credit Card Fraud on the Internet 1. Don’t give out your credit card number unless the site is secure and reputable!

2. Before using the site, check out security software/encryption software it uses.

3. Obtain a physical address and phone number rather than settling for a post office box number. Call the telephone number to ensure the company is legitimate.

4. Check out the email address to make sure it is active.

5. Check out the Better Business Bureau from the seller’s area.

6. Check out other websites about this person/company.

7. When possible, purchase items with your credit card because you can dispute the charges if something goes wrong.

8. Keep a list of all your credit cards as well as the seller’s information. If anything looks sus- picious, immediately report to your credit card issuer.

Source: Federal Bureau of Investigations, “Common Fraud Schemes: Internet Fraud,” http://www.fbi .gov/scams-safety/fraud/internet_fraud (accessed June 21, 2016).

online retailers are legitimate. Table 8.2 shows some effective tools that individuals can use to combat credit card fraud over the internet.

Many consumers, of course, do not engage in such activities. However, there are cases when buyers and sellers disagree on whether or how well companies have satisfied their economic responsibilities. Thus, a consumer may believe that a product is not worth the price paid, perhaps because he or she believes the product’s benefits have been exaggerated by the seller. For example, although some marketers claim that their creams, pills, special massages, and other techniques can reduce or even eliminate cel- lulite, most medical experts and dermatologists believe that only exercise and weight loss can reduce the appearance of this undesirable condition. Products for reducing cellulite remain on the market, but many consumers have returned these products and complained about the lack of results. In the United Kingdom, a number of cosmetics companies have been rep- rimanded by the Advertising Standards Authority for making misleading claims in advertising and packaging.10 If a consumer believes that a firm has not fulfilled its basic economic responsibilities, he or she may ask for a refund, tell others about the bad experiences, discontinue patronage, post a complaint to a website, contact a consumer agency, and even seek legal redress. Many consumer and government agencies keep track of consumer complaints. For example, every year the Federal Trade Commission (FTC) reports the top consumer complaints across the nation. Problems related to identity theft, debt collection, fraud involving bankers and lenders, impos- ter scams, and scams involving telephone and mobile services have been at the top of the list in recent years.11 To protect consumers and provide businesses with guidance, a number of laws and regulations have been enacted to ensure that economic responsibility is met in accordance with institutionalized standards.

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Legal Issues As we discussed earlier, legal issues with respect to consumers in the United States primarily fall under the domain of the FTC, which enforces federal antitrust and consumer protection laws. Within this agency, the Bureau of Consumer Protection works to protect consumers against unfair, decep- tive, and fraudulent practices. The bureau is further organized into eight divisions, including those focused on marketing practices, privacy and identity protection, advertising practices, and international consumer pro- tection.12 For example, the FTC charged Lumosity for claiming that its brain training devices could help with brain trauma and cognitive decline. The FTC claims the firm does not have sufficient evidence to back this up. The FTC claims that it is cracking down on firms that claim they can improve cognitive ability without substantiation, especially since many ads for these products tend to be geared toward more elderly people more likely to suffer from dementia or other cognitive issues.13

In addition to the FTC, several other federal agencies regulate specific goods, services, or business practices to protect consumers. The Food and Drug Administration, for example, enforces laws and regulations enacted to prevent distribution of adulterated or misbranded foods, drugs, medical devices, cosmetics, veterinary products, and potentially hazardous con- sumer products. The Consumer Product Safety Commission enforces laws and regulations designed to protect the public from unreasonable risk of injury from consumer products. Many states also have regulatory agencies that enforce laws and regulations regarding business practices within their states. Most federal agencies and states have consumer affairs or informa- tion offices to help consumers. The Federal Communications Commission’s Consumer Affairs and Outreach Division educates consumers on issues related to cable and satellite service, telecommunications, wireless tech- nology, and other areas under the FCC’s domain.14 In Montana, the Department of Justice’s Consumer Protection Division publishes infor- mation on their website to assist consumers in complaining effectively, recognizing scams, and avoiding identity theft. They also post information specific to the region such as farming and oil and gas industry concerns.15

In this section, we focus on U.S. laws related to exchanges and rela- tionships with consumers. Table 8.3 summarizes some of the laws that are likely to affect a wide range of companies and consumers. State and local laws can be more stringent than federal statutes, so it is important that businesses fully investigate the laws applicable to all markets in which they operate. In Texas, for example, the Deceptive Trade Practices Act prohibits a business from selling anything to a consumer that he or she does not need or cannot afford.16 In Colorado, the Colorado Consumer Protection Act is a broad law protecting consumers from damages associ- ated with fraud.

Health and Safety One of the first consumer protection laws in the United States came about in response to public outrage over a novel.

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TABLE 8.3 Major Consumer Laws

Act (Date Enacted) Purpose Pure Food and Drug Act (1906) Established the Food and Drug Administration; outlaws

the adulteration or mislabeling of food and drug products sold in interstate commerce.

Cigarette Labeling and Advertising Act (1965)

Requires manufacturers to add to package labels warn- ings about the possible health hazards associated with smoking cigarettes.

Fair Packaging and Labeling Act (1966)

Outlaws unfair or deceptive packaging or labeling of consumer products.

Truth in Lending Act (1968) Requires creditors to disclose in writing all finance charges and related aspects of credit transactions.

Child Protection and Toy Safety Act (1969)

Requires childproof devices and special labeling.

Fair Credit Reporting Act (1970) Promotes accuracy, fairness, and privacy of credit informa- tion; gives consumers the right to see their personal credit reports and to dispute any inaccurate information therein.

Consumer Product Safety Act (1972)

Established the Consumer Product Safety Commission to regulate potentially hazardous consumer products.

Equal Credit Opportunity Act (1974)

Outlaws denial of credit on the basis of race, color, reli- gion, national origin, sex, marital status, age, or receipt of public assistance and requires creditors to provide appli- cants, on request, with the reasons for credit denial.

Magnuson-Moss Warranty (FTC) Act (1975)

Establishes rules for consumer product warranties, includ- ing minimum content and disclosure standards; allows the FTC to prescribe interpretive rules in policy statements regarding unfair or deceptive practices.

Consumer Goods Pricing Act (1975)

Prohibits the use of price maintenance agreements among manufacturers and resellers in interstate commerce.

Fair Debt Collection Practices Act (1977)

Prohibits third-party debt collectors from engaging in deceptive or abusive conduct when collecting consumer debts incurred for personal, family, or household purposes.

Toy Safety Act (1984) Authorizes the Consumer Product Safety Commission to recall products intended for use by children when they present substantial risk of injury.

Nutrition Labeling and Education Act (1990)

Prohibits exaggerated health claims and requires all pro- cessed foods to contain standardized labels with nutri- tional information.

Home Ownership and Equity Protection Act (1994)

Requires home equity lenders to disclose to borrow- ers in writing the payment amounts, the consequences of default, and the borrowers’ right to cancel the loan within a certain time period.

Telemarketing and Consumer Fraud and Abuse Prevention Act (1994)

Authorizes the FTC to establish regulations for telemarket- ing, including prohibiting deceptive, coercive, or privacy- invading telemarketing practices; restricting the time during which unsolicited telephone calls may be made to consum- ers; and requiring telemarketers to disclose the nature of the call at the beginning of an unsolicited sales call.

(Continued )

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Identity Theft Assumption and Deterrence Act (1998)

Makes the FTC a central clearinghouse for identity theft complaints and requires the FTC to log and acknowledge such complaints, provide victims with relevant informa- tion, and refer their complaints to appropriate entities (e.g., the major national consumer reporting agencies and other law enforcement agencies).

Children’s Online Privacy Protection Act (1998)

Protects children’s privacy by giving parents the tools to control what information is collected from their children online.

Do-Not-Call Registry Act (2003) Allows the FTC to implement and enforce a do-not-call registry.

Fair and Accurate Credit Transactions Act (2003)

Amends the Fair Credit Reporting Act (FCRA), gives con- sumers the right to one free credit report a year from the credit reporting agencies, adds provisions designed to prevent and mitigate identity theft, and grants consumers additional rights with respect to how information is used.

Bankruptcy Abuse Prevention and Consumer Protection Act (2005)

Amends the Truth in Lending Act including requiring cer- tain creditors to disclose on the front of billing statements a minimum monthly payment warning for consumers and a toll-free telephone number, established and maintained by the Commission, for consumers seeking information on the time required to repay specific credit balances.

Credit Card Accountability Responsibility and Disclosure Act (2009)

Amends the Truth in Lending Act to prescribe fair prac- tices regarding the extension of credit under an open-end consumer credit plan.

Dodd-Frank Wall Street Reform and Consumer Protection Act, Titles X and XIV (2010)

Established a Bureau of Consumer Financial Protection to protect consumers from complex and deceptive financial products.

Sources: Federal Trade Commission, “Statutes Relating to Consumer Protection Mission,” http://www .ftc.gov/enforcement/statutes?title=&field_mission_tid%5B%5D=2973 (accessed June 21, 2016).

TABLE 8.3 (Continued )

In The Jungle, Upton Sinclair exposed atrocities, including unsanitary con- ditions and inhumane labor practices, by the meat-packing industry in Chicago at the turn of the twentieth century. Appalled by the unwhole- some practices described in the book, the public demanded reform. Con- gress responded by passing the Pure Food and Drug Act in 1906, just six months after The Jungle was published.17 In addition to prohibiting the adulteration and mislabeling of food and drug products, the new law also established one of the nation’s first federal regulatory agencies, the Food and Drug Administration.

Since the passage of the Pure Food and Drug Act, public health and safety have been major targets of federal and state regulation. For example, the Consumer Product Safety Act established the Consumer Product Safety Commission to enforce rules relating to product safety. IKEA recalled 36 million dressers after three children were killed after the dressers fell on them.18 Companies that provide defective or faulty products resulting in customer harm must respond quickly to avoid government penalties.

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They will still probably face civil litigation from those who were harmed or killed by the defective products. Other laws attempt to protect children from harm, including the Child Protection and Toy Safety Act and the Children’s Online Privacy Protection Act.

Credit and Ownership Abuses and inequities associated with loans and credit have resulted in the passage of laws designed to protect consumers’ rights and public interests. The most significant of these laws prohibits discrimination in the extension of credit, requires creditors to disclose all finance charges and related aspects of credit transactions, gives consum- ers the right to dispute and correct inaccurate information on their credit reports, and regulates the activities of debt collectors. For example, the Home Ownership and Equity Protection Act requires home equity lend- ers to disclose, in writing, the borrower’s rights, payment amounts, and the consequences of defaulting on the loan. Together, the U.S. Department of Justice and Department of Housing and Urban Development (HUD) enforce laws that ensure equal access to sale and rental housing. Every April, the government sponsors Fair Housing Month to educate property owners, agents, and consumers on rights with respect to housing.

While home ownership is often considered part of the American Dream, specific business practices in the banking and finance industry have been questioned. During our last recession, the alarming number of mortgage foreclosures arose from a combustible situation involving risky lending practices, subprime mortgage disasters, and a general economic downturn. Many Americans assumed high interest rate loans or bought a house they could not really afford and eventually could no longer make mortgage payments. In many cases, individuals or institutions bought or sold financial products they did not fully understand. The response included Titles X and XIV of the Dodd-Frank Act, which established a Bureau of Consumer Financial Protection to oversee the finance industry and help prevent financial practices that could deceive consumers.

Marketing, Advertising, and Packaging Legal issues in marketing often relate to sales and advertising communications and information about product content and safety. Abuses in promotion can range from exagger- ated claims, concealed facts, and deception to outright lying. Such mislead- ing information creates ethical issues because the communicated messages do not include all the information consumers need to make sound purchas- ing decisions. Sketchers paid consumers $40 million after it was found to have engaged in deceptive advertising. Sketchers claimed that its Shape-Up Shoes as well as other shoe lines would help women lose weight and shape their posteriors. This settlement came a year after Reebok was forced to pay $25 million to settle deceptive advertising claims stating its EasyTone and RunTone shoes would help to tone the body. The FTC determined that there was no evidence to support either of these claims.19

Although a certain amount of exaggeration and puffery is tolerated, deceptive claims or claims that cannot be substantiated are likely to invite

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legal action from the FTC. For example, the FTC levied a $26.5 million fine against the marketers of Sensa, a supposed weight loss company, for marketing campaigns that used unsupported claims and misleading endorsements. The FTC also sued L’Occitane over claims that their skin cream had slimming properties. Cases such as these prompted the FTC to develop a list of phrases that should alert both consumers and mar- keters to unsubstantiated or false claims about weight loss products (see Figure 8.1).20

Since the FTC Act of 1914 outlawed all deceptive and unfair trade practices, additional legislation has further delineated which activities are permissible and which are illegal. For example, the Telemarketing and Consumer Fraud and Abuse Prevention Act requires telemarketers to disclose the nature of the call at the beginning of an unsolicited sales call and restricts the times during which such calls may be made to con- sumers. Another legal issue in marketing has to do with the promotion of products that involve health or safety. Numerous laws regulate the promotion of alcohol and tobacco products, including the Public Health Cigarette Smoking Act (1970) and the Cigarette Labeling and Advertising Act (1965). The 18th Amendment to the U.S. Constitution prohibited the manufacture and sale of alcoholic beverages in 1919; the prohibition was repealed in 1933 by the 21st Amendment. However, this amendment gave states the power to regulate the transportation of alcoholic beverages across state lines. Today, each state has unique regulations, some of which require the use of wholesalers and retailers to limit direct sales of alcoholic beverages to final consumers in other states. In this case, a law aimed at protecting consumers by promoting temperance in alcohol consumption now affects wine sellers’ ability to implement e-commerce and subsequent interstate sales. Currently, roughly 19 states prohibit the interstate sale of wine, another 19 states allow interstate sales on a limited basis, and

FIGURE 8.1 Red Flags: Inaccurate Weight Loss Claims

Source: Federal Trade Commission, “FTC Releases Guidance to Media on False Weight-Loss Claims,” December 9, 2003, https://www.ftc.gov/news-events/press-releases/2003/12/ftc-releases-guidance- media-false-weight-loss-claims (accessed June 21, 2016).

Cause weight loss of 2 pounds or more a week for a month or more without dieting or exercise

Cause substantial weight loss no matter what or how much the consumer eats

Cause permanent weight loss (even when the consumer stops using product)

Block the absorption of fat or calories to enable consumers to lose sub- stantial weight

Cause substantial weight loss for all users Cause substantial weight loss by wearing it on the body or rubbing it

into the skin

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12 states provide for reciprocal transactions only (e.g., between the states of Colorado and New Mexico).21

Sales and Warranties Another area of law that affects business relation- ships with consumers has to do with warranties. Many consumers consider the warranty behind a product when making a purchase decision, espe- cially for expensive durable goods such as automobiles and appliances. One of the most significant laws affecting warranties is the Magnuson- Moss Warranty (FTC) Act of 1975, which established rules for consumer product warranties, including minimum content and standards for disclo- sure. All 50 states have enacted “lemon laws” to ensure that automobile sales are accompanied by appropriate warranties and remedies for defects that impair the safety, use, or value of the vehicle. Courts have ruled that consumers who lease instead of purchase automobiles are also entitled to warranty protection under Magnuson-Moss.22

Product Liability One area of law that has a profound effect on busi- ness and its relations with consumers is product liability, which refers to a business’s legal responsibility for the performance of its products. This responsibility, which has evolved through both legislation and court inter- pretation (common law), may include a legal obligation to provide financial compensation to a consumer who has been harmed by a defective product. To receive compensation, a consumer who files suit in the United States must prove that the product was defective, that the defect caused an injury, and that the defect made the product unreasonably dangerous. Under the concept of strict liability, an injured consumer can apply this legal respon- sibility to any firm in the supply chain of a defective product, including contractors, suppliers of component parts, wholesalers, and retailers. Com- panies with operations in other countries must understand the various forms of product liability law that exist. For example, China passed a new law providing parameters for product liability. The law, which was passed as a result of many consumer injuries and deaths, covers medical devices, environmental pollution, and automobiles. Prior to this legislation, victims could file civil suits, but many claimed they were insufficient. Now, con- sumers have a more effective means of retribution through the courts and a chance to receive monetary compensation for their distress.23

Because the law typically holds businesses liable for their products’ performance, many companies choose to recall potentially harmful prod- ucts; such recalls may be required by legal or regulatory authorities as well. However, critics believe the FTC’s recall process is too slow. For instance, it took 165 days for a nut butter manufacturer to recalls its products after salmonella was detected. Part of the delay may come from the firm’s chance to issue a voluntary recall. The FDA would prefer the firm to vol- untarily recall a dangerous product rather than having it be mandatory.24

Product liability lawsuits have increased dramatically in recent years, and many suits have resulted in huge damage awards to injured consumers or their families. In a much-publicized case, a jury awarded a McDonald’s

product liability A business’s legal responsi- bility for the performance of its products.

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customer $2.9 million after she was scalded when she spilled hot coffee on her lap. Although that award was eventually reduced on appeal, McDonald’s and other fast-food restaurants now display warning signs that their coffee is hot to eliminate both further injury and liability. Most companies have taken steps to minimize their liability, and some firms— such as medical technology company C.R. Bard—have stopped making products or withdrawn completely from problematic markets because of the high risk of expensive liability lawsuits. Johnson & Johnson discon- tinued its power morcellator, used to remove uterine fibroids in women, because it could spread undetected cancers. Several wrongful death and product liability lawsuits have been filed against Johnson & Johnson, which will likely spend millions in resolving these cases.25 Although some states have limited damage awards and legislative reform is often on the agenda, the issue of product liability remains politically sensitive.

International Issues Concerns about protecting consumers’ legal rights are not limited to the United States. Most developed nations have laws and offices devoted to this goal. For example, the Chinese government enacted tougher safety standards for automobiles, bringing Chinese expectations in line with safety standards in the United States and Europe.26 In the Euro- pean Union (EU), the health and consumer protection directorate general oversees efforts to increase consumer confidence in the unified market. Its initiatives center on health, safety, economic, and public-health interests. One EU directive establishes minimum levels of consumer protection in member states. For example, EU consumers now have a legal guarantee of two years on all consumer goods. If they find a defective product, they may choose repair or replacement or, in special circumstances, ask for a price reduction or rescind the contract altogether.27

In Japan, unlike in the United States, product liability lawsuits are much less common. In the early 1990s, Chikara Minami filed one of the first such lawsuits against Japanese automaker Mitsubishi. Minami’s suit alleged a defect in the Mitsubishi Pajero. Although the court sided with the automaker in the said case, ten years later Mitsubishi was accused of deliberately covering up consumer complaints. Despite this revelation and an enhanced product liability law in 1995, consumer rights are often sub- verted to preserve the power and structure of big business in Japan.28 Much like Japan, China’s consumer rights movement is also relatively new and resulted from economic policy changes away from isolationism and central economic planning. The China Consumers’ Association was established in 1984 and has helped create consumer expectations and company responses that are starting to resemble those found in Western economies. Despite this action, however, there have been numerous consumer scares sur- rounding products manufactured in China and other countries. Table 8.4 discloses a number of cases involving food products, medicine, and toys.29

As we have discussed in this section, there are many laws that influ- ence business practices with respect to consumers all over the world. Every year, new laws are enacted, and existing rules are modified in response to

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TABLE 8.4 Notable Cases Involving Recalls

Year Recall Description 2007 Lead paint toys It was discovered that many Mattel toys had been painted

using lead paint, which is poisonous if ingested

2007 Pet food Contaminated pet food from China resulted in the sickness and death of many pets

2010 Children’s medicines Johnson & Johnson issued a massive recall on children’s medi- cines such as Tylenol due to product contamination

2012 Peanut Butter Salmonella bacteria was detected in many peanut products

2013 Chobani yogurt Mold was detected in some Chobani yogurt products

2014 General Motors GM issued a recall on several car models because of faulty ignition switches

2016 Samsung Samsung recall its Galaxy Note 7 due to overheating and fire risk

the changing business environment, including the incidence of consumer product concerns. Although companies must monitor and obey all laws and regulations, they also need to keep abreast of the ethical obligations and standards that exist in the marketplace.

Ethical Issues In 1962, President John F. Kennedy proclaimed a Consumer Bill of Rights that includes the rights to choose, to safety, to be informed, and to be heard. Kennedy also established the Consumer Advisory Council to integrate consumer concerns into government regulations and processes. These four rights established a philosophical basis on which state and local consumer protection rules were later developed.30 Around the same time, Ralph Nader’s investigations of auto safety and his publication of Unsafe at Any Speed in 1965 alerted citizens to the dangers of a common con- sumer product. Nader’s activism and Kennedy’s speech provided support for consumerism, the movement to protect consumers from an imbalance of power on the side of business and to maximize consumer welfare in the marketplace.31 The consumer movement is a global phenomenon, as is indicated by the annual celebration of World Consumer Rights Day.

Over the last five decades, consumerism has affected public policy through a variety of mechanisms. Early efforts were aimed primarily at advocating for legislation and regulation, whereas more recent efforts have shifted to education and protection programs directed at consumers.32 The Consumers Union (CU), for example, works with regional and federal leg- islators and international groups to protect consumer interests, sponsors conferences and research projects, tests consumer products, and publishes the results in its Consumer Reports magazine. The magazine details busi- ness practices that the CU deems unfair to consumers, such as predatory lending, the poor value of some life insurance products, and advertisements

consumerism The movement to protect consumers from an imbal- ance of power on the side of business and to maximize consumer welfare in the marketplace.

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aimed at vulnerable groups, like children and senior citizens.33 The internet and electronic communication have become main vehicles for consumer advocacy, education, and protection. Visitors to the National Consumers League website at www.nclnet.org or www.consumerworld. org find publications on many consumer issues, research and campaign reports, product reviews, updates on legal matters, and many other types of services. Thus, consumer groups and information services have shifted the balance of power between consumer and business because consumers are able to compare prices, read independent rankings, communicate with other buyers, and have greater knowledge about products, companies, and competitors.34

Despite the opportunities to exert more power, some researchers ques- tion whether most consumers take the time and energy to do so. For exam- ple, although the internet provides a great deal of information and choices, access to the internet partly depends on educational level and income. In addition, the volume of information available online may actually make it more difficult to analyze and assimilate. Even with these issues, consumer groups have developed a legion of e-activists who e-mail legislators and regulators and work to get consumer protection legislation passed. These consumer activists hope to use their campaigns to spur policy changes in the area of consumer protection. Some major accomplishments include lower credit card rates, improved card services, and higher security of financial information.35 The CU provides a number of consumer advocacy tools on its website, such as recommendations for writing letters to govern- ment agencies and corporations.

All U.S. presidents since Kennedy have confirmed the four basic con- sumer rights and added new ones in response to changing business condi- tions. President William J. Clinton, for example, appointed a commission to study the changing healthcare environment and its implications for consumer rights. The result was the proposal of a Patient’s Bill of Rights and Responsibilities to ensure rights to confidentiality of patient informa- tion, to participate in healthcare decisions, to access emergency services, and other needs.36 During the same period, a Financial Consumer’s Bill of Rights Act was proposed in the U.S. House of Representatives to curb high bank fees, automated teller machine surcharges, and other practices that have angered consumers.37

Consumer rights were first formalized through a presidential speech and subsequent affirmations, resulting in the legal establishment of specific elements of these rights. However, the relatively broad nature of the rights means they must be interpreted and implemented on a company-by-com- pany basis. Table 8.5 lists six consumer rights that have become part of the ethical expectations of business. Although these rights are not necessarily provided by all organizations, our social responsibility philosophy requires their attention and implementation.

Right to Choose The right to choose implies that, to the extent possible, consumers have the opportunity to select from a variety of products at competitive prices. This right is based on the philosophy of the competitive

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TABLE 8.5 Basic Consumer Rights

Right General Issues To choose Consumers have the opportunity to select from a variety of products at

reasonable prices

To safety All products should be safe for their intended use, include instructions for proper and safe use, and have been sufficiently tested to ensure reliability

To be informed Information is accurate, adequate, and free of deception so consumers can make a sound decision

To be heard Provides opportunities for consumers to communicate or voice their concerns in the public policy process

To redress The right for consumers to express dissatisfaction and seek restitution from a business when a product does not meet their expectations

To privacy Relates to consumers’ awareness of how personal data are collected and used and places a burden on firms to protect this information

nature of markets, which should lead to high-quality products at reason- able prices. Antitrust activities that reduce competition may jeopardize this right. This right has been called into question with respect to safety in some parts of the United States. The right has manifested itself differently in recent times. Google, for example, was ordered by an EU ruling dubbed the “right to be forgotten” to erase consumers’ information in search results. This gives consumers in the EU more power to choose how their informa- tion will be used. While the rule only applies in the EU, the effects of this mandate may be far-reaching.38

Right to Safety The right to safety also implies that all products should be safe for their intended use, include instructions for proper and safe use, and have been sufficiently tested to ensure reliability. Companies must take great care in designing warning messages about products with potentially dangerous or unsafe effects. These messages should take into account con- sumers’ ability to understand and respond to the information. Warnings should be relevant and meaningful to every potential user of the product. Some warnings use symbols or pictures to communicate. Companies that fail to honor the right to safety risk expensive product liability lawsuits. In an instance of unfortunate timing, McDonald’s announced its response to media allegations of serving unsafe food items in China soon before World Consumer Rights Day. Claims involved the serving of chicken an hour past the suggested time period after being cooked as well as the serv- ing of unsanitary beef. The incident damaged the company’s reputation as they had launched a marketing campaign highlighting their commitment to food quality and safety only weeks before.39

Right to Be Informed Consumers also have the right to be informed. Any information, whether communicated in written or verbal format, should be accurate, adequate, and free of deception so that consumers can make a sound decision. This general assertion has also led to specific legislation,

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such as the Nutrition Labeling and Education Act of 1990, which requires certain nutrition facts on food labels. This right can be associated with safety issues if consumers do not have sufficient information to purchase or use a product effectively. Other types of violations include companies charging customers for unrequested products or not providing them with enough information. The Federal Communications Commission fined AT&T $100 million because it did not inform customers with unlimited plans that after using 5 gigabytes of data per month, the carrier would slow transmission speeds. This slower speed interfered with the functionality of mobile apps and appeared to contradict the network speeds that AT&T advertised. AT&T did not tell its customers that their transmission speed would go slower after 5 gigabytes of data usage, and the FCC believed this violated consumer rights.40

In an age of rapid technological advances and globalization, the degree of complexity in product marketing is another concern related to consum- ers’ right to information. This complexity may relate to the ways in which product features and benefits are discussed in advertising, how effective salespeople are in answering consumer questions, the expertise needed to operate or use the product, and the ease of returning or exchanging the product. To help consumers make decisions based on adequate and timely information, some organizations sponsor consumer education programs. For example, pharmaceutical companies and health maintenance orga- nizations sponsor free seminars, health screenings, websites, and other programs to educate consumers about their health and treatment options. Nonprofit organization URAC is committed to promoting healthcare quality and provides a “seal of approval” that lets consumers know that the website’s content is trustworthy and reliable.41

Right to Be Heard The right to be heard relates to opportunities for con- sumers to communicate or voice their concerns in the public policy pro- cess. This also implies that governments have the responsibility to listen and take consumer issues and concerns into account. One mechanism for fulfilling this responsibility is through the FTC and state consumer affairs offices. Another vehicle includes congressional hearings held to educate elected officials about specific issues of concern to consumers. At the same time, consumers are expected to be full participants in the process, meaning they must be informed and willing to take action against misconduct in the marketplace.

Right to Seek Redress In addition to the rights described by Kennedy, consumers also have the right to express dissatisfaction and seek restitu- tion from a business when a good or service does not meet their expecta- tions. However, consumers need to be educated in the process for seeking redress and to recognize that the first course of action in such cases should be with the seller. At the same time, companies need to have explicit and formal processes for dealing with customer dissatisfaction. Although some product problems lead to third-party intervention or legal recourse, the

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majority of issues should be resolvable between the consumer and the business. One third party that consumers may consult in such cases is the Better Business Bureau (BBB), which promotes self-regulation of business. To gain and maintain membership, a firm must agree to abide by the ethical standards established by the BBB. This organization collects complaints on businesses and makes this information, along with other reports, available for consumer decision-making. The BBB also operates the dispute resolu- tion division to assist in out-of-court settlements between consumers and businesses. For example, the division has a program, BBB Auto Line, to handle disputes between consumers and automobile manufacturers.42 This self-regulatory approach not only provides differentiation in the market but can also minimize or prevent new laws and regulations.

Right to Privacy The advent of new information technology and the inter- net has prompted increasing concerns about consumer privacy. This right relates to consumers’ awareness of how personal data are collected and used, and it places a burden on firms to protect this information. How information is used can create concerns for consumers. Although some e-commerce firms have joined together to develop privacy standards for the internet, many websites do not meet the FTC’s criteria for fair informa- tion practices, including notice, choice, access, and security.43 We will take a closer look at the debate surrounding privacy rights in Chapter 10.

A firm’s ability to address these consumer rights can serve as a com- petitive advantage. Service Line Warranties of America (SLWA), a utility service company and a past recipient of the National Torch Award for Marketplace Ethics given by the BBB, is highly regarded for their ethical approach to consumers. They help consumers understand their respon- sibilities with respect to utility maintenance so that they are not charged extra fees by their utility companies. The company’s mission is to take care of the complexities of home ownership, so consumers can enjoy more free time.44

When consumers believe a firm is operating outside ethical or legal standards, they may be motivated to take some type of action. As we dis- cussed earlier, there are a number of strategies consumers can employ to communicate their dissatisfaction, such as complaining or discontinuing the relationship. For example, some people believe Walmart’s presence has contributed to the demise of locally owned pharmacies and variety stores in many small towns. The chain’s buying power ensures lower prices and wider product variety for consumers but also makes it difficult for some smaller retailers to compete. Other consumers and community leaders worry about the traffic congestion and urban sprawl that accompany new retail sites. Some Walmart critics have taken their discontent with the retailer to the internet. Disgruntled customers and others share complaints about the retail chain, provide updates about legal action, and promote campaigns against the retailer on makingchangeatwalmart.org.45

Stakeholders may use the three types of power—symbolic, utilitarian, and coercive—discussed in Chapter 2 to create organizational awareness

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of important issues. For example, wealthy Thai consumers who support military rule asked consumers to avoid purchasing European brands after the EU criticized a Thai government coup. In particular, the EU criticized the decisions to make it harder to express dissent as well as delays in elec- tions. Brussels announced it was suspending official visits to Thailand and would not sign an agreement with the country. Wealthy Thai consumers felt betrayed by a region with which they extensively trade.46 While this response is not a result of a company’s action, the situation highlights the lingering contention between the two countries. These consumers are engaging in another form of consumer action, a boycott, by abstaining from using, purchasing, or dealing with an organization.

Many groups choose to boycott certain businesses or products because of disagreements over beliefs or governmental policies. Famous celebrities and organizations boycotted the Beverly Hills Hotel because of the actions of its owner, Sultan Hassanal Bolkiah of Brunei, a country located on the north coast of the island of Borneo. The boycott occurred after the sultan stated he was enforcing Sharia law in the country. Boycotters protested against some of the harsher punishments levied against certain people groups committed of crimes under Sharia law.47 Protests are also a common consumer method of showing displeasure with an organization’s policies.

Philanthropic Issues Although relationships with consumers are fundamentally grounded in economic exchanges, the previous sections demonstrate that additional levels of expectations exist. Research continues to show that the major- ity of consumers would be likely to switch to brands associated with a good cause, as long as price and quality were equal. These results suggest that today’s consumers take for granted that they can obtain high-quality products at reasonable prices, so businesses need to do something to differentiate themselves from the competition. More firms are therefore investigating ways to link their philanthropic efforts with consumer inter- ests. Starbucks, for example, has contributed to environmental programs, sustainable farming initiatives, and investment in employee well-being and happiness. These programs not only form a link between the company’s possible effects and its interest in the natural environment but also provide a service to its customers and other stakeholders.

From a strategic perspective, a firm’s ability to link consumer interests to philanthropy should lead to stronger economic relationships. As we shall see in Chapter 9, philanthropic responsibilities to consumers usually entail broader benefits, including those that affect the community. For example, large pharmaceutical and health insurance firms provided finan- cial support to the Foundation for Accountability (FACCT), a nonprofit organization that assists healthcare consumers in making better decisions. FACCT initiated an online system for patients to evaluate their physician on several quality indicators. Although FACCT ceased its operations, the Markle Foundation continues to host the nonprofit’s legacy with

boycott A form of consumer action in which consumers abstain from using, purchasing, or dealing with an organiza- tion.

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Ethical Responsibilities in Marketing

General Motors Recall: We Know Something You Don’t Know

General Motors (GM) faced immense criticism as it dealt with the fallout from the faulty ignition switch scandal in 2014. As the story unfolded, it appeared that GM had violated many of the rights outlined in Kennedy’s Consumer Bill of Rights. These failures had major reper- cussions for GM, including massive recalls, lawsuits, testimonies before Congress, and reputational damage.

Earlier GM issued a recall of 2.6 million Chevrolet Cobalts. The problem involved faulty ignition switches that could inadvertently switch to a position that could cause the car to stall and the air bags to be disabled. Soon, recalls were issued on other models for the same reason, bringing the number of vehicles recalled in North America to 30 million. At least 15 deaths have been attributed to faulty ignition switches in GM vehicles (actual deaths are believed to be about 124).

A product recall is a serious issue by itself. However, the situation for GM worsened when it was revealed that certain employees in the company knew about the defective component since 2004. Although GM developed a snap-on cover to prevent the problem, it did not issue a recall. Instead, it provided the snap-on covers to dealers and told them to install them if cus- tomers complained.

GM’s failure to address the problem violated consum- ers’ rights to safety and to be informed. The ignition switch defect made vehicles unsafe for consumers. As a company selling a product that could be deadly if it failed to work properly, GM had an obligation to ensure customer safety to the best of its ability. Owners of the vehicles were not informed of the potential dangers,

even though GM had found a way to fix the problem through a snap-on cover. These failures on GM’s part sug- gest an indifferent attitude toward consumer well-being.

According to some employees, the GM culture also had the tendency to punish or ignore those with bad news. One whistleblower claims he was demoted after discovering vehicle defects and pressing for recalls. However, a lawsuit he filed against the company was dismissed. Others claim that this type of retaliation dissuaded them from reporting product quality issues. It appears that the right to be heard was also ignored at GM.

This debacle prompted Congress to require testi- mony from GM CEO Mary Barra about why it took GM so long to issue the recalls. An internal investigation that GM conducted concluded that knowledge about the defects had existed for a decade and that GM was negligent in its responsibility to customers. This led to the dismissal of 15 employees for failing to take action after discovering the product defect.

Due to this serious safety issue, consumers sought their right for redress by filing lawsuits against GM. GM lawyers argued that their previous bankruptcy should mitigate depreciation claims that occurred before then. Although initially a bankruptcy judge ruled in GM’s favor, a federal court overruled the ruling and claimed that GM’s bankruptcy cannot protect it from lawsuits involving accidents from before its bankruptcy filing. Despite these challenges, General Motors resolved these major legal issues and rebounded with record profitability in 2016.

Sources: Jeff Bennett, “New Set of GM Recalls Involves Pickups, SUVs,” The Wall Street Journal, June 9, 2014, p. B3; Ashby Jones, “Plaintiff Lawyers Take Aim At GM,” The Wall Street Journal, June 9, 2014, p. A1; Tim Higgins and Nick Summers, “If Only They Had Listened,” Bloomberg Businessweek, June 18, 2014, pp. 48–53; Bill Vlasic, “G. M. Inquiry Cites Years of Neglect Over Fatal Defect,” The New York Times, June 5, 2014, http://www.nytimes.com/2014/06/06/business/gm-ignition-switch-internal-recall-investigation-report. html (accessed July 20, 2016); Max Blau, “No Accident: Inside GM’s deadly ignition switch scandal,” Atlanta Magazine, January 2016, http://www.atlantamagazine.com/great-reads/no-accident-inside-gms-deadly-ignition-switch-scandal/ (accessed July 20, 2016); Nathan Bomey, “Court: Ignition-switch lawsuits against GM can proceed,” USA Today, July 14, 2016, http://www.usatoday.com/story/money/ cars/2016/07/13/general-motors-bankruptcy-ignition-switch-lawsuit/87029916/ (accessed July 20, 2016).

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documents and white papers. The foundation partners with other orga- nizations to improve the role of technology in addressing critical public health needs.48

Companies will have more successful philanthropic efforts when the cause is a good fit with the firm’s product category, industry, customer concerns, and/or location. This alignment is an important contributor to the long-term relationships that often develop between specific compa- nies and cause-related organizations. Many firms involved in medicine and pharmaceuticals will contribute to causes that improve access to proper healthcare and medication, provide stronger patient support and outcomes, decrease accidents and injuries, and respond to emergency or critical needs of a community. Table 8.6 describes the philanthropic contribution levels of 10 firms, all of which rank in the top 50 corporate foundations in terms of annual giving. These companies have established corporate foundations with large endowments, which means that annual contributions are relatively unaffected by corporate profitability and the economic cycle. Nonprofits prefer consistent donations rather than wide variance from year to year.

STRATEGIC IMPLEMENTATION OF RESPONSIBILITIES TO CONSUMERS As this chapter has demonstrated, social responsibility entails relation- ships with many stakeholders—including consumers—and many firms are finding creative ways to meet these responsibilities. Just as in other aspects of social responsibility, these relationships must be managed,

TABLE 8.6 Top Ten Philanthropic Companies

Corporate Foundation Annual Giving ($) Novartis Patient Assistance Foundation, Inc. 456,825,176

Wells Fargo Foundation 189,380,780

The Bank of America Charitable Foundation, Inc. 175,729,430

The Wal-Mart Foundation, Inc. 168,582,621

The JPMorgan Chase Foundation 130,855,483

GE Foundation 108,401,652

The Coca-Cola Foundation, Inc. 90,518,700

Citi Foundation 78,000,000

ExxonMobil Foundation 75,212,563

Bayer U.S. Patient Assistance Foundation 58,474,547

Source: Foundation Center, “50 Largest Corporate Foundations by Total Giving,” http://foundationcenter. org/findfunders/topfunders/top50giving.html (accessed June 21, 2016).

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nurtured, and continuously assessed. Resources devoted to this effort may include programs for educating and listening to consumers, surveys to discover strengths and weaknesses in stakeholder relationships, hiring consumer affairs professionals, the development of a community rela- tions office, and other initiatives. Business in the Community, a coali- tion of companies in the United Kingdom, developed nine marketplace responsibility principles to guide its members and other businesses in dealing with consumers and the supply chain. Table 8.7 lists these prin- ciples, along with eight best practices for effectively putting them into action.

Understanding consumer and stakeholder issues can be especially complex in the global environment. For example, PUMA intended to honor the United Arab Emirates (UAE) as it celebrated its 40th National Day by developing a limited edition shoe with the colors of the UAE flag. However, when it was released UAE consumers were outraged. They viewed it as putting a respected symbol on something perceived to be unclean in Middle Eastern culture. PUMA had to apologize and remove the shoes.49 Organizations must understand the importance of integrating all stakeholders into their social responsibility efforts, including employ- ees, as we explored in Chapter 7, and the general community, which we examine in Chapter 9.

TABLE 8.7 Business in the Community Marketplace Responsibility The Marketplace Responsibility Principles:

Respect your customers Support vulnerable customers Seek potential customers within excluded groups Manage the impact of product or service Actively discourage product misuse Actively manage responsibility in your supply chain Treat suppliers as partners Work with the rule makers Have consistent standards

Best Practice for Marketplace Responsibility:

Be consistent Anticipate trends Aim to deliver quality results Put at the heart of business strategy Part of the culture Encourage and motivate responsible behaviour Mainstream not niche Share best practice within the business

Source: Business in the Community, “The Marketplace Responsibility Principles,” http://www.bitc.org .uk/our-resources/report/marketplace-responsibility-principles (accessed June 21, 2016).

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SUMMARY Companies face complex decisions about how to respond to the expecta- tions, attitudes, and buying patterns of consumers—those individuals who purchase, use, and dispose of products for personal and household use. Consumers are primary stakeholders because their awareness, purchase, use, and repurchase of products are vital to a company’s existence.

Consumers and businesses are fundamentally connected by an economic relationship. Economic responsibilities include following through on prom- ises made in the exchange process. Consumer fraud involves intentional deception to derive an unfair economic advantage over an organization. If consumers believe that a firm has not fulfilled its economic responsibility, they may ask for a refund, tell others about the bad experience, discontinue their patronage, contact a consumer agency, or seek legal redress.

In the United States, legal issues with respect to consumers fall under the jurisdiction of the FTC, which enforces federal antitrust and con- sumer protection laws. Other federal and state agencies regulate specific goods, services, or business practices. Among the issues that may have been addressed through specific state or federal laws and regulations are consumer health and safety, credit and ownership, marketing and adver- tising, sales and warranties, and product liability. Product liability refers to a business’s legal responsibility for the performance of its products. Concerns about protecting consumers’ legal rights are not limited to the United States.

Ethical issues related to consumers include the Consumer Bill of Rights enumerated by President Kennedy. Consumerism refers to the movement to protect consumers from an imbalance of power with business and to maximize consumer welfare in the marketplace. Some specific elements of consumer rights have been mandated by law, but the relatively broad nature of the rights means they must be interpreted and implemented on a company-by-company basis. Consumer rights have evolved to include the right to choose, the right to safety, the right to be informed, the right to be heard, the right to seek redress, and the right to privacy. When consumers believe a firm is operating outside ethical or legal standards, they may be motivated to take action, including boycotting—abstaining from using, purchasing, or dealing with an organization.

More firms are investigating ways to link their philanthropic efforts with consumer interests. From a strategic perspective, a firm’s ability to link consumer interests to philanthropy should lead to stronger economic relationships.

Many companies are finding creative ways to satisfy their responsi- bilities to consumers. Much like employee relationships, these responsi- bilities must be managed, nurtured, and continuously assessed. Resources devoted to this effort may include programs for educating and listening to consumers, surveys to discover strengths and weaknesses in stakeholder relationships, hiring consumer affairs professionals, working with industry groups, and the development of other initiatives that engage consumers.

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Responsible Business Debate

The Use of Clearance Pricing as A Price Signal

Issue: Should the use of clearance pricing be regulated?

Sales are price discounts that are designed to encour- age purchase of a particular item. Sometimes the term clearance is used, but not with the term sale, since the use of the term sale is regulated in most states. According to the American Marketing Association, clearance is “an end-of-season sale to make room for more goods.” While retailers can offer sales for tempo- rary time periods, items in a clearance do not return to their original prices. Rather, the product is discounted until it is sold. Clearance events are often short in dura- tion, and items under clearance are not advertised.

Studies have demonstrated that many view the word “clearance” as a price signal indicating substan- tial discounts. Yet unlike other forms of sales promo- tion, clearance events are less regulated. Many retail- ers, including Macy’s and clothing stores, use the word clearance extensively. By 2004, more than 30 percent of merchandise was sold at clearance. Consumers may be attracted to clearance pricing due to the following factors: (1) fear that the product will be discontinued before they purchase it, (2) belief that others will get to the item first, (3) perceived value of the product, (4) the belief that they are saving money, and (5) escalation of commitment due to time spent searching for sales.

It has generally been ruled that the term “clear- ance” is an example of puffery, an exaggerated promo- tional claim that should not be taken seriously by a rea- sonable person. In 1985, the state of Wisconsin filed a lawsuit against American TV & Appliance alleging that the retailer’s claims of offering “a clearance sale on the finest washers and dryers you can buy” was deceptive due to the following factors: (1) the products were not deemed to be of the finest quality, (2) the store was using the advertisement to get people in the store

and then tried to up-sell them higher priced products, and (3) the merchandise was purchased exclusively for the event and therefore did not qualify as clearance. Although at first the courts ruled against the retailer, a later court overturned the ruling, stating that the term “clearance” in the ad was an example of puffery.

However, do consumers themselves view the term clearance as an exaggerated claim they should not accept at face value? Critics argue no. It has been generally accepted that clearance indicates substantial price discounts, so using the term “clearance” inap- propriately can be deceptive. Without regulation, they argue, retailers can use this term to make con- sumers think they are receiving a substantial deal. In fact, research has shown that less than 15 percent of consumers know the amount of the associated price discount.

On the other hand, regulating how the term “clear- ance” is used could have negative implications. Like any form of business regulation, regulation of the word clearance would limit what a business can and cannot do. Placing limits on how clearance sales can be used will likely mean that retailers will display the term “clearance sale” less due to the fear of violating FTC regulations. Yet clearance sales can be important strategies for retailers in selling products, particularly for firms that face much demand uncertainty for a product.

There Are Two Sides to Every Issue: 1. Retailers should be able to use the term clearance

without having to qualify or justify the amount of the discount.

2. Because the term clearance is potentially mislead- ing, usage of the term should be regulated and not used unless there are substantial price discounts.

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Sources: State of Wisconsin v. American TV & Appliance of Madison, Inc., 430 N.W.2d 709 (Wisc. App. Ct. 1988); Cullen Goretzke, The Resurgence of Caveat Emptor: Puffery Undermines the Pro-Consumer Trend in Wisconsin’s Misrepresentation Doctrine, 2003 Wis. L. Rev. 171, 222; Kit Yarrow, “Why Shoppers Just Can’t Resist Clearance Sales,” Time, http://business.time.com/2013/01/07/why-shoppers-just-cant- resist-clearance-sales/ (accessed July 20, 2016). Volker Nocke and Martin Peitz, “A Theory of Clearance Sales,” Economic

Journal 117, no. 522 (July 2007): 964; American Marketing Association, “Dictionary,” Marketing Power, http://www.mar- ketingpower.com/_layouts/dictionary.aspx?dletter=c (accessed July 20, 2016); Kenneth C. Manning, O.C. Ferrell, and Linda K. Ferrell, “Toward Understanding ‘Clearance’ Promotions,” Working paper; J. Jeffrey Inman, Leigh McAlister, and Wayne D. Hoyer, “Promotion Signal: Proxy for a Price Cut?” Journal of Consumer Research 17 (June 1990): 74–81.

KEY TERMS consumers (p. 263) consumer fraud (p. 264)

product liability (p. 271) consumerism (p. 273)

boycott (p. 278)

DISCUSSION QUESTIONS 1. List and describe the consumer rights that have

become social expectations of business. Why have some of these rights been formalized through leg- islation? Should these rights be considered ethical standards?

2. Look at Southwest Airline’s Customer Service Commitment at http://www.southwest.com/ assets/pdfs/corporate-commitments/customer- service-commitment.pdf. Describe how different elements of its commitment relate to specific economic, legal, ethical, or philanthropic respon- sibilities that the airline has to its customers.

3. What is the purpose of a boycott? Describe the characteristics of companies and consumers that are likely to be involved in a boycott situation. What circumstances would cause you to consider participating in a boycott?

4. How can companies strive for successful relation- ships with consumers, including meeting their economic, legal, ethical, and philanthropic expec- tations?

5. How will consumer rights and activism change over the next decade? Will the movement strengthen or decline? Why?

EXPERIENTIAL EXERCISE Visit the website of Consumers International (http:// www.consumersinternational.org//). What is the pur- pose of this website? Select a current issue and read the information provided by CI on that issue. How useful is

this information to you? With what information do you agree and/or disagree? How could a business manager use this site to understand and improve a company’s relationship and reputation with consumers?

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Justin Thompson was excited. He really enjoyed his job at the Kingston’s department store downtown. This location housed Kingston’s first store and still had many of its original features. As he rode the subway into the city center, Justin thought about the money he would earn this summer and the great car he hoped to buy before school started. He was lucky to have secured this type of job, since many of his friends were working early or late hours at fast-food chains or out in the sum- mer heat. The management team at Kingston’s had initi- ated a program with his high school counselors, hoping to attract top high school seniors into retail manage- ment throughout their college career and beyond. Justin was a strong student from a single-parent background, and his counselor was highly complimentary of his work ethic and prospects for professional employment.

Justin’s first week was consumed with various training sessions. There were eight students in the spe- cial high school program. They watched a company video that discussed Kingston’s history, ethics policy, current operations, and customer service philosophy. They met with staff from Human Resources to fill out paperwork. They learned how to scan merchandise and operate the computer software and cash register. They toured the store’s three levels and visited with each department manager. Justin was especially excited about working in the electronics department, but he was assigned to men’s clothing.

Justin worked alongside several employees during the first few weeks on the store floor. He watched the experienced employees approach customers, help them,

and ring up the sale. He noticed that some employees took personal telephone calls and that others did not clean up the dressing rooms or restock items very quickly. On slower days, he eventually worked alone in the department. Several times when he came to work in the afternoon, he had to clean up the mess left behind by the morning shift. When he spoke to various colleagues about it in the break room, they told him it was best to keep quiet. After all, he was a high school student earning money for a car, not a “real employee” with kids to feed and bills to pay. Justin assumed that retail work was much like team projects in school—not everyone pulled their weight but it was hard to be the tattletale.

One Saturday morning was extremely busy, as Kingston’s was running a big sale. People were swarm- ing to the sales racks, and Justin was amazed at how fast the time was passing. In the late afternoon, several friends of one of his coworkers dropped by the men’s section. Before long, their hands were filled with mer- chandise. The crowd was starting to wane, so Justin took a few minutes to clean up the dressing room. When he came out of the dressing room, his coworker was ringing up the friends’ merchandise. Justin saw two ties go into the bag, but only one was scanned into the system. He saw an extra discount provided on an expensive shirt. Justin was shocked to see that not every item was scanned or that improper discounts were applied, and his mind was racing. Should he stop his coworker? Should he “take a break” and get security? Was there another alternative? What would you do?

THERE’S A RINGING IN MY EARS: WHAT WOULD YOU DO? ?

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CHAPTER NINE

Community Relations and Strategic Philanthropy

Chapter Objectives

●● To describe the community as a stakeholder

●● To discuss the community relations function

●● To distinguish between strategic philanthropy and cause-related marketing

●● To examine how social entrepreneurship relates to social responsibility.

●● To identify the benefits of strategic philanthropy

●● To explain the key factors in implementing strategic philanthropy

Chapter Outline

Community Stakeholders

Responsibilities to the Community

Philanthropic Contributions

Strategic Philanthropy Defined

Strategic Philanthropy and Social Responsibility

Social Entrepreneurship and Social Responsibility

Benefits of Strategic Philanthropy

Implementation of Strategic Philanthropy

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287

Although many organizations try to incorporate cause- related marketing into their business operations, TOMS Shoes takes the concept of philanthropy one step further. TOMS blends a for-profit business with social entrepre- neurship in what it terms the one for one model. For every pair of shoes sold, another pair is provided to a child in need. TOMS has also expanded into eyewear and the coffee business. For every pair of sunglasses sold, a person with vision problems in developing countries receives surgery, prescription glasses, or medical treatment to help restore his or her sight. For every TOMS coffee product sold, clean water is donated to a person in need. Unlike many nonprofits, TOMS’ for-profit business enables the company to support its philanthropic component, which keeps the company from having to solicit donations.

The idea for TOMS Shoes occurred after founder Blake Mycoskie witnessed the immense poverty in Argentinean villages—poverty so bad that many fami- lies could not afford to purchase shoes for their chil- dren. As a result, Mycoskie decided to create a business that would consist of two parts: TOMS Shoes, a for- profit business that would sell the shoes, and Friends of TOMS, the company’s nonprofit subsidiary that would distribute shoes to those in need.

For his original product, Mycoskie decided to adopt the alpargata shoe worn in Argentina. The alpargata is a slip-on shoe made from canvas or fabric with rubber soles. After a Los Angeles Times article fea- tured Mycoskie’s new business, demand for the shoes exploded. Today TOMS is a thriving business.

After distributing its 1-millionth pair of shoes in 2010, TOMS began to consider other products that could be used in the one-to-one model. Because 80 percent of vision impairment in developing countries is preventable or curable, TOMS decided that for every pair of sunglasses it sold, the company would provide

treatment or prescription glasses for those in need. TOMS chose Nepal as the first country to apply its one-to-one model. TOMS also recognized that many people in developing countries lack access to clean water. Polluted water is one of the biggest causes of disease. Therefore, TOMS has also expanded into the coffee business, once again applying its one for one model. With every TOMS Roasting Co. product sold, the organization provides clean water to a person in need.

TOMS takes its obligations for social responsibility seriously. The company builds the cost of the extra pair of shoes and eye care into the price of the products it sells. TOMS also works closely with local humanitarian organizations so they can understand the communities to which they are donating.

Customers who do business with TOMS feel com- mitted to the company because they know that their purchases are going toward a good cause, even if they might pay a bit more in the process. TOMS goes to great lengths to educate the public about the impor- tance of its mission. For instance, the company provides internship opportunities and engages brand ambas- sadors at universities to spread the TOMS message. Every year the company promotes the One Day Without Shoes campaign, in which participants spend one day without shoes to understand what children in develop- ing countries must undergo daily. These events have been supported by celebrities such as Charlize Theron, Kris Ryan, and the Dallas Cowboys Cheerleaders.

Despite its success, TOMS’ mission is far from com- plete. As its expansion into eyewear and coffee demon- strates, the company is looking for new opportunities for applying its one for one model to address social issues. TOMS demonstrates how an innovative concept and the ability to engage in social entrepreneurship can create a successful company that can make a difference.1

TOMS Walks into the Eyewear Business

Opening Vignette

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TOMS Shoes, like most organizations with operational expertise and other core competencies, can also focus on implementing social responsibility and satisfying stakeholder groups. From a social responsibility perspective, the key challenge is how an organization assesses its stakeholders’ needs, integrates them with company strategy, reconciles differences between stakeholders’ needs, strives for better rela- tionships with stakeholders, achieves mutual understandings with them, and finds solutions for problems. In this chapter, we explore community stakeholders and how organizations deal with stakeholder needs through philanthropic initiatives. We explore the relationship with communities and the economic, legal, ethical, and philanthropic responsibilities that must be addressed by business. We define strategic philanthropy and inte- grate this concept with other elements of social responsibility. Next, we trace the evolution of corporate philanthropy and distinguish the concept from cause-related marketing. We also provide examples of best practices of addressing stakeholders’ interests that meet our definition of strategic philanthropy. From there, we define social entrepreneurship and explain how it relates to strategic philanthropy and social responsibility. Then we consider the benefits of investing in strategic philanthropy to satisfy both stakeholders and corporate objectives. Finally, we examine the pro- cess of implementing strategic philanthropy in business. Our approach in this chapter is to demonstrate how companies can link strategic philan- thropy with economic, legal, and ethical concerns for the benefit of all stakeholders.

COMMUNITY STAKEHOLDERS The concept of community has many varying characteristics that make it a challenge to define. The community does not always receive the same level of acceptance as other stakeholders. Some people even wonder how a company determines who is in the community. Is a community defined by city or county boundaries? What if the firm operates in multiple locations? Or is a community prescribed by the interactions a firm has with various constituents who do not fit neatly into other stakeholder categories? For a small restaurant in a large city, the owner may define the community as the immediate neighborhood where most patrons live. The restaurant may demonstrate social responsibility by hiring people from the neighborhood, participating in the neighborhood crime watch program, donating food to the elementary school’s annual parent-teacher meetings, or sponsoring a neighborhood Little League team. For example, J.P. Morgan Chase & Co. has instituted a program called Corporate Challenge, a global initiative that invites employees to participate in running events for charity. One of the latest events, which took place in Syracuse, New York, hosted over 28,000 runners and walkers from more than 350 companies. The pro- ceeds supported local nonprofit Hillside Work-Scholarship Connection. Each year, this series of events brings in over $500,000 for causes around

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the world.2 For a corporation with facilities in North and South America, Europe, and Africa, the community may be viewed as virtually the entire world. To focus its social responsibility efforts, the multinational corpo- ration might employ a community relations officer in each facility who reports to and coordinates with the company’s head office.

Under our social responsibility philosophy, the term community should be viewed from a global perspective, beyond the immediate town, city, or state where a business is located. Thus, we define community as those members of society who are aware of, concerned with, or in some way affected by the operations and output of an organization. With information technology, high-speed travel, and the emergence of global business interests, the community as a constituency can be geographically, culturally, and attitudinally quite diverse. Issues that could become impor- tant include pollution of the environment, land use, economic advantages to the region, and discrimination within the community, as well as exploi- tation of workers or consumers.

From a positive perspective, an organization can significantly improve the quality of life through employment opportunities, economic development, and financial contributions for educational, health, artis- tic, and recreational activities. Through such efforts, a firm may become a neighbor of choice, an organization that builds and sustains trust with the community.3 To become a neighbor of choice, a company should strive for positive and sustainable relationships with key individuals, groups, and organizations; demonstrate sensitivity to community con- cerns and issues; and design and implement programs that improve the quality of community life while promoting the company’s long-term business strategies and goals.4 Merck’s Neighbor of Choice program interacts with organizations and initiatives that are in line with the company’s mission on well-being. Finding solutions to health and social issues where the company is located and bringing results to stakehold- ers or neighbors is the top goal of each initiative. The company made contributions in grants awarded to local nonprofit organizations in health, education, social services, environment, the arts, and civic and international issues.5

Similar to other areas of life, the relationship between a business and the community should be symbiotic. A business may support educational opportunities in the community because the owners feel it is the right thing to do, but it also helps develop the human resources and consumer skills necessary to operate the business. Customers and employees are also com- munity members who benefit from contributions supporting recreational activities, environmental initiatives, safety, and education. Many firms rely on universities and community colleges to provide support for ongoing education of their employees. The Dow Chemical Company, for example, committed to an annual investment of $25 million over the course of ten years to universities for research purposes. Beyond that, they have working relationships with faculty, students, and other academicians to apply the research and create useful solutions to pressing issues.6

community Members of society who are aware of, concerned with, or in some way affected by the operations and output of an organization.

neighbor of choice An organization that builds and sustains trust with the community through employment opportunities, economic development, and financial contribu- tion to education, health, artistic, and recreational activities of the community.

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290 Business and Society

To build and support these initiatives, companies may invest in community relations, the organizational function dedicated to building and maintaining relationships and trust with the community. In the past, most businesses have not viewed community relations as strategically important or associated them with the firm’s ultimate performance. Although the community relations department interacted with the community and often doled out large sums of money to charities, it essentially served as a buffer between the organization and its immediate community. Today, commu- nity relations activities have achieved greater prominence and responsibil- ity within most companies, especially due to the rise of stakeholder power and global business interests. The function has gained strategic importance through linking to overall business goals, professionalizing its staff and their knowledge of business and community issues, assessing its perfor- mance in quantitative and qualitative terms, and recognizing the breadth of stakeholders to which the organization is accountable.7 Community relations also assist in short-term crisis situations, such as disaster relief. Humanitarian aid organization Direct Relief was given an Excellence Award by the Committee Encouraging Corporate Philanthropy (CECP) for its collaboration with FedEx to bring health services to people and places stricken by disaster. When the typhoon hit the Philippines, more than 250,000 people received needed medical supplies. Additionally, the partnership has provided over 10 million Americans with approximately $400 million in necessary medications.8 Progressive companies manage community relations with partnership in mind. They seek out community partners for a range of interests and activities—philanthropy, volun- teerism, quality educational system and qualified workforce, appropriate roads and infrastructure, quality housing, and other community assets.

Over the past two decades, corporate support for philanthropy has been steadily growing. According to Giving USA Foundation, corporate giving totaled $18.45 billion in 2015. This number increased by 3.9 percent from the year before. The sluggish recovery of the economy since the Great Recession had an effect on corporate giving, but as the economy recovers corporate giving has begun to increase once more. PepsiCo, for instance, has a matching gifts program and is involved in a number of sustainability initiatives. The company donated a $1 million grant to Kiva, a nonprofit organization that provides small loans to entrepreneurs in developing countries to start their own businesses.9 Even before the economic downtown, corporate giving was becoming more effective and strategic. Companies are working to align their stakeholder interests and develop partnerships that are more closely aligned to business goals, community interests, and sustainable activities.10

In a diverse society, however, there is no general agreement as to what constitutes the ideal model of business responsibility to the community. Businesses are likely to experience conflicts among stakeholders as to what constitutes a real commitment to the community. Therefore, the community relations function should cooperate with various internal and external constituents to develop community mission statements and assess opportunities and develop priorities for the types of contributions it will

community relations The organizational function dedicated to building and maintaining relationships and trust with the com- munity.

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make to the community. Table 9.1 provides several examples of company missions and programs with respect to community involvement. As you can see, these missions are specific to the needs of the people and areas in which the companies operate and are usually aligned with the competen- cies of the organizations involved and their employees.

TABLE 9.1 Community Mission Statements Organization Community Mission The Advisory Board Company With an EVP mission to serve hospitals, health systems, and

universities by helping them tackle their most pressing chal- lenges, The Advisory Board Company helps them achieve their highest calling: improving health and educational out- comes for their partners, and in turn, for their communities. The gift of empowering an organization to achieve efficient protocols enables them to reach and serve more individuals they set out to help. As with many non-profits, resources and capital are not abundant. The Advisory Board Company realizes this and has taken on the challenge to empower their community partners with the tools needed to meet their service goals.

Capital One At Capital One, we have always believed that as business leaders we have a unique opportunity to create value in the communities where we live and work. One of the most impactful ways Capital One serves the community is through the volunteer efforts of its thousands of talented associates.

Eli Lilly and Company Lilly’s commitment to corporate responsibility is not new—it’s a fundamental part of the corporate culture. Through its Lilly Hands and Hearts Employee Volunteer Program, employees have committed to building healthier communities where they live and work, looking beyond operations to address significant societal challenges. Lilly and its employees are creating communities that are healthier in the traditional sense—as well as cleaner, more vibrant and prosperous, and with citizens who are better educated.

Pinnacol Assurance Pinnacol’s community involvement program, Pinnacol in Action, is an integral part of the company’s culture. Employees receive paid time off to participate in volunteer activities such as youth mentoring and education, human services programs, community beautification and promoting health awareness.

Salesforce.com Salesforce.com established the Salesforce.com Foundation soon after the company was founded in 1999 to ensure that community service was a central part of the corporate culture. To formalize this vision, salesforce.com implemented “1/1/1 Model” to harnesses the power of Salesforce.com’s people, resources and technology through 1 percent Time, 1 percent Equity and 1 percent Product to improve its com- munities, inspire youth to be more successful, support the world during times of extreme need, and promote compas- sionate capitalism.

(Continued )

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292 Business and Society

Community mission statements are likely to change as needs are met and new issues emerge. For example, as Japan-based Takeda Pharmaceutical Company Limited continues to expand operations throughout the world, their community involvement also expands to meet the needs of each com- munity. In Brazil, the company focuses on renovating orphanages, while in South Africa, they have initiatives teaching children to make blankets. When global communities experience unexpected disasters, such as flood- ing in Australia, Takeda has been there to assist with the recovery.11 Thus, as stakeholder needs and concerns change, the organization will need to adapt its community relations efforts. To determine key areas that require support and to refine the mission statement, a company should periodically conduct a community needs assessment like the one presented in Table 9.2.12

RESPONSIBILITIES TO THE COMMUNITY It is important for a company to view community stakeholders in a trust- ing manner, recognizing the potential mutual benefit to each party. In a networked world, much about a company can be learned with a few clicks of a mouse. Activists and disgruntled individuals have used websites to publicize the questionable activities of some companies. Target and Ryanair have been the focus of “hate” websites that broadcast concerns about the company’s treatment of employees, pricing strategies, and mar- keting and advertising tactics.13 Because of the visibility of business activi- ties and the desire for strategic social responsibility, successful companies strive to build long-term mutually beneficial relationships with relevant communities. Achieving these relationships may involve some trial and error. Table 9.3 illustrates some of the common mistakes organizations make in planning for and implementing community responsibilities. A positive example, on the other hand, is Eli Lilly Pharmaceuticals’ strong support for the Indianapolis Symphony Orchestra. In return, the orchestra stages private concerts for Eli Lilly employees. Dell Computer has a similar

TABLE 9.1 (Continued ) UnitedHealth Group UnitedHealth Group’s comprehensive approach to employee

volunteering begins with an analysis of skills-based volunteer needs, followed by the creation of strategic programs that offer rich and rewarding opportunities for UnitedHealth Group employees. This holistic approach has provided valu- able insight on volunteering and health and contributed to UnitedHealth Group’s leadership in corporate service as a resource and advocate for the benefits of employee volun- teer programs.

Sources: Eli Lilly, “Points of Light Institute Honors Corporate America’s Renewed Call to Service,” Lilly, June 24, 2009, https://investor.lilly.com/releasedetail.cfm?releaseid=391819 (accessed June 22, 2016); “2014 Corporate Engagement Award of Excellence Honorees,” Hands On Network, http:// www.handsonnetwork.org/corporateawards (accessed July 30, 2014).

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TABLE 9.2 Community Needs Assessment For each of the questions in the survey, circle the number that corresponds to your assessment:

Community Issues Exceptional Adequate Inadequate Don’t Know Parks 3 2 1 0

Culinary water system 3 2 1 0

Street maintenance 3 2 1 0

Garbage collection 3 2 1 0

Snow removal 3 2 1 0

Fire protection 3 2 1 0

Police protection 3 2 1 0

Ambulance service 3 2 1 0

Building inspection 3 2 1 0

Animal control 3 2 1 0

Other code enforce- ment (weeds, junk cars, etc.)

3 2 1 0

Arts 3 2 1 0

Street lighting 3 2 1 0

Other issues that can be evaluated: grocery stores, pharmacies, clothing stores, fast-food restaurants, entertainment, hardware/lumber stores, auto services, banking/financial services, affordable housing, business offices, warehouses, convenience stores, community colleges, higher education satellite campuses.

Source: Utah State University Extension, “Community Needs Assessment Survey Guide,” http://exten- sion.usu.edu/files/uploads/surveyguide.pdf (accessed June 22, 2016).

TABLE 9.3 Common Myths About Community Relations 1. Support of political and regulatory officials is not needed

2. We will cause a problem for our company if we engage in community relations

3. The community has no expertise on our decisions and actions

4. Engaging the community will delay us in finding the right solution

5. Community officials have no concern for the cost of solutions to issues

6. We serve the community simply through employment opportunities and paying taxes

7. Our only focus is national and global relationships

8. Community relationships involve only public relations

9. The local community does not impact our success

10. Spending time with the community distracts from the economic success of the firm

relationship with the Round Rock Express, a minor league (Texas League) baseball team. A community focus can be integrated with concerns for employees and consumers. Chapter 1 provided evidence that satisfied customers and employees are correlated with improved organizational performance.

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294 Business and Society

Economic Issues From an economic perspective, business is absolutely vital to a commu- nity. Companies play a major role in community economic development by bringing jobs to the community and allowing employees to support themselves and their families. These companies also buy supplies, raw materials, utilities, advertising services, and other goods and services from area firms; this in turn produces more economic effects. In com- munities with few employers, an organization that expands in or moves to the area can reduce some of the burden on community services and other subsidized support. Even in large cities with many employers, some companies choose to address social problems that tax the community. In countries with developing economies, a business or industry can also provide many benefits. A new company brings not only jobs but also new technology, related businesses, improvements to infrastructure, and other positive factors. Conversely, globalization has incited criti- cism regarding the effects of U.S. businesses on other parts of the world, namely developing countries. For example, Nestlé has been criticized for marketing baby formula to nursing mothers in Turkey, claiming that their offspring will receive more nutrition from the formula than from their mothers; aggressive selling of bottled water in developing parts of the world, which is said to be expensive for consumers and works as a deterrent to governments to solve water sanitation issues; and for child labor accusations in African cocoa farms. The company has committed to “The Nestlé Cocoa Plan” which involves building schools and providing cocoa trees to farmers with the aim of contributing to the betterment of the local community.14

Interactions with suppliers and other vendors also stimulate the economy. Some companies are even dedicated to finding local or regional business partners in an effort to enhance their economic responsibility. For example, Starbucks, in an unprecedented move for the company, began franchising locations in Europe. By having locals run the coffee chains’ stores, the company hopes to further its influence in the region.15 Furthermore, there is often a contagion effect when one business moves into an area: by virtue of its prestige or business relationships, such a move can signal to other firms that the area is a viable and attractive place for others to locate. There are parts of the United States that are highly con- centrated with automotive manufacturing, financial services, or technology. Local chambers of commerce and economic development organizations often entice new firms to a region because of the positive reputation and economic contagion it brings. Finally, business contributions to local health, education, and recreation projects not only benefit local residents and employees but also may bring additional revenue into the community from tourism and other businesses that appreciate the region’s quality of life. AT&T, for example, hosts the Pebble Beach National Pro-Am golf tournament. The annual event has raised more than $110 million for local charities and honors different influential groups each year.16

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Just as a business brings positive economic effects by expanding in or relocating to an area, it can also cause financial repercussions when it exits a particular market or geographical location. Thus, workforce reduction, or downsizing—a topic discussed in Chapter 7—is a key issue with respect to economic responsibility. The impact of layoffs due to plant closings and corporate restructuring often extends well beyond the financial well-being of affected employees. Laid-off employees typically limit their spending to basic necessities while they look for new employment, and many may ultimately leave the area altogether. Even employees who retain their jobs in such a downsizing may suffer from poor morale, distrust, guilt, and continued anxiety over their own job security, further stifling spending in a community.

Because companies have such a profound impact on the economic viability of the communities in which they operate, firms that value social responsibility consider both the short- and long-term effects on the community of changes in their workforce. Today, many companies that must reduce their workforce—regardless of the reasons—strive to give both employees and the community advance notice and offer placement services to help the community absorb employees who lose their jobs. Quad/Graphics, the second largest printer in the United States, closed plants in Illinois and Minnesota. The company offered to transfer affected employees to other plants in the nation. However, for those who did not want to transfer, Quad/Graphics agreed to offer a severance package including pay, career placement assistance, and exten- sion of benefits.17 Depending on economic circumstances and business profitability, companies may choose to offer extra compensation com- mensurate with an employee’s length of employment that gives laid-off employees a financial cushion while they find new work. However, the realities of economic turmoil mean that many employees receive little compensation.

Legal Issues To conduct business, a company must be granted a “license to operate.” For many firms, a series of legal and regulatory matters must be resolved before the first employee is hired or the first customer is served. If you open a restaurant, for example, most states require a business license and sales tax number. These documents require basic information, such as business type, ownership structure, owner information, number of expected employees, and other data.

On a fundamental level, society has the ability to dictate what types of organizations are allowed to operate. In exchange for the license to operate, organizations are expected to uphold all legal obligations and standards. We have discussed many of these laws throughout this book, although individual cities, counties, and municipalities will have additional laws and regulations that firms must obey. For example, a construction company in Destin, Florida, was charged with repeated safety violations

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that have endangered employees. The leading cause of fatality in construc- tion work is falling, and the company has been found liable for neglecting to provide employees with protections against this danger.18

Other communities have concerns about whether and how businesses fit into existing communities, especially those threatened by urban sprawl and small towns working to preserve a traditional way of life. Some states, cities, and counties have enacted legislation that limits the square foot- age of stores in an effort to deter “big-box stores,” such as Walmart and Home Depot, unless local voters specifically approve their being allowed to build. In most cases, these communities have called for such legislation to combat the noise and traffic congestion that may be associated with such stores, to protect neighborhoods, and to preserve the viability of local small businesses.19 Thus, although living wages and store location may be ethical issues for business, some local governments have chosen to move them into the legal realm.

Ethical Issues As more companies view themselves as responsible to the community, they will contemplate their role and the impact of their decisions on com- munities as they make managerial ethical decisions. Many companies have opted to be proactive on important issues, such as minimum wages and benefits for employees. While legislative bills have been proposed on rais- ing the minimum wage, it may take time before any changes to the law are made in this respect. Ikea, however, raised the minimum wage for employees in all U.S. locations to $10.76 per hour because they believe it is the right thing to do. Other companies such as Gap and Costco have followed suit, raising their minimum wages to $9 and $11.50 per hour, respectively.20 Walmart raised wages so that new employees will receive $9 per hour and move up to $10 per hour after completing training.21

Business leaders are increasingly recognizing the significance of the role their firms play in the community and the need for their leadership in tackling community problems. Bill Daniels, founder of Cablevision, was an extremely successful entrepreneur. His approach to ethical decision- making in Cablevision had a positive impact on the communities. He established The Daniels Fund, which has a significant impact on busi- ness ethics education and other social concerns in the states of Wyoming, Colorado, New Mexico, and Utah. Millions of dollars have been donated to causes such as ethics and integrity, education, youth development, and amateur sports.22

These examples demonstrate that the ethical dimension of community responsibility can be multifaceted. This dimension and related programs are not legally mandated but emanate from the particular philosophy of a company and its top managers. Since many cities have not mandated a living wage, the actions of Ikea, Gap, and Costco are based on an ethical obligation felt toward employees and the community. There are many ways that a company can demonstrate its ethical commitment to the

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community. As Bill Daniels’s commitment to business ethics illustrates, a common extension of “doing the right thing” ethically provides a role model for all political and civic leaders.

Philanthropic Issues The community relations function has always been associated with phi- lanthropy, as one of the main historical roles of community relations was to provide gifts, grants, and other resources to worthy causes. Today, that thinking has shifted. Although businesses have the potential to help solve social issues, the success of a business can be enhanced from the publicity generated by and through stakeholder acceptance of community activities. For example, Colorado-based New Belgium Brewing Company donates $1 for every barrel of beer brewed the prior year to charities within the markets it serves. The brewery tries to divide the funds among states in proportion to interests and needs, considering environmental, social, drug and alcohol awareness, and cultural issues. Donation decisions are made by the firm’s philanthropy committee, which is a volunteer group of diverse employees; employees are encouraged to bring philanthropy suggestions to the committee.23 However, New Belgium belongs to an industry that some members of society believe contributes to social prob- lems. Thus, regardless of the positive contributions such a firm makes to the community, some members will always have a negative view of the business.

One of the most significant ways that organizations are exercising their philanthropic responsibilities is through volunteer programs. Volunteerism in the workplace, when employees spend company-supported time in support of social causes, has been increasing among companies of all sizes. Approximately 62.8 million Americans spend nearly 8 billion hours sup- porting formal volunteer activities. The four main activities that volunteers perform are fundraising, collecting and distributing food, helping with general labor needs, and tutoring or teaching. These activities are per- formed for a variety of organizations, with religious, education, and social service agencies topping the list.24 Figure 9.1 shows the states, large cities, and mid-sized cities with the highest rates of volunteerism.

People who volunteer feel more connected to other people and society and ultimately have lower mortality rates, greater functional ability, and lower rates of depression later in life than those who do not volunteer. When volunteering is a result of employment, benefits of volunteering accrue to both the individual, in terms of greater motivation, enjoyment, and satisfaction, and to the organization through employee retention and productivity increases.25 Communities benefit from the application of new skills and initiatives toward problems, better relations with business, a greater supply of volunteers, assistance to stretch limited resources, and social and economic regeneration.26 Philanthropic issues are just another dimension of voluntary social responsibility and relate to business’s con- tributions to stakeholders.

volunteerism When employees spend company-supported time in support of social causes.

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Chicago-based Exelon Energy, for example, instituted their Energy for the Community volunteer engagement program that offers incentives to encourage employees to volunteer. One of the incentives is the Dollars for Doers program in which an employee can volunteer either 10, 20, or 40 hours per year at an organization of his or her choice, and Exelon awards a corresponding grant to the organization. Employees who volunteer more than 50 hours per year are nominated for the Exelon Employee Volunteer Award, who are recognized during National Volunteer Week. In the most recent year, employees volunteered for over 129,000 hours, Exelon con- tributed $2.19 million in matching gifts, and employees contributed over $6.3 million dollars to the annual United Way.27

There are several considerations in deciding how to structure a vol- unteer program. Attention must be paid to employee values and beliefs; therefore, political or religious organizations should be supported on the basis of individual employee initiative and interest. Some companies will partner with nonprofit organizations as a means to give their employees more options for volunteerism. For example, WorldVision humanitarian organization partners with corporations for financial, volunteer hour, and product donations as well as opportunities for cause-related marketing. Volunteer opportunities exist in education, sanitation, economic develop- ment, etc. all over the globe.28

Another issue is what to do when some employees do not wish to volunteer. If the company is not paying for the employees’ time to vol- unteer and volunteering is not a condition of employment or an aspect of the job description, it may be difficult to convince a certain percentage of the workforce to participate. If the organization is paying for one day a month, on the other hand, to allow the employee exposure to volun- teerism, then individual compliance is usually expected.

Utah Idaho Wisconsin Minnesota Kansas

46.0%

35.8%

35.4%

35.3%

35.1%

FIGURE 9.1 States with Highest Volunteerism

Source: Corporation for National and Community Service, “Volunteering and Civic Life in America 2015–National, State, and City Information,” http://www. volunteeringinamerica.gov/rankings.cfm (accessed June 22, 2016).

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PHILANTHROPIC CONTRIBUTIONS Philanthropy provides four major benefits to society. First, it improves the quality of life and helps make communities places where people want to do business, raise families, and enjoy life. Thus, improving the quality of life in a community makes it easier to attract and retain employees and customers. Second, philanthropy reduces government involvement by pro- viding assistance to stakeholders. Third, philanthropy develops employee leadership skills. Many firms, for example, use campaigns by the United Way and other community service organizations as leadership- and skill- building exercises for their employees. Philanthropy helps create an ethical culture and promotes the values that can act as a buffer to organizational misconduct.29 In the United States, charitable giving has stagnated at 2 percent of gross domestic product annually.30

The most common way that businesses demonstrate philanthropy is through donations to local and national charitable organizations. Corporations gave more than $18.5 billion to environmental, educational, and social causes in a recent year. Individual giving, which is always the largest component of charitable contributions, was an estimated $264.6 bil- lion, or 71 percent of the total. Figure 9.2 displays the sources of charitable giving. Figure 9.3 displays the major recipients of the $373.25 billion in phil- anthropic donations made. Religious organizations received 33 percent of all contributions, with educational causes collecting 16 percent of the funds.31

philanthropy Acts such as donations to charitable organizations to improve the quality of life, reduce government involve- ment, develop employee leadership skills, and create an ethical culture to act as buffer to organizational misconduct.

$0.0

$50.0

$100.0

$150.0

$200.0

$250.0

$300.0

Individuals Corporations Foundations Bequest

$18.45

$264.58

$58.46

$31.76

Source: “Giving Statistics,” Charity Navigator, 2016, http://www.charitynavigator.org/index. cfm?bay=content.view&cpid=42#.U7q_BhZX9g0 (accessed June 22, 2016).

FIGURE 9.2 Sources of Charitable Giving ($ in billions)

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300 Business and Society

In a general sense, philanthropy involves any acts of benevolence and goodwill, such as making gifts to charities, volunteering for community projects, and taking action to benefit others. For example, your parents may have spent time on non-work projects that directly benefited the com- munity or a special population. Perhaps you have participated in similar activities through work, school groups, or associations. Have you ever served Thanksgiving dinner at a homeless shelter? Have you ever raised money for a neighborhood school? Have you ever joined a social club that volunteered member services to local charities?

Most religious organizations, educational institutions, and arts pro- grams rely heavily on philanthropic donations from both individuals and organizations. Philanthropy is a major driver of the nonprofit sector of the economy, as these organizations rely on the time, money, and talents of both individuals and organizations to operate and fund their programs. Consider the partnership between Pampers and UNICEF. These two organizations have had a successful decade-long partnership in which Pampers donates a portion of its proceeds to UNICEF to provide tetanus shots for babies around the world. This partnership fits well with Pampers’ core product.32

STRATEGIC PHILANTHROPY DEFINED Our concept of corporate philanthropy extends beyond financial contri- butions and explicitly links company missions, organizational competen- cies, and various stakeholders. Thus, we define strategic philanthropy as

strategic philanthropy The synergistic use of an organization’s core com- petencies and resources to address key stakeholders’ interests and to achieve both organizational and social benefits.

$0.00

$20.00

$40.00

$60.00

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$120.00

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Source: “Giving Statistics,” Charity Navigator, 2016, http://www.charitynavigator.org/index. cfm?bay=content.view&cpid=42#.U7q_BhZX9g0 (accessed June 22, 2016).

FIGURE 9.3 Recipients of Charitable Giving ($ in billions)

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Chapter 9  Community Relations and Strategic Philanthropy 301

the synergistic use of an organization’s core competencies and resources to address key stakeholders’ interests and to achieve both organizational and social benefits. Strategic philanthropy goes well beyond the tradi- tional benevolent philanthropy of donating a percentage of sales to social causes by involving employees (utilizing their core skills), organizational resources and expertise (equipment, knowledge, and money), and the abil- ity to link employees, customers, suppliers, and social needs with these key assets. Strategic philanthropy involves both financial and nonfinancial contributions to stakeholders (employee time, goods and services, and company technology and equipment as well as facilities), but it also ben- efits the company.

Organizations are best suited to deal with social or stakeholder issues in areas with which they have some experience, knowledge, or expertise. From a business perspective, companies want to refine their intellectual capital, reinforce their core competencies, and develop synergies between business and philanthropic activities. The process of addressing stake- holder concerns through philanthropy should be strategic to a company’s ongoing development and improvement. For example, SAP, a global soft- ware company, has made financial and product investments in developing economies such as Mexico and Swaziland. These investments are beneficial to both parties as the technology aids economic, educational, and health advancements for the communities. However, it also allows the company to identify emerging talent and become established in these economies for their own growth.33 Some critics would argue that this is not true philan- thropy because SAP will receive business benefits. However, social respon- sibility takes place on many levels, and effective philanthropy depends on the synergy between stakeholder needs and business competencies and goals. Thus, the fact that each partner receives unique benefits does not diminish the overall good that results from a project. As global competi- tion escalates, companies are increasingly responsible to stakeholders in justifying their philanthropic endeavors. This ultimately requires greater planning and alignment of philanthropic efforts with overall strategic goals. Table 9.4 provides additional examples of philanthropic activities.

TABLE 9.4 Examples of Strategic Philanthropy The Target Corporation donates 5 percent of its pretax income to charities. Patagonia donates 1 percent of profits to 1 Percent for the Planet, a global movement that

donates the proceeds to environmental organizations. Salesforce.com donates 1 percent of its technology, 1 percent of its resources, and 1

percent of its people (employees can take off six days a year to volunteer) to nonprofits and to their communities.

Home Depot has a strong partnership with the nonprofit Habitat for Humanity, spending significant time and resources in its mission to build homes for those in need.

New Belgium Brewing engages in extensive philanthropy grants, product donations, and sponsorships to support the community.

Whole Foods holds a number of community giving days in which 5 percent of the day’s net revenue goes toward nonprofits or education.

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STRATEGIC PHILANTHROPY AND SOCIAL RESPONSIBILITY It is important to place strategic philanthropy in the context of organi- zational responsibilities at the economic, legal, ethical, and philanthropic levels. Most companies understand the need to be economically successful for the benefit of all stakeholders and to comply with the laws required within our society and others in which they do business. Additionally, through the establishment of core values and ethical cultures, most firms are recognizing the many benefits of good ethics. As we saw in Chapter 1, evidence is accumulating that there is a positive relationship between social responsibility and performance, especially with regard to customer satisfaction, investor loyalty, and employee commitment. Strategic social responsibility can reduce the cost of business transactions, establish trust among stakeholders, improve teamwork, and preserve the social capital necessary for an infrastructure for doing business. In sum, these efforts improve the context and environment for corporate operations and performance.34

When Daniel Lubetzky founded Kind Healthy Snacks, he had trans- parency and kindness in mind. Transparency is demonstrated in the fact that the company’s bars and snacks contain ingredients that are easily pro- nounced (meaning they are natural), and come in clear packaging where those ingredients can be seen. The company initiated a charitable cam- paign where it donated $10,000 per month to a different charity through a program called “Do the Kind Thing.” Each charity was crowdsourced, meaning that people would visit the company’s website to vote for the charity they thought should get that month’s donation. The self-described “not-only-for-profit” company has become the fastest growing energy and nutrition bar in the United States.35 In this way, Kind Healthy Snacks has linked philanthropic contributions to revenue generation.

Many companies consider philanthropy only after they have met their financial, legal, and ethical obligations. As companies strive for social responsibility, their ability to meet each obligation lays the foundation for success with other responsibilities. In addition, there is synergy in corpo- rate efforts directed at the four levels of responsibility. As one of the most voluntary dimensions of social responsibility, philanthropy has not always been linked to profits or business ethics. In fact, the traditional approach to philanthropy disconnects giving from business performance and its impact on stakeholders. Before the evolution of strategic philanthropy, most corporate gift programs separated the company from the organiza- tions, causes, and individuals that its donations most benefited.36

Research has begun to highlight organizations’ formalization of philanthropic activities and their efforts to integrate philanthropic goals with other business strategies and implementation. U.S. companies are adopting a more businesslike approach to philanthropy and experienc-

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ing a better image, increased employee loyalty, and improved customer ties.37 Philanthropy involves using organizational resources, and spe- cific methods are used to measure its impact on key stakeholders. In this case, philanthropy is an investment from which a company can gain some type of value. For instance, J.P. Morgan and other wealthy entities and individuals engage in impact investing. Impact investing is the investment of a significant amount of money toward finding solu- tions for a social problem, with the promise of financial return that depends upon the achievement of a stated goal. This measured activity is becoming increasingly popular because not only is it drawing in mil- lions of dollars to be invested, but many hurdles are being overcome in environmental and social issues. Examples of some initiatives include sustainable farming in East Africa and banking options to low-income communities in Mexico. J.P. Morgan has spent $68 million in impact investing across 11 funds.38 Indeed, there are numerous examples of companies supporting community involvement. Although these actions are noble, they are not always considered in tandem with organizational goals and strengths.

In some cases, corporate contributions may be made to nonprofit organizations in which top managers have a personal interest. When Unilever acquired Ben and Jerry’s Homemade, they agreed to support the causes and initiatives that are extremely important to founders Ben Cohen and Jerry Greenfield. Unilever agreed to maintain the Vermont employ- ment and manufacture base, pay workers a livable wage with complete benefits, buy milk from Vermont dairy farmers who do not use bovine growth hormones, contribute over $1.1 million annually to the Ben and Jerry’s Foundation, open more Partner Shops owned by nonprofit orga- nizations providing employment opportunities for disadvantaged persons, and maintain relationships with alternate suppliers.39 Finally, many com- panies will match employees’ personal gifts to educational institutions. Although gift-matching programs instill employee pride and assist educa- tion, they are rarely linked to company operations and competencies.40 In the traditional approach to corporate philanthropy, then, companies have good intentions, but there is no solid integration with organizational resources and objectives.

In the social responsibility model that we propose, philanthropy is only one focal point for a corporate vision that includes both the welfare of the firm and benefits to stakeholders. This requires support from top management as well as a strategic planning structure that incorporates stakeholder concerns and benefits. Corporate giving, volunteer efforts, and other contributions should be considered and aligned not only with cor- porate strategy but also with financial, legal, and ethical obligations. The shift from traditional benevolent philanthropy to strategic philanthropy has come about as companies struggled in the 1990s and 2000s to redefine their missions, alliances, and scope, while becoming increasingly account- able to stakeholders and society.

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Strategic Philanthropy versus Cause-Related Marketing The first attempts by organizations to coordinate organizational goals with philanthropic giving emerged with cause-related marketing in the early 1980s. Whereas strategic philanthropy links corporate resources and knowledge to address broader social, customer, employee, and sup- plier problems and needs, cause-related marketing ties an organization’s product(s) directly to a social concern. Table 9.5 compares cause-related marketing and strategic philanthropy.

Cause-related marketing donates a percentage of a product’s sales to a cause appealing to the relevant target market. The Avon Breast Cancer Crusade, for example, generates proceeds for the breast cancer cause through several fundraising efforts, including the sale of special “pink rib- bon” products by Avon independent sales representatives nationwide. Gifts are awarded by the Avon Products Foundation, Inc., a nonprofit 501(c)(3) accredited public charity, to support six vital areas of the breast cancer cause. Both the cause and Avon Crusade “pink ribbon” products appeal to Avon’s primary target market: women. The Avon Breast Cancer Crusade generated more than $800 million net in total funds raised worldwide to fund access to care and in finding a cure for breast cancer.41

American Express was the first company to use cause-related marketing widely, when it began advertising in 1983 that it would give a percentage of credit-card charges to the Statue of Liberty and Ellis Island Restoration Fund.42 As is the case with Avon, American Express companies generally prefer to support causes that are of interest to their target markets. In a single year, organizations raised roughly $1.92 billion for causes through marketing efforts.43 Thus, a key feature of cause-related marketing is the promise of donations to a particular social cause based on customer sales or involvement. Whereas strategic philanthropy is tied to the entire organi- zation, cause-related marketing is linked to a specific product and market- ing program. The program may involve in-store promotions, messages on packages and labels, and other marketing communications.44

cause-related marketing Ties an organization’s product(s) directly to a social concern.

TABLE 9.5 Strategic Philanthropy Contrasted with Cause-Related Marketing Strategic Philanthropy Cause-Related Marketing

Focus Organizational Product or product line

Goals Improvement of organizational competence or tying organi- zational competence to social need or charitable cause Builds brand equity

Increase of product sales

Time frame Ongoing Traditionally of limited duration

Organizational mem- bers involved

Potentially all organizational employees

Marketing department and related personnel

Cost Moderate—alignment with organizational strategies and mission

Minimal—alliance development and promotion expenditures

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Although cause-related marketing has its roots in the United States, the marketing tool is gaining widespread usage in other parts of the world. Population Services International (PSI) was founded with mar- keting for social issues as its base. After traveling to Africa in the 1990s and witnessing the devastating effects of HIV/AIDS on the population, founder Kate Roberts decided to use her marketing expertise to address the problem. She established YouthAIDS as an education and prevention program for young people using media, celebrity partnerships, and music to relay messages to the target group. Over the years, YouthAIDS became a recognizable brand. This success led to the organization’s involvement with other social issues such as malaria, sanitary water, and tuberculosis in over 50 countries.45

Cause-related marketing activities have real potential to affect buying patterns. For cause-related marketing to be successful, consumers must have awareness and affinity for the cause, the brand and cause must be associated and perceived as a good fit, and consumers should be able to transfer feelings toward the cause to their brand perceptions and purchase intentions. Studies have found that a majority of consumers said that, given equal price and product quality, they would be more likely to buy the product associated with a charitable cause. More than 80 percent of customers say they have more positive perceptions of firms that support causes about which they personally care. These surveys have also noted that most marketing directors felt that cause-related marketing would increase in importance over the coming years.46 Through cause-related marketing, companies first become aware that supporting social causes, such as environmental awareness, health and human services, education, and the arts, can support business goals and help bolster a firm’s reputa- tion, especially those with an ethically neutral image. However, firms that are perceived as unethical may be suspected of ulterior motives in develop- ing cause-related campaigns.47

One of the main weaknesses with cause-related marketing is that some consumers cannot link specific philanthropic efforts with companies.48 Consumers may have difficulty recalling exact philanthropic relationships because many cause-related marketing campaigns have tended to be of short duration and have not always had a direct correlation to the spon- soring firm’s core business. Because strategic philanthropy is more per- vasive and relates to company attributes and skills, such alliances should have greater stakeholder recognition and appreciation

SOCIAL ENTREPRENEURSHIP AND SOCIAL RESPONSIBILITY While social philanthropy and cause-related marketing are important ways for businesses to demonstrate social responsibility, some entrepreneurs are taking this a step further by structuring their entire business model around creating positive social change. Traditionally, organizations that structured

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themselves around the creation of social value chose to become nonprofit organizations. Nonprofits are organizations that are formed to meet some public purpose rather than making profits. Unlike for-profit companies, non-profits must reinvest any additional earnings into their operations.49 While some non-profits sell their goods or perform services to raise funds, many depend upon stakeholder donations to support their causes.

However, a new type of organizational structure is emerging that spans across or within nonprofit, business, and government industries. The social enterprise is an organization that uses entrepreneurial principles to create positive social change. Because it is an emerging field, research- ers have not yet come up with a consensus on how to define it. For our purposes, we define social entrepreneurship as what occurs when an entrepreneur founds a business with the purpose of creating social value. This means that unlike a traditional for-profit business, the main goal of a social entrepreneur is not to earn profits but to provide a solution to a social problem.50

As mentioned earlier, because the overarching purpose of social entre- preneurship is creating social value, social enterprises can be organized as a nonprofit, business, or government form of an organization—as well as a combination of any of these. Many social enterprises are set up with a nonprofit organizational structure. However, social enterprises differ from more traditional nonprofits as they pursue business-led strategies to achieve social objectives.51 While a social enterprise might be a nonprofit, it operates more like an entrepreneurial business venture in its strategy, structure, norms, values, and its approach to finding innovative solutions to social problems.52 Like a business entrepreneur, social entrepreneurs seek to be change agents by seizing upon opportunities and finding solu- tions that others missed to solve challenges in society.53 We go into further detail about nonprofit and for-profit types of social enterprises in the fol- lowing sections.

History of Social Entrepreneurship Social entrepreneurship as a concept is relatively new, but its precursors go back hundreds of years. Using entrepreneurial practices as a means to support a social mission is not new. For instance, monasteries sold surplus wine and cheese and used the money to further their mission.54 Early social entrepreneurs included historical figures such as Florence Nightingale, John Muir, Susan B. Anthony, and Maria Montessori.55 The concept itself was first widely used in the 1960s and 1970s. In 1980, entrepreneur Bill Drayton made major inroads in popularizing the concept when he founded Ashoka as an enterprise to encourage and support social entrepreneurs throughout the world.56

Probably the most famous social entrepreneurship success story is Muhammad Yunus’ establishment of micro-lending organization Grameen Bank in Bangladesh. Micro-lending occurs when investors provide small loans to local entrepreneurs to start their own businesses, cutting out the

social entrepreneurship When an entrepreneur founds a business with the purpose of creating social value.

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middlemen and avoiding predatory lending rates that are often common in developing countries. The inspiration for Grameen Bank occurred in 1974 during a famine when Yunus lent $27 to a woman and her neighbors to help them earn a living. After he was paid back in full, Yunus realized the difference these small amounts of money could have in the lives of poor people. The Grameen Bank Project was founded in 1976, and in 1983 a government ordinance allowed Yunus to turn his micro-lending project into an independent bank.57

Grameen Bank adopted an innovative approach to lending. It would have borrowers take out loans in groups of five, and each borrower would guarantee the other’s debts.58 Interest rates are around 16 percent, which is lower than bank rates in many other countries. Grameen’s model places pressure upon the borrowers to repay their loans or risk being shamed in front of their community members. Grameen Bank has had a high repay- ment rate, with 95 percent of borrowers paying back their loans.59

Grameen Bank has successfully changed the business environment in Bangladesh. Not only did it develop an innovative model to help villagers get out of poverty, but because 97 percent of loans are made to women, Grameen’s micro-lending model promoted respect for women entrepre- neurs.60 Grameen also established training programs to replicate its micro- lending model in other countries.

Approximately 95 percent of the bank is owned by the borrowers themselves, giving them the incentive to see the bank succeed.61 In 2006, Yunus and Grameen Bank won the Nobel Peace Prize.62 The bank’s emphasis on joint accountability and ownership has led to a successful lending model to address a major economic problem. Grameen Bank has also been sustainable; with the exception of a couple of years, the bank has earned a profit.63 Today, similar micro-finance organizations include Kiva. org, BRAC, Accion, and FINCA International.

Types of Social Entrepreneurship Many social enterprises tend to organize themselves as nonprofits. The Delancey Street Foundation is a nonprofit based in San Francisco. Founded by Mimi Silbert in 1971, the purpose of the Delancey Foundation is to assist homeless people, drug addicts, felons, and others into changing their lives. The Delancey Street Foundation acts as a residential educa- tion center that trains people in skills and expertise so they can become productive members of society. Approximately 65 percent of the Delancey Street’s operating costs are paid for by operating over 20 small businesses, including the Delancey Street Restaurant, which are staffed by the people using Delancey’s services. Thus far, Delancey Street has helped more than 14,000 people change their lives.64

Other social entrepreneurs decide to organize as a for-profit organiza- tion or as hybrid between the two. Blake Mycoskie’s Toms, for instance, was created with the mission to provide a pair of shoes to children in need throughout the world. However, the model was incorporated into

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a for-profit business that builds the cost of the free pair of shoes into shoe sales. Another for-profit firm, Sseko Designs, provides internships to women in Uganda. The women make leather bags and ribbon sandals to sell in the United States. The intention of the internships is to help these Ugandan women save enough to go to college. A certain amount of the women’s earnings go toward a college fund. At the end of their intern- ships, Sseko Designs matches the savings so that the women will have enough to attend college.

It is clear that social entrepreneurship does not encompass any par- ticular type of business structure. Rather, it is distinguished from tradi- tional organizations—both for-profit and non-profit—by its emphasis on innovative solutions and entrepreneurial principles to solve social problems.

Social Entrepreneurship and Strategic Philanthropy There are many distinct similarities among social entrepreneurship, cause-related marketing, and strategic philanthropy. All of these con- cepts emphasize social responsibility and a desire to support positive change. The delineation occurs more in how they achieve their goals. Businesses with cause-related marketing initiatives have not incorporated philanthropy into their business models. Rather, they use programs to strongly support initiatives to benefit society, such as Yoplait’s support of the Susan G. Komen Foundation or Avon’s support for breast cancer research. Strategic philanthropy uses organizational core competencies to achieve both organizational and social benefits. Strategic philanthropy in business occurs when organizations incorporate these causes into their overall strategies. As part of its strategy to support environmental aware- ness, Patagonia donates 1 percent of its profits to a global movement of companies called 1 Percent for the Planet, which in turn donates to envi- ronmental organizations.

Like social entrepreneurship, strategic philanthropy implements strategies to support solutions for societal challenges. Companies incorporating strategic philanthropy, however, usually outsource the execution of their program and its goals to other organizations, often nonprofits. Home Depot, for instance, strongly supports Habitat for Humanity but its operations are not centered around building houses for people in need. In contrast, the social entrepreneur executes the organi- zation’s program for change directly.65 The business objectives of these organizations are to create social value; Grameen, therefore, is in the business of microlending, while Sseko Designs was founded to increase Ugandan women’s access to a college education. Cause-related market- ing, strategic philanthropy, and social entrepreneurship are all innova- tive and socially responsible ways to meet the organization’s obligations to society.

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Earth in the Balance

Heal the World & Make It a Better Place

Sources: Anonymous, “Two Awards for the Institute of OneWorld Health,” Appropriate Technology, June 2005, p. 26; Christian Seelos and Johanna Mair, “Social Entrepreneurship,” Business Horizons 48, no. 3 (May–June 2005): 241–246; “Global Initiatives,” VIVALEAP, http://www.vivaleap.com/global.html (accessed July 28, 2016); Skoll Foundation, http://skoll.org/ (accessed July 28, 2016); John L. Thompson, “The World of the Social Entrepreneur,” The International Journal of Public Sector Management 15 (2002): 412–432; Sekem website, http://www.sekem.com/index.html (accessed July 28, 2016); PATH website, http://sites.path.org/drugdevelopment/ (July 28, 2016); “Innovative Models Promoting Adaptation and Climate Technologies (IMPACT) Business Award: Call for Submissions,” FANRPAN, http://www.fanrpan.org/documents/d01233/ (accessed July 28, 2016).

Many companies worldwide have become increasingly concerned with the society and communities in which they operate. This new breed of business is concerned about bettering the lives of the surrounding community while providing a profitable good or service at the same time. This new type of business is called social entre- preneurship. Leaders in organizations from the United States to Egypt are becoming social entrepreneurs.

Social entrepreneurs typically follow a four-stage process. In the first stage of envisioning, a clear need, gap, and opportunity are identified. The second stage is engaging in the opportunity and doing something about it. Enabling something to happen is the third stage. The final stage is enacting and leading the proj- ect to completion.

The Institute of PATH, based in San Francisco, has been a leader in social entrepreneurship. PATH’s focus is on creating medicines to cure diseases that affect Third World countries. The nonprofit organization is currently working with partners in biotechnology, pharmaceutical, and academic industries to increase the availability of artemisinin-based combination therapy through improv- ing the manufacturing process of the drug. Artemisinin- based combination therapy is effective against malaria, but the supply of this drug, which comes from a plant, varies. By improving the manufacturing process, PATH and its partners hope to help the 200 million people each year that become victims of malaria.

The nonprofit status offers many advantages to PATH. Most of its funding comes from the govern- ment or philanthropic organizations. Biotech compa- nies have gained a channel for intellectual property that might normally have gone unused because of lack of profit potential. Many members of the scientific

community are donating time and effort to help fight disease in Third World countries.

Social entrepreneurs are present all over the world. Take, for example, Sekem, located just north of Cairo, Egypt. Sekem was founded in 1977 by Dr. Ibrahim Abouleish. Since 1977, the organization has grown from one person to several business firms. Sekem pro- duces several organic products on its farms. Some of its long-term goals include the following:

We endeavor to build our economic, social, and cultural activities so that they invigorate each other.

We nurture the development of all coworkers by facilitat- ing the possibility to learn through their work, to commit themselves to their task and to practice agriculture.

We intend to restore the earth through implementing and developing biodynamic agriculture.

We provide Primary Health Care and therapy using holistic medicine.

We strive through our research to meet the questions of all aspects of life for the present age.

Sekem developed an alternative method for using pesticides to protect cotton crops. This new system led to a ban on crop dusting in Egypt. In 2011, Sekem won the IMPACT Business Award in recognition of their innovative contributions to preventing climate change. In 2013, Dr. Abouleish won the “Award for Excellence in Positive Change” by the Global Thinker Forum.

Sekem has also opened a school for holistic educa- tion. The profits earned by Sekem help fund medical centers and education for both children and adults. They are committed to helping the community break away from the poverty that has taken control of their lives. Sekem is continually expanding operations to help the community achieve a higher quality of life.

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BENEFITS OF STRATEGIC PHILANTHROPY To pursue strategic philanthropy successfully, organizations must weigh both the costs and benefits associated with planning and implementing it as a corporate priority. Companies that assume a strategic approach to philanthropy are using an investment model with respect to their chari- table acts and donations. In other words, these firms are not just writing checks; they are investing in solutions to stakeholder problems and cor- porate needs. Such an investment requires the commitment of company time, money, and human talent to succeed. Companies often need to hire staff to manage projects, communicate goals and opportunities throughout the firm, develop long-term priorities and programs, handle requests for funds, and represent the firm on other aspects of philanthropy. In addi- tion, philanthropy consumes the time and energy of all types of employees within the organization. Thus, strategic philanthropy involves real corpo- rate costs that must be justified and managed.

Most scholars and practitioners agree that the benefits of strategic philanthropy ultimately outweigh its costs. The positive return on stra- tegic philanthropy is closely aligned with benefits obtained from strong social responsibility. First, in the United States, businesses can declare up to 10 percent of pretax profits as tax-deductible contributions. Most firms do not take full advantage of this benefit, as 10 percent is viewed as a very generous contribution level. In fact, corporate giving has dipped to 0.7 percent of pretax profits in the last year.66 Second, companies with a strategic approach to philanthropy experience rewards in the workplace. Employees involved in volunteer projects and related ventures not only have the opportunity to refine their professional skills but also develop a stronger sense of loyalty and commitment to their employer. A national survey of employees demonstrated that corporate philan- thropy is an important driver in employee relations. Those who perceive their employer as strong in philanthropy were four times as likely to be very loyal as those who believed their employer was less philanthropic. Employees in firms with favorable ratings on philanthropy are also more likely to recommend the company and its products to others and have intentions to stay with the employer. Positive impressions of the executives’ role in corporate philanthropy also influenced employees’ affirmative attitudes toward their employer.67 Results such as these lead to improved productivity, enhanced employee recruitment practices, and reduced employee turnover, each contributing to the overall effectiveness and efficiency of the company.

As a third benefit, companies should experience enhanced customer loyalty as a result of their strategic philanthropy. By choosing projects and causes with links to its core business, a firm can create synergies with its core competencies and customers. Consider the Pampers partnership with UNICEF described earlier. Pampers has developed a partnership to donate a portion of proceeds to help improve the health of babies throughout the world. This resonates well with the target market for Pampers: parents of

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infants and newborns. Another example is Home Depot’s partnership with Habitat for Humanity.

Finally, strategic philanthropy should improve a company’s overall reputation in the community and ease government and community rela- tions. Research indicates a strong negative relationship between illegal activity and reputation, whereas firms that contribute to charitable causes enjoy enhanced reputations. Moreover, companies that contribute to social causes, especially to problems that arise as a result of their actions, may be able to improve their reputations after committing a crime.68 If a business is engaged in a strategic approach to contributions, volunteerism, and related activities, a clear purpose is to enhance and benefit the commu- nity. By properly implementing and communicating these achievements, the company will “do well by doing good.” Essentially, community mem- bers and others use cues from a strategic philanthropy initiative, along with other social responsibility programs, to form a lasting impression—or reputation—of the firm. These benefits, together with others discussed in this section, are consistent with research conducted on European firms. Table 9.6 highlights the perceived benefits of corporate philanthropy. The table suggests that companies believe that their charitable activities generally have a positive effect on goodwill, public relations, community relations, employee motivation, and customer loyalty.69

IMPLEMENTATION OF STRATEGIC PHILANTHROPY Attaining the benefits of strategic philanthropy depends on the integration of corporate competencies, business stakeholders, and social responsibil- ity objectives to be fully effective. However, fruitfully implementing a strategic philanthropy approach is not simple and requires organizational resources and strategic attention. In this section, we examine some of the key factors associated with implementing strategic philanthropy.

Although some organizations and leaders see beyond economic con- cerns, other firms are far less progressive and collaborative in nature. To the extent that corporate leaders and others advocate for strategic

TABLE 9.6 Benefits of Socially Responsible Strategic Corporate Philanthropy Consumer trust

Stakeholder loyalty

Employee engagement

Reputation

Enhance brand image

Increase share value

Positive publicity

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philanthropy, planning and evaluation practices must be developed just as with any other business process. Almost all effective actions taken by a company are well-thought-out business plans. However, although most large organizations have solid plans for philanthropy and other community involvement, these activities typically do not receive the same attention that other business forays garner. A study by the American Productivity and Quality Center found that many organizations are not yet taking a systematic or comprehensive approach in evaluating the impact of philanthropy on the business and other stakeholders.70

Top Management Support The implementation of strategic philanthropy is impossible without the endorsement and support of the chief executive officer and other members of top management. Although most executives care about their communi- ties and social issues, there may be debate or confusion over how their firms should meet stakeholder concerns and social responsibility. Under CEO Jean-Laurent Bonnafé, BNP Paribas has partnered with the Chair of Philanthropy at ESSEC Business School in order to collaborate and contribute to the development of philanthropy itself. This is in addition to the Individual Philanthropy Offering program established by the seventh largest bank and the social activities of the BNP Paribas Foundation.71

Top managers often have unique concerns with respect to strategic philanthropy. For example, chief executive officers may worry about hav- ing to defend the company’s commitment to charity. Some investors may see these contributions as damaging to their portfolios. A related concern involves the resources required to manage a philanthropy effort. Top man- agers must be well versed in the performance benefits of social responsi- bility that we discussed in Chapter 1. Additionally, some executives may believe that less philanthropic-minded competitors have a profit advan- tage. If these competitors have any advantage at all, it is probably just a short-term situation. The tax benefits and other gains that philanthropy provides should prevail over the long run.72 In today’s environment, there are many positive incentives and reasons that strategic philanthropy and social responsibility make good business sense.

Planning and Evaluating Strategic Philanthropy As with any initiative, strategic philanthropy must prove its relevance and importance. For philanthropy and other stakeholder collaborations to be fully diffused and accepted within the business community, a performance benefit must be evident. In addition, philanthropy should be treated as a corporate program that deserves the same professionalism and resources as other strategic initiatives. Thus, the process for planning and evaluating strategic philanthropy is integral to its success.

To make the best decisions when dealing with stakeholder concerns and issues, there should be a defensible, workable strategy to ensure that

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every donation is wisely spent. Author Curt Weeden, President of Business & Nonprofit Strategies, Inc., has developed a multistep process for ensur- ing effective planning and implementation of strategic philanthropy.

1. Research If a company has too little or inaccurate information, it will suffer when making philanthropic decisions. Research should cover the internal organization and programs, organizations, sponsorship options, and events that might intersect with the interests and competencies of the corporation.

2. Organize and Design The information collected by research should be classified into relevant categories. For example, funding opportunities can be categorized according to the level of need and alignment with organizational competencies. The process of organizing and designing is probably the most crucial step in which management should be thor- oughly involved.

3. Engage This step consists of engaging management early on so as to ease the approval process in the future. Top managers need to be co-owners of the corporate philanthropy plan. They will have interest in seeing the plan receive authorization, and they will enrich the program by sharing their ideas and thoughts.

4. Spend Deciding what resources and dollars should be spent where is a very important task. A skilled manager who has spent some time with the philanthropy program should preferably handle this. If the previous steps were handled appropriately, this step should go rather smoothly.73

Evaluating corporate philanthropy should begin with a clear under- standing of how these efforts are linked to the company’s vision, mission, and resources. As our definition suggests, philanthropy can only be strate- gic if it is fully aligned with the values, core competencies, and long-term plans of an organization. Thus, the development of philanthropic pro- grams should be part of the strategic planning process.

Assuming that key stakeholders have been identified, organizations need to conduct research to understand stakeholder expectations and their will- ingness to collaborate for mutual benefit. Although many companies have invested time and resources to understand the needs of employees, custom- ers, and investors, fewer have examined other stakeholders or the potential for aligning stakeholders and company resources for philanthropic reasons. Philanthropic efforts should be evaluated for their effects on and benefits to various constituents.74 Although philanthropists have always been con- cerned with results, the aftermath of September 11 brought not only wide- spread contributions but also a heightened sensitivity to accountability. For example, the American Red Cross suffered intense scrutiny after its leaders initially decided to set aside a portion of donations received in response to the terrorist strikes. The rationale for setting aside $200 million was that a long-term program on terrorism response needed to be developed and funded. Many donors rejected this plan, and the Red Cross reversed its decision. A survey in late 2002 indicated that 42 percent of Americans have less confidence in charities than they did before the September 11

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attacks. Major philanthropists are also stepping up their expectations for accountability, widespread impact, strategic thinking, global implications, and results. A recent report by The Panel on the Nonprofit Sector discusses four major areas that all non-profit organizations need to address in order to demonstrate solid governance and ethical practices. Table 9.7 lists these areas, along with specific recommendations on how charitable organiza- tions can go about preserving the soundness and integrity of the nonprofit

TABLE 9.7 Principles for Sound Practice for Charities and Foundations 1. Legal Compliance and Public Disclosure

2. Effective Governance

3. Strong Financial Oversight

4. Responsible Fundraising

Source: Independent Sector, “Principles for Good Governance and Ethical Practice: A Guide for Charities and Foundations,” https://www.independentsector.org/principles (accessed June 22, 2016).

Table 9.8 A Donor Bill of Rights Philanthropy is based on voluntary action for the common good. It is a tradition of giving and sharing that is primary to the quality of life. To assure that philanthropy merits the respect and trust of the general public and that donors and prospective donors can have full confidence in the not-for-profit organizations and causes they are asked to support, we declare that all donors have these rights:

1. To be informed of the organization’s mission, of the way the organization intends to use donated resources, and of its capacity to use donations effectively for their intended pur- poses

2. To be informed of the identity of those serving on the organization’s governing board and to expect the board to exercise prudent judgment in its stewardship responsibilities

3. To have access to the organization’s most recent financial statements

4. To be assured their gifts will be used for the purposes for which they were given

5. To receive appropriate acknowledgment and recognition

6. To be assured that information about their donations is handled with respect and with confidentiality to the extent provided by law

7. To expect that all relationships with individuals representing organizations of interest to the donor will be professional in nature

8. To be informed whether those seeking donations are volunteers, employees of the organization, or hired solicitors

9. To have the opportunity for their names to be deleted from mailing lists that an organization may intend to share

10. To feel free to ask questions when making a donation and to receive prompt, truthful, and forthright answers

Source: Association of Fundraising Professionals, “A Donor Bill of Rights,” http://www.aps.org/about/ support/upload/bill-rights.pdf (accessed June 22, 2016). The Donor Bill of Rights was created by the Association of Fundraising Professionals (AFP), the Association for Healthcare Philanthropy (AHP), the Council for Advancement and Support of Education (CASE), and the Giving Institute: Leading Consultants to Non-Profits. It has been endorsed by numerous organizations.

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community.75 Table 9.8 lists ten guidelines that potential donors should use in evaluating and choosing organizations with which to partner or provide funding. Both types of input are important to individuals and companies in the process of deciding where to donate time and money.

Methods to evaluate strategic philanthropy should include an assess- ment of how these initiatives are communicated to stakeholders. It is rec- ommended that organizations develop an overall evaluation framework to be used to measure the initiative’s success. This evaluation framework pro- vides guidelines for how the organization will view the evaluation as well as descriptions of the evaluation type, standards to demonstrate successful implementation, and methods for communicating results.76 Such report- ing mechanisms not only improve stakeholder knowledge but also lead to improvements and refinements. Although critics may deride organizations for communicating their philanthropic efforts, the strategic philanthropy model is dependent on feedback and learning to create greater value for the organization and its stakeholders, as we shall see in the next chapter.

SUMMARY More firms are investigating ways to link their philanthropic efforts with consumer interests. From a strategic perspective, a firm’s ability to link consumer interests to philanthropy should lead to stronger economic rela- tionships. Community relations are the organizational functions dedicated to building and maintaining relationships and trust with the community. To determine the key areas that require support and to refine the mission statement, a company should periodically conduct a community needs assessment.

Companies play a major role in community economic development by bringing jobs to the community, interacting with other businesses, and making contributions to local health, education, and recreation projects that benefit residents and employees. When a company leaves an area, financial repercussions may be devastating. Because they have such a pro- found impact on the economic viability of their communities, firms that value social responsibility consider both the short- and long-term effects of changes in their workforce on the community.

For many firms, a series of legal and regulatory matters must be resolved before launching a business. On a basic level, society has the abil- ity to dictate what types of organizations are allowed to operate. As more companies view themselves as responsible to the community, they consider their role and the impact of their decisions on communities from an ethical perspective.

The success of a business can be enhanced by the publicity generated from and through stakeholder acceptance of community activities. One way that organizations are exercising their philanthropic responsibilities is through volunteerism, the donation of employee time by companies in support of social causes. In structuring volunteer programs, attention must be paid to employee values and beliefs.

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Many companies are finding creative ways to satisfy their responsibili- ties to consumers and the community. These relationships must be man- aged, nurtured, and continuously assessed. Resources devoted to this effort may include programs for educating and listening to consumers, surveys to discover strengths and weaknesses in stakeholder relationships, hiring consumer affairs professionals, the development of a community relations office, and other initiatives.

Generally, philanthropy involves any acts of benevolence and good- will. Strategic philanthropy is defined as the synergistic use of organi- zational core competencies and resources to address key stakeholders’ interests and to achieve organizational and social benefits. Strategic phi- lanthropy involves both financial and nonfinancial contributions to stake- holders, but it also benefits the company. As such, strategic philanthropy is part of a broader philosophy that recognizes how social responsibility can help an organization improve its overall performance. Research suggests that companies that adopt a more businesslike approach to philanthropy will experience a better image, increased employee loyalty, and improved customer ties.

Corporate giving, volunteer efforts, and other philanthropic activities should be considered and aligned with corporate strategy and financial, legal, and ethical obligations. The concept of strategic philanthropy has evolved since the middle of the twentieth century, when contributions were prohibited by law, to emerge as a management practice to support social responsibility in the 1990s. Whereas strategic philanthropy links corporate resources and knowledge to address broader social, customer, employee, and supplier problems and needs, cause-related marketing ties an organi- zation’s product(s) directly to a social concern. By linking products with charities and social causes, organizations acknowledge the opportunity to align philanthropy to economic goals and to recognize stakeholder inter- ests in organizational benevolence.

Social entrepreneurship occurs when an entrepreneur founds a busi- ness with the purpose of creating social value. There are many distinct similarities among social entrepreneurship, cause-related marketing, and strategic philanthropy. All of these concepts emphasize social responsibil- ity and a desire to support positive change. The delineation occurs more in how they achieve their goals. Like social entrepreneurship, strategic philanthropy implements strategies to support solutions for societal chal- lenges. Companies incorporating strategic philanthropy, however, usually outsource the execution of their program and its goals to other organiza- tions, often nonprofits. The social entrepreneur executes the organization’s program for change directly. The business objectives of these organizations are to create social value.

Many organizations have skillfully used their resources and core com- petencies to address the needs of employees, customers, business partners, the community and society, and the natural environment. To pursue strategic philanthropy successfully, organizations must weigh the costs and benefits associated with planning and implementing it as a corporate

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priority. The benefits of strategic philanthropy are closely aligned with benefits obtained from social responsibility. Businesses that engage in strategic philanthropy often gain a tax advantage. Research suggests that they may also enjoy improved productivity, stronger employee commit- ment and morale, reduced turnover, and greater customer loyalty and satisfaction. In the future, many companies will devote more resources to understand how strategic philanthropy can be developed and integrated to support their core competencies.

The implementation of strategic philanthropy is impossible without the support of top management. To integrate strategic philanthropy into the organization successfully, the efforts must fit with the company’s mission, values, and resources. Organizations must also understand stakeholder expectations and the propensity to support such activities for mutual benefit. This process relies on the feedback of stakeholders in improving and learning how to better integrate the strategic philanthropy objectives with other organizational goals. Finally, companies will need to evaluate philanthropic efforts and assess how these results should be com- municated to stakeholders.

Responsible Business Debate

The Influence of Business on Society Issue: Does business owe anything to society?

For decades, there have been two clear and opposing responses when answering the question, “What is the role of business in society?” One camp argues that the business of business is business, and therefore, there ought to be little consideration beyond profit and shareholder return. Milton Friedman was a sup- porter of this belief. He believed businesses only owed responsibility to shareholders and worried that any concern for the general public would lead to a totali- tarian state.

There is also the fear that big businesses could have too much power over our daily lives. Critics believe that if society relinquishes its decision-making authority and power to businesspeople, then negative consequences are likely to result. Businesses might try to make deci- sions that some people believe should be a personal choice. The marketing of unhealthy food to children is a good example. While many societal members are

calling for companies to increase their healthy food offerings or decrease their marketing of unhealthy food, critics believe this decision belongs to the parents and it is their job to oversee what their children eat. For this reason, they claim that business is about mak- ing a profit and business ideas probably won’t work for confronting societal issues.

The other group focuses on the prospects for social responsibility and for business to play a critical and pos- itive role in society. Because business has such a major impact, it should be responsible for reducing the nega- tive impact of its decisions. Pollution is one example. It is not uncommon for business operations to result in the emission of greenhouse gases or unusable chemical runoff. A common belief is that this pollution should belong to the business, and it should carry the costs of disposing of it. Others also point out that business is in a unique position to make a significant positive differ- ence. While government regulation takes a long time to pass, businesses can make the conscious decision to

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give back to their communities, take action to reduce their harmful impact on stakeholders, and promote objectives that would benefit society. Businesses have the financial resources and human talent that can be effectively applied to community needs and problems. Supporters of this mentality argue that in so doing, businesses build a positive relationship with customers, investors, and other stakeholders, leading to more busi- ness and increased profits for the firm.

Beyond the theoretical question, however, emerges the reality of the funds, time, and ideas that business contributes to a host of charitable, social, and quasi- governmental platforms. Implied in these activities is

that business has a role to play beyond its own indus- try, products, and employees. Clearly, if society expects business to make these contributions, then there ought to be consideration to the level and type of influence that business will have on society over the long-term.

There Are Two Sides to Every Issue: 1. Big business should be concerned solely with profits

and leave societal concerns out of the equation. 2. Businesses operate in society and therefore have a

social responsibility to effect positive change. Source: Milton Friedman, “The Social Responsibility of Business Is To Increase Its Profits,” The New York Times Magazine, September 13, 1970.

community (p. 289) neighbor of choice (p. 289) community relations (p. 290)

volunteerism (p. 297) philanthropy (p. 299) strategic philanthropy (p. 300)

cause-related marketing (p. 304) social entrepreneurship (p. 306)

KEY TERMS

DISCUSSION QUESTIONS 1. What are some of the issues you might include in

a defense of strategic philanthropy to company stockholders?

2. Describe your personal experiences with philanthro- py. In what types of activities have you participated? Which companies that you do business with have a philanthropic focus? How did this focus influence your decision to buy from those companies?

3. How have changes in the business environment contributed to the growing trend of strategic phi- lanthropy?

4. Compare and contrast cause-related marketing with strategic philanthropy. What are the unique benefits of each approach?

5. Compare social entrepreneurship to cause-related marketing and strategic philanthropy.

6. What role does top management play in develop- ing and implementing a strategic philanthropy approach?

7. Describe the four-stage process for planning and implementing strategic philanthropy.

EXPERIENTIAL EXERCISE Choose one major corporation and investigate how closely its philanthropic efforts are strategically aligned with its core competencies. Visit the company’s website, read its annual reports, and use other sources to justify your conclusions. Develop a chart or table to depict

how the company’s core competencies are linked to various philanthropic projects and stakeholder groups. Finally, provide an analysis of how these efforts have affected the company’s performance.

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As a new vice president of corporate philanthropy, Jack Birke was looking forward to the great initiatives and partnerships the company could create through his office. During his 18-year career, Jack worked for sev- eral large nonprofit organizations and earned an excel- lent reputation for his ability to raise funds, develop advisory boards, and in general, work well with the business community.

About a year ago, Jack decided to investigate other opportunities within the fundraising industry and started looking at companies that were formalizing their philan- thropy efforts. He was hired as vice president less than a month ago and was in the process of developing an office structure, getting to know the organization, and creating a strategic plan. His charge over the next year was to develop a stronger reputation for philanthropy and social responsibility with the company’s stakehold- ers, including employees, customers, and the communi- ty. An executive assistant, director of volunteerism, and director of community relations were already on board, and Jack was looking for additional staff.

The position and office were new to the com- pany, and Jack had already heard dissent from other

employees, who openly questioned how important phi- lanthropy was to the business. After all, the economy was slowing, and it seemed that customers were more concerned about price and value than any “touchy feely” program. About half of the company’s employ- ees worked on the manufacturing line, and the other half was employed in administrative or professional positions. Both groups seemed to be equally suspicious of Jack and his office. The company developed an employee volunteer program two years ago, but it was never very successful. A program to gather food, gifts, and money to support needy families at Christmas, however, drew strong support. The firm had fairly good relationships in the community, but these were primarily the top executives’ connections through the chamber of commerce, industry associations, non- profit boards, and so forth. In sum, while Jack had the support of top management, many employees were unsure about philanthropy and its importance to the company. Jack was starting to think about short-term policies and long-term strategy for “marketing” his office and goals to the rest of the organization. What would you do?

CREATING ‘BUY IN’ FOR VOLUNTEERISM: WHAT WOULD YOU DO? ?

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CHAPTER TEN

Technology Issues

Chapter Objectives

●● To examine the nature and characteristics of technology

●● To explore the economic impact of technology

●● To examine technology’s influence on society

●● To provide a framework for the strategic management of technology issues

Chapter Outline

The Nature of Technology

Technology’s Influence on the Economy

Technology’s Influence on Society

Strategic Implementation of Responsibility for Technology

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Uber, Airbnb, Instacar, Lyft—while these names were unheard of a few years ago, today they are recog- nized worldwide. The advent of mobile technology— combined with economic conditions such as wide-scale unemployment—has led to an entirely new economic model: the sharing economy. The sharing economy involves the sharing of underutilized assets. Private individuals with resources such as cars or houses can “rent” these resources, becoming their own entrepre- neurs. This allows consumers to make extra money off underutilized resources as well as be their own boss.

Riding high on the success of the sharing economy is Uber, founded in 2009 as a ride sharing service. Uber is a disruptive technology that has revolutionized the trans- portation industry. It operates via a mobile phone app that connects drivers – everyday people with cars– with passengers that want to get somewhere. The passenger’s credit card is automatically charged, and the driver gets a commission. Uber has operations in 300 cities worldwide and has an estimated $60 billion value.

Uber offers convenience to customers who are looking for a quick way to get to their destination. Using the app on their phone gives customers the abil- ity to contact a local Uber driver in their area. The Uber driver operates as independent contractors, meaning they drive their own cars. For many consumers Uber proves to be cheaper than taxi services, although this depends upon the time and distance. Uber operates with surge-based pricing, meaning it uses an algorithm to determine pricing based on demand. In periods of higher demand, Uber charges higher pricing.

Uber has upended the transportation industry, and many traditional transportation firms are unhappy about it. Taxi companies argue that the ride-sharing model should be held to the same rules as taxies. Global governments have begun limiting Uber from operating until they can determine how to regulate it. In France an attempt was made to ban an Uber service because driv- ers do not have to be licensed. Calls for Uber regulations occur when a driver commits a crime, even when not driving for Uber at the time.

However, it is also facing challenges on its home front. For instance, both Uber and its competitor Lyft left Austin, Texas because unfavorable regulation requires drivers to have fingerprint background checks. The taxi industry claimed Uber puts them at a competi- tive disadvantage because of its advantage on saving costs on licensing, insurance, and other fees. Regulators are considering regulations that will deal with obstacles necessary to level the competitive playing field.

Despite these challenges, Uber’s success has popu- larized a number of sharing services, from transpor- tation to lodging, chores to doctor visits. Some of these firms, such as Lyft, and Didi Kuaidi in China, are competing against Uber directly. Others have taken on totally different industries. For instance, TaskRabbit uses its digital site to connect independent contrac- tors with clients who need chores performed, and DogVacay focuses on dog watching. Companies are finding that with technology, the possibilities for offer- ing services through the sharing models are nearly endless.

Responding to Business Challenges Uber Disrupts the Transportation Industry

Opening Vignette

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In this chapter, we explore the nature of technology and its positive and negative effects on society. Technology’s influence on the economy is very powerful, especially with regard to growth, employment, and working environments. This influence on society includes issues related to the internet, privacy, intellectual property, health, and the general quality of life. The strategic direction for technology depends on government as well as on business’s ability to plan, implement, and audit the influence of technology on society.

THE NATURE OF TECHNOLOGY Technology relates to the application of knowledge, including the pro- cesses and applications to solve problems, perform tasks, and create new methods to obtain desired outcomes. It includes intellectual knowledge as well as the physical systems devised to achieve business and per- sonal objectives. The evolution of civilization is tied to developments in technology. Through technological advances, humans have moved from a hunter-gatherer existence to a stable agricultural economy to the Industrial Revolution. Today, our economy is based more on informa- tion technology and services than on manufacturing. This technology is changing the way we take vacations, shop for groceries, do homework, track criminals, navigate to places, and maintain friendships. Technology has made it possible to go to work or attend meetings without leaving the house. Our new economy is based on these dynamic technological changes in our society.

Characteristics of Technology Some of the characteristics of technology include the dynamics, reach, and self-sustaining nature of technological progress. The dynamics of technol- ogy relate to the constant change that often challenges the structure of social institutions. The automobile, airplane, and personal computer all created major changes and influenced government, the family, social rela- tionships, education, the military, and leisure. These changes can happen so fast that they require significant adjustments in the political, religious, and economic structures of society. Some societies have difficulty adjust- ing to this rate of change to the point that they even attempt to legislate against new technologies to isolate themselves. China tried to isolate its citizens from the internet and the social trends resulting from the applica- tion of new technology to music, movies, and other carriers of culture. But eventually they eased restrictions, allowing for limited and monitored use. Since then, internet use in China has grown, with the number of regular users totaling more than 700 million, usually on mobile devices. However, the government still utilizes a number of strategies for reminding Chinese citizens that their internet activity is being monitored. Often, the Chinese government will completely shut down the use of instant messaging or

technology Relates to the application of knowledge, including the processes and applications to solve problems, perform tasks, and create new methods to obtain desired outcomes.

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social media applications to limit the potential of groups to organize pro- tests or other anti-government activities.2

The dynamics of technology are not only changing many traditional products, such as books and music, but also the way in which we conduct everyday activities. The proliferation of e-readers and smartphones pre- pared consumers for the introduction of iPads. These devices changed the way people accomplish both work-related and personal tasks, as well as the way we store data. As the capacity for cloud storage of data increases, other storage devices such as USB drives will likely become a thing of the past. Today we can conduct banking transactions without going to a bank, draft a document while riding the bus to work and save it to our Dropbox account, and share information with others with a touch of a button. Each advance in technology seems to lead to new developments across industries, sometimes making things more convenient, while at other times raising seri- ous concerns about privacy, protection of digital property, and other issues.

Reach relates to the broad nature of technology as it moves through society. For instance, every community in both developed and developing countries has been influenced by cellular and wireless telephones. The abil- ity to make a call from almost any location has many positive effects, but negative side effects include increases in traffic accidents and noise pollution as well as fears about potential health risks. Through telecommunications, businesses, families, and governments have been linked from far distances. Satellites allow instant visual and voice electronic connections almost any- where in the world. These technologies have reduced the need for in-person meetings via business travel. Web conferencing and video conferencing are becoming more popular alternatives, although it may be difficult for tech- nology to fully replace the nature of face-to-face encounters. Even though collaboration technology continues to grow in lieu of business travel, com- panies recognize that some occasions demand face-to-face interaction, such as meeting a new client for the first time, dealing with certain cultures, and discussing significant financial and legal transactions.

The self-sustaining nature of technology relates to the fact that tech- nology acts as a catalyst to spur even faster development. As innovations are introduced, they stimulate the need for more technology to facilitate further development. For example, the internet created the need for broad- band transmission of electric signals through phone lines (DSL), satellites, and cable. Broadband allows connections to the internet to be 50 times faster than through a traditional telephone modem. It also allows users to download large files and creates the opportunity for a rich multimedia experience. Today, most people refer to it as Wi-Fi, and many restaurants and coffee shops offer it as a feature to attract customers. The latest dis- cussion in the advancement of internet transmission is through fiber optic cables. Many developed countries are heavily investing in building and utilizing fiber optic infrastructure for faster internet connections, and we are seeing adoption among consumers rapidly increase. Google Fiber, the company’s fiber optic internet connection, claims to run 100 times faster than broadband.3

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Effects of Technology Civilizations must harness and adapt to changes in technology to maintain a desired quality of life. The cell phone, for example, has dramatically altered communication patterns, particularly in developing countries where there are few telephone lines. Innovations can also change entire industries. Companies and governments are creating supercomputers that are millions of times more powerful than personal computers. The com- puters are making use of “big data,” which is the accumulation of large volumes of varied data that need to be transmitted at very fast speeds. The concept of big data is a result of the continual use of the internet via computers and mobile devices.4 Such examples illustrate how technology can provide new methods to accomplish tasks that were once thought impossible. These advancements create new processes, new products, and economic progress and ultimately have profound effects on society.

The global economy experienced the greatest acceleration of techno- logical advancement that ever occurred, propelling increased productivity, output, corporate profits, and stock prices, over the last decade.5 Among the positive contributions of these advances were reductions in the num- ber of worker hours required to generate the nation’s output. At the same time, the economic conditions that accompanied this period of technical innovation resulted in increased job opportunities. But in the early 2000s, with the fall of the dot-coms and the integrity meltdown of major U.S. corporations, the economy had taken a downturn, along with the falling stock market. Many information technology firms expanded too rapidly and misreported revenue and earnings to hold onto stock prices and please executives and investors. The result was incidences of massive account- ing fraud that damaged confidence and the economy. Earlier chapters dealt with many of these cases and their effect on social responsibility expectations. The traditional work environment has changed because telecommunications (e.g., e-mail and video conferencing) reduce the need for face-to-face interaction. Through online shopping, the internet can also reduce the need for trips to a shopping center and has increased the amount of business done by UPS and FedEx. In addition, the ease and number of business-to-business transactions have expanded.

However, there are concerns that dramatic shifts in the acceleration and innovations derived from technology may be spurring imbalances not only in the economy but also in our social existence. The flow of technology into developing countries can serve as a method to jump-start economic development. In Kenya many residents use the mobile phone payment ser- vice M-Pesa to quickly and securely transfer funds to merchants and family members, reducing the need to travel long distances to banks. The service has also allowed many to start their own businesses, contributing to the growth of the local economy.6 However, a failure to share technology or provide methods to disseminate technology could cause a major divide in the quality of life. Limited resources in underdeveloped countries and the lack of a technology infrastructure may lead to many social, political, and economic problems in the future.

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In the United States, the federal government implemented plans to subsidize computers, mobile phones, and internet access for low-income households and individuals across the nation. Although this initiative was somewhat controversial, proponents argued it had the potential to raise the standard of living for low-income families.7 Some companies are also trying to help bridge the technology gap that exists between those who can afford technology and those who are on the other side of the so- called digital divide. Comcast Corporation established a program called Internet Essentials where people can sign up to see if they qualify for low- cost internet connection, computers for $150, and free internet training.8 Other internet providers offer programs similar to Comcast’s and serve as examples of a corporate attempt to keep the positive effects of the reach of technology available to all segments of society.

There are concerns about the way information technology can improve the quality of life for society. In addition, there are concerns about the neg- ative consequences of the reduction of privacy and the emergence of cyber- crime. It is becoming common for hackers to install malware into company and government computer systems to steal secrets or consumer data. If higher security measures are not taken, significant changes in our economy and individual lifestyles could occur, causing the roles of business, govern- ment, and technology to be questioned. Public advocacy organizations are helping by participating in charting the future of computer networks to integrate these technological innovations into the way we live.9

TECHNOLOGY’S INFLUENCE ON THE ECONOMY Technology has had an enormous influence on the global economy. In many ways, technology has contributed to significant economic growth through new business opportunities, better ways to connect across long distances, and more efficient processes. For example, the widespread growth of com- panies like Uber and Airbnb have led to a new economic term called the sharing economy. In the sharing economy, independent contractors can “rent out” underutilized resources such as cars or lodging to earn extra income. Companies like Uber act as agents. Their technology links the buyer and seller, but they do engage in the distribution process directly. The sharing economy has led to a number of opportunities for both buyers and sellers. However, technology has also given rise to concerns as well. The following sections document technology’s overall impact on the economy.

Economic Growth and Employment Technological advancements have had a profound impact on economic growth and employment. Over the past several decades, technology has been a major factor in the economic growth of the United States. Investments in educational technologies, increased support for basic government research, and continued commitment to the mission of research and development (R&D) in both the public and private sectors

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have become major drivers of economic growth. Through lower interest rates, tax credits, and liberalization of export controls, the government established the economic infrastructure for using technology to drive economic development. The expansion of industry-led technology partnerships among corporations, governments, and non- profit organizations has also been a key component of growth. Table 10.1 shows some leading technology firms and their number of employees.

Investments in research and development are among the highest return investments a nation can make. Technological innovation has been a key contributor to the nation’s growth in productivity.10 For example, the

ability to access information in real time through the electronic data interface among retailers, wholesalers, and manufacturers has reduced the time it takes to produce and deliver products. Likewise, product design times and costs have declined because computer modeling has minimized the need for architectural drafters and some engineers required for build- ing projects. Medical diagnoses have become faster, more thorough, and more accurate thanks to the accessibility of information and records over the internet, which has hastened treatment and eliminated unnecessary procedures.11

The relationship between businesses and consumers has been trans- formed through e-commerce, as more people turn to the internet to make all type of purchases from one-time purchases to everyday purchases. The sharing of information has led to greater transparency, and social media has facilitated closer communication and greater customer loyalty. Business-to-business (B2B) e-commerce involving companies buying from and selling to each other online is also growing in popularity as it is the preferred method of purchase for more than half of all businesses. Certain aspects of internet transactions are particularly important in B2B relationships, where the improved quantity, reliability, and timeliness of information have reduced uncertainties. It has also facilitated supply chain management as more companies outsource purchasing over the internet.12

Walmart and Amazon are two companies that have not only mastered the management and integration of their supply chains over the years but have also used the internet to establish further efficiencies within the sup- ply chain. Walmart’s technology infrastructure is among the largest in the world and informs operations regarding accurate forecasting of demand and inventory, the most efficient transportation routes, and manage- ment of customer relationships and service response logistics. Amazon has fulfillment centers strategically located in areas where customers can be reached quickly. A technology known as sortation allows Amazon to determine how different items can be combined to efficiently fit into boxes. The software instructs employees on where to store the item in the warehouse and how large a package will be needed when it comes time to ship. Amazon’s expertise at supply chain management has earned it strong accolades and saved it billions of dollars in costs.13

TABLE 10.1 Leading Technology Firms

Company Number of Employees Google 57,100

Intel 107,300

Microsoft 112,689

Apple Inc. 115,000

Sony 131,700

Amazon.com 230,800

Samsung 319,000

IBM 377,757

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Science and technology are powerful drivers of economic growth and improvements in the quality of life in the United States. Advancements in technology have created millions of new jobs, better health and longer lives, new opportunities, and more. Public and private investment in R&D contributes to these advancements and continues to produce more jobs and improve living standards. Industries that have grown as a result of innovations in technology include biotechnology, computers, communica- tions, software, aerospace, and semiconductors. Retailing, wholesaling, and other commercial institutions have also been transformed by technol- ogy as we can tell from the examples of Amazon and Dell above.

Economic Concerns about the Use of Technology Despite the staggering economic growth fostered by technological advance- ments, there are some economic downsides to technology. For instance, some people have lost their jobs because of technology. Technology makes it easier to outsource business activities to other countries with less expen- sive labor, leading to a loss in domestic jobs. Also, many factories have increasingly invested in robotics, which can be used to replace factory workers at a lower cost. Although technology also creates numerous job opportunities, this is little consolation for those who lose their jobs and do not have the technological skills to get new jobs in the growing technologi- cal emerging field.

Small businesses in particular may have difficulty taking advantage of certain opportunities such as digital supply chain management systems or other large-scale information technology (IT) applications. The ability to purchase technology may affect the nature of competition and the suc- cess of various types of businesses. Limited resources and tough economic times may cause small businesses to cancel, modify, or delay IT projects; decrease IT budgets; and reduce staffing and training levels. Experts rec- ommend several solutions to IT problems in small business:

1. Focus on core competencies while seeking to explore outsourcing options. 2. Take advantage of free software and other offerings. 3. Explore the benefits of “cloud computing” where applications are uti-

lized and maintained on a subscription basis. 4. Consider IT infrastructure alternatives to capital expenditures through

hosted hardware, software, and services.14

As mentioned earlier, a key concern today with advancing technol- ogy is the digital divide that occurs when certain groups have limited access to the latest technology. Also, part of the debate involves access issues for certain populations, such as persons with disabilities, people who are barely literate, the distribution of technology among low- income and high-income households, and accommodations for senior citizens.15

There are several ways to address these inevitable consequences of accelerating change in the technology drivers of the new economy. One way to address the negative consequences of accelerating new technology

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is to assess problems related to its impact on competition. Restraining competition, domestic or international, to suppress competitive turmoil is a major concern of governments. Allowing anticompetitive practices, price fixing, or other unfair methods of competition would be counterproduc- tive to rising standards of living.16

TECHNOLOGY’S INFLUENCE ON SOCIETY Information and telecommunications technology minimizes the borders between countries, businesses, and people and allows people to overcome the physical limitations of time and space. Technological advances also enable people to acquire customized goods and services that cost less and are of higher quality than ever imagined.17

For example, airline passengers can purchase tickets online and either print out boarding passes on their home or office printers or download them to their mobile devices so that they can go straight to their plane on arrival at the airport after clearing security.18 Cartographers and geologists can create custom maps—even in three dimensions—that aid experts in managing water supplies, finding oil, and pinpointing future earthquakes.19 In this section, we explore four broad issues related to technology and its impact on society, including the internet, privacy, intellectual property, and health and biotechnology. Although there are many other pressing issues related to technology, these seem to be the most widely debated at this time.

The Internet The internet, the global information system that links many computer networks together, has profoundly altered the way people communicate, learn, do business, and find entertainment. Although many people believe the internet began in the early 1990s, its origins can be traced to the late 1950s (see Table 10.2). Over five decades, the network evolved from a system for government and university researchers into an information and entertainment tool used by millions around the globe. With the develop- ment of the World Wide Web, which organizes the information on the internet into interconnected “pages” of text, graphics, audio, and video, use of the internet exploded in the 1990s.

Today, more than 3.2 billion people around the world utilize the internet. In the United States alone, nearly 287 million access the internet via comput- ers or mobile devices. Internet use by consumers in other countries, especially Japan (115 million users), the United Kingdom (60 million), Germany (71 million), Brazil (139 million) and France (56 million), has escalated rapidly.20 Figure 10.1 shows the pattern of active internet usage around the world. To keep up with the growing demand for new e-mail and website addresses, the Internet Corporation for Assigned Names and Numbers has added over 300 domain name suffixes to allow for the creation of millions of new addresses. In addition, recent petitions have been approved to allow for hundreds more

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TABLE 10.2 History of the Internet

Year Event 1969 The first node is connected to Advanced Research Projects Agency Network (ARPANET), the initial version of the

internet. ARPANET was a government project created to serve as a communications network during the Cold War.

1972 Email is invented by adapting an internal messaging program and extending it to use the ARPANET to send messages between sites. Within a year, three quarters of ARPANET traffic is email.

1989 The World Wide Web is invented to make information easier to publish and access on the internet.

1993 The first Web-browser, Mosaic, is launched. It introduced proprietary HTML tags and more sophisticated image capabilities. The browser is a massive success and businesses start to notice the web’s potential.

1994 Internet Magazine launches, reporting on London’s first cybercafe and reviewing 100 websites. It was known as the ’most extensive’ list of websites ever to appear in a magazine. A 28.8Kbps modem costs £399 (plus VAT).

Jerry and David’s Guide to the World Wide Web is renamed Yahoo! and receives 100,000 visitors. In 1995, it begins displaying advertisements.

1995 Search engine Alta Vista is launched, which can store and index the HTML from every internet page. It also introduces the first multilingual search.

Amazon.com, an online bookseller that pioneers ecommerce, is launched.

eBay is launched to enable internet users to trade with each other.

1998 Google launches and pioneers a ranking system that uses links to assess a website’s popularity. The site’s simple design is soothing while existing search engines cram their pages with animated advertisements.

2000 The infamous dotcom bust occurs after several years of venture capitalists investing in internet business proposals that do not have a viable business model.

2004 Media companies start selling music and video online. Napster and iTunes are the major players.

Facebook launches at Harvard University. The social networking site gained 30 million members by 2007 and over 200 million active users in 2009.

Photo sharing website Flickr launches, coinciding with the rise in digital photography. (Kodak discontinues reload- able film cameras in Western Europe and North America in this year.)

2006 Twitter is launched.

2010 The industry of big data, or the accumulation of large volumes of varied data that need to be transmitted at very fast speeds, is estimated to be worth more than $100 billion.

2013 Media reports reveal the extent to which national security agencies monitor the online activities of citizens without search warrants.

2015 The Internet of Things, in which consumer or industrial devices are connected to the internet for management and monitoring, became a popular concept in our connected environment.

Facebook has 1.6 billion active users

Sources: Adapted from “A Short History of the Internet,” http://www.sean.co.uk/a/science/history_of_the_internet.shtm (accessed June 22, 2015); Economist staff, “Data, data everywhere,” The Economist, February 25, 2010, http://www.economist.com/node/15557443 (accessed June 22, 2016).

to come into existence. These new suffixes will differ from the traditional website endings such as .com (for companies), .edu (schools and universities), .gov (government agencies and offices), .mil (military use), .net (networks), etc., and will be more descriptive of the website’s purpose or content. For example, a clothing retailer may have the suffix .clothes, while a plumber may have a website ending in .plumbing.21

The interactive nature of the internet has created tremendous oppor- tunities for businesses to forge relationships with consumers and business

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customers, target markets more precisely, and even reach previously inac- cessible markets. The internet also facilitates supply chain management, allowing companies to network with manufacturers, wholesalers, retail- ers, suppliers, and outsource firms to serve customers more efficiently.22 However, widespread use of the internet has also led to the storing of mass amounts of information that hackers and other cybercriminals can take advantage of. Online fraud has become a major issue for businesses and consumers, with U.S. business losing $32 billion in a one year period.23 Interestingly, the rate of online fraud targeting businesses is decreasing, while the rate for consumer online fraud increases. This is largely due to the fact that companies are using more sophisticated methods of tracking abnormal credit and debit transactions. Many are making use of data by analyzing trends such as average amount spent per month and locations where the money is spent. Automated systems quickly keep track of these behaviors and notify customers when there are any abnormalities from the trends.24 However, the methods by which cybercriminals and other hack- ers infiltrate payment and information systems all across the internet are also becoming increasingly sophisticated. It is often hard for the average consumer to spot malware or other viruses created by hackers, which can lead to unknowing participation in scams and significant monetary losses.

Consumers, companies, and governments alike are having difficulty keeping up with the fast pace of cybercriminal technology, and are increas- ingly worried about becoming victims of online fraud. The newspapers have been filled with examples of this over the past few years. Sometimes, consum- ers and companies can become victims of online fraud without making a pur- chase from a personal computer or mobile device. Credit card transactions

Note: *Commonwealth of Independent States (CIS) is a regional organization whose participants are former Soviet Republics.

Source: ITU, “Key 2005-2015 ICT data for the world, by by geographic regions and by level of development,” Interntional Telecommunication Union (ITU), http://www.itu.int/en/ITU-D/Statistics/ Pages/stat/default.aspx (accessed June 22, 2016).

FIGURE 10.1 Use of the Internet around the Globe

Africa

Arab States

Asia and Pacific

CIS (former USSR)

Europe

Americas

193 141

1,506

170

487

651

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occur by means of the internet even when a purchase is made in a physical location. Target’s credit card system was hacked during the holiday season, and personal information from approximately 40 million customers was sto- len. This shows that online fraud can include information as well as money. In addition, some say that the fraudulent methods employed by the cyber- criminals were not especially complex, indicating the commonality of such activities.25 Consumers, government agencies, and merchants are exploring options, including regulation, to protect the security of online transactions.26

It is estimated that by the end of this decade, up to 50 billion things, including cars, household items such as refrigerators, and medical devices, will be hooked up to web connections. Known as the Internet of Things, this phenomenon is already being extensively pursued in countries such as South Korea. The Internet of Things has the potential to greatly enhance our ability to do activities and make devices more efficient. For instance, a doctor with smart medical devices can monitor patients from far away. On the other hand, with cybersecurity risks increasing, many are worried that criminals will use these connections to sabotage or hack into devices. Just as a hacker hacks into a computer, so a criminal might be able to hack into a smart car. The risks are worse because hacking into a smart car or smart medical device could endan- ger lives. Technology firms such as Cisco and IBM are setting up consortiums to identify innovative ways to prevent these attacks. They believe that the sharing of information will help alert both people and companies to risks, prompting them to take action to prevent cybercrimes before they strike.27

Privacy The extraordinary growth of the internet has generated issues related to privacy. As instances of hacking become more commonplace and severe, consumers are realizing the responsibility they have to protect their own privacy. However, while a large percentage of online shoppers are con- cerned about their privacy, many are not taking appropriate measures to protect their information. This is largely a result of consumers feeling like this problem is beyond their control. Table 10.3 describes top privacy concerns for consumers.

Because of the ease of access to personal information, however, unau- thorized use of this information may occur.28 Information can be collected on the internet with or without a person’s knowledge. Many websites fol- low users’ tracks through their site by storing a “cookie,” or identifying string of text, on their computers. These cookies permit website operators to track how often a user visits the site, what he or she looks at while there, and in what sequence. Cookies also allow website visitors to customize services, such as virtual shopping carts, as well as the particular content they see when they log on to a webpage. However, if a website operator can exploit cookies to link a visitor’s interests to a name and address, that information could be sold to advertisers and other parties without the visitor’s consent or knowledge. The potential for misuse has left many consumers rather uncomfortable with this technology.29

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Identity theft, the access and theft of personal information, is a top crime in the nation, with 300,000 identity theft complaints submitted to the Federal Trade Commission (FTC) annually. Fraud is another major type of misconduct. The most common types of theft and fraud include government documents/benefits fraud, the misuse of credit card information, phone or utilities fraud, bank fraud, employment-related fraud, and loan fraud.30 Identity fraud is defined as the use of someone’s personal information to access money. The infraction affects about one person every two seconds in the United States, and the rate of increase is growing rapidly. Data breaches, like the one Target experienced, are the most common source of identity theft and identity fraud. Over 45 percent of those whose information was collected in a data breach experienced fraud in later months, while 28 per- cent of identity theft victims experienced takeovers of their bank accounts. Internal data breaches are also becoming a problem. It is estimated that 27 percent of attacks on organizations come from within the organization from disgruntled employees. New tools such as Scout are being developed that can be used to analyze the language in employee emails and flag any- thing that seems suspicious or that indicates the employee is unhappy. However, this too generates privacy concerns as employees may not realize the language in their emails is being examined.31

Nearly all internet websites require visitors to register and provide information about themselves to access some or all of their content. How this information is used is generating concern. This is another aspect

TABLE 10.3 Top Privacy Concerns

Privacy Issue Concern Example Cookies (tracking) Companies can track where I have been on

the internet Many well-known companies, including Amazon.com, use cookies to track activity

Seizures of cloud data Whatever information I put on cloud sourcing sites belongs to the online service I am using

Government authorities can seize data on crowd sourcing sites such as Google Drive

Location data Companies will know where I am at all times Based on the location of a person’s cell phone, digital coupons could be sent for neighboring businesses

Facial recognition software Online photos can be picked up by an online facial recognition database

Photos posted on Flickr could easily be used in facial recognition

Cybersecurity scanning Government authorities may monitor my online activity in the name of cybersecurity

Government authorities are increasing their scanning to try and detect cyber risks before they hit—possibly leading to monitoring of consumer posts in the process

Marketing research My data on social networks will be used for advertising, marketing research, and other purposes

Facebook conducted a study which involved manipulating the news feeds of some users to monitor how they react

Hacking My personal identifying data such as credit card and social security numbers are not safe

Criminals hacked into Target’s system and stole the personal information of millions of customers

Source: Adapted from Melissa Riofrio, “The 5 Biggest Online Privacy Threats of 2013,” PC World, April 8, 2013, http://www.pcworld. com/article/2031908/the-5-biggest-online-privacy-threats-of-2013.html (accessed June 22, 2016).

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of the big data concept mentioned earlier in the chapter. A variety of organizations have been collecting and storing information on consumers for years and are now able to see trends and behaviors. This informa- tion is valuable to companies that want to better target people’s buying behaviors and interests, and it is becoming a multi-billion dollar industry. For example, Facebook is generating revenue by allowing companies to access users’ email addresses and phone numbers in order to better target their advertising efforts, while Barclays announced that it would begin selling information to third parties. The bank assured customers that their information would be presented along with many others to show trends rather than distinctive personal information. However, because there are no current regulations regarding the selling of customer information, many people are concerned about the practice.32

Privacy issues remain at the forefront of the FTC’s investigative and enforcement activities. Snapchat, a mobile messaging service, settled a case with the FTC regarding misstatements of privacy measures. The messag- ing service distinguished itself on the basis of privacy concerns by allow- ing users to send messages that would disappear within seconds of being opened. They promised users that their messages would not be stored in databases nor would they collect any personal information. The FTC found otherwise. Not only were the message contents stored, an unsecure feature in the app allowed hackers to steal information from more than 4 million users.33

Privacy issues related to children are generating even more debate, as well as laws to protect children’s interests. The U.S. Children’s Online Privacy Protection Act (COPPA) prohibits websites and internet providers from seeking personal information from children under age 13 without parental consent.34 The law was recently amended to protect children’s privacy in using social media sites and mobile devices. However, issues still exist. For example, photosharing app Instagram has received criticism for allowing children under the age of 13 to join the site. The company’s policy is that only users above the age of 13 are allowed to join, but enter- ing a date of birth upon registering is not required, making it difficult to track underage users. A Pew poll indicated that Instagram is the third most popular site among teens, and this con- cerns parents because their children are posting pictures of themselves and their friends along with the locations they frequent. This can make them vulner- able to predators or create other dan- gerous situations. This is an issue that many social networking sites, including Facebook, Tumblr, and Twitter, are also dealing with. Parents are calling for tighter company controls and monitor- ing of user ages.35 Table 10.4 provides recommendations for improving child safety on the internet.

TABLE 10.4 Six Tips to Improve Child Safety on the Internet 1. Know what your children are doing online.

2. Get to know the technologies your children are using.

3. Discuss the risks with your children and agree on some rules for internet use.

4. Install an internet content filter.

5. Make sure your children know not to share personal information or photos.

6. Report inappropriate, harmful, or criminal activities that occur online or on a mobile device.

Source: ”Protect Your Children,” Stay Smart Online, http://www.staysmart online.gov.au/home_users/protect_your_children (accessed July 14, 2014).

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Ethical Responsibilities in Human Resources

Big Brother IS Watching You With the explosion of social media sites, a person’s private details are increasingly becoming public infor- mation. Individuals like to share their lives through postings, photos, videos, and other content with friends or acquaintances. However, due to the public nature of social media, much of what a person puts up about him or herself could be viewed by individuals that the user did not anticipate—including employ- ers. According to a survey, 39 percent of employers research potential job candidates using social media. Employers recognize that an employee’s online pres- ence speaks volumes about his or her character; 43 per- cent of employers who research job candidates’ online profiles have reported that they have eliminated candi- dates from consideration because of what they found out about them online.

Many users of social media place privacy controls on their pages to keep unauthorized people from seeing their activities. However, employers have a way of getting beyond these controls by asking employees or candidates for hire for their login and password information. In most states, this is not yet illegal. There is currently legislation pending in 23 states to address this issue. While some states have barred private employers from asking employees this question, public employers are not necessarily covered. Needless to say, many employees and regu- lators believe that requiring employee information to monitor their personal social media activities is an invasion of privacy.

However, with so many people engaging in social media, work life and personal life have become blurred. It is not uncommon for an employee who might have once kept something private, such as a complaint about a job, to post it online for others to see. Carelessly posting something regarding company product intro- ductions or financials could be devastating for a firm if it gets out beforehand. For this reason, the Financial Industry Regulatory Authority and Wall Street are ask- ing regulators to make an exception for employees in the financial industry. Worries of insider trading, poten- tial Ponzi schemes, and influencing stock activity on the market are at the heart of this request. For instance, one CFO was fired after venting on social media using confidential financial information. Such information could negatively impact the firm if released early.

Regulators allow financial firms to communicate information through social media outlets as long as they disclose to the investor where, when, and how they plan to divulge this information. This could lead employees to believe it is also all right to discuss non- public information on social media. Financial firms are concerned that by protecting employees’ privacy on social media, they become vulnerable to potential scandals involving the misappropriation of financial information, which could harm investors. While the requested amendment to the privacy laws will only be put to use if an employee is suspected of releasing unwarranted information, critics believe that such an exception will erode employee privacy altogether.

Sources: Jean Eaglesham and Michael Rothfeld, “Wall Street vs. Its Employees’ Privacy,” The Wall Street Journal, April 22, 2013, p. A1; Jennifer Van Grove, “Securities Regulators Balk at Employee Social Media Privacy,” CNet, April 22, 2013, http://news.cnet.com/8301- 1023_3-57580814-93/securities-regulators-balk-at-employee-social-media-privacy/ (accessed August 5, 2016); Rachel Emma Silverman, “Facebook and Twitter Postings Cost CFO His Job,” The Wall Street Journal, May 14, 2012, http://online.wsj.com/article/SB100014240527 02303505504577404542168061590.html (accessed August 5, 2016); National Conference of State Legislators, “Employer Access to Social Media Usernames and Passwords,” http://www.ncsl.org/research/telecommunications-and-information-technology/employer-access-to- social-media-passwords-2013.aspx (accessed August 5, 2016); John Weber, Nancy Flynn, and Lewis Maltby, “Should Companies Monitor Their Employees’ Social Media?” The Wall Street Journal, May 11, 2014, http://online.wsj.com/news/articles/SB100014240527023038256 04579514471793116740 (accessed August 5, 2016); Marcia Heroux Pounds, “Does your boss have a right to know your Facebook pass- word?” Sun Sentinel, November 13, 2015, http://www.sun-sentinel.com/business/fl-facebook-employers-legislation-20151113-story.html (accessed August 5, 2016).

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Some measure of protection for personal privacy is already provided by the U.S. Constitution as well as Supreme Court rulings and federal laws (see Table 10.5). The FTC also regulates, enforces privacy standards, and monitors websites to ensure compliance. Similar laws are coming into existence to address privacy issues resulting from mobile device use. The Location Privacy Protection Act addresses the use of GPS devices in the following areas: companies are required to obtain users’ permission before collecting location information, mobile apps created explicitly for stalking are prohibited, and companies that collect location information of more than 1,000 devices must post the details of what is collected and how it is used on the website. These are just a few provisions of the law.36

Unsurprisingly, many other issues regarding mobile and internet pri- vacy exist. For example, company privacy statements are often lengthy and filled with legal jargon that the average consumer will not understand if they take the time to read them. The FTC has set out some best practices for mobile companies to be more transparent. Some of these principles include creating “just-in-time” permission requests for the company to col- lect location, personal information, photos, etc., and instituting a “Do Not Track” feature on devices and websites so the user has a choice as to the data being collected.37 The Commission has also addressed best practices for mobile payment security and children’s use of mobile applications.38 These best practices are important guidelines for companies to follow to avoid litigation and protect the privacy of customers.

International Initiatives on Privacy The European Union (EU) has made great strides in protecting the privacy of its citizens. The 1998 European Union Directive on Data Protection specifically requires companies that want to collect personal information to explain how the information will be used and to obtain the individual’s permission. Companies must make customer data files available on request, just as U.S. credit-reporting firms must grant customers access to their personal credit histories. The law also bars website operators from selling e-mail addresses and using cookies to track visitors’ movements and preferences without first obtaining permis- sion. Because of this legislation, no company may deliver personal infor- mation about EU citizens to countries whose privacy laws do not meet EU standards.39 In an effort to further protect citizens’ privacy, the EU instituted the “right to be forgotten” rule, which mandates that internet companies erase search results of individuals who make such a request. This has sparked some controversy in the United States. Critics claim the law will hinder the sharing of information and law enforcement activi- ties. EU legislators are also working on making data collection a choice of the user rather than the company offering the service. One proposal will require that companies specifically detail each data item that they will col- lect and how it will be used. Also, they would not be allowed to begin the process of collecting data until they have received permission from the user. Such regulations highlight the differences in how Europeans and Ameri- cans approach online privacy.40

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TABLE 10.5 Privacy Laws

Act (Date Enacted) Purpose Privacy Act (1974) Requires federal agencies to adopt minimum standards for collecting and processing

personal information; limits the disclosure of such records to other public or private parties; requires agencies to make records on individuals available to them on request, subject to certain conditions.

Right to Financial Privacy Act (1978)

Protects the rights of financial institution customers to keep their financial records private and free from unjust government investigation.

Computer Security Act (1987) Brought greater confidentiality and integrity to the regulation of information in the public realm by assigning responsibility for the standardization of communication protocols, data structures, and interfaces in telecommunications and computer systems to the National Institute of Standards and Technology (NIST), which also announced security and privacy guidelines for federal computer systems.

Computer Matching and Privacy Protection Act (1988)

Amended the Privacy Act by adding provisions regulating the use of computer matching, the computerized comparison of individual information for purposes of determining eligibil- ity for federal benefits programs.

Video Privacy Protection Act (1988)

Specifies the circumstances under which a business that rents or sells videos can disclose personally identifiable information about a consumer or reveal an individual’s video rental or sales records.

Telephone Consumer Protection Act (1991)

Regulates the activities of telemarketers by limiting the hours during which they can solicit residential subscribers, outlawing the use of artificial or prerecorded voice messages to residences without prior consent, prohibiting unsolicited advertisements by telephone facsimile machines, and requiring telemarketers to maintain a “do not call list” of any consumers who request not to receive further solicitation.

Driver Privacy Protection Act (1993)

Restricts the circumstances under which state departments of motor vehicles may disclose personal information about any individual obtained by the department in connection with a motor vehicle record.

Fair Credit Reporting Act (amended in 1997)

Promotes accuracy, fairness, and privacy of information in the files of consumer report- ing agencies (e.g., credit bureaus); grants consumers the right to see their personal credit reports, to find out who has requested access to their reports, to dispute any inaccurate information with the consumer reporting agency, and to have inaccurate information corrected or deleted.

Children’s Online Privacy Protection Act (amended in 2013)

Regulates the online collection of personally identifiable information (name, address, e-mail address, hobbies, interests, or information collected through cookies) from children under age 13 by specifying what a website operator must include in a privacy policy, when and how to seek consent from a parent, and what responsibilities an operator has to protect children’s privacy and safety online.

Sources: “Computer Matching and Privacy Protection Act,” Internal Revenue Service, http://www.irs.gov/irm/part11/irm_11-003-039. html (accessed June 22, 2016); “United States Privacy Laws,” Information Shield, http://www.informationshield.com/usprivacylaws.html (accessed July 14, 2014).

In Canada, private industry has taken the lead in creating and develop- ing privacy policies through the Direct Marketing Association of Canada (DMAC). The DMAC’s policies resulted in the proposal of legislation to pro- tect personal privacy. The Personal Information Protection and Electronic Documents Act established a right of personal privacy for information col- lected by Canadian businesses and organizations. The law instituted rules governing the collection, use, and disclosure of personal information in the private sector. It also works in conjunction with other legislation that

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protects personal information collected by federal and/or provincial govern- ments. The Canadian Standards Association (CSA) was also instrumental in bringing about privacy protection guidelines in Canada. The CSA Model Code for the Protection of Personal Information requires organizations to protect personal information and to allow individuals access to their own personal information, allowing for correction if necessary.41

In Japan, the Ministry of International Trade and Industry established the Electronic Network Consortium (ENC) to resolve issues associated with the internet. The ENC (which comprises 93 organizations) has pre- pared guidelines for protecting personal data gathered by Japanese online service providers. These guidelines require websites to obtain an individ- ual’s consent before collecting personal data or using or transferring such data to a third party. The guidelines also call for organizations to appoint managers who understand the ENC guidelines to oversee the collection and use of personal data and to utilize privacy information management systems such as the Platform for Privacy Protection (P3P).42 P3P is a set of standards recommended by the World Wide Web Consortium that would permit websites to translate their privacy statements and standards into a uniform format that Web-browsing software could access to supply users with relevant information about a particular firm’s policies. Website visi- tors could then decide what information, if any, they are willing to share with websites.43 However, P3P has not been widely implemented, and Internet Explorer is the only major browser to make use of P3P. Critics maintain that P3P makes it too difficult for consumers to protect their privacy online. Google has claimed P3P privacy protection features are “impractical” for the modern Web. These sites have adopted alternative tools for their websites’ privacy policies.44

Protection of citizens’ privacy on the internet is not a major public con- cern in Russia. For many years, internet activity was largely left unmoni- tored, and citizens and companies were able to do what they wanted with data. However, the Russian parliament passed legislation requiring internet companies to store Russian users’ data within the country’s borders. The country will put restrictions on how the companies can use the data if they do not comply with these storage measures, and will most likely ask them to stop doing business in the country. In addition, the government granted themselves the authority to block websites. In conjunction with this law, another deemed the “bloggers law” requires influential bloggers (those whose site is visited more than 3,000 times per day) to register with the state. This limits the amount of outspoken writers who have previously been able to anonymously voice their opinions without fear. While the gov- ernment claims to be doing this for the sake of protecting people’s privacy, ensuring national security and protecting against piracy, many conclude that it is for the purpose of controlling free speech and censorship.45

Privacy Officers and Certification Businesses are beginning to recognize that the only way to circumvent further government regulation with respect to privacy is to develop systems and policies to protect consumers’ interests.

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In addition to creating and posting policies regarding the gathering and use of personal information, more companies—including American Express, AT&T, and Citigroup—employ chief privacy officers (CPOs). The Inter- national Association of Privacy Professionals (IAPP) was established as a result of this movement, and is responsible for developing and launching the first broad-based credentialing program in information privacy. This program is known as the Certified Information Privacy Professional (CIPP). Most healthcare related businesses must appoint a privacy official to safe- guard patient data. High-level executives are typically given broad powers to establish policies to protect consumer privacy and, in so doing, to protect their companies from negative publicity and legal scrutiny. Table 10.6 lists the major provisions of the FTC’s Fair Information Practices, which can be used as a starting point in developing a corporate privacy policy.

Several organizations have also stepped in to help companies develop privacy policies. Among the best known are TRUSTe and Guardian. TRUSTe is a for-profit organization devoted to promoting global trust in internet technology by providing a standardized, third-party oversight pro- gram that addresses the privacy concerns of consumers, website operators, and government regulators. Companies that agree to abide by TRUSTe’s privacy standards may display a “trustmark” on their websites. These firms must disclose their personal information collection and privacy policies in a straightforward privacy statement. TRUSTe is supported by a network of corporate, industry, and nonprofit sponsors.46 For example, eBay’s website is TRUSTe certified, which means that its online privacy practices fulfill TRUSTe’s requirements. The online auction company’s privacy policy promises that eBay will not share any personal information gathered from customers with any third parties and specifies how it will

TABLE 10.6 Fair Information Practice Principles Notice Websites would be required to provide consumers clear and conspicuous notice

of their information practices, including what information they collect, how they collect it, how they use it, how they provide Choice, Access, and Security to consumers, whether they disclose the information collected to other entities, and whether other entities are collecting information through the site.

Choice Websites would be required to offer consumers choices as to how their personal identifying information is used beyond the use for which the information was provided. Such choice would encompass both internal secondary uses and external secondary uses.

Access Websites would be required to offer consumers reasonable access to the infor- mation a Web site has collected about them, including a reasonable opportunity to review information and to correct inaccuracies or delete information.

Security Websites would be required to take reasonable steps to protect the security of the information they collect from consumers.

Source: Federal Trade Commission, “Privacy Online: Fair Information Practices In The Electronic Marketplace,” May 2000, https://www.ftc.gov/reports/privacy-online-fair-information-practices- electronic-marketplace-federal-trade-commission (accessed June 22, 2016).

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use the information it obtains. TRUSTe maintains the largest privacy seal program, with thousands of websites certified throughout the world. The organization is very active in educating and encouraging companies to improve privacy, security, and related aspects of business.

The mission of Guardian is to promote trust and confidence in e- commerce by encouraging ethical business practices. The Guardian eCommerce SSL Privacy Seal Program provides verification of trustworthy sites, as companies that receive the seal must abide by Guardian’s code of ethics. The code of ethics is comprised of seven sections outlining the following important practices: honesty and integrity; disclosure of informa- tion; terms of sale; trust, online privacy, and e-commerce security; customer satisfaction; the protection of children; and abiding by the law. Guardian’s strong oversight and evaluation methods ensure that seal-bearing websites are operating legally and truthfully, according to the code of ethics. For example, websites are checked for accuracy and functionality regard- ing description of services and contact information, the establishment and enforcement of privacy policies, and reputation among other online businesses.47

Intellectual Property In addition to protecting personal privacy, many are concerned about protecting their rights to property they create, including songs, movies, books, and software. Such intellectual property (IP) consists of the ideas and creative materials developed to solve problems, carry out applica- tions, educate, and entertain others. It is the result, or end product, of the creative process. Intellectual property is most commonly protected by patents and copyrights; however, technological advancements are increas- ingly challenging the ownership of such property. Online advertising is one of these challenging areas, as Google has experienced. The company has been sued by several companies regarding the selling of trademarked keywords in Google AdWords. For instance, Rosetta Stone filed a lawsuit against Google for allowing other companies—including competitors—to purchase Rosetta Stone’s trademarked names to use as key search words. These keyword searches would generate “sponsored links” advertisements on search results Web pages. The two companies eventually reached a settlement.48 While this may be considered a general competitive practice, intellectual property protections complicate the matter and require clear guidelines internet firms can use to deal with this issue.

Intellectual property losses in the United States total more than $300 billion a year in lost revenue from the illegal copying of computer pro- grams, movies, compact discs, and books. IP losses also relate to stolen business plans, customer-related information, basic research reports, manufacturing process plans, product specifications, and many other proprietary documents. IP and other intangible assets typically represent about 70 percent of a company’s value and source of revenue creation. Some experts estimate that companies lose several billions of dollars in

Intellectual property (IP) Consists of the ideas and creative materials developed to solve problems, carry out applications, educate, and entertain others.

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proprietary information and intellectual property each year through a variety of channels.49 Most cases involve one of the following scenarios:

1. Inadvertent actions by current or former employees, such as oral semi- nar presentations, discussions at an exhibit booth, and electronically misdirected fax and/or e-mail.

2. Deliberate actions by current or former employees, such as unauthorized physical access to information and deliberate disclosure to unauthorized parties.

3. Deliberate actions by individuals/entities in trusted relationships other than employee relationships, such as the exploitation of vendor-client relationships, subcontractor knowledge, joint ventures, and other rela- tionships.

4. Deliberate actions or activities by outsiders—those without a trusted relationship, such as data mining of open-source data and public infor- mation and the practice of hiring away employees and placing them in a position where they must use trade secrets from a former employer.50

This issue has become a global concern because of disparities in enforcement of laws throughout the world. For example, a report by the IP Commission revealed an instance wherein an American software company’s software was downloaded illegally onto 30 million Chinese computers—a multibillion-dollar infraction.51 The Business Software Alliance says 39 percent of software installed on computers worldwide is unlicensed. Chief information officers believe that 15 percent of employ- ees install unlicensed software on work computers. This is particularly concerning because malware attacks are greater with unlicensed software. It is estimated that cyberattacks cost companies $400 million annually. Russia and China are the two worst countries in terms of piracy viola- tions. It is predicted that the trade-related aspects of intellectual property rights disputes will make countries more accountable for adhering to copyright standards.52 Former U.S Attorney General Eric Holder indicted five Chinese military officials after discovering they had hacked into the systems of several American organizations. The allegations included steal- ing thousands of emails in order to obtain trade secrets and other intel- lectual property. Those companies whose systems were infiltrated included U.S. Steel Corp., Westinghouse Electric Co., and Alcoa Inc. Other cases of foreign IP theft are being investigated against Russia, Syria, and Iran.53

Microsoft has been particularly aggressive in battling software piracy. In one year alone, the company settled 3,265 cases related to copyright infringement worldwide. Only 35 of these cases took place in the United States, while 3,230 were international cases encompassing 42 countries. The company’s efforts to stamp out piracy have been facilitated by cus- tomers reporting the illegal activity.54 Microsoft is working to transform the economics of the software business, allowing cheaper, more innovative software to be available for legitimate, paying customers, as well as some free online software options.55 Microsoft has even opened up a howto- tell.com website for people to consult when loading software onto their

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computers. The website helps educate customers on how to tell if their software is genuine.

U.S. copyright laws protect original works in text form, pictures, movies, computer software, musical multimedia, and audiovisual work. Owners of copyrights have the right to reproduce, derive from, distrib- ute, and publicly display and perform the copyrighted works. Copyright infringement is the unauthorized execution of the rights reserved by a copyright holder. Congress passed the Digital Millennium Copyright Act (DMCA) in 1998 to protect copyrighted materials on the internet and to limit the liability of online service providers (OSPs). The DMCA provides a “safe harbor” provision that limits judgments that can be levied against OSPs for copyright infringement by their customers. To limit their liability, service providers must pay a nominal fee and comply with the act’s report- ing requirements.56

Digital copyright violations are not always clear cut and often involve lengthy lawsuits that can progress all the way to the higher courts. Streaming technology company Aereo Inc. sold equipment that captured broadcast signals from major broadcasting networks. Aereo’s service allowed customers to download television shows onto their mobile devices the day after they aired for $8 per month. Broadcasters sued Aereo for copyright infringement since it was not licensing the content to resell. Aereo claimed it was simply a provider of equipment similar to a cable company. The Supreme Court ruled against Aereo Inc. and ordered Aereo to halt its services.57 Table 10.7 provides additional facts about copyrights.

The internet has created other copyright issues for some organiza- tions that have found that the web addresses (URLs) of other online firms either match or are very similar to their own trademarks. In some cases, “cybersquatters” have deliberately registered web addresses that match or relate to other firms’ trademarks and then have attempted to sell the registration to the trademark owners. A number of companies, including Taco Bell, MTC, and KFC, have paid thousands of dollars to gain con- trol of names that match or parallel company trademarks.58 Registering a domain name involves filling out an online form to automatically reserve a domain name. This process makes it easy for cybersquatters or other scammers looking to defraud businesses and consumers. The Federal Trademark Dilution Act of 1995 was enacted to help companies resolve this conflict. The law gives trademark owners the right to protect their trademarks, prevents the use of trademark-protected entities by others, and requires cybersquatters to relinquish trademarked names.59 However, this does not always hold up in foreign countries that do not have strict intellectual property laws. Starbucks first filed for a trademark in Russia in the 1990s, but because it did not open any stores, a Russian lawyer used a loophole to convince the government to annul Starbucks’ trade- mark registration. He then registered the company name and offered to relinquish it to Starbucks for $600,000. Although Starbucks eventually prevailed in a lawsuit, the legal entanglements kept the firm from opening Starbucks locations in Russia for three years.60

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TABLE 10.7 Facts About Copyrights -

tion is required to place copyright notice on works [© Year Name of Owner]. (No  “innocent infringers” if there is notice on the work.). Copyright registration is required before a law- suit may be brought. (See U.S. Copyright Office)

creator of works may have relinquished his or her rights, or it may not be copyright protectable.

involves weighing four factors (See US Copyright Office Publication) and the use of a work for criticism, comment, news reporting, teaching, scholarship, research, or parody.

new owner does not now possess the copyright but can sell the copy or give it away with- out the copyright owner’s permission.

the exception of works that fall under the “fair use doctrine,” derivative works cannot be sold without permission from the original copyright holders.

(for “innocent infringers”) up to $150,000 for intentional, willful violations. Remedies can go up or down depending upon whether the copyright violation was intentional or not.

Source: Derived and paraphrased with permission from Willow Misty Parks, ©Copyrights and Businesses, PPT presentation on UNM Daniels Fund Ethics Initiative website, http://danielsethics.mgt. unm.edu/teaching-resources/presentations.asp (accessed June 22, 2016); “The U.S. Copyright Office,” http://copyright.gov.

The Internet Corporation for Assigned Names and Numbers (ICANN), a nonprofit organization charged with overseeing basic technical matters related to addresses on the internet, has had success, including the intro- duction of a competitive domain registrar and registration market, the Uniform Dispute Resolution Policy (UDRP), and the creation of seven new top-level domains.61 Many trademark holders immediately turn to the Internet Corporation for Assigned Names and Numbers’ Uniform Dispute Resolution Policy as a vehicle for combating cybersquatters. However, rem- edies available in federal court under the Anti-Cybersquatting Consumer Protection Act may better protect the rights of trademark holders. All ICANN-authorized registrars of domain names in the .com, .net, and .org top-level domains must agree to abide by the UDRP. Under the terms of the UDRP, a domain name will be transferred between parties only by agreement between them or by order of a court of competent jurisdiction or a UDRP-authorized dispute resolution provider.62

Since ICANN is overseen by the U.S. Department of Commerce, lead- ers in other countries have begun to question whether the United States has too much control of the internet. Under the philosophy that the internet is above the domain of any one government, these leaders pose several con- cerns. First, ICANN controls the master root file that provides users with access to the internet. Some countries have threatened to develop a com- peting master root file, which would create parallel internets. China has already developed a competing file and is encouraging other countries to

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join its effort. Second, ICANN has the power to affect selective parts of the internet. For example, ICANN delayed adoption of a new .xxx top-level domain (TLD) for adult content because of pressure from U.S. govern- ment agencies. It went into operation in 2011.63 Third, because ICANN is a private corporation performing a significant public service, critics point to a lack of transparency and effectiveness in its operations and decisions. Finally, some leaders worry that ICANN will serve as a social and cultural gatekeeper, since all new TLD names and other requests must be approved by ICANN. The debate over governance of the internet is related to a num- ber of significant issues, including intellectual property, privacy, security, and other top-level concerns of the public and government.64

Health and Biotechnology The advance of life-supporting technologies has raised a number of medi- cal and health issues related to technology. Bioethics refers to the study of ethical issues in the fields of medical treatment and research, including medicine, nursing, law, philosophy, and theology, though today medi- cal ethics is also recognized as a separate discipline.65 All of these fields have been influenced by rapid changes in technology that require new approaches to solving issues. Genetic technologies have shown promise in giving medical ethics an even greater role in social decision-making. For example, the Human Genome Project, a program to decode the entire human genetic map, identified a number of genes that may contribute to particular diseases or traits.

Because so many of our resources are spent on healthcare, the role of the private sector in determining the quality of healthcare is an important consideration to society. The pharmaceutical industry, for example, has been sharply criticized by politicians, health-care organizations, and con- sumers because of escalating drug costs. Investigators from federal and state agencies all over the nation have initiated legal action over allegations that Medicare and Medicaid overpaid for drugs by $1 billion or more a year.66 T. Mark Jones, founder of Ven-A-Care, a company that acts as a whistleblower on account of taxpayers, built a business on stopping pharmaceutical com- panies from overcharging Medicare. Since 1995, Ven-A-Care has restored $3 billion back to the taxpayers, and was awarded $597.6 million in awards, making it the most successful whistleblower in the United States.67 On the other hand, pharmaceutical companies claim that the development of new lifesaving drugs and tests requires huge expenditures in research and development. The pharmaceutical industry is among the most profitable U.S. industries and spends billions each year in marketing, including drug samples provided to doctors, advertising in medical journals, and other strategies. More than $5 billion is spent by the pharmaceutical industry on direct-to-consumer advertising.68 The visibility of pharmaceutical advertis- ing and promotion prompted Pharmaceutical Research & Manufacturers of America, an industry association, to develop its Guiding Principles on Direct-to-Consumer (DTC) Advertising. The voluntary guidelines are

bioethics Refers to the study of ethical issues in the fields of medical treatment and research, including medicine, nursing, law, philosophy, and theology.

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designed to ensure that DTC advertising is accurate, accessible, and useful. Table 10.8 shows the preamble that accompanies the association’s booklet on the guiding principles.

Biotechnology The biotechnology industry emerged over 40 years ago when Stanley Cohen and Herbert Boyer published a new recombinant DNA technique, a method of making proteins, such as human insulin, in cultured cells under controlled manufacturing conditions. Boyer went on to co-found Genentech, which is one of the most well-known biotechnology companies. From these insights, other scientists set out to map the human genome, a 13-year project to discover all of the estimated 20,000–25,000 human genes and make them accessible for further biological study. The ability to map the human genome has spurred over 250 new vaccines and medicines, and many more are being tested in product trials. These inno- vations are changing the way that cancer, diabetes, AIDS, arthritis, and multiple sclerosis are treated. Biotech innovations in other fields, such as manufacturing, have led to cleaner processes that produce less waste and use less energy and water. Most laundry detergents marketed in the United States contain biotechnology-based enzymes that combine better with bleach, are biodegradable, and reduce the need for hot water. Law enforcement officials used DNA finger printing, a biotech process, to catch criminals, increase conviction rates, and perform stronger investigations and forensic science.69 There are over 1,300 biotechnology companies in the United States in a variety of sectors including health, agriculture, and

TABLE 10.8 Preamble to PhRMA Guiding Principles for Direct-to-Consumer Advertisements

Preamble Given the progress that continues to be made in society’s battle against disease, patients are seeking more information about medical problems and potential treatments so they can better understand their healthcare options and communicate effectively with their physicians. An important benefit of direct-to-consumer (DTC) advertising is that it fosters an informed conversation about health, disease and treatments between patients and their healthcare practitioners.

A strong empirical record demonstrates that DTC communications about prescription medicines serve the public health by:

Increasing awareness about diseases;

Educating patients about treatment options;

Motivating patients to contact their physicians and engage in a dialogue about health concerns;

Increasing the likelihood that patients will receive appropriate care for conditions that are frequently under-diagnosed and under-treated; and

Encouraging compliance with prescription drug treatment regimens.

Source: Pharmaceutical Research and Manufacturers of America, “PhRMA Guiding Principles: Direct-to-Consumer Advertisements About Prescription Medicines,” http://www.phrma.org/sites/ default/files/pdf/phrmaguidingprinciplesdec08final.pdf (accessed June 22, 2016).

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industrial.70 Finally, the biotechnology industry invests approximately $50 billion per year in research and development activities.71

The government and the private sector often partner with academic researchers and nonprofit institutes to develop new technologies in health and biotechnology. Research ranges from mapping the human genetic code to finding drugs that cure cancer to genetically modifying food products. Many of these collaborative efforts to improve health involve scientists, funded globally by a variety of sources. For example, the Avon Foundation donated more than $800 million through its Avon Breast Cancer Crusade, which supports virtually every facet of the cause by funding five critical areas: breast cancer biomedical research, clinical care, support services, education, and early detection programs.72 National Institutes of Health scientists created great excitement when they reported that embryonic stem cells had been coaxed to form pancreatic cells that make insulin, a potential treatment for diabetes. But another study suggests that the cells didn’t really make insulin and instead just absorbed it from the culture medium they were grown in and later released it.73 Using cell-engineering techniques, scientists may have found a way to generate unlimited sup- plies of brain cells for transplanting into patients with ALS, Parkinson’s disease, epilepsy, and stroke. Other advances have revealed ways to slow the progression of Alzheimer’s disease and provide treatments for blind- ness.74 These examples illustrate technology advances that could result in commercially viable products that save and/or prolong life.

Cloning, the replication of organisms that are genetically identical to the parent, has become a highly controversial topic in biotechnology and bioethics. Human cloning has raised unanswered questions about the future of human reproduction. Since Scottish scientists first cloned Dolly the sheep, scientists have also successfully cloned mice, cows, pigs, goats, and cats but with mixed reports about the health of the cloned progeny. While cloning humans would appear to be the final step of scientific repro- duction, indisputable proof of the first human clone will actually serve as a starting point for many years of research. Like in vitro fertilization, human clones will need to grow up before scientists know the effects that this process will have on a person’s physical, mental, and emotional states.75 Cloning has the potential to revolutionize the treatment of diseases and conditions such as Parkinson’s disease and cancer. Stem cell technol- ogy has allowed doctors to create replacement organs, thereby restoring infected organs and lengthening human lives.76 The ability to create and modify life processes is often generated through collaborative research involving businesses, universities, and government. The results of such research have already contributed to life-altering products of the future, and more progress is expected for years to come.

Despite the potential of this technology, many people have negative views about cloning. Some contend that it is unethical to “meddle with nature,” whereas others believe that cloning is wrong because every time it is used to treat a patient, a cloned human embryo is destroyed.77 New processes in cloning and stem cell research have reduced the need for

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embryos since cells can be taken from consenting adults without inva- sive procedures. Nevertheless, ethical concerns exist.78 The cloning of a miniature pig, named Goldie, lacking both copies of a gene involved in immediate immune rejection has brought the prospect of transplanting pig organs into people a little closer. The small pig’s organs are similar in size to those of humans, and the missing genes make the organs less likely to be rejected. But although Goldie’s creation may have solved the problem of immediate transplant rejection, there is a slower rejection in which the transplant is attacked by the recipient’s white blood cells.79 Some people argue that cloning of human beings should be banned, and several bills have been introduced in Congress and various state legislatures to do just that. Additionally, 19 European nations have signed an agreement prohibiting the genetic replication of humans. Harvesting stem cells from surplus in vitro fertilization (IVF) embryos is allowed by the Australian government, and the United Kingdom allows researchers to harvest stem cells from surplus IVF embryos and to conduct therapeutic cloning. In the past, the United States restricted federally funded researchers from pursu- ing therapeutic cloning or harvesting stem cells from discarded embryos. However, today the ban is lifted, allowing both public and private entities to conduct research.80

Genetic research holds the promise to revolutionize how many dis- eases are diagnosed and treated. However, consumer advocates urged the World Trade Organization (WTO) to place limits on gene patents, which they claim are tantamount to “ownership of life.” As patents dealing with human DNA increased, worries about the limitations on ownership also increased. These worries came to the forefront of a Supreme Court deci- sion that stated natural DNA cannot be patented as it does not fit within the characteristics of things that can be patented (“novel, useful, and non-obvious”), but complementary DNA (a copy of the original) can be patented. While this may seem a straightforward solution to the advocates’ concerns, these definitions are not as distinct as they sound. There are times when complementary DNA contains components that are both natu- ral and synthetic. Many other issues arise from patents relating to genetics whether they belong to humans, animals, or even plants. For example, Monsanto has been involved in many lawsuits regarding the patents of their genetically modified seeds. As more discoveries are made in the field, more complexities in the realm of laws and ethics will be made manifest.81

A final concern with genetics is the increasing availability of direct-to- consumer testing kits. With these kits, consumers can proactively manage their health, including gaining access to knowledge about predispositions to cancer, diseases, and illnesses. Most specialists agree that the results of such tests are best delivered in a professional medical setting, not via the internet or mail. A consumer could receive a positive finding on a DNA-based pros- tate cancer screening test through a mail-order kit, and may take measures to self-treat rather than consult a doctor. Other dangerous situations may ensue, as receiving the news of potentially having cancer is hard to hear. In addition, the result of the test may not be straightforward. For instance, the

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consumer may have cancerous growths that can be removed, cancer that has spread, or neither because the test is a false positive. Medical advice is warranted at this point because the consumer has no way of determining the appropriate course of action. Genetic testing company 23andMe was ordered by the FTC to stop selling their tests for these reasons.82

Genetically Modified Foods More than 800 million people around the world don’t have enough to eat. Increasing food production to satisfy the growing demand for food without increasing land use will require farmers to achieve significant increases in productivity. Genetically modified (GM) foods offer a way to quickly improve crop characteristics such as yield, pest resistance, or herbicide tolerance, often to a degree not possible with tradi- tional methods. GM crops can be manipulated to produce completely arti- ficial substances, from the precursors of plastics to consumable vaccines.83 Also discussed in Chapter 11, genetically modified, or transgenic, crops are created when scientists introduce a gene from one organism to another. Scientists believe that genetically engineered crops could raise overall crop production in developing countries by as much as 25 percent.84 The idea that GM crops can significantly reduce world hunger is hotly debated. Some say it will make all the difference, while others point out issues with these claims. For example, a large population of the developing world suf- fers from hunger and malnourishment. A new development called “golden rice” is said to be high in vitamin A and can serve as a food source for these people. However, it has been noted that the “golden rice” will require fertilizer, pesticides, significant amounts of water, and corresponding irri- gation systems that are too expensive for these areas. Further, because of the severe state of the populations’ malnutrition, the vitamin A cannot be absorbed into their bodies.85

Others are concerned about potential health and environmental risks of GM foods. The European public has been known to call GM products “Frankenfood” for fear it could pose a health threat or create an environ- mental disaster. It is presumed that genes may jump from GM crops to wild plants and reduce biodiversity or create superweeds. For a time, Europe held up approvals of U.S. exports of GM foods, until parliament voted to require extensive labeling and traceability of food containing geneti- cally modified organisms. Only those foods that meet these standards are accepted into the EU. However, regulations still restrict the growing of GM crops. Over 20 years have passed since countries have begun growing GM crops all over the world, and there has not been significant evidence showing that these foods or the presence of crops are actually harmful. For this reason, many advocates, scientists, and others in the EU are pressing the regulatory agencies to rethink and update the GM crop and food laws to better reflect evidence-based research.86

Many people do not realize that some of the foods they eat are made from genetically engineered crops. Consumer groups are increasingly con- cerned that these foods could be unhealthy and harmful to the environment. The power of genetic modification techniques raises the possibility of human

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health, environmental, and economic problems, including unanticipated allergic responses to novel substances in foods, the spread of pest resistance or herbicide tolerance to wild plants, inadvertent toxicity to benign wild- life, and increasing control of agriculture by biotechnology corporations.87 Many consumers are boycotting products made from genetically modified materials, and several countries have opposed trade in GM foods through the World Trade Organization. In addition, Japan has asked U.S. corn pro- ducers not to include genetically modified corn in animal feed exported to Japan.88 Insects and birds transport seeds from one field to the next, allow- ing cross-pollination geneticists never intended. Unlike chemical or nuclear contamination, gene pollution can never be cleaned up. Advocates in the United States are urging regulators to mandate that GM foods be labeled. Vermont had already signed such a law into action. Under pressure from states, Congress passed a requirement for labeling products containing GM ingredients. However, in a blow to Vermont the new requirement, which

supersedes its law, gives manufacturers years to com- ply and allows them the option to use straightforward language, digital codes, or symbols to indicate the presence of GM ingredients.89 Table 10.9 demon- strates the millions of hectares that are being used to cultivate GM crops across the world. There has been solid growth of GM crops since 1996.90

A number of companies have responded to pub- lic concerns about genetically modified food products by limiting or avoiding their use altogether, while others have responded on the basis of transparency. Unilever and General Mills, for example, state on their websites that they are committed to following regulations regarding GM labeling while at the same time maintaining their belief in the benefits of GM products to alleviate hunger and reduce the amounts of energy and water needed to maintain traditional crops. They also state that their organic product lines will be packaged with non-GM labels as appropri- ate. Whole Foods Market and Allegro Coffee, on the other hand, are committed to mandatory GM label- ing. Whole Foods has committed to ensuring all GM products are labeled in their Canada and U.S. stores by 2018, while Allegro Coffee has many products already approved by the Non-GMO Project and sev- eral others in the process of being approved.91

Ethical questions about the use of some types of genetically modified products have also been raised. For example, Monsanto and other companies had begun developing so-called terminator technology to create plants that are genetically engineered to pro- duce sterile seeds. Other plants in development will

TABLE 10.9 Commercial Cultivation of Genetically Modified Crops (in millions of hectares)

Hectares (Million) Acres (Million) 1998 27.8 69.5

1999 39.9 98.6

2000 44.2 109.2

2001 52.6 130.0

2002 58.7 145.0

2003 67.7 167.2

2004 81.0 200.0

2005 90.0 222.0

2006 102.0 250.0

2007 114.3 282.0

2008 125.0 308.8

2009 134.0 335.0

2010 148.0 365.0

2011 160.0 395.0

2012 170.3 420.8

2013 175.2 433.2

2014 181.5 448.0

2015 179.7 444.0

TOTAL 1,964.6 4,854.6

Source: Clive James, 2015. “Pocket K No. 16: Biotech Crop Highlights in 2015,” International Service for the Acquisition of Agri-Biotech Applications, 2016, http:// www.isaaa.org/resources/publications/pocketk/16/ (accessed June 22, 2016).

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require spraying with chemicals supplied by the seed companies to produce desired traits, such as resistance to certain pests or disease. Farmers say the issue isn’t the technology itself but, rather, who controls the technology— in most cases, the multinational seed companies. In response to global concerns about this issue, Monsanto halted commercial development of the terminator technology.92 Control over who owns the seeds after purchase continues to be an issue with GM crops. In one case, Indiana soybean farmer Vernon Hugh Bowman purchased seeds from Monsanto and continued to use them for eight seasons. When Monsanto discovered this, they sued Bowman for patent infringement. The court ruled in favor of Monsanto, and some worry that the incident would renew interest in terminator technology so companies can further protect their patents.93

Defenders of biotechnology say consumer health fears about genetically modified foods have not been substantiated by research.94 As the U.S. agri- culture industry is eager to point out, the technology has been a big success: it has reduced the amount of pesticides farmers have had to spray on their cornfields, with happy consequences for the environment and human health. U.S. health regulators have not been able to find anything wrong with eating Bwt (Bacillus thuringiensis) corn. It is now found in roughly 90 percent of all corn, beet, and soybean products on U.S. store shelves.95 One disturb- ing trend that is occurring, however, is growing resistance to certain GM crops. Rootworms once vulnerable to GM crops containing a gene called Bt are now developing a resistance against it, making the gene ineffective. As resistance grows, some farmers are beginning to turn to older pesticides.96 The issue of resistance to herbicides and pesticides is a significant issue that Monsanto and other biotechnology companies are working to address.

STRATEGIC IMPLEMENTATION OF RESPONSIBILITY FOR TECHNOLOGY To accrue the maximum benefits from the technologies driving the new economy, many parties within society have important roles to play. While many continue to debate the issues associated with technology, the gov- ernment must take steps to provide support for continued technological advancements and to ensure the benefits of technology apply to as many people as possible. The challenge is to establish regulations as needed in order to minimize any potential for harm to competition, the environment, and human welfare while not stifling innovation. Stakeholders, includ- ing employees, customers, special-interest groups, and the general public, can influence the use and control of technology through the public policy process. Businesses also have a significant role to play in supporting tech- nology. New technologies are developed, refined, and introduced to the market through the research and development and marketing activities of business. Businesses that aspire to be socially responsible must monitor the impact of technology and harness it for the good of all.

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The Role of Government An economy that is increasingly driven by technology requires a govern- ment that maintains the basic infrastructure and support for technology in our society. The Department of Defense, for example, explores ways that technology can improve the quality of life. The government also serves as a watchdog to ensure that technology benefits society, not criminals. However, as the pace of technology continues to escalate, law enforcement agencies ranging from the FBI to local police forces are struggling to recruit and retain officers and prosecutors who are knowledgeable about the lat- est technology and the ways criminals can exploit it. High-caliber forensic computer experts are often lured away to technology firms and private security outfits by salaries more than twice their government paychecks.97 Computer crimes currently share sentencing guidelines with larceny, embezzlement, and theft, where the most significant sentencing factor is the amount of financial loss inflicted, and additional points are awarded for using false IDs or ripping off more than ten victims. “Cyberterrorism,” in which a foreign power sabotages another country’s computer system, has been declared a potential act of war by the U.S. government. The govern- ment believes cyberattacks represent a significant threat toward U.S. secu- rity and therefore requires serious action in response. This decision came after a major cyberattack was launched against Google and its computer servers—which included the accounts of some government officials.98

Digital copyright lawsuits illustrate a significant difference in opin- ion in the interpretation of existing laws when exploiting the evolving multimedia potential of the internet. Although the government’s strategy thus far has been not to interfere with the commercial use of technol- ogy, disputes and differing interpretations of current laws increasingly bring technology into the domain of the legal system. New laws related to breakthrough technologies that change the nature of competition are constantly being considered. Usually, the issues of privacy, ownership of intellectual property, health and safety, environmental impact, competi- tion, or consumer welfare are the legislative platforms for changing the legal and regulatory system.

The Role of Business Business, like government, is involved in both reactive and proactive attempts to market and make effective use of technology. Reactive con- cerns relate to issues that have legal and/or ethical implications as well as issues of productivity, customer welfare, or other stakeholder concerns. Many large firms have suffered public embarrassment, legal bills, com- pensation claims, and clean-up costs when employees seek inappropriate material online, send e-mail to people they shouldn’t, accidentally circulate confidential information outside a business, or spread a computer virus. As a result, some companies are purchasing software that assists employees in managing the internet time they spend on personal activities.

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On the other hand, a strategic, proactive approach to technology will consider its impact on social responsibility. Proactive management of tech- nology requires developing a plan for utilizing resources to take advantage of competitive opportunities. For instance, many companies address the proper use of computers and other technology in their codes of ethics. Addressing these risk areas beforehand allows employees to understand what is and is not acceptable. These policies inform employees about corporate expectations regarding company technology and the potential penalties for misuse.

With competition increasing, companies are spending more time and resources to establish technology-based competitive advantages. The stra- tegic approach to technology requires an overall mission, strategy, and coordination of all functional activities, including a concern for social responsibility, to have an effective program. To promote the responsible use of technology, a firm’s policies, rules, and standards must be inte- grated into its corporate culture. Reducing undesirable behavior in this area is a goal that is no different from reducing costs, increasing profits, or improving quality that is aggressively enforced and integrated into the corporate culture to be effective in improving appropriate behavior within the organization.

Top managers must consider the social consequences of technology in the strategic planning process. When all stakeholders are involved in the process, everyone can better understand the need for and requirements of responsible development and use of technology. There will always be conflicts in making the right choices, but through participation in decision- making, the best solutions can be found. Individual participants in this process should not abdicate their personal responsibility as concerned members of society. Organizations that are concerned about the conse- quences of their decisions create an environment for different opinions on important issues.

Strategic Technology Assessment To calculate the effects of new technologies, companies can employ a procedure known as a technology assessment to foresee the effects new products and processes will have on their firm’s operations, on other busi- ness organizations, and on society in general. This assessment is a tool that managers can use to evaluate their firm’s performance and to chart strategic courses of action to respond to new technologies. With informa- tion obtained through a technology assessment or audit, managers can estimate whether the benefits of adopting a specific technology outweigh costs to the firm and to society at large. The assessment process can also help companies ensure compliance with government regulations related to technology. Remember that one of the four components of social respon- sibility is legal compliance. A strategic technology assessment or audit can help organizations understand these issues and develop appropriate and responsible responses to them (see Table 10.10).99

technology assessment A procedure used by companies to calculate the effects of new technologies by foreseeing the effects new products and processes will have on their firm’s operations, on other business organizations, and on society in general.

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TABLE 10.10 Strategic Technology Assessment Issues

Yes No Checklist O O Are top managers in your organization aware of the federal, state,

and local laws related to technology decisions?

O O Does your organization have an effective system for monitoring changes in the federal, state, and local laws related to technology?

O O Is there an individual, committee, or department in your organization responsible for overseeing government technology issues?

O O Does your organization do checks on technology brought into the organization by employees?

O O Are there communications and training programs in your organization to create an effective culture to protect employees and organizational interests related to technology?

O O Does your organization have monitoring and auditing systems to determine the impact of technology on key stakeholders?

O O Does your organization have a method for reporting concerns about the use or impact of technology?

O O Is there a system to determine ethical risks and appropriate ethical conduct to deal with technology issues?

O O Do top managers in your organization understand the ramifications of using technology to communicate with employees and customers?

O O Is there an individual or department in your organization responsible for maintaining compliance standards to protect the organization in the areas of privacy and intellectual property?

If the assessment process indicates that the company has not been effective at utilizing technologies or is using them in a way that raises questions, changes may be necessary. Companies may need to consider setting higher standards, improving reporting processes, and improving communication of standards and training programs, as well as participat- ing in aboveboard discussions with other organizations. If performance has not been satisfactory, management may want to reorganize the way certain kinds of decisions are made. Table 10.10 contains some issues to assess for proactive and reactive technology responsibility issues. Some social concerns might relate to a technology’s impact on the environment, employee health and working conditions, consumer safety, and commu- nity values.

Finally, the organization should focus on the positive aspects of tech- nology to determine how it can be used to improve the work environment, its products, and the general welfare of society. Technology can be used to reduce pollution, encourage recycling, and save energy. Also, information can be made available to customers to help them maximize the benefits of products. Technology has been and will continue to be a major force that can improve society.

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SUMMARY Technology relates to the application of knowledge, including the processes and applications to solve problems, perform tasks, and create new methods to obtain desired outcomes. The dynamics of technology relate to the con- stant change that requires significant adjustments in the political, religious, and economic structures of society. Reach relates to the far-reaching nature of technology as it moves through society. The self-sustaining nature of technology relates to the fact that technology acts as a catalyst to spur even faster development. Civilizations must harness and adapt to changes in technology to maintain a desired quality of life. Although technological advances have improved our quality of life, they have also raised ethical, legal, and social concerns.

Advances in technology have created millions of new jobs, better health and longer lives, new opportunities, and the enrichment of lives. Without greater access to the latest technology, however, economic development could suffer in underserved areas. The ability to purchase technology may affect the nature of competition and business success. Information and telecommunications technology minimizes borders, allows people to overcome the physical limitations of time and space, and enables people to acquire customized goods and services that cost less and are of higher quality.

The internet, a global information system that links many computer networks together, has altered the way people communicate, learn, do business, and find entertainment. The growth of the internet has generated issues never before encountered and that social institutions, including the legal system, have been slow to address.

Because current technology has made it possible to collect, share, and sell vast quantities of personal information, often without consum- ers’ knowledge, privacy has become a major concern associated with technology. Many websites follow users’ tracks through their site by stor- ing a cookie, or identifying string of text, on the users’ computers. What companies do with the information about consumers they collect through cookies and other technologies is generating concern. Privacy issues related to children are generating even more debate and laws to protect children’s interests. Identity theft occurs when criminals obtain personal informa- tion that allows them to impersonate someone else to use that individual’s credit to obtain financial accounts and to make purchases. Some measure of protection of personal privacy is provided by the U.S. Constitution as well as by Supreme Court rulings and federal laws. Europe and other regions of the world are also addressing privacy concerns. In addition to creating and posting policies regarding the gathering and use of personal information, more companies are beginning to hire chief privacy officers.

Intellectual property consists of the ideas and creative materials developed to solve problems, carry out applications, educate, and enter- tain others. Copyright infringement is the unauthorized execution of the rights reserved by a copyright holder. Technological advancements are

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challenging the ownership of intellectual property. Other issues relate to “cybersquatters” who deliberately register Web addresses that match or relate to other firms’ trademarks and then attempt to sell the registration to the trademark owners.

Bioethics refers to the study of ethical issues in the fields of medical treatment and research, including medicine, nursing, law, philosophy, and theology. Genetic research, including cloning, may revolutionize how diseases are diagnosed and treated. Genetically modified crops are created when scientists introduce a gene from one organism to another. However, these technologies are controversial because some people believe they are immoral, unsafe, or harmful to the environment.

To accrue the maximum benefits from the technology driving the new economy, many parties within society have important roles to play. With an economy that is increasingly driven by technology, the government must maintain the basic infrastructure and support for technology in our society. The government also serves as a watchdog to ensure that technol- ogy benefits society, not criminals.

Business is involved in both reactive and proactive attempts to make effective use of technology. Reactive concerns relate to issues that have legal or ethical implications as well as to productivity, customer welfare, or other stakeholder issues. Proactive management of technology requires developing a plan for utilizing resources to take advantage of competitive opportunities. The strategic approach to technology requires an overall mission, strategy, and coordination of all functional activities, including a concern for social responsibility, to produce an effective program. To calculate the effects of new technologies, companies can employ a procedure known as technology assessment to foresee the effects of new products and processes on their firm’s operation, on other business organizations, and on society in general.

Responsible Business Debate

Is Technology Detrimental for Society? Issue: What are the benefits and drawbacks of technology to social interaction?

While technology has brought advancements, con- veniences, and efficiencies to our lives, some critics wonder if the benefits outweigh the costs, especially those that are transforming the ways we communi- cate, connect with other people, solve problems, and generally interact as human beings. In other words, are

we losing the relationships that have made the United States a great place to live and work?

In 1831, Alexis de Tocqueville visited the United States on behalf of the French government. He set out to study the prison system, but ended up writing a grand treatise, Democracy in America. In his book, Tocqueville noted how Americans were dedicated to social cohe- sion, equality, common purpose, and concern for both individuals and the community. Years  later, writers on

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DISCUSSION QUESTIONS

the topic of social capital, mentioned in Chapter 2, drew from Tocqueville’s work to describe the American approach to community service, active neighborhood associations, and other types of civic engagement. Recent studies, however, indicate civic engagement is declining. Is technology part of the problem?

Consider these daily occurrences: students do not talk to classmates after class, as they are quick to begin texting people they already know. With autocorrect fea- tures on their phones that correct their writing, they do not even have to know how to spell correctly. People on the subway rarely acknowledge the riders they see every day, because they are busy checking their smartphones and getting a jumpstart on the day. Many children spend more time on the internet or playing video games than they do playing outside with other children. Coworkers send each other emails, rather than walk 30 steps to the next office for a brief conversation. Studies show that younger generations do not even realize that you need to dial “1” first to call long-distance on a landline. Finally, handwriting is so passé that a hand-written envelope will be opened much sooner than any other piece of mail.

On the other hand, technology has opened up new avenues for research and business activities.

Because of the internet, researchers literally have librar- ies of knowledge at their fingertips. Marketers use social media and other digital channels to connect on a more one-on-one basis with customers. Southwest even has a Twitter team to answer customer concerns quickly, making for a smoother customer service process. Small business owners now have the ability to use technology to sell their products across the world without needing the infrastructure required to set up a large company. Online chat forums can help people connect from dif- ferent parts of the country who never would have met otherwise. Additionally, many people have used social networks like Facebook to reconnect with friends they had known from long ago.

There Are Two Sides to Every Issue: 1. Defend the changes that technology has brought

to society’s communication patterns, such as the expediency of email and texting, reduced costs, and access to people around the world.

2. Defend the need for society to rely less on technol- ogy and more on traditional communication pat- terns, such as face-to-face meetings, verbal conver- sations, and hand-written correspondence.

KEY TERMS technology (p. 322) intellectual property (p. 339)

bioethics (p. 343) technology assessment (p. 351)

1. Define technology and describe three character- istics that can be used to assess it.

2. What effect has technology had on the United States and global economies? Have these effects been positive or negative?

3. Many people believe that the government should regulate business with respect to privacy online, but companies say self-regulation is more appro- priate. Which approach would benefit consum- ers most? Businesses?

4. What is intellectual property? How can owners of intellectual property protect their rights?

5. What is bioethics? What are some of the conse- quences of biomedical research?

6. Should genetically modified foods be labeled as “genetically modified”? Why or why not?

7. How can a strategic technology assessment help a company?

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EXPERIENTIAL EXERCISE Visit three websites that are primarily designed for chil- dren or that focus on products of interest to children under age 13. For example, visit the websites for new movies, games, action figures, candy, cereal, or bever- ages. While visiting these sites, put yourself in the role and mind-set of a child. What type of language and

persuasion is used? Is there a privacy statement on the site that can be understood by children? Are there any parts of the site that might be offensive or worrisome to parents? Provide a brief evaluation of how well these sites attend to the provisions of the Children’s Online Privacy Protection Act.

James Kitling thought about his conversation with Ira Romero earlier that day. He was not really surprised that the human resources (HR) department was concerned about the time employees were spending on personal issues during the workday. Several departments were known for their rather loose management approach. Internet access for personal tasks, like shopping, using Instant Messaging services, and answering nonwork e-mails, had been a concern for several months. Recent news reports indicated that over 50 percent of large companies now filter or monitor e-mail. Companies are also monitoring Web browsing, file downloads, chat room use, and group postings. A survey published in the media reported that workers spend an average of eight hours a week looking at nonwork internet sites.

As the director of information technology, James was very dedicated to the effective use of technology to enhance business productivity. Although he was knowl- edgeable about technology, James was equally attuned to the ways in which technology can be abused in a work setting. He knew that some employees were prob- ably using too much internet time on personal tasks.

On the other hand, his company mainly employed professionals, administrative staff, and customer service personnel. All 310 employees were expected to use the computer a great deal throughout the day. At present, the company had a skeleton code of ethics and policy on the use of company resources, including the internet.

A couple of managers and now HR had spoken with James about the prospects of monitoring employee computer and internet use. Ira’s inquiry about the soft- ware, however, was a bit more serious. An employee had recently been formally reprimanded for downloading

and printing nonwork documents from the internet. These documents were designed to help the employee’s spouse in a new business venture. Although the employ- ee did most of the searching and downloading during lunch, the supervisor felt this was an improper use of company resources. Other employees had been infor- mally spoken with about their use of the internet for personal matters. Ira believed this was a growing prob- lem that definitely affected productivity. He had read the news reports and believed that monitoring software was becoming a necessary tool in today’s workplace.

So far, James had been hesitant to purchase and implement one of these systems. The employee internet management software was somewhat expensive, run- ning approximately $25 per computer. He felt that the software could cause employee trust to sharply decline, resulting in even greater problems than currently existed. After all, employees engage in some personal tasks during work hours, including making personal telephone calls, getting coffee, chatting with coworkers, and so forth. James wondered if the internet was that much different from these other personal activities. He recalled a discussion in a management class in his MBA program, where they learned that employees in the early 1900s were only allowed to use the telephone to call the police. Thus, the telephone was once thought of as a great distracter, much like the internet today.

Ira and a few other managers were pretty firm in their beliefs about the internet monitoring system. James was still not convinced that it was the best route to curbing the problem. In his role, however, he was expected to provide leadership in developing a solution. What would you do?

THE EMAIL POLICE: WHAT WOULD YOU DO? ?

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358

CHAPTER ELEVEN

Sustainability Issues

Chapter Objectives

●● To define sustainability

●● To examine the nature of sustainability as it relates to social responsibility

●● To explore a variety of global environmental issues faced by business and society

●● To examine the impact of environmental policy and regulations

●● To gain an understanding of different types of alternative energy

●● To examine business responses to sustainability

●● To discuss a strategic approach to respond to environmental responsibility

Chapter Outline

Defining Sustainability

How Sustainability Relates to Social Responsibility

Global Environmental Issues

Environmental Policy and Regulation

Alternative Energy

Business Response to Sustainability Issues

Strategic Implementation of Environmental Responsibility

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359

Hydraulic fracturing, known as fracking, has the poten- tial to reduce the United States’ dependence on foreign oil. Fracking forces water, sand, and chemicals into underground tunnels of shale rock, bringing natural gas to the surface. Because of fracking, energy prices are lowering and the United States is becoming more self-sufficient in generating their own energy. The United States is now the world’s second leading pro- ducer of natural gas after Russia.

Natural gas releases half the carbon dioxide of oil, and the United States has the potential to produce more than 30 percent more than currently consumed. Natural gas releases fewer sulfur dioxide, nitrogen oxide, and mercury emissions than coal. Lower-income towns have benefited economically from fracking because the drilling creates jobs and inserts money into the community. For instance, fracking is growing in North Dakota, and the state has the lowest unemploy- ment rate in the nation.

However, fracking does have some negative impacts on the environment. There have been instances where fracking chemicals have contaminated drinking water and increased levels of methane in water wells. Currently, fracking is exempt from elements of the Safe Drinking Water Act. Gas companies can declare their chemical formulas as proprietary trade secrets (although this may be changing). Oil from fracking operations is also more volatile, making it more dif- ficult and risky to transport it. Studies have also sug- gested links between fracking and minor earthquakes.

Many fear that the energy crisis and economic benefits will overshadow environmental concerns. Natural gas is a critical component of the government’s

plan for the country to run on 70 percent clean energy by 2035. Yet this has not stopped a number of states, provinces, and even countries from banning frack- ing operations within their borders. France as well as Quebec and New York have placed moratoriums on fracking.

On the other hand, many believe that the dan- gers of fracking will be significantly reduced if certain safety precautions are taken. Wells that are properly cemented and well-built can keep fracking chemicals from infiltrating groundwater. Any leaks discovered must be fixed immediately. Because the effects of fracking on groundwater are still somewhat unknown, studies could be conducted to determine if fracking negatively affects groundwater, as well as the extent. The Environmental Protection Agency (EPA) has man- dated that fracking wells must have pollution control mechanisms to catch methane and volatile organic compound emissions.

Gas and oil companies themselves can adopt socially responsible practices when fracking. Some are looking for alternatives, such as trying to engage in hydraulic fracking without the use of chemicals. Others are able to recycle contaminated water used in the fracking process. It is important for gas and oil companies to safely dispose of chemicals and train all employees in appropriate safety procedures.

Fracking remains a controversial topic. It could very well lead the United States on its quest toward energy independence, but its environmental impact is uncertain. Gas and oil companies must find a balance between the economic benefits and the potential costs to the environment and worker safety.1

Keep Calm and Frack On?

Opening Vignette

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360 Business and Society

As concerns over fracking, global warming, erratic weather patterns, and diminished quality of life continue to rise, public and business support for environmental causes has increased a great deal since the first Earth Day was held in 1970. Most Americans claim that they have made changes in their lifestyles, like switching to energy efficient light bulbs or recycling, to help the environment. One survey indicated that 78 percent of Americans purchase green products in certain circumstances, with Millennials more likely to purchase green products than other age groups. Nearly half of those who purchase green products indicate they do so because it is better for the environment.2 Many businesses have adopted environmental policies in their operations, and 77 Fortune 500 corpora- tions are using nearly 14.6 billion kWh of green power each year.3

In this chapter, we explore the concept of sustainability in the context of social responsibility in today’s complex business environment. First, we define sustainability and explore some of the significant environmental issues that businesses and society face. Next, we consider the impact of government environmental policy and regulation on business and examine how some companies are going beyond the scope of these laws to address environmental issues and act in an environmentally responsible manner. We also examine different types of alternative energy. Finally, we highlight a strategic approach to environmental issues, including risk management and strategic audits.

DEFINING SUSTAINABILITY Most people probably associate the term environment with nature, including wildlife, trees, oceans, rivers, mountains, and prairies. Until the twentieth century, people generally thought of the environment solely in terms of how these resources could be harnessed to satisfy their needs for food, shelter, transportation, and recreation. As Earth’s population swelled and technol- ogy advanced, however, humans began to use more of these resources with greater efficiency. Although these conditions have resulted in an improved standard of living, they come at a cost. Plant and animal species, along with wildlife habitats, are disappearing at an accelerated rate; water use has become a critical issue in many parts of the globe; and pollution has rendered the skies of some cities a gloomy haze. How to deal with these issues has become a major concern for business and society in the twenty-first century.

Although the scope of the word sustainability is broad—including plants, animals, human beings, oceans and other waterways, land, and the atmosphere—in this book, we discuss the term from a strategic business perspective. Thus, we define sustainability as the potential for long-term well-being of the natural environment, including all biological entities, as well as the interaction among nature and individuals, organizations, and business strategies. Sustainability includes the assessment and improve- ment of business strategies, economic sectors, work practices, technolo- gies, and lifestyles while maintaining the natural environment. It meets the

sustainability The potential for long-term well-being of the natural environment, including all biological entities, as well as the interaction among nature and individuals, organizations, and business strategies.

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needs of the present without compromising the ability of future genera- tions to meet their own needs.4

However, it is important to realize that sustainability means different things to different cultures. Europeans use both environmental and eco- nomic variables when considering the sustainability of an organization. In the United States, sustainability is used more often in relation to environ- mental concerns. Others still believe the term is too broad; some research- ers want the term sustainability in business to only emphasize human sustainability with a customer focus.5 This lack of a clear consensus com- plicates the matter for businesses, especially when trying to evaluate ways to broaden the sustainable footprint of their operations.6 For the purposes of this chapter, we use the U.S. concept of sustainability to describe how organizations interact with the natural environment.

HOW SUSTAINABILITY RELATES TO SOCIAL RESPONSIBILITY Sustainability does not mean the same thing as social responsibility.7 Rather, sustainability is a domain of social responsibility. Social respon- sibility is an attempt to maximize an organization’s positive impact and minimize its negative impact on stakeholders. Sustainability according to our definition seeks to minimize a business’s negative impact on the natural environment while maximizing its positive impact. Like any social concern, organizations should respond to consumer concerns over sustain- ability by addressing the issue in their strategies, policies, and objectives. This involves the process of assessing risks, monitoring ethical and legal compliance, and developing policies to minimize unethical conduct.

Although social responsibility and sustainability are not the same things, many socially responsible organizations display sustainable behaviors. Social responsibility meets the needs of stakeholders, including both environmental stakeholders and consumers concerned about the impact of business opera- tions on the earth. Sustainability requires the organization to make ethical decisions on how it will implement, monitor, and improve upon sustain- ability initiatives. Figure 11.1 re-illustrates the major emphases of social responsibility featured in Chapter 1 to demonstrate sustainability’s role.

Stakeholders are demanding that businesses become more sustainable. At the very least, organizations are expected to minimize their negative effects on the environment through such activities as the proper disposal of chemicals, recycling, or keeping greenhouse gas emissions down to a mini- mum. Organizations such as Best Buy have been responding by including sustainability as a key factor in annual corporate social responsibility reports. These reports are mandatory for publicly held corporations in Europe.

Sustainability has become a major issue for organizations for differ- ent reasons. First, sustainable business practices can result in competitive advantages. Sustainable practices are beneficial to stakeholder relationships

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and can even lower costs in areas such as energy in the long-term. Second, as consumers become more aware of environmental issues, their power over organizations in this area is increasing.8 Third, sustainable organizations are more likely to have their brand associated with positive concepts such as social value and product quality. Fourth, organizations are using sustain- ability to differentiate themselves from competitors and to market their goods and services. Patagonia has adopted the unique campaign of encour- aging consumers not to buy products from the company that they do not need. They also want customers to return used products that the customer no longer wants so the organization can reuse it. This positions Patagonia as a sustainable company truly desiring to live its mission.

Sustainability not only involves best practices, but it is increasingly becoming an issue of concern to lawmakers. Companies that recognize this are investing in sustainable practices before laws are passed that may limit their activities. For instance, in anticipation of stricter miles per gallon standards, automakers like Ford are investing in ways to increase the gas mileage of its cars. Oil and gas companies are some of the biggest investors in renewable energy technologies. Total, Shell, Statoil and ExxonMobil are investing billions of dollars in alternative energy projects.9 Many stake- holders respond positively to these changes.

GLOBAL ENVIRONMENTAL ISSUES The protection of air, water, land, biodiversity, and renewable natural resources emerged as a major issue in the twentieth century in the face of increasing evidence that pollution, uncontrolled use of natural resources, and population growth were putting increasing pressure on the long-term

© O.C. and Linda Ferrell, 2016.

FIGURE 11.1 Major Emphases of Social Responsibility

Issues

Social Issues

Sustainability

Consumer Protection

Corporate Governance

Philanthropy

Legal Responsibilities

Employee Well-Being

Recognition Outcomes

Stakeholder Evaluations

DecisionsIssue Awareness

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sustainability of these resources. As the environmental movement sounded the alarm over these issues, governments around the globe responded with environmental protection laws during the 1970s. In recent years, compa- nies have been increasingly incorporating these issues into their overall business strategies. Most have been the focus of concerned citizens as well as government and corporate efforts. Some nonprofit organizations have stepped forward to provide leadership in gaining the cooperation of diverse groups in responsible environmental activities. For example, the Coalition for Environmentally Responsible Economies (CERES), a union of businesses, consumer groups, environmentalists, and other stakeholders, has established a set of goals for environmental performance.

In the following section, we examine some of the most significant envi- ronmental issues facing business and society today, including air pollution, acid rain, global warming, water pollution and water quantity, land pol- lution, waste management, deforestation, urban sprawl, biodiversity, and genetically modified foods.

Atmospheric Issues Among the most far-reaching and controversial environmental issues are those that relate to the air we breathe. These include air pollution, acid rain, global warming, and pollution emitted by coal.

Air Pollution Air pollution typically arises from three different sources: sta- tionary sources such as factories and power plants; mobile sources such as cars, trucks, planes, and trains; and natural sources such as windblown dust and volcanic eruptions.10 These sources discharge gases, as well as particu- lates, that can be carried long distances by surface winds or linger on the sur- face for days if there is a lack of winds or if geographical conditions permit.

The World Health Organization (WHO) has issued standardized safe lev- els of particulate matter (PM), which are used to determine whether a city’s pollution is considered dangerous. Particulates measuring 2.5 are the most dangerous to public health, as these particles are small enough to enter the bloodstream and cause ailments such as cancer and emphysema. China has long been considered the country with the most air polluted cities. However, India has since taken the lead, and it is estimated that half a million people in India die premature deaths annually as a result of pollution.11 Such condi- tions can cause markedly shorter life spans, along with chronic respiratory problems (e.g., asthma, bronchitis, and allergies) in humans and animals, especially in the elderly and the very young. Some of the chemicals associated with air pollution may contribute to birth defects, cancer, and brain, nerve, and respiratory system damage. Air pollution can also harm plants, animals, and water bodies. Haze caused by air pollution can reduce visibility, interfer- ing with aviation, driving, and recreation.12 As a result of experiencing the detrimental effects of pollution on the population and the economy, China has “declare[d] a war on pollution” by reducing energy levels, closing facto- ries, and minimizing the amount of cars driving on the roads.13

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Acid Rain In addition to the health risks posed by air pollution, when nitrous oxides and sulfur dioxides emitted from manufacturing facilities react with air and rain, the result is acid rain. This phenomenon has con- tributed to the deaths of many valuable forests and lakes in North America and Europe. It also corrodes paint and deteriorates stone, leaving auto- mobiles, buildings, and cultural resources such as architecture and outside art vulnerable unless they are protected from its effects.14 While we have made great strides since the passing of the Clean Air Act in 1963, some of our forests and lakes are still recovering from the damage caused by acid rain.15 In addition, we have not yet been able to eliminate this phenom- enon, although implementing more environmentally conscious practices has been successful in reducing emissions that cause acid rain. Today the United States emits around 5.7 million tons of sulfur dioxide emissions and 2.0 million tons of nitrogen oxide into the atmosphere each year—a sig- nificant decrease from previous years. Cleaning up emissions from factories and cars is one way to help reduce acid rain.

Global Warming When carbon dioxide and other gases collect in Earth’s atmosphere, they trap the sun’s heat like a greenhouse and prevent Earth’s surface from cooling. Without this process, the planet becomes too cold to sustain life. However, during the twentieth century, the burning of fos- sil fuels—gasoline, natural gas, oil, and coal—accelerated dramatically, increasing the concentration of “greenhouse” gases like carbon dioxide and methane in Earth’s atmosphere. Chlorofluorocarbons—from refrigerants, coolants, and aerosol cans—also harm Earth’s ozone layer. A hole, measur- ing nine miles high and several hundred miles wide, was discovered in the lowest layer of the atmosphere and is believed to be caused by the presence of chlorofluorocarbons. The protective layer of the ozone, that protects the earth from the sun’s harmful ultraviolet rays, is said to be stripped away. These harmful rays not only damage the environment but also humans’ eyesight and skin health.16

World carbon dioxide emissions are currently around 31 billion met- ric tons and are expected to rise to 45 billion metric tons by 2040.17 The United States and China are the two largest greenhouse gas emitters in the world.18 As noted above, India, as well as other developing countries, are going to make up an increasing percentage of overall emissions, since they are most likely to use coal—the dirtiest of all fossil fuels in terms of emissions. Figure 11.2 below shows emissions outputs by countries in the Organisation for Economic Co-operation and Development (OECD), excluding the BRIICS (Brazil, Russia, India, Indonesia, China, and South Africa) and the rest of the world (ROW). To cut greenhouse gas emissions, the EPA has written rules providing stricter standards for new cars to cut the amount of greenhouse gases emitted from new cars by 25 percent. Large trucks and power plants will also have standards that will contribute to a 17 and 30 percent reduction, respectively.19

Most scientists believe that concentrations of greenhouse gases like meth- ane and carbon dioxide in the atmosphere are accelerating a warming of the

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planet. Accumulations of greenhouse gases have increased dramatically in the past century. The year 2015 is the hottest year on record. The second hottest year on record was 2014, and 2010 was recorded as the third hottest around the world.20 The accumulation of gases appears to have increased average temperatures by 1.4°F over the last century. Although this does not sound like much of a change, it is sufficient to increase the rate of polar ice sheet melting, which is occurring at unprecedented rates.21 The years 2008 and 2009 marked record years for severity of summer ice cap melting. Climate change has caused such dramatic melting of glaciers along the Italian/Swiss border in the Alps that mapmakers were forced to redraw the border between the two countries to follow the new glacial boundaries.22 Climate change has also affected weather in this region—making Switzerland to the north more prone to flooding and Italy to the south more drought-ridden.

As the polar ice caps melt, scientists fear that rising sea levels will flood many coastal areas and even submerge low-lying island nations. With less snow and ice cover to reflect the sun’s rays, Earth absorbs even more of the sun’s heat, accelerating the warming process. Some scientists also think that global warming may alter long-term weather patterns, causing drought in some parts of the world while bringing floods to others—some- thing that many believe we are already witnessing in the form of extreme

Note: ROW short for Rest of the World

Source: Organisation for Economic Co-operation and Development, “OECD Environmental Outlook to 2050,” OECD, November 2011, http://www.oecd.org/env/cc/49082173.pdf (accessed June 22, 2016).

5.4

3.8

6.2

15.3

10.4

5.5

8.9

0

2

4

6

8

10

12

14

16

18

OECD BRIICS ROW Global

tC O

2/ pe

r ca

pi ta

2010 2050

13.4

FIGURE 11.2 GHG Emissions Per Capita

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weather patterns. For example, many claim that the effects of Hurricane Sandy on the east coast were so devastating due to warmer waters and higher coast lines. Additionally, record-breaking heat waves, droughts, and winter storms are also said to be a result of the changing atmospheric conditions caused by global warming.23

The concept of global warming has been controversial among some groups, especially in the United States. Critics of global warming argue that apparent temperature increases are part of a natural cycle of tem- perature variation that the planet has experienced over millions of years. Some people even like the sound of global warming, as it brings to mind warmer temperatures and longer growing seasons. Many companies and organizations have also maligned the theory because reducing emissions and tightening environmental laws means greater expenses at the outset. Nevertheless, most nations, scientists, and businesses now agree that something must be done about climate change. Failure to act may create extreme climate conditions that could have negative consequences.

Hydraulic fracturing (fracking), discussed in the opening vignette, is controversial due to its effects on global warming. While supporters claim fracking is better for the environment and is leading to energy indepen- dence for the United States, critics say otherwise. They claim the burn- ing of natural gas releases harmful methane into the atmosphere. They estimate methane to be 21 times more potent than carbon dioxide over a period of 100 years. The Intergovernmental Panel on Climate Change claims the estimate is closer to 34 times. Since the rise of fracking, the EPA has issued rules for production and consumption and will continue to do so as more information on its effects on the climate become known.24

The Kyoto Protocol is a treaty among industrialized nations aimed at slowing global warming. The United States did not ratify the treaty and therefore was not bound to it. Since its creation in 1997, the Kyoto Protocol was highly unpopular amongst polluting multinational corpora- tions. At the time, signing the treaty required reducing levels of green- house gas emissions by five percent that of 1990 levels. However, only 37 countries as well as the European Union (EU) signed the protocol, leaving out the largest polluters such as Canada, the United States, Australia, and developing countries including China and India. The United States has adopted a voluntary U.S. Global Climate Initiative for reporting greenhouse gases, as outlined in Table 11.1. Many leaders worried that compliance would jeopardize businesses and the economy.25 The treaty went into effect in 2005 and instituted its first commitment period for years 2008–2012. The second commitment period (2013–2020) has goals to reduce emissions by 18 percent of the 1990 levels, with 192 signatory nations.26 Also in 2012, another attempt to develop a legally binding international agreement to reduce greenhouse gas emissions was discussed. The Doha Gateway Agreement calls for both developed and developing countries to decrease greenhouse gas emissions. The global agreement is expected to be implemented in 2020. As of 2016, 66 coun- tries have signed the amendment.27

Kyoto Protocol A treaty among industrialized nations aimed at slowing global warming.

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TABLE 11.1 Elements of the U.S. Global Climate Change Initiative Enhancement of the 1605(b) Voluntary Reporting of Greenhouse Gases Program Significantly expanded funding for basic scientific research and advanced technology devel-

opment Tax incentives, such as credits for renewable energy, cogeneration, and new technology Challenges for business to undertake voluntary initiatives and commit to greenhouse gas

intensity goals, such as through recent agreements with the semiconductor and aluminum industries

Transportation programs, including technology research and development and fuel econo- my standards

Carbon sequestration programs, which include increased funding for U.S. Department of Agriculture conservation programs under the Farm Bill

Investments in climate observation systems in developing countries Funding for “debt-for-nature” forest conservation programs Use of economic incentives to encourage developing countries to participate in climate

change initiatives Expanding technology transfer and capacity building in the developing world Joint research with Japan, Italy, and Central America

Sources: Energy Information Administration, U.S. Department of Energy, “Voluntary Reporting of Greenhouse Gases—Summary,” http://www.eia.doe.gov/oiaf/1605/vrrpt/summary/special_topic.html (accessed June 22, 2016); USAID, “U.S. Global Climate Change Initiative,” https://www.usaid.gov/ climate (accessed June 22, 2016).

Many U.S. businesses are responding to stakeholder pressure and are committing to self-regulatory standards with respect to global warm- ing and related areas, even in the absence of federal mandates. States like California have worked hard to gain the right to issue their own environmental legislation. After many years of making arguments to the federal government, the EPA granted California the right to impose tough emissions standards on cars and trucks. California had wanted to re-implement the toughest reading of the Clean Air Act legislation in over 40 years. This change in ruling opened the door for other states to pass similar emissions legislation and demonstrated a willingness on the part of the EPA to let states decide how strict they want to be on polluters.28 A host of energy-efficient designations now exist to help consumers make more environmentally friendly choices. For example, Energy Star, a joint program between the U.S. EPA and the U.S. Department of Energy, helped Americans and businesses reduce greenhouse gas emissions by 2.5 bil- lion metric tons—all while saving them more than $362 billion on utility bills.29 Table 11.2 describes some ways companies and governments are adopting climate change strategies.

Coal and Carbon Emissions As already mentioned, coal is an area of debate among different countries and is considered to be one of the dirtiest forms of energy.30 The consumption of coal pollutes the air by releasing large amounts of gaseous and particulate matter into the atmosphere. Many governments believe that their intervention is needed to bring down

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TABLE 11.2 Climate Change Strategy

Climate Change Strategy

Description Example

Greenhouse Gas Reduction

A commitment to reduce carbon emissions by a certain percentage

To reduce greenhouse gas emissions, the U.S. government is requiring auto- mobiles to get 35.5 miles per gallon (mpg) by 2016

Cap-and-Trade Program

Set emissions limits (caps) for businesses, countries, or individuals

The United States used a cap-and-trade program for acid rain, requiring fossil- fueled power plants to reduce levels of sulfur oxide and nitrogen oxide emissions

Proactive Business Practices

Occurs when businesses proac- tively adopt business practices to address sustainability before there is a call for them

Walmart has worked on adopting a sustainability index that will allow cus- tomers to determine how eco-friendly a product is

levels of greenhouse gas emissions. Some countries are intervening with cap-and-trade programs, which set emissions limits (caps) for businesses, countries, or individuals. Companies are given a certain amount of carbon they are allowed to emit, and to legally emit anything beyond that limit, a company must purchase carbon credits from another company that did not pollute as much. The EU has been at the forefront of mandated emissions reductions and has implemented a cap-and-trade program on carbon emis- sions known as the European Union Emission Trading Scheme.

When the EU signed the Kyoto Protocol, it committed to collectively reduce its greenhouse gas emissions by 8 percent. The EU does this by issuing a fixed number of permits to businesses and other parties that limits the amount of emissions their companies can give off. A carbon emissions cap can strain many businesses, especially manufacturing com- panies, which emit large amounts of carbon in the process of operating. Opponents of this scheme argue that a single cap puts certain companies at a financial disadvantage, as they can only reduce their carbon footprint by so much before they begin sacrificing productivity. To solve this problem, a cap-and-trade system allows for businesses to sell the carbon permits they do not use. In other words, companies that do not release as much carbon emissions can sell their permits to companies that do. Companies that pollute less are therefore rewarded with extra income, while compa- nies that produce more are allowed to continue working. In order to give companies time to adapt more efficient technologies, governments impose progressively smaller caps over the years.31

The cap-and-trade program has gained some support in the United States. For several years, ten states, including California, New York, and Maryland, have implemented these programs to reduce emissions. Cap-and-trade has also been used to reduce acid rain by restricting the amount of sulfur dioxide and nitrogen oxides released by fossil-fired power plants.32 However, opposition has been fierce, and federal legisla- tion has not focused on mandating cap-and-trade programs. Instead, the

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government is more concerned with providing collective goals that must be met. The EPA works with companies and states on implementing rules to meet these goals. One initiative supported by the Obama administration is to reduce emissions 30 percent from 2005 levels by the year 2030. The EPA has suggested market-based programs, investment in existing or new energy efficiency programs, or expansion of renewable energy initiatives to state legislators, who will decide what methods work best for their states.33 However, opposition to this proposed rule remains high, particularly as it would significantly impact the nation’s 600 coal-fired plants. As a result, the Supreme Court temporarily put a hold on the initiative in 2016.34

Proactive businesses do not have to wait for legislation to be passed to reduce their carbon footprint. Many companies have created best prac- tices programs which utilize cleaner energy over dirty forms of energy like gasoline or coal, as well as more efficient building codes. These codes have been shown to cut energy consumption by a significant amount. As these codes are implemented and reevaluated, drafters are able to revise the codes, making them all the more effective.35 However, most companies have a long way to go. According to a report compiled by the EPA, nearly half of all U.S. emissions are produced by businesses across all industries.36 A business needs to know the size of its carbon footprint before it can effec- tively reduce emissions and other environmental pollutants. Companies including Walmart, Coca-Cola, and Nestlé have actively monitored their carbon output and have set ambitious goals, such as eventually becoming net zero when it comes to emissions.

Water Issues Water is emerging as the most important and contested resource of the twenty-first century. Nothing is more important to human survival, yet water is being polluted and consumed at an unprecedented rate. An esti- mate published by the United Nations suggests that 1.8 billion people will be living in conditions of absolute water scarcity by 2025, and that approximately 75 percent of the global population may be living with lim- ited access to potable water. There are many reasons for this—including industrial waste, 70 percent of which pollutes water supplies in developing countries; human waste, which accounts for 2 million tons per day; and agricultural waste, which pollutes 40 percent of water in high income areas and 54 percent in low income areas.37 In order to remain viable, all busi- nesses must think about water conservation, purification, and allocation.

Water Pollution Water pollution results from the dumping of sewage and toxic chemicals from manufacturing into rivers and oceans; from oil and gasoline spills; and from the burial of trash and industrial waste in the ground where it can contaminate underground water supplies. Fertilizers and pesticides used in farming and grounds maintenance also drain into water supplies with each rainfall. These chemicals are harmful to all life that depends on oceans and streams. Fertilizers upset algae balances in

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rivers causing fish to die. Mercury contaminates the oceans and therefore human food supplies. Overuse of water can lead to shortages; deforestation and climate change are contributing to desertification of sections of China and even the United States; and various chemical and methane leaks associ- ated with fracking are seeping into water supplies.38 Additionally, one in ten people lack access to safe water, and every 90 seconds one child dies from a disease obtained from unsafe water.39

From the passage of the Clean Water Act in 1972 to 2001 the United States made significant strides to clean up and protect water sources. However, the water preservation movement lost federal backing in the early 2000s. According to the Natural Resources Defense Council (NRDC), 10 percent of U.S. beaches are highly polluted, causing them to be closed or on advisory for most of the year. Six of these beaches are located in the Great Lakes area, as water pollution problems are especially notable in heavily industrialized areas.40 A large percentage of streams, lakes, and other American waterways are not fit for fishing or swimming, and pollution from agriculture and organic decomposition are significant enough to have created “dead zones” in large bodies of water. The Gulf of Mexico is known to have a dead zone the size of the state of New Jersey.41

While the United States has one of the safest drinking water supplies in the world, pollution remains a problem. Flint, Michigan experienced a state of emergency after it switched its water supply from Lake Huron to the Flint River. The Flint River was known for being filthy. Soon iron and lead was leaking into the water supply, creating a toxic supply that could cause long-term effects to residents who drank or bathed in it. However, the problem of lead is not limited to Flint, Michigan. Safety experts are warning that only nine states in the United States claim to have safe lev- els of lead in their drinking water.42 Many of these have unknown side effects on people and wildlife. The EPA released a study on the quality of water coming from 50 wastewater treatment plants all over the nation, and found over 25 types of pharmaceuticals present in the water supply. Pharmaceutical companies have released the drugs into the water supply, but consumers who take the drugs are the largest contributor to the prob- lem. Pharmaceuticals have also been found in water sources in Europe, Asia, and Australia. Although the concentrations found have been small, scientists worry about the long-term health effects they could have upon humans. Effects have already been found in male frogs that have ingested small amounts of estrogen and developed eggs.43 Tougher regulations are needed globally to address pollution from activities such as dumping waste into the ocean, large animal-feeding operations, logging sites, public roads, parking lots, and industrial waste created by production operations.

Water Quantity In addition to concerns about the quality of water, some parts of the globe are increasingly worried about its quantity. Over the last two decades, water use has soared, resulting in serious consequences for the global water supply. This creates issues for businesses in various industries that consume large amounts of water in their operations. For example, it

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takes approximately 20 gallons of water to brew a pint of beer, 132 gallons to make a two-liter bottle of soda, and 500 gallons to make a pair of Levi’s jeans. In light of the decreasing amount of water on the planet, companies are taking a responsible approach by measuring their water footprints. Levi Strauss & Co. partnered with several organizations to develop assessments for the lifecycle impact of their jeans. As a result, the company has been able to determine ways to use up to 96 percent less water to make their jeans without compromising the quality.44

Record-breaking years of heat and below-average precipitation result in costly and dangerous droughts across the nation. About 15 percent of the United States experienced a moderate to extreme drought during July of 2014. These conditions put added pressure on facility managers to conserve water. The nation’s supply of accessible fresh water is decreasing drastically, in no small part because of consumption rates. The average American uses 100 gallons of water per day, and it is estimated that up to 10 percent of American homes are fitted with leaking water pipes, faucets, and toilets that waste 90 gallons of water each day. As a result, at least 40 states are preparing for or experiencing water shortages. There are many small things companies and individuals can do to slow down water con- sumption rates. For example, switching to low-flow toilets could save as much as 640 billion gallons of water.45

Land Issues Land sustainability is diverse and encompasses some of the issues already discussed, such as pollution and waste as well as loss of biodiversity and genetically modified foods. Our land is becoming less viable for human and animal habitation due to the impact of these activities. Because busi- nesses generate waste and require natural resources, stakeholders believe they have the responsibility to minimize their harmful impact on the envi- ronment.46

Land Pollution Land pollution results from the dumping of residential and industrial waste, strip mining, and poor forest conservation. Such pol- lution causes health problems in humans, jeopardizes wildlife habitats, causes erosion, alters watercourses (leading to flooding), and can eventu- ally poison groundwater supplies. China is at the epicenter of a debate over pollution. The country’s rapid development as manufacturer to the world has exposed hundreds of millions of people to the ill effects of pollution. A report released by Chinese officials indicated the extent to which their land is polluted. Of the 3.7 million square miles of land, at least 16 per- cent is polluted with heavy metals, including cadmium, nickel and arsenic. An additional 19 percent of farmland has been deemed polluted, which necessarily infects a large portion of food grown in the country. The gov- ernment announced an investment of $4.8 billion to clean polluted land and prevent these levels from recurring. However, these efforts will take time and significant damage has already been done.47 In order to reduce

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pollution around the planet, businesses are all going to have to be aware of and accept responsibility for the problem of pollution.

Determining responsibility for environmental degradation is not always easy, especially on a global scale involving different countries. In 2015 Shell was sued by a community in the Niger River Delta for oil spills that contaminated the land and settled the claim for $84 million. A year later more communities in Nigeria sued Shell for destruction caused by leaking oil. The communities claim that Shell does not have the proper technology to detect and shut off leaks in the area. Shell maintains that the pollution occurs mainly because of thieves who are trying to steal oil from the pipelines.48 Ecuador sued Chevron for environmental damage that occurred years earlier with oil and gas firm Texaco. Chevron later acquired Texaco, and the country claimed that Chevron was responsible for the environmental damage. After many court battles, a U.S. court ruled in favor of Chevron citing an agreement Texaco had signed with Ecuador absolving it of liability.49

Fracking has also led to concerns over land pollution. Fracking often occurs in rural areas where trees are cut down to make way for roads, well pads, and other infrastructure specific to fracking. Wyoming, for example, has experienced habitat fragmentation, a reduction in hunting, and a depop- ulation of wildlife; sections of forests in Pennsylvania have been cut down; and Alberta, Canada, has reported serious detrimental effects to land and other natural resources in the area believed to be caused by fracking.50

Waste Management Improper or irresponsible disposal of waste is another aspect of the land pollution problem. American consumers are by far the world’s biggest wasters. In one year, they contributed 254 million tons of waste, which strains declining landfill space. The United States has over 3,000 active landfills and more than 10,000 abandoned landfills. Often left untreated, these abandoned landfills result in hazardous leakage. Methane gas makes up the largest emissions given off from landfills, which is 20 times more powerful than carbon dioxide in terms of atmospheric heating. Some organizations have learned to convert that gas into power.51 The EPA established the Landfill Methane Outreach Program (LMOP), with part- ners consisting of landfill owners and operators, industry organizations, energy providers and marketers, state agencies, communities, end users, and other stakeholders to convert landfill methane gas into power. Europe also has thousands of biogas plants that convert methane from farm waste and trash into electricity, which in a 15-year period has reduced methane emissions from landfills by 3.1 million tons annually.52

Plastics in landfills are a major concern as they can take up to 1,000 years to biodegrade. A large contributor is plastic bags, of which Americans use 1 billion per year. Twelve cities have passed legislation either prohibiting the use of plastic bags in stores or charging a fee for their use. Many countries have passed similar legislation in various regions.53 Stores like Whole Foods banned plastic bags voluntarily, and offer incentives for consumers to use more recyclable materials such as canvas grocery bags. The United States

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recycles more than 34 percent of waste produced, while other countries such as Germany, Austria, and Belgium recycle at least half of their waste.54

Electronic waste (e-waste) in landfills has been proven to release harmful toxins into the air and water. It is estimated that the United States generated 3.14 million tons of e-waste, and only 16 percent of the world’s e-waste is recycled.55 Increasingly, electronics firms are pressured to take back used electronics for recycling. Large chains such as Best Buy offer e-recycling, as does Dell and Sprint. Sprint takes a slightly different approach with their buyback program, wherein customers may receive up to a $300 buyback value for qualifying devices.56 The EPA established its own electronics recycling program, and a host of state governments have passed laws to encourage the recycling of electronic devices. Many stake- holders, including environmental groups and some politicians, believe that companies that produce the goods should be responsible for their proper disposal and recycling.57

Deforestation Rainforests serve to regulate temperatures and weather pat- terns, absorb carbon dioxide, and maintain water supplies. Before defor- estation became a common occurrence, there was approximately 6 million square miles of rainforests, whereas today rainforests cover a little over 2 million square miles. It is estimated that the global tree count has fallen to 46 percent of what it was at the dawn of human civilization.58 The reasons for deforestation are varied. The boom in biofuels in Southeast Asia and the Pacific regions have resulted in the cutting down of trees to make room for palm oil plantations. Brazil cuts down the Amazon rainforests for farm- ing or for raising sugarcane. The amount of deforestation that occurred in Brazil’s rain forests last year covers an area the size of Rhode Island.59

A competitive global economy drives the need for money in economi- cally challenged tropical countries. In the short term, logging and convert- ing forestlands to other uses seems the profitable thing to do. However, the profits from deforestation are generally short lived due to the poor quality in rainforest soil. While initially it can create a boom of prosperity, farm- ing and other activities are only sustainable by moving and cutting down more trees.60 Deforestation began largely out of need that sprang from poverty in these areas. However, those involved in the activity are more commonly large corporations. Many see this as an advantage because it is easier to put pressure on these entities to be more responsible. In addition, this pressure can come from many stakeholder groups, which can increase the response time.61

Companies are obtaining certifications like the one granted by the Forest Stewardship Council (FSC), a nonprofit organization comprised of loggers, environmentalists, and sociologists. The FSC seeks to coordinate forest management around the world and to develop a uniform set of stan- dards. FSC-certification helps companies indicate to consumers and stake- holders that they are committed to preserving forest resources, are focused on social responsibility, and hold a long-term perspective of environmental management. Table 11.3 lists some facts about deforestation.

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TABLE 11.3 Facts about Global Deforestation One and a half acres of forest is cut down every second. Loss of forests contributes between 12 and 17 percent of annual global greenhouse gas

emissions. If the current rate of deforestation continues, it will take less than 100 years to destroy all

the rainforests on the earth. 20 percent of the world’s oxygen is produced in the Amazon forest. Poverty, over-population and unequal land access are the main causes of man-made defor-

estation. Industrialized countries consume 12 times more wood and its products per person than the

non-industrialized countries. Soil erosion, floods, wildlife extinction, increase in global warming, and climate imbalance

are a few of the effects of deforestation. Deforestation affects water cycle. Trees absorb groundwater and release the same into the

atmosphere during transpiration. When deforestation happens, the climate automatically changes to a drier one and also affects the water table.

On an average, a person in the United States uses more than 700 pounds of paper every year.

Fuel wood in sub Saharan African countries is consumed up to 200 percent times more than the annual growth rates of the trees. This is causing deforestation, lack of timber resources and loss of habitat for the species living in it.

Source: “Deforestation Facts,” Conserve Energy Future, http://www.conserve-energy-future.com/ various-deforestation-facts.php (accessed June 22, 2016).

Urban Sprawl Urban sprawl began in the United States with the post– World War II building boom that transformed the nation from primarily low-density communities designed to accommodate one-car households, bicyclists, and pedestrians to large-scale suburban developments at the edges of established towns and cities. Downtowns and inner cities deterio- rated as shopping malls, office parks, corporate campuses, and residential developments sprang up on what was once forest, prairie, or farmland. As the places where people live, work, and shop grew further apart, people began spending more time in automobiles, driving ever greater distances. Urban sprawl consumed wildlife habitat, wetlands, and farmland, and has also contributed to land, water, and air pollution. Lack of urban planning means that these places grow without reason, contributing to uneven devel- opment of services. In an age of erratic gas prices, traffic congestion, and obesity, it has become increasingly expensive, in both dollars and health, to live in sprawling cities. Large companies with many locations, such as Walmart and Starbucks, have been criticized for contributing to urban sprawl.

Some urban areas fight to limit sprawl. Portland, Oregon, for example, established an Urban Growth Boundary to restrict growth and preserve open space and rural land around the city. The California legislature passed a bill that limits urban sprawl through better transportation and more efficient land use. Adding to the appeal of returning to cities is a movement to increase urban parks. Rather than allowing loggers to profit

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from forests, more cities are buying forested land to convert to park space. Stemming sprawl also preserves natural spaces outside of the city. Additionally, people realize that living near their place of employment is more convenient, cheaper, and better for their health. Although limiting urban sprawl creates disadvantages for car and oil companies, many busi- nesses can benefit from urban renewal movements that reduce sprawl.

Biodiversity Deforestation, pollution, development, and urban sprawl put increasing pressure on wildlife, plants, and their habitats. Many plants and animals have become extinct, and thousands more are threatened. For example, in the Brazilian Savannah, scientists examined 163 tree species and deter- mined that 70 of them would eventually become nonexistent.62 Experts’ fears that over-utilization of natural resources will cause catastrophic imbalance to the environment are becoming realized. Because each bio- logical species plays a unique role in its ecosystem and is part of a com- plex chain of events, the loss of any one of them may threaten the entire ecosystem.

Decrease in Bees, Bats, and Frogs An alarming rate of decline in the populations of bees, bats, and frogs are at the forefront of this issue. Pol- linators play a significant role in that they help fruits and vegetables grow by spreading pollen from plant to plant. Increasing development and wide- spread use of pesticides have reduced populations of bees, insects, and bats needed for plant reproduction. The population of domestic honey- bees, the primary pollinators of food-producing plants, has declined by at least one-third, and many wild honeybees have become virtually extinct in many places around the world. This decline has become so widespread that the phenomenon has been termed Colony Collapse Disorder (CCD), and organizations are working to stop the decline before complete extinc- tion occurs. Declines in pollinating species not only threaten the success of their relevant ecosystems but also may harm long-term global food produc- tion because significant portions of all food products require pollinators to reproduce.63

Bat populations are also on the decline, due mainly to a fungus disease called White Nose Syndrome. Many believe that this epidemic is due to environmental and habitat changes resulting from human-related activities. Bats aid the environment in a number of ways, such as feeding on insects, which reduces the need for pesticide use.64 The same is true for amphibians such as toads, salamanders, and frogs, which are declining at an annual rate of 3.7 percent. Scientists claim that if this rate continues, frog extinc- tion will occur within the next 20 years. Frogs are especially vulnerable to environmental changes including habitat modification, urban sprawl, pollution, and depletion of the ozone layer because their skin is made to absorb the water wherein they live. Any changes in frog populations imme- diately inform us of negative changes in the environment.65

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Genetically Modified Organisms Depending on whom you ask, genetically modified foods are either going to save impoverished areas from starvation and revolutionize agriculture, or they will destroy biodiversity and make us all sick. Genetically modified (GM) organisms are created through manipulating plant and animal DNA so as to produce a desired effect like resistance to pests and viruses, drought resistance, or high crop yield. This process generally involves transferring genes from one organism to another in a way that would never occur natu- rally, in order to create a new life form that has unique traits. Companies like Monsanto and DuPont develop genetically modified corn, soybeans, potatoes, canola oil seeds, and cotton plants they claim are more resistant to weeds and insects, sometimes require fewer chemicals to produce, and pro- duce higher yields. However, studies show that certain GM crops are losing their effectiveness as insects become increasingly resistant. More farmers have reverted to using pesticides, which also damages the environment.66

Many people also fear that these unnatural genes will have negative effects on nature, somewhat like how invader species of plants and animals can wipe out native ones, or even have negative effects on humans. Other concerns result from the fact that these seeds are patented, restricting farm- ers from keeping and replanting the seeds and requiring them to purchase new seeds each year. Nevertheless, considerable interest in GM products remains. In countries where malnutrition is a problem, the prospect of higher yields is very appealing, even if the seed itself is more expensive. Monsanto, the world’s largest agricultural biotechnology company, has released GM seeds that can withstand drought, which could make a major difference in many regions.67

GM foods may be controversial, but some researchers and scientists see the technology as a valuable way to develop drugs in the future. The U.S. Food and Drug Administration (FDA) approved the first GMO drug, ATryn, created to treat people who suffer from the blood-clotting condition antithrombin deficiency. The drug comes from goats that were genetically engineered to produce human antithrombin in their milk.68 As with GM plants, the problem with the genetic engineering of animals or animal prod- ucts is that the long-run effects are unknown. Large numbers of genetically altered animals could upset the balance in relationships among various spe- cies with undetermined effects, such as the ability to reproduce or fight dis- eases and pests. Additionally, if genetically modified plant seeds are carried by wind or pollinators to areas with native plants, it is possible that genetic contamination could take place among native plants, thus reducing biologi- cal diversity. Further research is needed to address public concerns about the safety and long-term environmental effects of these technologies.

The long-term impact of this genetic tinkering is a question that con- cerns many, despite the fact that the FDA has deemed GM food safe to consume and many scientific research studies have shown no dangers to human health. Today, more than 75 percent of all processed food contains GM ingredients.69 The United States does not require labeling. Because

genetically modified (GM) organisms Organisms created through manipulating plant and animal DNA so as to produce a desired effect like resistance to pests and viruses, drought resistance, or high crop yield.

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Earth in the Balance

Organic and Natural: Labeling Lies? There is a general belief that organic and natural foods are healthier because of their lack of addi- tives and pesticide use. The fears over issues such as genetically modified food have driven more people to embrace organic and natural food claims. For this reason, companies such as Whole Foods and Trader Joe’s have become popular among grocery shoppers. Even Walmart is capitalizing on this trend by offering organic food products in stores.

However, the idea that organic and natural labels automatically means healthier could be misleading. The FDA has determined that there is no proof that organic food is healthier than genetically modified food. Additionally, the word “organic” does not neces- sarily mean totally pesticide-free. Organic farmers are allowed to use organic pesticides on their crops and still be considered organic.

One benefit is that organic farmers must meet strict criteria developed by the U.S. Department of Agriculture to be able to label their crops as such. Products can adopt this label if at least 95 percent of the content is organic. However, the costs of growing organic food are not cheap. On average, organic fruit costs 13–36 cents more per pound for fruits and vegetables. Hormone- and antibiotic-free milk averages approximately $6 per gallon versus $3.50 for regular milk.

The word natural is more vague than organic because there is no single definition of what is meant by “natural.” This makes it easier for companies to come under criticism when consumers dispute their “natural” claims. For instance, a lawsuit was filed against PepsiCo

for labeling its Naked Juice brand as natural. Consumer groups had found that synthetic vitamins had been added to the juice as well as manmade fibers. “Natural” is generally thought to mean a food product that has not been processed. However, even the FDA admits this is difficult because the majority of products have been processed in some way. While there is certification for use of the word “organic,” companies can use “natural” more freely—although not necessarily without conse- quences. Companies cannot use this term to mislead consumers. The Federal Trade Commission charged five companies with falsely promoting skin products, shampoo, and sunscreen as natural when they actually contained synthetic ingredients. This was the first time the FTC took action against natural claims.

Supporters, however, claim that there may be unreal- ized benefits of organic and natural food. Genetically modified food is still under suspicion in many countries, and the long-term health effects are not readily known. Because organic farmers use more organic techniques to grow their crops, this reduces the negative impact of farming on the environment. Additionally, many consum- ers simply enjoy the feeling of consuming more natural products and are therefore willing to pay a higher price.

The choice of whether to eat organic or natural foods is up to the consumer. However, it is important that the consumer realize that the label organic or natural does not necessarily mean healthier. Natural potato chips, for instance, still contain fats and sugars. Consumers should still look at the ingredients to ana- lyze the nutrition of the product.

Sources: Manoj Hastak and Michael B. Mazis, “Deception by Implication: A Typology of Truthful but Misleading Advertising and Labeling Claims,” Journal of Public Policy & Marketing 30, no. 2 (Fall 2011: 157–167; David Biello, “Is Organic Really Better?” Scientific American, http://www.scientificamerican.com/podcast/episode.cfm?id=is-organic-really-better-09-05-28 (accessed August 8, 2016); “Organic Pesticides Not Always Greener Choice,” Science Daily, June 23, 2010, http://www.sciencedaily.com/releases/2010/06/100622175510.htm (accessed August 8, 2016); Associated Press, “Pepsi Co. To No Longer Call Naked Juices ‘Natural’,” USA Today, July 26, 2013, http://www.usatoday. com/story/money/business/2013/07/26/pepsi-co-naked-juice-not-natural/2589717/ (accessed August 8, 2016); Ethan Huff, “Pepsi Forks Over $9 Million Settlement, Agrees to Stop Calling Naked Juice ‘Natural’,” Natural News, July 30, 2013, http://www.naturalnews.com/041412_ Naked_Juice_food_labeling_all_natural.html (accessed August 8, 2016); Rachel Tepper, “Naked Juice Class-Action Lawsuit Settlement Over Health Claims Means $9 Million for Consumers,” The Huffington Post, September 24, 2013, http://www.huffingtonpost.com/2013/08/28/ naked-juice-class-action-lawsuit_n_3830437.html (accessed August 8, 2016); Mayo Clinic staff, “Organic Food: Are They Safer? More Nutritious?” Mayo Clinic, http://www.mayoclinic.org/healthy-living/nutrition-and-healthy-eating/in-depth/organic-food/art-20043880

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many consumers demand to know what is in their food, organic and all-natural grocery chains like Whole Foods have take advantage of this market opportunity by implementing their own policies regarding labeling or the elimination of GM ingredients.

Another example of the backlash against GM organisms is in the dairy industry. Many large dairy producers use hormones, called recombinant bovine growth hormones, or rBGH, to increase milk production in cows. Many cows get sick from the hormones and are also given antibiotics. Even in America, where government bans are not in place and GM food is more accepted, many Americans refuse to buy milk that has come from cows given these drugs because it is perceived as less healthy. Companies such as Walmart, Starbucks, Kroger, and Safeway grocery store chains stopped carrying rBGH milk after strong consumer backlash.70 While this has had some effect on the milk market, 40 percent of dairy products in stores still contain rBGH.71

Countries Against GM Food All of these concerns have prompted consum- ers around the world, particularly in Europe and Japan, to boycott products made from GM crops. Moreover, 60 countries—including all of the Euro- pean Union, Australia and Japan—have imposed bans or restrictions on GM products.72 However, as more GM crops are grown and more GM foods are consumed without detrimental effects, some countries are becoming open to the technology. However slowly it may be, countries in Africa are adopt- ing the crops in order to combat hunger and ecological changes. Egypt and Sudan have cultivated small crops, while South Africa has lessened restric- tions on GM crop imports due to a prolonged drought. Additionally, Nigeria has proposed a bill to lessen the restrictions on GM crops.73

GM Trout and Other Living Organisms Researchers have created GM rainbow trout having up to 20 percent more muscle mass that non-GM trout. By injecting 20,000 eggs with different myostatin-supressing DNA (a protein that controls muscle growth), 300 eggs were found to carry the gene, resulting in muscular trout. These fish carry the potential benefit of increasing food supply, although concerns about them being released into water streams are high. The effects of them breeding with native fish are unknown, as their new genes will be transferred to offspring. In addition, their size will require them to consume more food, which may cause short- ages, and birds that typically feed on small fish may eventually find their food supply lacking. In effect, releasing these muscular fish into the wild could upset the entire ecosystem.74

(accessed August 8, 2016); United States Environmental Protection Agency, “Pesticides and Food: What ‘Organically Grown’ Means,” May 9, 2012, http://www.epa.gov/pesticides/food/organics.htm (accessed July 25, 2014); U.S. Department of Agriculture, “What is Organic?” USDA website, October 17, 2012, http://www.ams.usda.gov/AMSv1.0/ams.fetchTemplateData.do?template=TemplateC&leftNav=NationalO rganicProgram&page=NOPConsumers&description=Consumers (accessed August 8, 2016) Serena Ng, “FTC Charges Five ‘Natural’ Products Firms Over Claims,” The Wall Street Journal, April 13, 2016, http://www.wsj.com/articles/ftc-charges-five-natural-products-firms-over- claims-1460500050 (accessed July 20, 2016).

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There are over 30 types of GM animals under development for the purpose of selling commercially as food. AquaBounty Technologies is the leading company that has fully developed GM salmon for the din- ner table. These salmon are twice the size and grow twice as fast as original salmon. In addition, they are able to be grown year round, which will increase the food supply. The FDA has issued studies citing no harm in ingesting these GM foods and is expected to approve these foods for commercialization. If approved, the salmon will be the first fully GM food to make its way to dinner plates. The Food and Drug Administration approved the genetically-modified salmon, but fishing and environmental groups filed lawsuits against the agency claiming that it did not sufficiently examine environmental impact or consider the opinions of other stakeholders.75

Supreme Court Ruling About Seed Contamination Seed contamina- tion is described as the cross pollination of natural seeds with GM seeds. This has become an issue for several reasons. First, the crops of farmers who are committed to producing natural and/or organic foods have been compromised when GM seeds are blown into their fields. One Oregon farmer’s wheat was found to contain GM seeds developed by Monsanto, which were still in the experimental phase and had not yet achieved USDA approval. This discovery had international impact, as wheat shipments in Japan and South Korea had to be put on hold until the issue was resolved. Another organic farmer in Australia lost his organic certification due to GM seeds infiltrating his crops. Several more complex instances abound from seed contamination, and many court cases have been initiated.

However, because the GM seeds are patent protected, there is little recourse farmers can take in this regard. In fact, they are likely to be charged with patent infringement if GM seeds are found in their fields without them purchasing them. Monsanto has been known for enforcing their patents on farmers whose fields are found with their seeds, as well as farmers who have purchased their seeds and reused them in succeed- ing years. In a Supreme Court ruling regarding seed contamination, the verdict was in favor of Monsanto, mainly because of the patented nature of the seeds. Monsanto has said that it will not sue farmers whose fields end up with the protected seeds by accidental means, but farmers whose livelihood depends on the organic or all-natural quality of food could be compromised by the presence of these seeds.76

ENVIRONMENTAL POLICY AND REGULATION The United States, like most other nations, has passed numerous laws and established regulatory agencies to address environmental issues. Most of these efforts have focused on the activities of businesses, government agen- cies, and other organizations that use natural resources in providing goods and services.

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Environmental Protection Agency The most influential regulatory agency that deals with environmental issues and enforces environmental legislation in the United States is the Environmental Protection Agency (EPA). The EPA’s founding in 1970 was the culmination of a decade of growing protests over the deteriora- tion of environmental quality. This movement reached a significant cli- max with the publication of Rachel Carson’s Silent Spring, an attack on the indiscriminate use of pesticides, which rallied scientists, activists, and citizens from around the country to crusade to protect the environment from abuses of the time. Twenty million Americans joined together on April 22, 1970, for the first Earth Day, a nationwide demonstration for environmental reforms. The EPA was formed in response to these events. The EPA is an independent agency that establishes and enforces environ- mental protection standards, conducts environmental research, provides assistance in fighting pollution, and assists in developing and recommend- ing new policies for environmental protection. The agency is also charged with ensuring the following:

Protecting Americans from significant risks to their health and to the environment.

Managing environmental risks based on the best scientific information available.

Enforcing federal laws protecting human health and the environment fairly and effectively.

Ensuring environmental protection is an integral consideration in U.S. policies.

Ensuring access to accurate information sufficient to all parts of society. Ensuring environmental protection contributes to diverse, sustainable,

and economically productive communities and ecosystems.77

To fulfill its primary mission to protect human health and sustainabil- ity into the twenty-second century, the EPA established five long-term stra- tegic goals to define its planning, budgeting, analysis, and accountability processes (see Table 11.4). To determine these goals, the agency solicited and evaluated significant stakeholder input on priority areas related to

Environmental Protection Agency (EPA) The most influential regula- tory agency that deals with environmental issues and enforces environmental legislation in the United States.

TABLE 11.4 Strategic Goals of the Environmental Protection Agency 1 Taking action on climate change and improving air quality

2 Protecting America’s waters

3 Cleaning up communities and advancing sustainable development

4 Ensuring the safety of chemicals and preventing pollution

5 Enforcing environmental laws

Source: “FY 2011–2015 EPA Strategic Plan,” Environmental Protection Agency, http://nepis.epa.gov/ Exe/ZyPDF.cgi?Dockey=P1008YOS.PDF (accessed June 22, 2016).

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human health and environmental protection activities. Thus, these goals reflect public priorities as voiced by Congress in the form of statutes and regulations designed to achieve clean air and water, proper waste manage- ment, and other important concerns.78

To achieve these goals and carry out its public mission, the EPA is empowered to file civil charges against companies that violate the law. For years, many companies involved in the mining and extraction industries were not forced to pay for cleanup of environmental damage. However, the EPA has taken steps to ensure that companies are financially respon- sible for future environmental damage, rather than taxpayers and other stakeholders.79

Environmental Legislation A number of laws have been passed to address both general and specific environmental issues, including public health, threatened species, toxic substances, clean air and water, and natural resources. For instance, leaded gasoline was phased out during the 1990s because catalytic con- verters, which are used to reduce pollution and required by law on most vehicles, do not work properly with leaded gasoline. In addition, lead exposure is harmful to people. The automobile industry is responding to increased Corporate Average Fuel Economy (or CAFE) standards by determining methods to increase gas mileage. Federal regulation requires automobiles to get 35.5 miles per gallon (mpg) by 2016 and 54.5 mpg by 2025, and car makers have devised alternative ways of building their cars to achieve these goals.80 Strategies include incorpo- rating lighter materials like aluminum, increased production and sales of hybrid vehicles, and improving electric cars and hydrogen fuel-cell technology.81 Table 11.5 summarizes some significant laws related to environmental protection.

Clean Air Act The Clean Air Act is a comprehensive federal law that regu- lates atmospheric emissions from a variety of sources.82 The law established national air quality standards as well as standards for significant new pol- lution sources emitting hazardous substances. These maximum pollutant standards, called National Ambient Air Quality Standards (NAAQS), are federally mandated to protect public health and the environment. States have the responsibility of developing implementation plans to meet the NAAQS by restricting emissions of criteria pollutants from stationary sources (industries) within the state.

The Clean Air Act mandates that states are responsible for their air quality. The majority of people appear to overwhelmingly agree with the purpose of the Clean Air Act. For instance, a survey conducted by the American Lung Association indicated that 75 percent view clean air as very or extremely important.83 This means that clean air should be a pri- mary concern for businesses in order to maintain good relationships with stakeholders.84

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TABLE 11.5 Major Environmental Laws

Act (Date Enacted) Purpose National Environmental Policy Act (1969)

Established national environmental policy, set goals, and provided a means for implementing the policy; promotes efforts to prevent damage to the biosphere and to stimulate human health and wel- fare, established a Council on Environmental Quality.

Occupational Safety and Health Act (1970)

Ensures worker and workplace safety by requiring employers to provide a place of employment free from health and safety hazards.

Clean Air Act (1970) Regulates emissions from natural, stationary, and mobile sources; authorized the EPA to establish National Ambient Air Quality Standards (NAAQS) to protect public health and the environment.

Federal Insecticide, Fungicide, and Rodenticide Act (1972)

Provides for federal control of pesticide distribution, sale, and use; requires users to register when purchasing pesticides.

Endangered Species Act (1973)

Established a conservation program for threatened and endangered plants and animals and their habitats; prohibits the import, export, interstate, and foreign commerce or any action that results in a “taking” of a listed species or that adversely affects habitat.

Safe Drinking Water Act (1974)

Protects the quality of drinking water in the United States; autho- rized the EPA to establish water purity standards and required pub- lic water systems to comply with health-related standards.

Toxic Substances Control Act (1976)

Empowered the EPA to track industrial chemicals currently pro- duced or imported into the United States; authorized the EPA to require reporting or testing of chemicals and to ban the manufac- ture and import of chemicals that pose an unreasonable risk.

Resource Conservation Recovery Act (1976)

Empowered the EPA to control the generation, transportation, treatment, storage, and disposal of hazardous waste.

Clean Water Act (1977) Authorized the EPA to set effluent standards on an industry-wide basis and to continue to set water quality standards for all con- taminants in surface waters; made it unlawful for any person to discharge any pollutant from a point source into navigable waters without a permit.

Comprehensive Environmental Response, Compensation, and Liability Act (1980)

Established prohibitions and requirements concerning closed and abandoned hazardous waste sites; authorized a tax on the chemi- cal and petroleum industries to establish a “superfund” to provide for cleanup when no responsible party could be identified.

Superfund Amendments Reauthorization Act (1986)

Amended the Comprehensive Environmental and Response, Compensation, and Liability Act to increase the size of the super- fund; required superfund actions to consider the standards and requirements found in other state and federal environmental laws and regulations; provided new enforcement authorities and tools.

Emergency Planning and Community Right-to- Know Act (1986)

Enacted to help local communities protect public health and safety and the environment from chemical hazards; requires each state to appoint a State Emergency Response Commission (SERC) and to establish Emergency Planning Districts.

Oil Pollution Act (1990) Requires oil storage facilities and vessels to submit plans detailing how they will respond to large spills; requires the development of area contingency plans to prepare and plan for responses to oil spills on a regional scale.

(Continued )

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Pollution Prevention Act (1990)

Promotes pollution reduction through cost-effective changes in production, operation, and use of raw materials and practices that increase efficiency and conserve natural resources, such as recy- cling, source reduction, and sustainable agriculture.

Food Quality Protection Act (1996)

Amended the Federal Insecticide, Fungicide, and Rodenticide Act and the Federal Food, Drug, and Cosmetic Act to change the way the EPA regulates pesticides; applies a new safety standard— reasonable certainty of no harm—to all pesticides used on foods.

Beaches Environmental Assessment and Coastal Health Act (2000)

Amended the Clean Water Act to include provisions decreasing the risks of illness due to using the nation’s recreational waters.

Energy Policy Act (2005) Addresses the way energy is produced in the United States in terms of energy efficiency, renewable energy, oil and gas, coal, Tribal energy, nuclear matters and security, vehicles and motor fuels, hydrogen, electricity, energy tax incentives, hydropower and geo- thermal energy, and climate change technology.

American Clean Energy Act (2009)

Seeks to create clean energy jobs; more energy independence; reduce greenhouse gas emissions; and lay the groundwork for a clean energy economy

Sources: Environmental Protection Agency, “Major Environmental Laws,” http://www.epa.gov/pahome/ laws.htm (accessed June 22, 2016); Environmental Protection Agency, “Summary of the Energy Policy Act,” http://www2.epa.gov/laws-regulations/summary-energy-policy-act (accessed June 22, 2016); Environmental Protection Agency, “About the BEACH Act,” https://www.epa.gov/beach-tech/about- beach-act (accessed June 22, 2016).

TABLE 11.5 (Continued )

Endangered Species Act The Endangered Species Act established a pro- gram to protect threatened and endangered species as well as the habitats in which they live.85 An endangered species is one that is in danger of extinction, whereas a threatened species is one that may become endan- gered without protection. The U.S. Fish and Wildlife Service of the Depart- ment of the Interior maintains the list of endangered and threatened species, which currently includes 1,229 endangered species (732 are plants) and 367 threatened species (166 are plants).86 The Endangered Species Act pro- hibits any action that results in the harm to or death of a listed species or that adversely affects endangered species habitat. It also makes the import, export, and interstate and foreign commerce of listed species illegal. Pro- tected species may include birds, insects, fish, reptiles, mammals, crusta- ceans, flowers, grasses, cacti, and trees.

The Endangered Species Act is highly controversial because some threatened or endangered species are a nuisance to ranchers and farmers, and have been harmed or killed by landowners seeking to avoid the hassle or expense of complying with the law. Concerns about the restrictions and costs associated with the law are not entirely unfounded. For example, a man was charged with unlawfully killing a grizzly bear (a species listed as threatened under the Endangered Species Act) when it and her two cubs showed up on his property. Several of the man’s children were playing outside when the bears appeared, and he shot at them in order to protect

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his family. At the time of trial, the man was facing two years in prison, a $50,000 fine, and one year probation. In the end, the man was not convicted, but this example shows the kind of issues that can arise from this law.87

Toxic Substances Control Act Congress passed the Toxic Substances Control Act to empower the EPA with the ability to track the 75,000 indus- trial chemicals currently produced or imported into the United States. The agency repeatedly screens these chemicals and requires reporting or testing of those that may pose an environmental or human health hazard. It can also ban the manufacture and import of chemicals that pose an unreason- able risk. The EPA tracks the thousands of new chemicals developed by industry each year with either unknown or dangerous characteristics. It also controls these chemicals as necessary to protect human health and the environment.88 For instance, new rules for bisphenol A (BPA), a toxic chemical found in some plastics, were implemented under this law. Today, the chemical can no longer be used in the manufacturing of plastic baby bottles or children’s sippy cups.89

Clean Water Act The Federal Water Pollution Control Act was renamed as the Clean Water Act in 1977. The law grants the EPA the authority to establish effluent standards on an industry basis and continue the earlier law’s requirements to set water quality limits for all contaminants in sur- face waters. The Clean Water Act makes it illegal for anyone to discharge any pollutant from a point source into navigable waters without a per- mit.90 This includes the pouring of contaminates down the drain. Duke Energy pleaded guilty to nine violations of the Clean Water Act. For many years, the company had polluted four North Carolina rivers with toxic coal ash from its power plants. The firm was fined $102 million for these viola- tions. It was also put on a five-year probation for environmental crimes.91

Food Quality Protection Act The Food Quality Protection Act amended the Federal Insecticide, Fungicide, and Rodenticide Act and the Federal Food, Drug, and Cosmetic Act to fundamentally change the way the EPA regulates pesticides. The law included a new safety standard—reason- able certainty of no harm—that must be applied to all pesticides used on foods.92 The legislation establishes a more consistent, science-based regu- latory environment and mandates a single health-based standard for all pesticides in all foods. The law also provides special protections for infants and children, expedites approval of safer pesticides, provides incentives for the development and maintenance of effective crop protection tools for farmers, and requires periodic reevaluation of pesticide registrations and tolerances to ensure that they are up-to-date and based on good science.

Energy Policy Act The Energy Policy Act focuses the nation’s priorities on alternative forms of energy in the hopes to lessen U.S. dependence on foreign oil. The bill offered tax breaks and loan guarantees to alternative

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energy companies, like nuclear power plants, solar companies, and wind energy farms, and also requires utilities to comply with federal reliability standards for the electricity grid. Consumers who purchased hybrid gaso- line-electric cars and other energy-saving measures were rewarded with tax benefits. Tax credits were also provided for plug-in electric drive conver- sion kits.93 The bill also extended daylight savings time by one month to save energy.94

ALTERNATIVE ENERGY Ongoing plans to reduce global carbon emissions are spurring countries and companies alike toward alternative energy sources. Traditional fos- sil fuels are problematic because of their contribution to climate change and global warming, as well as because of the increasing depletion of resources. Foreign fossil fuels are often imported from politically and economically unstable regions, often making it unsafe or unseemly to conduct business there. About 24 percent of petroleum consumed in the United States came from foreign sources. This is the lowest level since 1970.95 This decrease is largely due to the recognition by the U.S. govern- ment of the need to look toward alternative forms of energy as a source of fuel and electricity. These sources include wind power, solar power, nuclear power, biofuels, and hydro and geothermal power. Table 11.6 provides some examples of companies and/or countries that use these alternative power sources.

TABLE 11.6 Alternative Energy

Energy Source Examples Wind SC Johnson uses wind power to power its largest manufacturing facility

Geothermal The largest complex of geothermal plants, known as the Geysers in Northern California, produces 60 percent of the average electricity demand in the North Coast region of California

Solar Kohl’s has begun installing solar panels at some of its locations

Nuclear 75 percent of France’s electricity comes from nuclear power

Biofuels Boeing is partnering with South African Airways and Dutch company SkyNRG to work on developing jet fuel from a type of tobacco plant

Hydropower Yahoo uses hydropower at its New York facilities

Sources: Chad Garland, “Boeing, South African Airways to Develop Jet Fuel From Tobacco,” Los Angeles Times, August 6, 2014, http://www.latimes.com/business/la-fi-tn-boeing-biofuel-tobacco- 20140806-story.html (accessed June 22, 2016); Calpine Corporation, “About Geyser Energy,” http:// www.geysers.com/geothermal.aspx (accessed June 22, 2016); Yevgeniy Sverdlik, “Yahoo Launches Second ‘Computing Coop’ Data Center in New York State,” Data Center Knowledge, April 27, 2015, http://www.datacenterknowledge.com/archives/2015/04/27/second-yahoo-data-center-comes-online- in-new-york-state/ (accessed June 22, 2016).; SC Johnson, “SC Johnson Powers Up Wind Energy at Company’s Largest Manufacturing Facility,” December 18, 2012, http://www.scjohnson.com/en/ press-room/press-releases/12-18-2012/sc-johnson-powers-up-wind-energy-at-largest-mfg-facility.aspx (accessed June 22, 2016).

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Wind Power The Great Plains of the United States is one of the greatest sources of wind energy in the world, and many people believe that harnessing this energy will go a long way toward providing the United States’ energy needs in the future. In fact, wind power is the fastest growing form of renewable energy worldwide. It consists of nearly 4 percent of total electricity generation capacity in the United States, and some states—including Iowa and South Dakota—generate more than 25 percent of their electricity needs through this method.96 However, there are a number of roadblocks standing between taking abundant wind and turning it into affordable energy. First of all, restructuring the nation’s power grids to efficiently transmit wind, solar, and other forms of renewable energy will require a large investment. Widespread adoption of wind power has been slowed by the high cost of the turbines and limitations on an outdated national power grid. The technology is more expensive and less efficient than fossil fuels currently, but advances are being made all of the time. Many people believe that the United States will be a wind power hot spot in the future, and more Americans than ever are supporting the movement. The United States is a close second to China, the largest producer of wind power.97

Wind energy has long been popular in other countries such as the Netherlands and Denmark and is becoming a lucrative business for many companies. Danish Company Vestas Wind Systems is the world’s largest producer of wind turbines. It has 19 percent of the U.S. wind energy mar- ket. It has even expanded production to the United States in order to take advantage of the growing interest in wind energy.98

Mexico also has goals to become one of the top producers of wind power. Energy in Mexico has long relied on oil. However, new legislation serves to dissolve that monopoly and open the market to new forms of energy—including wind power. Two gigawatts of wind power per year will be installed, enabling the country to achieve its goal of 35 percent electricity generated from renewable sources by 2024.99 However, some setbacks are present. Mexico’s Isthmus of Oaxaca was one of the pro- posed areas for a wind farm, because of the vast landscape and presence of winds. Indigenous residents oppose the wind farm because of its unknown and possibly detrimental effects to the ecosystem, upon which their liveli- hood depends. The strong opposition resulted in the cancellation of the wind farm in this area, and highlights some obstacles Mexico will have to overcome in implementing renewable energy initiatives.100

Geothermal Power Geothermal energy comes from the natural heat inside the Earth, which is extracted by drilling into steam beds. Although initial costs to build geo- thermal plants are high, savings in the long-term are well worth the invest- ment. For example, Lipscomb University in Nashville, Tennessee, utilizes a geothermal heating and cooling system in many of their campus buildings,

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saving the University up to 70 percent annually.101 Carbon dioxide emis- sions are less than those produced by efficient natural gas power plants, and geothermal plants use less water than coal power plants. Geothermal power also provides a steady flow of electricity every day of the year, unlike wind or solar energy.

Despite these advantages, the extraction of fluids from the ground causes pollution and can sometimes cause the land to subside if careful envi- ronmental measures are not implemented. Additionally, geothermal drilling sites are not readily available everywhere because of certain factors such as the permeability of rock. This—along with the high cost—has resulted in slow adoption, as geothermal power represents less than 10 percent of global energy. The United States, France, Russia, Mexico, Costa Rica, Indonesia, New Zealand, the Philippines, Iceland, Portugal, Japan, and Lithuania are the countries where the most geothermal energy is generated.102 Research has shown that geothermal energy could become cheaper than fossil fuels as research and development receive more investment.

Solar Power Solar power is a 100 percent renewable, passive energy source that can be converted into electricity through the use of either photovoltaic cells (solar cells) on homes and other structures or solar power plants. The major disadvantages of solar power are that the technology remains expensive and inefficient compared to traditional fossil fuel-generated energy and that the infrastructure for mass production of solar panels is not in place in many locations. Cloudy days, a seeming disadvantage, are not neces- sarily a problem as the UV rays required to generate power filter through clouds. Germany, a country not exactly known for its abundant sunshine, is number one in the world for solar power implementation.

Given the strong sunshine in places like the U.S. Southwest and California, solar power has gained a lot of support in the United States. For example, the world’s largest solar power plant was completed in California, having the capacity to power nearly 95,000 American homes.103 Additionally, the United States is adopting solar power at a record-breaking rate which will outpace Germany if it continues.104 Solar energy is becoming an increasingly viable alternative for businesses to cut their pollution and emissions. Many Walmart facilities, with their huge flat roofs perfect for solar panels, now use solar power to generate the electricity of some stores.

Nuclear Power Countries throughout Europe have managed to greatly reduce their emis- sions through the implementation of nuclear power plants, yet this form of power remains controversial. Because of the danger associated with nuclear meltdowns and radioactive waste disposal, nuclear power has some significant disadvantages. On the one hand, nuclear power is pollution- free and cost-competitive. Uranium is abundant enough that generating

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even 60 times more energy than what is produced today would not be a problem. The United States is the leader in nuclear power generation. The U.S. government provided $319 million in nuclear research and develop- ment for new power plant design.105

On the other hand, concerns over the safety of nuclear power plants and the disposal of waste are prevalent. Radiation output of nuclear power can be harmful to workers and the areas where transport of nuclear waste occurs. The Chernobyl accident in the Ukraine resulted in deaths, sickness, and birth defects. The crisis that occurred in Japan after nuclear reactors were damaged in the 2011 earthquake and tsunami was disturb- ing to many people as Japan is a developed country that has significant infrastructure. The fact that a natural disaster could lead to a nuclear emergency has led some to question our abilities to ensure the complete safety of nuclear power.

Biofuels Biofuels are derived from organic materials like corn, sugarcane, vegetable oil, even trash. Ethanol made from sugarcane has been widely used in Brazil for decades, and the United States has adopted the use of ethanol made mostly from corn. This has become especially popular with those who want to reduce their car’s carbon output or who are concerned with the nation’s addiction to foreign oil. Automobile makers have responded by creating flex fuel and hybrid vehicles that can run on biofuels or gaso- line. General Motor’s Chevrolet Volt is an electric car with a backup motor for distances over 40 miles. When it uses gasoline, the Volt is designed to run mostly on E85, a blend of 85 percent ethanol (a type of alcohol that can be used as a biofuel) and a small percentage of gasoline.

Legal mandates to incorporate biofuels have been passed in some countries. This is a major reason for Brazil’s widespread use, as they made it a requirement to blend gasoline with ethanol. There is some controversy over the use of biofuels in the United States, however, because it is made from corn, which is highly energy intensive to produce. Another point of criticism is that they currently use food crops, which with widespread adoption, could lead to food shortages.

Researchers have been hard at work developing new technologies that could produce biofuels without deforestation of land or compromising food supplies. Cellulosic ethanol would be made from non-edible plants like grasses, sugarcane waste, algae, and wood waste. Euglena Company, based in Japan, makes biofuel using algae. Japan’s largest airline, ANA Holdings, has partnered with Euglena to use a mix of fuel in which 10 percent is algae-based.106

Hydropower Throughout history people have used water as a power source and a means of transportation. From the water-powered mills of centuries past to mod-

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ern hydroelectric dams, water is a powerful renewable energy source. Although in the United States, hydroelectric power only provides 2.8 per- cent of total output, hydropower provides 16 percent of total electricity production worldwide, making it the largest form of renewable energy. As with all other forms of energy production, hydropower has benefits and downsides. One of the major downsides is the destruction of wildlife habitats and sometimes even human habitations, when valleys are flooded due to dams. Hydroelectricity also disrupts the lifecycles of aquatic life. Damming the Columbia River between Washington and Oregon States decimated the region’s salmon industry, for example. Benefits of hydro- electric energy include little pollution and inexpensive maintenance costs, once the infrastructure is in place.107

BUSINESS RESPONSE TO SUSTAINABILITY ISSUES Many businesses have adopted a triple-bottom line approach that takes into consideration social and environmental performance in addition to economic performance. Firms are learning that being environmentally friendly and sustainable has numerous benefits—including increased goodwill from stakeholders and even money savings from being more effi- cient and less wasteful. Positions such as vice president of environmental affairs have been created to help companies achieve their business goals in an environmentally responsible manner. Businesses like Walmart and Nike have also developed environmental scorecards for their suppliers.108 Corporate efforts to respond to environmental issues focus on green mar- keting, recycling, emissions reductions, and socially responsible buying.

Yet despite the importance of the environment, companies are in business to make a profit. Economic performance is still a necessary bottom line for most businesses. This begs the question: is going green cost-effective for companies? Studies suggest that improving a company’s environmental performance can in fact increase revenues and reduce costs. Table 11.7 provides examples of how companies have used sustainability opportunities to impact performance.

Better environmental performance can increase revenue in three ways: through better access to certain markets, differentiation of products, and the sale of pollution-control technology. A firm’s innovation in sustain- ability can be based on applying existing knowledge and technology or creating a completely new approach. Improving a firm’s reputation for environmental stewardship may help companies capture this growing market niche.

Supply Chain Issues An important aspect of building a corporate reputation is ensuring the sustainability of the supply chain. Walmart, for instance, is requiring their

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TABLE 11.7 Sustainability Opportunities for Economic Performance

Sustainability Opportunity Example Differentiation of products Method successfully used sustainability to differentiate its

cleaning products from the competition

Cost of energy Walmart lowers its energy costs through the use of solar power

Relationship with customers Customers that purchase a Preserve Products recycled toothbrush are given a mailer that they can use to mail the toothbrush back to the company for recycling at the end of their use

Employee loyalty New Belgium Brewing motivates employees to be sustain- able by providing them with a mountain bike after they have worked there for one year

Community relations Patagonia has a Common Threads Initiative that encourages people to reduce their consumption and help the environ- ment by refraining from buying items they do not need

suppliers to be more environmentally friendly. Walmart has developed a Sustainability Index that it uses to track the environmental impact of its products. So far the index has been applied to 700 product categories.109 These kinds of activities should go a long way toward helping consumers make ‘greener’ choices.110 Improving a supply chain’s environmental per- formance may be key to attracting more business from the retail industry.

Better environmental performance can also reduce costs by improving risk management and stakeholder relationships, reducing the amount of materials and energy used, and reducing capital and labor costs. Improved environmental standards should help prevent some major environmental disasters in the future. For those disasters that cannot be avoided, the firm can at least show that it applied due diligence with its environmental per- formance, which may reduce the company’s culpability in the public’s eye. Companies can also decrease the costs of compliance with governmental regulations and reduce fines if they become more energy efficient.

Green Marketing Green marketing is a strategic process involving stakeholder assessment to create meaningful long-term relationships with customers, while maintain- ing, supporting, and enhancing the natural environment. One company that is known for its commitment to being green is New Belgium Brewing in Fort Collins, Colorado. From its conception, New Belgium has been a company committed to sustainability. Its facilities use natural lighting and evaporative coolers to save on energy costs, and the buildings themselves were constructed of pine trees that were killed by invasive beetles (a grow- ing problem in the Rockies). The brewery has been wind powered for over

green marketing A strategic process involving stakeholder assessment to create meaningful long- term relationships with customers while maintaining, supporting, and enhancing the natural environment.

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a decade and uses waste from the brewing process to produce on-site methane gas for energy as well. The company encourages its employ- ees to bike to work, and actively engages in benchmarking and set- ting ambitious goals for reducing energy and waste even further.111

Many products are certified as “green” by environmental organi- zations such as Green Seal and carry a special logo identifying them as such. In Europe, companies can voluntarily apply for an Eco-label (see Figure  11.3) to indicate that their product is less harmful to the environment than competing products based on scientifically determined criteria. The European Union supports the Eco-label program, which has been utilized in product categories as diverse as refrigerators, mattresses, vacuum cleaners, footwear, and televisions. Certification does not include food and medicine.112

Greenwashing Businesses must approach their green marketing tactics with caution so as not to mislead consumers.113 Greenwashing involves misleading a consumer into thinking that a good or service is more environmentally friendly than it is. It occurs when companies want to attract environmen- tally-conscious consumers and can range from making environmental claims that are required by law and are therefore irrelevant (CFC-free) to puffery, or exaggerating environmental claims, to fraud. Researchers compared claims on products sold in ten countries, including the United States, to labeling guidelines established by the International Organization for Standardization (ISO), which prohibit vague and misleading claims as well as unverifiable ones such as “environmentally friendly” and “non- polluting.” The study found that many products’ claims are too vague or misleading to meet ISO standards.114 For example, some products will be labeled as “chemical-free,” when in fact everything contains chemicals, including plants and animals. Products with the highest number of mis- leading or unverifiable claims were laundry detergents, household clean- ers, and paints. Advocates agree there is still a long way to go to ensure that shoppers are adequately informed about the environmental impact of the products they buy.115

Often, consumers do not find out about these false claims until after the purchase. 116 So while greenwashing may increase sales in the short- term and build the appearance of a company’s sustainability reputation, it will cause serious repercussions when consumers learn they have been misled. This leads to poor long-term financial performance, which nega- tively affects all stakeholders of the company.117 At the same time, the terms “green” and “sustainability” can be hard to define, resulting in unintentional greenwashing. The FTC issued green guidelines to help mar- keters determine the truthfulness of “green” claims in order to reduce this confusion.118

greenwashing Misleading a consumer into thinking that a product is more environmentally friendly than it is.

Source: “European Union Eco-label Logo,” Europa, European Union, http://ec.europa.eu/environment/ ecolabel/ (accessed June 22, 2016).

FIGURE 11.3 The European Eco-label

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STRATEGIC IMPLEMENTATION OF ENVIRONMENTAL RESPONSIBILITY Businesses have responded to the opportunities and threats created by environmental issues with varying levels of commitment. Some companies, like New Belgium Brewing, consider sustainability a core component of the business. Other companies engage in greenwashing and do not actively seek to be more sustainable at all. As Figure 11.4 indicates, a low-commitment business attempts to avoid dealing with environmental issues and hopes that nothing bad will happen or that no one will ever find out about an environmental accident or abuse. Such firms may try to protect themselves against lawsuits. If you recall the example of Chevron earlier in the chap- ter, you will notice this is also an example of a low-commitment company in terms of sustainability. Other firms are more proactive in anticipating risks and environmental issues. Such firms develop strategic management programs, which view the environment as an opportunity for advancing organizational interests. These companies respond to stakeholder interests, assess risks, and develop a comprehensive environmental strategy. Home Depot, for example, has established a set of environmental principles that include selling responsibly marketed products, eliminating unnecessary packaging, recycling and encouraging the use of products with recycled content, and conserving natural resources by using them wisely. The com- pany also makes contributions to many environmental organizations.

FIGURE 11.4 Strategic Approaches to Environmental Issues

Low Commitment

Medium Commitment

Deals only with existing problems

Attempts to comply with environmental laws

High Commitment

Has strategic programs to address environmen- tal issues

Makes only limited plans for anticipated problems

Deals with issues that could cause public relations problems

Views environment as an opportunity to advance the business strategy

Fails to consider stakeholder environmental issues

Views environmental issues from a tactical, not a strategic, perspective

Consults with stakeholders about their environmental concerns

Operates without concern for long-term environmental impact

Views environment as more of a threat than an opportunity

Conducts an environmental audit to assess performance and adopts international standards

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Recycling Initiatives Many organizations engage in recycling, the reprocessing of materials, espe- cially steel, aluminum, paper, glass, rubber, and some plastics, for reuse. In fact, recycling is one of the country’s greatest sustainability success stories. Sixty-seven percent of all newspaper and mechanical paper used in the United States is now recycled. About 63 percent of paper and paperboard is recovered.119 Paper is not the only thing that is recyclable, however. New Belgium Brewing engages in a type of recycling by using waste from beer production to generate methane gas that powers its facilities. Gills, the largest onion processor in the country, uses onion waste to make electricity and cattle feed. Starbucks makes coffee grounds available free to those who wish to use them for compost to add nutrition to their gardens.

Sometimes companies join partnerships and become members of orga- nizations like WasteWise, which aims to reduce municipal solid waste and industrial waste.120 These collaborations help companies save money through reducing waste, receiving positive publicity, and tracking how they reduce waste over time. Local and regional governments are also finding ways to recycle water to avoid discharging chemicals into rivers and streams and to preserve diminishing water supplies. After decades of siphoning water from surrounding regions, the city of Dallas, Texas, had to change their behaviors due to dwindling resources. Many conservation- ists see city-dwellers’ love of green lawns and golf courses in a drought- prone region as simply wasteful and irresponsible. Part of the plan to address this thirst for water is the installation of more and larger water recycling facilities.121

Stakeholder Assessment Stakeholder analysis is an important part of a high-commitment approach to environmental issues. This process requires acknowledging and actively monitoring the environmental concerns of all legitimate stakeholders. Thus, a company must have a process in place for identifying and pri- oritizing the many claims and stakes on its business and for dealing with trade-offs related to the impact on different stakeholders. Although no company can satisfy every claim, all risk-related claims should be evalu- ated before a firm decides to take action on or ignore a particular issue. To make accurate assumptions about stakeholder interests, managers need to conduct research, assess risks, and communicate with stakeholders about their respective concerns.

However, not all stakeholders are equal. There are specific regula- tions and legal requirements that govern some aspects of stakeholder relationships, such as air and water quality. A business cannot knowingly harm the water quality of other stakeholders in order to generate a profit. Additionally, some special-interest groups take extreme positions that, if adopted, would undermine the economic base of many other stakeholders (e.g., fishing rights, logging, and hunting). Regardless of the final decision

recycling The reprocessing of materi- als, especially steel, alumi- num, paper, glass, rubber, and some plastics, by many organizations for reuse.

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a company makes with regard to particular environmental issues, informa- tion should be communicated consistently across all stakeholders. This is especially important when a company faces a crisis or negative publicity about a decision. Another aspect of strong relationships is the willingness to acknowledge and openly address potential conflicts. Some degree of negotiation and conciliation will be necessary to align a company’s deci- sions and strategies with stakeholder interests.

Risk Analysis The next step in a high-commitment response to environmental concerns is assessing risk. Through industry and government research, an organiza- tion can usually identify environmental issues that relate to manufacturing, marketing, consumption, and use patterns associated with its products. Through risk analysis, it is possible to assess the environmental risks associated with business decisions. The difficulty is measuring the costs and benefits of environmental decisions, especially in the eyes of interested stakeholders. Research often conflicts, adding to the confusion and con- troversy over sustainability.

Debate surrounding environmental issues will force corporate deci- sion-makers to weigh the evidence and take some risks in final decisions. The important point for high-commitment organizations is to continue to evaluate the latest information and to maintain communication with all stakeholders. For example, if the millions of sport utility vehicles (SUVs) on U.S. roads today were replaced with fuel-efficient electric-powered cars and trucks, there would be a tremendous reduction of greenhouse gas emissions. However, the cooperation and commitment needed to gain the support of government, manufacturers, consumers, and other stakehold- ers to accomplish this would be impossible to achieve. Although SUVs may contribute to the detriment of the environment, many of their owners prefer them because they provide greater protection in an accident than smaller vehicles.

The issue of environmental responsibility versus safety in SUVs illus- trates that many environmental decisions involve tradeoffs for various stakeholders’ risks. Through risk management, it is possible to quantify these tradeoffs in determining whether to accept or reject environmen- tally related activities and programs. Usually, the key decision is between the amount of investment required to reduce the risk of damage and the amount of risk acceptable in stakeholder relationships. A company should assess these relationships on an ongoing basis. Both formal and informal methods are needed to get feedback from stakeholders. For example, the employees of a firm can use formal methods such as exit interviews, an open-door policy, and toll-free telephone hotlines. Conversations between employees could provide informal feedback. But it is ultimately the respon- sibility of the business to make the best decision possible after processing all available research and information. Then, if it is later discovered that a mistake has been made, change is still possible through open disclosure and

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thoughtful reasoning. Finally, a high-commitment organization will incor- porate new information and insights into the strategic planning process.

The Strategic Environmental Audit Organizations that are highly committed to environmental responsibility may conduct an audit of their efforts and report the results to all inter- ested stakeholders. Table 11.8 provides a starting point for examining environmental sensitivity. Such organizations may also wish to use glob- ally accepted standards, such as ISO 14000, as benchmarks in a strategic environmental audit. The International Organization for Standardization developed ISO 14000 as a comprehensive set of environmental standards that encourage a cleaner, safer, and healthier world. There is considerable variation among the environmental laws and regulations of nations and regions, making it difficult for high-commitment organizations to find acceptable solutions on a global scale. The goal of the ISO 14000 stan- dards is to promote a common approach to environmental management and to help companies attain and measure improvements in environmental performance. Companies that choose to abide by the ISO standards must review their environmental management systems periodically and identify all aspects of their operations that could impact the environment.122 Other performance benchmarks available for use in environmental audits come

ISO 14000 A comprehensive set of environmental standards that encourage a cleaner, safer, and healthier world developed by the Inter- national Organization for Standardization.

TABLE 11.8 Strategic Sustainability Audit

Yes No Checklist O O Does the organization show a high commitment to a strategic environ-

mental policy?

O O Do employees know the environmental compliance policies of the organization?

O O Do suppliers and customers recognize the organization’s stand on environ- mental issues?

O O Are managers familiar with the environmental strategies of other organizations in the industry?

O O Has the organization compared its environmental initiatives with those of other firms?

O O Is the company aware of the best practices in environmental management regardless of industry?

O O Has the organization developed measurable performance standards for environmental compliance?

O O Does the firm reconcile the need for consistent responsible values with the needs of various stakeholders?

O O Do the organization’s philanthropic efforts consider environmental issues?

O O Does the organization comply with all laws and regulations that relate to environmental impact?

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from nonprofit organizations such as CERES, which has also developed standards for reporting information about environmental performance to interested stakeholders. The Green Globe program also offers environmen- tal auditing and benchmarking services along with worldwide environ- mental certification for businesses.123

As this chapter has demonstrated, social responsibility entails respond- ing to stakeholder concerns about the environment, and many firms are finding creative ways to address environmental challenges. Although many of the companies mentioned in this chapter have chosen to implement stra- tegic environmental initiatives to capitalize on opportunities and achieve greater efficiency and cost savings, most also believe that responding to stakeholders’ concerns about environmental issues will both improve rela- tionships with stakeholders and make the world a better place.

SUMMARY Although the scope of sustainability is quite broad, we define it as the potential for long-term well-being of the natural environment, includ- ing all biological entities, as well as the interaction among nature and individuals, organizations, and business strategies. Sustainability includes the assessment and improvement of business strategies, economic sectors, work practices, technologies, and lifestyles while maintaining the natural environment. Sustainability does not mean the same thing as social respon- sibility. Rather, sustainability is a domain of social responsibility.

A major part of achieving sustainability is reducing sources of pol- lution. Air pollution arises from stationary sources such as factories and power plants; mobile sources such as cars, trucks, planes, and trains; and natural sources such as windblown dust and volcanic eruptions. Acid rain results when nitrous oxides and sulfur dioxides emitted from manufac- turing facilities react with air and rain. Scientists believe that increasing concentrations of greenhouse gases in the atmosphere are warming the planet, although this theory is still controversial. The Kyoto Protocol is a treaty among industrialized nations to slow global warming. However, major polluters such as the United States and China were not signatories of the Kyoto Protocol. The second commitment phase is currently in place. Europe has instituted a cap-and-trade program, which places a limit (cap) on carbon emissions, but allows businesses to purchase carbon permits from other companies. The United States is avoiding a wide-scale cap-and- trade program but is placing limits on carbon emissions that will impact coal plants.

Water pollution results from the dumping of raw sewage and toxic chemicals into rivers and oceans; from oil and gasoline spills; from the burial of industrial waste in the ground where it can reach underground water supplies; and from the runoff of fertilizers and pesticides used in farming and grounds maintenance. The amount of clean water available is also a concern and the topic of political disputes.

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Land pollution results from the dumping of residential and industrial waste, strip mining, and poor forest conservation. How to dispose of waste in an environmentally responsible manner is an important issue. Deforestation to make way for agriculture and development threatens animal and plant species, as well as humans. Urban sprawl, the result of changing human development patterns, consumes wildlife habitat, wet- lands, and farmland.

Deforestation, pollution, and urban sprawl threaten wildlife, plants, and their habitats and have caused many species to become endangered or even extinct. Biodiversity is threatened by all these activities, and should be an important topic of consideration for organizations and businesses. Scientists poorly understand rainforests and other biologically diverse environments, yet we do know that they still hold many important discoveries.

Genetically modified (GM) organisms are created through manipulat- ing plant and animal genes so as to produce a desired effect like resistance to pests and viruses, drought resistance, or high crop yield. Many farmers now plant GM crops that are more pest and insecticide resistant, require fewer chemicals to produce, and have higher yields. The long-term con- sequences of these scientific innovations are unknown. Some fear that, because GM food is not naturally occurring, it could harm biodiversity or cause health problems in humans. Even so, there is a continued interest in GM products as a way to solve problems such as world hunger, drought, and pest invasions.

The U.S. Environmental Protection Agency (EPA) is an independent regulatory agency that establishes and enforces environmental protection standards, conducts environmental research, provides assistance in fight- ing pollution, and assists in developing and recommending new policies for environmental protection.

To reduce greenhouse gas emissions and dependence on fossil fuels, many countries and businesses are investigating in alternative forms of renewable energy. Wind power utilizes large turbines to convert wind into electricity. It has long been popular in windy regions such as northern Europe and is catching on in places like the United States and Mexico. Geothermal power harnesses the heat trapped inside the earth to generate power. While not feasible everywhere, it is an attractive option because energy is available all of the time, unlike with wind or solar power. Solar power can also be converted to electricity. Sunny places like the American Southwest are the sites of intensive solar power research. Nuclear power is another possible, albeit controversial, form of alternative energy. Countries in Europe and Asia continue to use nuclear power a great deal, but concerns remain over possible meltdowns and how to dispose of the waste. Biofuels have gained in popularity as a way to reduce the consump- tion of gasoline. However, adopting corn ethanol in the United States has been more problematic as it involves using a key food source. Hydropower is the most common alternative fuel used in the world but is expensive to initially set up and can have detrimental effects on river systems and sur- rounding areas.

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Businesses are applying creativity, technology, and business resources to respond to environmental issues. Some firms have a vice president of environmental affairs position to help them achieve their business goals in an environmentally responsible manner. Green marketing is a strate- gic process involving stakeholder assessment to create meaningful long- term relationships with customers, while maintaining, supporting, and enhancing the natural environment. While green marketing has become more popular, companies must be careful not to engage in greenwashing. Greenwashing involves misleading a consumer into thinking that a prod- uct is more environmentally friendly than it really is.

There is growing agreement among environmentalists and businesses that companies should work to protect and preserve sustainability. Many organizations engage in recycling, the reprocessing of materials—espe- cially steel, aluminum, paper, glass, rubber, and some plastics—for reuse. Businesses have responded to the opportunities and threats created by environmental issues with varying levels of commitment. A high-commit- ment business develops strategic management programs, which view the environment as an opportunity for advancing organizational interests. Stakeholder analysis requires a process for identifying and prioritizing the many claims and stakes on its business and for dealing with trade-offs related to the impact on different stakeholders. Risk analysis tries to assess the environmental risks and trade-offs associated with business decisions. Organizations that are highly committed to environmental responsibility may conduct an audit of their efforts and report the results to all interested stakeholders. Such organizations may use globally accepted standards, such as ISO 14000, as benchmarks in a strategic environmental audit.

Responsible Business Debate

The Pros and Cons of GM Crops Issue: Are seeds that have been genetically modified a bet- ter alternative than pesticides?

In the United States, GM food has become a way of life. More than half of the crops grown in the coun- try are genetically modified, including 70 percent of corn. While the European Union has largely resisted GM crops, biotechnology firms such as Monsanto see opportunities to expand in places such as Africa and India. However, new findings have cast a cloud over GM seed. Despite the numerous benefits, their extensive use in agriculture has created controversy.

GM crops offer a number of benefits. Because they are able to develop their own toxins to kill pests, they have enabled farmers to use fewer pesticides on crops. One study indicates that GM crops have prevented the use of 965 million pounds of pesticide. Because fuel is needed for farmers to operate machinery in spray- ing pesticides, GM crops have been estimated to save on carbon dioxide emissions to the equivalent of 8.6 million cars. GM crops are also beneficial because they have been modified to target certain types of pests. Pesticides, on the other hand, tend to kill a number of insects without differentiating which ones are harmful

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to the crop. Finally, GM crops result in greater crop yields. Corn crop yields are approximately 31 million tons larger worldwide. This increase in crop yields is important as the world’s population grows.

Despite these benefits, obstacles to GM crops remain. Although the FDA has studied the impact of GM crop consumption and have determined it to be safe, many consumers are still skeptical. Because they are relatively new, critics argue, it is impossible to gauge their long-term health effects. Biodiversity is also an issue since wind and pollinators can transport GM seeds into areas with non-GM plants, leading to the contamination of native vegetation.

Another major problem is insect resistance. The more a pesticide—or a GM crop that produces its own toxins— is used, the more likely insects are to develop resistance. Insects that become resistant to these toxins are harder to kill. While companies like Monsanto have advised farmers to rotate their crops every year to keep resistance at bay, many farmers do not follow these guidelines. Consequently, certain GM crops are starting to lose their effectiveness, and resistant super bugs are emerging. For example, rootworms have been attacking crops after becoming resistant to a rootworm-targeting gene called Bt. This is causing some U.S. farmers to once again turn toward pesticides. An increase in pesticide use not only exposes the environment to potential harm but also eliminates one of the biggest benefits of using GM seeds.

Biotechnology companies are working on a solution to the problem of resistance. Monsanto is working on seeds that possess multiple traits for killing rootworms, which should increase the GM seed’s effectiveness. Monsanto also plans to release new technology to com- bat pests. However, some scientists believe that even multiple trait seeds might not solve the problem for long as rootworms resistant to one trait are more likely to become resistant to the other traits also.

There Are Two Sides to Every Issue: 1. Genetically modified crops are more effective in

combating pests and are therefore more beneficial than pesticide use.

2. Genetically modified crops are not a permanent solution to pesticides and are therefore not a more beneficial alternative.

Sources : “Monsanto Attempts to Balance Stakeholder Interests,” in Business Ethics: Ethical Decision Making and Cases, 9th ed. (pp. 308–318), ed. O.C. Ferrell, John Fraedrich, and Linda Ferrell (Mason, OH: South-Western Cengage Learn- ing, 2013); Ian Berry, “Pesticides Make a Comeback,” The Wall Street Journal, May 21, 2013, http://online.wsj.com/article/SB1000 1424127887323463704578496923254944066.html (accessed August 8, 2016); “The Perils of Always Ignoring the Bright Side,” The Wall Street Journal, http://online.wsj.com/article/SB100008723963904440047 04578030340322277954.html (accessed August 8, 2016).

sustainability (p. 360) Kyoto Protocol (p. 366) genetically modified (GM)

organisms (GMOs) (p 376)

Environmental Protection Agency (EPA) (p 380)

green marketing (p. 390) greenwashing (p. 391)

recycling (p. 393) ISO 14000 (p. 395)

KEY TERMS

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DISCUSSION QUESTIONS 1. Define sustainability in the context of social

responsibility. How does adopting this concept affect the way businesses operate?

2. Describe the controversy surrounding GM foods.

3. Discuss renewable energy initiatives such as wind, solar, and geothermal. Which do you think are most feasible and most important for businesses to focus on?

4. Think of instances of greenwashing that you have encountered. What is the harm of greenwashing?

5. What is the role of the EPA in U.S. environmental policy? What impact does this agency have on businesses?

6. What federal laws seem to have the greatest

impact on business efforts to be environmentally responsible?

7. What role do stakeholders play in a strategic approach to environmental issues? How can busi- nesses satisfy the interests of diverse stakeholders?

8. What is environmental risk analysis? Why is it important for an environmentally conscious com- pany?

9. What is ISO 14000? What is its potential impact on key stakeholders, community, businesses, and global organizations concerned about environ- mental issues?

10. How can businesses become more sustainable? What are the advantages and disadvantages of striving to become more sustainable?

EXPERIENTIAL EXERCISE Visit the website of the U.S. EPA (http://www.epa. gov/newsroom/). What topics and issues fall under the authority of the EPA? Peruse the agency’s most recent news releases. What themes, issues, regula-

tions, and other areas is the EPA most concerned with today? How can this site be useful to consumers and businesses?

The Sustainability Committee’s first meeting was sched- uled for Thursday afternoon. Although it was only Tuesday, several people had already dropped by com- mittee members’ offices to express their opinions and concerns about the company’s new focus on sustain- ability. Some colleagues had trouble with the broad definition of sustainability—“to balance the economic, environmental, and social needs of today’s world while planning for future generations.” Others worried the sustainability project was just another passing fad. A small group of colleagues believed the company should be most concerned with performance and should forget about trying to become a leader in the social responsi- bility movement. In general, however, most employees were either supportive or neutral on the initiative.

As the committee’s meeting started, the com- mittee chair reminded the group that the company’s CEO was very committed to sustainability for several reasons. First, the company was engaged in product development and manufacturing processes that had

environmental effects. Second, most companies in the industry were starting initiatives on sustainable devel- opment. Third, recent scandals had negatively affected public opinion about business in general. Finally, the company was exploring markets in Europe where envi- ronmental activism and rules were often more stringent. With these reasons in mind, the committee set out to develop plans for the next year.

For an hour, the committee discussed the general scope of sustainability in the company. They agreed that sustainability was concerned with increasing positive results while reducing negative effects on a variety of stakeholders. They also agreed that sustain- ability focused on the “triple bottom line” of financial, social, and environmental performance. For example, a company dedicated to sustainability could design and build a new facility that used alternative energy sources, minimized impact on environmentally sensi- tive surrounding areas, and encouraged recycling and composting. Another firm might implement its

THE ‘SUSTAINABILITY’ OF SUSTAINABILITY: WHAT WOULD YOU DO? ?

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Chapter 11  Sustainability Issues 401

sustainability objectives by requiring suppliers to meet certain standards for environmental impact, business ethics, economic efficiency, community involvement, and others.

After this discussion, the committee made a list of current and potential projects that were likely to be affected by the company’s new sustainability focus. These projects included

Energy consumption Philanthropy

Manufacturing emis- sions and waste

Product development

Employee diversity Technology

Community relations Supplier selection

Corporate governance Employee health and safety

Regulations and com- pliance

Volunteerism

After much discussion, the committee agreed that each member would take one of these 12 projects and prepare a brief report on its link to the environmen- tal component of sustainability. This report should review the ways environmental issues can be discussed, changed, improved, or implemented within that area to demonstrate a commitment to sustainability. What would you do?

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402

CHAPTER TWELVE

Social Responsibility in a Global Environment

Chapter Objectives

●● To define cultural intelligence and its importance

●● To discuss the global nature of stakeholder relationships

●● To examine the importance of national competitiveness

●● To describe the role of business in global development

●● To explore global standards for social responsibility reporting

Chapter Outline

Cultural Intelligence

Global Stakeholders

Global Development

Global Reporting Initiative

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From its humble founding in a Bellevue, Washington garage in 1994, Amazon.com has risen to become a global player in the e-commerce industry. Although it started out as a bookstore, today Amazon is known for being a retailer that “sells everything.” In the United States, Amazon sells approximately 488 million items. A top seller in Japan and Europe, Amazon is currently the world’s eighth largest retailer. In terms of market value, however, Amazon has surpassed the world’s big- gest retailer, Walmart.

Amazon sees great opportunities for expansion in other countries. It tripled the rate of fulfillment centers in Europe, Asia, and America between 2010 and 2013. With approximately 100 fulfillment centers across the world, Amazon is well poised to have its products delivered to customers from all over. In Great Britain, Amazon is even testing with making last-minute deliv- eries itself.

Amazon is making a very small profit, and most of this profit comes from vendors selling on the Amazon site. This means Amazon can use its pricing to crush the competition or force them to sell out to Amazon. There are also complaints that Amazon pushes its workers in warehouses too hard. These are important consider- ations in analyzing whether Amazon is acting fairly on a global level.

Despite Amazon’s worldwide success, it has come across a number of unique challenges in expansion— both at home and abroad. Amazon has been heav- ily criticized for destroying small businesses such as bookshops. To give bookshops more of an edge, the French government banned free shipping that Amazon

offered to its customers on book orders. Amazon responded to the ban by charging shipping fees of only a penny, thereby adhering to the letter—if not the spirit—of the law.

Another more recent dispute occurred in Germany. Unionized workers at some of Amazon’s logistics cen- ters went on strike to protest what they believed to be unfair pay. The union maintains that Amazon pays less than comparable industries, whereas Amazon claims it pays more. Germany is a lucrative market for Amazon, with sales growing 21 percent in one year. Amazon responded to the situation by claiming it would work with employee-works councils rather than the union.

Amazon is growing faster than any other retailing format and is challenging many traditional retailers. Most durable goods can be purchased through Amazon, often at lower prices than at traditional stores. Amazon is starting its own delivery fleet. Through Amazon Prime, consumers can receive their products in one or two days, depending on their location. While Alibaba, a large Chinese online retailer, is attempting to chal- lenge Amazon on a global basis, it has had a number of ethical and legal issues, especially involving counter- feit products. Walmart, in order to protect itself in the online market, purchased Jet.com, a shopping site that is trying to compete against Amazon.

It is likely Amazon will have to make concessions on things in some countries that it would not necessar- ily have to make in other countries. However, Amazon’s relentless pursuit of satisfying the customer and sus- taining growth is likely to increase its popularity on a global scale.1

The 10,000 Pound Gorilla in the Room Lives in Amazon

Opening Vignette

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The expanding global marketplace requires that executives and man-agers develop the ability to conduct business effectively and in a socially responsible manner in different regions of the world. As Amazon.com is learning, values and expectations can differ from country to country. In this chapter, we elaborate on key topics and concepts dis- cussed in Chapters 1 through 11, by examining the unique nature of issues in the global environment and trends around the world. We discuss the importance of cultural intelligence, delve into the complexities of working with stakeholders, provide emerging trends with primary stakeholders, and point to global standards of social reporting.

CULTURAL INTELLIGENCE The movement of people across cities and continents means that ideas, val- ues, traditions, languages, and customs have also migrated. While managers in different parts of the world may have unique and even contrasting perspec- tives, they also identify with a number of similar problems and opportunities, such as employee turnover, new business development, environmental pro- tocols, and product innovation plans. Therefore, any culturally diverse work group will have a set of common experiences and another set of differences that must be recognized and managed. The potential for the group to achieve positive outcomes is largely based on each member’s level of cultural intelli- gence. Cultural intelligence (CQ) is the ability to interpret and adapt success- fully to different national, organizational, and professional cultures.2 There are three components to the development and use of cultural intelligence:

1. Cognitive—Knowledge of economic, legal, ethical, and social systems prevalent in different cultures and subcultures.

2. Motivational—Intrinsic desire to learn about different cultures and sub- cultures and the confidence to function effectively in situations where differences are present.

3. Behavioral—Ability to use appropriate verbal and nonverbal actions when interacting with people from different cultures and subcultures.3

Cultural intelligence is desired of all employees but is necessary for those who work in different countries, manage diverse groups, and in general, have responsibilities that require the ability to interpret unfamiliar gestures, behaviors, and situations. These employees must be comfortable suspending immediate judgment and practice thinking before acting. For example, when an American businesswoman made multiple presentations to potential partners in Bangkok, Thailand, she was surprised there were so many side discussions while she presented. Since she did not speak Thai, she did not know the content of their discussions and wondered if they were bored, disinterested, or even disrespectful. She decided to relax, con- tinue, and accept the chatter. It occurred to her that these side discussions were likely a cultural norm, or perhaps simply the act of translating key points to a colleague who had less familiarity with English. In this exam- ple, this businesswoman demonstrated strong cultural intelligence and

cultural intelligence (CQ) The ability to interpret and adapt successfully to different national, organi- zational, and professional cultures.

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Chapter 12  Social Responsibility in a Global Environment 405

in so doing, ensured her company established a strong market presence in Thailand and Southeast Asia. If she had shown anger or frustration, the potential partners may have decided to take their business elsewhere. Figure 12.1 provides a short self-assessment of your CQ.

Interpreting Your Quick CQ Self-Assessment Responses Sum your answers to the four questions in the Quick CQ Assessment Tool. Your score can range from 4 to 20.

4–7 points You see yourself as low in Cultural Intelligence. A CQ personal devel- opment plan could help you to become more capable of functioning effectively in culturally diverse situations.

8–16 points You see yourself as moderate in Cultural Intelligence. A CQ personal development plan could help you to enhance your capabilities in areas where you see yourself as less capable of functioning effectively in culturally diverse situations.

17–20 points You see yourself as high in Cultural Intelligence. A CQ personal de- velopment plan could help you to build on your impressive CQ strengths and be- come even more capable of functioning effectively in culturally diverse situations.

Source: Cultural Intelligence Center, “Self-Assessment of Your CQ,” http://www.culturalq.com/ selfassess.html (accessed July 28, 2014).

Quick CQ Self-Assessment Tool Think about your cultural intelligence in each of the following areas.

Select the answer (1 – 5) that BEST describes you as you really are. 1 – None of the description fits me. 2 – Only some of this fits me. 3 – Half of the description fits me. 4 – Most of the description fits me. 5 – The statements describe me perfectly.

CQ-Strategy 1 2 3 4 5

I plan carefully before I meet with someone who is from a different cultural background. After one of these experiences, I reflect carefully and try to make sense of the interaction.

CQ-Knowledge 1 2 3 4 5

I generally understand other cultures and cultural values. I know about the basic ways in which cultural are similar and the ways they are different.

CQ-Motivation 1 2 3 4 5 I am very interested in other cultures, and I enjoy meeting people who have dif- ferent cultural backgrounds. I am confident that I can live in different cultures and that I can adapt to different parts of the world.

CQ-Behavior 1 2 3 4 5 I modify my behavior to make others more comfortable when I interact with peo- ple who are from different cultural backgrounds. I change the way I speak and act when I am in cross cultural settings. I mimic others to make sure that I follow local conventions so that my speech patterns and body language are not offensive.

Copyright © 2006 VanDyne and Ang

FIGURE 12.1 Self-Assessment of CQ

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406 Business and Society

The effective practice of cultural intelligence requires a manager to parcel out what actions are true of all people, those that are unique to a particular group or culture, or whether the action lies somewhere along this continuum.4 A person with high CQ will be skilled at recognizing how one individual or group is influenced by national, professional, and organi- zational cultures. For example, there are multiple layers of cultural effects to manage when an Irish manufacturing process expert from a consulting firm works with a Croatian engineer for a government agency. The Irish expert would have to interpret and act according to Croatia’s national culture, laws and governmental system, the agency’s role and scope, the engineering profession’s code of ethics, and the engineer’s personality and values. Therefore, to achieve social responsibility in a global context, CQ is integral. Cognitively, employees are obliged to learn the rules, values and standards of different cultures. This entails studying the history, laws, symbols, customs, and related facets of a new culture. Motivationally, they should be willing and confident enough to adapt to these standards but also strong enough to resist adapting when a legal, ethical, or other social responsibility expectation is in jeopardy. Finally, employees must develop a keen capacity to mirror gestures, words, and other behaviors that dem- onstrate they have “entered the world” of their cultural counterparts.5

Finally, it is important to remember that even one country is not entirely homogeneous. The extent to which a country has experienced immigration, supported and encouraged diversity, and realized the “melting pot” effect determines the internal homogeneity or heterogeneity of the country. For example, Japan, Norway, Saudi Arabia, and Poland are relatively homoge- neous when compared to India, Australia, Britain, the United States, and Canada. The world’s 200 countries contain 5,000 different ethnic groups. Approximately two-thirds of all countries have at least one minority group that comprises 10 percent of the total population and therefore represents a distinct subculture.6 In more heterogeneous countries, astute managers will need to recognize and respond to subcultures. This, of course, requires a higher commitment to the cognitive, motivational, and behavioral aspects of CQ amidst an array of stakeholder interests and influences.

GLOBAL STAKEHOLDERS In Chapter 1, we defined stakeholders as those people and groups to whom an organization is responsible—including customers, investors and shareholders, employees, suppliers, governments, communities, and many others—because they have a “stake” or claim in some aspect of a company’s products, operations, markets, industry, or outcomes. These groups not only are influenced by businesses, but they also have the abil- ity to affect businesses. Table 12.1 describes stakeholder issues that are likely to be present when planning and conducting business outside of the home country. Note that these issues include economic, legal, ethical, and philanthropic considerations of other cultures and countries.

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Chapter 12  Social Responsibility in a Global Environment 407

From an economic perspective, differences in the development of countries can easily pose new challenges with stakeholders. As more companies move manufacturing and customer service operations to less developed nations, critics speak out about job loss in the home country and the pay and working conditions in the offshore operation. While overseas outsourcing adds another layer of complexity for management, economic considerations for cost cutting typically trump social and politi- cal concerns. Some firms report significant savings in salary costs due to the eagerness and productivity of workers, allowing the salary dollar to go further in developing nations.7

Clearly, the legal and regulatory environment varies from country to country. Managers need to understand not only the written code but also the nuances of implementation and enforcement. One of the most widely

TABLE 12.1 Examples of Stakeholder Issues in a Global Environment Stakeholder Groups

Potential Issues

Employees Wages and benefits relative to home country standards

Attitudes toward employees from different genders and ethnicities, especially in executive positions Existence of collective bargaining efforts Laws and regulations for employee rights, health and safety Norms of employee volunteering Availability and comfort with open-door policies and other manage- ment practices

Customers Laws and regulations on product safety and liability

Presence and power of consumer rights groups Respect for the product needs of subcultures and minority groups Attitudes and accommodations for customers with disabilities

Shareholders Laws and regulations regarding ownership and corporate governance

Stability and governance of stock exchanges Willingness and ability to participate in shareholder meetings

Suppliers Ethical and social considerations in the supply chain

Prices offered to suppliers in developed countries and developing countries in comparison to other suppliers Availability and attitudes toward minority suppliers

Community Norms of community relations and dialogue

Expectations of community service and/or philanthropy Rights of indigenous people Availability and quality of infrastructure (roads, utilities, schools, etc…)

Environmental Groups Environmental law and regulations

Availability of “green” electricity, recycled materials, and other envi- ronmentally friendly inputs Environmental expectations relative to those in home country Use of natural resources to achieve business goals

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408 Business and Society

discussed stakeholder issues in the global economy is the extent to which bribery is a common and expected practice. Some American multinational corporations claim the passage of the Foreign Corrupt Practices Act severely reduces their ability to compete in the global marketplace. French power and transportation company Alstom pled guilty to violating the Foreign Corrupt Practices Act with bribes to foreign officials in Indonesia, Saudi Arabia, Egypt, and the Bahamas. It paid $772 million to settle the charges. The number of bribery cases filed by civil and criminal investi- gators has increased in the United States over the last several years. This resurgence is supported by new efforts in the European Union and Japan to prosecute bribery cases.8

Beyond the complexities of the law lay the ethical standards of stake- holders around the world. As discussed in earlier chapters, there are several factors that influence the ethical decision-making process, with top management setting the tone and communicating expectations for all employees, suppliers, and business partners. For companies with opera- tions in several countries, the code of conduct originating from the home office may not provide sufficient guidance. The United Parcel Service (UPS) published its first ethics code for domestic employees but realized an inter- national version was needed. Instead of imposing the American version, the company established advisory panels in different regions and conducted 35 focus groups around the world. Using the domestic code as a starting point, UPS ultimately produced 28 codes of conduct for its overseas opera- tions. The codes incorporated cultural differences that did not override key corporate values. For example, UPS managers in France knew that a policy prohibiting alcohol consumption during working hours would not work; in France, it is customary to have a glass of wine at lunch. When language experts started to translate antitrust law into other languages, it translated as “against trust” and needed to be revised. Executives at UPS acknowledge the tremendous resources expended on the process but are confident the culturally intelligent approach is most effective.9

Finally, the philanthropic expectations of stakeholders are also widely varied. The United States has a strong focus on building a culture of busi- ness philanthropy and employee volunteerism. However, this is not true around the world. In Latin America, for example, the roots of philanthropy extend to the Catholic Church, which provided education, healthcare, and social services. Later, wealthy families provided funds to “secular societies of social benefit” that implemented welfare and social projects. Corporate interest in philanthropy is more recent but has grown significantly as a way for business to become socially engaged. The Inter-American Development Bank hosts an annual conference for Latin American business leaders to learn more about social responsibility and philanthropy. Attendance has increased over the years and activities in corporate social investing, social reporting activities, and membership associations for philanthropy execu- tives are being implemented.10

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Chapter 12  Social Responsibility in a Global Environment 409

Shareholder Relations and Corporate Governance While the prospect for global agreement on economic, legal, ethical, and philanthropic standards for business may seem beyond reach, existing efforts hold great promise. Whatever form it takes, a successful initiative must begin and end with the role of corporate governance and share- holder power in corporate decision-making. The board of directors must be committed to a system of oversight, accountability, and control that incorporates a social responsibility perspective. Without this commitment, checks and balances are not in place to limit opportunism and self-interest, advocate for stakeholder rights, or ensure a firm’s corporate culture estab- lishes integrity in all relationships. As discussed in Chapter 3, corporate governance reflects fundamental beliefs about the purpose of business organizations—ranging from maximizing shareholder value to a more col- laborative and relational approach with multiple stakeholders.

The movement to write and implement widely accepted codes of conduct is several decades old. It began with social activists who derided apartheid in South Africa and urged companies to withdraw their investments and business interests from the country. Led by Reverend Leon Sullivan, who sat on the board of General Motors, interested citizens and other groups developed requirements any company should demand for its employees and workplace conditions. These standards covered non-segregation, equal and fair compensation, programs to move minorities into management ranks, and other measures that clearly conflicted with South African law permitting racial segregation and unequal rights. Eventually, the Sullivan Principles were adopted by over 100 companies in the United States that also withdrew existing operations and investments out of South Africa.11

The influence of the Sullivan Principles prompted several groups to develop codes of conduct or similar documents in an effort to build multi- cultural agreement on acceptable corporate governance and business prac- tices. Perhaps the most successful initiative resulted in the Caux Round Table Principles for Business. The round table consists of business leaders from all regions of the world who have a strong desire and interest in promoting socially responsible capitalism. Frederick Phillips, former presi- dent of Phillips Electronics, and Olivier Giscard d’Estaing, former vice- chairman of INSEAD, a preeminent business school, founded the group in 1986. Although the original intent was to reduce trade tensions, the round table quickly turned to global corporate responsibility and established its principles. Today, the group’s governing board includes executives from multinational corporations and governments.12

In addition to this fundamental guidance, the Caux Round Table publishes periodic opinions on a range of social responsibility issues, including executive compensation, environmental protection, and corrup- tion. Table 12.2 provides an example of the type of principles often found in foundational statements such as the Caux Round Table.

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410 Business and Society

Employee Relations A critical consideration for companies conducting business around the world is how to manage differences that exist in employment standards and expectations. Modern corporations recognize the importance of tap- ping into global markets and talent pools in order to remain competitive.

TABLE 12.2 Global Principles for Ethical Business Conduct Global principles are integrity statements about foundational beliefs that should remain con- stant as businesses operate globally. These principles address issues such as accountability, transparency, trust, natural environment, safety, treatment of employees, human rights, impor- tance of property rights, and adherence to all legal requirements. The principles are designed to focus on areas that may present challenges to the ethical conduct of global business.

1. Require accountability and transparency in all relationships. Accountability requires accurate reporting to stakeholders, and transparency requires openness and truthfulness in all transactions and operations.

2. Comply with the spirit and intent of all laws. Laws, standards, and regulations must be respected in all countries as well as global conventions and agreements developed among nations.

3. Build trust in all stakeholder relationships through a commitment to ethical con- duct. Trust is required to build the foundation for high integrity relationships. This requires organizational members to avoid major international risks such as bribery and conflicts of interest. Laws supporting this principle include the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act, OECD Convention, and UN Convention Against Corruption.

4. Be mindful and responsible in relating to communities where there are opera- tions. The communities where businesses operate should be supported and improved as much as possible to benefit employees, suppliers, customers, and the community overall.

5. Engage in sustainable practices to protect the natural environment. This requires the protection of the long-term well-being of the natural environment including all biologi- cal entities as well as the interaction among nature, individuals, organizations, and busi- ness strategies.

6. Provide equal opportunity, safety, and fair compensation for employees. Employees should be treated fairly, not exploited or taken advantage of, especially in developing countries. Laws supporting this principle include equal opportunity legislation throughout the world.

7. Provide safe products and create value for customers. Product safety is a global issue as various governments and legal systems sometimes provide opportunities for firms to cut corners on safety. All products should provide their represented value and performance.

8. Respect human rights as defined in the UN Global Compact. Human rights are a major concern of the UN Global Compact and most other respected principles statements of international business.

9. Support the economic viability of all stakeholders. Economic viability supports all par- ticipants in business operations. Concerns such as fair trade and payment of a living wage are embedded in this principle.

10. Respect the property of others. Respect for property and those who own it is a broad concept that is an ethical foundation for the operation of economic systems. Property includes physical assets as well as the protection of intellectual property.

Source: O. C. Ferrell and Linda Ferrell, Anderson School of Management, University of New Mexico, Copyright © 2016.

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Chapter 12  Social Responsibility in a Global Environment 411

TABLE 12.3 Differences in Employment Law: United States and Canada

Legal Issue Canada United States Termination of Employment Employers must give statutory

notice of termination Employment is “at will” and notice depends upon employ- ment contracts or policies

Severance Severance plans are uncom- mon and do not overrule statutory rights

Most severance plans require the employee to agree to a release of claims before receiving severance pay

Employment Litigation Lawsuits against employers are generally settled quickly, and damage awards are pre- dictable

Lawsuits against employ- ers usually involve claims of human rights discrimination; litigation is costly, and dam- age awards are unpredictable

Compensation Disclosure Despite new rules on dis- closure, companies are not required to disclose the amounts of compensation actually received by executive officers from their exercise of options

Public companies must fully disclose the compensation of executives and board mem- bers in plain English, including the objectives and implemen- tation of executive compensa- tion programs

Healthcare Benefits Single-payer universal health- care system; hospital ser- vices are nonprofit, reducing administrative costs

Universal healthcare system involving many insurance companies and overhead; administrative costs very high

Even in the best cases, building a dedicated, engaged, and satisfied work- force takes strategic planning and daily oversight by management. Executing this process in a new culture or across cultures takes more than merely transferring the policies and practices from the home country and home office. It must include consideration of the economic, legal, ethical, and philanthropic expectations of employee stakeholders in different countries. For example, Table 12.3 outlines key differences between employment law in Canada and the United States. There are important differences between these cultures, even though we often consider them to be similar.

Longitudinal research has affirmed what many global managers already know: employee attitudes and perceptions about work vary from country to country. As discussed in Chapter 7, employees typically value high ethical standards and volunteer activities and become more loyal and satisfied with their employer as a result. Thus, variations in employee attitudes and perceptions are integral to the successful implementation of social responsibility programs. For example, workers in France value a work-life balance more than any other national group. Japanese employ- ees are often pleased with incentive compensation but lament relatively low base pay. Australians want a manager who acts as a coach and Chinese employees yearn for more training opportunities. In its annual survey, Mercer, an international research firm, identifies the factors most

(Continued )

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412 Business and Society

important for employee engagement, the psychological state in which employees feel a vested interest in the company’s success and are motivated to perform at levels that exceed job requirements. Table 12.4 depicts the results of Mercer’s study of employees in different countries. The survey identifies four global drivers of employee engagement. Despite national differences, employees in different parts of the world are fairly consistent in noting the importance of (1) the work itself, including opportunities for development, (2) confidence and trust in leadership, (3) recognition and rewards, and (4) organizational communication. This information is valuable to managers, as it improves the cognitive nature of cultural intelli- gence and provides direction on motivational and behavioral competencies that should be impactful across nations. Understanding the four drivers enables human resource (HR) professionals to instill consistency across policies in a multinational firm.13

As discussed earlier in this chapter, cultural intelligence is an integral part of employees’ ability to manage and succeed in a global economy. In the context of business ethics, CQ is especially critical. Applying the legal requirements of the host or home country to the problem may be a starting point. However, as we discussed in earlier chapters, legal standards are not sufficient for a firm dedicated to ethical business practices. Some industries operate under a set of values or principles, which may also serve a purpose in the international arena. For example, the tourism industry established

employee engagement The psychological state in which employees feel a vested interest in the company’s success and are motivated to perform at levels that exceed job requirements.

Unions No “right-to-work” laws that prohibit unions or for requir- ing employees covered by union contracts to pay; many provinces have bans on tem- porary or permanent striker replacement

Harder to get a union started; states beginning to pass “right-to-work” legislation which mandates that work- ers do not have to support a union even though they ben- efit from collective bargaining

Changes to Post-Retirement Benefits

Very difficult to decrease post-retirement benefits with- out providing notice; almost impossible to reduce benefits for existing retirees.

More flexibility in making changes to post-retirement benefits

Sources: Adapted from Christina Medland, “Ten Key Differences in Canadian and US Employment Law,” TLOMA Today, April 22, 2008, http://tloma.com/docs/tloma-today/tloma-today-april-2008 (accessed June 22, 2016); Andrew MacDougall and Elizabeth Walker, “Trick or Treat? Changes to Canadian Executive Compensation Disclosure Rules Come into Effect October 31, 2011,” Oslesr, August 3, 2011, http://www.osler.com/NewsResources/Details.aspx?id=3660 (accessed June 22, 2016); Adrienne Silnicki, “America, Want Freedom of Choice? Try Public Healthcare Like Canada,” The Guardian, November 25, 2013, http://www.theguardian.com/commentisfree/2013/nov/25/america- canada-freedom-of-choice-public-healthcare (accessed June 22, 2016); Kris Warner, “The Real Reason for the Decline of American Unions,” Bloomberg, January 23, 2013, http://www.bloombergview.com/ articles/2013-01-23/the-real-reason-for-the-decline-of-american-unions (accessed June 22, 2016); Dave Jamieson, “Michigan Right To Work: Caught Off-Guard, Unions Hope To Stop Anti-Labor Law From Spreading,” Huffington Detroit, December 11, 2012, http://www.huffingtonpost.com/2012/12/11/ michigan-right-to-work-unions_n_2277900.html (accessed June 22, 2016).

TABLE 12.3 (Continued )

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Chapter 12  Social Responsibility in a Global Environment 413

a global code of ethics that enumerates the industry’s obligation to build respect between societies, assist in sustainable development, maintain cul- tural heritage, treat employees well, and promote individual fulfillment.14 In other cases, guidance from a broad set of guidelines, such as the Caux Round Table Principles for Business, could be utilized. However, broad principles are often less useful in day-to-day situations.

The ethical decision-making framework discussed in Chapter 5 is fully effective in the global environment, but cultural differences introduce new complexities to the process. For this reason, companies know that train- ing rubrics are pivotal to an employee’s ability to assess an ethical issue and determine the most appropriate decision and action. Organizations develop a fixed set of principles and values globally. While decisions have to comply with national and local laws, codes of conduct for the firm are implemented globally. There are usually adjustments in training approaches as well as certain ethical risks that may be more important to address in a particular country.

TABLE 12.4 Employee Engagement Factors in Six Countries Brazil

accomplishment

management

performance

customer service

industry

Canada

good service to clients/ customers

China

accomplishment

performance

customer service

industry

management

needs

feedback

United States

objectives can be met

accomplishment

success

to manage career

customer service

United Kingdom

accomplishment

management

performance

customer service

industry

Sweden

involved with

accomplishment

Source: Kathy Gurchiek, “Engagement Factors Vary by Country, Business, Function,” Society for Human Resource Management, January 23, 2008, http://www.shrm.org/publications/hrnews/pages/ engagementfactorsvary.aspx (accessed August 13, 2014).

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414 Business and Society

Consumer Relations International trade leaves some members of the economy, whether indepen- dent or corporate, marginalized and vulnerable to economic exploitation. From some consumer perspectives, conventional trade interferes with the ability of many people, particularly those in poor nations, to secure basic, sustainable livelihoods. By contrast, fair trade is a trading partnership based on dialogue, transparency, and respect that seeks greater equity in interna- tional trade and contributes to sustainable development. Fair trade benefits those who have limited opportunities to begin with and are further stunted by market forces that identify them as negligible. Table 12.5 describes the five principles of fair trade organizations, including the rights and responsibilities of producers, intermediaries, business partners, resellers, and consumers.

Products that meet fair trade standards are licensed to display the Fair Trade Certified label, signifying a producer’s adherence to fair economic, social, and environmental practices in producing and selling products. There are nearly 12,000 fair trade certified products coming from approxi- mately 1.2 million farmers and workers in 70 countries. Fair trade prod- ucts are available in most grocery stores, restaurants, and cafes, all over the United States, contributing to the record volume growth year after year.15

As discussed in Chapter 8, consumers are increasingly concerned with the origins of products they purchase, including the working conditions, eth- ical standards, and related social responsibility practices of manufacturers. For example, low wages and substandard working conditions have marked

fair trade A trading partnership based on dialogue, transparency, and respect that seeks greater equity in interna- tional trade and contributes to sustainable development.

TABLE 12.5 Charter of Fair Trade Principles

Principle Description 1. Market access for marginalized

producers Fair Trade helps producers realize the social benefits of

trade with producers who would otherwise be exclud-

that producers receive more from the final selling price of their goods than is the norm in conventional trade via multiple intermediaries.

2. Sustainable and equitable trading relationships

The economic basis of transactions within Fair Trade relationships takes account of all costs of production, both direct and indirect. Fair Trade buyers offer trading terms that enable producers and workers to maintain a sustainable livelihood. Prices and payment terms are determined by assessment of economic, social, and envi- ronmental factors rather than just reference to current market conditions. The commitment to long-term trad- ing partnership found in Fair Trade enables both sides to cooperate through information sharing and planning.

3. Capacity building and empowerment

Fair Trade relationships assist producer organizations to understand more about market conditions and trends and to develop knowledge, skills, and resources to exert more control and influence over their lives.

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Chapter 12  Social Responsibility in a Global Environment 415

the reputation of clothing manufacturers. In an effort to minimize these costs, Fair Trade USA began certifying apparel. PrAna, a yoga apparel company, is one of the first American firms to receive this certification. The certification comes from verification of sources of materials as well as a review of the company’s books, systems, and pay scales.16 Today, PrAna sells at least nine fair trade certified products.

Rice farming is present all over the world and is responsible for billions of jobs, making it an important aspect in the social well-being of numerous communities. Pesticides and chemicals used in rice farming initially increase production, but they eventually reduce production and negatively affect workers’ health. A decline in global rice prices puts farm- ers in difficult situations. When prices fall, some farmers apply for loans that may carry high interest rates while others might lose their livelihoods. Areas particularly dense with rice farms are reported to have high suicide rates and incidents of children being sold for sex. Fair trade rice seeks to improve these conditions by providing stability in the market, seeking organic methods, and regulating the use of chemicals in production.17

The Fair Trade Certified label is not only recognized by 73 percent of American consumers but is also a trusted symbol among this group. There is a high level of durability among fair trade certified products even dur- ing times of economic downturn. This is due in large part to the system of standards of the Fair Trade organization. In order to continue to remain relevant, they are committed to revising these standards every five years. For example, Fair Trade USA announced it would revise the previously separate standards for farmers and independent growers by combining them to apply to both groups. Such a move reduces complexity and allows for consistency and relevance in the certification process. Table 12.6 shows some of the Fair Trade Certified brands currently on the market.18

4. Consumer awareness raising and advocacy

Fair Trade relationships provide the basis for connect- ing producers with consumers and for informing con- sumers of the need for social justice and the oppor- tunities for change. Consumer support enables Fair Trade organizations to be advocates and campaigners for wider reform of international trading rules and to achieve the ultimate goal of a just and equitable global trading system.

5. Fair trade as a “social contract” Fair Trade transactions exist within an implicit “social contract” in which buyers agree to do more than is

- ducers use the benefits of Fair Trade to improve their social and economic conditions, especially among the most disadvantaged members of the organization. Fair Trade is not charity but a partnership for change and development through trade.

Source: World Fair Trade Organization and Fairtrade Labelling Organizations International, A Charter of Fair Trade Principles, January 2009, http://www.wfto.com/sites/default/files/Charter-of-Fair-Trade- Principles-Final%20%28EN%29.PDF (accessed June 22, 2016).

TABLE 12.5 (Continued )

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416 Business and Society

GLOBAL DEVELOPMENT Companies are increasing efforts to enhance the infrastructure, human rights, and educational systems of a particular country, state, or city to further global development. Experts have concluded that political, social, and economic freedoms are fundamental to national competitiveness and development. Without widespread trust and the effective operations of different institutions, a given society will not be able to enhance and enrich the lives of its people. Political freedoms, such as free speech and elections, lead to economic security, and social freedoms such as education and healthcare lead to stronger economic participation. Finally, economic security frees people to participate in social and political activities.19 Multinational corporations are increasingly interested in mechanisms for promoting freedom and development.

Development refers to improvement in the economic, environmen- tal, educational, and health conditions of a country. Common issues in development include poverty, quality of healthcare, access to education, voting rights, water quality, governance and rule of law, domestic finance systems, and climate change. A major goal of the United Nations (UN) is to realize improvements in the development of countries around the world. While these improvements may be grounded in ethical concerns, they are critical to the stability of the global economy. The UN works from the phi- losophy that it is in the world’s best interest to tackle problems that limit the capacity of some people to live healthy and prosperous lives. The UN’s Millennium Development Goals are designed to meet these challenges and have established the following goals: (1) eradicate extreme poverty and hunger, (2) achieve universal primary education, (3) eliminate gender disparity in primary and secondary education, (4) reduce child mortality, (5) improve maternal health, (6) combat HIV/AIDS, malaria, and other diseases, (7) ensure environmental sustainability, and (8) develop a global partnership for development.20 Meeting these goals and finding solutions

development An improvement in the economic, environmental, educational, and health conditions of a country.

TABLE 12.6 Fair Trade Certified Brands Allegro Coffee Company Appalachian Coffee Company Arrowhead Mills

Barefoot & Chocolate LLC Bigelow Tea

Celestial Seasonings China Mist Chocolate Alchemy

Clearly Kombucha Dawn Food Products

General Mills Good & Fair Clothing Green Mountain Coffee Roasters

Hershey Company Honest Tea Lundberg Family Farms

Naked Juice Company Organic Spices Traditional Medicinals

Source: “Products and Partners,” Fair Trade USA, http://fairtradeusa.org/products-partners?partner_ type=Brandholder#tabset-tab-2 (accessed June 22, 2016).

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Chapter 12  Social Responsibility in a Global Environment 417

to these problems progress the economy and improves the lives of indi- viduals in areas heavily affected by these issues.

The UN also established the Global Compact, which encourages organi- zations to commit to common principles whereby effective and responsible business can be conducted on a global scale. The UN’s Global Compact is a set of ten universally accepted principles (See Table 12.7) in the areas of human rights, labor, environment, and anti-corruption, to which approxi- mately 10,000 organizations have officially declared their commitment. Corporate signatories attest to their willingness to integrate these principles into everyday business practices, publish examples of their commitment and projects on an annual basis, and commit to a stronger alignment between the objectives of the international community and those of the business world.21

Although the UN has been most progressive in gaining corporate support for global development and popularizing business partnerships, corporations have aligned themselves with non-business organizations to advance development for a number of years.22 For example, a company interested in building an offshore call center may realize roadways and utilities need to be improved in the area. In another situation, a firm may know a natural resource is abundant in a developing country, yet realizes the people and government of the country do not have the economic and educational resources to market it worldwide. In both cases, the company may choose to invest resources by partnering with the local government, nonprofit agencies, and other nongovernmental organizations. Critics muse that while this approach certainly has a social component, the busi- ness case for making a profit is the overriding concern. An extensive review

TABLE 12.7 Ten Principles of the UN Global Compact Human Rights

1. Support and respect the protection of internationally proclaimed human rights

2. Ensure nonparticipation in human rights abuses

Labor

3. Uphold the freedom of association and the effective recognition of the right to collective bargaining

4. Eliminate all forms of forced and compulsory labour

5. Abolition of child labour

6. Eliminate discrimination with respect to employment and occupation

Environment

7. Support a precautionary approach to environmental challenges

8. Undertake initiatives to promote greater environmental responsibility

9. Encourage the development and diffusion of environmentally friendly technologies

Anticorruption

10. Work against corruption in all its forms, including extortion and bribery

Source: “Ten Principles,” United Nations Global Compact, http://www.unglobalcompact.org/ AboutTheGC/TheTenPrinciples/index.html (accessed June 22, 2016).

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418 Business and Society

of the outcomes of development partnerships between large oil companies and local governments in the Nigerian Delta region revealed (1) the link- age between improvement in social infrastructures and economic growth is nonexistent, (2) it is almost impossible for business investments to make significant gains because these communities have long been neglected, and (3) business-driven investment in social infrastructure has been unevenly distributed and failed to prioritize community needs.23

There are many diverse types of partnerships for development. While the partnership consists of at least one public entity and one private entity, the specific kinds of public and private entities involved vary to include a wide range of social and economic players. However, each partnership must confront two elements: (1) the level of social control via stakeholder influence they maintain and (2) the challenges they pose to conventional business management and goals. In lieu of these two points, partnerships for development may be categorized into four types: conventional busi- ness partnerships, corporate social responsibility partnerships, corporate accountability partnerships, and social economy partnerships. Table 12.8 provides a brief description of the four types.

TABLE 12.8 Partnerships for Development of Social Responsibility Conventional business partnerships

These partnerships focus on efficient and effective decisions to carry out a business objective when there is limited competition. Social responsibility is not a strategic concern. Example: Tennessee Valley Authority

Corporate social responsibility partnerships

Businesses make a profit but also serve the public interest. Through voluntary cooperative rela- tionships, businesses and their partners arrive at a win-win authentic partnership. They thrive and prosper for their stakeholders. Example: Starbucks supports coffee growers in receiving a fair wage.

Corporate accountability partnerships

These partnerships focus on rules and structure with an emphasis on ethics, compliance, and

- ity audit to social responsibility.

Social economy partnerships

These are based on partnerships between nonprofit organizations and businesses. Both parties help to develop and institutionalize objectives to benefit society. Example: Home Depot part- ners with Habitat for Humanity

Sources: Ananya Mukherjee Reed and Darryl Reed, “Partnerships for Development: Four Models of Business Development,” Journal of Business Ethics 90, supplement 1 (May 2009): 3-37; Maria May Seitanidi and Andrew Crane, “Implementing CSR Through Partnerships: Understanding the Selection, Design and Institutionalisation of Nonprofit-Business Partnerships,” Journal of Business Ethics 85, supplement 2 (April 2008): 413-429; Scott James, “CSR Means True Partnerships,” Forbes, July 30, 2011, http://www.forbes.com/sites/csr/2011/07/30/csr-means-true-partnerships/ (accessed June 22, 2016); CompliSpace, “A New Global Standard for Compliance: ISO 19600,” September 15, 2014, http://complispace.wordpress.com/2014/09/15/a-new-global-standard-for-compliance-iso-19600/ (accessed June 22, 2016).

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Chapter 12  Social Responsibility in a Global Environment 419

Conventional Business Partnerships Conventional business partnerships (CBPs) for development may seem unlikely. However, in the case of some public services, such as utilities, they do sometimes emerge. The goal of these partnerships is to promote efficiency in markets where competition does not exist. This assumes that states are inefficient and that a business organization provides the best solution. The role of business is to increase efficiency, while the role of government is to make sure that the benefits of increased efficiency are delivered to consumers. Government also monitors access to and afford- ability of the public service. CBPs do not have to prove a specific effort toward social responsibility but are commonly recognized and supported by the United Nations, World Bank, and other supraregional organiza- tions. Specifically, these organizations have sought privatization through conventional business partnerships.

Privatization occurs when public operations are sold to private enti- ties. Public-private partnerships count as partial privatization. Full priva- tization further reduces the public element of the equation. Social services often attract privatization interest, particularly those in developing nations since privatization provides a point of entry into new markets for inves- tors. But long-standing public provision of goods and services carries deeply imbedded interests in keeping the goods and services public.24

The World Bank began advocating the privatization of public utilities in the early 1990s and eventually, this became a requirement for some countries seeking substantial loans. While there have been successes, water privatiza- tion efforts in Bolivia provides a stark reminder that CBPs may be fraught with difficulty. Protesters in El Alto, Bolivia demanded control of water be taken back from Suez, a French water company affiliated with the World Bank. Within three days, the President of Bolivia met the public’s demand and cancelled the deal. Five years earlier, Bolivian citizens protested against the control of water by the Bechtel Corporation. That protest was much more dramatic and violent, with the government declaring martial law. At this time, however, the reluctance to cancel the foreign control of water service was due to financial and political pressure. Cancellation of this deal would have made foreign investors hesitant to pursue investment opportuni- ties in the country, and Bolivia was forced to privatize in order to receive much needed aid from the World Bank. While many citizens did not agree with the principle of privatizing water service, their outrage came from the practical results that followed the change in service. Theoretically, privatiza- tion would bring investment and successful management to services tradi- tionally run with little efficiency and much corruption. When implemented, however, investment translated to unaffordable, market rate pricing, and successful management translated into indifference to poor social conditions that were either introduced or exacerbated by privatization.25 The World Bank eventually softened its position by becoming open to other options besides privatization, but the idea that poor governments need to increase their reliance on private agents for political and economic risks remains.

privatization A process that occurs when public operations are sold to private entities. Public- private partnerships count as partial privatization.

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420 Business and Society

Corporate Social Responsibility Partnerships Corporate social responsibility partnerships (CSRPs) are voluntary and business centered. Potential benefits alone compel individual businesses to enter into these partnerships, and success rests in the motivation causing corporate engagement. Such motivation may be philosophical or ethical, though it may be that pragmatic concerns are the major sources of moti- vation. CSRPs provide resources for social initiatives, such as job training and entrepreneurial development, that contribute to a citizen’s livelihood. While these initiatives benefit members of society, they also provide for a stronger work force and economic contagion. Microcredit programs are part of CSRP’s activity in resource provision, with the largest such part- nership being the Global Microcredit Summit, a nonprofit organization dedicated to improving access to credit and financial self-sufficiency for the poorest people in the world.26

Microcredit activity began in Bangladesh. The initiative produced remarkable success to the extent that prominent figures of the endeavor, Grameen Bank and its founder Muhammad Yunus, received the Nobel Peace Prize. Microcredit works toward moving large populations out of poverty through financial assistance. Grameen Bank remains an influential model for microcredit institutions and partnerships all over the world. While microcredit allows borrowers to take action that directly improves their income, indirect improvements such as quality of life also result. Borrowers have access to better housing, food, sanitation, and education and are better able to take advantage of the improved options.27

Corporate Accountability Partnerships The final two categories of partnerships for development take a distrust of corporate social responsibility models as a starting point for defining their framework. Corporate accountability partnerships (CAP) spring from the idea that corporate social responsibility partnerships are neither account- able nor effective and are only really interested in public relations. As the name implies, corporate accountability partnerships focus on accountabil- ity and the setting of requirements and standards based on what society expects.

For corporate accountability partnerships to be successful, they must gain and direct public support, maximize the limited resources they tend to have, plan for the long-term, and convince public institutions of the neces- sity and importance of enforcing socially demanded standards. Corporate accountability partnerships use legal and social means, ranging from policy and certification initiatives to protests and activism. Certification CAPs focus mainly on labor rights and the environment and try to achieve answerability, enforcement, and universality. CAPs seek to achieve cor- porate recognition of standards deemed appropriate by society and utilize third party audits and checks on the partnership.

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Chapter 12  Social Responsibility in a Global Environment 421

A widely known certification CAP is the Fair Labor Association (FLA), which was organized after numerous media reports decrying child labor, poor working conditions, and low wages were released. Today, the FLA works to end sweatshop conditions for factory workers and organizes universities, social groups, and socially responsible organizations to pro- tect workers’ rights and insist on better working conditions all over the globe. Nestlé is an example of a corporation working with the FLA to ensure fair labor conditions. The cocoa industry is notorious for forced and child labor conditions, and as one of the world’s largest food com- panies, Nestlé allowed the FLA to conduct a review of labor conditions throughout the entire supply chain. The FLA commented that this was the first such review of a multinational company. The findings concluded that, despite implementation of industry standards, many violations were still occurring. In the Ivory Coast, especially, both child and forced labor are culturally normal behaviors. Nestlé now knows that better communication of labor practices, along with stronger oversight, farther down the supply chain are needed in order to come closer to eliminating these undesirable labor practices.28

Social Economy Partnerships Social economy partnerships (SEPs) pursue alternatives to conventional corporations and profit maximization. SEPs have a distinctly social purpose, use democratic governance, and cooperate with other social economy partnerships. Social economy organizations include nonprofits, community economic development corporations, cooperatives, and coop- erative development organizations.

The SEP philosophy emphasizes cooperation and assistance rather than traditional business logic. These partnerships provide resources and support mostly in informal sectors of the urban poor. SEPs bring people together for recycling, street vending, and other work that many other citizens will not perform. Entrepreneurship is viewed collectively and the group stays connected to social and political movements. Social economy partnerships in these informal sectors provide economic profits as well as social benefits that are usually reserved for those with full-time jobs in the formal sector. The Self Employed Women’s Association is a trade union in India for poor, self-employed women. These women compose the major- ity of the labor force but are part of the unorganized sector and are not provided with the regular salaries and benefits. The SEWA organizes coop- erative arrangements to help women find regular employment, increase their incomes, become literate, access better healthcare, obtain child care, and increase their financial assets. Through various cooperatives, women obtain insurance, get assistance in marketing their goods worldwide, par- ticipate in leadership training, and access significant loans and banking products. Without SEWA and its extended partnerships, these women would be destined for a life of poverty.29

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422 Business and Society

Ethical Responsibilities in Finance

Rabobank: Banking on Cooperatives Cooperatives are organizations that seek a variety of benefits by approaching economics and entrepreneur- ship in social terms. Instead of investors, the co-op is developed by members who have one vote a piece in governance matters. The integration of business and social interests is made easier by the democratic governance of the co-op. Equality in voting also means accountability and transparency are requisite. A co-op may have individual people as members or it may have small business and organization members. While cooperatives are usually surprisingly successful financially, the traditional dynamics that motivate and relate owners, consumers, and workers are altered. However, cooperatives still have to operate in a sound business manner and try to produce a surplus similar to a profit.

The cooperative began to emerge in the beginning of the nineteenth century in Europe. First, owners of a cotton mill in Scotland came together in order to extend the distribution of profits to employees. A few years later, a group of English textile workers called the Rochdale Pioneers established a cooperative in 1844. This cooperative joined together weavers and other artisans who were facing poverty, yet decided they should pool their meager resources to open a store selling food they could no longer afford. They opened their store with a small number of items but quickly expanded their product range. Before long, the Rochdale Pioneers offered one of the best selections of food and household items in the area and was fully meeting its objective: to form arrangements for the pecuniary benefit and the improvement of the social and domestic conditions of its members. The concept spread to a variety of industries and countries.

Rabobank is a group of Dutch banks that has its origins in two rural cooperative banks founded in 1898. In 1972, the two banks merged to form Rabobank. Rabobank has 106 local member banks and is identified as one of the safest cooperative banks in the world. Rabobank’s growth was made possible through the retention of its profits. It is owned and controlled by its members and works for its members. Rabobank has always had a commitment to corporate social responsibility and implements social responsibility in its lending practices. Accordingly, in making credit decisions, Rabobank assesses a company’s strategy and track record for handling sensitive issues that call for corporate social responsibility.

Rabobank views companies that lack social respon- sibility as a credit risk and also a risk to the co-op’s reputation. For this reason, it has an Ethics Committee that is tasked with assessing ethical issues, developing ethics policies, publishing recommendations, strength- ening employee confidence in ethical decision-making, and discussing social issues in which the bank should take a stand. Rabobank also developed a CSR spectrum to describe how corporate social responsibility is inte- grated into daily activities:

! CSR ambitions ! CSR organization

! CSR in client acceptance process ! CSR client engagement !

! Social activities ! Dialogue with stakeholders

! Internal environment policy ! Internal personnel policy

Sources: Kevin M. Blakely, “At Rabobank, It’s All About the Customer,” The RMA Journal 91, no. 10 (July/August 2000): 36–43 (accessed via ProQuest Database); Riccardo Lottie, Peter Mensing, and Davide Valenti, “A Cooperative Solution,” Strategy + Business 43 (Summer 2006); David Thompson, “Co-op Principles: Then and Now (Parts 1 and 2),” http://www.grocer.coop/articles/co-op-principles-then-and-now-parts- 1-and-2 (accessed August 9, 2016); Rabobank, “The dynamics of ethics,” https://www.rabobank.com/en/about-rabobank/in-society/ethics/ index.html (accessed August 9, 2016); Peter Vos, “Water: The Need to Pay the Due,” Rabobank, http://www.unep.org/resourceefficiency/ Portals/24147/scp/water/documents/Presentations/Rabobank%20(Peter%20Vos).pdf (accessed August 9, 2016); Rabobank, “Rabobank members agree to new governance,” December 2, 2015, https://www.rabobank.com/en/press/search/2015/Rabobank_governance%20.html (accessed August 9, 2016).

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Chapter 12  Social Responsibility in a Global Environment 423

The four models of business involvement in development allow almost any firm the opportunity to engage in partnerships that improve health, education, economic, and other prospects for people around the world. In addition to corporate efforts, individual countries are also engaged in development efforts. The Center for Global Development produces a Commitment to Development Index (CDI) that ranks 27 developed nations by their contributions to and support of development in poorer, developing countries. While these contributions are considered the right thing to do and usually reflect national ideals and values, there are also benefits to global security and economic health. Countries included in the index are assessed based on governmental policy efforts in areas including aid, trade, investment, migration, the environment, security, and technol- ogy. Policy efforts are used as indicators partly to control for the varying sizes of economies among the countries ranked. For the CDI, policies of rich countries, particularly the coherence of those policies, are important to development. The CDI also shows evidence that development involves more than monetary aid and that partnerships can provide greater benefits than the individual partners can produce alone.30

GLOBAL REPORTING INITIATIVE Regardless of the social responsibility activities a company pursues, it must also consider the best mechanisms for communicating its values and plans, high- lighting successes, and gaining feedback for the future. In some cases, a firm may be a signatory to a set of standards, member of a particular association, or otherwise obligated to formally assess and document social responsibility outcomes. As stated earlier, companies that commit to the Global Compact are required to present an annual account of how they implement the ten principles and support the UN’s development goals. This document, entitled the Communication on Progress, may be part of the company’s annual report, sustainability report, or some other social reporting mechanism.

The Global Reporting Initiative (GRI) provides a framework for busi- nesses and other organizations to assess their performance across an array of social responsibility indicators. A firm may use this as a self-audit, but others choose to formally share the audit results with stakeholders. One of the great- est benefits of the GRI is that it makes comparisons possible because it uses a globally applicable and well vetted framework. The GRI emphasizes con- sensus and continuous improvement in developing and maintaining the GRI Sustainability Reporting Framework, which seeks to provide transparency and accountability in sustainability reporting akin to that found in financial reporting. Diverse representatives contribute business, civil, academic, labor, and other professional perspectives in deciding which areas of sustainability are to be included in the framework and the appropriate measures to be used for determining performance in those areas. The framework is in perpetual draft form, with innovation in technologies and shifts in cultural attitudes accommodated by the GRI’s continuous improvement approach.

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The GRI Sustainability Reporting Framework includes three categories of core indicators: economic, environmental, and social performance. The social category of core indicators is further divided into labor practice, human rights, product responsibility, and society. Quantitative or qualita- tive performance indicators are used to evaluate different aspects of each category.

The economic category examines an organization’s interaction with the economic system in which it operates by measuring economic perfor- mance, market presence, and indirect economic impact indicators. The environmental category covers an organization’s energy use, both direct and indirect, as well as pollution. The category assumes a link between energy consumption and emissions that contribute to climate change, and thus emphasizes efficient energy use and an increasing reliance on renew- able energy sources over fossil fuel.

The society category examines the organization as it functions in rela- tion to market structures and social institutions. Measures include the impact on local communities, bribery and corruption, and public policy making. The human rights indicators consider the operation of an orga- nization as it provides for basic human rights. Measures include incidents regarding human rights and provisions made for such rights in an organi- zation’s internal and external business relationships. The labor practices category is an extension of the human rights category that focuses specifi- cally on the environment and practices to which workers are subject. An examination of workforce demographics, communications between the organization and its employees, and opportunities extended to workers for personal development comprise the category’s measurements. Finally, the product responsibility category focuses on the products of an organization as they affect consumers. Considerations such as safety, product informa- tion, and privacy rights of customers are evaluated. Indicators appear in pairs with one addressing the relevant processes of the organization and the second addressing the compliance of the organization.31

SUMMARY In this chapter, we discussed a variety of social responsibility issues and stakeholders from a global perspective. The expanding global marketplace requires that executives and managers develop the ability to conduct business effectively and in a socially responsible way the world over. The movement of people across cities and continents means that ideas, values, traditions, languages, and customs have also migrated and global employees need many skills. Cultural intelligence is the ability to interpret and adapt successfully to different national, organizational, and profes- sional cultures. There are three components to the development and use of cultural intelligence, including cognitive, motivational and behavioral. Cultural intelligence is desired of all employees but is mandatory for those who work in different countries, manage diverse groups, and have respon- sibilities that require them to interpret unfamiliar behaviors and situations.

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Chapter 12  Social Responsibility in a Global Environment 425

Cultural intelligence is critical for dealing effectively with stakeholders, including customers, investors and shareholders, employees, suppliers, governments, communities and others. Stakeholders in other countries and cultures will bring unique insights and attitudes to bear on the business relationship, including differences in economic, legal, ethical, and philan- thropic expectations. We delved into a few trends related to stakeholders in the global economy, including the Caux Round Table Principles for Business, fair trade, employee engagement, and others.

The reflexive nature of the global economy means that the success of a particular company is a function of many factors, including the extent to which the firm’s home country is comprised of trust-based institutions. Some nations have well-developed systems for ensuring economic, legal, and ethical standards in business activities. In other cases, corporations are interested in a particular market but know that fundamental institutions and standards are sorely underdeveloped and negatively affect market potential. The four models of business involvement in development allows almost any firm the opportunity to engage in partnerships that improve health, education, economic, and other prospects for people around the world. In addition to corporate efforts, individual countries are also engaged in development efforts.

Finally, the Global Reporting Initiative (GRI) provides a frame- work for businesses and other organizations to assess their perfor- mance across an array of social responsibility indicators. A firm may use this as a self-audit but others choose to formally share the audit results with stakeholders. One of the greatest benefits of the GRI is that it makes comparisons possible because it uses a globally applicable and well-vetted framework.

Responsible Business Debate

Europe’s Wood Harvesting from the United States

Issue: Is it ethical for the European Union to harvest wood from the United States to meet its energy goals?

The European Union (EU) is known for their strict environmental goals for reducing greenhouse gas emis- sions. In 2007, the EU’s environmental agency set the goal of incorporating renewable energy sources that will account for 20 percent of their overall power by the year 2020. While renewable sources such as wind

and solar are being used, many of the EU’s power plants run on coal energy. As a result, the EU has decid- ed to power their plants with wood instead of coal. Wood is a cleaner fuel source than coal and is said to be renewable because trees can be replanted. However, this creates a significant challenge for the EU. The EU requires that loggers obtain permits before they begin cutting down trees, and there are many restrictions as to where and how many trees can be cut. Additionally,

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the amount of forests in the EU is significantly less than in the United States, and the United States does not have as many logging restrictions.

For these reasons the EU has contracted with log- ging companies in the southern United States to cut, press, and ship wood pellets. Many in the industry are happy about this new demand, since the closing of paper mills in the area have created unemploy- ment. The EU states that they only take small trees and branches from these forests and only from forests that can successfully be reforested. Furthermore, it is said that newer trees absorb more carbon dioxide than older ones, so once trees have been cut, new trees are planted.

However, environmentalists are concerned that the scope of the demand will deteriorate the forests. There are not strict controls for cutting, and sometimes older trees constitute some of the material for the pellets. Cutting older trees could defeat the purpose for clean energy as the older trees harbor large amounts of car- bon, which is released once it is burned.

Despite assurances, large-scale clear-cutting is taking place in these forests. Because this is a fairly new terri- tory for renewable energy, there are no set guidelines nor is one entity officially held accountable for how the forests are being cut. Clear-cutting is mostly illegal in the EU with a few exceptions. Critics see the EU as going against their own environmental laws as a means of achieving energy goals. Environmentalists also fear that due to the demand and lack of strict controls, some U.S. wetlands and other sensitive areas are being logged.

In one year, Europe burned 6.7 million tons of wood pellets, and America supplied 1.9 million tons of those pellets. The European consumption of pellets is expected to double by 2020, and the American con- tribution has been exponentially growing. The EU is aware of the challenges between their laws and their practices in the United States, and they are making an effort to analyze the rules and influence the policy. As a general rule, suppliers adhere to state-recommended best-management practices, and customers are allowed to investigate operations as a means of control.

There Are Two Sides to Every Issue: 1. It is acceptable for the European Union to harvest

American wood because wood is cleaner than coal and the harvesting is done as sustainably as possible.

2. It is unacceptable for the European Union to harvest American wood because it destroys American for- ests and will have negative long-term consequences.

Sources: Justin Scheck and Ianthe Jeanne Dugan, “Europe’s Green-Fuel Search Turns to America’s Forests,” The Wall Street Journal, May 27, 2013, http://online.wsj.com/article/ SB10001424127887324082604578485491298208114. html?mod=ITP_pageone_0 (accessed August 9, 2016); Michael Bastasch, “Europe Importing US Trees to Keep the Lights On,” May 28, 2013, Daily Caller, http://dailycaller.com/2013/05/28/ europe-importing-u-s-trees-to-keep-the-lights-on/ (accessed August 9, 2016); Sasha Lyutse’s Blog, National Resources Defense Council (NRDC), “How European Power Companies Skirt Their Own Environmental Rules By Logging in the U.S. Forests For Fuel,” Switchboard, May 29, 2013, http:// switchboard.nrdc.org/blogs/slyutse/how_european_power_ companies_s.html (accessed August 9, 2016).

cultural intelligence (p. 404) employee engagement (p. 412)

fair trade (p. 414) development (p. 416)

privatization (p. 419)

KEY TERMS

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Chapter 12  Social Responsibility in a Global Environment 427

DISCUSSION QUESTIONS 1. Define cultural intelligence in your own terms.

Compare your definition with the definition used in this chapter.

2. How are stakeholder relationships in a global context different from those in a domestic con- text? In what ways are they alike?

3. What is the likelihood that corporate leaders agree on a global set of social responsibility stan- dards? What evidence do you have?

4. How can organizations create stronger engage- ment with employees? What would be the effects on social responsibility? How would social responsibility affect engagement?

5. Define fair trade in your own terms. In what ways should consumers consider fair trade issues when making purchases and investments?

6. Review the UN Global Compact principles in Table 12.7. In what ways are these principles and issues related to a successful global economy? What benefits and/or challenges do they present to multinational corporations?

7. What are some ways that a company can measure its progress to comply with global reporting ini- tiative guidelines? Propose both quantitative and qualitative measures.

EXPERIENTIAL EXERCISE Choose two multinational companies, each based in a different home country, and visit their respective web- sites. Peruse these sites for information that is directed at three company stakeholders: employees, custom- ers, and the community. Make a list of the types of

information that are on the site and indicate how the information might be used and perceived by these three stakeholder groups. What differences and similarities did you find between the two companies? How are the differences attributable to cultural nuances?

Jaime and Catherine looked at each other. Each was thinking, “How do we do this?,” but offered no imme- diate suggestions. Both were mid-level executives with a multinational corporation that manufactured cloth- ing, handbags, and accessories in developing countries, including Guatemala and Honduras. The company is a member of the Fair Labor Association and takes pride in its commitment to a safe, healthy, and equitable work environment for all employees. Jaime, a native of Mexico, had professional experience in Peru, Chile, and Mexico. Catherine, a native of the United States, spoke fluent Spanish and was being groomed to take international assignments. Two weeks ago, the Vice President of Latin American Operations called Jaime and Catherine, asking them to take on an internal con- sulting project.

The Vice President was concerned about rumors surrounding the company’s largest manufacturing site in Honduras. This site employed over 1,000 people, the majority of whom worked in low-skilled

manufacturing roles. Although no employee had come forward, or used the firm’s ethics hotline, the site’s regional manager (RM) was concerned about man- agement practices and workplace conditions. Each time the RM visited the site, he sensed that he was not experiencing the daily “reality” of the manufacturing site. So far, he had little proof but decided to share his concerns with other executives. Specifically, he was worried about (1) possible intimidation of union members and leaders, (2) discriminatory management tactics, and (3) forced overtime that was not properly compensated.

Two weeks later, Jaime and Catherine arrived at the site, tasked with determining whether management practices and workplace conditions were compatible with corporate standards and FLA principles. First, they need to develop a plan for gathering information from employees, including those who were either scared of retaliation or generally mistrusting of corporate man- agement. What would you do?

MANUFACTURING MISCONDUCT: WHAT WOULD YOU DO? ?

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428

CASE 1

Uber Faces Ethical and Regulatory Challenges*

Uber Technologies, Inc. (Uber) is a tech startup that provides ride-sharing services by facilitating a connec- tion between independent contractors (drivers) and riders with the use of an app. Uber has expanded its operations to 300 cities around the world and is valued at around $60 billion. Because its services cost less than taking a traditional taxi, in the few years it has been in business, Uber and similar ride-sharing services have upended the taxi industry. The company has experi- enced resounding success and is looking toward expan- sion both domestically and abroad.

However, Uber’s rapid success is creating ethical challenges in the form of legal and regulatory, social, and technical obstacles. The taxi industry, for instance, is arguing that Uber has an unfair advantage because it does not face the same licensing requirements as they do. Others accuse Uber of not vetting their drivers, cre- ating potentially unsafe situations for their passengers. An accusation of rape in India brought this issue of safety to the forefront. Some major cities are banning ride-sharing services like Uber because of these various concerns. Other cities are making it increasingly dif- ficult for Uber to operate. For instance, the firm left Austin, Texas because the city adopted unfavorable regulation that required fingerprint background checks. Additionally, Uber has faced various lawsuits, including a lawsuit filed by its independent contractors. Its pres- ence in the market has influenced lawmakers to draft new regulations to govern these ride-sharing systems. Legislation can often hinder a company’s expansion opportunities because of the resources it must expend to comply with regulatory requirements.

On the other hand, Uber is highly praised for giving independent contractors an opportunity to earn money as long as they have a car, while also offering conve- nient ways for consumers to get around at lower costs. Although its “Surge Pricing” technique has been criti- cized for charging higher fares during popular times, it is becoming a model for other companies. For instance,

Zappos is adopting Uber’s surge pricing strategy in how it compensates its call center employees. The biggest issues Uber faces include legal actions because drivers are not licensed, rider and driver safety, protection and security of customer and driver information, and a lack of adequate insurance coverage. To be successful Uber must address these issues so it can reduce resistance as it expands into other cities.

BACKGROUND Uber is probably the most well-known company that operates in the sharing economy. The sharing economy refers to an economic model that involves the sharing of underutilized resources. Although Uber was not the first firm to operate in the sharing economy, it has largely popularized this new economic model, paving the way for other firms to begin offering services in other industries.

The story of Uber began in 2009 when co-founders Travis Kalanick and Garrett Camp developed a smart- phone application to connect drivers-for-hire with people needing rides to a destination in their city. This innovative service was originally founded as UberCab, Inc., a privately held company. It was renamed Uber Technologies, Inc. in 2010. Co-founders Kalanick and Camp designed the mobile app for iPhone and Android smartphones, enabling customers to get an estimated time of arrival from the driver on their smartphone with the use of an integrated GPS system. Uber has been referred to as a “labor-broker,” a firm that connects people who need transportation services with those willing to provide them.

Consumers liked the Uber app because of its convenience and ease-of-use. After the mobile app is downloaded to their smartphones, passengers can pay for the rides-for-hire service through a third party, known as a Transportation Network Company (TNC),

*This case was developed by Jennifer Sawayda under the direction of O.C. and Linda Ferrell. Noushin Laila Ansari, Lecia Weber, Sederick Hood, and Christian Otto developed an earlier version of this case under the direction of O. C. Ferrell and Linda Ferrell, Belmont University. This case was prepared for classroom discussion rather than to illustrate effective or ineffective handling of an administrative situation. ©O.C. Ferrell and Linda Ferrell, 2016.

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Case 1  Uber Faces Ethical and Regulatory Challenges 429

using the UberX platform that scans or takes a picture of their credit card with the smartphone’s camera. Uber does not maintain automobile inventory for drivers, such as a fleet of taxicabs or limousines. Instead, each driver-for-hire supplies his or her own personal auto- mobile, gas, insurance, and maintenance of his or her own car. Drivers can drive their own cars where they want when they want, providing them with significant freedom to run their own small businesses. A surge pric- ing model is used during times of peak demand. While Uber initially charged about a 20 percent commission, it later introduced a tiered structure in some cities that charged different commission rates depending upon the number of hours worked. For instance, in San Francisco a driver pays Uber a 30 percent commission on the first 20 rides in the week, 25 percent on the next 20 rides, and 20 percent on rides after that.

Due to the increased demand in the rides-for-hire industry, Uber has an estimated total valuation of $60 billion. Uber recently relocated to new headquar- ters in San Francisco, providing office space for nearly 700 employees. In the near future, it plans to expand to two 10-story buildings, increasing its total square feet of office space utilization to more than 700,000 square feet.

Uber Technologies, Inc. provides rides-for-hire ser- vices to 300 cities worldwide. Uber maintains a pres- ence in major U.S. cities including Los Angeles, San Francisco, New York City, Chicago, Washington D.C., and Boston. Uber technology-based products are avail- able under these various brands: UberX, UberXL, UberPop, UberBlack, UberSUV, UberTaxi, UberLux, UberSelect, UberPool, and the logistics-request brands referred to as UberRush and UberEats. Uber has also upgraded its current navigation service (Google and Apple) with deCarta Mapping Company. This new mapping system will continue to improve Uber’s naviga- tion and location technologies.

UBER’S MARKETING STRATEGY Like all companies, Uber must understand its tar- get market and maintain a strong marketing mix to be successful. Due to its technology, Uber does not have as many constraints as taxicabs, although it has encountered regulatory obstacles and public resistance. The Uber business model takes advantage of the smart- phone technology of consumers and links them with independent drivers as their cabs. This provides a more potentially efficient and less expensive way to purchase transportation.

PRODUCTS Uber’s service products are digitally mediated via a smartphone app that consumers download. When they want to request a ride, they can use the app to contact a driver in the near vicinity. The Uber app allows consum- ers to track the location of the car and alerts them to when the car arrives.

Uber offers a few different services to customers based upon their preferences. Its most used service is UberX, the low-budget option. Drivers use their own vehicles to transport passengers. UberTaxi is an app that connects licensed taxi drivers to passengers. UberBlack is for consumers who desire to have their own private driver in a high-end sedan. UberSelect costs twice as much as UberX but less than UberBlack. UberSelect uses vehicle brands like BMW and Lexus. UberSUV connects users with SUVs, while UberLux is the most expensive service with luxury vehicles. UberXL is simi- lar to UberSUV but costs 50 percent less. Other low- cost options include UberPool, which allows passengers to share rides and split the costs, and UberPop, a service costing less than UberX because it utilizes nonprofes- sional drivers and smaller cars. Despite the opportuni- ties UberPop provides, its use of nonprofessional drivers has led to regulatory issues in different countries.

Uber is also attempting to expand into other servic- es. Its UberRush app, launched in New York., Chicago, and San Francisco, is used for package deliveries. Uber is marketing its UberRush service to businesses who want to provide on-demand delivery to their clients. UberEats is a meal delivery app that partners with local restaurants to offer meals to consumers within 10 min- utes. These new services are allowing Uber to branch out and expand its services into different businesses.

DISTRIBUTION One major reason Uber is so popular is because its app allows users to contact any drivers in the near vicinity. Drivers use the Uber app to provide them with direc- tions. It is estimated that Uber has more than 450,000 drivers in the United States who make at least four trips. The number of drivers has doubled every 6 months for the past 2 years. Los Angeles, San Francisco, New York, Chicago, Washington D.C., and Boston have the most drivers in the United States. Most Uber drivers offer their ride-sharing services on a part-time basis.

To be successful, Uber engages in strategic part- nerships with other companies. In the United States, it

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430 Business and Society

has partnered with American Express. Card members enrolled in American Express’s Membership Rewards program can earn points with Uber for rides. Strategic partnerships with local firms are especially important as Uber expands internationally because it allows the company to utilize the resources and knowledge of domestic firms familiar with the country’s culture. Uber has partnered with Times Internet in India, Baidu in China, and America Movil in Latin America.

PRICING Uber uses its app to determine pricing. Once the passenger completes his or her ride with an Uber partner–driver, the person’s credit card is charged automatically. Fees charged for speeds over 11 miles per hour are charged by the dis- tance traveled. Uber operates on a cost leadership basis, claiming that it offers lower rates than taxis. However, the app OpenStreetCab suggests that Uber might be more cost-efficient only when the fare is more than $35.

Uber uses an algorithm to estimate fees charged when demand is high. Called surge pricing, Uber has even applied for a patent for this type of system. This “peak pricing” strategy is not too different than when utilities or flights charge higher prices when demand is high. Passengers are alerted during times where the price is higher. However, the extent of the pricing increase has been questioned, as some consumers believe Uber uses this high demand to “price gouge” passengers.

In some situations, Uber’s surge pricing has led to considerable criticism. During one New Year’s Eve, pric- ing surged up to seven times the normal price. During a hostage crisis in Sydney, Australia, Uber charged as much as four times the normal price as an influx of people struggled to evacuate. During ice storms and snowstorms, surge pricing may also be applied. Uber responded by claiming its price hikes encouraged more drivers to pick up passengers in the area, but consumers were outraged about the hostage crisis situation. Within an hour Uber agreed to refund users in the area who paid the higher prices. In extreme shortages, prices are some- times hiked to as high as 6 to 8 percent. On the one hand, Uber argues that surge pricing increases the number of drivers during times of high demand. It is estimated that the number of drivers increases by 70 to 80 percent due to surge pricing. Still, some consumers believe this is a form of price gouging and that Uber capitalizes on emergency situations such as the Sydney hostage crisis. Uber has to reconcile these different situations to create a pricing strategy considered fair and ethical by its users.

PROMOTION Uber has engaged in a number of promotional activities to make its brand known. Often it adopts buzz-mar- keting strategies to draw attention to its services. For instance, to celebrate National Ice Cream Month, Uber launched on-demand ice cream trucks in seven major cities. In one promotion, Uber partnered with General Electric to offer free DeLorean rides to San Francisco users reminiscent of the movie Back to the Future. Uber also uses promotion to portray its benefits compared to its rivals. For instance, Uber assumed a combative advertising approach to its major rival Lyft through a Facebook ad campaign. Uber advertising often stresses the convenience and low cost of its ride-sharing services.

However, like all companies, Uber must take care to ensure that its advertising could not be construed as misleading. A lawsuit was filed in the U.S. District Court in San Francisco stating that Uber violated the 1946 Lanham Act that prohibits false advertising. Taxi companies claimed, for instance, that Uber’s drivers do not have to undergo fingerprinting in California as part of background checks, and yet it uses advertising such as “the safest ride on the road” and sets “the strictest safety standards possible,” as well as Uber’s $1 “Safe Rides Fee.” According to the taxi drivers, these deceptive advertising practices take customers away from their services and are therefore leading to economic harm.

UBER FACES CHALLENGES Uber faces a number of additional challenges including internal struggles, legal and regulatory challenges, and global issues. In the United States, major cities are con- sidering regulating Uber. However, it faces more obsta- cles as it expands internationally. Some countries are opting to ban Uber or certain services altogether. Uber will have to adapt its marketing strategy to address both domestic challenges within the United States as well as to the various laws enforced in different countries.

INTERNAL CHALLENGES—DRIV- ER SATISFACTION

Uber operates in an industry where trust between strangers is vital. This trust ensures a safe and com- fortable ride for both passenger and driver. Uber has developed a rating system to help assure this trust and reliability between passengers and drivers, called a

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rideshare ratings system. Rideshare rating systems pose a unique challenge for Uber because of the way they are set up and the level of rider objectivity. Uber’s insistent policy of maintaining a five-star fleet can put drivers at a disadvantage. Uber rivals have similar policies; for instance, Lyft tells customers that anything less than five stars indicates unhappiness with the ride.

Low driver scores can mean drivers are forced to take remedial classes where they learn about safe driving techniques and driver etiquette. Those who fail to increase their scores risk suspension or permanent deactivation. Because consumers have different views of what constitutes quality, it can be argued that Uber drivers are placed at the mercy of the consumer’s mood.

Drivers have also expressed unhappiness with Uber’s pay. Uber will often lower fare rates in order to gain a competitive advantage in different markets, which cuts into driver earnings. Additionally, drivers are driving their own cars and spending their personal funds on upkeep and insurance. In 2014 drivers work- ing with Teamsters Local 986 launched the California App-based Drivers Association (CADA), an Uber driv- ers’ union. More cities have started their own unions.

Uber has begun to guarantee hourly earnings of $10 to $26 per hour for its drivers, but to qualify driv- ers have to comply with Uber’s rules—including accept- ing 90 percent of ride requests, doing one ride per hour, and being online 50 out of 60 minutes. Critics say these restrictions effectively keep drivers from working for other ride-sharing services. Uber drivers are indepen- dent contractors and not employees of the company, so they have the option to work for competitors. However, these new criteria may be a way to keep drivers working for Uber and no one else.

This independent contractor status has created controversy for drivers. Drivers claim that Uber’s requirements make them more like employees than independent contractors. For instance, Uber has cer- tain rules about types of cars and soliciting business. Disgruntled drivers have staged protests and filed class-action lawsuits against the firm. Uber has lost class-action lawsuits in California and Massachusetts. According to the rulings in these states, Uber drivers qualified as employees. Therefore, Uber owed them money in the form of expense reimbursements and car maintenance. After losing the lawsuits in California and Massachusetts, Uber agreed to pay as much as $100 million, which will be distributed among the driv- ers in those areas. However, compensation will depend on time spent driving and mileage. Those who drove less than 750 miles will likely only receive about $24.

As a result of the settlement, Uber has announced changes that will apply to its drivers across the country. For instance, it will no longer deactivate Uber drivers from its app unless there is sufficient cause to do so. Drivers must be given two warnings beforehand (unless it involves fraud, discrimination, or other illegal con- duct), and the reason must be stated in writing. Uber also agreed to provide more information to its drivers about how its rating system works, and it will fund a Drivers Association in the two states. These associations will enable Uber drivers in California and Massachusetts to elect a leader who will meet with Uber on a quarterly basis and discuss driver issues. Finally, Uber was required to clarify in its communications that drivers can request tips because tips are not included on Uber’s app. These actions are an attempt on Uber’s part to provide drivers with more freedom as independent contractors. The more control Uber exerts over drivers, the more likely they will be considered as employees rather than independent contractors. To ensure that it operates on the right side of employment law, Uber must carefully understand the line separating independent contractors from employees.

COMPETITOR SABOTAGE AND DATA LEAKS Lyft, Uber’s main competitor, claims that Uber employees and recruiters were ordering rides from Lyft and then cancelling them simply to put them at a disadvantage. This wasted the time of Lyft drivers and caused them to lose out on legitimate passengers. Lyft claims that one Uber recruiter opened up 29 accounts using the Lyft app. The recruiter booked and then cancelled 1,524 rides. Lyft also complained that when Uber employees did book and accept rides from Lyft, they only did so to try to convince the Lyft driver to work for Uber instead. Uber promised it would “tone down their sales tactics” and apologized for the misconduct. There is no evidence to suggest that com- petitor sabotage was ever sanctioned by Uber headquarters.

Additionally, in 2014 Uber experienced a data breach that exposed the data of 50,000 U.S. drivers. After Uber learned about the breach, it did not alert drivers in a timely manner. Another issue regarding driv- er privacy involves what has been termed Uber’s “god view” tool. This tool reveals the locations of Uber cars and their drivers. The New York attorney general filed a lawsuit against Uber in regards to the data breach and for not alerting its drivers in a timely manner that their information might have been compromised. Uber paid $20,000 to settle.

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LEGAL CHALLENGES Regulation is a constant challenge for Uber. As it becomes more popular, Uber will become subject to more legal and regulatory requirements common to other big businesses. For instance, the Americans with Disabilities Act is becoming a challenge for Uber. Since the Uber service is usually operated within a driver’s personal vehicle, many of the vehicles are not wheel- chair friendly. The National Federation of the Blind also filed lawsuits against Uber because of instances where passengers were denied access to rides because they had service dogs. According to allegations, some drivers left passengers in extreme weather and then charged them cancellation fees afterward. A complaint filed in the Northern California District Court claims that a woman’s service dog was placed in the trunk. Uber responded by claiming that according to its policy, drivers are terminated if they refuse to grant access to service dogs. However, the National Federation of the Blind claims that Uber had allegedly responded by say- ing they have no control over their drivers. The orga- nization maintains that since Uber manages payments and services through its app and assesses customer feedback on driver performance, it has an obligation to ensure its drivers are not discriminating against the visually impaired. Uber claims that it is committed to equal access and has partnered with organizations such as the Lighthouse for the Blind in San Francisco to enable access to its technological services for those who are blind. The Uber app is compatible with VoiceOver iOS so that blind individuals are able to access and use its app.

Taxi lobbying groups are also pressuring local gov- ernments to block Uber in many cities. They claim that Uber hurts their business and has an unfair advantage, as Uber drivers are not subject to the same restrictions as licensed taxi drivers. For this reason, they do not have to pay taxes or licensing fees. Cities have taken action against Uber by blocking ordinances that provide a path to legalization for mobile ride-booking apps and issuing cease-and-desist orders. Several U.S. airports such as Salt Lake City have restrictions on Uber.

In addition to having an unfair competitive advan- tage, another accusation levied against Uber is that it does not adhere to proper safety standards. Allegedly, Uber drivers were involved in three rapes in Delhi, India; Chicago; and Boston. These rapes have harmed Uber’s reputation and cast its safety into serious question. In India the rapist was convicted and sentenced to life in prison. The victim filed a lawsuit against Uber, which

it settled out of court. Additionally, a lawsuit was filed against Uber in San Francisco for the wrongful death of a 6-year-old girl. The lawsuit alleged that a driver was distracted using the UberX app when he struck and killed the girl. Uber responded by claiming that the driver was not an agent for Uber and was not en route or transporting a passenger at the time of the accident. However, it settled with the family of the victim.

In 2016 a driver named Jeffrey Dalton in Kalamazoo, Michigan shot individuals in a rampage that lasted five hours. Six people were killed. It appears that Dalton picked up Uber passengers both before and after the shootings. It is important to note that Dalton did not have a criminal record, and even the FBI con- cedes that he did not raise any red flags. While it does not seem that Uber could have foreseen the attacks, the procedures it uses for background checks are increas- ingly questioned.

To reestablish its reputation for safety, Uber has added a “safe ride checklist” to its app that is a pre- pickup notification encouraging riders to confirm the license plate number and verify their driver’s name and appearance before entering a vehicle. They have also added a team of safety and fraud experts to authenti- cate drivers and a dedicated incident-response team to address rider issues in India. However, Uber does not require fingerprint scans for its drivers, except in New York City and Houston. Uber has even threatened to exit the Houston market as it claims that the fingerprint scan requirements have resulted in a 35 percent increase in wait time for passengers. It already exited the market in Austin, Texas because of the government’s mandatory fingerprinting.

Insurance is another criticism against Uber. Although Uber’s website claims that it offers $1 million in liability insurance plans for its drivers, some states are issuing warnings stating that rideshare insurance may not cover them should there be an accident. Many states are reconsidering insurance requirements in light of this issue, and insurance firms such as GEICO and MetLife have begun offering insurance packages for ride-sharing services.

GLOBAL EXPANSION Uber has adopted the motto “Available locally, expand- ing globally” to describe the opportunities it sees in global expansion. International expansion is a major part of Uber’s marketing strategy, and it has thus far established the ride-sharing service in 300 global cities.

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Uber is correct in assuming that consumers from other countries would also appreciate the low cost, conve- nience, and freedom that its app services offer.

Many countries have regulatory hurdles that have caused trouble for Uber to successfully operate in these areas. Several cities across the world have banned select Uber services. On the other hand, it is hard for countries and cities to ban Uber completely since so many of the activities are performed over the Internet. U.S. cities such as Portland, Oregon have accused Uber of aggres- sively trying to move into new territories in spite of legal opposition. In fact, Costa Rica maintains that Uber drivers are operating in the country illegally.

Many, if not all, of the instances involve banning Uber or Uber services due to the lack of professional licenses for drivers. In Taiwan authorities claimed that Uber services violated highway laws by not hav- ing transport-licenses to operate legally. The ministry of Economic Affairs has looked into the possibility of revoking Uber’s business registration. In Spain, Uber shut down its ride-sharing service after a judge ruled that Uber drivers are not legally authorized to transport passengers by unfairly competing against licensed taxi drivers. In Australia, Victoria and New South Wales ruled Uber’s app to be illegal due to safety concerns. Police in Cape Town, South Africa, impounded 33 cars operating with the Uber app because the drivers did not have a taxi license. Taxi driver protests against Uber have occurred frequently in the various countries in which Uber is trying to expand, sometimes resulting in driver injuries and vandalism.

FRANCE In 2011 Paris became the first city outside of the United States where Uber set up operations. However, the government banned UberPop because drivers for this service do not need to be licensed. French police even raided Uber’s Paris office. A French law was passed mandating that operating a service that connects pas- sengers to nonlicensed drivers is punishable with fines over $300,000 and up to 2 years in prison. Hundreds of Uber drivers in France were issued fines for operating illegally, and two executives were arrested.

Uber challenged that law, claiming that it is uncon- stitutional because it hinders free enterprise. A French court decided against banning UberPop and sent the case to a higher court. This has generated strong criti- cism from taxicab officials in France as they claim that they have to license drivers while Uber is currently

free from this restriction. In 2015 the Constitutional Council in France upheld the ban.

Taxi drivers have staged numerous protests in France, resulting in damaged vehicles and some inci- dents where Uber drivers were held against their will. One protest gained notable attention because it involved rocker Courtney Love, who was caught in the protest on her way from the airport. Love claims the car was vandalized and her driver was held hostage. The French government informed the public that violence was not justified and that UberPop continues to remain illegal. Violating the ban could subject drivers to fines, imprisonment, and vehicle seizures. However, according to government authorities, the Uber app itself cannot be banned without a court order.

INDIA India is Uber’s second largest market after the United States. India rejected Uber’s application for a taxi license. In New Delhi a woman’s rape allegation led to a ban against app-based services without radio-taxi per- mits in the capital. In response to the alleged rape, Uber began installing “panic button” and tracking features to its app. Uber also began offering its service in New Delhi without charging booking or service fees.

Despite these changes, Uber continued to run afoul of Indian authorities. India asked Internet service pro- viders to block Uber’s websites because it continued to operate in the city despite being banned. However, it did not ban the apps themselves because doing so would require it to institute the ban across the entire country. Uber must tread carefully to seize upon opportunities in India without violating regulatory requirements. This is more difficult as Uber drivers are independent contrac- tors who set their own schedules and make their own decisions about whether to work.

GERMANY Uber provides its ride-sharing service in Germany’s five biggest cities, namely Frankfurt, Berlin, Hamburg, Munich, and Düsseldorf. In 2014 Frankfurt’s court filed an injunction against Uber. A nationwide ban was instituted against Uber’s UberPop services after taxicab operators asked for an emergency injunction, but it was overturned because the judge determined they waited too long to file the injunction.

However, in 2015 a German court banned Uber services if they used unlicensed drivers. Uber argued in

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court that the company itself is only an agent to con- nect driver and rider. Rules that apply to taxi services supposedly do not apply, and all services are deemed to be legal, according to Uber. The court ruled that Uber’s business model clearly infringes the Personal Transportation Law, because drivers transport riders without a personal transportation license. The injunc- tion includes a fine of more than $260,000 per ride for noncompliance. If the injunction is breached, drivers could go to jail for up to half a year, in addition to an imposition of fines. The German Taxi Association (Taxi Deutschland) was pleased with the outcome, claiming that taxi services will remain in the hands of qualified people and keep everyone safer.

Despite the ruling, an Uber spokesperson said that the company would not give up on Germany because UberBlack and UberTaxi services will remain unaffected by the District Court’s verdict. UberBlack and UberTaxi use licensed taxis and limousine drivers. However, competitors have quickly risen to challenge Uber in the German market, and some question whether Uber has a future in Germany.

CONCLUSION The long-term viability of Uber depends on managing future risks in six key areas:

Ethics and Compliance: Uber does not communicate ethical values or a code of ethics for its indepen- dent contractors. Drivers are provided with various training modules to deal with issues such as safety. However, Uber does not require drivers to complete these modules before becoming an independent con- tractor for the firm. Most drivers indicate that they skip over these training modules; they simply have their car approved and undergo a background check. Independent contractors in the direct selling industry are provided with a comprehensive code of ethics to provide guidance for ethical behavior. Uber will con- tinue to face ethical risks if it does not communicate required ethical standards to drivers.

Drivers: The number of disgruntled drivers could get out of control if Uber increases its profit share deductions. With recent laws mandating healthcare insurance, drivers may require healthcare coverage. Training programs to improve driving skills could reduce risk from negligent drivers and decrease liability insurance costs.

Competitors: Uber’s business model can be found in similar rides-for-hire services, such as Lyft, Sidecar,

and Curb. More rides-for-hires could emerge, in addition to the everyday competition from taxicabs, limos, rental car businesses, air travel, trains, and city and chartered buses. In China Didi Chuxing seems to be gaining market share.

Customer Base: Increasing the demand for rides- for-services is a continuous or future challenge that requires attention primarily to safety improvements and rates that have a cost/benefit to both passen- gers and drivers. Unpredictable demand is a future risk that could be met with product diversification. Currently, Uber offers technology-oriented products, and it must continue to be competitive in an industry where there is intense competition for rates.

Technology: Customers are wary of downloading apps, and some online businesses have been hacked for credit card information. Uber itself experienced a data breach that resulted in the data of 50,000 driv- ers being hacked. Because Uber has responsibilities to protect the privacy of both its independent con- tractors and passengers, it must increase its security protocols and communicate any potential breaches in a timely fashion.

Customer satisfaction: Some customers experience long waits, inexperienced drivers, and even sexual harassment. Better Business Bureau complaints mainly involve pricing and problems with service. Uber might use the Internet to check consumer complaints and address them to improve customer satisfaction.

The emergence of Uber has influenced many services to follow the Uber business model. There are similar firms that offer ride-sharing services, and there are firms that want to be an Uber-type business in the way they deliver goods and services. For example, Cargomatic has devel- oped an app to help fill space on trucks. Cargomatic, which now operates in California and New York, has been called the Uber for truckers because it connect shippers with drivers who are looking for extra ship- ments to haul. This is signaling a shift in the industry in which people are the infrastructure rather than build- ings or fleets of vehicles.

Uber faces a number of ethical challenges, includ- ing regulatory and legal issues both inside and outside of the United States. Laws that protect consumers specifically target taxi services, whereas Uber defines its services as “ride sharing” and Uber as an “agent” of their “individual contractors.” However, many courts do not view its services in the same way and are forcing Uber to comply with licensing laws or stop business in certain areas.

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Despite Uber’s challenges, the company has become widely popular among consumers and independent con- tractors. Supporters claim that Uber is revolutionizing the transportation service industry. Investors clearly believe Uber is going to be a strong market player in the long run.

Uber has a bright future and expansion opportu- nities are great. It is therefore important for Uber to ensure the safety of their riders and the drivers. They should also adopt controls to ensure that independent contractors using their app obey relevant country laws. Uber has to address these issues to uphold the trust of their customers and achieve long-term market success.

Questions for Discussion 1. What are the ethical challenges that Uber faces in

using app-based peer-to-peer sharing technology? 2. Since Uber is using a disruptive business model and

marketing strategy, what are the threats that the company will have to overcome to be successful?

3. Because Uber is so popular and the business model is being expanded to other industries, should there be regulation to develop compli- ance with standards to protect competitors and consumers?

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Joana Sugden and Aditi Malhotra, “Indian officials draft- ing national rules for Uber, other taxi apps,” Wall Street Journal, April 7, 2015, http://www.wsj.com/ articles/indian-officials-drafting-national-rules-for-uber- other-taxi-apps-1428427528 (accessed May 21, 2015).

Taylor Sopper, “Uber for picture framing: Mountary launches service in Seattle, brings experts to your door,” April 7, 2015, http://www.geekwire.com/2015/

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uber-for-picture-framing-mountary-launches-service-in- seattle-brings-experts-to-your-door/ (accessed May 21, 2015).

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Sam Schechner, “Uber wins French court reprieve over legality of low-cost service,” Wall Street Journal, March 31, 2015, http://www.wsj.com/articles/uber- wins-french-court-reprieve-over-legality-of-low-cost- service-1427794312 (accessed May 22, 2015).

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Andrew Watts, “The Real Reason Uber and Lyft Left Austin,” The Huffington Post, Mary 10, 2016, http:// www.huffingtonpost.com/andrew-watts/the-real- reason-uber-and-lyft-left-austin_b_9889406.html (accessed July 18, 2016).

Karen Weise, “How Uber Rolls,” June 29-July 5, 2015, Bloomberg Businessweek, 54–59.

Elizabeth Weise, “Most Uber drivers to get less than $25 from big settlement,” USA Today, April 27, 2016, http://www.usatoday.com/story/tech/2016/04/26/most- uber-drivers-see-little-100-milion-payout/83546898/ (accessed July 22, 2016).

Kale Williams, “Uber denies fault in S.F. crash that killed girl,” SFGate, May 7, 2014, http://www.sfgate.com/ bayarea/article/Uber-denies-fault-in-S-F-crash-that- killed-girl-5458290.php (accessed May 22, 2015).

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INTRODUCTION In 1963, brothers Stanley and Sidney Goldstein founded the first Consumer Value Store (CVS) with partner Ralph Hoagland in Lowell, Massachusetts. The store originally sold health and beauty supplies. It was widely successful, and grew to include 17 stores in one year. By 1967, CVS began offering in-store pharmacy depart- ments, and in less than a decade it was acquired by the retail holding corporation Melville Corporation. This marked the beginning of CVS’s expansion across the east coast through new store openings or mergers and acquisitions. It soon reached the milestone of exceeding $100 million in sales in 1974.

As the company grew, it faced intense competition, which it responded to through a differentiation strategy. CVS focused on its core offerings of health and beauty products, placing stores in shopping malls to generate more foot traffic. This strategy worked well for the company, allowing it to hit $1 billion in sales by 1985. The company celebrated its 25th year in 1988 with 750 stores and $1.6 billion in sales. The acquisition of People’s Drug stores enabled CVS to establish its pres- ence more widely along the coast and spurred the launch of PharmaCare, a pharmacy benefit management (PBM) company providing services to employers and insurers. In 1996 the Melville Corporation restructured, and CVS became independent as a publicly traded company on the New York Stock Exchange.

This new surge of investment allowed the company to expand widely across the nation into the Midwest and Southeast. CVS’s acquisition of 2,500 Revco stores became the largest acquisition in U.S. retail phar- macy history. With the rise of the Internet, CVS seized upon the opportunity to launch CVS.com in 1999 (and Caremark.com after the 2007 acquisition). This became the first fully integrated online pharmacy in the United States. In another first for the U.S. pharmacy retail industry, the company introduced the ExtraCare Card loyalty program in 2001. The company’s 40th

anniversary in 2003 was marked with increasing west- ward expansion, 44 million loyalty card holders, and more than 4,000 stores in approximately 30 states. In the following five years, the company’s acquisitions allowed CVS to gain leadership in key markets, begin a mail order business, and open its 7,000th retail location. It would also undergo a name change to CVS/Caremark after acquiring Caremark Rx, a prescription benefits management organization.

The two most important acquisitions in the history of CVS include MinuteClinic walk-in health clinics (in 2005) and Caremark Rx, Inc., (in 2007), a pharmacy benefits management company. To date, MinuteClinic has facilitated over 18 million patient visits in 800 clinics across 27 states, putting them in prime position to reach their 2017 goal of operating 1,500 clinics in 35 states. CVS/Caremark, as it was renamed after the acquisition, became the second largest pharmacy in the United States after Walgreen’s, introducing new services such as online prescription refills. By 2011, the company had more than $100 billion in revenue, 7,500 retail pharmacies, 31 retail specialty pharmacies, 12 specialty mail order pharmacies, 18 onsite pharmacies, and a pharmacy benefit management business.

CVS sells products that meet the highest quality standards as well as its own line of products whose specifications and performance are annually tested and reviewed to ensure compliance with applicable consum- er safety laws. In addition, the company has instituted its own Cosmetic Safety Policy that cosmetic products on the shelves must meet. CVS employs 243,000 people in over 9,600 locations across 49 states, the District of Columbia, Puerto Rico, Brazil, and Northern Ireland. Corporate headquarters are located in Woonsocket, Rhode Island. In one year, CVS filled and managed 1.9 billion prescriptions, provided services to 75 million PBM clients, and surpassed $139 billion in net revenues. The company is proud to note their number 10 spot on the Fortune 100 list. Today, CVS is one of the largest pharmacy health care providers and pharmacies in the

CASE 2

The Mission of CVS: Corporate Social Responsibility and Pharmacy Innovation

*This case was prepared by Yixing Chen, Christine Shields, and Michelle Urban for and under the direction of O. C. Ferrell and Linda Ferrell © 2014. It was prepared for classroom discussion rather than to illustrate either effective or ineffective handling of an adminis- trative, ethical, or legal decision by management. All sources used for this case were obtained through publicly available material.

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United States, and is comprised of four business func- tions: CVS/Caremark, MinuteClinic, PBM Services, and Retail Pharmacy. In 2014 CVS decided to change its name to CVS Health to reflect it emphasis on the health care industry. To further this goal, CVS made a deal to purchase Target’s health services and clinics. Pharmacies in Target stores will be rebranded as CVS Pharmacies. CVS paid Target $1.9 billion for the pharmacy business and will pay Target $20 to $25 million in rent for the space.

The following case will explain some of the legal and ethical challenges CVS/Caremark has encoun- tered, including a settlement with the Federal Trade Commission (FTC) and U.S. Department of Health & Human Services (HHS) regarding violations of the Health Insurance Portability and Accountability Act (HIPAA) Privacy Rule, deceptive business practices, and unseemly conduct by a manager resulting in a death. Our examination will also include how CVS/Caremark responded to such allegations, and how it has worked to redefine the company as a healthcare provider. We will analyze the company’s ethical structure, including their recent decision to stop selling cigarettes, as well as an overview of some criticisms the company has received during their transition. The conclusion offers some insights into the future challenges CVS will likely experience.

ETHICAL CHALLENGES Like most large companies, CVS must frequently address ethical risk areas and maintain socially respon- sible relationships with stakeholders. Although CVS has excelled in social responsibility, it has suffered from ethical lapses in the past. The next section addresses some of CVS’s most notable ethical challenges, some of which resulted in legal repercussions.

HIPAA Privacy Case of 2009 As a company grows and achieves widespread influ- ence, it also inherits a responsibility to act ethically and within the law. In 2009, CVS/Caremark was accused of improperly disposing of patients’ health informa- tion. It was alleged that company employees threw prescription bottle labels and old prescriptions into the trash without destroying sensitive patient informa- tion, making it possible for the information to fall into public hands. This is a violation of the HIPAA Privacy

Rule, which requires companies operating in the health industry to properly safeguard the information of their patients. The allegations initiated investigations by the Office of Civil Rights (OCR) and the FTC, marking the first such collaborative investigation into a company’s practices. These investigations revealed other issues as well, including a failure of company policies and procedures to completely address the safe handling of sensitive patient information, lack of proper employee training on disposal of sensitive information, and neg- ligence in establishing repercussions for violations of proper disposal methods. This was in spite of the fact that CVS materials reassure clients that their privacy is a top priority for the pharmacy. This claim, in addition to the investigative findings, prompted the FTC to allege that CVS was making deceptive claims and had unfair security practices, both of which are violations of the FTC Act.

CVS settled the case with the U.S. Department of Health & Human Services (HHS), which over- sees the enforcement of the HIPAA Privacy Rule, for $2.25 million regarding improper disposal of patients’ health information. The settlement also mandated that the company implement a Corrective Action Plan with the following seven guidelines: (1) revise and distribute policies regarding disposal of protected health infor- mation; (2) discipline employees who violate them; (3) train workforce on new requirements; (4) conduct internal monitoring; (5) involve a qualified, indepen- dent third-party to assess company compliance with requirements and submit reports to HHS; (6) establish internal reporting procedures requiring employees to report all violations of these new privacy policies; and (7) submit compliance reports to HHS for three years. The company also settled with the FTC by signing a consent order, requiring the company to develop a com- prehensive program that would ensure the security and confidentiality of information collected from customers. In so doing, the company agreed to a biennial audit from an independent third party. This audit is meant to ensure that CVS’s program meets the FTC’s standards for its security program. CVS is forbidden by law from misrepresenting its security practices.

Deceptive Business Practices In addition to privacy challenges, CVS/Caremark has been accused of deceptive business practices. A 2008 civil lawsuit involving 28 states was filed against the personal benefits management division of

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CVS/Caremark, which acts as the prescription drug claim intermediary between employers and employees. It also maintains relationships with drugstores and manufacturers. The allegations of the lawsuit included urging doctors to switch patients to name brand pre- scriptions under the notion that it would save them money. Furthermore, these switches were encouraged without informing doctors of the financial burden it would impose on patients, and employer healthcare plans were not informed that this activity would benefit CVS/Caremark. This could be seen as a conflict of inter- est at the expense of customers. Due to these allegations, the suit called for a revision in how the division gives information to consumers. In the end, CVS/Caremark signed a consent decree without admitting fault and paid a settlement of $38.5 million to reimburse states for the legal costs and patients overcharged due to the switch in prescription. In a similar matter, a multiyear- long FTC investigation concluded (in 2009) that the company had misled consumers regarding prices on certain prescriptions in one of its Medicare plans. The switch harmed elderly customers as they were billed for up to ten times the amount they anticipated. CVS/Caremark settled with the FTC for $5 million to reimburse customers for the change in price.

Overdistribution of Oxycodone In 2012, CVS faced challenges with another federal agency—the Drug Enforcement Administration (DEA). The DEA suspended the company’s license to sell con- trolled substances at two Florida locations, only a few miles apart from one another. These locations were found to have ordered a total of 3 million oxycodone pills in 2011. The average order for a U.S. pharmacy in the same year is 69,000 pills. Intensifying the mat- ter, abuse of narcotics (pain pills) is prevalent in the area. Florida state legislation had been implemented in response to the issue as local clinics became known as “pill mills” for their liberal distribution of prescriptions for pain pills.

CVS responded to the DEA’s investigation by notifying some of the area doctors that they would not fill prescriptions written for oxycodone (Schedule II narcotics). However, they also requested a tempo- rary restraining order against the DEA, which would disable the temporary suspension of selling the drugs.

The DEA suspension decreased the amount of such narcotics being distributed to the two CVS locations by 80 percent in a period of three months, limiting their ability to make a profit. When the matter came before a federal judge, he ruled that the company was at fault for lack of proper oversight in distributing the drug and other narcotics. The ruling further implied company negligence as such a large amount of pills should have been noticed as a blatant abnormality.

Later that year, the DEA completely revoked the licenses of the two locations to sell controlled substances—the first time this has occurred with a national retail pharmacy chain. CVS claims that they have improved their procedures regarding its distribu- tion of controlled substances; however, the DEA’s claims explicitly included negligence on the part of pharmacists in light of obvious “questionable circumstances.” These circumstances included the fact that several customers were coming to Florida from out of state to fill pre- scriptions. Many lacked insurance and paid in cash, a red flag that can suggest illegal use of drugs. This was in addition to the heavy pill problem in the area which had already prompted state legislation.

Testimonies from employees indicated company negligence as they had knowledge of the top prescrib- ing doctors in the area and awareness that daily oxy- codone quotas were being depleted—sometimes within 30 minutes of the pharmacy opening. Pharmacists also indicated that they set aside pills for those patients they considered to have a real need for them because they had strong suspicions that most of the people purchas- ing the pills were abusers. They did not feel at liberty to refuse prescriptions to customers, however, because they are not trained to diagnose illnesses. In 2013, CVS announced a review of its database of healthcare pro- viders to find abnormalities in narcotic prescriptions. They found and notified at least 36 providers to whom they would no longer fill orders due to high prescrip- tion rates.

Another incident in 2014 involving the disap- pearance of 37,000 pain pills in four California stores brought the DEA and CVS together again. These stores have a history of not being able to account for sev- eral pain prescription drugs. This incident carries up to 2,973 violations of the Federal Controlled Substances Act and could cost the company up to $29 million in penalties. In 2012, the DEA investigated missing pills in a store wherein an employee admitted taking

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approximately 20,000 pills. This piqued the curiosity of investigators, who found three retail locations that each had thousands of pills missing.

Death of a Shoplifter In 2010, a man accused of shoplifting toothpaste was chased out of a CVS store by a manager. Video surveil- lance footage showed an altercation between the two. Six bystanders came to the manager’s assistance, one of whom was seen kicking and punching the perpetrator while the manager held him around the neck. Within seconds, the man was heard saying he could not breathe and died shortly thereafter. Police investigated the incident and have not filed charges despite the medical examiner’s classification of the death as a homicide. The manager claimed that the shoplifter punched him, so he retaliated in self defense. The victim’s mother is filing a civil lawsuit against the manager and claiming CVS is liable for her son’s death. Whether or not CVS is found culpable, the tragedy cast a shadow over CVS and how it handles shoplifters.

MOVING TOWARD A HEALTHCARE COMPANY Despite the ethical challenges CVS has experienced, it is trying to reposition itself as a socially responsible organization that places priority on consumer health. Being a quality healthcare company not only offers reputational benefits, but financial advantages as well. Changes in both the economic and healthcare landscape are creating new opportunities for CVS to provide dif- ferent programs and redefine itself. Trends including the declining number of primary care physicians, the 16 million baby boomers who are becoming eligible for Medicare benefits, and the more than 30 million newly insured Americans under the Affordable Care Act (ACA) offer CVS an attractive market in which to expand. For example, CVS has refocused its efforts on supplying the growing need for chronic disease man- agement that consumes costly resources when patients do not adhere to physician recommended medications and monitoring methods to maintain health. PBM ser- vices are being successfully implemented, including mail order, specialty pharmacy, plan design and administra- tion, formulary management, discounted drug purchase arrangements, and disease management services.

Innovative programs such as Pharmacy Advisor and Maintenance Choice, developed in collaboration with researchers from Harvard University and Brigham and Women’s Hospital, help patients stay on their medica- tions. Research shows that regular interaction between patient and pharmacist increases the likelihood that patients will adhere to their medication regimen. Many patients who take regular prescriptions often think that they are well enough to cease taking their medication. However, when the symptoms of their ailments reap- pear, the costs are great, both financially and medically. CVS’s programs allow the company to inform patients about the benefits and risks of these effects through edu- cation and awareness. The entire industry also benefits from this knowledge by preventing more costly medical procedures due to medication non-adherence, which occurs when patients skip or incorrectly take their dos- age requirements. This is estimated to cost between $5 and $10 for every $1 spent on adherence programs. These services are key components of CVS’s com- petitive advantage, allowing them to provide the best possible patient care. They were also proactive in pre- paring patients for Health Care Reform. For instance, CVS/Caremark partnered with the Centers for Medicare and Medicaid Services to raise awareness about new services available to Medicare patients under the ACA.

To help people keep up with these and other changes in healthcare, CVS has established its pres- ence on social media and mobile devices. The company introduced a mobile application for customers to con- veniently refill prescriptions, while their Facebook and Twitter pages provide helpful health tips. Customers benefit from using CVS’s digital tools for savings and new user experience. CVS’s iPad application allows individuals to have a 3D digital pharmacy experience reminiscent of shopping in a store. Those who are unable to physically visit the store, or prefer the conve- nience of shopping from home, are able to partake in the CVS experience through the company’s technology. With over 10 million registered users, many are saving money and time filling and refilling prescriptions as well as having instant access to essential drug information.

MinuteClinics are one of the major contributors to CVS’s rebranding efforts. These clinics are the first in healthcare retail history to be accredited by the Joint Commission, the national evaluation and certify- ing agency for healthcare organizations and programs in the United States. This accreditation signifies the clinic’s commitment to and execution in providing safe, quality healthcare that meets nationally set standards.

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In addition to healthcare services, MinuteClinics provide smoking cessation and weight loss programs that con- tribute positively to people’s health. These clinics are also the first retail clinic provider to launch a partner- ship with the National Patient Safety Foundation for its health literacy program to help improve patient educa- tion and community health.

Under the ACA, healthcare organizations are eli- gible to become members of the Accountable Care Organizations (ACO) program. This program ensures that members are accountable in providing qual- ity healthcare to the sick as well as meeting certain standards to provide health-conscious programs such as those related to smoking cessation and weight loss. Accountability is measured by positive outcomes, resulting in cost savings, which in turn is divided up among members to continue these effective programs and services. There are more than 700 ACOs covering 23.5 million patients, with 7.8 million a part of Medicare ACO programs.

REVEALING CVS’S NEW DIRECTION: TOBACCO-FREE CVS In order to be consistent with their transition from pharmacy to healthcare company, CVS has made some landmark decisions aimed toward helping individuals lead healthier lives. In 2014, CVS announced that it would no longer sell tobacco products. The revenues generated from selling tobacco products are about $2 billion annually, so this bold decision sends a strong message to stakeholders regarding the values of the company. A company that is consistent in their actions will gain a good reputation, which will attract more customers and generate revenue. This decision also gives CVS an advantage in terms of the ACA. As the ACA changes the healthcare landscape, companies are racing to get a stronghold in the new system to be listed as a preferred pharmacy. CVS/Caremark’s alignment in defining itself as a healthcare provider will likely result in stronger relationships with doctors and hospitals, creating an advantage of preference. The goal is that referrals for medication will be done through CVS and serve to boost reputation within all CVS segments. This, in conjunction with its status as an ACO, puts CVS in a competitive position to attract newly insured Americans.

This decision spurred 24 state attorneys general to send letters to other pharmacy retailers, including Walmart Stores, Inc., Walgreen Co., and Rite Aid Corp.,

highlighting the contradiction of selling deadly products and healthcare services simultaneously. The letter also noted that drug store sales make it easier for younger age groups to begin smoking and more difficult for those trying to quit smoking. Walmart and Walgreen acknowledged the letter, but made no indication that they would stop selling tobacco products. Rite Aid responded by saying they will continue to sell both tobacco products as well as smoking cessation services, as the practice is legal. While this letter does not seem to have much of an influence on retailers, some specu- late that it increases the pressure on the $100 billion tobacco industry, which is already facing decreasing sales, rising taxes, and smoking bans. For CVS, the decision will affect their short-term profits and reduce each share by $0.06–$0.09 each. Investors do not seem worried, however, as the long-term benefits will make up the difference.

CRITICISM AGAINST CVS CVS’s new programs are encroaching on the medical industry by providing services to patients. As custom- ers increasingly choose to visit local pharmacy clinics for aches, pains, or common illnesses, primary physi- cians are feeling the losses, especially since this sector’s healthcare professionals are dwindling. Choosing a retail pharmacy clinic over a physician’s office benefits the patient with lower costs and savings, which is a threat to traditional doctors’ offices. Some groups are publicizing negative feedback on pharmacy care. For instance, the American Academy of Pediatrics issued a statement warning patients not to visit such clinics because they cannot offer the specialized care children need. Some groups argue that programs such as CVS’s MinuteClinic do not offer the same caliber of service and care as a doctor. However, as stated above, CVS holds itself to a very high standard for care in trying to help patients be healthy. It continues to be accredited by the Joint Commission.

CVS MinuteClinics do recognize their limitations, however. Their website offers information to visitors regarding when they should and should not visit the clinics. For example, the website recommends that patients with severe symptoms such as chest pain, short- ness of breath and difficulty breathing, poisoning, tem- peratures above 103 degrees Fahrenheit (for adults) and 104 (for children), and ailments requiring controlled substances should seek care elsewhere. MinuteClinics staff nurse practitioners and physician assistants who

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are able to provide services for minor wounds, com- mon illnesses, wellness tests and physicals, etc. Other information regarding insurance and pricing are also available on the website.

STAKEHOLDER ORIENTATION CVS’s mission to be a pharmacy innovation company is guided by five values: innovation, collaboration, caring, integrity, and accountability. CVS uses these values to determine their actions and decisions, which offers a glimpse into their ethical culture. The company’s goal is to use their assets to reinvent the pharmacy experience and offer innovative solutions that help people on a bet- ter path to health. This goal relays to stakeholders that the company cares about their health. CVS/Caremark’s business is committed to fostering a culture that encourages creativity and innovation, recognizing that contributions from all members are a high priority. This commitment highlights their value of collaboration with partners and stakeholders, which also serves to hold them accountable for their operating activities—thus strengthening their integrity. Another important factor in their ethical culture is to address enhanced access to care while also lowering its cost.

CEO Larry J. Merlo emphasizes the long-term per- spective the company is committed to with each deci- sion and how it will affect each stakeholder group. He states that CVS’s priorities remain in customer health, the sustainability of healthcare systems, good steward- ship, positive contributions to their communities, and a meaningful workplace for employees. Such a statement from the top leader of the company sets the tone that creates the ethical culture behind CVS. The company’s Code of Conduct includes ethical behavior expecta- tions, and they are proud to have good relationships with employee unions who represent approximately 6 percent of their workforce. CVS employs a Chief Compliance Officer, offers regular compliance educa- tion and training, provides an ethics hotline for con- fidential reporting, and has developed a response and prevention guideline for addressing violations of CVS’s policies or federal, state, or local laws. CVS’s corporate governance includes a privacy program, information security, and a corporate framework that focuses on the company’s values.

So far we have addressed how CVS meets the needs of its customer stakeholders. However, CVS tries to maintain a stakeholder orientation in which all stakeholder needs are addressed. The following sec-

tions will describe how they meet the needs of other stakeholders.

Employees CVS implemented the Values in Action program for employees, giving them a chance to recognize colleagues through online reward systems. Peers can nominate each other across the company for leadership traits and other commendable accomplishments. Each nomination grants points, which can be redeemed for merchandise, travel, and more. Programs like these let employees know they are valued and empower them in their com- mitment to CVS. The Values in Action Breakthrough Awards is an annual company-wide broadcast that honors specific individuals exemplifying the company’s values in innovation, collaboration, caring, integrity, and accountability.

CVS focuses strongly on compliance and integrity training for employees. The compliance and integrity training for employees is led by a Compliance Officer. Regular compliance education and training programs, a confidential 24/7 ethics hotline, and an efficient audit, response, and prevention process are components that make this program comprehensive. The company also supports the development of employees through professional development training sessions. The pur- pose of such training is not only to keep employees current on new technologies and processes but to help them advance in their careers within the company.

Shareholders CVS seeks to protect shareholder interests while main- taining broad stakeholder engagement. As a result, CVS carefully designed a comprehensive corporate governance system ranging from board independence to executive compensation. Following a corporate gov- ernance framework, a variety of specialized committees has been established with different functions for share- holders. From an information governance standpoint, the oversight committee makes recommendations to enhance the ability of information security. On behalf of the board of directors, the audit committee is in charge of the risk oversight and is responsible for protecting the reputation and core interests of the company.

In order to balance the interests of different groups, senior management created a reformative executive compensation system. This system is based on financial

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performance as well as service quality and customer satisfaction. While a pay for performance compensation system is still utilized at CVS, a significant portion of annual executive compensation is delivered into long- term equity rather than short-term. In a move to further align the commitment of CVS to link pay with perfor- mance, total shareholder return is added on a three-year incentive plan. Each three-year period is known as a cycle that has a predetermined set of goals for the com- pany/executive to accomplish. At the end of each term, performance is evaluated and the executive will receive compensation based on these results. For example, if the results surpass the goal by 25 percent, the executive pay will increase by a certain predetermined amount. The details will vary for each cycle, but the purpose of the plan is to pay only when the company and its sharehold- ers are benefited from the performance of the executive.

Communities CVS has grown its ethical culture not only to include the company’s functions but the communities around them. Community engagement and philan- thropic endeavors, for example, are long-standing commitments CVS has devoted time and resources in developing. Community partnerships have supported veteran hiring, scholarships to future pharmacists, and engaged high school, college, and post-graduate students’ interest in science, technology, engineering, and math (STEM) careers. CVS believes that by help- ing to further advancements in the best health out- comes, they are investing in their current and future workforce.

CVS donated over $56 million to various organi- zations to support community needs and builds stra- tegic partnerships with them to create an awareness of healthy behaviors and educate the community on ways to become insured under the ACA. The company also offers free health screenings and flu shots for the uninsured, prescription discount card programs, and other community programs to supply individuals with the medications they need to maintain health. The discount card program saves customers over 70 per- cent on medications, resulting in millions of dollars in savings every year. Volunteerism is also supported by CVS, as employees are encouraged to form groups and obtain sponsorship from the company to address needs within their community. The amount of time that CVS employees volunteered for their communities is valued at $1.5 million.

Suppliers CVS has developed a commitment called Prescription for a Better World, which encompasses their Code of Conduct, Supplier Ethics Policy, Supplier Diversity, and Supplier Audit Program to promote integrity, accountability, and diversity. These programs work to ensure that human rights are respected throughout the entire supply chain. In developing these policies, CVS used principles initiated by the International Labor Organization and the United Nations’ Universal Declaration of Human Rights. The human rights frame- work guides all suppliers of CVS to avoid unethical and illegal practices such as child labor, human trafficking, discrimination, and dangerous workplace conditions.

The Supplier Audit Program is a risk-based assess- ment conducted by more than one third party to evaluate workplace conditions, including labor, wages and hours, health and safety, management system and environment, as well as operational, financial and legal risks, to assure that employees’ rights are not being violated. This program was fully expanded to factories in countries considered to be at high risk for such viola- tions, and they are in the process of implementing full social audits for subcontractors in these areas. In addi- tion, CVS works with globally recognized organizations including Worldwide Responsible Accredited Production (WRAP) and Social Accountability International (SAI) to ensure their measurements are relevant and effec- tive. Finally, partnerships with Intertek’s GSV pro- gram maintains the company’s certification status with the U.S. Customs-Trade Partnership Against Terrorism (C-TPAT) program to ensure quality of products made in countries such as China.

Environmental Impact Environmental impact is also important to CVS. They record their progress on this front in their annual Corporate Social Responsibility (CSR) Report. They have set a carbon intensity reduction goal of 15 percent by 2018, and through energy efficiency upgrades have been able to surpass this goal by reaching 16 percent in 2015. CVS opened their first Leadership in Energy and Environmental Design (LEED) Platinum store, which will serve as a test site to determine the most effective and relevant environmental innovations for the company’s environmental operations goals. They will use this information to set best practices before constructing other stores.

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CVS expanded their Energy Management System (EMS), which is designed to ISO (International Organization for Standardization) specifications. This digital system tracks and manages energy use, so that each store can be continually monitored and adjusted according to each location’s condition. They are also in the process of upgrading lighting in the stores to more energy efficient bulbs. Increasing water use was identi- fied as a significant inefficiency, and CVS has responded by eliminating irrigation at retail locations and opting for less water-intensive landscapes. Finally, CVS offers customers ways to recycle and properly dispose of expired, unused, or unwanted medications, which ben- efits both human and environmental well-being.

CONCLUSION CVS is implementing strategies and allocating resources in the hope of achieving an ethical culture that benefits all stakeholder groups. This helps CVS to maximize eth- ical decision-making and remain sustainable for years to come. It seems they have learned from previous ethi- cal lapses by being aware of addiction problems within their communities. In 2014, CVS voluntarily opted to stop selling some cold medications in West Virginia and surrounding areas as more methamphetamine labs and corresponding abuse became more prominent through- out the state. The company’s impact on the environment is one of the next big challenges they will have to over- come. As one of the largest pharmacies in the United States, they have a long way to go to reduce their overall footprint. However, they are on the right track, having set goals and implementing action steps to achieve these goals. With the mission of helping people live healthier lives and innovating the pharmacy industry, CVS has a great responsibility in developing a business model allowing them to remain competitive while acting ethi- cally at the same time.

Questions for Discussion 1. How has CVS handled its ethical challenges? 2. Evaluate CVS’s decision to no longer sell tobacco

products. 3. What is the future of CVS in positioning itself as

a healthcare company based on its decision to be socially responsible?

Sources Reed Abelson and Natasha Singer, “CVS Settles

Prescription Price Case,” The New York Times, January 12, 2012, http://www.nytimes.com/2012/01/13/business/ cvs-caremark-settles-charges-over-prescription-prices. html (accessed August 9, 2016).

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Hank Cardello, “CVS and the Rise of Corporate Profitable Morality,” Forbes, February 27, 2014, http://www. forbes.com/sites/forbesleadershipforum/2014/02/27/cvs- and-the-rise-of-profitable-corporate-morality/# 2569f0383aca (accessed August 9, 2016).

“Corporate Social Responsibility Report,” CVS Caremark, 2013, http://info.cvscaremark.com/CSR-Report/#1 (accessed August 9, 2016).

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“CVS Caremark Settles FTC Charges: Failed to Protect Medical and Financial Privacy of Customers and Employees; CVS Pharmacy Also Pays $2.25 Million to Settle Allegations of HIPAA Violations,” The Federal Trade Commission, February 18, 2009, http://www.ftc .gov/news-events/press-releases/2009/02/cvs-caremark- settles-ftc-chargesfailed-protect-medical-financial (accessed August 2, 2014).

CVS Health, “CVS Health at a Glance,” https://cvshealth. com/about/facts-and-company-information (accessed August 9, 2016).

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Case 2  The Mission of CVS: Corporate Social Responsibility and Pharmacy Innovation 447

CVS Health, “Our New Name,” September 3, 2014, http://cvshealth.com/newsroom/our-new-name (accessed August 9, 2016).

CVS Health, Prescription for a Better World: 2015 Corporate Social Responsibility Report, 2016, http:// cvshealth.com/sites/default/files/2015-csr-report.pdf (accessed August 9, 2016).

“CVS Pays $2.25 Million & Toughens Disposal Practices to Settle HIPAA Privacy Case,” U.S. Department of Health and Human Services, http://www.hhs.gov/ ocr/privacy/hipaa/enforcement/examples/cvsresolu- tionagreement.html (accessed August 9, 2016).

Mike Estrel, “States Urge Retailers to Drop Tobacco,” The Wall Street Journal, March 18, 2014, p. B3.

“Everybody Loves a Quitter,” CVS MinuteClinic, http:// www.cvs.com/minuteclinic/resources/smoking-cessation (accessed August 9, 2016).

Joseph H. Harmison, “CVS Caremark Abuses Warrant through FTC Investigation and Remedies,” The Hill, May 25, 2010, http://thehill.com/blogs/congress-blog/ healthcare/99759-cvs-caremark-abuses-warrant-through- ftc-investigation-and-remedies (accessed August 9, 2016).

Chris Isidore, “Cigarette Sales: Walgreens, Rite-Aid, Wal-Mart, Kroger & Safeway Urged to Selling Tobacco,” CNN Money, March 17, 2014, http:// www.wptv.com/web/wptv/news/health/cigarette-sales- walgreens-rite-aid-wal-mart-kroger-safeway-urged-to- selling-tobacco (accessed August 6, 2014).

Bruce Japsen, “How Obamacare Helps CVS Kick The Habit,” Forbes, February 2, 2014, http://www.forbes. com/sites/brucejapsen/2014/02/15/how-obamacare- helps-cvs-kick-the-habit/#4ef34990179b (accessed August 9, 2016).

Elisabeth Leamy, “Drug Discount Cards Help You Save on Prescription Meds,” ABC News, August 20, 2012, http://abcnews.go.com/Business/drug-discount-cards- save-money-prescription-meds/story?id=17029498 (accessed August 9, 2016).

Donna Leinwand Leger, “DEA: Oxycodone Orders by Pharmacies 20 Times Average,” USA Today, February 7, 2012, http://usatoday30.usatoday.com/ money/industries/health/story/2012-02-06/dea-cvs- oxycodone-raid/52994168/1 (accessed August 9, 2016).

Natasha Leonard, “Homeless man Choked to Death After Shoplifting Toothpaste,” Salon, January 18, 2013, http://www.salon.com/2013/01/18/homeless_ man_choked_to_death_after_shoplifting_toothpaste/ (accessed August 9, 2016).

“The Long-Term Incentive Plan, CVS Caremark,” March 24, 2009, http://www.wikinvest.com/stock/

CVS_Caremark_Corporation_(CVS)/Long-term_ Incentive_Plan (accessed August 9, 2016).

Kris Maher and Sara Germano, “CVS Takes Steps on Meth Abuse in West Virginia,” The Wall Street Journal, July 8, 2014, p. A3.

Timothy W. Martin, “CVS to Kick Cigarette Habit,” The Wall Street Journal, February 6, 2014, pp. B1–B2.

James P. Miller, “CVS Caremark Settles Deceptive- practices Complaint for $38.5 Million,” Chicago Tribune, February 15, 2008, http://articles.chicagotri bune.com/2008-02-15/business/0802140788_1_cvs- caremark-caremark-rx-pharmacy-benefits (accessed August 9, 2016).

Chris Morran, “CVS Being Investigated After 37,000 Pain Pills Go Missing,” The Consumerist, March 11, 2014, http://consumerist.com/2014/03/11/cvs-being-investigated- after-37000-pain-pills-go-missing/ (accessed May 9, 2016).

Mark Morelli, “Healthy First: CVS Will Stop Selling Cigarettes,” The Motley Fool, February 7, 2014, http:// www.fool.com/investing/general/2014/02/07/healthy- first-cvs-will-stop-selling-cigarettes.aspx (accessed August 9, 2016).

David Muhlstein, “Growth and Dispersion of Accountable Care Organizations in 2015,” Health Affairs Blog, March 31, 2015, http://healthaffairs.org/blog/ 2015/03/31/growth-and-dispersion-of-accountable- care-organizations-in-2015-2/ (accessed August 9, 2016).

“Pharmacy Advisor,” CVS Caremark, http://info.cvscare mark.com/cvs-insights/our-pharmacy-advisor-program (accessed August 9, 2016).

Paul Edward Parker, “Rite Aid Responds to CVS Decision to Stop Selling Tobacco,” Providence Journal, February 6, 2014, http://www.providencejournal.com/arti- cle/20140206/News/302069917 (accessed August 9, 2016).

Amy Pavuk, “Rx for Danger: DEA Blasts CVS for Ignoring ‘Red Flags’ at Sanford Stores,” Orlando Sentinel, October 28, 2012, http://articles.orlandosentinel .com/2012-10-28/news/os-cvs-dea-oxycodone- ban-20121028_1_sanford-cvs-sanford-pharmacies- sanford-stores (accessed August 9, 2016).

Amy Pavuk, “Two Sanford Pharmacies Banned From Selling Oxycodone, Controlled Substances,” Orlando Sentinel, September 12, 2012, http://articles.orlandosentinel. com/2012-09-12/news/os-sanford-cvs-caremark-revoke- drugs-20120912_1_revokes-prescription-drug-abuse- oxycodone-and-other-prescription (accessed August 9, 2016).

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“Press Release: More Partnerships between Doctors and Hospitals Strengthen Coordinated Care for Medicare Beneficiaries,” Centers for Medicare and Medicaid Services Press Release, December 23, 2013, https:// www.cms.gov/Newsroom/MediaReleaseDatabase/ Press-Releases/2013-Press-Releases-Items/2013-12-23. html (accessed August 9, 2016).

“Quality,” CVS MinuteClinic, http://www.cvs.com/ minuteclinic/visit/about-us/quality (accessed August 9, 2016).

“Services,” CVS MinuteClinics, http://www.cvs.com/ minuteclinic/services (accessed August 9, 2016).

Kyle Stock, “Pediatricians Seek Risk-to Kids and Themselves-in DrugStore Health Clinics,” Bloomberg, February 24, 2014, http://www.bloomberg.com/news/ articles/2014-02-24/apa-warns-parents-about-cvs-

and-walgreens-child-health-clinics (accessed August 9, 2016).

Christopher Tkaczyk, “The 10 biggest companies of the Fortune 500,” Fortune, June 4, 2015, http://fortune. com/2015/06/04/biggest-companies-fortune-500/ (accessed August 9, 2016).

“We’re a Pharmacy Innovation Company and Every Day We’re Working to Make Health Care Better,” About CVS Caremark, http://info.cvscaremark.com/about-us/ our-purpose-building-bridge-better-health (accessed August 5, 2014).

Jessica Wohl, “CVS Cuts Off Docs Who Prescribe Too Many Narcotics,” NBC News, August 22, 2013, http:// www.nbcnews.com/health/health-news/cvs-cuts-docs- who-prescribe-too-many-narcotics-f6C10975693 (accessed August 9, 2016).

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INTRODUCTION Belle Mead Plantation, over 200 years old, is using social entrepreneurship to preserve the history of the nineteenth century. In 1807, John Harding founded the Belle Meade Plantation in Nashville, Tennessee. The plantation would become known for breeding some of the best-known thoroughbred horses in U.S. history. By the time of the U.S. Civil War, the Plantation had become famous as a 5,400-acre stud farm that was producing some of the best racehorses in the United States. Following the Civil War, much of the thorough- bred industry moved to the Lexington, Kentucky area. Kentucky remained in the Union and had the advantage during reconstruction. However, Belle Meade recovered, and various family members managed a successful thoroughbred breeding plantation that was among the best in the nation. After the plantation was sold early in the twentieth century, the grounds of Belle Meade Plantation were eventually converted into a museum focusing on its history. Today Belle Meade Plantation operates as a nonprofit to preserve its history and pro- vide an opportunity to experience life in the nineteenth century. The plantation gives families the chance to have an educational experience. Guests can visit the planta- tion and tour the mansion, stables, and other buildings to experience ‘stepping back in time.’

This case focuses on the challenges in 2004 when Alton Kelley, executive director of Belle Meade Plantation, and his wife, Sheree, were both facing the monumental task of securing adequate, long-term fund- ing to maintain Belle Meade Plantation. At the time, the existing sources of funding for the operations of Belle Meade Plantation were (in descending revenue order): (1) ticket sales from visiting tourists, (2) host- ing special events, (3) corporate and private donations, and (4) sales of items from the gift shop, including a line of private-labeled products, such as cheese, coun- try ham, grits, and a variety of souvenirs. For the fifth

consecutive year, donations from corporations and indi- viduals had declined to the lowest levels in memory, and the couple believed they had little choice but to look for solutions that were well outside of the proverbial box. The organization and its board of directors could no longer rely solely on corporate donations for the ongo- ing operations of the Belle Meade Plantation.

After evaluating and discarding a variety of other alternatives, the Kelleys set about pursuing an ambi- tious plan to use social entrepreneurship to generate revenue for maintaining the nonprofit. Their solution was to build and operate a nonprofit winery on the historic site to help sustain current and future long term financing needs. The idea was bold, given that there were no other known nonprofit wineries in the United States. However, the Kelleys believed that if they could successfully navigate through the numerous legal and market-based challenges, this social enterprise would provide the necessary funding required for supporting the property’s ongoing operations.

The first step was in 2009, when The Harding House Restaurant opened on the grounds, immedi- ately adjacent to the mansion, to replace the popular “Martha’s at the Plantation.” The restaurant is an independent operation and pays rent to Belle Meade Plantation with all profits remaining in the restaurant.

This case will analyze the next step of Belle Meade’s use of social entrepreneurship to create a sustainable organization. We begin by examining the history of Belle Meade Plantation. Next, background is provided on the challenges nonprofits encounter in trying to remain economically sustainable. Belle Meade recognized that the market for wine in Tennessee offered a major opportunity, leading them to adopt the nation’s only nonprofit winery. We then discuss the different forms of promotion used to promote Belle Meade and its winery, including social media and events. We conclude with an examination of some of the challenges Belle Meade is likely to encounter as it continues to expand.

CASE 3

Belle Meade Plantation: The First Nonprofit Winery Engages in Social Entrepreneurship

*Dr. Robert P. Lambert and Dr. Joe Alexander, Belmont University © 2014. Alton Kelley, Executive Director of Belle Meade Plantation, and Sheree Kelley, Belle Meade Winery Manager, participated in developing this case. Jennifer Sawayda assisted in editing a version of this case. It was prepared for classroom discussion rather than to illustrate either effective or ineffective handling of an administrative, ethical, or legal decision by management. All sources used for this case were obtained through personal interviews, publicly available material, and the Belle Meade website.

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BRIEF HISTORY OF BELLE MEADE PLANTATION The roots of Belle Meade extend back to its successful breeding of thoroughbreds. As early as 1816, founder John Harding was placing advertisements in Nashville newspapers to promote his horses. In 1820, he commis- sioned a brick home in the Federal style on his farm and officially named the estate “Belle Meade.” By this time, he became interested in racing his horses locally. John registered his own racing silks with the Nashville Jockey Club in 1823 and was training horses on the track at another of his properties, McSpadden’s Bend Farm. By the time John Harding’s son, William Giles Harding, assumed management of the Belle Meade plantation, he already shared his father’s interest in breeding and racing. Even though the Civil War interrupted both breeding and horse-racing in the southern United States, Belle Meade was large enough in acreage to elude Union troops by hiding the prized horses at various locations throughout the heavily wooded nearby hills.

After the Civil War, Harding became famous for winning more purses with his horses than any man living at that time in the United States—even though much of the thoroughbred industry had moved to Kentucky. He was also the first in Tennessee to use the auction system for selling thoroughbreds. With the auction system, he became the most successful thoroughbred breeding farm and distributor in the State of Tennessee. Belle Meade’s breeding lineage has boasted some of the best-known thoroughbred horses in U.S. history, including Bonnie Scotland, Secretariat, Seabiscuit, Barbaro, and 2014 Kentucky Derby win- ner California Chrome. When General Harding died in 1886, The Spirit of the Times praised him as having done as much to promote breeding interests as any American in the nineteenth century.

After Harding’s death, his son-in-law General William Hicks Jackson and oldest daughter assumed one-third ownership of the horse farm. General Jackson’s flair for entertaining and his confident, outgo- ing nature helped the farm attract thousands of people to the yearling sales. He later modernized the mansion’s interior. By the time the plantation was sold in the early twentieth century, it had hosted a number of American historical figures, including President Grover Cleveland, Robert Todd Lincoln, General Ulysses S. Grant, General William T. Sherman, General Winfield Scott Hancock, and Adlai E. Stevenson.

Today, the Greek revival-styled mansion is the cen- terpiece of the affluent Belle Meade region of Nashville, with the historic homestead surrounded by 30 acres of manicured lawns and shade trees. A long driveway leads uphill to the mansion, fronted by six columns and a wide veranda. Inside, the restored building is fur- nished with nineteenth-century antiques that illustrate the elegance and wealth that the Southern gentility enjoyed in the late 1800s. Tours are provided to the general public, with costumed guides following a theme that changes every three months with the seasons. These themed tours are intended to provide fascinating glimpses into the lives of the people who once lived at Belle Meade. During the tour, visitors are able to see the numerous historic facilities on the property, including a log cabin, smokehouse, and creamery. The tour makes the nineteenth century come alive and provides an opportunity to experience life in the nineteenth century. Belle Meade’s park-like grounds has made it a popular site for festivals throughout the year.

NONPROFITS MOVE IN DIRECTION OF SOCIAL ENTREPRENEURSHIP Recent decades have led to challenges for nonprofits like Belle Meade Plantation. Since the last economic down- turn reduced household incomes and lowered investors’ and consumers’ confidence in the economy, nonprofit contributions plummeted. Most nonprofits’ incomes dwindle during recessionary periods based on a vari- ety of factors: (1) corporate and individual donations decrease, (2) federal, state, and local funding sources decline, and (3) earnings from endowments shrink with their capital market values. At the same time, economic downturns also put added demands on nonprofits’ already dwindling resources, including: (1) a typical increase in the frequency of client requests for financial or service needs, and (2) a decrease in the number of individuals who, based on concerns regarding their own household incomes, are either unable or unwilling to volunteer their time in support of an organizational mission. As a result, nonprofits tend to focus their dol- lars more directly into client services. Charitable con- tributions to nonprofits bottomed out in 2009. The average rate of growth in charitable giving during 2010 and 2011 was at its lowest in 40 years. Even as the economy began to improve, many nonprofits continued

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Case 3  Belle Meade Plantation: The First Nonprofit Winery Engages in Social Entrepreneurship 451

to report that their contributions had either decreased or remained stable.

Belle Meade was faced with exactly these prob- lems. Like other nonprofits, its leaders needed to look for innovative solutions toward increasing the long- term sustainability of their organizations. As leaders of the nonprofit sector plan for the future, understanding the economic climate and the actions taken as a result of challenging economic times can assist executive direc- tors and other leaders in determining strategically the operational needs of their organization and how to best serve their communities.

Nonprofit organizations, facing cuts in dona- tions from individuals and organizations, have been experimenting with new ways to strengthen their bot- tom lines. In addition to cutting costs and eliminating waste, nonprofit leaders such as the Kelleys had to think more creatively about their fundraising strategies and consider the role of nontraditional philanthropic organizations or individuals. Even at significant levels of visitor traffic at Belle Meade, base admission ticket revenues were not nearly enough to fully support the site’s operation. According to the Kelleys, “Every time there is a new charity in Nashville, the ‘giving pie’ gets thinner.” The Kelleys therefore began to consider the idea of social entrepreneurship. Social entrepreneurship occurs when an entrepreneur founds a business with the purpose of creating social value. In this case, Belle Meade could sell a product and then use the proceeds to support the nonprofit. Generating their own revenue would reduce the dependence on outside contributions and make the nonprofit less susceptible to economic downturns.

The Kelleys knew that management clearly had no choice but to consider substantive changes in their revenue model in order to ensure long-term survival. The question involved deciding upon what product would be appropriate to sell to generate revenue and align with Belle Meade’s strong historical roots. Management knew from historical research that Muscadine grapes were grown on the plantation back into the 1800s. The Hardings, Belle Meade’s nine- teenth-century founders, actually produced wine from the vineyards on their property. Curator John Lamb confirmed the story: “There are numerous invoices from the 1800s that show the Hardings purchased and served fine wines and also purchased empty wine bottles—presumably to fill with wines made on the property.”

The Kelleys became convinced that resurrecting wine production and sales on the property would provide a major source of revenue and self-sufficiency for the property. The winery at Belle Meade Plantation would become the only winery registered in Nashville and the only nonprofit winery in the United States. Although it would operate as a nonprofit—reinsert- ing profits into the maintenance and operation of the museum—the winery would effectively develop a strategic business approach and implement a successful revenue model.

MARKET FOR WINE IN TENNESSEE The wine industry in Tennessee was dealt a blow with Prohibition during the 1920s, so until 1975 the state had no formal modern wineries. In the late 1970s, Judge William O. Beach championed legislation that enabled the State’s wine industry to move forward more rapidly. Another industry leader was Fay Wheeler, who was instrumental in assuring passage of the Wine and Grape Act of 1977. In 1980, she started Tennessee’s first licensed winery, and to many, Wheeler is considered the founder of Tennessee’s contemporary wine industry. By 1995 Tennessee had 15 wineries, and in the next 10 years this number would double to 27. As of 2010, Tennessee boasted 45 registered wineries, with the like- lihood of continued growth. Belle Meade recognized that these strong growth opportunities would be ben- eficial toward their decision to open a nonprofit winery.

There are, at present, between 500 and 750 acres of wine grapes grown in Tennessee—a number that is on the rise. Many vineyards are small (i.e., less than five acres), which is a challenge to growers, since winer- ies juggle the decision to buy small quantities locally or purchase larger quantities from outside the state’s borders.

Finally, it is worth noting that not all wines are produced from grapes. Several Tennessee fruit- bearing trees or bushes are commonly used to produce what are accordingly referred to as “fruit wines.” The more common take advantage of fruits such as black raspberries, peaches, blackberries, strawberries, rhu- barb, and apples—all of which grow well within a por- tion of the geographic areas included within the State. For example, one of the wines that Belle Meade offers is a blackberry wine.

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BEGINNING OF THE WINERY Belle Meade did understand the challenge of developing a successful winery. It was not enough just to sell wine with a Belle Meade label. To align with Belle Meade’s mission, the product would have to fit with the organization’s historical background. “There was a lot of brainstorm- ing among staff to come up with new ideas,” the Kelleys claim. “And as we continue to believe, it is important that everything we do is connected to the site’s heritage. We just look for ways to modernize what the original owners did and make money to support the site.”

With a desire to narrow viable possibilities to those that fit with the historical nature of the Plantation’s roots, the seeds of a winery concept began to germinate. A decision was subsequently made to visit the Biltmore Estate’s Winery in Ashville, North Carolina as it is the most visited winery in the United States. “We were look- ing for best practices,” the Kelleys said. These practices would be used to establish their own winery to support its nonprofit mission.

While the Kelleys’ initial concept for a winery in Nashville was relatively small compared to Biltmore’s, they saw incredible potential for such an operation since there were currently no wineries in Nashville. They also learned that at Biltmore, one out of five guests to the Estate made a wine purchase before leaving the property. This further fueled their beliefs that a winery would generate the revenue needed to operate Belle Meade. Their next decision was to locate the winery on the Belle Meade property.

The Kelleys presented their proposal for a winery at the next meeting with the board of directors. Through their research, the Kelleys had determined that an existing building on the property built in 1998 as an education venue could be converted into the winery and a gift shop. However, this would not come without financial risk. In order to get the winery operational, an investment of $250,000 would be required. The Kelleys had determined that in the first year of opera- tion, all of the bottling activities would be done by hand using employees of the historic plantation, the winery, and volunteers. If sales increased beyond $1,000,000, mobile bottling equipment would be used for the higher volume.

The Kelleys provided the board with projected revenues for the first five years, along with the planned operation’s anticipated expenses. Two of the board members were presidents of local banks and were con- vinced that the proposed winery was a fairly low-risk investment. The remaining board members concurred,

and ultimately a final vote yielded approval for the project.

The Winery at Belle Meade first opened to visitors touring the mansion in November 2009. The building housing the winery made it a reasonably good fit for serving as the initial start-up site. By 2009, the direc- tors of the historic plantation renovated the building for use as a combination winery and tasting room, and Brian Hamm was appointed as the winemaker. The staff began to research which wines should be produced to meet plantation revenue objectives. Advice from the local wine-making community informed them that if their objective was ‘status,’ then dry wines should be the target. However, they advised Belle Meade to adopt sweeter wines if their objective was to make money. It is no secret that Belle Meade’s current portfolio of wines leans heavily to the sweet end of the spectrum. This fits with their objectives to generate revenue for the plantation.

A major start-up hurdle for Belle Meade turned out to be the issue of where to store the bottled wine. Ideally, the location needed to be secure and near the point-of-sale as well as of sufficient size to accommo- date growth in volume over time. It also needed to be “climate-friendly” to minimize significant variations in temperature to protect the product. The best solution turned out to be the historical dairy located right there on the property. It was a large building located rela- tively close to the mansion. Because it was made out of stone, it created an almost ideal environment for storing the cases of wine. This became Belle Meade’s bonded storage facility.

When the idea of a winery was first conceived, the Kelleys immediately realized that the existing 250,000 annual visitors to the historic property were going to be the primary initial market for the wines produced at the winery. Property tours were redesigned to conclude with an opportunity for guests to be escorted to the tasting room for a complimentary tasting. Each wine would be presented to include the background on its composition and properties, along with any relevant historical facts that aligned with what had been presented on the earlier tour. Each bottle comes in Belle Meade-specific packag- ing with thoroughbred horse designer labels to connect it with the Plantation’s past. Because of the unique vintages produced at the winery, tourists often purchase multiple bottles and sometimes take cases back to their family and friends.

According to Sheree Kelley, Belle Meade Winery Manager, “We are different because people come to see the plantation and then discover the winery.” As with all

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Case 3  Belle Meade Plantation: The First Nonprofit Winery Engages in Social Entrepreneurship 453

social entrepreneurships, the main purpose is to create social change. As the Belle Meade Plantation website explains, the site makes history real for visitors by edu- cating them about their historical roots. The winery prof- its are used for historical preservation of the Plantation and educational initiatives on-site. One such educational initiative involves hosting summer camps for children. During the school year, the nonprofit also underwrites many school trips to the Plantation, enabling children to experience and learn about the history of the 1800s.

SUCCESS BEYOND EXPECTATIONS: TOURS, TASTINGS, AND SOCIAL MEDIA An official tour of the Belle Meade Plantation begins as guests enter the front doors of the mansion. The mansion is maintained as closely as possible to how it is believed to have existed in the 1890s. Upon entering the mansion, visitors enter a dark, subdued foyer deco- rated with framed pictures of racing horses to emphasize the plantation’s history in thoroughbred breeding and racing. Since the 1990s, every horse that has run the Kentucky Derby has been a blood descendent of Belle Meade Plantation. Many of these legendary horses grace the various Belle Meade labels on their wine bottles.

After touring the grounds, visitors are invited to wine tastings in Belle Meade’s tasting room. The interior of the tasting room fits in with the historical roots of the plantation, from the medium dark wood supported by a stone base to a wood-burning fireplace to add ambi- ence to the room. Glass windows allow visitors a direct view into the tank room where the wine is stored prior to bottling. To enhance its warmth and hospitality, the room also includes a dessert counter with Peanut Butter Pecans, artisanal chocolates, and other confectionaries. These desserts also serve as added revenue for the non- profit. A wine garden is available outside the doorway for visitors who want to purchase a bottle of wine and enjoy it on the premises. Since opening in 2009, the winery has become an all-staff effort. The winery has been an overwhelming success, exceeding the first year’s 10,000-bottle sales goal with sales topping 54,000 bottles. Figure 1 shows an illustration of the company’s hand-bottling efforts during the first year of opera- tion. Belle Meade ensures that everyone on their staff is knowledgeable about the winery process. “Some of the grapes are grown and crushed in Middle Tennessee, and the juice is brought to our tanks on site. Everyone on staff knows how to bottle wine—it’s a great team- building exercise,” the Kelleys explain.

The winery’s annual revenues has grown to approx- imately $3.0 million, with an additional $200,000 in wine-related merchandise. Table 1 presents a pro forma income statement summarizing the Winery’s first four years of operations. However, despite their success, the Kelleys are careful to note that “starting a winery is a monumental decision. It’s not for the faint of heart!”

Promoting the Social Enterprise Belle Meade’s staff does not rest on their laurels. Like any business, they recognize the need to engage in marketing. The winery sells all of its output each year at current prices, with the ability to sell more if stor- age and warehousing becomes available. The primary means of marketing the winery is through the organiza- tion’s own website (www.bellemeadewinery.com), tour- ist visits, local press/media, social media, and word of mouth. Because of current demand for its products, the Winery has not undertaken any traditional advertising. However, it does make extensive use of social media for no-cost promotions with a quick turn-around time.

“In 2011, we started a Groupon promotion in the third week of January,” stated the Kelleys. “We offered two tours and two free wine tastings at half-price and

FIGURE 1 Illustration of Hand-Bottling—Year One of Operations

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454 Business and Society

sold 1,300 tickets. That is 2,600 people who have 60 days to redeem their voucher.” Groupon’s success prompted another discount voucher promotion through Living Social. A Valentine’s Day special resulted in the sale of 1,000 tickets. Even more impressive, these incen- tives generated record sales in Belle Meade’s slowest months. The Winery also hosts several events for the local community, such as Jazz on the Lawn during the summer and Tennessee’s largest Kentucky Derby Party.

The organization is also examining market trends to improve demand for their tours. “We were look- ing at travel trends, and we know that people want to be more involved than just taking a tour,” said the Kelleys. As a result, Belle Meade is introducing a Southern culinary experience using graduate stu- dents from the University of Mississippi’s Southern Foodways program to create the tour. The plan is to use the original kitchen to give visitors the chance to taste Southern biscuits, beaten biscuits, and corn- bread. The experience includes a tour of the root cellar and smokehouse where visitors will learn why the South’s heat and humidity created a need for food preservation techniques such as curing ham.

New tours are also being planned that fur- ther incorporate the winery. With help from Belmont University’s MBA students, a marketing plan was developed suggesting an event called the Progressive Wine Tour. This event would provide guests with a tour of the historic Belle Meade Mansion and a personalized

walking tour of historical points of interest on the plantation property. During the tour, guests would be treated to five of the Belle Meade premium wines paired with light appetizers at focal points throughout the property.

The winery has become exceedingly popular. Many local prominent restaurants in Nashville have requested that Belle Meade wines become the official wine of their restaurant. The Winery has been forced to decline to sell to restaurants due to limited supply. The Winery also sells its products online and is available in over 15 states.

APPROACHING CHALLENGES FACING BELLE MEADE PLANTATION While the winery has experienced phenomenal success since opening, there are still significant risk factors that it must address. One of the major challenges involves man- aging future growth. The winery is constrained by liquor laws that require the production of wine be done on-site where the wine is sold. An off-site storage facility is not legal in the State of Tennessee. Because visitation to the Plantation has grown at a record pace and approached capacity limits, handling the growing crowds and staff- ing at Belle Meade has proven to be a challenge.

TABLE 1 Pro Forma Income Statement—Belle Meade Winery 2010–2015

2010 2011 2012 2013 2014 2015

Revenue:

Wine Sales $456,485 $1,019,346 $1,536,865 $2,001,223 $3,050,000 $3,150,000*

Gift Shop Sales 31,500 42,478 45,650 53,275 60,100 112,500**

Total Revenue $487,985 $1,061,824 $1,582,515 $2,054,498 $3,110,100 $3,262,500

Expenses:

Cost of Sales $165,212 $375,620 $566,552 $736,714 $915,000 $1,308,000

Other Expenses 91,234 122,925 173,500 195,800 298,595 $424,000

Total Expenses $256,446 $498,545 $730,052 $932,514 $1,213,595 $1,732,000

Net Income $231,539 $563,279 $852,463 $1,121,984 $1,896,505 $1,530,000

storage of bonded wine **

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Case 3  Belle Meade Plantation: The First Nonprofit Winery Engages in Social Entrepreneurship 455

Currently, Belle Meade Winery is the only win- ery located in Nashville. However, like any entre- preneurial endeavor success tends to create more competition. Belle Meade must be on the lookout for rivals who might choose to establish themselves in Nashville. While the company has seen great suc- cess with social media, to date it has done little in the way of formal promotional spending. Its excellent sales staff, outstanding products, captive audience, social media marketing, and a lack of direct com- petition eliminates the need for formal spending on promotion, but this might change if competitors enter the same area. It is also possible that other historic properties in Nashville, such as The Hermitage or Belmont Mansion, might try to pursue similar social entrepreneurship opportunities. Belle Meade still faces competition from other historic sites that capture consumers’ time and money. Finally, with Nashville as the epicenter of the food movement, Belle Meade is faced with more decisions regarding whether to pair local foods and wines within their operations. These challenges illustrate that Belle Meade must operate with the same business concepts as for-profit orga- nizations. Social entrepreneurship rests on a sound business strategy.

Questions for Discussion 1. Analyze the strengths and weaknesses of the Belle

Meade strategy and implementation of their non- profit winery.

2. Given the success of the current Belle Meade Winery, how can Belle Meade effectively address the challenges facing the winery for future growth?

3. Understanding the success of the Belle Meade Winery, what could other nonprofit organizations learn in creating social entrepreneurship ventures to sustain their operations?

Sources Robert Barro, Crisis of governments: The ongoing global

financial crisis and recession, 2011, http://www.iea .org.uk/sites/default/files/publications/files/Crises%20 of%20Government.pdf (accessed August 8, 2016).

Belle Meade, “The History of Belle Meade,” bellemeade- plantation.com/history (accessed August 8, 2016).

Belle Meade, “The Winery at Belle Meade Plantation,” bellemeadewinery.com (accessed August 8, 2016).

Woods Bowman, “Financial Capacity and Sustainability of Ordinary Nonprofits,” Nonprofit Management Leadership 22, no. 1 (Fall 2011): 37–51.

Julianne Gassman, Norma A Dolch, Ann Marie Kinnell, Regan Harwell Schaffer, Sue Ann Strom, and Amy Costliow, “A Three Year Study of the Nonprofit Sector’s Response to the Economic Challenges in Six Cities Across the Nation,” Center for Nonprofit Strategy and Management, Baruch College, The City University of New York, June 2012.

GuideStar, “Late Fall 2011 Nonprofit Fundraising Study,” 2014, http://www.guidestar.org/rxg/news/publications/ nonprofits-and-economy-late-fall-2011.aspx (accessed August 8, 2016).

Michelle Nichols, “Charities Still Struggling in Wake of Recession,” The Fiscal Times, June 19, 2012, http:// www.thefiscaltimes.com/Articles/2012/06/19/Charities- Still-Struggling-in-Wake-of-Recession (accessed August 8, 2016).

Lisa M. Sontag-Padilla, Lynette Staplefoot, and Kristy Gonzalez Morganti, Financial Sustainability for Nonprofit Organizations; A Review of the Literature, 2012, Rand Corporation, 1200 South Hayes Street, Arlington, VA, p. 2.

Terry and Kathy Sullivan, “Tennessee,” Wine Trail Traveler, http://winetrailtraveler.com/tennessee/tennes- see.php (accessed August 8, 2016).

“Welcome to Tennessee Wine Country,” Tennessee Wines, http://www.tennesseewines.com/ (accessed August 8, 2016).

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456

CASE 4

Multilevel Marketing Under Fire: Herbalife Defends Its Business Model

INTRODUCTION Herbalife International is the third largest direct-selling, multi-level marketing company in the world. Its product line consists of weight-management and nutrition prod- ucts. These products are not sold in retail stores; rather, consumers interact with independent contractors to order the products. Herbalife’s headquarters are located in Los Angeles, California, and they operate in several countries throughout the world. Herbalife is a publicly traded company that is both loved and hated by inves- tors and consumers.

This case first discusses the history of the company from its founding to its present status, followed by a description of the types of products Herbalife offers. Then we will get into a discussion of multilevel mar- keting and the role of independent contractors in the direct-selling model. Next will be a discussion of pyra- mid schemes and why they are often confused with the multilevel marketing model. We then examine Herbalife to determine whether it is a pyramid scheme.

We will illuminate the role of hedge fund investor William Ackman in the backdrop of Herbalife’s busi- ness model and show his contentions with the company and some of the criticisms against him. The case shows that while Ackman’s accusations may be the most wide- ly known, there are other accusations (mostly referring to pyramid schemes) that Herbalife has had to face over the course of its existence. The case ends with a brief overview of Herbalife’s social responsibility program and conclusions.

HISTORY Herbalife is a company that focuses on nutrition, weight-management, and personal care products with independent contractors in more than 90 countries. Mark Hughes founded the company in 1980 out of a

desire to create a safe alternative to other weight-loss products. Herbalife’s first sales were made from out of the trunk of Hughes’ car in Los Angeles, California, and two years later the company reached $2 million in sales. Herbalife was taken public in 1986 on the NASDAQ stock exchange. Since then, Herbalife has become a multi-billion dollar global company.

In 1999, Hughes planned to take the company back to the private sector by purchasing all of its remaining shares, but this attempt was stopped as investors sought legal action. The next year, Mark Hughes died unex- pectedly at the age of 44. Christopher Pair, who was Herbalife’s former Chief Operating Officer (COO), then became President and Chief Executive Officer (CEO) of the company. His reign at Herbalife was cut short as he stepped down one year later.

An Internet retailer, Rbid.com, made a bid of $173 million to acquire Herbalife, but the Mark Hughes Family Trust rejected the offer. In 2002, the investment firm J.H. Whitney & Co. purchased the company along with another investor and took it back to the private sector. However, in 2004, Herbalife went public once again and was traded on the New York Stock Exchange. Michael O. Johnson has been Herbalife’s CEO since 2003. The company currently employs 8,000 people and has almost three million independent contractors throughout the world.

PRODUCTS Herbalife sells weight-management, targeted nutrition, energy and fitness, and personal care products, all intended to support a healthy lifestyle. Additionally, the firm offers a set of core products: Formula 1 Nutritional Shake Mix is a protein and fiber shake with several min- erals, vitamins, and nutrients offered in seven flavors; Formula 2 Multivitamin Complex is a multivitamin that contains over 20 vitamins, minerals, and herbs

*This case was prepared by Michelle Urban, Katy Melloy, Carin Malm, and Emily McGowan for and under the direction of O.C. Ferrell and Linda Ferrell ©2014. Jennifer Sawayda provided editorial assistance. It was prepared for classroom discussion rather than to illus- trate either effective or ineffective handling of an administrative, ethical, or legal decision by management. All sources used for this case were obtained through publicly available material.

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Case 4  Multilevel Marketing Under Fire: Herbalife Defends Its Business Model 457

essential to healthy living; and Formula 3 Cell Activator promotes absorption of minerals and vitamins while improving energy levels. These three core products are at the heart of the Herbalife product line and serve as the baseline for nutrition and weight management goals.

The weight-management line consists of a variety of Formula 1 protein shakes, supplements, weight-loss enhancers, protein bars, and snacks, all serving the purpose of helping customers attain their weight goals. There are three weight-management program sets, each with a combination of shakes, supplements, and enhancers designed for different types of weight man- agement needs. Each component of this line can also be purchased separately. The Personalized Protein Powder and the Protein Drink Mix offer an alternative to tradi- tional meals while providing energy and curbing hunger cravings, whether consumers just want to lose or main- tain their weight or build muscle mass. The enhancers and supplements offer a mix of vitamins, minerals, herbs, and nutrients. For example, Prolessa Duo and Snack Defense work to stave off hunger in order to control weight gain and help the body process sugars more efficiently. Other enhancers, such as Total Control, boost metabolism, energy, and alertness, while Thermo- Bond helps the digestive system. Cell-U-Loss helps the body eliminate unnecessary water and rejuvenate skin with its combination of herbal extracts. An assortment of healthy snacks and beverages are also offered in this line, such as protein bars, soups, teas, and soy nuts.

Targeted nutrition products include dietary and nutritional supplements that contain herbs, vitamins, minerals, and other natural ingredients to strengthen specific areas of the body that tend to be problematic for most people. For example, Tri-Shield helps the heart stay healthy by maintaining good cholesterol levels and providing antioxidants; Ocular Defense Formula and Joint Defense Advanced offer support to the eyes and joints of aging adults; Active Fiber Complex and Aloe Vera Powder helps those with digestive issues; RoseGuard and Schizandra Plus strengthen the liver, immune system, and cells; and Relax Now and Sleep Now, which are part of the stress management line, serve to promote ease and rest. Herbalife also offers nutrition products specifically for women, men, and children.

Herbalife also provides energy and hydration drinks for those engaged in sports and fitness activities. Customers can choose from an assortment of bever- ages such as Liftoff, a fizzy drink mix that enhances clarity and rehydrates the body, or they can choose

supplements such as N-R-G Nature’s Raw Guarana Tablets, which also promote mental clarity. Herbalife24 is the sports drink line that includes formulas for hydra- tion, prolonged endurance, restoration of strength, and recovery.

Personal care products include skin cleansers, moisturizers, lotions, shampoos, and conditioners from a variety of different lines. Herbal Aloe Strengthening Shampoo and Conditioner, hand and body wash, cream, soothing gel, and bath and body bar is claimed to improve the look and feel of hair and skin. The Multivitamin line is similar to taking a multivitamin every day and includes a cleanser, toner, moisturizer, sunscreen, eye gel, and cream infused with vitamins for skin. Radiant C scrub cleanser, skin booster, and body lotion claim to renew and rehydrate the skin with a con- centration of vitamin C. Other items include anti-aging products and fragrances for men and women.

MULTILEVEL MARKETING Direct selling is the marketing of products to ultimate consumers through person-to-person sales presentations at home or online. People are attracted to direct selling for many reasons. Some are passionate about the prod- uct and want to promote the company. Others want to receive a discount on their personal orders. Many find working as a direct seller to be a flexible, part- time opportunity for extra income. Additionally, some independent contractors simply enjoy the social aspect of direct selling. Within the direct selling model are two compensation models: single-level marketing and multilevel marketing. Single-level marketing is when a contractor makes a commission for arranging a sale or earns a margin as a reseller. Multilevel marketing, sometimes called network marketing, is a compensation wherein contractors earn income from their own sales of products as well as commissions from sales made by those they have recruited. Sales are never forced, as a legitimate company does not force downline sales.

However, it is not necessary for contractors to recruit other individuals in order to earn money. It is a choice made by the contractor if they want to increase their earnings by making a commission from the sales of their recruits. Approximately 71–72 percent of Herbalife members are single-level distributors, mean- ing they do not sponsor other Herbalife distributors. This means that these Herbalife members buy products from the company at a discount and have the complete

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freedom to determine pricing as well as in all decisions involving their final customers. Since many of these members simply want a discount on these products, they may not be as interested in making profits but simply enjoy the opportunity to receive these discounts. Furthermore, rewards are not given simply for recruit- ing another contractor. See Table 1 for the top ten global direct selling companies.

Another aspect of multilevel marketing involves internal consumption, which is the purchasing of prod- ucts at a discount from the firm for the contractor’s own use. Most retailers provide internal consumption incen- tives by offering discounts to employees who purchase products. Department stores, automobile manufactur- ers, and airline companies provide incentives such as discounts that encourage internal consumption. Many people become resellers to get discounts on products for their own use. Therefore, the claim that internal consumption is unacceptable is refutable on the basis that the vast majority of companies selling consumer products encourage their employees or independent

contractors to purchase their products. Many individu- als committed to these products believe in the brands for their own personal use and want to ‘spread the word’ by creating a broader sales and communication network. Some do not even necessarily care about mak- ing a profit from the business. This is a common and legal approach for direct selling products around the world. In fact, most direct selling companies use mul- tilevel marketing. At Herbalife, there is no limit to the number of levels of recruits.

Despite the legitimacy of multilevel marketing, China has restricted direct selling to single-level marketing only. China believes multilevel marketing is linked to fraudulent activities such as pyramid schemes because of the assumption that discounts are used to force internal consumption. China allows direct sell- ing companies to do business within their borders if they sign a contract saying they will not employ the multilevel marketing aspect of direct selling. Instead of having independent contractors recruit others, they sell their products from retail stores.

TABLE 1 Top Ten Direct Selling Companies

Company Name and Product Line 2015 Revenue (USD Billions)

1 Amway Nutrition, Beauty, Bath and Body, Home, Jewelry, Food and Beverage, Fragrances

$9.5

2 Avon Cosmetics, Skin Care, Fragrance, Personal Care, Hair Care, Jewelry, Gifts

$6.16

3 Herbalife Nutrition, Weight-Loss Management, Personal Care

$4.47

4 Vorwerk Household Appliances and Cosmetics

$4.00

5 Infinitus Chinese supplements

$3.58

6 Mary Kay Cosmetics, Skin Care, Body and Sun, Men’s Product’s, Fragrance Gifts

$3.70

7 Perfect Health Food, Household, Beauty, and Skincare Products

$3.58

8 Natura Cosmetics

$2.41

9 Tupperware Food Storage and Preparation, Cookware, Serving Items, Cosmetics, Beauty

$2.28

10 Nu Skin Skin Care

$2.25

Source: Direct Selling News, “2016 DSN Global 100 List,” Direct Selling News, 2016, http://directsellingnews.com/index.php/view/2016_ dsn_global_100_list#.V2ri93kUVVJ (accessed June 22, 2016).

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Case 4  Multilevel Marketing Under Fire: Herbalife Defends Its Business Model 459

INDEPENDENT CONTRACTORS There are nearly 3 million independent contractors of Herbalife products, and all of them personally use these products. Many are attracted to the low startup cost of selling Herbalife. The startup cost for a part-time contrac- tor is $57.75 for a kit. For this price, they will receive the mini-International Business Pack, which includes forms, applications, a tote bag, and samples of various Herbalife products. Informational and training materials educate the contractor on using and retailing the products, busi- ness basics, and how to build a sales and marketing plan. Alternately, if a contractor wants to work full-time, they can purchase the full International Business Pack for $89.55. This pack comes with all of the materials that the mini-pack offers but with more product samples and information on how to run your business. There is no fee to join, and the only money spent is for the value of the kit.

Contractors enjoy discounts off products, ranging from 25–50 percent depending on the level of contrac- torship. Herbalife resellers often purchase the products themselves and then resell them directly to buyers; however, it is possible for the reseller to make the sale and get the product directly from Herbalife. Resellers can resell the products at any price they want. Each Herbalife product has a certain number of Value Points, and the number of Value Points a contractor accumu- lates determines what level of contractorship he or she has. Personally purchased Value Points are awarded based on the volume that a contractor purchases from Herbalife using his or her Herbalife identification num- ber. Royalty Override Points are accumulated based on the Total Volume of products sold by personally spon- sored supervisors that the reseller has recruited.

To go from basic distributor to the Senior Consultant level, a Herbalife member must have accumulated a minimum of 500 Volume Points in one month. To be promoted from Senior Consultant to Senior Contractor, a contractor must accumulate at least 1,000 personally purchased Value Points in one order. Levels after that include Qualified Producer (2,500 Volume Points accu- mulated in 1–3 months), Supervisor (4,000 Value Points in one month, 2,500 Value Points in each of two consecu- tive months, or 5,000 personally purchased Value Points within 12 months), and World Team (2,500 Value Points in each of 4 consecutive months, 10,000 Volume Points at 50 percent in one month, or 500 Royalty Override Points in 1 month). Once a contractor reaches the Supervisor level, the product discount is increased from 25 to 50 percent and a profit can be made on sales to other con- tractors, which can reach up to 5 percent.

In the event that a contractor no longer wants to sell Herbalife products, the company will buy back the remaining inventory the contractor has on hand. Herbalife goes beyond the Direct Selling Association’s ethical guidelines for buying back products by reim- bursing the distributor for everything that he or she paid for initially (100 percent buyback policy). The company also discourages contractors from inventory loading, which the Federal Trade Commission (FTC) has defined as a practice requiring a contractor to make a large purchase of a large amount of nonreturnable inventory. To renew their membership, contractors pay a $10 annual membership fee to Herbalife.

The Herbalife business model has succeeded due to their excellent products and customer support. Most independent contractors do not have a physical store location but practice direct selling from home. They are not employees but business people who choose how they want to operate. There are strict company policies and legal requirements that contractors must abide by that regulate product information, sales techniques, advertising, lead generation, social media, and related issues. For instance, members can sell online, but there are advertising restrictions for online sales. The prod- ucts cannot be searchable online by their price, and the only way a potential buyer can get more information is by getting a password from the reseller. This facilitates a conversation between the buyer and reseller, allowing a relationship to develop even through online transac- tions. Contractors are not able to resell products on auction sites or in retail stores (excluding China).

Herbalife’s selling policies are guided by the principles of the World Federation of Direct Selling Association (WFDSA) and the Direct Selling Association (DSA) in the United States. The WFDSA promotes ethi- cal practices in direct selling globally through advocacy and strong relationships with government, consumers, and academia. The DSA also emphasizes ethics and requires that members adhere to their code of ethics (See Table 2). Herbalife is a member of the DSA and abides by their code of ethics. This code of ethics recog- nizes the importance of a fair and ethical approach to direct selling, since direct selling requires sensitive and personal one-on-one interaction that can lead to undue pressures placed upon consumers. The code has no tolerance for deceptive or unlawful practices regarding recruits and customers; requires that salespeople pro- vide accurate and truthful information about the price, quality, promotion, etc. of the products; illuminates and enforces the need for a clear record of the sales made by contractors; necessitates that warranties and

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TABLE 2 Direct Selling Association Code of Ethics As a consumer you should expect salespeople to:

Tell you who they are, why they are approaching you, and what products they are selling.

Promptly end a demonstrations or presentation at your request.

Provide a receipt with a clearly stated cooling off period permitting the consumer to withdraw from a purchase order within a minimum of three days from the date of the purchase transaction and receive a full refund of the purchase price.

Explain how to return a product or cancel an order.

Provide you with promotional materials that contain the address and telephone number of the direct selling company.

Provide a written receipt that identifies the company and salesperson, including contact information for either.

Respect your privacy by calling at a time that is convenient for you.

Safeguard your private information.

Provide accurate and truthful information regarding the price, quality, quantity, performance, and availability of their product or service.

Offer a written receipt in language you can understand.

Offer a complete description of any warranty or guarantee.

As a salesperson, you should expect a DSA member company to:

Provide you with accurate information about the company’s compensation plan, products, and sales methods.

Describe the relationship between you and the company in writing.

Be accurate in any comparisons about products, services or opportunities.

Refrain from any unlawful or unethical recruiting practice and exorbitant entrance or training fees.

Ensure that you are not just buying products solely to qualify for downline commissions.

Ensure that any materials marketed to you by others in the salesforce are consistent with the company’s policies are reasonably priced and have the same return policy as the company’s.

Require you to abide by the requirements of the Code of Ethics.

Safeguard your private information.

Provide adequate training to help you operate ethically.

Base all actual and potential sales and earning claims on documented facts.

Encourage you to purchase only the inventory you can sell in a reasonable amount of time.

Repurchase marketable inventory and sales aids you have purchased within the past 12 months at 90 percent or more of your original cost if you decide to leave the business.

Explain the repurchase option in writing.

Have reasonable start-up fees and costs.

Source: Direct Selling Association, “DSA Code of Ethics,” MLM.com, 2016, http://mlm.com/summary-version-of-the-dsa-code-of-ethics/ (accessed June 22, 2016).

guarantees be fully acknowledged; requires salespeople to clearly identify themselves to customers and maintain the confidential information of their customers; has no tolerance for pyramid schemes; and provides guidelines on inventory purchases, earnings reporting, inventory loading, paying fees, and training.

A 2013 survey conducted by Nielsen, a repu- table global information measuring company, showed (without interference from Herbalife) the number of

end-consumers Herbalife serves. The study, which took place online over the course of two months, sampled 10,525 consumers and was balanced in terms of demographics, income, and geographic placement. The results indicated that 3.3 percent of the general popu- lation made a Herbalife purchase sometime over the last three months. This percentage of the population translates into 7.9 million customers, which does include Herbalife’s contractors. According to the data, however,

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Case 4  Multilevel Marketing Under Fire: Herbalife Defends Its Business Model 461

the number of contractors is approximately 550,000, indicating that the number of end users is higher than the number of independent contractors. Additionally, the study showed that those who made a purchase in the last three months tend to make Herbalife purchases consistently (approximately every two months), and that the most popular products are those having to deal with weight management (95 percent of those who made a purchase in the last three months).

One of the biggest arguments against Herbalife is its line commissions. Currently, Herbalife contractors can earn commissions on what every recruit below them buys or sells. There are no restrictions on the number of levels of recruits that contractors can earn a commission on, unlike some other multilevel marketing companies.

PYRAMID SCHEME There are four defining characteristics of a pyramid scheme. The first, which is dictated by the FTC, is that consumers or investors are promised large profits based primarily on recruiting others to join their program. The promise is not based on profits from any real investment or real sale of goods. Second, according to the Securities and Exchange Commission (SEC), the promise of high profits rests on nothing more than a consumer or inves- tor handing over their money and convincing others to do the same. Third, the Federal Bureau of Investigation (FBI) warns that pyramid schemes can be in the form of marketing and investment frauds when an individual is offered a contractorship or franchise to market a particu- lar product. The real profit is earned not by the sale of the product but by the sale of new contractorships. Lastly, the California Department of Justice identifies the difference between a pyramid scheme and a legitimate multilevel marketing plan. In a multilevel marketing model, money is only made through the eventual retail sale of the prod- uct to an end user. In an illegal pyramid scheme, the par- ticipants at the top of the pyramid earn money when new members are recruited. Each new member is then required to recruit new participants. As this process goes on, the possible pool of participants shrinks, making it hard for those at the bottom to gain a return on their investment. A pyramid scheme will ultimately collapse due to a lack of new recruits and is therefore unsustainable. Another important point is that a pyramid scheme that seems to offer a product will have little to no market value. The recruits are being sold on an idea or a model.

Pyramid schemes can be hard to identify clearly, but the FTC has warned consumers about two red flags.

The first is inventory loading, which looks similar to internal consumption because it encourages large-scale purchases of nonrefundable products by a distributor. Not only is inventory loading a red flag but also illegal. The second is a lack of retail sales. If a supposed busi- ness has both of these characteristics, it is possible that it is a pyramid scheme and not a business at all. Another way of detecting a pyramid scheme is by examining the intention of the buyer. If the buyer purchased a product he or she really did not want just to participate, it is an indication that it could be a pyramid scheme. It is for these reasons that some direct selling businesses using the multilevel marketing compensation method can appear to be pyramid schemes. Because Herbalife sells not only their nutrition products but also a business opportunity, the firm has been accused of running a pyramid scheme.

IS HERBALIFE A PYRAMID SCHEME? In 2012, Herbalife was accused of being an elaborate pyramid scheme by hedge fund manager William Ackman. Ackman had bet $1 billion in a short sale off Herbalife’s stock. Short selling occurs when an inves- tor sells shares borrowed from a lender (e.g. a broker) in the belief that the stock will decrease. The investor takes the money for the stock sale, but eventually must re-purchase the stock and return them to the lender. If the stock has gone down, the investor makes a profit. However, if it has gone up, the investor loses money because he or she is buying back the shares at a higher rate than the price at which they originally sold them.

Ackman’s accusations against Herbalife included the following: 1) the majority of contractors for Herbalife lose money, 2) Herbalife pays more for recruiting new contractors than selling actual products, and 3) only the top 1 percent of contractors earn most of the money. The accusation is a result of the confusion that comes from the way their earning structure oper- ates. Ackman argued that Herbalife recruits contrac- tors under false beliefs that they can earn the income of those at the top by selling the product and that the real money comes not from selling products but from recruiting other contractors. His reasoning is that con- tractors earn rewards for every member they recruit, and every member the recruits recruit. However the term “rewards” is misleading. In a multilevel marketing compensation method, contractors earn a commission on the sales of their recruits.

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The term “rewards” implies that there is some amount of money given for simply recruiting. However, this is not how Herbalife pays its contractors. Herbalife operates a little differently than other multilevel marketers in that most have a cut-off on what level of recruits a contractor can earn compensation from. Herbalife does not have a cut-off (although the average is approximately six levels downline). While this characteristic differs from other multilevel marketing companies, it is not enough to classify Herbalife as a pyramid scheme.

Another contention of Ackman’s is that when an individual goes to purchase Herbalife products, dis- tributors try to convince him or her to become a recruit rather than remain a customer. He argues that the only thing keeping the company running is new recruits, and it will soon run out of available people to recruit into the business. Ackman alleges that Herbalife enters new countries after the current pool of recruits in a particu- lar country is exhausted.

On the other hand, many consumers and organiza- tions buy and use Herbalife products and see them as high-quality and credible. For example, Los Angeles fire and police department officers use Herbalife products in their fitness centers. Herbalife products have even been adopted by some Chinese Olympic teams. Additionally, because the number of end users is larger than the number of independent contractors, supporters of Herbalife claim it cannot possibly be operating a pyramid scheme. This supports the fact that Herbalife uses a valid and successful business model, which is producing profits directly related to product sales and allowing them to expand globally.

Ackman, however, has made claims to invalidate these numbers. He claims that the survey measuring the number of contractors versus end consumers con- tradicts two others that were released by the company. He also states that Herbalife refuses to make the details of its recruiting process public knowledge so it can be scrutinized. Ackman’s company has accused the survey sample of being too small, making the results overly optimistic. He takes issue with the fact that there are not enough specifics in the survey (prices consumers paid and an itemized breakdown of the products purchased).

Herbalife has also been accused of issuing false accounting statements. There has never been any legal accusation about the recording of sales. According to allegations, products are sold to contractors and are shown as retail sales on the company’s revenue. The company does not always trace whether the product was consumed by the contractor (i.e., internal consump- tion) or to whom the contractor sold the product. The criticism is that the company should not be making

money off the contractors but should only record rev- enues made from end users. Those who criticize internal consumption by contractors or employees within a com- pany fail to recognize that this is an acceptable prac- tice. Coca-Cola has 100 percent internal consumption because all of its products are sold to resellers. Costco also has 100 percent internal consumption because all of its products are sold to Costco members. This shows that the percentage of internal consumption is not by itself enough to indicate a pyramid scheme. There has never been major criticisms of companies encouraging internal consumption except with the direct selling, multilevel marketing compensation model.

Second, sometimes when new contractors are recruited, they need to buy products that they can con- sume themselves or sell to others. These practices have caused suspicion among Herbalife’s critics. On the other hand, a contractor is only required to buy more products after the initial purchase if they want or need it for per- sonal or business purposes. Once individuals sign up to be contractors, they indicate if they want the products for personal use or to make available for sale. If contractors have recruits under them, they have the opportunity to earn commissions based on the sales of those recruits. On the other hand, if the contractors do not care about the commission, they do not have to purchase anything more. In the case of Herbalife, the amount of products contractors are required to purchase is lower than many other multilevel marketing businesses.

There is also a criticism that a large number of contractors are not successful in selling their products. The ease of entry and extremely low cost of becoming a contractor makes it possible for those with little experi- ence to enter the business. Even if they are not success- ful at direct selling, the cost of entry is less than $100 and they still have products that they can consume. Herbalife’s records show that only 1 percent of its regis- tered contractors will make $100,000 from the business in their lifetime. Ackman has argued that the numbers Herbalife reports are false. He estimates their retail sales to be only 3 percent of their revenue, while the rest is made by recruiting practices. Ackman also implied that Herbalife saturates markets, requiring it to get most of its sales from new, undeveloped markets.

These discrepancies can be explained when the types of contractors are analyzed. There are those that sign up only to get the contractor’s discount on the product because they want the product for personal use; those who only want to sell the products as a source of addi- tional income; and those that want to sell as a full-time business opportunity. Furthermore, every kind of direct

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Case 4  Multilevel Marketing Under Fire: Herbalife Defends Its Business Model 463

selling business requires a large amount of effort to make a good profit. Even with businesses like Herbalife, if a contractor wants to make a living from distributing, relationships with customers must be maintained, and relationships with recruits must be maintained to encour- age them to make as many sales and new recruits as pos- sible. Many who begin in any direct selling business are either not willing or lack the business knowledge to put in that much effort. Those who sign up for this opportunity as a side job only work part-time or less, depending on how much extra money they want to make. In terms of market saturation, it would appear that Ackman is incor- rect. Herbalife receives approximately 90 percent of its sales from markets in which it has done business for at least ten years, and growth in mature markets is growing by double digits.

Herbalife has defended itself against allegations of being a pyramid scheme. It responded to Ackman’s charges in January 2013. However, the company’s stock fell 43 percent four days after Ackman’s accusations to $24.24, which was the largest drop the company had seen in several months. In response to Ackman’s lobby- ing efforts, Herbalife hired a lobby team consisting of Glover Park Group and the Podesta Group.

CRITICISM AGAINST WILLIAM ACKMAN As mentioned earlier, in accusing Herbalife of operating a pyramid scheme, William Ackman bet against their stock to the amount of $1 billion. Initially, the accusations caused Herbalife’s stock to drop, benefiting Ackman’s company because of his short sale. Ackman had pledged to give any profits from the short sale to charity, but to many people the short sale and subsequent accusations appeared to be a serious conflict of interest.

Another issue involved letters from supposed vic- tims of Herbalife’s deceptive practices. Because one of Ackman’s contentions is that Herbalife targets minori- ties, Ackman’s company has paid civil rights organiza- tions $130,000 to collect names of people who were victims of Herbalife. However, the Nevada Attorney General found issues with some of these letters. Three of the letters from nonprofit groups signed by Hispanic community leaders were identical, and none of the lead- ers could identify any Herbalife victims by name. Other attorneys general have had similar experiences. Some of the leaders who had allegedly written the letters later denied they had written them. This could represent questionable conduct to encourage regulators to act.

Shortly after Ackman’s accusations, another inves- tor, Carl Icahn, came to the defense of Herbalife and became a majority shareholder and board member. This helped boost investor confidence in Herbalife, and their stock began to increase. This was bad news for Ackman when he was forced to cover his short sale. He took a loss on 8 million shares of stock. However, the state of Herbalife was still uncertain amid accusations, investor uncertainty, and Herbalife’s strong stance that it was not operating a pyramid scheme. Pyramid schemes take some time to reveal themselves, so it was just a matter of waiting until Herbalife either crumbled or succeeded before anyone could be certain about the future of the company.

An article in the March 15, 2014, issue of the Economist as well as The New York Times provided a critical assessment of Ackman’s attempts to use state- of-the-art lobbying in Washington to support his $1 billion short bet against Herbalife. Ackman has been at the heart of well-executed lobbying, although he claims to have spent only $264,000 on his lobbying campaign. On the other hand, Ackman’s company’s lobbying budget was seven times that much. According to the Economist, Ackman sees himself as a moral crusader against Herbalife, but his critics see him as simply a “greedy billionaire who is now exploiting America’s newly laissez-faire attitude to political spending in pur- suit of a big financial payday.” Ackman has gained sup- port from one U.S. senator and a U.S. Congressperson who have asked for the FTC to investigate Herbalife. The FTC did begin an investigation, and Herbalife claims that they welcome the opportunity to vet their business model and put these attacks behind them.

THE CONTROVERSY CONTINUES Despite the company’s recent success, the allegations continue. Special interest groups such as the Hispanic Federation and the National Consumers League are taking issue with the company and urging the FTC to investigate Herbalife’s operations. Not only are they continuing the claim that Herbalife is operating a massive pyramid scheme but they are furthering the argument to say that the company is targeting vulner- able groups including low-income Hispanic immigrants and low-income African Americans. The allegations against Herbalife include aggressive recruiting tech- niques, promises of getting rich with minimal work, and taking advantage of people with little or no business experience.

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The claims arose from the proliferation of nutri- tion clubs that have been established in Latino/Hispanic communities in Southern California. Nutrition clubs involve community members who pay a membership fee to discuss health issues and consume Herbalife products in a social setting. The popularity of these nutrition clubs originated in Mexico, which is where most of the immigrants in Southern California immigrated from. Herbalife claims that the nutrition clubs started arising in these areas because Hispanics saw how successful they were in Mexico and wanted to import the idea to the United States. Others claim that these clubs are harming the community because they turn out to be too costly for those who run them and end up losing more than they bargained for. Congresswoman Linda Sanchez, who represents Southern California, has writ- ten a letter to the FTC asking the agency to investigate Herbalife. She cited the intense media coverage and outreach from special interest groups and constituents as reasons for the FTC to investigate the company. Similar claims also abound in New York. New York City Councilwoman Julissa Ferreras has also written to the FTC advocating for an investigation.

Desmond Walsh, President of Herbalife, maintains that the company does not target specific demographics and that the rise of nutrition clubs in Latino/Hispanic communities is a result of immigrants seeing the busi- ness opportunity and importing the clubs from Mexico. Another issue with these clubs is that owners are oper- ating them out of their homes and making and selling shakes. The Los Angeles Department of Health has closed some of these clubs as it is illegal to make and sell food items out of one’s home. These clubs have to follow the same regulations as restaurants, requiring permits and other sorts of time-consuming and expen- sive governmental red tape. Critics claim that Herbalife does not adequately train their contractors in areas such as business and laws, so they are destined to fail. Herbalife, on the other hand, refutes those claims and states that they encourage their contractors to abide by their local laws.

In February 2013, it was reported that Hispanics make up 60 percent of Herbalife’s customer base. One reason may be because they are good at direct selling due to their large network base and relationship build- ing tendencies. The SEC is currently conducting an investigation into Herbalife’s business operations.

One of their own former contractors filed a Class Action Complaint against Herbalife claiming, among other serious allegations, that the company is operat- ing as a pyramid scheme. Some of the key allegations

provided in this particular case include undisclosed facts, such as a large majority of all contractors (approximately 71 percent) make few, if any, retail sales and are forced to self-consume the Herbalife products. Herbalife will likely continue facing similar accusations in the future and must remain proactive in addressing them.

In 2014, Ackman profiled Herbalife’s top distribu- tors and continued his lobbying in Washington to have Herbalife investigated by the FTC. The FTC announced that it was initiating a probe into Herbalife’s business practices. Herbalife responded by launching a new website, iamherbalife.com, that features dozens of positive testimonials from users of its products. One of Ackman’s accusations is that the company sells a questionable product to gullible immigrants. Research shows that Herbalife sales continue to increase and that it has millions of customers who are not independent contractors or distributors using its products. While multilevel marketing compensation systems have been examined by the FTC in the past, the laws associated with pyramid schemes are considered ambiguous by some stakeholders. One of the key factors in a pyramid scheme is that there is no product sell-through, and in the case of Herbalife, they have definitively demonstrat- ed that the sales are driven primarily by selling products to consumers. This seemed to be the conclusion reached by the FTC. The FTC did allege that Herbalife had not disclosed enough to distributors and that it pro- moted “get-rich-quick” promises that were not realistic. Herbalife paid $200 million and promised to improve disclosures with distributors. The FTC did not rule that Herbalife was a pyramid scheme. This refuted Ackman’s accusations and meant that he will probably lose hun- dreds of million in his short sales of Herbalife stock.

However, the concept of internal consumption— although legitimate—continues to be questioned by regulators. The belief prevails that a large amount of internal consumption in direct selling companies indi- cates a pyramid scheme. In 2012 a U.S. judge ordered an organization called BurnLounge to disband and reimburse customers $17 million after the FTC deduced that the company was operating a pyramid scheme. BurnLounge marketed itself as a way for entrepreneurs to sell digital music and earn large incomes. Participants paid to enter the scheme. Very little sales were recorded, and 90 percent of participants did not act as indepen- dent distributors selling a product.

BurnLounge appealed. They stated that the FTC did not have enough evidence. The appeal in 2014 was held by the Ninth Circuit Court of Appeals. The implications

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of this case for the multilevel marketing direct selling industry were significant. In the initial judgment against BurnLounge, it was ruled that sales of products to ulti- mate users do not include sales to participants. It was feared that a legal decision could rule that the majority of products must be sold to people outside the company’s network. In other words, a majority of sales would have to be made to end consumers, with sales to distributors not counted. This possibility could have put limitations on internal consumption. The 2016 FTC consent order with Herbalife dealt directly with the concept of internal consumption. Although this order does not apply to all companies, it requires Herbalife to carefully track the sales of products that are viewed as internal consump- tion and sales of products sold outside the network. This FTC requirement attempts to address the issue of inventory loading, or independent contractors who buy large amounts of the product in order to increase their commissions. The FTC is also severely limiting any com- missions that can be made on products that independent contractors consume themselves.

The federal appeals court upheld the FTC’s deci- sion that BurnLounge was operating an illegal pyramid scheme. However, the ruling was viewed favorably by the direct selling industry overall because BurnLounge was determined to be a pyramid scheme due to the fact that participants had to pay to join the scheme and were mainly motivated by recruiting others into the scheme (versus selling an actual product). The biggest relief for organizations like Herbalife is that the court did not rule that commissions generated from goods sold to independent contractors were illegal. Internal consump- tion was defined as purchases made by distributors for personal consumption or resale, and not for buying products simply to qualify for bonuses or to get a dis- count. Like any other reseller, distributors purchasing products for internal consumption have the option of consuming the product or selling it to others. It would be impossible to know the exact percentage of the product being consumed by the independent contractor versus sales to consumers.

Rather than focusing upon the amount of consump- tion, the decision seemed to focus more upon whether the emphasis of the business involves sales of products or recruitment. Other areas of emphasis involve how these organizations calculate commissions and the importance of selling the product for the successful operation of the business. The intent for purchase is also a crucial component. If the purchases are driven by the product’s value, instead of by money-making ventures, then it is most likely a legitimate operation.

Additionally, the BurnLounge decision described some tests that could indicate a pyramid scheme. Specifically, red flags include focusing more upon recruitment than merchandise, paying bonuses primar- ily on recruitment activity, promoting the program instead of selling the product, having participants purchase the right to earn profits through the recruit- ment of other individuals, developing strong incentives for recruitment, motivating package purchases by the opportunity to earn money, and making it unlikely that meaningful retail sales will occur.

Although some of these are not necessarily red flags by themselves, several of them taken together could indicate a pyramid scheme. For instance, the Court found that 95 percent of BurnLounge distribu- tors brought premium products but only 35 percent of non-distributors did so. BurnLounge products had little value, and distributors were required to buy pre- mium packages if they wanted to be eligible to receive additional commissions. Because Herbalife contractors sell products of value, participants do not have to pay simply to participate, and retail sales do occur, this legal decision lends more credence to Herbalife as a legiti- mate business model.

HERBALIFE’S SOCIAL RESPONSIBILITY Herbalife is proud of its Corporate Social Responsibility program and believes it best sums up the company’s top value of doing the right, honest, and ethical thing. These methods and policies relate to the directing and admin- istering of short and long-term goals. They are put in place to ensure accountability and economic efficiency for Herbalife’s stakeholders. Herbalife is proud that because of these policies they met independence criteria almost a year early and meet all NYSE-listed public company requirements for transparency.

Herbalife’s business ethics allows it to uphold the highest ethical standards in the operation of the com- pany. CEO Michael Johnson has said that its reputation is its greatest asset, and its Corporate Code of Business Conduct and Ethics reflects this. Herbalife encour- ages fair interactions and good judgment between any persons associated with the company and customers. There are guidelines set in place as to how contractors and employees of Herbalife should interact with sup- pliers, competitors, business partners, and the govern- ment. Herbalife encourages obedience to laws and sets boundaries on gifts and entertainment, describing the

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difference between small gifts for hospitality and bribes. The company discourages conflict of interest situations as well as insider trading and offers three methods of reporting unethical behavior through the company hotline, website, or by contacting the General Counsel. Individuals who do not comply are disciplined, sus- pended, or terminated. Herbalife also requires annual ethics training for all employees worldwide.

Another aspect of its Social Responsibility pro- gram includes its philanthropic efforts. The Herbalife Family Foundation (HFF) and the Casa Herbalife program, founded in 1994 by Mark Hughes, provide funding and volunteerism to charitable organizations taking care of children-at-risk around the world. HFF works to improve nutrition and help with disaster relief efforts. Herbalife has also partnered with the Global Alliance for Improved Nutrition (GAIN) and DSM Nutritional Products, a producer of vitamins and nutri- tion ingredients, to help deliver nutrients to women and children around the world. This partnership is under the umbrella of GAIN’s Future Fortified campaign.

Lastly, as a part of Herbalife’s Corporate Social Responsibility program, it engages in Employee Wellness and Live Green environmentally conscious initiatives. The company encourages and incentivizes employees to become and stay healthy and participate in fitness activities. Such incentives include complimen- tary products and lower individual health insurance costs. The company has even been recognized by Men’s Fitness magazine as “One of the 15 Fittest Companies in America.” Through environmentally conscious ini- tiatives, Live Green and the 3Rs—reduce, reuse and recycle—Herbalife makes its impact on the environment a priority.

CONCLUSION Herbalife battled Ackman’s accusations from late 2012 until July 2016. During that time, Ackman was success- ful in getting the Federal Trade Commission to launch a major investigation into whether Herbalife was a pyra- mid scheme. After the long investigation, the Federal Trade Commission concluded that Herbalife was not a pyramid scheme but reached a consent order, which is a joint agreement, that Herbalife would change some of its business practices. Specifically, the company has to track the sales of its products to consumers outside of its network and sales that involve internal consumption. In addition, the company has to provide more training and monitoring of its independent contractors to make

sure they do not over-promise the financial opportunity in selling Herbalife products.

The products of Herbalife are exclusively sold by nearly 2.3 million independent contractors in 90 differ- ent countries It sponsors several professional athletes, teams, and sporting events. Additionally, the company is proud of its Corporate Social Responsibility initiatives. Herbalife is a successful company, but ethical issues will continue to ensue. Trust in business is at a low point in our society. Marketing is often seen as a part of business that is suspect. A direct selling firm receives additional scrutiny as it is focused on personal selling to distribute all of its products.

Herbalife contractors do not have the overhead expenses that a retail store with a building, fixtures, utilities, and other expenses requires. Therefore, the markup on products such as cosmetics, nutritional sup- plements, jewelry, and clothing may be similar in both the retail store and in direct selling. A direct selling com- pany is a flat organization with low overhead and com- pensation systems for the network of sales contractors that make the product available to final consumers. The concept of internal consumption, which exists in nearly all businesses, is considered questionable by some crit- ics who fail to understand that there is nothing illegal or unethical about internal consumption. However, the Federal Trade Commission has asked Herbalife to keep precise records, including the names of purchasers, to differentiate between internal consumption and sales to consumers outside the network.

On the other hand, some direct selling companies have been associated with inventory loading, some- times called garage stuffing, when sales contractors are encouraged to buy more products than they can consume or sell. This ethical breach has nothing to do with a company being a pyramid scheme just because it uses a multilevel compensation method. All businesses have compensation methods that reward sales manag- ers and higher-level managers, including the CEO, for performance. Every business has to produce revenue, and the marketing function is exclusively in charge of developing sales.

However, companies can fight against criticism of their operations by maintaining total transparency concerning how their sales incentive models work, and there should be due diligence to ensure that sales contractors are not exploited in any way. Herbalife continues to have many loyal contractors throughout the world, showing that the firm has many supporters who believe the company is a legitimate and successful business operation.

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Case 4  Multilevel Marketing Under Fire: Herbalife Defends Its Business Model 467

Questions for Discussion 1. Why has Herbalife’s multilevel compensation

model been confused with a pyramid scheme? 2. Describe the differences between a legitimate

business model and a pyramid scheme. 3. How has Herbalife demonstrated social

responsibility?

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Case 4  Multilevel Marketing Under Fire: Herbalife Defends Its Business Model 469

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470

CASE 5

Hobby Lobby: Balancing Stakeholders and Religious Freedom in Business Decisions

INTRODUCTION Ethical business and stakeholder management is com- plex by any standard. Business leaders must balance a variety of competing pressures and concerns and make the best decisions they can to produce quality products, satisfy customers, provide a favorable work experience for employees, consider the environmental and social impact of their business operations, potentially con- tribute independently to society through donations and public service, and more. All of this must be resolved in pursuit of the traditional overarching goal of bottom line (or, more recently, triple bottom line) profitability. How much, then, is this complexity multiplied when a company seeks not only to grow and remain profitable but also to accomplish a separate mission, such as to exemplify and adhere to the deeply held religious and personal values of its founders?

Hobby Lobby is such a company. Although on its face it is simply a successful arts, crafts, and home deco- rating retailer, the family that founded it and continues to own it privately does not see this as its overall mis- sion. They established the company on a firm bedrock of biblical Christian principles, and an essential and enduring part of the firm’s mission is to honor these val- ues in its business choices. The company keeps its stores closed on Sundays; refuses to sell certain items such as shot glasses or contract out “back-haul” trucking space to transport beer; pays its lowest-level employees signif- icantly more than the legal minimum wage; and donates half of its profits to ministries and charitable organiza- tions. These decisions have cost it millions in potential earnings, but the owners consider it a cost of running a business the way they believe it should be done.

Whether this style constitutes ethical business practices and effective stakeholder management is in the eye of the beholder. Christian organizations such as the National Bible Association have bestowed Hobby Lobby and its leadership with ample praise. However,

even non-Christians can find much to appreciate in the firm’s high base wages, its focus on an employee work- life balance, charitable donations, and so on. The com- pany has also steadily expanded and has experienced continued financial success.

On the other hand, conflicts have inevitably arisen between the company’s Christian focus and the needs and desires of non-Christian employees, customers, and other stakeholders. At no time has this conflict been more starkly exhibited than in the company’s 2012–2014 lawsuit against the government to strike down the 2010 Patient Protection and Affordable Care Act’s requirement that most companies expand their employee health insurance coverage to pay for certain contraceptives the company’s leadership consid- ers “abortifascients”—causing the death of human life after it has begun. Hobby Lobby won the case—the U.S. Supreme Court struck down the requirement—but the legal battle has polarized public perception of the company, with many viewing its biblical foundation as nothing more than its owners attempting to force their religious beliefs upon customers, employees, and society at large. While the long-term effects of the Supreme Court’s decision on the law of religious freedom and expression for closely held private companies—as well as on the future of Hobby Lobby itself—are still unknown, the situation serves as a striking landmark in the history of a company that has attempted, for better or worse, to hold to its own unique perception of what constitutes ethical business management.

This case describes the Supreme Court ruling in favor of Hobby Lobby and its implications. We begin by looking at how Hobby Lobby was developed. Its ethical and socially responsible business practices are based on biblical principles that the company uses to guide its decision-making. The second part of this case describes the ethical challenges Hobby Lobby has faced, including its refusal to offer certain contraceptives and its 401(k) plans.

*This case was prepared by RuthAnn Tibbetts, Mariah Maestas, and Isaac Emmanuel for and under the direction of O. C. and Linda Ferrell, © 2015. Jennifer Sawayda provided editorial assistance. It was prepared for classroom discussion rather than to illustrate either effective or ineffective handling of an administrative, ethical, or legal decision by management. All sources used for this case were obtained through publicly available material.

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Case 5  Hobby Lobby: Balancing Stakeholders and Religious Freedom in Business Decisions 471

THE CRAFTING OF HOBBY LOBBY Hobby Lobby opened its doors in Oklahoma City, Oklahoma in 1972, founded by David Green as an extension of a miniature picture frame company he originally ran out of his garage. The company has now grown to over 600 stores in more than 41 states and employs 28,000 employees.

Ethics, Corporate Social Responsibility, and Business Practices—Based on Biblical Principles Hobby Lobby was founded on biblical Christian prin- ciples. As founder and current CEO David Green has written, “I’ve always said that the first two goals of our business are (1) to run our business in harmony with God’s laws, and (2) to focus on people more than money.” The company’s current website states, “We believe that it is by God’s grace and provision that Hobby Lobby has endured. He has been faith- ful in the past, and we trust Him for our future.” The Hobby Lobby mission statement includes the following commitments:

- Honoring the Lord in all we do by operating the company in a manner consistent with biblical principles.

- Offering our customers exceptional selection and value in the crafts and home decor market.

- Serving our employees and their families by estab- lishing a work environment and company policies that build character, strengthen individuals, and nurture families.

- Providing a return on the owner’s investment, sharing the Lord’s blessings with our employees, and investing in our community.

These commitments are based on the core Christian values that the Green family lives by, and company leaders deeply stress these values, along with a shared company vision that emphasizes a family culture. This overall viewpoint and focus greatly affects the company’s practical business decisions, often in ways that forego profits. For example, the company

gives a 10 percent discount to churches, schools, and national charitable organizations. The company also takes care of its employees through various benefits. As of July 2014, a full time hourly employee received $14.50 per hour, double the required national mini- mum wage. The company stresses a strong work-life balance; stores are closed on Sundays (costing the company an estimated $100 million or more in lost sales annually); and workdays are shorter than most other retailers to allow employees to spend qual- ity time with their families and handle other needs. The company’s healthcare plan is also very generous compared to most other retail companies, and it hires chaplains to attend to employees’ emotional and spiritual needs.

Smaller business decisions are affected as well. As mentioned earlier, the company will not sell certain disapproved items such as shot glasses. It passes up free revenue by refusing to contract out excess “back-haul” trucking space to carry beer (“back-haul” meaning space in trucks returning from cargo deliveries who have to expend the same amount of gas and effort to drive back but often do not have much to transport). It stocks a significant amount of religious, mostly Christian, merchandise such as crosses and other deco- rations, plays Christian music in its stores, and does not allow violent or bloody Halloween decorations.

Both Hobby Lobby as a company and the Green family privately spend a significant amount of money promoting charitable, primarily Christian-focused, causes, and have been recognized for doing so. Over 10 percent of Hobby Lobby’s yearly income, including 50 percent of profits, is donated to ministries and other nonprofits according to biblical principles (tithing a set portion of income to God’s work). Some of that money has gone toward acquiring one of the world’s largest private collections of Bibles and biblical artifacts, which will eventually be placed in a public Bible-themed muse- um planned in Washington, D.C. In 2010, David Green and his wife, Barbara, signed on to the Giving Pledge, a campaign begun by Bill Gates and Warren Buffet to encourage wealthy individuals and families to commit to giving half of their wealth over the course of their lives (or after death) to philanthropic causes. In 2013, Hobby Lobby president Steve Green was presented with the Templeton Award by the National Bible Association in recognition of his “outstanding example for business leaders across the country … his exemplary spiritual values and his continued commitment to the Bible.”

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472 Business and Society

Despite this focus on Christian values, beliefs, and causes, the Green family has stated that they welcome individuals with different religious backgrounds and beliefs into the company. The core values of their reli- gion call for respect of all individuals, and therefore they do not hire on the basis of religion.

Hobby Lobby does not appear to have a formal ethics and compliance program. Although it is a private corporation, this may become an issue as the Federal Sentencing Guidelines for Organizations highly recom- mend having a formal ethics and compliance program— especially for larger companies. When company size increases, ethical risk areas become harder to detect without the internal controls provided by a formal eth- ics and compliance program. However, David Green has high-quality traits that he shares with each of his employees. Through these qualities Green believes that employees will act and live ethically in accordance with biblical principles. Most businesses today as well as the government would recommend additional training and due dialogue on ethical risk areas. Some ethical risks have legal ramifications that may require specialized compliance training. For example, many accounting and human resources decisions can have legal conse- quences. There are many ethical gray areas that may need to be resolved by those with experience or a legal background. Elements of an ethics program are not just principles but include codes of ethics, training, and opportunities for reporting misconduct.

ETHICAL CHALLENGES— BALANCING RELIGIOUS CONVICTION WITH STAKEHOLDER INTERESTS Like all companies, Hobby Lobby has encountered a number of controversies over the years. These contro- versies are intensified by the fact that the beliefs of the company’s leadership sometimes clash with those of other societal stakeholders.

Minor Controversies Not all of Hobby Lobby’s challenges have been major. Hobby Lobby has faced several minor controversies in relation to its Christian-based value structure. One such ethical challenge occurred in October 2013, when a customer shopping at a Hobby Lobby store asked why

they did not sell Hanukkah items. The Hobby Lobby employee allegedly responded, “We don’t cater to you people.” An online blogger heard about the story, called another store to ask the same question, and was told that Hobby Lobby does not carry Jewish merchandise because the owners are Christian. He subsequently wrote a blog post harshly criticizing Hobby Lobby’s apparent refusal to sell Jewish items, and the post quickly went viral.

In response, Hobby Lobby released a statement officially apologizing for any inappropriate employee remarks and explaining that it has no problem selling items celebrating Jewish holidays. The firm claims they have sold Jewish holiday items in the past and will continue to do so in regions where there is a significant Jewish population. The statement also emphasized the company’s respect for the Jewish faith and noted that Hobby Lobby contributes to several Jewish-focused charitable organizations. This was sufficient to defuse the situation, with the blogger and other offended par- ties accepting the apology and expressing appreciation for Hobby Lobby’s prompt and concerned response.

When Chik-Fil-A came under fire for its owner publicly stating that the company opposed same-sex marriage based on biblical and Christian principles, Hobby Lobby received numerous requests to clarify its own stance, considering it was also a company founded on Christian values. In August 2012, Debra Love, presi- dent of Hobby Lobby International, released a com- ment to PR Newswire, stating:

Our core values call for respect for each other, our customers and our suppliers and for us to treat others as we would best like to be treated ourselves. We believe that we must demonstrate love for our fellow man as we are called upon to do as Christians. We respect our employees by offering a workplace that is free of judgment and bias, and one that gives everyone an opportunity to succeed and grow.

Although these controversies ended up being of little practical consequence to Hobby Lobby, they effectively illustrate the difficulties the company necessarily faces in attempting to remain both true to Christian prin- ciples and accommodating to the needs of its diverse stakeholder base. This emphasizes the need for Hobby Lobby to ensure that its values are effectively commu- nicated to all employees. A shared value system helps to avoid inconsistencies in employee behavior, such as what occurred with the employees who responded negatively to the questions of Jewish customers.

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Case 5  Hobby Lobby: Balancing Stakeholders and Religious Freedom in Business Decisions 473

The Lawsuit: Burwell v. Hobby Lobby In 2010, President Obama signed into enactment the Patient Protection and Affordable Care Act (ACA). The law requires that if a company with 50 or more employees offers them health insurance, that health insurance must provide “minimum essential coverage” as determined by the U.S. Department of Health and Human Services. Failure to meet this standard or failure to provide health insurance at all potentially subjects the company to significant daily and/or yearly fines.

Since August 2011, this required “minimum essen- tial coverage” includes full coverage for 20 types of contraceptives. Four of these—two “morning after” emergency contraceptive pills and two intrauterine devices—are considered by some to be “abortifacients,” meaning that they potentially take effect only after the egg has already been fertilized. For those who believe human life begins at fertilization, these contraceptives have the effect of ending life—something which they believe to be highly immoral. While there are numerous exceptions to which companies must comply with the contraception coverage requirement—such as exemp- tions for fully religious organizations like churches and religious nonprofit organizations—none of them cover a for-profit corporation with religious underpinnings such as Hobby Lobby.

The Green family has no objection to contracep- tion as a general matter; in fact, before the contra- ception coverage requirement was enacted, Hobby Lobby was already voluntarily providing coverage for all 20 contraception methods as part of its gen- erous benefits plan. However, the Green family was unaware that their offered coverage included the four “abortifascent” methods, which they are religiously against and believe violates biblical principles. After the ACA was enacted, Hobby Lobby was contacted by The Beckett Fund for Religious Liberty, a non- profit public interest law firm dedicated to promoting religious freedom, who informed them of the new contraception coverage requirements and offered to represent them in fighting it. The Green family claimed that they were shocked that their company had been providing coverage of these contraception methods. They asked their insurer to discontinue cov- ering them and then evaluated their options.

If it refused to comply with the requirement, Hobby Lobby would face a fine of $100 per employee per day, adding up to an enormous $475 million per year. If it refused to provide health insurance at all, it could be fined the still-hefty cost of up to $26 million

yearly, as well as lose the competitive advantage of its above-average health insurance plans—not to mention cutting out a significant piece of its “people over profit” corporate culture. Caught between legal compliance, unsustainable financial and business consequences, and the Green family’s refusal to be complicit in actions that violated their religious convictions, Hobby Lobby filed suit against the government in September 2012.

Over the next two years, the lawsuit went through the courts, from the federal district court (which ruled against Hobby Lobby, finding they were required to provide the coverage) to the circuit court of appeals (which reversed, finding Hobby Lobby could not be required to do so) and finally coming before the U.S. Supreme Court. As it did so, Hobby Lobby found itself at the center of a polarized public debate over the argu- ments and potential effects of the lawsuit. Some saw the case as a clear exercise of religious freedom—private owners running their company the way they saw fit. Others were outraged and saw it as quite the opposite— a single religious family using their company to impose their beliefs on thousands of women and thus trampling their employees’ own religious freedom, reproduc- tive freedom, freedom of choice, and more. Were for- profit corporations even capable of holding religious values that would enable them to be protected by the Constitution and/or laws promoting religious freedom? If Hobby Lobby won, would it unleash a number of lawsuits from companies attempting to claim religious exemptions to everything, from social security contri- butions to the minimum wage? On the other hand, if Hobby Lobby lost, what would it mean for the future of the company and for the claims of the many other companies (as of June 2014, at least 80) also challeng- ing the contraceptive mandate?

On June 30, 2014, the U.S. Supreme Court issued a divided 5-4 decision in Burwell v. Hobby Lobby. Consolidating the Hobby Lobby claims with the essen- tially identical claims of two other companies, the majority of the Court found that none of them could be required to cover the four “abortifascent” contracep- tion methods. This ruling was not based directly on the First Amendment’s protection of religious free exercise but rather on a 1993 law called the Religious Freedom Restoration Act (RFRA), which proscribed limits on the federal government’s ability to burden free exercise of religion. One of these limits was that the govern- ment’s action must be “the least restrictive means” of accomplishing its goal. The Court found that the RFRA could be applied to protect private, closely held cor- porations; that such corporations were legally capable

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474 Business and Society

of “exercising religion” through religiously motivated business practices and the beliefs of their private own- ers; and that the contraception mandate was not the least restrictive means to provide contraceptive cover- age to business employees, as clear alternatives existed such as the government allowing employers to opt out and then provide the coverage directly itself.

The Court emphasized that its holding was narrow, applying only to the contraceptive mandate, and claimed its holding should have little effect on whether employ- ees can actually get contraceptive coverage. According to the Court, it only applies to whether employers must provide it under the ACA. Regardless of the details, however, the decision was a clear victory for the Green family. They would no longer be required to choose between endangering the future financial stability of their company and violating their Christian convictions, and—in this aspect at least—could continue to run Hobby Lobby the way they felt was right.

This could have major consequences for businesses. Essentially, the ruling states that Hobby Lobby employ- ees can receive free contraceptive coverage through third parties, much as non-profits can. One issue is how to define a closely held corporation. The definition of a closely held corporation is important because it will determine whether a for-profit business has the same rights and exemptions as a nonprofit. The Department of Health and Human Services (HHS) has recommend- ed that closely held corporations should include those that do not have publicly traded shares and where there is a limited or specified number of shareholders. HHS believes a solid definition is needed to protect the rights of closely held corporations to exercise their religious freedom while simultaneously giving women right to contraceptive care.

The future implications of this saga on Hobby Lobby’s public reputation and business success remain to be seen. Many who were previously unaware of the company’s religious underpinnings may now see the company in a different light, and choose accord- ingly. This is not helped by the large amount of mis- information that has circulated about the case, from what exactly Hobby Lobby was suing over (refusal to support what they saw as abortive measures, not contraception as a whole) to the true implications of the Supreme Court’s ruling (much narrower and less wide-ranging than many have stated). The Green family made a choice as to which values to uphold, and only time will tell the consequences.

A Final Wrinkle—Hobby Lobby’s 401(k) Plans Some critics of Hobby Lobby’s stance on the contra- ception mandate have noted that the 401(k) plans Hobby Lobby offers its employees allow investment in companies that are manufacturing the very contracep- tive methods Hobby Lobby sued to be free of support- ing. Being as Hobby Lobby holds over $73 million in mutual funds and 401(k) plans and contributes large matching funds to its employees’ investments, these crit- ics see contradiction and hypocrisy in the Green family’s apparent decision to fight in one arena and let the other be. Does this exhibit complacent management? Is the company truly as deeply based on Christian principles as it claims?

Supporters of Hobby Lobby point to what they see as essentially important distinctions between providing insurance coverage of “abortifascent” contraception methods and contributing to 401(k) plans that include investments in the companies that make them. For example, employees choose what to invest their plans in; Hobby Lobby’s involvement is completely passive, unlike a mandate to specifically pay for the contracep- tion. Also, 401(k) funds necessarily involve diversified portfolios of investments in hundreds or even thousands of companies, making the link much more indirect and attenuated. Whether these arguments are satisfactory likely depends on the individual, but they again show the balance Hobby Lobby must attempt to achieve between its biblical foundations and the realities of its business operations and decision-making.

CONCLUSION Although Hobby Lobby is founded on biblical prin- ciples, they have faced several ethical challenges and risks as a company. Their strong religious beliefs make them competitive, and they believe this has contributed to their continued success. The leadership of Hobby Lobby is committed to a greater good through corpo- rate socially responsible behavior, such as donations to communities and giving back through other means. Another factor of their social responsibility is the fact that they have great benefits for their employees. Ethical leadership drives the benefits offered to their employees. Having wages above minimum wage, offering above normal healthcare coverage, being closed on Sundays,

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Case 5  Hobby Lobby: Balancing Stakeholders and Religious Freedom in Business Decisions 475

and having shorter than normal work days benefit the employees and create a favorable workplace. On the other hand, some of their customers would like to make purchases on Sunday, so Hobby Lobby does miss out on this opportunity for sales. In addition, some consumers may think Hobby Lobby closing on Sunday is an attempt to force the acceptance of their religious principles.

While there would almost be unanimous agree- ment that Hobby Lobby’s ethical intentions are sound, some critics might argue that the principles, values, and beliefs of specific stakeholders such as consumers and employees should be respected. There are concerns about taking an individual’s personal principles and being in a position of power to enforce those principles on others. However, in this case, employees and cus- tomers can analyze the facts and decide whether they want to work for Hobby Lobby or be a customer. The conflicts and controversies associated with the success- ful appeal to the Supreme Court to restrict the coverage of “abortifascients” will continue.

Although Hobby Lobby has been ethical in responding to the challenges they have faced in the past, the Affordable Care Act really brings their beliefs into view. The ruling of this case is at the forefront as some other companies in the future might be able to file similar lawsuits claiming religious beliefs for not offer- ing benefits or certain rights to employees. The ruling was in favor of Hobby Lobby, and this could enable other companies to be exempt for at least some benefits to employees.

The challenge for Hobby Lobby will be to main- tain a strong reputation as a religious organization while still accepting others’ rights. Hobby Lobby is a positive example of a business and will demonstrate the character of their company through the future decisions they have to make. The lawsuit against the government is a display of their religious beliefs, and their success in obtaining the right to withhold certain medical benefits illustrates their commitment to principles. On the other hand, stakeholders may continue to question the Green family because there are firms in the 401(k) plans that are involved with the type of contraceptives they claim to be against. This might violate some of their principles.

The ethics of the Green family and the running of the for-profit company Hobby Lobby has been strong in the past. However, the Affordable Care Act has brought to light some ethical leadership challenges, and how Hobby Lobby faces them will determine the future of this company.

Questions for Discussion 1. Should the founders and owners of a private com-

pany that serves the public incorporate their reli- gious values in the policies that impact the behavior of employees, consumers, and other stakeholders?

2. Evaluate the decision of Hobby Lobby to spend considerable resources in refusing to offer cover- age of “abortifascient” birth control methods and taking their fight to the U.S. Supreme Court.

3. How will the U.S. Supreme Court decision in Burwell v. Hobby Lobby (divided 5-4 deci- sion) impact Hobby Lobby’s stakeholders and its future success?

Sources Susan Berfield, “Does God Hate Obamacare? Hobby

Lobby Takes Its Case to the Supreme Court,” Bloomberg Businessweek, April 2014, pp. 76–79.

ChristiaNet, “Hobby Lobby CEO, David Green,” ChristiaNet, 2012, http://christiannews.christianet. com/1096289115.htm (accessed August 10, 2016).

Forbes, “America’s Largest Private Companies,” http:// www.forbes.com/companies/hobby-lobby-stores/ (accessed August 10, 2016).

Jaime Fuller, “Here’s What You Need to Know About the Hobby Lobby Case,” The Washington Post, March 24, 2014, https://www.washingtonpost.com/news/the-fix/ wp/2014/03/24/heres-what-you-need-to-know-about- the-hobby-lobby-case/ (accessed August 10, 2016).

Billy Hallowell, “Hobby Lobby President Apologizes, Pledges to Carry Jewish Holiday Items After Blogger Claims Worker Said They Don’t ‘Cater to You People’,” The Blaze, October 7, 2013, http://www.theblaze.com/ stories/2013/10/07/hobby-lobby-president-apologizes- pledges-to-carry-jewish-holiday-items-after-blogger- claims-worker-said-they-dont-cater-to-you-people/ (accessed August 10, 2016).

Hobby Lobby, Customer Service: Frequently Asked Questions, 2014, http://www.hobbylobby.com/custom- er_service/faq.cfm (accessed August 10, 2016).

Hobby Lobby, “Hobby Lobby Marks 40 Years of Helping Families Celebrate Life,” Business Wire, September 8, 2010, http://www.businesswire.com/news/ home/20100908006739/en/Hobby-Lobby-Marks-40- Years-Helping-Families (accessed August 10, 2016).

“Hobby Lobby,” Our Story, http://www.hobbylobby.com/ about-us/our-story (accessed August 10, 2016).

Hobby Lobby, Burwell v. Hobby Lobby: FAQ, http://www. hobbylobbycase.com/faq/ (accessed August 10, 2016).

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Alex Murashko, “Hobby Lobby’s President Honored for Practicing Biblical Values in the Marketplace,” The Christian Post, February 5, 2013, http://www.chris tianpost.com/news/hobby-lobbys-president-honored- for-practicing-biblical-values-in-marketplace-89462/ (accessed August 10, 2016).

PR Newswire iReach, “Hobby Lobby comments on Chik- Fil-A,” PR Newswire, August 5, 2012, http://www. prnewswire.com/news-releases/hobby-lobby-comments- on-chik-fil-a-165046896.html (accessed August 25, 2014).

Thomas Reese, “In the Hobby Lobby case before the Supreme Court, law is not the ethics,” National Catholic Reporter: The Independent News Source, April 11, 2014, https://www.ncronline.org/blogs/faith- and-justice/hobby-lobby-case-supreme-court-law-not- ethics (accessed August 10, 2016).

The Seattle Times, “Hobby Lobby CEO Green joins Giving Pledge list,” The Seattle Times, December 10, 2010, http://seattletimes.com/html/businesstechnology /2013642781_apusgivingbywealthyokla.html (accessed August 10, 2016).

Sanjeev Sriram, “My Faith Is Offended by Inequality, Not Birth Control,” Huff Post: Politics, March 26, 2014, http://www.huffingtonpost.com/sanjeev-k-sriram/ my-faith-is-offended-by-i_b_5031689.html (accessed August 10, 2016).

Nina Totenberg, “Hobby Lobby Contraceptive Case Goes Before Supreme Court,” NPR, March 25, 2014, http:// www.npr.org/2014/03/25/293956170/hobby-lobby- contraceptive-case-goes-before-supreme-court (accessed August 10, 2016).

Supreme Court of the United States, Burwell, Secretary of Health and Human Services, et al. v. Hobby Lobby Stores, Inc., et al.: Certiorari to the United States Supreme Court of Appeals for the Tenth Circuit, No. 13-354, June 30, 2014.

Ilya Shapiro, “Hobby Lobby: Government Can’t Violate Religious Liberties Willy-Nilly,” The Federalist, July 1, 2014, http://thefederalist.com/2014/07/01/hobby-lobby- government-cant-violate-religious-liberties-willy-nilly/ (accessed August 10, 2016).

Mark L. Russell, “A Candid Interview with David Green Founder and CEO of Hobby Lobby,” The High Calling, October 25, 2014, http://www.thehighcalling. org/leadership/candid-interview-david-green-founder- and-ceo-hobby-lobby (accessed August 25, 2014).

Ryan Ellis, “Hobby Lobby Owners Can Have a 401(k) and First Amendment Rights,” Forbes, July 1, 2014, http:// www.forbes.com/sites/ryanellis/2014/07/01/hobby- lobby-owners-can-have-a-401k-and-first-amendment- rights/#909f6e35b54f (accessed August 10, 2016).

Alex Kocman, “Hobby Lobby Raises Minimum Wage to $14: What Happens When Govt Doesn’t Tie Businesses’ Hands,” Charisma News, July 3, 2014, http://www. charismanews.com/marketplace/44543-hobby-lobby- raises-minimum-wage-to-14-what-happens-when- govt-doesn-t-tie-businesses-hands (accessed August 10, 2016).

Susan Thurston, “Hobby Lobby’s Religious Convictions Aren’t for Sale,” Tampa Bay Times, January 10, 2014, http://www.tampabay.com/news/business/retail/hobby- lobbys-religious-convictions-arent-for-sale/2160568 (accessed August 10, 2016).

Glenn Kessler, “Hillary Clinton’s Claim That Hobby Lobby Wanted to Stop Covering All Contraceptive Procedures,” Washington Post, July 3, 2014, https:// www.washingtonpost.com/news/fact-checker/ wp/2014/07/03/hillary-clintons-claim-that-hobby- lobby-wanted-to-stop-covering-all-contraception- procedures/ (accessed August 10, 2016).

Maggie Fox, “Supreme Court on Birth Control: What Hobby Lobby Ruling Means,” NBC News, June 30, 2014, http://www.nbcnews.com/health/health-care/ supreme-court-birth-control-what-hobby-lobby-ruling- means-n144526 (accessed August 10, 2016).

Kent Hoover, “HHS Issues Contraception Workaround in Response to Hobby Lobby Ruling,” Columbus Business First, August 22, 2014, http://www.biz- journals.com/columbus/news/news-wire/2014/08/22/ hhs-issues-contraception-workaround-in-response-to. html?ana=e_abq_rdup&s=newsletter&ed=2014- 08-25&u=38ahMxn8yHTkJb3pqpxi7Q091b98b0 &t=1408977152 (accessed August 10, 2016).

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INTRODUCTION Howard Schultz joined Starbucks in 1982 as director of retail operations and marketing. Returning from a trip to Milan, Italy, with its 1,500 coffee bars, Schultz recognized an opportunity to develop a similar retail coffee bar culture in Seattle.

In 1985, the company tested the first downtown Seattle coffeehouse, served the first Starbucks café latté, and introduced its Christmas Blend. Since then, Starbucks expanded across the United States and around the world, now operating over 24,000 stores in 70 countries. Historically, Starbucks grew at a rate of about three stores a day, although the company cut back on expansion in recent years. The company serves approximately 70 million customers per week and has revenues of approximately $19 billion a year. It is the largest coffeehouse company in the world.

Starbucks locates its retail stores in high-traffic, high- visibility locations. The stores are designed to provide an inviting coffee bar environment that is an important part of the Starbucks product and experience. It was the intention of Howard Schulz to make Starbucks into “the third place” for consumers to frequent, after home and work. Because the company is flexible regarding size and format, it locates stores in or near a variety of settings, including office build- ings, bookstores, and university campuses. It can situate retail stores in select rural and off-highway locations to serve a broader array of customers outside major metro- politan markets and further expand brand awareness.

In addition to selling products through retail outlets, Starbucks sells coffee and tea products and licenses its trademark through other channels and its partners. For instance, its Frappuccino coffee drinks, Starbucks Doubleshot espresso drinks, super-premium ice creams, and VIA coffees can be purchased in gro- cery stores and through retailers like Walmart and Target. Starbucks partnered with Courtesy Products to create single-cup Starbucks packets marketed toward hotel rooms. Starbucks also partnered with Green

Mountain Coffee Roasters to introduce Starbucks- branded coffee and tea pods to the market. These pods target consumers who own Keurig single-cup brewing machines. Although the two businesses would normally be rivals, this partnership is beneficial for both Green Mountain and Starbucks. Since Green Mountain owns Keurig’s single-serve machines, the partnership enables Starbucks to access this technology to market a new product. Green Mountain benefits because the partner- ship generates new users of Keurig single-cup brewing machines attracted to the Starbucks name.

This partnership between Green Mountain and Starbucks did not stop Starbucks from launching its own line of single-serve machines. In 2012, Starbucks introduced its Verismo 580 Brewer that allows con- sumers to brew a cup of Starbucks coffee in their own homes (later versions include the Verismo 583 and 600). The coffee has the strong, bold flavor of a cup purchased in any Starbucks retail location. Starbucks offers a limited assortment of coffees to emphasize quality rather than quantity. Not to be outdone, Green Mountain released another type of single-serve coffee brewer called the Rivo. Unlike the Verismo, that uses powdered milk pods, the Rivo uses fresh milk. The race to conquer the single-serve coffee market is intensifying between the two companies.

A common criticism of Starbucks is the company’s strategy for location and expansion. Its “clustering” strategy, placing a Starbucks literally on every cor- ner in some cases, forced many smaller coffee shops out of business. This strategy dominated for most of the 1990s and 2000s and Starbucks became the butt of jokes. Many people began to wonder whether two Starbucks directly across the street from each other were really needed. The last recession brought a change in policy, however. Starbucks pulled back on expansion, closed hundreds of stores around the United States, and focused more on international markets. Now Starbucks is beginning to focus on U.S. expansion once more.

CASE 6

Starbucks’ Mission: Social Responsibility and Brand Strength

*This case was prepared by Michelle Urban and Jennifer Sawayda for and under the direction of O.C. Ferrell and Linda Ferrell © 2015. It was prepared for classroom discussion rather than to illustrate either effective or ineffective handling of an administrative, ethical, or legal decision by management. All sources used for this case were obtained through publicly available material and the Starbucks website.

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At the end of 2014, Starbucks opened a 15,000 square-foot Starbucks Reserve Roastery and Tasting Room in Seattle, a place where coffee is roasted, bagged, sold, and shipped internationally. Equipped with a Coffee Library and Coffee Experience Bar, the roastery is intended to redefine the coffee retail experience for customers. The roastery sells 28-30 different coffees and gets 1,000 to 2,000 customers daily. CEO Howard Schultz believes the roastery has the potential to redefine the Starbucks retail experi- ence. Starbucks has also added local Mora ice cream to the product line at the roastery so consumers can create Affogato-style beverages (espresso poured over ice cream).

NEW PRODUCT OFFERINGS Starbucks introduced a number of new products over the years to remain competitive. In 2008, Starbucks decided to return to its essentials with the introduc- tion of its Pike Place Blend. The company hoped that the blend would return Starbucks to its roots of distinctive, expertly blended coffee. In order to get the flavor perfect, Starbucks enlisted the inputs of 1,000 customers over 1,500 hours. To kick off the new choice, Starbucks held the largest nationwide coffee tasting in history. To make the brew even more appealing, Starbucks joined forces with Conservation International to ensure the beans were sustainably har- vested. Also, after feedback revealed many of its cus- tomers desired a lighter blend, Starbucks introduced Blonde Roast blend in 2011. In 2015 the company commercialized the Flat White based on a latte drink popular in Australia. Unlike previous new offerings, the company did not perform limited-market testing but instead introduced it nationwide in an attempt to remain competitive with rivals.

Starbucks executives believe the experience customers have in the stores should be consistent. Therefore, Starbucks began to refocus on the customer experience as one of the key competitive advantages of the Starbucks brand. To enhance the European coffee shop experience for which Starbucks is known, shops are replacing their old espresso machines with new, high-tech ones. To keep the drink-making operation running efficiently and accurately, Starbucks mandated baristas to make no more than two drinks at the same time. It is also introducing more lines of single-origin coffees to appeal to coffee enthusiasts interested in where their coffee comes from.

Additionally, Starbucks fosters brand loyalty by increasing repeat business. One of the ways it accom- plishes this is through the Starbucks Card, a reloadable card introduced in 2001. For the tech-savvy visitor, Starbucks introduced the Starbucks Reward Mobile app. With the app customers are able to order or pre-order their coffee, and merely scan their phone for payment. Today the company has 12 million active users of its Starbucks Rewards mobile app –the third most popular digital payment app in the country. It is estimated that Starbucks processes 5 million mobile payments a week. Howard Schultz believes the future is digital and is plac- ing more emphasis on digital marketing strategies.

STARBUCKS CULTURE In 1990, Starbucks’ senior executive team created a mission statement that specified the guiding principles for the company. They hoped the principles included in the mission statement would assist partners in determin- ing the appropriateness of later decisions and actions. After drafting the mission statement, the executive team asked all Starbucks partners to review and comment on the document. Based on their feedback, the final statement put “people first and profits last.” In fact, the number one guiding principle in Starbucks’ mission statement is to create a great and respectable work envi- ronment for its employees.

Starbucks has done three things to keep the mission and guiding principles alive over the decades. First, it distributes the mission statement and comment cards for feedback during orientation to all new partners. Second, Starbucks continually relates decisions back to the guiding principle or principles it supports. These principles focus on coffee, partners, customers, stores, neighborhoods, and shareholders. And finally, the company formed a “Mission Review” system so partners can comment on a decision or action relative to its consistency with one of the six principles. These guiding principles and values have become the cornerstone of a strong ethical culture of predominately young and educated workers.

Starbucks founder and CEO Howard Schultz has long been a public advocate for increased awareness of ethics in business. In a 2007 speech at Notre Dame, he spoke to students about the importance of balancing “profitability and social consciousness.” Schultz is a true believer that ethical companies do better in the long run, something that has been confirmed by research. Schultz maintains that, while it can be difficult to do the right thing at all times, in the long term it is better

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for a company to take short-term losses than lose sight of its core values.

The care the company shows its employees is a large part of what sets it apart. Starbucks offers all employees who work more than 20 hours per week a comprehensive benefits package that includes stock options as well as medical, dental, and vision benefits. In another effort to benefit employees, Starbucks partnered with Arizona State University (ASU) to offer tuition assistance to those who want to earn a degree from the university’s online program. In 2014, it was voted as one of the most ethical companies on Ethisphere’s annual list for the eighth consecutive year.

Another key part of the Starbucks image involves its commitment to ethics and sustainability. To address concerns related to these issues, Starbucks launched the Shared Planet website. Shared Planet has three main goals: to achieve ethical sourcing, environmental stewardship, and greater community involvement. The website is a means of keeping customers current on initiatives within the company. It describes how well Starbucks fares on achieving its social responsibility goals, and it provides a means for customers to learn things like the nutrition data of Starbucks’ offerings and other concerns related to Starbucks products.

Starbucks actively partners with nonprofits around the globe. Starbucks is one of the largest buyers of Fair Trade Certified as well as certified organic coffee. It also purchased 4.4 million pounds of certified organic coffee. Another organization Starbucks partnered with is the Foodservice Packaging Institute/Paper Recovery Alliance. The partnership addresses the issue of respon- sible foodservice packaging in terms of its use, recovery, and processing. Starbucks has invested over $70 million in programs for farmers around the world.

Conservation International joined with Starbucks in 1998 to promote sustainable agricultural practices, namely shade-grown coffee, and help prevent deforesta- tion in endangered regions around the globe. The results of the partnership proved to be positive for both the environment and the farmers. For example, in Chiapas, Mexico, shade-grown coffee acreage (that reduces the need to cut down trees for coffee plantations) increased well over 220 percent, while farmers receive a price premium above the market price. Starbucks and Oprah, two of the biggest global brands, joined forces to create Oprah’s Chai Tea in 2014. A specially created blend from the stores of Teavana, one of Starbucks’ most recent acquisitions, these branded products contribute to youth education programs. All profits made from this tea go toward this cause.

Starbucks works with many other organizations as well, including the African Wildlife Foundation and Business for Social Responsibility. The company’s efforts at transparency, the treatment of its workers, and its dozens of philanthropic commitments demonstrate how genuine Starbucks is in its mission to be an ethical and socially responsible company.

CORPORATE SOCIAL MISSION Although Starbucks supported responsible business practices virtually since its inception, as the company has grown, so has the importance of defending its image. At the end of 1999, Starbucks created a Corporate Social Responsibility department, now known as the Global Responsibility Department. Global Responsibility releases an annual report in order for shareholders to keep track of its performance and can be accessed through the Shared Planet website. Starbucks is con- cerned about the environment, its employees, suppliers, customers, and communities. Howard Schultz has com- mented that achieving social change to improve society is an important part of the company’s core identity.

Environment In 1992, long before it became trendy to be “green,” Starbucks developed an environmental mission statement to clearly articulate the company’s environmental priori- ties and goals. This initiative created the Environmental Starbucks Coffee Company Affairs team, the purpose of which was to develop environmentally responsible policies and minimize the company’s “footprint.” As part of this effort, Starbucks began using environmental purchasing guidelines to reduce waste through recycling, conserving energy, and educating partners through the company’s “Green Team” initiatives. Concerned stake- holders can now track the company’s progress through its website that clearly outlines Starbucks’ environmental goals and how the company fares in living up to those goals. Starbucks also began offering a $1 plastic cup for purchase that is good for a recommended 30 uses.

Employees Growing up poor with a father whose life was nearly ruined by an unsympathetic employer who did not offer health benefits, Howard Schultz always considered the creation of a good work environment a top priority. He

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believes companies should value their workers. When forming Starbucks, he decided to build a company that provided opportunities his father did not have. The result is one of the best healthcare programs in the coffee shop industry. Schultz’s key to maintaining a strong business is developing a shared vision among employees as well as an environment to which they can actively contribute. Understanding how vital employees are, Schultz is the first to admit his company centers on personal interactions: “We are not in the coffee business serving people, but in the people business serving cof- fee.” Starbucks is known for its diversity, and 40 percent of its baristas are ethnic minorities.

However, being a great employer does take its toll on the company. In 2008, Starbucks closed 10 percent of stores in order to continue to provide employees with health insurance. This decision, based on its guiding principle of “people first, profits last,” shows how much the company values its employees.

Employees have an opportunity to join Starbuck’s stock-sharing program called Bean Stock. They have generated $1 billion in financial gains through stock options. In 2015 Starbucks gave employees a raise and increased starting pay rates across the country.

As a way to improve employee health, Starbucks established a program for employees called “Thrive Wellness” that offers various resources aimed at assist- ing employees in incorporating wellness into their lives. The program offers resources such as smoking cessation, weight loss, and exercise. Starbucks also estimates that 70 percent of employees are either currently in college or desire to earn a degree. The aforementioned partner- ship with ASU provides this opportunity as students can choose from 40 programs online or in-person with no obligation to remain as a Starbuck’s employee while receiving or achieving their degree. More than 2,000 employees applied to the program when it was initially launched. The rising cost of education is an important issue that CEO Howard Schultz wants to help alleviate.

Suppliers Even though it is one of the largest coffee brands in the world, Starbucks maintains a good reputation for social responsibility and business ethics throughout the international community of coffee growers. It builds positive relationships with small coffee suppliers while also working with governments and nonprofits wherever it operates. Starbucks practices conserva- tion as well as Starbucks Coffee and Farmer Equity

Practices (C.A.F.E.), a set of socially responsible cof- fee buying guidelines that ensure preferential buying status for participants that receive high scores in best practices. Starbucks pays coffee farmers premium prices to help them make profits and support their families. More than 95 percent of total coffee purchases are C.A.F.E. verified, and the company is on track to have 100 percent of its coffee purchases verified by 2015.

The company is also involved in social development programs, investing in programs to build schools and health clinics, as well as other projects that benefit cof- fee-growing communities. Starbucks collaborates direct- ly with some of its growers through Farmer Support Centers, located in Costa Rica, Rwanda, Tanzania, South America, and China. Farmer Support Centers provide technical support and training to ensure high-quality coffee into the future. In 2013, Starbucks donated approximately $11 million for loans and farmer sup- port programs, with the goal of reaching $20 million for the 2015 year. It is a major purchaser of Fair Trade Certified, shade-grown, and certified organic beans that further support environmental and economic efforts. The purchase was one step toward Starbucks’ goal of increas- ing its ethically sourced coffee to 100 percent by 2015.

Customers Strengthening its brand and customer satisfaction is more important than ever as Starbucks seeks to regroup after the latest recession forced the company to rethink its strategy. Starbucks refocused the brand by upgrading its coffee-brewing machines, introducing new food and drink items for health and budget-conscious consumers, and refocusing on its core product. Recognizing the concern over the obesity epidemic, Starbucks ensures that its grab-and-go lunch items are under 500 calories and is involved in two sodium reduction programs: the National Salt Reduction Initiative in New York and the UK Food Standards Agency Salt Campaign. The company focuses more on the quality of the coffee, the atmosphere of the coffee shops, and the overall Starbucks experience, rather than continuing its rapid expansion of stores and products. Enhancing the cus- tomer experience in its stores became a high priority. As a way to encourage people to relax and spend time there, Starbucks offers free wireless Internet access in all its U.S. stores. They have also partnered with Duracell Powermat to install over 100,000 wireless phone char- gers in Starbucks and Teavana locations across the United States.

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Communities Starbucks coffee shops have long sought to become the “instant gathering spot” wherever they locate, a “place that draws people together.” The company established community stores, which not only serve as a meeting place for community programs and trainings but also as a source of funding to solve issues specific to the local community. There are currently five such loca- tions (including one in Thailand), and Starbucks aims to establish a total of 50 by 2018. Schultz even used the advance and ongoing royalties from his book, Pour Your Heart into It, to create the Starbucks Foundation that provides opportunity grants to nonprofit literacy groups, sponsors young writers’ programs, and part- ners with Jumpstart, an organization helping children prepare developmentally for school. The company announced its intention to hire 10,000 veterans by 2018.

Additionally, Starbucks takes a proactive approach to addressing employment opportunities and job train- ing. The company has joined other firms to support the “100,000 Opportunities Initiative,” with the goal to create 100,000 employment and internship opportuni- ties for lower-income youth between 16 and 24 years of age. Howard Schultz helped spearhead the initiative and announced plans to hire 10,000 young workers over a three-year period. Starbucks also announced it was building 15 new store locations in lower-income, predominately minority neighborhoods in an attempt to improve communities through employment, educa- tion, and training. For instance, its location in Ferguson, Missouri acts as a coffee shop as well as a job training facility for community members. Starbucks also plans to partner with local organizations to sell their products in its stores.

BRAND EVOLUTION Although Starbucks achieved massive success in the last four decades, the company realizes it must modify its brand to appeal to changing consumer tastes. All established companies, no matter how successful, must learn to adapt their products and image to appeal to the shifting demands of their target markets. Starbucks is no exception. The company is associated with premium coffee beverages, an association that served it well over the years. However, as competition in specialty cof- fee drinks increases, Starbucks recognized the need to expand its brand in the eyes of consumers.

One way it is doing this is through adopting more products. In addition to coffee, Starbucks stores sell cof- fee accessories, teas, muffins, CDs, water, grab-and-go products, Starbuck Petites, upscale food items, hand- crafted sodas called Fizzios, as well as wine and beer in select locations. Food sales make up 20 percent of Starbucks’ revenue. The rise in coffee prices has created an opportunity for expansion into consumer packaged goods that will protect Starbucks against the risks of relying solely on coffee. In order to remain competitive, Starbucks made a series of acquisitions to increase the value of its brand, including Bay Bread (a small artisan bakery), La Boulange (a bakery brand), Evolution Fresh (a juice brand), and Teavana (a tea brand). This allowed Starbucks to offer high quality breakfast sandwiches as well as Paninis and wraps for lunch.

To symbolize this shift into the consumer packaged goods business, Starbucks gave its logo a new look. Previously, the company’s circular logo featured a mer- maid with the words “Starbucks Coffee” encircling it. In 2011, Starbucks removed the words and enlarging the mermaid to signal to consumers Starbucks is more than just the average coffee retailer.

SUCCESS AND CHALLENGES For decades, Starbucks revolutionized our leisure time. Starbucks is the most prominent brand of high-end cof- fee in the world but also one of the defining brands of our time. In most large cities, it is impossible to walk more than a few blocks without seeing the familiar mermaid logo.

In the past few decades, Starbucks achieved amaz- ing levels of growth, creating financial success for shareholders. Starbucks’ reputation is built on product quality, stakeholder concern, and a balanced approach to all of its business activities. Of course, Starbucks does receive criticism for putting other coffee shops out of business and creating a uniform retail culture in many cities. Yet the company excels in its relationship with its employees and is a role model for the fast-food industry in employee benefits. In addition, in an age of shifts in supply chain power, Starbucks is as concerned about its suppliers and meeting their needs as it is about any other primary stakeholder.

In spite of Starbucks’ efforts to support sustainabil- ity and maintain high ethical standards, the company garnered harsh criticism in the past on issues such as a lack of fair trade coffee, hormone-added milk, and Howard Schultz’s alleged financial links to the Israeli

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government. In an attempt to counter these criticisms, in 2002 Starbucks began offering Fair Trade Certified coffee, a menu item that was quickly made permanent. Approximately 95 percent of coffee in the United States is ethically sourced currently.

Starting in late 2008, Starbucks had something new to worry about. A global recession caused the market to bottom out for expensive coffee drinks. The company responded by slowing its global growth plans after years of expanding at a nonstop pace and instead refo- cused on strengthening its brand, satisfying customers, and building consumer loyalty. After Starbucks stock started to plummet, Howard Schultz returned as CEO to return the company to its former glory.

Schultz was successful, and Starbucks rebounded from the effects of the recession. The company is once again looking toward possibilities in international markets. This represents both new opportunities and challenges. When attempting to break into the U.K. market, for instance, Starbucks met with serious resis- tance. Realizing the homogenization of its stores did not work as well in the United Kingdom, Starbucks began to remodel its stores so they took on a more local feel. At the end of 2012, Starbucks came under public scrutiny for allegedly not paying taxes for the last 14 of the 15 years they were established in the United Kingdom. A protest group called UK Uncut began “sitting in” at the stores, encouraging coffee drinkers to buy their coffee elsewhere. Starbucks claims it did not pay taxes because it did not make a profit. However, the company said it would stop using certain accounting techniques that showed their profits overseas. Starbucks also agreed to pay 20 million pounds over the next two years, whether or not it makes a profit.

Starbucks is rapidly expanding in China, and the country set to become the company’s second largest market behind the United States. Starbucks effectively overcame obstacles in tapping into the Chinese market and adapted its strategy to attract Chinese consum- ers. After the 2007 closure of the retail operation in the Forbidden City, resulting from cultural concerns of the presence of a Western staple in a sacred area, Starbucks became more sensitive to the specific needs and nuances of the country. Through educating Chinese consumers on coffee (because the beverage is not largely consumed there), they are now drinking as much coffee as Americans.

Another challenge Starbucks must address is despite the company’s emphasis on sustainability, billions of disposable Starbucks cups are thrown into landfills each year. Although Starbucks has taken initiatives to make

the cups more ecofriendly, such as changing from poly- ethylene No. 1 to the more ecofriendly polypropylene No. 5, the cup represents a serious waste problem for Starbucks. Starbucks encourages consumers to bring in reusables (such as the Starbucks tumblers it sells) for a 10-cent rebate, yet these account for less than 2 percent of drinks served. The company hopes to achieve less cup waste with its new $1 reusable cup. It remains to be seen whether Starbucks will achieve its goal of total recyclabil- ity in the short term.

CONCLUSION Despite the setbacks it experienced during the reces- sion, the future looks bright for Starbucks. In 2015 the company underwent a 2-for-1 stock split as its way of addressing record highs in the company’s stock history. It is estimated the Starbucks shares have quadrupled four times over the past five years. The company contin- ues to expand globally into markets such as Bangalore, India; San Jose, Costa Rica; Oslo, Norway; and Ho Chi Minh City, Vietnam. Schultz is hopeful that the new roastery in Seattle will continue to spread the Starbucks name and the distribution of its coffee globally. The challenges the company experienced and will continue to experience in the future have convinced the firm to focus on its strengths and embrace the opportunity to emphasize community involvement, outreach work, and its overall image and offerings. The company must continue to apply the balanced stakeholder orientation that is so crucial to its success.

Questions for Discussion 1. Why do you think Starbucks has been so con-

cerned with social responsibility in its overall corporate strategy?

2. Is Starbucks unique in being able to provide a high level of benefits to its employees?

3. Do you think Starbucks has grown rapidly because of its ethical and socially responsible activities or because it provides products and an environment customers want?

Sources Chris Barth, “Green Mountain Hopes to Beat Starbucks

in the U.S. with One Simple Ingredient,” Forbes, November 9, 2012, http://www.forbes.com/sites/chris-

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barth/2012/11/09/green-mountain-hopes-to-beat-star- bucks-in-the-u-s-with-one-simple-ingredient/ (accessed August 10, 2016).

Susan Berfield, “Starbucks’ Food Fight,” Businessweek, June 12, 2012, http://www.businessweek.com/articles/ 2012-06-12/starbucks-food-fight (accessed August 10, 2016).

Christine Birkner, “Taking Care of Their Own,” Marketing News, February 2015, pp. 45–49.

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CASE 7

Lululemon: Encouraging a Healthier Lifestyle

INTRODUCTION Lululemon Athletica is an athletic apparel company intended for individuals with active lifestyles. The orga- nization has deep roots in the yoga community and is one of the few businesses to offer apparel for this spe- cific market. Lululemon is based in Vancouver, British Columbia, Canada, and operates its clothing stores in numerous countries throughout the world. The apparel store offers product lines that include fitness pants, shorts, tops, and jackets for activities such as yoga, run- ning, and other fitness programs. It operates in three segments. These segments consist of corporate-owned and operated retail stores, a direct to consumer e-com- merce website, and wholesale avenues. As of 2015, the company operates 354 stores predominantly in the United States, Canada, Australia, and New Zealand. With nearly 2,800 employees, Lululemon has grown rapidly in the last 20 years and is expected to continue its growth strategy well into the foreseeable future. It has also established a subsidiary geared toward youth called Ivivva Athletica.

Store growth and expansion into other countries has allowed Lululemon to achieve financial success. The organization has seen continuous increases in revenue, with its annual revenue over $2 billion. Over the past four years, Lululemon has consistently posted annual revenue increases of about $300 million. While financially stable, the organizational structure has seen changes with the hiring of a new CEO. Lululemon hired Laurent Potdevin in January of 2014 hoping to appoint a worthy and experienced industry professional. The company also hopes to distance itself from negative headlines circling former CEO Denis “Chip” Wilson. Potdevin was once the CEO at TOMS Shoes and has worked in the industry for over 20 years.

There is no question that Lululemon has seen great success in recent years. From its conception in 1998, the organization has grown tremendously in markets across

the globe. However, Lululemon’s success has also been tainted by controversy, negative publicity, and question- able ethical decisions. This case will detail the issues and controversies circling this organization and identify how Lululemon has managed these issues. In addition, we provide information regarding the positive ethical deci- sions that have been made throughout Lululemon’s history.

BACKGROUND Lululemon was founded by Denis “Chip” Wilson in 1998 in British Colombia, Canada. Prior to Lululemon, Wilson had spent two decades in the surf, skate, and snowboard business. He was looking for a change. After attending the first commercial yoga class offered in Vancouver, Wilson fell in love with the activity and felt incredible during and after the exercises. With a passion for technical athletic fabrics, Wilson realized that the current cotton clothing being used for power yoga was inappropriate and unpractical. Movements required breathability, flexibility, and a stretchiness that an individual could pour sweat into during exercise. With this in mind, Wilson created a design studio for his new clothing. Struggling to pay rent, the design studio became a yoga studio during the night hours. Yoga instructors who taught at the studio were asked to wear the new products and provided Wilson with useful insight and feedback on the clothing. In order to name the new company, Wilson surveyed 100 people and offered a list of 20 brand names as well as 20 logos. Lululemon is a created word that has neither roots nor meaning. It is believed that Wilson selected this name because he enjoys the sound of the 3 L’s when the word is spoken. The logo, which is actually a stylized letter A, was a logo intended for the brand name Athletically Hip, which was not selected as the company’s name.

The first store opened in November 2000, in the beach area of Vancouver, British Columbia. The store

*This case was prepared by Justus Adams, Kristen Bruner, Ivan Mora Juarez, and Jennifer Sawayda for and under the direction of O.C. Ferrell and Linda Ferrell ©2015. It was prepared for classroom discussion rather than to illustrate either effective or ineffective handling of an administrative, ethical, or legal decision by management. All sources used for this case were obtained through publicly available material.

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was intended to be a community-gathering place for individuals to discuss health topics like dieting, exercise, and cycling. However, the store was so popular and busy that satisfying the customer became nearly impos- sible. The business grew quickly as products were popu- lar among customers and the staff was eager to learn, expand, and challenge themselves.

From the beginning, Lululemon had a strong mission that embraced a healthy and active lifestyle. Inspired by author and philosopher Ayn Rand, Chip Wilson modeled Lululemon with the intent that involves “elevating the world from mediocrity to greatness.” The company adopted the following mission statement: “Creating components for people to live longer, healthi- er, fun lives.” Lululemon tries to reflect this in its corpo- rate culture. Store managers, for instance, are provided with much control over the operations of their stores, and Lululemon operates with a decentralized corporate culture. Lululemon employees are recruited and hired based on their level of commitment and how well they fit into the corporate culture. To bring its mission state- ment to fruition, Lululemon refers to its employees as “educators” to acknowledge the crucial role they play in helping customers to obtain a healthy and active lifestyle.

Lululemon stores today are focused heavily on community involvement and interaction with local enthusiasts. Nearly all stores host in-house events on a nightly or weekly basis, with classes ranging from beginner and advanced yoga to goal setting and self- defense workshops. Events and workshops generally occur after store hours and occur on the saleroom floor after racks and products have been moved.

Unlike many stores, Lululemon does not offer dis- counts, but sells approximately 95 percent of its prod- ucts at full price. It also sells its products at higher prices than its competitors, reflecting the value of Lululemon’s products. Lululemon operates on the concept of scarcity to encourage customers to buy immediately. Its store shelves often have fewer products than the shelves can hold, and many products have quick life cycle times such as six-week life cycles. Customers are therefore encouraged to purchase the product before it is gone, which is thought to be a major influence in Lululemon’s continued popularity and success with customers.

In order to anchor its mission statement, Lululemon has adopted seven core values: quality, product, integrity, balance, entrepreneurship, fun, and greatness. These val- ues serve to motivate employees and guide their decisions.

ETHICAL RISKS AND CHALLENGES Despite Lululemon’s strong mission statement and core values, Lululemon has faced much controversy over its history. Founder and former CEO Chip Wilson has also been criticized for controversial statements he has made, which eventually helped lead to his ouster as CEO. There have also been questions regarding whether Lululemon’s corporate culture—with its strong emphasis on greatness and competitiveness—is neces- sarily healthy for employees.

Founder Chip Wilson Lululemon founder Chip Wilson is thought of by many as a man with unorthodox opinions. Although Wilson has not been CEO since 2005, he has been known to do things without informing top manage- ment, such as printing out Lululemon tote bags with the phrase “Who Is John Galt?” from Ayn Rand’s Atlas Shrugged. A former CEO at Lululemon felt pressured by Wilson to attend the Landmark Forum, a leadership-development training program which Wilson highly supports. Wilson has performed other controversial actions that have generated concern from Lululemon’s board.

Much of the controversy around Chip Wilson centers on his statements. For instance, in a 2009 interview with Canada’s National Post Business Magazine, he admitted to having chosen the company name because “it’s funny to watch [Japanese] say it.” Wilson also stated on a blog his opinion that the rise in divorce rates and breast cancer among “Power Women” was due to a combination of smoking, taking birth control pills, and the additional stress which came from taking on the career responsibilities once held mostly by men. He attributed Lululemon’s growth as stemming from the coming together of “female education levels, breast cancer, yoga/athletics and the desire to dress feminine.”

Another highly controversial statement of Chip Wilson’s involves his opinions regarding child labor laws. Wilson argues that “third-world children should be allowed to work in factories because it provides them with much-needed wages.” He claims this can help lead citizens of these countries out of poverty. The practice of child labor is a hot-button

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issue in the Western world because of the poor working conditions and rampant abuse worldwide. This support of child labor has angered critics, who believe Lululemon might be exploiting children in developing countries. They argue that providing children with more education is much more likely to lift them out of poverty than having them earn low wages at a dangerous job. Lululemon founder Chip Wilson would continue to make controversial statements, eventually leading to his resignation as Chairman of the Board.

Chip Wilson later challenged the board, claiming that the current board was not aligned with Lululemon’s core values. He released this statement at the June 2014 shareholders meeting and voted against the board’s chairman and another director. Both men were re-elected. A few months later, Wilson sold half of his 27 percent stake to private equity organization Advent International, who in turn received two board seats on Lululemon’s board. With less of a stake in the firm, Wilson’s impact on decision-making at the organization may be reduced.

MISLEADING ADVERTISING In 2007, the New York Times cast doubt on the authenticity of Lululemon’s VitaSea line of products. Lululemon claimed that its VitaSea products were infused with seaweed, which had medicinal properties including stress relief. In November 2007, the New York Times released an article claiming that it had tested VitaSea products and could not find seaweed fiber in the product. This claim unleashed a storm of criticism.

Lululemon responded by refuting the claims of the New York Times. They cited independent tests performed the previous year. They also responded to the accusations by stating that a lab in Hong Kong had performed different tests on the product throughout the year, all of which confirmed that the products contained everything that they advertised.

However, Canada’s Competition Bureau chal- lenged Lululemon, not due to the content of the VitaSea product, but rather the company’s claims about the product’s health benefits. The bureau believed that these claims of health benefits from seaweed were unsubstantiated and ordered Lululemon to remove all such labeling.

Corporate Culture As mentioned earlier, Wilson founded his company on the values of Ayn Rand. The notion of striving for greatness resonated with Wilson after having read Rand’s book Atlas Shrugged at the age of 18. Since then, he has utilized the concept as a way to market his brand. This idea of “greatness” contributes to a competitive organizational culture. Wilson admits that the firm tries to hire employees with Type A person- alities, or those with more competitive personalities who are concerned with achievement and personal improvement. New hires read books selected by Chip Wilson that he feels is critical to personal development. Employees are also required to write out their goals for the next ten years, which are then posted in Lululemon stores. Employees are encouraged to exercise regularly and remain close-knit.

Some have questioned how this competitive culture obsessed with greatness fits in with the yoga tradition based on Buddhist and Hindu philosophies. Both ideolo- gies promote the notion of ridding one’s self of the Ego. The Ego is seen as a source of suffering, and Buddhism is based on the absolution of suffering. Enlightenment is achieved when the Ego has been successfully removed. There are specific postures used to accomplish this, and it can take years of practice. On the other hand, one of the criticisms of Lululemon goes back to Ayn Rand’s teachings and their promotion of “rugged individual- ism,” the elevation of mediocrity to greatness, and the relentless pursuit of happiness. Despite it being a busi- ness, some believe that these “individual” teachings do not belong in the yoga clothing industry, because they directly contradict the Vedic philosophy that underlies yoga. Others have claimed that Lululemon’s corporate culture is almost “cultish” in its style.

In March 2011, an employee of Lululemon located in Bethseda, Maryland was brutally murdered by her co-worker after hours. It is believed the employee had observed the co-worker trying to steal clothing from Lululemon. After the store closed, the co-worker lured the employee back into the store and brutally murdered her. She then attempted to make the scene look as if two masked men had broken in and harmed them. After the truth was revealed, the co-worker was sentenced to life in prison without parole.

Lululemon and many others attribute this bru- tality as a random act of violence. However, those who describe the corporate culture as “cultish” and

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Case 7  Lululemon: Encouraging a Healthier Lifestyle 489

“ competitive” argue that the culture creates an envi- ronment where employees are pressured to live up to company standards. Although this in itself is certainly not the reason for the murder, critics have sometimes charged Lululemon with having an unethical corporate culture promoting competition over collaboration.

Too-Sheer Yoga Pants A more recent ethical problem for Lululemon occurred in March 2013, when they released black Luon yoga pants that become sheer when the wearer bends over. They instituted a massive recall which comprised 17 percent of all the women’s pants sold in their stores. The recall resulted in large shortages, which impacted financial results and drove the stock price down. The company lost $2 billion in market value. Afterward, investors attempted to sue Lululemon, claiming that they purposefully hid defects in the pants. However, the lawsuit was dismissed the next year.

The scandal resulted in the resignation of CEO Christine Day. A few months later, in November 2013, Chip Wilson defended his product by suggesting that women’s bodies are to blame for the fabric’s sheer- ness and their tendency for pilling. He also claims that many women buy pants that are too small for them, which wears them out. When questioned about whether Lululemon is truly a clothing retailer for everybody, Wilson stated that the product was appropriate for all sizes but that some people simply misuse the product. Critics viewed this as a sexist comment, exacerbating the issue at hand. In the midst of consumer outrage, Wilson stepped down as Chairman of the Board.

Customer Privacy Lululemon is known for wanting to avoid collecting large amounts of customer information through big data techniques. Instead, they desire to have a close and open relationship with customers. One of the ways they do this is by listening to customers as they shop in the store. Lululemon takes customer complaints or concerns seriously and will attempt to make decisions based on this information.

Although this emphasis on listening to the cus- tomer is an important part of Lululemon’s customer relations, some people believe Lululemon takes it too far. A less well-known ethical risk that the company practices is the training of retail employees to eavesdrop on their customers. Lululemon prefers this to spending

money on marketing software that tracks purchases, or sending out survey requests. Christine Day, the former CEO, used to spend much of her time in retail stores, pretending to be a customer, in order to listen to com- plaints and observe shopping habits. When she was with the company, she had stores set up their clothes-folding tables next to the fitting rooms so employees could better overhear any complaints. Whether these practices are smart marketing techniques or infringements on employee privacy is ambiguous.

POSITIVE ETHICAL PRACTICES Despite the criticisms launched against Lululemon, the mission to help customers live a better life continues. Lululemon defines having a better life as living healthier, leading to a longer and more adequate life. Its mis- sion to elevate humanity from mediocrity to greatness demonstrates that it wants consumers and employees to achieve their maximum potential. This is not too different from Abraham Maslow’s concept of self- actualization. Lululemon has developed a manifesto to describe their way of business: “We are passionate about sweating every day and we want the world to know it. Breathing deeply, drinking water and getting outside also tops the list of things we can’t live without. Get to know our manifesto and learn a little more about what lights our fire.”

This manifesto clearly shows the backbone of Lululemon and the way they do business. The manifesto strives toward providing greatness to the people that use Lululemon products. The higher prices Lululemon charges are a sign of excellence and the belief that they are selling more than just clothing to the customers. It is a belief that the customer is buying a lifestyle that comes with the Lululemon brand and the set of values that Lululemon is conveying in the manifesto. As a result, Lululemon has gained a large following and clientele that believe in their products.

Contributions to Communities Lululemon takes its responsibilities to communities seriously. It recognizes that community involvement will not only help gain new customers, but will also promote their mission of creating a healthier lifestyle. For these reasons, Lululemon holds free weekly yoga classes taught by fitness professionals. Lululemon shop- pers who have attended the free yoga classes can get a 15 percent discount on their purchases.

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Additionally, while the practice of secretly observ- ing customers might be controversial in some ways, it also demonstrates Lululemon’s commitment toward meeting customer needs. Lululemon believes that cus- tomer relationships are not based on technology, but rather on more basic marketing techniques like sim- ply talking with the customer. The Lululemon culture encourages employees to establish strong connections with their customers, which is why the company emphasizes that its employees are “educators.” By lis- tening carefully to customer concerns as they shop, Lululemon gets an immediate picture of problems that the company can address. For instance, one time when the CEO was in a Lululemon store she overheard many complaints that a certain type of knit sweater had sleeves that were too tight. Based on this information, she canceled future orders. It is clear that Lululemon is willing to make quick product changes in response to customer feedback.

Lululemon also contributes to local charities throughout their communities. In many communities, Lululemon empowers customers by offering the clien- tele the ability to suggest organizations and charities to receive donations. Lululemon’s program allows for up to eight local charities to receive donations. This shows their commitment to their local communities and their willingness to give back as much as possible, while still maintaining a healthy bottom line. Lululemon’s efforts display a stakeholder mindset as they make decisions that benefit their shareholders, clients, local neighbor- hoods, and nearby businesses.

RELATIONSHIPS WITH EMPLOYEES Lululemon recognizes that customer satisfaction is only as good as the employees that provide it. Lululemon therefore strives to make its employees into ambassa- dors for the brand. This can only happen if employees are passionate and committed to company products and values. The hiring process at Lululemon is extensive as the firm only wants to hire those who it believes will be the right fit with its company culture. It is also costly. Applicants may go through more than one interview, and those that get farther in the process are often asked to attend yoga classes where the recruiters can see how they interact with others. When an applicant is chosen as an employee, he or she will undergo 30 hours of training. They also spend three weeks working on the floor.

As mentioned before, Lululemon strives to get employees inspired. Employees must develop their personal goals, which are then hung in the stores. To encourage healthy living and incentivize employees, the company offers staff free fitness classes. It also tries to help their employees find the right balance between family and work. Lululemon frequently sends merchan- dising tips to their sales employees and encourages them to take responsibility and ownership of the store.

Lululemon believes in hiring managers internally, which motivates lower-level employees because they know they have a good chance of becoming a leader. Approximately 70 percent of Lululemon managers are internal hires. Employee satisfaction at Lululemon appears to be high; in exit interviews, 90 percent of employees claim they would recommend for their friends to work at Lululemon.

Lululemon also offers its employees unique perks. It frequently sanctions events such as group hikes or exercise sessions to help its employees bond with one another. After a year of employment, Lululemon sends employees to the Landmark Forum, a three-day self-improvement program at a cost of approximately $500 per employee. (Some have criticized the Landmark Forum and Chip Wilson’s endorsement of it, while others claim the experience transformed their lives.) Lululemon has also created the “Fund a Goal” program for high-performing employees. This incentive pays for these employees to achieve one of the goals on their list.

CONCLUSION Lululemon focuses much of their efforts on the legacy that they will leave behind (the legacy they are creat- ing now for future generations). Throughout the years, Lululemon has created a culture of promoting a healthy lifestyle, which can be achieved through healthy eating, yogi tradition, and in-store fitness classes. The company stresses a culture in which employees, customers, and other stakeholders can achieve greatness. As a result, the organization has seen rapid success and growth during the last decade. However, the company has been hit by a number of scandals, requiring them to rebuild their reputation and adopt new leadership.

The changes that Lululemon has implemented demonstrate that the organization is willing to make difficult decisions to do the right thing. If Lululemon continues to put stakeholders first and refuses to deviate from its values, it is likely to avoid similar ethical issues in the future. A strong values-based corporate culture

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will help Lululemon remain a successful company with a reputation for both ethical behavior and quality prod- ucts. In addition, most companies the size of Lululemon have an effective ethics and compliance program to help build an ethical culture. Based on past issues that the company has faced, it appears that it is time to embrace a more proactive approach to managing ethics and social responsibility.

Questions for Discussion 1. How has Lululemon handled various ethical

issues that it has faced over the last few years? 2. How has the ethical culture of Lululemon impacted

its relationship with customers and employees? 3. To avoid negative publicity and ethical challenges,

what steps should Lululemon take to improve its stakeholder relationships?

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Melissa Lustrin and Felicia Patinkin, “Lululemon Founder Chip Wilson Blames Women’s Bodies for Yoga Pant Problems,” ABC News, November 7, 2013, http:// abcnews.go.com/US/lululemon-founder-chip-wilson- blames-womens-bodies-yoga/story?id=20815278 (accessed August 11, 2016).

Ashley Lutz, “Lululemon Spends $500 for Workers to Attend a Controversial Retreat Endorsed by Founder Chip Wilson,” Business Insider, January 9, 2014, http://www.businessinsider.com/lululemons-landmark- retreat-for-workers-2014-1 (accessed May 16, 2014).

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Market Watch, “lululemon athletica inc.,” 2016, http:// www.marketwatch.com/investing/stock/lulu/financials (accessed August 11, 2016).

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CASE 8

The Hershey Company and West African Cocoa Communities

INTRODUCTION With over $7.4 billion dollars in sales every year, the Hershey Company is one of the world’s largest produc- ers of chocolate and candy products. Hershey’s prod- ucts are sold in more than 70 countries and include Hershey’s Kisses and Hershey’s Milk Chocolate Bars as well as brands such as Reese’s, Whoppers, Almond Joy, and Twizzlers.

Although Hershey strives to be a model company and has several philanthropic, social, and environmental programs, the company has struggled with ethical issues related to the labor issues associated with West African cocoa communities, including child labor. Hershey has developed several initiatives to improve the lives of West African cocoa workers and is involved with a number of organizations that are involved in cocoa communi- ties. However, critics argue that Hershey is not doing enough to stop labor exploitation on cocoa plantations. This case examines some of the issues related to the Hershey Chocolate Company and West African cocoa communities.

HERSHEY’S HISTORY The Hershey Chocolate Company was founded in 1894 by candy-manufacturer Milton Hershey. Originally in the business of making caramel, Hershey began produc- ing chocolate in 1893 after he purchased chocolate- making equipment. Hershey’s chocolate business started off as a side project, a way to create sweet chocolate coatings for his caramels; however, the company soon began producing baking chocolate and cocoa and then selling the extra product to other confectioners. The successful sale of Hershey’s excess products was enough to make the chocolate department its own separate entity.

Despite its immediate success, Milton Hershey still craved more chocolate, especially milk chocolate. At the time, milk chocolate was perceived as a treat only the wealthy could afford to enjoy. Hershey set out to find a less expensive way to produce milk chocolate while still maintaining its quality. Therefore, in 1896, Hershey bought a milk processing plant in Derry Township, Pennsylvania and began working day and night until 1899 when he created the perfect milk chocolate rec- ipe—a recipe that could be manufactured cheaply and efficiently while maintaining a high level of quality. The company soon opened a factory and began introducing new chocolate treats; the most popular of these was the Hershey’s Kiss, a small dollop-shaped chocolate candy wrapped in foil.

The Kiss was only the beginning; Hershey’s soon came out with Mr. Goodbar and the Krackel bar, both of which remain popular today. In 1923 Hershey’s began collaborating with another famous confectioner, Reese. H.B. Reese was a former employee at the Hershey Company who started his own candy company that focused on a single product, the peanut butter cup. Due to his ties with the Hershey Company, the choco- late coating for the Reese’s peanut butter cups was sup- plied by Hershey.

Throughout the mid-20th century, the Hershey Chocolate Company continued to expand. The com- pany’s entrepreneurial spirit continued after Milton Hershey’s death in 1945. The company acquired several other companies, including Reese’s, and was renamed the Hershey Foods Corporation in 1968. From 1969 to 2004, the company grew from $334 million to $4.4 billion in net sales. The company changed its name to the Hershey Company in 2005.

Today, the Hershey Company is North America’s largest producer of chocolate and candies. It plans to expand into other products such as cookies, beverages, and health foods. The company sells over 80 brands of

*This material was developed by Harper Baird, Nicole Guevara, and Aleksander Karpechenko under the direction of O.C. Ferrell and Linda Ferrell. Jennifer Sawayda provided updates. It is intended for classroom discussion rather than to illustrate effective or ineffec- tive handling of administrative, ethical, or legal decisions by management. Users of this material are prohibited from claiming this material as their own, emailing it to others, or placing it on the Internet. (2016)

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products in approximately 70 countries and generates annual sales of $7.4 billion.

ETHICS, VALUES, AND SOCIAL RESPONSIBILITY AT HERSHEY Hershey’s commitments to its stakeholders through ethical behavior are outlined in the Code of Ethical Business Conduct. The code covers issues from conflicts of interest and antitrust to fair trade, sustainable supply chain management, and workplace diversity. The com- pany encourages ethics reporting through a variety of channels, including management, HR, executives, and third-party reporting. All employees go through ethics training and certify their adherence to the code every year. Hershey’s Ethical Business Practices Committee provides oversight and guidance in all ethical issues at the company.

Hershey’s Values Hershey’s four core values are centered on the idea of “One Hershey”: Open to Possibilities: “We are open to possibilities

by embracing diversity, seeking new approaches and striving for continuous improvement.”

Growing Together: “We are growing together by sharing knowledge and unwrapping human poten- tial in an environment of mutual respect.”

Making a Difference: “We are making a difference by leading with integrity and determination to have a positive impact on everything we do.”

One Hershey: “We are One Hershey, winning together while accepting individual responsibility for our results.”

Hershey’s Social Responsibility Strategy Hershey’s corporate social responsibility (CSR) strategy centers on engagement with its stakeholders and contin- ually improving its CSR performance. The company also incorporates its values into its programs and initiatives. The company believes that “The Hershey Company’s commitment to corporate social responsibility is a direct reflection of our founder’s life-affirming spirit.” Hershey

uses its value chain to categorize its social responsibility activities into four groups: Marketplace, Environment, Workplace, and Community.

MARKETPLACE Hershey strives to conduct business fairly and ethically by focusing on the integrity of its supply, consumer well-being, and alignment with customers.

For Hershey, the integrity of supply includes not only the ingredients but also the people and processes used to grow, process, and acquire those ingredients (the entire supply chain). Cocoa is of particular concern to Hershey, and it is involved in a number of cocoa-sector initiatives and partnerships to make progress in sus- tainable cocoa farming and fair labor. These issues are explored in greater detail later in this case.

The company sponsors several consumer health initiatives and programs, including Moderation Nation, a national consumer education initiative that promotes balanced lifestyles, which is sponsored by the Hershey Center for Health & Nutrition (HCHN) and the American Dietetic Association (ADA). The company also hosts Hershey’s Track and Field Games across the U.S. to encourage children ages 9-14 to engage in sports and a healthy lifestyle.

ENVIRONMENT Maintaining the environment is important to Hershey, and it is taking many steps to reduce its impact on the environment, including sustainable product designs, sustainable sourcing, and efficient business operations. Some specific programs include the following:

Sustainable palm oil sourcing: Palm oil comes from the African oil palm tree and is used in a wide variety of products, include Hershey’s chocolate. However, the production of palm oil is highly controversial because of its impact on ecosystems. To combat con- cerns, Hershey became a member of the Roundtable of Sustainable Palm Oil (RSPO) and purchases its palm oil only from suppliers that are also RSPO members.

Sustainable paper: In 2011 Hershey began to pur- chase paper for its office from suppliers that use sus- tainable forestry practices and are Forest Stewardship Council or Sustainable Forestry Initiative certified.

Recyclable packaging: More than 80 percent of Hershey’s packaging is recyclable, including syrup

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bottles, foil, paper wrappers, and boxes. Recycling helped Hershey to reduce its packaging waste by 1.75 million pounds in 2014.

Zero-waste-to-landfill facility: In 2011, the Reese’s plant became a zero-waste-to-landfill facility, mean- ing that none of the plant’s routine manufactur- ing waste went to a landfill. Today six Hershey manufacturing plants and five other facilities have achieved zero-waste-to-landfill. The waste that is not recycled goes to an energy incinerator and is used as a source of fuel.

WORKPLACE Hershey wants to provide value to its employees and make the company a desirable place to work by focusing on safety, wellness, openness, and inclu- sion. The company has strong diversity policies and focuses on continuous safety improvements in its manufacturing facilities. However, this does not mean that Hershey never faced workplace issues. In 2011, over 400 foreign students working for Hershey went on strike after Excel, one of the company’s sub- contractors, misled and underpaid them. OSHA later fined the sub-contractor $283,000 for health and safety violations.

Hershey has continued to improve its work- place practices. In 2013 it was listed in Corporate Responsibility magazine as one of America’s “Best Corporate Citizens.” It launched an initiative called “Manufacturing Apprenticeship Program” to recruit, train, and retain employees with physical or intellectual disabilities for its manufacturing plants. Hershey is also considered one of the best places to work for LGBT employees.

COMMUNITY Hershey’s biggest philanthropic contribution is through its Milton Hershey School. Milton Hershey and his wife, Catherine, started the school in 1909 to help orphan boys receive an education while living in a nurturing environment that included meals and clothes. The school was a cause dear to the couple’s heart because they were unable to have children of their own. After his wife’s death, Milton Hershey created

the Hershey Trust Fund, to which he donated most of his money, to be used for the support of the school. To this day, the fund remains the company’s biggest share- holder and largest beneficiary. It holds a 30 percent stake in Hershey.

Although the school is Hershey’s biggest phil- anthropic contribution, the company also donates to and supports over 1,400 organizations including the American Red Cross, Habitat for Humanity, Junior Achievement, Dress for Success, and the Children’s Miracle Network. The company has also designed a way to get their employees involved in the community. Hershey designed a program called “Dollars for Doers” in which employees who participate in 50 hours of com- munity service over one year are rewarded $250, by the company, to donate to an organization of their choice.

Board changes Despite its strong record of social responsibility, in 2016 Hershey experienced a board upheaval when the Hershey Trust Co. settled with the Pennsylvania attorney general’s office. The attorney general’s office had begun investigating concerns that board mem- bers were overpaid, received reimbursements for excessive travel expenses, and exceeded 10-year term limits. There were also questions about whether board members of the trust were acting in the best interests of the Milton Hershey School. The board had rejected different offers by other firms to acquire Hershey. The local community of Hershey, Pennsylvania encouraged Hershey to remain inde- pendent, but some believe that selling the company would be the most beneficial option for the school. The Hershey Trust holds 81 percent of the voting power, which gives it the power to control votes on mergers or acquisitions.

The allegations are serious enough that Hershey agreed to make corporate governance changes. Some of the board members resigned. Additionally, Hershey developed a legal document that caps board member terms as well as compensation. This lapse in corporate governance is a slight blow to Hershey’s reputation, but it also offers the firm an opportunity to learn from its mistakes and develop more sound leadership for the future.

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LABOR ISSUES IN THE COCOA INDUSTRY Although the Hershey Company strives to engage in ethical and responsible behavior, the realities of the cocoa industry present several ethical challenges related to the fair and safe treatment of workers, especially children. Chocolate is one of the world’s most popular confections, but few people consider the sources of the chocolate they consume.

The process of making chocolate spans several countries and companies even before the ingredients arrive at the manufacturing plant. It starts with the cocoa bean, which is found within the Theodroma Cacao, also known as the cocoa pod (fruit). The harvest process is labor intensive and starts when the seeds (cocoa beans) are extracted by splitting the pod with a machete. Each pod can contain anywhere from 20 to 50 beans, and around 400 beans are needed to produce one pound of chocolate. After the beans have been extracted, they are laid out to dry in the sun for several days in order to acquire the flavor needed for chocolate. The beans are then packed into bags and sent out for shipment.

Chocolate manufacturers rarely buy directly from cocoa bean companies. The actual process of procuring cocoa beans and other cocoa products is conducted through one of the two world exchanges, either the NYSE Euronext or the Intercontinental Exchange. The chocolate industry is valued at $100 billion.

The cocoa bean supply chain is extensive and elaborate; at times the cocoa bean can go through up to 12 different stages before getting to the chocolate manufacturers, and the price per pound of cocoa beans changes significantly throughout the supply chain. By the time the beans reach the chocolate manufactur- ers, they are a mix of beans from hundreds of cocoa plantations.

Although the process of manufacturing chocolate requires many steps before it can begin, most of the major ethical and legal issues are related to the source of the cocoa bean. Cocoa plantations are found in areas with rainy, hot, tropical climates and high amounts of vegetation. The global cocoa market is currently sup- plied by mostly poor nations, with 70 percent from Africa (Ivory Coast, Ghana, Nigeria, Cameroon), espe- cially the Ivory Coast, which supplies 40 percent of the entire global market, and Ghana, which supplies 20 percent. This is followed by 19 percent from Asia and Oceania (Indonesia, Papua New Guinea, Malaysia),

and 11 percent from the Americas (Ecuador, Brazil, Colombia).

With the majority of the global cocoa supply com- ing from Africa, the need for workers on plantations never dwindles, which has brought about the thriving business of child labor, slavery, and human trafficking across African borders. Many cocoa farms do not own the cocoa plantation and pay the land owner 50-66 percent of each year’s crop. To keep costs low, farmers often use their own family members as a source of labor.

Children who work on cocoa plantations are usu- ally somewhere between 12 and 15 years old but some are as young as 5 years old. Many of them work in haz- ardous conditions on the plantations. Hazardous condi- tions include applying pesticides, working with sharp objects like knives and machetes, working without safety equipment, and working in environments full of snakes, insects, and other dangerous animals. Although governments and corporations are aware of this prob- lem, no accurate information, aside from estimates, exists regarding the true number of children working on cocoa plantations. The difficulty of obtaining accu- rate data can be attributed to the immense quantity of cocoa plantations across Africa, totaling well over 1,000,000 small plantations (average size 2-4 hectares), with between 600,000 and 800,000 plantations located throughout the Ivory Coast.

Nonetheless, it is estimated that two-thirds of African farms use child labor. Research conducted by the International Labor Organization (ILO) stated that in 2007 there were 284,000 children who worked in hazardous conditions related to cocoa in the Ivory Coast. Furthermore, according to surveys conducted by both Tulane University and the Government of the Ivory Coast, an estimated 819,921 children in the Ivory Coast alone are working in some area of the cocoa business. According to an ILO investigation in 2002, an esti- mated 12,000 child laborers in the Ivory Coast had no relatives anywhere near the plantations, which suggests that they may have been trafficked.

In addition to child labor, many cocoa plantations engage in exploitation of other workers. While some non-family workers are paid, others may be enslaved or work in abusive conditions. They may have been trafficked from neighboring countries or tricked into owing large amounts of money to their employers. The workers are often threatened with physical punishment or death if they attempt to leave the plantation.

The number of victims of labor exploitation has increased. A recent survey has found that child labor

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has increased 21 percent from five years before. About 2.1 million children are employed in child labor in the Ivory Coast and Ghana. Most of the people working on cocoa farms live well below the poverty line. In Ghana the average income per day is 84 cents, while in the Ivory Coast it is 50 cents. According to the World Bank, $1.90 is the cutoff rate for extreme poverty. Demand for chocolate has increased with the rising middle class of consumers in places like China. In fact, prices of cocoa have increased by 13 percent. The Ivory Coast exports 1.8 million metric tons of cocoa a year, two-fifths of the world’s production. Yet many farmers do not see any increase in additional compensation or standard of living.

Global Efforts to Improve Labor Conditions The issues of child labor, human trafficking, and forced labor in West Africa have drawn the attention of many organizations as well as the companies who procure products from that region. They have implemented many different initiatives, laws, and other precaution- ary measures in order to reduce the use of children for cocoa farming in terms of manual labor. In Africa indi- viduals under the age of 14 are not allowed by law to work within the business sector, which does not include family farms. This law seems to be effective, but in real- ity, it does almost nothing when considering the large amounts of family cocoa farms and the ease of hiding non-family laborers.

To help change labor practices without relying on governmental or legal support, several organizations are working to encourage the ethical sourcing of cocoa. Most of these organizations focus on the fair treatment and education of cocoa producers and raising voluntary support from companies. The following are some of the global organizations and programs that are working to combat the labor problem within the cocoa industry: World Cocoa Foundation (WCF): An organization

devoted to improving cocoa farmers’ lives through sustainable and responsible cocoa farming practices.

Sustainable Tree Crops Program (STCP): Farmers learn to improve their cocoa crop yields and earn more money through nine-month field training courses.

Harkin-Engel Protocol: An initiative enacted in 2001 to commit the chocolate industry to fighting the worst cases of child labor. The agreement was

signed by eight chocolate manufacturers, including The Hershey Company.

International Cocoa Initiative (ICI): An independent foundation established in 2002 under the Harkin- Engel Protocol to address the worst forms of child labor and adult forced labor on cocoa farms in West Africa. The organization works to inform and edu- cate communities on child labor and how to create community-based solutions.

International Labor Organization (ILO): An orga- nization working to combat the various child labor related problems within West Africa. The different programs initiated by the ILO have focused on creat- ing sustainable ways of removing children from child labor in the cocoa business, improving community initiatives to fight child labor, and increasing overall income for the adult sector to prevent the need for child labor.

In addition, the fair trade movement encourages traders of chocolate and other products to move beyond ethi- cal sourcing. The intent of the fair trade movement is to raise awareness about working conditions, culture, and identity of producers. Traders must meet several standards, including paying a sustainable price to pro- ducers that reflects the costs of production and living as well as paying a premium that producers can use to invest in business and social programs, make advance payments when requested, and sign long-term contracts to encourage planning. Products made using fair trade practices are usually certified and sold to consumers at a higher price. While the demand for fair trade products is growing, the market is currently small.

HERSHEY’S EFFORTS TO IM- PROVE LABOR CONDITIONS Hershey has made several commitments to help reduce labor issues in its own supply chain and in the choco- late industry. Hershey is involved in West Africa and the organizations that fight child labor in West African cocoa farming. The company is a member of the WCF, ICI, and is one of the eight corporations that signed the Harkin-Engel Protocol. Involvement in these programs and organizations requires Hershey to commit to cer- tain standards and contribute to fighting child labor.

The Hershey Company is dedicated to sustainably and ethically supplying the cocoa needed for its prod- ucts, as well as educating its suppliers. One program that

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integrates these two concepts is Hershey’s “CocoaLink – Connecting Cocoa Communities” program. CocoaLink use mobile technology to share practical information with rural cocoa farmers. Farmers receive free text or voice messages that cover topics such as improving farming practices, farm safety, child labor, health, crop disease prevention, post-harvest production, and crop marketing. Farmers can also share information and receive answers to specific cocoa-farming questions.

In 2012 Hershey launched the Hershey Learn to Grow (LTG) farm program in Ghana, which provides local farmers with information on best practices in sustainable cocoa farming. Specifically, the program seeks to encourage ethical farming practices as well as leadership and empowerment. Both men and women are being trained on how to improve crop yields. Those who meet acceptable certification standards receive extra money. Hershey estimates that this program influ- enced over 31,000 farmers by 2015.

Hershey also produces some of its products using ethical and sustainable cocoa. Hershey Bliss, one of the company’s specialty chocolates, is made with 100 per- cent Rainforest Alliance Certified cocoa. This means that the cocoa is grown using farming methods that are safe, sustainable, and that respect the rights of the workers.

By 2017 Hershey hopes to expand its cocoa community programs by investing in West Africa and working closely with agricultural experts and the government. Hershey also announced that over a five- year period, it will invest $10 million in West Africa in order to reduce child labor, improve the cocoa farming community, and directly benefit 750,000 African cocoa farmers.

In 2013 Hershey initiated the 21st Century Cocoa Plan with the intent to have all of its cocoa certified as sustainable by 2020. It has partnered with three certification organizations: UTZ, Fairtrade USA, and Rainforest Alliance. The company claims that by the end of 2015, it had achieved sustainable certification for 50 percent of its cocoa. In order to achieve sustainable certification, third-party auditors must examine farmers supplying the cocoa to see whether they are following best practices. One crucial practice analyzed is whether the farmers make use of child labor.

As part of its initiative toward sustainably-sourced cocoa, in 2014 Hershey helped co-found an industry approach with 10 other chocolate companies referred to as CocoaAction. Operated under the World Cocoa Foundation, CocoaAction has $500 million in funding, which is being used to improve the lives of farmers in

the Ivory Coast and Ghana through training and edu- cational opportunities.

Criticism of Hershey’s Efforts Some critics argue that Hershey is not doing enough to combat labor exploitation and improve communities in West Africa. Over the past few years, Mars, Mondelez, Nestlé, Cargill, and other competitors have worked to adopt fair trade certification and/or release information regarding their suppliers. Despite many requests for public disclosure of its cocoa suppliers, Hershey still declines to name them. It is well known that Hershey acquires most of its cocoa from West Africa, but the specific sources are more difficult to identify.

According to a 2010 report titled “Time to Raise the Bar: The Real Corporate Social Responsibility for the Hershey Company,”

“Hershey has no policies in place to purchase cocoa that has been produced without the use of labor exploitation, and the company has consistently refused to provide public informa- tion about its cocoa sources…Finally, Hershey’s efforts to further cut costs in its cocoa production has led to a reduction in good jobs in the United States.”

The report, compiled by Global Exchange, Green America, the International Labor Rights Forum, and Oasis USA, accused Hershey of not embracing fair trade practices despite having a U.S. market share of over 40 percent. It also accused Hershey of greenwashing, or creating a false impression regarding its eco-friendly behavior, by donating to various programs without actually changing its policies to ensure that its cocoa is ethically produced. Green America even created a coalition called “Raise the Bar, Hershey!” to urge the company to address child labor and trafficking in the supply chain.

Since then relations between Hershey and Green America seem to have improved somewhat. The orga- nization was pleased with Hershey’s pledge to source 100 percent of its cocoa from sustainable sources (free from child labor) by 2020. However, the company has many obstacles to overcome, and Green America has ranked Hershey’s competitors higher than Hershey in its approach to solving the child labor problem. Green America developed a “Big Chocolate Scorecard” to

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Case 8  The Hershey Company and West African Cocoa Communities 499

grade chocolate manufacturers on the sustainability of their supply chains. Hershey ranked behind its major competitors Nestlé, Mars, Mondelez, and Ghirardelli (owned by Lindt). Hershey received a C- according to the scorecard’s ranking criteria. However, even Nestlé— the highest ranked among the top chocolate manufac- turers—only scored a C+. A representative from Green America maintains that Hershey scored lower because it relies more on third-party certification rather than direct engagement. The organization believes that while third-party certification is a step in the right direction, it is only part of the solution to combatting child labor.

CONCLUSION The labor issues in the chocolate industry are complex and are connected to the poverty within West Africa. The exploitation of cocoa communities is intertwined with the meager incomes for the majority of the popu- lation, a lack of education and opportunity, govern- mental corruption, and other conditions in the region. Improving the overall well-being of West Africa is an important part of any attempt to effectively fight the problems associated with labor cocoa plantations.

The Hershey Company recognizes the need to improve labor conditions in the supply chain and has developed several initiatives to help create positive change in the cocoa industry. However, despite the company’s large financial contributions, the company trails behind competitors Nestlé, Mars, Mondelez, and Ghirardelli on efforts to address sustainability, pov- erty, and child labor. On the other hand, the company appears to have improved significantly in combatting child labor after initiating the 21st Century Cocoa Plan in 2013.

In the end, labor exploitation in the chocolate industry cannot be solved by one company alone. There are many possible solutions, and it will take many years and a large amount of investment from the chocolate industry before conditions change. However, by mak- ing small changes to West African cocoa communities, the quality of life for thousands of cocoa workers will slowly improve.

Questions for Discussion 1. Should Hershey be held ethically responsible for

child labor conditions in the West African cocoa communities?

2. How can Hershey balance its ethical culture and concern for labor conditions in West Africa in relating to various stakeholders?

3. If it is not possible for Hershey to gain control of its supply chain for a required raw material (cocoa beans) in its final product, what are its alternatives?

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