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C H A P T E R S I X

Organizational Ethics

Faced with increasing pressure to create an ethical environment at work, businesses can take tangible steps to improve their ethical performance. The organization’s culture and ethical work climate play a central role in promoting ethics at work. Ethical situations arise in all areas and func- tions of business, and often professional associations seek to guide managers in addressing these challenges. Corporations can also implement ethical safeguards to create a comprehensive ethics program. This can become a complex challenge when facing different customs and regulations around the world.

This Chapter Focuses on These Key Learning Objectives:

LO 6-1 Classifying an organization’s culture and ethical climate.

LO 6-2 Recognizing ethics challenges across the multiple functions of business.

LO 6-3 Creating effective ethics policies and identifying responsible individuals to become the organization’s ethics and compliance officer.

LO 6-4 Constructing successful ethics reporting mechanisms, ethics training programs, and similar safeguards.

LO 6-5 Understanding how to conduct business ethically in the global marketplace.

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In 2016, British regulators fined the U.S. pharmaceutical giant Pfizer $107 million for overcharging 48,000 patients in their national health care system for the generic version of the epilepsy drug phenytoin sodium. Pfizer had worked with the drug distribution com- pany, Flynn Pharma Limited, to de-brand the drug in 2012 in order to raise the price to insurers. Generic drugs are not normally subject to government—pharmaceutical com- pany negotiations, so the prices could be freely determined by Pfizer. The drug company charged wholesalers and pharmacies a price 17 times higher than the amount it had charged before 2012.1

In 2016, Wells Fargo, a global banking and financial giant, was fined $185 million for issuing credit cards to consumers without their consent. Over a period of five years, Wells Fargo employees opened around 1.5 million unauthorized bank accounts and issued over half a million credit cards fraudulently. Over time, consumers started to accumulate banking fees for accounts they did not want or know about. Some of the victims were even contacted by debt collectors for not paying their fees. Wells Fargo refunded approximately $2.6 million to the affected consumers, but the damage to these individuals’ credit ratings lingered on. Over 5,300 Wells Fargo employees and managers involved in the scandal were fired as the firm cited major weaknesses in the company’s corporate culture.2

Pfizer and Wells Fargo are just two of many companies from around the world that over the years have been charged with excessive pricing, defrauding their customers, lying about their finances, mishandling investors’ funds, jeopardizing the safety of consumers, and many other illegal and unethical activities. Why are business executives, managers, and employees repeatedly being caught conducting illegal and unethical activities? What can firms do to minimize or prevent the unethical activities perpetrated by their executives and employees? Can companies set in place systems or programs to monitor workplace activities to detect illegal or unethical behavior?

Corporate Ethical Climates

Personal values and moral character play key roles in improving a company’s ethical per- formance, as discussed in Chapter 5. However, they do not stand alone, because personal values and character can be affected by a company’s culture and ethical climate.

The terms culture and climate are often used interchangeably and, in fact, are highly interrelated. Corporate culture is a blend of ideas, customs, traditional practices, company values, and shared meanings that help define normal behavior for everyone who works in a company. Culture is “the way we do things around here.” Erica Salmon Byrne, executive vice president, governance and compliance for The Ethisphere Institute, warns businesses and the public:

“This is a lesson we have learned, re-learned, and will likely learn again. Regulators around the globe are increasingly calling on organizations to examine their cul- ture. From Enron to Volkswagen, the Challenger to WorldCom, there are multiple examples of organizations with formal systems that say one thing and cultures that promote another. When those kinds of alignment gaps are allowed to persist, you eventually have a failure of one variety or another: ethics, quality, safety, or a combination of all three .”3

1 “Pfizer Fined $107 Million for Overcharging U.K. for Epilepsy Drug,” The Wall Street Journal, December 7, 2016, www.wsj.com. 2 “Wells Fargo Fined $185 Million for Fraudulently Opening Accounts,” The New York Times, September 8, 2016, Page B1, www.nytimes.com. 3 Erica Salmon Byrne, “Culture Matters,” Ethikos, September–October 2016, pp. 1–2.

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The Ethics Resource Center (ERC) observed that a “strong ethical culture in a company has a profound impact on the kinds of workplace behavior that can put a business in jeop- ardy.” Weak ethical cultures can foster ongoing bad behavior. In a national business ethics survey conducted by the Ethics and Compliance Initiative, 26 percent of employees reported that misconduct they had observed in their companies was part of an ongoing pattern. Forty-one percent claimed that the unethical behavior was repeated a second time, indicating a weak ethical work culture.4

Most companies have a kind of moral atmosphere. People can feel which way the ethi- cal winds are blowing. They pick up subtle hints and clues that tell them what behavior is approved and what is forbidden. The ethical climate represents an unspoken understanding among employees of what is and is not acceptable behavior based on the expected stan- dards or norms used for ethical decision making. It is the part of broader corporate culture that sets the ethical tone in a company. One way to view ethical climates is diagrammed in Figure 6.1. Three distinct ethical criteria are egoism (self-centeredness), benevolence (con- cern for others), and principle (respect for one’s own integrity, for group norms, and for society’s laws). (These parallel the levels of moral development developed by Lawrence Kohlberg that are discussed in Chapter 5.) These ethical criteria can be used to describe how individuals, a company, or society at large approach various moral dilemmas.

For example, if a company approaches ethics issues with benevolence in mind, it would emphasize friendly relations with its employees, stress the importance of team play and coop- eration for the company’s benefit, and recommend socially responsible courses of action. However, a company using egoism would be more likely to think first of promoting the company’s profit and striving for growth at all costs, as illustrated by the following example:

A Brazilian meat company, JBS, lost many of its customers and business partners amid a bribery scandal in 2017. The company admitted to bribing almost 2,000 politicians in exchange for subsidies that helped make JBS the largest meat- packer in the world. Restaurants and supermarkets in Brazil, including Domino’s Pizza Brasil and Subway, stopped buying JBS meats because of the corrupt behavior. The backlash against JBS even reached the United States, as Walmart publicly stated that they would not tolerate unethical behavior by their suppliers and would monitor the situation at JBS closely. Its shortsighted, self-focused actions had very high reputational costs to the company.5

Researchers have found that multiple ethical climates, or subclimates, may exist within one organization. For example, one company might include managers who often interact with the public and government regulators, using a principle-based approach, compared to

4 “National Business Ethics Survey 2013,” Ethics and Compliance Initiative, 2013, www.ethics.org. 5 “Business Partners Back Away from JBS amid Bribery Scandal,” The Wall Street Journal, June 8, 2017. www.wsj.com.

Ethical Criteria Focus of Individual Person Organization Society

Egoism (self-centered approach)

Self-interest Company interest Economic efficiency

Benevolence (concern- for-others approach)

Friendship Team interest Social responsibility

Principle (integrity approach)

Personal morality Company rules and procedures

Laws and professional codes

FIGURE 6.1 The Components of Ethical Climates

Source: Adapted from Bart Victor and John B. Cullen, “The Organizational Bases of Ethical Work Climates,” Administrative Science Quarterly 33 (1988), p. 104.

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another group of managers, whose work is geared toward routine process tasks and whose focus is mainly egoistic—higher personal pay or company profits.6

Corporate ethical climates can also signal to employees that ethical transgressions are acceptable. By signaling what is considered to be right and wrong, corporate cultures and ethical climates can pressure people to channel their actions in certain directions desired by the company. This kind of pressure can work both for and against good ethical practices.

Business Ethics across Organizational Functions

Not all ethics issues in business are the same. Because business operations are highly spe- cialized, ethics issues can appear in any of the major functional areas of a business firm. Accounting, finance, marketing, information technology, supply chain, and other areas of business all have their own particular brands of ethical dilemmas. In many cases, profes- sional associations in these functional areas have attempted to define a common set of ethical standards, as discussed next.

Accounting Ethics The accounting function is a critically important component of every business firm. By law, the financial records of publicly held companies are required to be audited by a cer- tified professional accounting firm. Company managers, external investors, government regulators, tax collectors, and labor unions rely on such public audits to make key deci- sions. Honesty, integrity, transparency, and accuracy are absolute requirements of the accounting function, and the impact can be devastating for organizations when these val- ues are absent.

In 2016, the United Kingdom established a new regulatory body, the Financial Reporting Council (FRC), to monitor auditing firms and investigate questionable financial statements. This action was in response to a $5.5 billion lawsuit against PricewaterhouseCoopers LLC for the auditing firm’s failure to uncover a mortgage lender fraud scheme. This action was part of a Europe-wide initiative to place audi- tors under greater scrutiny and to ensure they delivered fair and accurate accounting statements to organizational stakeholders.7

Accountants often are faced with conflicts of interest, introduced in Chapter 5, where loyalty or obligation to the company (the client) may be divided or in conflict with self-interest (of the accounting firm) and the interests of others (shareholders and the public). For example, while conducting an audit of a company, should the auditor look for opportunities to recommend to the client consulting services that the auditor’s firm can provide? Sometimes, accounting firms may be tempted to soften their audit of a company’s financial statements if the accounting firm wants to attract the company’s nonaudit busi- ness. For this reason, the Sarbanes-Oxley Act severely limits the offering of nonaudit con- sulting services by the auditing firm.

Examples of the U.S. accounting profession’s efforts promoting ethics are shown in Exhibit 6.A. Spurred by a threat of liability suits filed against accounting firms and a desire

6 James Weber, “Influences upon Organizational Ethical Subclimates: A Multi-departmental Analysis of a Single Firm,” Organization Science 6 (1995), pp. 509–23. For a summary of ethical climate research, see Aditya Simha and John B. Cullen, “Ethical Climates and Their Effects on Organizational Outcomes: Implications from the Past and Prophesies for the Future,” Academy of Management Perspectives, 2012, pp. 20–34. 7 “The Morning Risk Report: Auditors under Increased Scrutiny,” The Wall Street Journal, August 16, 2016, blogs.wsj.com.

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to reaffirm professional integrity, these standards go far toward ensuring a high level of honest and ethical accounting behavior.8

In addition, a new international Code of Ethics for professional accountants was unveiled in 2018. According to Kim Gibson, member of the International Ethics Standards Board for Accountants (IESBA), “the new standards are designed to be easier to use, nav- igate, and enforce; be more relevant for professional accountants in business, [and] distin- guish more clearly between requirements and application material.”9

Financial Ethics Within companies, the finance department and its officers are typically responsible for man- aging the firm’s assets and raising capital—for example, by issuing stocks and bonds. Finan- cial institutions, such as commercial banks, securities firms, and so forth, assist in raising capital and managing assets for both individuals and institutions. Whether working directly for a business or in a firm that provides financial services, finance professionals face a par- ticular set of ethical issues. Consider the following ethical lapses in corporate finance:

∙ Barclays PLC and four of their former top executives were charged with fraud by con- vincing Qatari to make payments to inflate the bank’s financial condition during the financial crisis. The United Kingdom’s Fraud Office filed the criminal suit against

8 For several excellent examples of ethical dilemmas in accounting, see Leonard J. Brooks and Paul Dunn, Business & Profes- sional Ethics for Directors, Executives and Accountants, 8th ed. (Stamford, CT: Cengage Learning, 2017); and Steven M. Mintz and Roselyn E. Morris, Ethical Obligations and Decision-Making in Accounting: Text and Cases, 4th ed. (New York: McGraw-Hill, 2016). 9 “5 Things You Need to Know about the New International Ethics Code,” Journal of Accountancy, May 8, 2018, www.journalofaccountancy.com.

Excerpts of the Professional Codes of Conduct in Accounting and Finance

AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS (AICPA)

Code of Professional Conduct These Principles of the Code of Professional Conduct of the American Institute of Certified Public Accountants express the profession’s recognition of its responsibilities to the public, to clients, and to colleagues. They guide members in the performance of their professional responsibilities and express the basic tenets of ethi- cal and professional conduct. The Principles call for an unswerving commitment to honorable behavior, even at the sacrifice of personal advantage. The Principles include: professional responsibilities, serving the public interest, maintaining integrity, maintaining objectivity and independence, exhibiting due care, and adhering to the Principles when providing services.*

CHARTERED FINANCIAL ANALYST (CFA)®

CFA Institute Code of Ethics and Standards of Professional Conduct Members of CFA Institute (including Chartered Financial Analyst® (CFA®) charterholders) and candidates for the CFA designation (“Members and Candidates”) must act with integrity, competence, diligence, respect, and in an ethical manner, place the integrity of the investment profession and the interests of clients above their own personal interests, exercise independent professional judgment when making decisions, practice in a professional and ethical manner, promote the integrity for the ultimate benefit of society, and maintain their professional competence.†

*Source: AICPA Code of Professional Conduct. American Institute of CPAs. For a full text of the professional code, see www.aicpa.org. †Source: CFA Institute. For full text see www.cfapubs.org/doi/pdf/10.2469/ccb.v2014.n6.1.

Exhibit 6.A

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Barclays for conspiracy to commit fraud. Two separate financial capital investments by Qatari financiers raised nearly $15 billion to save the bank from collapse in the 2008 recession. This latest suit came on top of another investigation of Barclays over failures of disclosure linked to Qatar capital investments.10

∙ In 2018, the Royal Bank of Scotland agreed to pay $4.9 billion to settle with the U.S. Justice Department over the sale of toxic mortgage-backed securities during the lead-up to the global financial crisis. This settlement cleared the path for the bank’s privat- ization, ending the long-running probe into the bank’s actions. This settlement was in addition to the bank’s earlier payments involving these securities—$5.5 billion to the Federal Housing Finance Agency, $500 million settlement with the State of New York, and $125 million agreed to be paid to two large California pension funds.11

These and other lapses in ethical conduct occurred despite efforts by the finance profes- sions to foster an ethical environment. As shown in Exhibit 6.A, the highly regarded Char- tered Financial Analyst Institute, which oversees financial executives performing many different types of jobs in the financial discipline, emphasizes self-regulation as the best path for ethical compliance.12

Marketing Ethics Marketing refers to advertising, distributing, and selling products or services. Within firms, the marketing department is the functional area that typically interacts most directly with customers. Outside the firm, advertising agencies and other firms provide marketing services to businesses. The complex set of activities involved in marketing generates its own distinctive ethical issues.

One issue in marketing ethics emphasizes honesty and transparency in advertising and data about advertising.

In 2017, a tech start-up, Outcome Health, which installed and ran video monitors in physicians’ offices to show pharmaceutical advertising to patients, misled their corporate customers. Outcome Health inappropriately charged pharmaceutical com- panies for the placement of their ads on video screens that were never installed. The company even inflated data about how well the ads were performing and manipulated reports of third-party analyses of the success of the marketing strategy. The deceit also impacted the company’s investors, as Outcome Health overestimated its revenue by including the false data. These allegations were still being investigated in 2018.13

In addition to the general ethical questions that surround the marketing or advertising of products to consumers, consumer health and safety are another key ethics issue in mar- keting. Chapter 14 discusses several other issues in marketing ethics, including deceptive advertising, firm liability for consumer injury, and a firm’s responsibility for the unethical use of products by buyers.

To improve the ethics of the marketing profession, the American Marketing Association (AMA) has adopted a code of ethics for its members, as shown in Exhibit 6.B. The AMA

10 “Barclays, Four Former Top Executives Charged with Fraud over Fundraising with Qatari Investors,” Wall Street Journal, June 20, 2017, www.wsj.com. 11 “RBS in $4.9 Billion U.S. Settlement Over Mortgage-Backed Securities,” The Wall Street Journal, May 10, 2018, www.wsj.com. 12 For a good example of other financial ethics issues, see John B. Boatright, Ethics in Finance, 3rd ed. (Malden, MA: Wiley-Blackwell, 2014). 13 “Outcome, A Hot Tech Startup, Misled Advertisers with Manipulated Information, Sources Say,” The Wall Street Journal, October 13, 2017, www.wsj.com.

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Excerpts of the Professional Codes of Conduct in Marketing and Information Technology

AMERICAN MARKETING ASSOCIATION (AMA)

Statement of Ethics The American Marketing Association commits itself to promoting the highest standard of professional ethical norms and values for its members (practitioners, academics, and students). As Marketers, we must do no harm, avoiding harmful actions or omissions by embodying high ethical standards and adhering to all applica- ble laws and regulations; foster trust in the marketing system, striving for good faith and fair dealing as well as avoiding deception in product design, pricing, communication, and delivery of distribution; and, embrace ethical values, building relationships and enhancing consumer confidence by affirming these core values: honesty, responsibility, fairness, respect, transparency, and citizenship. We expect AMA members to be courageous and proactive in leading and/or aiding their organizations in the fulfillment of the explicit and implicit promises made to those stakeholders.*

ASSOCIATION OF INFORMATION TECHNOLOGY PROFESSIONALS (AITP)

Code of Ethics and Standards of Conduct This code begins with a commitment by each association’s member to promote the understanding of informa- tion processing methods and procedures, an obligation to fellow members to uphold the ideals of AITP and cooperate with my fellow members and treat them with honesty and respect at all times, an obligation to society to the dissemination of knowledge pertaining to the general development and understanding of infor- mation processing, an obligation to employers to discharge this obligation to the best of my ability, to guard my employer’s interests and to advise him wisely and honestly, an obligation to my country to uphold my nation and shall honor the chosen way of life of my fellow citizens, and to accept these obligations as a per- sonal responsibility and as a member of this Association.**

*Source: American Marketing Association’s Statement of Ethics, 2017, as it appears in www.marketing.com.

**Source: Association of Information Technology Professionals, 2011–16. A full text of the AITP code of ethics can be found at www.aitp.org.

Exhibit 6.B

code advocates professional conduct guided by ethics, adherence to applicable laws, and honesty and fairness in all marketing activities. The code seeks to help marketing profes- sionals translate general ethical principles into specific working rules.14

Information Technology Ethics One of the most complex and fast-changing areas of business ethics is in the field of informa- tion technology. Ethical challenges in this field involve invasions of privacy; the collection and storage of, and access to, personal and business information, especially through e-commerce transactions; confidentiality of electronic mail communication; copyright protection regard- ing software, music, and intellectual property; cyberbullying; and numerous others.

VTech, an electronics toymaker, agreed to pay a $650,000 penalty in 2018 for col- lecting personal information from hundreds of thousands of U.S. children without obtaining consent from their parents in violation of child privacy law. The Federal Trade Commission also required the Hong Kong-based company and its U.S. sub- sidiary to strengthen its data security measures and conduct external security audits of its operations as a part of the settlement. VTech’s actions were exposed after a

14 “Statement of Ethics,” American Marketing Association, n.d., www.ama.org.

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cyberattack incident in 2015, which revealed more than 6 million children’s per- sonal information, including name, gender, and birth date. Additionally, nearly 5 million parents’ personal information was breached.15

As discussed in later chapters of this book, the explosion of information technology has raised serious questions of trust between individuals and businesses. In response to calls by businesspeople and academics for an increase in ethical responsibility in the information technology field, professional organizations have developed or revised professional codes of ethics, as shown in Exhibit 6.B.16

Supply Chain Ethics Production and operations functions are part of an organizations’ supply chain and have also been at the center of some ethics storms.

Kobe Steel Limited, a Japanese metals manufacturer, admitted to misleading 500 companies about the quality of the copper the firm shipped to its customers for over 10 years. Japan’s Quality Assurance Organization is responsible for certifying that the quality of products meets Japanese and international standards. This agency investigated Kobe’s alleged manipulation of quality reports in 2017. The company admitted to falsifying quality documents on tens of thousands of metal orders involving copper piping and later to covering up evidence. Breaches in the failure to report accurate information expanded to include other manufacturing facilities owned by Kobe, violating laws, regulatory standards, and customers’ trust.17

Similar to other professional associations, supply chain managers also are guided by a professional code of ethics, shown in Exhibit 6.C.

Efforts by professional associations to guide their members toward effective resolution of ethical challenges make one point crystal clear: All areas of business, all people in busi- ness, and all levels of authority in business encounter ethics dilemmas from time to time. Ethics issues are a common thread running through the business world. Specific steps that businesses can take to make ethics work are discussed next.

15 “Electronic Toymaker VTech Reaches $650K FTC Settlement Over Child Privacy Rule Violations,” USA Today, January 8, 2018, www.usatoday.com. 16 For further discussion of ethics in information technology, see Sara Baase, A Gift of Fire: Social, Legal, and Ethical Issues for Computing and the Internet, 5th ed. (Upper Saddle River, NJ: Pearson, 2017); and Richard A. Spinello, Cyberethics: Morality and Law in Cyberspace, 6th ed. (Burlington, MA: Jones & Bartlett Learning, 2016). 17 “Kobe Steel Admits 500 Companies Misled in Scandal,” The Wall Street Journal, October 13, 2017, www.wsj.com; “Kobe Steel Finds More Products Shipped with Quality Issues,” The Wall Street Journal, October 20, 2017, www.wsj.com.

Professional Code of Conduct in Supply Chain Management

Similar to the other professional associations, whose codes of ethical conduct are presented in Exhibits 6.A and 6.B, the Institute for Supply Management (ISM) developed its Principles and Standards of Ethical Supply Chain Management Conduct with Guidelines that emphasize integrity, value, and loyalty across 10 main prin- ciples. The specific principles are avoid impropriety, conflict of interest, and negative influences; be responsi- ble to your employer, suppliers and customers, and social responsibility and sustainability practices; protect confidentiality; avoid reciprocity; follow applicable laws, regulations, and trade agreements; and exhibit pro- fessional competence.

Source: Institute for Supply Management’s Principles and Standards of Ethical Supply Management Conduct with Guidelines from www.instituteforsupplymanagement.org.

Exhibit 6.C

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Making Ethics Work in Corporations

Any business firm can improve the quality of its ethical performance. Doing so requires a company to build ethical safeguards into its everyday routines. This is sometimes called institutionalizing ethics. The percentage of the world’s largest firms (the Fortune 500 or 1000 as reported in Fortune magazine each year) that have adopted these safeguards since the 1980s is shown in Figure 6.2.

A 2015 Ethics Research Center study found that employees in large organizations with an effective ethics and compliance program were less likely to feel pressure to compromise their ethical standards (3 percent), compared to those without effective programs (23 percent). They were also less likely to observe misconduct (33 percent versus 62 percent) and less likely to experience retaliation (4 percent versus 59 percent). Employees at organizations with an effective ethics program were nearly three times more likely to report observed misconduct at work (87 percent versus 32 percent).18

Building Ethical Safeguards into the Company Managers and employees need guidance on how to handle day-to-day ethical situations; their own personal ethical compass may be working well, but they need to receive direc- tional signals from the company. Several organizational steps can be taken to provide this kind of ethical awareness and direction.

Lynn Sharp Paine, a Harvard Business School professor, has described two distinct approaches to ethics programs: a compliance-based approach and an integrity-based approach. A compliance-based program seeks to avoid legal sanctions. This

18 “The State of Ethics in Large Companies,” Ethics Research Center, 2015, www.ethics.org.

FIGURE 6.2 Percentage of Firms Reporting They Have the Ethical Safeguard

Sources: Center for Business Ethics, “Are Corporations Institutionalizing Ethics?” Journal of Business Ethics 5 (1986), pp. 85–91; Center for Business Ethics, “Instilling Ethical Values in Large Corporations,” Journal of Business Ethics 11 (1992), pp. 863–67; Ethics Resources Center, Ethics in American Business: Policies, Programs and Perceptions (Washington, DC, Ethics Resource Center, 1994); Ethics Resource Center, National Business Ethics Survey: How Employees View Ethics in Their Organizations 1994–2005, (Washington, DC, Ethics Resource Center, 2005); and James Weber and David Wasieleski, “Corporate Ethics and Compliance Programs: A Report, Analysis and Critique,” Journal of Business Ethics 112 (2013), pp. 609–26.

Developed code of ethics

O�ered ethics training

Created ethics o�ce/o�cer

Established ethics hotline

0%

20%

40%

60%

80%

100%

Center for Business Ethics, 1986

Center for Business Ethics, 1992

Ethics Resource Center, 1994

Ethics Resource Center, 2005

Weber and Wasieleski, 2013

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approach emphasizes the threat of detection and punishment in order to channel employee behavior in a lawful direction. Paine also described an integrity-based approach to ethics programs. Integrity-based ethics programs combine a con- cern for the law with an emphasis on employee responsibility for ethical conduct. Employees are told to act with integrity and conduct their business dealings in an environment of honesty and fairness. From these values a company will nurture and maintain business relationships and will be profitable.19

Researchers found that both approaches lessened unethical conduct, although in some- what different ways. Compliance-based ethics programs increased employees’ willingness to seek ethical advice and sharpened their awareness of ethical issues at work. Integrity-based programs, for their part, increased employees’ sense of integrity, commitment to the orga- nization, willingness to deliver bad news to supervisors, and their perception that better decisions were made.20

Top Management Commitment and Involvement

Research has consistently shown that the “tone at the top”—the example set by top executives— is critical to fostering ethical behavior. As Dan Amos, CEO and Chairperson for Aflac states, “Ethics is a mindset, not an option.”21 When senior-level managers and directors signal employees, through their own behavior, that they believe ethics should receive high priority in all business decisions, they have taken a giant step toward improving ethical performance throughout the company.

Whether the issue is sexual harassment, honest dealing with suppliers, or the reporting of expenses, the commitments (or lack thereof) by senior management and the employees’ immediate supervisor and their involvement in ethics as a daily influence on employee behavior are the most essential safeguards for creating an ethical workplace.

Ethics Policies or Codes

As shown in Figure 6.2, many U.S. businesses, especially large firms, have ethics policies or codes. An example of a corporate ethics code is shown in Exhibit 6.D. The purpose of such policies and codes is to provide guidance to managers and employees when they encounter an ethical dilemma. Research has shown significant differences among coun- tries. In the United States and Latin America, ethics policies were found to be primarily instrumental—that is, they provided rules and procedures for employees to follow in order to adhere to company policies or societal laws. In Japan, most policies were a mixture of legal compliance and statements of the company’s values and mission. Values and mission policies were also popular with European and Canadian companies.22 Despite some differ- ences in orientation, codes of ethics are clearly becoming more common.

Typically, ethics policies cover issues such as developing guidelines for accepting or refusing gifts from suppliers, avoiding conflicts of interest, maintaining the security of proprietary information, and avoiding discriminatory personnel practices. Yet, researchers have found that a written ethics policy, while an important contributor, is insufficient by itself to bring about ethical conduct. Companies must circulate ethics policies frequently and widely among employees and external stakeholder groups (for example, customers,

19 Lynn Sharp Paine, “Managing for Organizational Integrity,” Harvard Business Review, March–April 1994, pp. 106–17. 20 Gary R. Weaver and Linda Klebe Trevino, “Compliance and Values Oriented Ethics Programs: Influences on Employees’ Attitudes and Behavior,” Business Ethics Quarterly 9 (1999), pp. 315–35. 21 “Top CEOs Place High Value on Corporate Ethics and Social Responsibility to Drive Business,” Forbes, September 11, 2017, www.forbes.com. 22 Ronald C. Berenbeim, Global Corporate Ethics Practices: A Developing Consensus (New York: Conference Board, 1999).

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3M’s Code of Conduct

Named one of the world’s most ethical companies in 2018 for the fifth straight year by Ethisphere Institute, 3M maintains its reputation for its personal integrity, shared values, and ethical business practices around the world. Their code of conduct emphasizes six main principles:

1. Be Good. Obey the law and 3M’s Code of Conduct. 2. Be Honest. Act with uncompromising honesty and integrity. 3. Be Fair. Play by the rules, whether working with government, customers, or suppliers. 4. Be Loyal. Protect 3M’s interests, assets, and information. 5. Be Accurate. Keep complete and accurate business records. 6. Be Respectful. Respect one another and our social and physical environment around the world.23

Source: www.3m.com

23 “3M Recognized by Ethisphere Institute as a World’s Most Ethical Company for 5th Consecutive Year,” 3M News Center, Press Release, February 12, 2018, news.3m.com; and 3Msource.mmm.com/businessconduct. 24 “The 2014 Ethics and Compliance Program Effectiveness Report,” LRN, 2014, pp. 30–31. 25 “Getting Ahead of the Watchdogs: Real-Time Compliance Management, 2018 State of Compliance,” PricewaterhouseCoopers, 2018, www.pwc.com/us/stateofcompliance.

Exhibit 6.D

suppliers, or competitors). Many companies use posters, quick reference guides, and bro- chures to raise awareness and importance of their code.24

Ethics and Compliance Officers

Ethical lapses in large corporations throughout the 1980s prompted many firms to create a new position: the ethics and compliance officer (ECO), or sometimes called the chief compli- ance officer (CCO) or the chief integrity officer (CIO). A second surge of attention to ethics and the creation of ethics offices came in response to the 1991 U.S. Corporate Sentencing Guidelines, discussed in Chapter 5. The wave of corporate ethics scandals in the early 2000s and the passage of the Sarbanes-Oxley Act once again turned businesses’ attention toward entrusting ethical compliance and the development and implementation of ethics programs to an ethics or compliance officer. From 2000 to 2004, the number of members in the Ethics Officer Association doubled from 632 to more than 1,200 members and continued to grow to approximately 1,300 members representing over 400 organizations in over 50 countries by 2015. In 2015, the Ethics and Compliance Officer Association (ECOA), having renamed itself to reflect the growing number of managers charged with both compliance and ethics issues, and the Ethics Resource Center, America’s oldest non-profit organization advancing high ethical standards and practices in public and private institutions, merged into the Ethics and Compliance Alliance. One member of the ECOA is profiled in Exhibit 6.E.

A PricewaterhouseCoopers 2018 global compliance survey reported that 30 percent of the company’s ethics and compliance officers annually review the company’s code of con- duct and 49 percent update their firm’s compliance training and communication programs. Technology also plays a larger role for ethics officers. Half of the ethics and compliance officers surveyed reported they used technology to monitor employees’ compliance with ethics and compliance-related policies and procedures. “To prevent blind spots and flag exceptions as they occur, we must look to automation and technology to conduct real-time data mining and analytics,” explained Karen Griffin, executive vice present and chief com- pliance officer at Mastercard.25

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Meet Brad Smith, Microsoft’s Chief Compliance Officer

Brad Smith serves as Microsoft’s chief compliance officer, as well as its president and chief legal officer. He is responsible for the company’s corporate, external, and legal affairs, leading a team of more than 1,400 busi- ness, legal, and corporate affairs professionals working in 55 countries. These teams are responsible for the company’s legal work, its intellectual property portfolio, patent licensing business, corporate philanthropy, government affairs, public policy, corporate governance, and social responsibility work. Smith plays a key role in representing the company externally and in leading the company’s work on a number of critical issues including privacy, security, accessibility, environmental sustainability, and digital inclusion. Smith joined Microsoft in 1993 before becoming general counsel in 2002. Previously, he spent three years leading the legal and corporate affairs team in Europe and five years serving as the deputy general counsel responsible for legal and corporate affairs outside of the United States.

Sources: From the Leadership page in the Microsoft website, news.microsoft.com.

Exhibit 6.E

Ethics Reporting Mechanisms

In most companies, when employees are troubled about some ethical issue they seek out their immediate supervisor or someone else in senior management. But what if the employee is reluctant, for whatever reason, to raise the issue with their immediate supervi- sor? In that case, they can turn to their company’s ethics reporting mechanisms and call a “helpline” or send an e-mail expressing their concerns, anonymously if they wish. Ethics reporting systems typically have three uses: (1) to provide interpretations of proper ethical behavior involving conflicts of interest and the appropriateness of gift giving, (2) to create an avenue to make known to the proper authorities allegations of unethical conduct, and (3) to give employees and other corporate stakeholders a way to discover general informa- tion about a wide range of work-related topics.

A 2014 study found that 87 percent of firms made at least substantial progress on pro- viding employees with a secure and anonymous channel for reporting concerns. Another study found that more than one-third of the firms surveyed reported that the volume of calls to the organization’s reporting mechanism increased somewhat or a great deal in the last two years and only 12 percent of firms reported a decline in calls.26

While more and more employees are willing to use their companies’ ethical reporting mechanisms, a number of challenges remain. Executives tend to use the helpline more often than those farther down the organizational chart. The Ethics Resource Center study found that middle managers were “an area of vulnerability within companies” since they were less likely to use the helpline. The report also discovered that rates of helpline usage were lower in foreign-owned companies than in their U.S. counterparts. Yet, many busi- nesses described greater success when employees use the company’s helpline/hotline and were better able to avoid more serious ethical violations. Technology seemed to be the key.

A recent trend in corporate governance involves the use of ethics ambassadors, or liaisons, whose role is to promote and spread compliance and ethics messages throughout an organization. Most liaison programs focus on risk assessment and encouraging employees to communicate ethical infractions when they take place. New liaison programs go beyond this approach and try to design ways to better com- municate the ethics message to employees despite various competing sub-cultures within a given organization.27

26 “2014 LRN Study,” Ibid., p. 30; and “Helpline Calls and Incident Reports,” Society of Corporate Compliance, 2014. 27 “A Different Approach to Ethics Liaison Programs,” Ethikos, May/June 2016, pp. 1–4.

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But no matter how advanced the technology used in an ethics and compliance program, the ethics and compliance officer never really knows what to expect when monitoring calls to the helpline, as the following example showed:

“Oh, boy, this is one of those days,” thought the ethics officer at a midsized manu- facturing firm when she received a call on the ethics helpline that a toilet in the com- pany’s administration building was overflowing. She called maintenance and they found that someone had clogged up the toilet drain. When the same call was received a week later, the ethics officer knew she had to investigate. Through interviews with personnel who worked on that floor, she discovered that the supervisor had refused to allow workers to take bathroom breaks when needed, and an employee had boasted that “he was going to get even with his supervisor and plug up the toilet” to attract attention to unsafe working conditions. The call about the overflowing toilet and sub- sequent investigation allowed the ethics officer to address the real issue, counsel the supervisor, and repair the deteriorating working conditions at her company.28

Ethics Training Programs

Another step companies can take to build in ethical safeguards is to offer employee ethics training. This is generally the most expensive and time-consuming element of an ethics pro- gram. Studies have shown that only 20 to 40 percent of small businesses formally offer ethics training to their employees, often using less formal ways to communicate ethical values and procedures. Larger businesses, by contrast, usually conduct regular ethics training. As shown in Figure 6.3, businesses have several motivations for developing employee ethics training programs. In general, larger and more mature organizations are more inclined to believe that a culture of ethics encourages employees to speak up; whereas, small- and medium-size organizations are more likely to define training as an alignment with regulatory guidelines.29

As shown in Figure 6.3, most ethics and compliance training programs focus on making sure employees know what the law requires and the company expects. Some firms have gone further, exploring how individuals can contribute to strengthening the firm’s ethical culture.

An ethics training seminar sponsored by the Italian Cultural Institute in Copenhagen focused on the importance of individual creativity in making company cultures more ethical. Speakers at this cross-country congress of corporate governance professionals championed the great capacity of human ingenuity to facilitate ethical behavior in orga- nizations. For example, sessions at this conference included “The Responsibility of Indi- viduals and Organizations for Community Development and Progress” and “Innovative Approaches to Sustainable Development: From the Education of New Generations to the Processes for the Integration of Social Responsibility into Business Models.”30

One approach to ethics training in organizations that has become increasingly popular is known as “giving voice to values.” This approach is described in Exhibit 6.F.

The effectiveness of the ethics and compliance program is important to executives. Companies used to conduct formal ethics audits to ensure the quality of these programs, but today most firms have turned to a company-wide risk assessment audit to determine

28 Based on an interview with an ethics and compliance officer who requested that her firm and her identity remain anonymous. 29 See “Is Your Ethics and Compliance Training Really Preparing Your Employees?” Compliance and Ethics Professional, March–April 2012, www.corporatecompliance.org; and “2017 Ethics & Compliance Training Benchmark Report,” NAVEXGlobal (Lake Oswego, OR: NAVEXGlobal, 2017). 30 “Culture and Creativity as Key to Development Danish and Italian Applications: Ideas that Change the World,” conference sponsored by the Italian Cultural Institute in Copenhagen, www.fiveonlus.eu.

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Giving Voice to Values

Giving Voice to Values (GVV) was created Mary Gentile as an innovative approach to values-driven leadership development in business education and the workplace. As Gentile explained, “Rather than a focus on ethical analysis, the Giving Voice to Values curriculum focuses on ethical implementation and asks the questions: “What if I were going to act on my values? What would I say or do? How could I be most effective?” By 2018, this program was piloted in over 1,000 schools, companies, and other organizations on every continent. The GVV curriculum offers practical exercises, cases, modules, scripts, and teaching plans for handling a wide range of ethical conflicts in the workplace. The challenge for many moral managers is acting effectively on their beliefs in the day-to-day life of their organizations. Educator Mary Gentile tries to empower business leaders and managers by enabling them to give voice to—and to act on—their values at work. Gentile’s Giving Voice to Values program believes that the key is knowing how to act on your values despite opposing pressure. “GVV starts from the premise that most of us already want to act on our values, but that we also want to feel that we have a reasonable chance of doing so effectively and successfully. This pedagogy and curriculum are about raising those odds,” said Gentile.

Source: From www.darden.virginia.edu/ibis/initiatives/giving-voice-to-values.

Exhibit 6.F

FIGURE 6.3 Objectives and Motivations for Employee Ethics Training Programs

Source: “2017 Ethics & Compliance Training Benchmark Report,” NAVEXGlobal, 2017, Lake Oswego, OR: NAVEXGlobal).

0 10 20 30 40 50 60 70

Create a culture of ethics and respect

Improve employee understanding of compliance priorities and obligations

Prevent future issues or misconduct

Meet audit or certification requirements

Keep information secure and protected

Improve the skills of senior leaders and managers

Reinforce tone at the top

Improve training e�ectiveness by deploying courses that are higher quality

Establish strong legal defenses

Comply with laws and regulations 59%

57%

47%

39%

21%

20%

14%

14%

13%

8%

the effectiveness of the ethics program along with other risks. Experts believe that inte- grating various ethics safeguards into a comprehensive program is critically important and minimizes the firm’s risk. When all five components discussed in this chapter—top management commitment, ethical policies or codes, compliance officers, reporting mech- anisms, and training programs—are used together, they reinforce each other and become more effective.

As seen in Chapter 5, Ethisphere’s “The World’s Most Ethical Companies” financially outperformed the S&P 500 and FTSE 1000 every year since 2005. Figure 6.4 shows the 13 companies that have made the World’s Most Ethical Companies list each year from 2007–2017.

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Ethics in a Global Economy

Doing business in a global context raises a host of complex ethical challenges. One exam- ple of unethical activity is bribery, a questionable or unjust payment often to a government official to ensure or facilitate a business transaction. The act of bribery introduces an eco- nomic force that is not based on the product or service’s quality or other sales characteris- tics, therefore the element of bribery corrupts the economic exchange.

Bribery is found in nearly every sector of the global marketplace, but is more common in some countries than others.

A Berlin-based watchdog agency, Transparency International, annually publishes a sur- vey that ranks countries by their level of corruption, as perceived by executives and the public. In the 2017 survey, countries where having to pay a bribe was least likely included New Zealand, Denmark, Finland, Norway, and Switzerland. At the other end of the index, Syria, South Sudan, and Somalia were considered the world’s most corrupt countries, along with Afghanistan, Yemen, Sudan, Libya, and North Korea. The United States was tied for 16th on the list of 180 countries, with Canada 8th, Singapore and Sweden tied for 6th, the United Kingdom tied for 8th with the Netherlands, India tied for 81st with Ghana, China tied for 77th with Serbia and Suriname, and Russia tied for 135th.31

In some settings, corruption is so common as to be almost unavoidable. Transparency International interviewed over 160,000 adults from 119 countries around the globe from March 2014 to January 2017, to discover regional differences in corruption. This study found that one in four people claim to have paid a bribe when accessing public services in the 12 months prior to the survey. On average, the European Union had the lowest reported bribery rate at 9 percent compared to an average rate of 30 percent in the Middle East, North Africa, and the Commonwealth of Independent States in Eurasia. Latin American

31 For a complete list of all countries according to their perceived level of corruption, see https://www.transparency.org/ news/feature/corruption_perceptions_index_2017.

These firms were ranked among the highest ethical firms each year from 2007 through 2017.

AFLAC (insurance)

Deere and Company (industrial manufacturing)

Ecolab (chemicals)

Fluor Corporation (engineering)

General Electric (diversified)

International Paper (paper products)

Kao Corporation (consumer products)

Milliken & Company (industrial manufacturing)

PepsiCo (food & beverage)

Starbucks Coffee Company (restaurants)

Texas Instruments (computers)

UPS (transportation)

Xerox (computers)

FIGURE 6.4 The World’s Most Ethical Companies and Their Industries, According to Forbes Magazine

Source: “The World’s Most Ethical Companies, Forbes, March 14, 2017, www.forbes .com.

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and Asia Pacific regions were close behind with average bribery rates up to 29 percent. A survey in Nigeria found that Nigerians paid about $4.6 billion in bribes each year. Accord- ing to a 2017 study by the Prosecutor General’s Office in Russia, 25 percent of Russians admitted to having paid a bribe in the prior year.32

Bribery has significant economic, as well as ethical, consequences. Mythili Raman, a former senior executive at the Department of Justice explained,

“Our fight against foreign corruption is critical for so many reasons. The corrosive effects of transnational corruption are felt not just overseas, but also here in the United States. Although we may not experience as acutely, or as personally, some of the consequences of foreign bribery, such as hospitals or roads that go unbuilt because infrastructure funds are siphoned off by a corrupt official, American com- panies are harmed. They are denied the ability to compete in a fair and transparent marketplace. Instead of being rewarded for their efficiency, innovation and honest business practices, U.S. companies suffer at the hands of corrupt governments and lose out to corrupt competitors.”33

The following examples further demonstrate the harmful effects of bribery.

∙ Brazilian state-run oil company Petroleo Brasileiro SA announced that their corrup- tion scandal contributed to their stock shares dropping 6.2 billion reais ($2.1 billion) in value and led to a revised accounting charge of 44.6 billion reais ($14.8 billion) for 2014 after determining that assets were overvalued on its balance sheet.

∙ Alstom, a French conglomerate, plead guilty and paid $772 million to the United States for bribing Indonesian government officials with more than $4 billion to win power contracts from 2000 to 2011. Since Alstom has U.S. affiliate companies that are head- quartered in Connecticut, it is governed by United States laws, specifically the Foreign Corrupt Practices Act (the FCPA is introduced later in the chapter).

∙ Rolls-Royce, the luxury automobile, jet and marine engine manufacturer, settled a long- term corruption investigation by agreeing to pay U.S. and British government authori- ties more than $800 million in penalties. The company admitted in 2017 to engaging in corrupt business dealings overseas years earlier.34

Efforts to Curtail Unethical Practices Despite the prevalence of bribery, both companies and countries have taken a strong stand against it.

Huguette Labelle, the chair of Transparency International, stated, “People believe they have the power to stop corruption, and the number of those willing to combat the abuse of power, secret dealings, and bribery is significant.” Seventy-one percent of respondents to a

32 “People and Corruption: Citizens’ Voices from Around the World,” Transparency International, 2017, www.transparency .org; “Corruption Currents: Study Says Nigerians Pay $4.6 Billion in Bribes Per Year,” The Wall Street Journal, August 17, 2017, www.wsj.com; and “A Quarter of Russians Pay Bribes, Anonymous Survey Says,” Moscow Times, December 11, 2017, www.moscowtimes.com. 33 “Acting Assistant Attorney General Mythili Raman Speaks at the Global Anti-Corruption Compliance Congress,” Ethikos, May/June 2014, pp. 1–2. 34 “Brazil’s Petrobras Reports Nearly $17 Billion in Asset and Corruption Charges,” The Wall Street Journal, April 22, 2015, www.wsj.com; “Alstom to Pay U.S. Record $772 Million in Fine in Bribery Scheme,” The New York Times, December 22, 2014, www.nytimes.com; and, “Rolls-Royce to Pay More than $800 Million to Settle Corruption Probe,” The Wall Street Journal, January 14, 2017, www.wsj.com.

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Dow Jones Anti-Corruption survey said their companies had delayed or stopped activities with business partners over concerns about breaking anti-corruption regulations.

In 2017, Samsung Electronics’ vice-chairman, Lee Jae-yong, was convicted of brib- ery and sentenced to a five-year jail sentence. Lee was found guilty of bribing South Korea’s president and of involvement in a corruption scandal that had com- promised the previous government regime in his country. Allegedly, Lee had attempted to bribe President Park Geun-hye to get her to support business deals important to Samsung. The company admitted that it was complicit in the agree- ment to pay a close friend of Park $38 million. Prosecutors claimed that some of the payments made by Samsung were to guarantee that certain business deals were made for Samsung’s benefit. Park was later removed from political office and was tried and convicted of bribery and coercion. This bribery scandal spanned both cor- porate and political boundaries.35

Numerous efforts are under way to curb unethical business practices throughout the world. The most common method is government intervention and regulation.

Since 1977, the U.S. Foreign Corrupt Practices Act (FCPA) has prohibited executives of U.S.-based companies or businesses operating in the U.S. from paying bribes to govern- ment officials, political parties, or political candidates. To achieve this goal, the FCPA requires U.S. companies with foreign operations to adopt accounting practices that ensure full disclosure of the company’s transactions. In 2014, companies paid $1.56 billion to resolve FCPA cases. In 2015, companies paid $133 million; in 2016, $2.48 billion; and, in 2017, $1.92 billion.36

The United Kingdom’s Bribery Act was passed in 2010. Some believed it was even more stringent than the U.S.’s FCPA. The U.K. Bribery Act differs from the FCPA in that it

∙ prohibits the bribery of another person and receiving or accepting a bribe, whereas the FCPA only prohibits bribery of government officials. Bribery of a private business executive would be illegal under British, but not U.S., anticorruption law.

∙ does not require that the improper offer, promise, or payment be made “corruptly,” as the FCPA does require evidence of the intent to corrupt.

∙ does not provide exemptions for “facilitating payments” or the defense that there are reasonable and bona fide contractual or promotional expenses, as the FCPA does.

∙ contains a strict liability offense for failure to prevent bribery by commercial organiza- tions; the FCPA does not.37

Other governments have drafted and passed new legislation to combat corruption and bribery. In 2013, Brazil, one of the world’s top 10 largest economies, approved an anti- bribery law that imposed civil and criminal penalties on firms for acts committed against local and foreign government officials. Fines can be as high as 20 percent of the compa- ny’s annual gross revenues. India joined Brazil in 2014 by passing its own anticorruption legislation.

The Mexican government approved a major anticorruption reform bill in 2016 that revised 14 constitutional articles, creating two new laws and changing five others. Backed by civil society groups, this reform represented the largest and broadest attempt to address

35 “Samsung Heir Lee Jae-yong Convicted of Bribery, Gets Five Years in Jail,” The Wall Street Journal, August 25, 2017, www.wsj.com. 36 “2017 FCPA Enforcement Index,” The FCPA Blog, January 2, 2018, www.fcpzblog.com. 37 Bribery Act 2010, 2010, www.legislation.gov.uk/ukpga/2010/23/contents.

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rampant corruption in the country. Among the areas addressed by the new measures, dec- laration of assets by public contractors is now mandatory.38

While enforcement is often spotty, some countries have enforced their bribery laws aggressively. China imposed a $487 million fine on British pharmaceutical GlaxoSmith- Kline (GSK) for bribery, after Glaxo reportedly used payoffs to persuade hospitals and doctors to administer or sell Glaxo pharmaceuticals to their patients.39

While governmental efforts continue to emerge, a business scholar argued that “a legalistic approach, by itself, is unlikely to be effective in curbing bribery,” since culture has such a strong influence. Most effective in combating bribery may be an integrative approach of economic development, social investment in education, and business-friendly policies, in addition to anticorruption laws and punishments to combat bribery.40

Businesses of all sizes and from many diverse industries around the world have attempted to respond to the increasing pressure to create an ethical environment at work. As discussed, the organization’s culture and ethical work climate play a central role in pro- moting ethics at work and encouraging employees to act ethically. Businesses have imple- mented many ethical safeguards to create effective ethics programs. Challenges remain as organizations expand their operations globally and encounter a complex network of different customs and regulations.

38 “Mexico Wins: Anti-Corruption Reform Approved,” Forbes, July 18, 2016, www.forbes.com. 39 “Finally, Companies in Brazil Can Be Prosecuted for Corruption,” Transparency International, July 8, 2013, blog. transparency.org; “Indian: New Anti-Corruption Law,” The Law Library of Congress, January 8, 2014, www.loc.gov; and “China Fines GlaxoSmithKline Nearly $500 Million in Bribery Case,” The New York Times, September 19, 2014, www.nytimes.com. 40 Rajib Sanyal, “Determinants of Bribery in International Business: The Cultural and Economic Factors,” Journal of Business Ethics 59 (2005), pp. 139–45.

∙ A company’s culture and ethical climate tend to shape the attitudes and actions of all who work there, sometimes resulting in high levels of ethical behavior and at other times contributing to less desirable ethical performance.

∙ Not all ethical issues in business are the same, but ethical challenges occur in all major functional areas of business. Professional associations for each functional area often attempt to provide a standard of conduct to guide practice.

∙ Companies can improve their ethical performance by creating a values-based ethics program that relies on top management leadership and organizational safeguards, such as ethics policies or codes, ethics and compliance offices and officers, ethics reporting mechanisms, and ethics training programs.

∙ Companies that have a comprehensive, or multifaceted, ethics program often are better able to promote ethical behavior at work and avoid unethical action by employees.

∙ Ethical issues, such as bribery, are evident throughout the world, and many international agencies and national governments are actively attempting to minimize such unethical behavior through economic sanctions and international codes.

Summary

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Key Terms ethics reporting mechanisms, 126 U.S. Foreign Corrupt Practices Act, 131

bribery, 129 corporate culture, 116 employee ethics training, 127 ethical climate, 117

ethics and compliance officer, 125 ethics policies or codes, 124

Internet Resources

thecro.com CR: Corporate Responsibility Magazine www.dii.org Defense Industry Initiative on Business Ethics and Conduct ecoaconnects.theecoa.org Ethics and Compliance Initiative Connects (Ethics and

Compliance Officer Association) www.ethicaledge.com Ethics and Policy Integration Centre ethisphere.com Ethisphere Institute www.ethics.org Ethics and Compliance Initiative Connects (Ethics Resource

Center) www.globalethics.org Institute for Global Ethics www.saiglobal.com SAI Global www.business-ethics.org International Business Ethics Institute www.corporatecompliance.org Society of Corporate Compliance and Ethics www.transparency.org Transparency International

Discussion Case: Equifax’s Data Breach

The credit reporting company Equifax was at the center of a massive data breach affecting over 145 million customers. In 2017, hackers took advantage of a vulnerability in Equi- fax’s website software and stole the personal information, including names, addresses, and Social Security numbers, of as many as 145 million Americans. A separate but related incident at Equifax involved 15 million British citizens who had their records violated from 2011 to 2016. The failure of Equifax’s internal reporting and control measures led to a widespread violation of peoples’ rights to the privacy of their personal information and became a huge public relations crisis for the company.

Equifax’s top lawyer, John Kelley, was investigated by the board of directors for his pos- sible involvement in a cover-up of the hack and his mishandling of the situation. Kelley was responsible for approving the sales of company stock by executives after the breach was dis- covered, but before it had been revealed to the public. Upon the disclosure of the breach, company stock price fell 14 percent. Investors sold approximately $4.5 billion (25 percent) of the company’s market value after the hack was made public.

More than 10 million Americans had their driver’s license data exposed during the hack. Many people who had provided their driver’s license information to the company were simply verifying their information in order to receive credit reports and ratings from Equifax. Some had entered their information on the company’s web page in an effort to settle credit report disputes. The credit report dispute web page had been particularly vul- nerable to security breaches. Equifax CEO Richard Smith admitted during congressional

Chapter 6 Organizational Ethics 133

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hearings that he and other executives had been aware of the security weaknesses, but that a single employee at the firm had not properly heeded security warnings and did not ensure the implementation of software fixes. Smith added that there was a failure in their software systems designed to scan for the absence of “patches” necessary to protect pri- vate information.

Other internal control mechanisms at Equifax appeared to have been either ignored or dysfunctional. Frederick Lemieux, director of Georgetown University’s graduate pro- gram in Applied Intelligence, blamed the breach on what he called “passive complicity” in the firm’s culture. (Complicity means being involved in wrongdoing; passive complicity implies that executives were guilty of wrongdoing by not actively preventing it.) That top executives seemed to worry more about their own stock portfolios than the security of their customers’ personal information was troubling to many ethics experts. Observers also crit- icized the company for its delay in going public about the breach. Finally, it appeared that knowledge of the potential for hacking was isolated to only one employee. A more robust system where multiple individuals were responsible for preventing a problem might have avoided the hack.

Unlike banks, credit reporting agencies are relatively lightly regulated, and they typi- cally rely on internal systems to maintain security. Lemieux stated, “there is no incentive to comply with the best industry practices and no incentives to spend [funds on these pro- grams] because you’re not accountable for it.” He noted that credit reporting agencies did not face the same financial or legal consequences that banks or other businesses, like Tar- get or Home Depot, encountered when hacked. Pamela Pressman, president of the Center for Responsible Enterprise and Trade, said that the breach should remind Equifax and other firms to train their employees and raise awareness about proper “cyber hygiene . . . ensur- ing that your employees, your contractors, your vendors—those people that have access to your network and your data—understand their role in protecting the network and protect- ing the data.”

The cyberattack on Equifax was potentially more dangerous than other hacks in recent history because credit-reporting agencies played a significant role in determining who received financing and ultimately, how much credit they received. The data collected by these agencies was needed for applying for credit cards, loans, and background checks. The attack was conducted in one major maneuver, which facilitated the hackers’ ability to use the data for their own purposes.

This breach could lead to problems for small financial institutions, like community banks and credit unions, which typically relied on information collected by the credit-reporting firms to determine their loan decisions. Larger financial institutions were more likely to collect additional information from applicants, which made them less vulnerable.

Days after the company discovered the breach, CFO John Gamble and two other top Equifax executives reportedly sold a combined $1.8 million worth of shares of the com- pany, but all three denied knowing of the hack when they made the transactions, despite evidence to the contrary. CEO Smith stepped down from his post following these events. Smith had been in charge since 2005. The Federal Bureau of Investigation investigated Equifax’s handling of the situation as well as the actions of the top executives. When testi- fying before Congress, Smith downplayed the severity of the situation and the factors that facilitated the breach. He repeatedly blamed an IT worker who did not implement software remedies after Equifax executives had been warned of possible holes in Equifax’s website security by the U.S. Department of Homeland Security.

Equifax hired FireEye’s Mandiant group to investigate the breach. The Mandiant report determined that approximately 2.5 million additional U.S. consumers were potentially

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impacted, for a total of 145.5 million. Mandiant did not identify any evidence of additional or new attacker activity or any access to new databases or tables. Instead, this additional population of consumers was confirmed during Mandiant’s completion of the remaining investigative tasks and quality assurance procedures built into the investigative process. The review also has concluded that there is no evidence the attackers accessed databases located outside of the United States.

Equifax claimed they learned of hacking activity in May 2017, but the Mandiant report said the hack started two months earlier. Company executives did not formally disclose the breach until September 2017, however. They admitted that the hack was conducted from May through July 2017. The identity of the hackers was never disclosed.

Sources: “The Morning Risk Report: Equifax Breach Could Spur New Round of Training,” The Wall Street Journal, September 11, 2017, www.wsj.com; “How to Explain the Equifax Breach? Start with the Culture,” Georgetown University, September 15, 2017, ses.georgetown.edu; “Equifax CEO Richard Smith to Exit Following Massive Data Breach,” The Wall Street Journal, September 26, 2017, www.wsj.com; “At the Center of the Equifax Mess: Its Top Lawyer,” The Wall Street Journal, October 1, 2017, www.wsj.com; “2.5 Million More People Potentially Exposed in Equifax Breach,” The New York Times, October 2, 2017, www.nytimes.com; “Equifax Announces Cybersecurity Firm Has Concluded Forensic Investigation Of Cybersecurity Incident,” Equifax website, October 2, 2017, investor.equifax.com; and “Equifax Breach Caused by Lone Employee’s Error, Former CEO Says,” The New York Times, October 4, 2017, www.nytimes.com.

Discussion Questions

1. Do you think the company reacted appropriately upon learning about the breach? 2. What could Equifax have done differently to prevent the cyberattack? 3. What type(s) of ethical climate existed at Equifax, and did this contribute to the hacking

issues there? 4. What changes should managers and the board of directors make now to reduce to likeli-

hood of an incident like this from occurring in the future? 5. What types of ethics training would you recommend for Equifax employees in the future

to prevent such corrupt behavior?

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P A R T T H R E E

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Business and Public Policy

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C H A P T E R S E V E N

Business–Government Relations Governments seek to protect and promote the public good and in these roles establish rules under which business operates in society. Therefore, a government’s influence on business through pub- lic policy and regulation is a vital concern for managers. Government’s relationship with business can be either cooperative or adversarial. Various economic or social assistance policies significantly affect society, in which businesses must operate. Many government regulations also impact business directly. Managers must understand the objectives and effects of government policy and regulation, both at home and abroad, in order to conduct business in an ethical and legal manner.

This Chapter Focuses on These Key Learning Objectives:

LO 7-1 Understanding why sometimes governments and business collaborate and other times work in opposition to each other.

LO 7-2 Defining public policy and the elements of the public policy process.

LO 7-3 Explaining the reasons for regulation.

LO 7-4 Knowing the major types of government regulation of business.

LO 7-5 Identifying the purpose of antitrust laws and the remedies that may be imposed.

LO 7-6 Comparing the costs and benefits of regulation for business and society.

LO 7-7 Examining the conditions that affect the regulation of business in a global context.

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Uber Technologies, a U.S.–based international transportation network company founded in 2009, developed a mobile app that allowed consumers to submit a trip request, which was then routed to one of its drivers. By 2018, the service was available in 84 countries and nearly 800 cities worldwide. Yet, Uber encountered serious opposition when it attempted to expand into the European Union. The Employment Appeal Tribunal ruled in 2017 that the 50,000 Uber drivers in the United Kingdom must be considered employees, not indepen- dent contractors, as Uber had argued. This ruling meant that the drivers qualified for vari- ous employee rights such as paid vacations. Experts stated that this decision could serve as a bellwether for other employment lawsuits against Uber in the United States, Canada, and other countries, potentially jeopardizing the company’s business model globally.1

In 2016, the U.S. Food and Drug Administration (FDA) created tough regulatory standards for the e-cigarette industry, including banning all sales to anyone under 18 years of age, requir- ing package-warning labels, and making all products—even those currently on the market— subject to government approval. This was seen as a devastating blow to the fast-growing $3.5 billion e-cigarette industry, which was largely unregulated and dominated by small man- ufacturers and vape shops. Most experts predicted that this was only the first step and that the FDA would soon move to regulate the e-cigarette industry further, targeting advertising and e-cigarette flavors, such as cotton candy and watermelon, which may appeal to youth.2

What prompted or compelled governments to become more involved in the status of employees or the sale of a consumer product? How do these governments’ actions affect businesses and what they are permitted to do? How did these actions affect competition or society and the public’s health? Did governments’ involvement promote or harm compa- nies or allow other firms to maintain their competitive advantage? Were these efforts by the governments necessary and effective, or can this only be answered in time?

Governments create the conditions that make it possible for businesses to compete in the modern economy. As shown in the opening examples, governments can act in dramatic ways to provide or limit opportunities for businesses and control business activities to better ensure the public’s health. In good times and bad, government’s role is to create and enforce the laws that balance the relationship between business and society. Governments also hold the power to grant or refuse permission for many types of business activity. Even the largest multinational companies, which operate in dozens of countries, must obey the laws and public policies of national governments.

This chapter considers the ways in which government actions impact business through the powerful twin mechanisms of public policy and regulation. The next chapter addresses the related question of actions business may take to influence the political process.

How Business and Government Relate

The relationship between business and government is dynamic and complex. Understand- ing the government’s authority and its relationship with business is essential for managers in developing their strategies and achieving their organization’s goals.

Seeking a Collaborative Partnership In some situations, government may work closely with business to build a collaborative partnership and seek mutually beneficial goals. They see each other as key partners in the relationship and work openly to achieve common objectives.

1 “Uber Suffers Setback as U.K. Court Rules Its Drivers Should Have Workers’ Rights,” The Wall Street Journal, November 10, 2017, www.wsj.com. 2 “FDA to Regulate E-Cigarettes, Ban Sales to Minors,” The Wall Street Journal, May 5, 2016, www.wsj.com.

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The basis for this cooperation may be at the core of the nation’s societal values and customs. In some Asian countries, society is viewed as a collective family that includes both government and business. Thus, working together as a family leads these two powers to seek results that benefit both society and business. In Europe, the relationship between government and business often has been collaborative. European culture includes a sense of teamwork and mutual aid. Unions, for example, are often included on administrative boards with managers to lead the organization toward mutual goals through interactive strategies. One example of government–business collaboration is shown next.

While many businesses were requesting and supporting While House directives to eliminate or decrease regulatory control, quite the contrary drone makers and opera- tors were clamoring for more federal rules. They envisioned an increase in the regula- tory climate as an opportunity to open up the skies for unmanned aircraft. These businesses pledged to cooperate with regulators to make that happen. In response to these pressures, the Federal Aviation Administration gave approval for small, remotely piloted aircraft weighing up to 55 pounds to operate during daylight hours, up to an altitude of 400 feet and within sight of operators on the ground. Drone maker and operators took this opportunity to expand their operations. Unlike some other businesses that did not welcome government oversight, “we want and need rules and regulations to understand how we can fly drones commercially for expanded opera- tions,” said Gretchen West, a senior legal advisor to the drone industry.3

In this instance, both the Federal Aviation Administration and drone makers agreed on the need for regulation, leading to collaboration between the government and business.

Working in Opposition to Government In other situations, government’s and business’s objectives are at odds, and these conflicts result in an adversarial relationship where business and government tend to work in oppo- sition to each other.4

On three difference occasions, Tesla released relevant information to the National Transportation Safety Board (NTSB) to assist the government agency in its investi- gation of the cause of a crash of its semiautonomous driving Tesla Model S vehicle. But a few weeks later, the company withdrew from its formal agreement to cooper- ate with the NTSB after the preliminary investigation appeared to target the driver in the car, who died from injuries sustained in the accident. “Today, Tesla withdrew from the party agreement with the NTSB because it requires that we not release information about Autopilot to the public, a requirement which we believe funda- mentally affects public safety negatively,” explained a Tesla company press release. Tesla seemed upset that it could be a year or longer before the government investi- gators reached their conclusions, and meanwhile the company would be subject to negative publicity without an opportunity to respond with their side of the story.5

In this instance, a business concluded that cooperation with the government was not in its best interest.

3 “Unlike Most Industries, Drone Makers and Operators Clamor for Federal Regulation,” The Wall Street Journal, September 17, 2017, www.wsj.com. 4 The “collaborative partnership” and “in opposition” models for business–government relations is discussed in “Managing Regulation in a New Era,” McKinsey Quarterly, December 2008, www.mckinseyquarterly.com. 5 “Tesla Withdraws Formal Cooperation with Probe of Fatal Crash, Will Still Assist Investigators,” The Wall Street Journal, April 12, 2018, www.wsj.com.

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Why do businesses sometimes welcome government regulation and involvement in the private sector, and other times oppose it? Companies often prefer to operate without gov- ernment constraints, which can be costly or restrict innovation. But regulations can also help business, by setting minimum standards that all firms must meet, building public con- fidence in the safety of a product, creating a fair playing field for competition, or creating barriers to entry to maintain a business’s competitive advantage. How a specific company reacts to a specific government policy often depends on their assessment of whether they would be helped or hurt by that rule.

In short, the relationship between government and business can range from one of coop- eration to one of conflict, with various stages in between. Moreover, this relationship is constantly changing. A cooperative relationship on one issue does not guarantee coopera- tion on another issue. The stability of a particular form of government in some countries may be quite shaky, while in other countries the form of government is static but those in power can change unexpectedly or government leaders can change on a regular basis. The business–government relationship is one that requires managers to keep a careful eye trained toward significant forces that might alter this relationship or to promote forces that may encourage a positive business–government relationship.6

Legitimacy Issues When dealing with a global economy, business may encounter governments whose author- ity or right to be in power is questioned. Political leaders may illegally assume lawmaking or legislative power, which can become economic power over business. Elections can be rigged, or military force can be used to acquire governmental control.

Business managers may be faced with the dilemma of whether to do business in such a country, where their involvement would indirectly support this illegitimate power. Some- times, they may choose to become politically active, or refuse to do business in this coun- try until a legitimate government is installed.

Businesses can also influence the ability of a government leader or group of leaders to maintain political power. For example, companies can decide to withdraw operations from a country, as many U.S. firms did from South Africa in the 1970s to protest the practice of apartheid (institutionalized racial segregation). Some believe that the economic isolation of South Africa contributed to the eventual collapse of the apartheid regime. Governments may also order companies not to conduct business in another country because of a war, human rights violations, or lack of a legitimate government. These orders are called eco- nomic sanctions. As of 2018, the United States had imposed economic sanctions on the Balkans, Belarus, Myanmar, Cote D’Ivoire (Ivory Coast), Cuba, Democratic Republic of Congo, Iran, Iraq, Liberia, North Korea, Sudan, Syria, and Zimbabwe.7

Government’s Public Policy Role

Government performs a vital and important role in modern society. Although vigorous debates occur about the proper size of programs government should undertake, most peo- ple agree that a society cannot function properly without some government activities. Cit- izens look to government to meet important basic needs. Foremost among these are safety and protection provided by the military, homeland security, police, and fire departments.

6 See George Lodge, Comparative Business–Government Relations (Englewood Cliffs, NJ: Prentice Hall, 1990) and Tom Leh- man, “Six Arguments against Government Regulations,” www.capitalism.com. 7 See the Treasury Department’s Office of Foreign Asset Control, www.treasury.gov.

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These are collective or public goods, which are most efficiently provided by government for everyone in a community. In today’s world, governments are also expected to provide economic security and essential social services, and to deal with the most pressing social problems that require collective action, or public policy.

Public policy is a plan of action undertaken by government officials to achieve some broad purpose affecting a substantial segment of a nation’s citizens. Public policy, while differing in each nation, is the basic set of goals, plans, and actions that each national government follows in achieving its purposes. Governments generally do not choose to act unless a substantial segment of the public is affected and some public purpose is to be achieved. This is the essence of the concept of governments acting in the public interest.

The basic power to make public policy comes from a nation’s political system. In dem- ocratic societies, citizens elect political leaders who can appoint others to fulfill defined public functions ranging from municipal services (e.g., water supplies, fire protection) to national services, such as public education or homeland security. Democratic nations typi- cally spell out the powers of government in the country’s constitution.

Another source of authority is common law, or past decisions of the courts, the original basis of the U.S. legal system. In nondemocratic societies, the power of government may derive from a monarchy (e.g., Saudi Arabia), a military dictatorship (e.g., Eritrea), or reli- gious authority (e.g., the mullahs in Iran). These sources of power may interact, creating a mixture of civilian and military authority. The political systems in Russia, Libya, Tuni- sia, and other nations have undergone profound changes in recent times. And democratic nations can also face the pressures of regions that seek to become independent nations exercising the powers of a sovereign state, as has Canada with the province of Quebec.

Elements of Public Policy The actions of government in any nation can be understood in terms of several basic ele- ments of public policy. These are inputs, goals, tools, and effects. They will be illustrated using the example of distracted driving.

Public policy inputs are external pressures that shape a government’s policy decisions and strategies to address problems. Economic and foreign policy concerns, domestic politi- cal pressure from constituents and interest groups, technical information, and media atten- tion all play a role in shaping national political decisions. For example, a growing recognition of the dangers of distracted driving has pressured many state and local governments to ban or regulate the use of various electronic devices by drivers. Distracted driving may occur when a driver’s attention is diverted by personal grooming tasks, adjusting music or naviga- tion settings, eating, reading, and assorted other activities. It has become an even greater threat to driver and passenger safety as technologies have advanced. More and more drivers are now able to make or receive calls, send text messages, and even browse the Internet—all while driving a car at high speeds, in heavy traffic, or during bad weather conditions.8

According to an annual National Safety Council study, for the first time since 2007 more than 40,000 people died in motor vehicle crashes in a single year. Experts point to numerous causes for this record-breaking data, but typically focus on one important potential contributor: distracted driving. According to a national Consumer Reports survey of 622 licensed drivers, 52 percent admitted to engaging in distracting activities while driving, even though they knew it was wrong. Of those drivers surveyed, 41 percent admitted using their hands to send a text, 37 percent to playing music on a smartphone, and 8 percent to watching videos on

8 “Windshield Devices Bring Distracted Driving Debate to Eye Level,” The New York Times, May 29, 2015, www.nytimes.com.

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their phone while driving. Teens were particularly vulnerable. According to data from the Insurance Institute for Highway Safety, 60 percent of teen drivers involved in fatal crashes were distracted immediately before the accident. In a survey con- ducted by Zendrive Research of 3 million drivers globally, they found that drivers used their phones during 88 percent of their trips. An Erie Insurance study found that 15 percent of drivers admitted they had engaged in “romantic encounters” while behind the wheel and 9 percent said they had changed clothes while driving.9

In response to this growing epidemic, government bodies—legislatures, town councils, regulatory agencies—need to consider all relevant inputs in deciding whether or not to act, and if so, how.

Public policy goals can be broad (e.g., full employment) and high-minded (equal oppor- tunity for all) or narrow and self-serving. National values, such as freedom, democracy, and a fair chance for all citizens to share in economic prosperity, have led to the adoption of civil rights laws and economic assistance programs for those in need. Narrow goals that serve special interests are more apparent when nations decide how legislation will allocate the burden of taxes among various interests and income groups, or when public resources, such as oil exploration rights or timber cutting privileges, are given to one group or another. Whether the goals are broad or narrow, for the benefit of some or the benefit of all, most governments should ask, “What public goals are being served by this action?” For example, the rationale for a government policy to regulate distracted driving has to be based on some definition of public interest, such as preventing harm to others, including innocent drivers, passengers, and pedestrians.

The goal of distracted driving regulation is to prevent deaths and serious injuries resulting from drivers being distracted while driving. The factual data appears to be overwhelming. However, some members of the public have insisted on their right to use their phones for texting and other activities in their vehicles. Traveling sales- persons, for example, depend on their phones as an important tool of the job. Some regulations have addressed this by permitting drivers to use hands-free devices that permit them to keep their hands on the wheel. But some government safety experts have disagreed, saying, “When you are on a call, even if both hands are on the wheel, your head is in the call, and not your driving.”

The issue of banning the use of cell phones, hand-held or hands-free, for the sake of making our roads a little safer for all, remains at the forefront, but new technology has created even greater distractions. Devices can project information and data streamed from a smartphone onto the car’s windshield. Maps, speed, incoming texts, caller identification, and even social media notifications can be projected just above the dashboard of a car for the driver to read. The game Pokémon Go prompts drivers to search for virtual creatures on the highways or country roads. So, the goals of saving lives, reducing injuries, and eliminating health care costs are increasingly more urgent and the demand for regulation even more critical.

Governments use different public policy tools to achieve policy goals. The tools of pub- lic policy involve combinations of incentives and penalties that government uses to prompt

9 “Rise in U.S. Traffic Deaths Reported for a Second Year,” The New York Times, February 15, 2017, www.nytimes.com; “Consumer Reports Tackles Distracted Driving and Calls Traffic Deaths a Public Health Epidemic,” Forbes, November 19, 2017, www.forbes.com; “Zendrive Research: Largest Distracted Driving Behavior Study,” The Fiscal Times, April 18, 2017, www.thefiscaltimes.com; and “Study Asks Just How Distracted Are Motorists?” Pittsburgh Post-Gazette, March 30, 2015, www.post-gazette.com. For updated information on distracted driving, see www.distraction.gov and the Insurance Institute for Highway Safety’s website at www.iihs.org.

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citizens, including businesses, to act in ways that achieve policy goals. Governmental reg- ulatory powers are broad and constitute one of the most formidable instruments for accom- plishing public purposes.

Federal action limiting cell phone use in the United States stalled, so state and local governments stepped in to ban the use of cell phones by drivers while operating their vehicles. By 2018, 16 states had completely banned the use of cell phones while driving unless using a hands-free device, 38 had banned cell phone use by novice drivers, and 47 had banned text messaging for all drivers. And this was not just a public policy issue for Americans. More than 45 nations, including Australia, China, France, Germany, India, Israel, Japan, Russia, Spain, Taiwan, and the United Kingdom, have banned calling while driving.10

Public policy effects are the outcomes arising from government regulation. Some are intended; others are unintended. Because public policies affect many people, organiza- tions, and other interests, it is almost inevitable that such actions will please some and displease others. Regulations may cause businesses to improve the way toxic substances are used in the workplace, thus reducing health risks to employees. Yet other goals may be obstructed as an unintended effect of compliance with such regulations. For example, when health risks to pregnant women were associated with exposure to lead in the work- place, some companies removed women from those jobs. This action was seen as a form of discrimination against women that conflicted with the goal of equal employment oppor- tunity. The unintended effect (discrimination) of one policy action (protecting employees) conflicted head-on with the public policy goal of equal opportunity.

Different groups disagreed over the possible effects of distracted driving laws. Proponents obviously argued that the ban on cell phone use reduced accidents and saved lives. In fact, from 2012 to 2013, the number of deaths attributed to distracted driving nationwide declined nearly 7 percent, possibly due to the bans enacted by many states. Yet, these gains were short-lived as estimated deaths attributed to dis- tracted driving rose 14 percent in 2014 and another 6 percent in 2016. Opponents pointed to numerous other distractions that were not banned, such as drivers read- ing the newspaper, eating, putting on makeup, or shaving. “People have been driv- ing distracted since cars were invented. Focusing on mobile phones isn’t the same as focusing on distracted driving. Distraction is what has always caused car crashes and mobile phones don’t appear to be adding to that,” said a spokesperson for the Insurance Institute for Highway Safety.11

As the distracted driving examples illustrate, managers must try to be aware of the pub- lic policy inputs, goals, tools, and effects relevant to regulation affecting their business. As public issues emerge with significant negative consequences, such as death and injuries due to distracted driving, businesses should look for solutions. The automobile industry has increasingly done so, by introducing technologies that enable drivers to converse by phone or receive GPS directions and other notifications without removing their hands from the steering wheel or taking their eyes off the road.

10 For a complete listing of states that have regulated cell phone use while driving see the National Conference of State Legislators at www.ncsl.org. 11 Statistical information from “U.S. Motor Vehicle Deaths Surged 6% in 2016, NSC Says,” The Wall Street Journal, February 15, 2017, www.wsj.com; and “Study: No Evidence Cell Phone Bans Reduce Crashes,” Fox News, July 7, 2011, www.foxnews.com. 

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Types of Public Policy Public policies created by governments are of two major types: economic and social. Sometimes these types of regulation are distinct from each another and at other times they are intertwined.

Economic Policies

One important kind of public policy directly concerns the economy. The term fiscal policy refers to patterns of government collecting and spending funds that are intended to stim- ulate or support the economy. Governments spend money on many different activities. Local governments employ teachers, trash collectors, police, and firefighters. State gov- ernments typically spend large amounts of money on roads, social services, and parkland. National governments spend large sums on military defense, international relationships, and hundreds of public works projects such as road building. During the Great Depression of the 1930s, public works projects employed large numbers of people, put money in their hands, and stimulated consumption of goods and services. Today, fiscal policy remains a basic tool to achieve prosperity, as the following example illustrates.

In 2015, Chinese government leaders and economists were surprised by the coun- try’s sharp economic decline and were increasingly worried about the potential risk of job losses throughout the country. The world’s second largest economy grew at 7 percent in the first quarter of 2015, the lowest rate since the global financial crisis in 2008–9. The leaders turned to fiscal stimulus to revive the growth of the country. The National Development and Reform Commission, China’s top planning agency, infused large amounts of funding in an attempt to speed up investment projects in several key sectors, including water conservation, environmental protection, power grids, and health care. In explaining this government spending, the chairman of China’s National Development and Reform Commission said, “China was on track to achieve its economic growth, employment, inflation, fiscal revenue as well as imports and exports targets, but the country was falling behind in its goals for investment and wooing foreign investors.”12

Another important kind of economic policy is trade policy, the rules that govern imports from and exports to foreign countries. Governments sometimes favor free-trade policies, allowing the relatively unrestricted flow of goods and services across national borders, and at other times erect various barriers to this flow, such as tariffs and duties. In early 2018, President Trump reported that he was considering imposing widespread tariffs on imports of various goods in an effort to help protect ailing U.S. industries. While many U.S. manufacturers hailed these actions as necessary, other business groups in the U.S. were opposed. Forty-five trade associations, representing a wide range of the U.S. economy, petitioned Trump’s administration to halt its plans to levy tariffs on China and to work instead with other nations to pressure China to end their trade restrictions. For the United States to impose heavy tariffs, said a letter written by the trade groups, “would trigger a chain reaction of negative consequences for the U.S. economy, provoking retalia- tion; stifling U.S. agriculture, goods, and service exports; and raising costs for businesses and consumers.”13

12 “China Hints at More Government Spending to Shore Up Economic Growth,” South China Morning Post, August 30, 2017, www.scmp.com. 13 “Trade Associations to Petition Trump Administration to Halt China-Tariff Plans,” The Wall Street Journal, March 19, 2018, www.wsj.com.

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By contrast, the term monetary policy refers to policies that affect the supply, demand, and value of a nation’s currency. The worth, or worthlessness, of a nation’s currency has serious effects on business and society. It affects the buying power of money, the stabil- ity and value of savings, and the confidence of citizens and investors about the nation’s future. This, in turn, affects the country’s ability to borrow money from other nations and to attract private capital. In the United States, the Federal Reserve Bank—known as the Fed—plays the role of other nations’ central banks. By raising and lowering the interest rates at which private banks borrow money from the government, the Fed influences the size of the nation’s money supply and the value of the dollar. During the Great Recession, the Fed’s action to lower interest rates nearly to zero—an example of a monetary policy— was intended to stimulate borrowing and help the economy get moving again.

Other forms of economic policy include taxation policy (raising or lowering taxes on business or individuals), industrial policy (directing economic resources toward the devel- opment of specific industries), and trade policy (encouraging or discouraging trade with other countries).

Spurred by the president of the United States, Congress passed a $1.5 trillion tax cut in 2017. The most sweeping U.S. tax bill since 1986 cut the corporate tax rate from 35 to 21 percent, with the intent of stimulating the economy. In the first quar- ter of 2018, 108 of the nation’s largest companies reported saving almost $13 bil- lion in taxes, with nearly a third of the savings going to financial firms. AT&T and Comcast applauded the tax relief and promised to share the windfall by paying $1,000 bonuses to their more than 300,000 workers. Wells Fargo and Fifth Third Bancorp said they would raise their employees’ minimum wage to $15 an hour. However, Michael Dell, CEO of Dell Technologies, discovered that the new tax bill would prevent his company from deducting nearly $2 million it pays annually in interest on the company’s debt.14

Some thought that the tax reform would stimulate the economy, create jobs, and raise wages, but others cautioned that it would increase the national deficit, and that companies would be more likely use their windfalls to increase executive pay and shareholder divi- dends than to create jobs or pay workers more. According to economist Paul Krugman, while it is quite early to tell if the tax cut has been successful, “most voters say they haven’t seen any boost to their paychecks. To deliver on [the tax cut] backers’ promises, the tax cut would have to produce a huge surge in business investment—not in the long run, not five or 10 years from now, but more or less right away. And there’s no sign that anything like that is happening.”15 Yet, both critics and supporters say it will take months or years to draw conclusions on the law’s effects.

Social Assistance Policies

The last century produced many advances in the well-being of people across the globe. The advanced industrial nations have developed elaborate systems of social services for their citizens. Developing economies have improved key areas of social assistance (such as health care and education) and will continue to do so as their economies grow. International

14 “Trump Cheers GOP Tax Overhaul, Slams Democrats Who Opposed It,” The Wall Street Journal, December 20, 2017, www. wsj.com; “Thankful for Massive Tax Cut, AT&T, Wells Fargo Promise to Share the Wealth,” The Wall Street Journal, Decem- ber 21, 2017, www.wsj.com; “For Heavily Indebted Firms Like Dell, Tax Bill Delivers a Downside,” The Wall Street Journal, December 21, 2017, www.wsj.com; and “Corporate America Is Saving Boatloads on Trump Tax-Cut Windfall,” Bloomberg, April 30, 2018, www.bloomberg.com. 15 “How’s That Tax Cut Working Out?” The New York Times, April 30, 2018, www.nytimes.com.

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standards and best practices have supported these trends. Many of the social assistance pol- icies that affect particular stakeholders are discussed in subsequent chapters of this book.

One area often addressed by social assistance policies is housing. Many govern- ments have programs that subsidize rent payments, guarantee home loans, or pro- vide housing directly for low-income citizens or military veterans. For example, Brazil’s Minha Casa, Minha Vida (“My House, My Life”) program has invested R$300 billion ($80.27 billion U.S.) in mortgages, provided by a government- affiliated bank, resulting in more than 4.2 million housing units authorized for construction and 2.6 million units delivered to low-income families since the pro- gram began in 2009. Many of the first units built by the program were intended to house families displaced by development for the World Cup and Olympic Games in Rio de Janeiro.16

One particularly important social assistance policy—health care—has been the focus for concern on the international front and for national and state lawmakers. As discussed later in this chapter, the United States government has wrestled with the need for better health care for its citizens and the challenge of how to pay for this care.

Government Regulation of Business

Societies rely on government to establish rules of conduct for citizens and organiza- tions called regulations. Regulation is a primary way of accomplishing public policy, as described in the previous section. Because government operates at so many levels (federal, state, local), modern businesses face complex webs of regulations. Companies often require lawyers, public affairs specialists, and experts to monitor and manage the interaction with government. Why do societies turn to more regulation as a way to solve problems? Why not just let the free market allocate resources, set prices, and constrain socially irresponsible behavior by companies? There are a variety of reasons.

Market Failure One reason is what economists call market failure, that is, the marketplace fails to adjust prices for the true costs of a firm’s behavior. For example, a company normally has no incentive to spend money on product safety or pollution control equipment if customers do not demand it. The market fails to incorporate the cost of product safety or environmental harm into the business’s economic equation, because the costs are borne by someone else. In this situation, government can use regulation to force all competitors in the industry to adopt a minimum safety or pollution standards. Companies that want to act responsibly often welcome carefully crafted regulations, because they force competitors to bear the same costs. This behavior is seen in the following example.

In 2008, the European Union set regulatory standards for certain contaminants in foods, including maximum levels for lead, cadmium, and mercury. The EU explained, “in order to protect public health, to keep contaminants at levels which do not cause health concerns, maximum levels for lead, cadmium and mercury must be safe and as low as reasonably achievable based upon good manufacturing and agricultural/fishery practices.” These new regulatory standards affected food com- panies around the world that have business with or in Europe. Nestlé Purina

16 “Minha Casa Minha Vida Housing Program to Expand in Brazil,” The Rio Times, February 6, 2017, riotimesonline.com.

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Petcare, a pet food subsidiary of Nestlé, the Swiss-based and world’s largest food and beverage company, welcomed these new standards, believing it provided them with a competitive advantage. The company released the following statement: “We use science to make quality and safe pet foods … We test for well over 150 sub- stances, including arsenic, pesticides, lead, mercury and cadmium. … We do make an effort to source ingredients that contain lower levels of heavy metals. … We are committed to providing our consumers with accurate and transparent nutrition labelling based on sound science, regulation and law in a format that best helps them make informed, balanced and mindful product choice.”17

Negative Externalities Governments also may act to regulate business to prevent unintended adverse effects on others. Negative externalities, or spillover effects, result when the manufacture or distri- bution of a product gives rise to unplanned or unintended costs (economic, physical, or psychological) borne by workers, consumers, competitors, neighboring communities, or other business stakeholders. To control or reverse these costs, government may step in to regulate business action.

In 2014 U.S. government regulators announced new rules to fight an increase in black lung disease, caused by breathing coal dust. These new regulations were the first major efforts since the 1969 Coal Mine Health and Safety Act, which estab- lished modern health and safety requirements in mines nationwide. Government health officials attributed increasing rates of the disease to new machinery that gen- erated more dust, longer shifts for younger workers, and an increase in silica dust churned up when thinner coal seams were tapped after many years of mining at the same location.18

Natural Monopolies In some industries, natural monopolies occur. The electric utility industry provides an example. Once one company has built a system of poles and wires or laid miles of under- ground cable to supply local customers with electricity, it would be inefficient for a sec- ond company to build another system alongside the first. But once the first company has established its natural monopoly, it can then raise prices as much as it wishes because there is no competition. In such a situation, government often comes in and regulates prices and access. Other industries that sometimes develop natural monopolies include cable TV, broadband Internet service, software, and railroads.

Ethical Arguments There is often an ethical rationale for regulation as well. As discussed in Chapter 5, for example, there is a utilitarian ethical argument in support of safe working conditions: It is costly to train and educate employees only to lose their services because of prevent- able accidents. There are also fairness and justice arguments for government to set stan- dards and develop regulations to protect employees, consumers, and other stakeholders. In debates about regulation, advocates for and against regulatory proposals often use both

17 The European Commission legislation on heavy metals can be found at ec.europa.eu/jrc/en/eurl/heavy-metals/legislation and Nestlé Purina Petcare statement can be found at wjla.com, a report on company responses to the Washington, DC, ABC television station’s report on heavy metals in foodstuff. 18 “Black Lung Disease Spurs New Coal-Mine Rules,” The Wall Street Journal, April 23, 2014, online.wsj.com.

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economic and ethical arguments to support their views. Some issues have consequences that are so devastating that the government needs to step in and impose controls, as shown in the following example.

In 2015 the U.K. government passed the Modern Slavery Act, the first piece of U.K. legislation focusing on the prevention and prosecution of modern slavery and the protection of victims. According to the International Labour Organisation (ILO), 25 million people around the world were trapped in some form of forced labor, including trafficking, debt bondage, and child labor. In the United Kingdom, instances of slavery were found in nail salons, the fishing industry, two London medical professional offices, and cannabis farms. The new law made businesses accountable for slavery and labor abuses occurring along their supply chain of oper- ations. The goal was to ensure that there were no instances of slavery linked to any British products or services.19

Whether the actions are self-imposed by a company or forced on businesses by the gov- ernment, the protection of the public is often the motivation for regulatory action.

Types of Regulation Government regulations come in different forms. Some are directly imposed; others are more indirect. Some are aimed at a specific industry (e.g., banking); others, such as those dealing with job discrimination or pollution, apply to all industries. Some have been in existence for a long time—for example, the Food and Drug Act was passed in 1906— whereas others, such as the Wall Street Reform and Consumer Protection (or Dodd-Frank) Act of 2010, are of much more recent vintage. Just as public policy can be classified as either economic or social, so regulations can be classified in the same fashion.

Economic Regulations

The oldest form of regulation is primarily economic in nature. Economic regulations aim to modify the normal operation of the free market and the forces of supply and demand. Such modification may come about because the free market is distorted by the size or monopoly power of companies, or because the consequences of actions in the marketplace are thought to be undesirable. Economic regulations include those that control prices or wages, allocate public resources, establish service territories, set the number of partic- ipants, and ration resources. The decisions by the Federal Trade Commission (FTC) to prevent anticompetitive business practices illustrate one kind of economic regulation.

The U.S. Congress responded to the global recession, in part, by passing the Dodd- Frank Act in 2010. This legislation was heralded as the most comprehensive financial reg- ulatory reform measure since the Great Depression and intended to revolutionize many business activities. Among other things, the Dodd-Frank Act affected the oversight and supervision of financial institutions, created a new agency responsible for implementing and enforcing compliance with consumer financial laws, introduced more stringent regu- latory capital requirements, and implemented changes to corporate governance and execu- tive compensation practices.20 In 2017, President Trump signed two executive actions that scaled back some provisions of the Dodd-Frank Act with the intention of making it easier for businesses to borrow money.

19 “The U.K.’s New Slavery Laws Explained: What Do They Mean for Business?” The Guardian, December 14, 2015, www.theguardian.com. 20 “The Dodd-Frank Act: A Cheat Sheet,” Morrison & Foerster, n.d., www.mofo.com.

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Antitrust: A Special Kind of Economic Regulation

One important kind of economic regulation occurs when government acts to preserve com- petition in the marketplace, thereby protecting consumers. Antitrust laws prohibit unfair, anticompetitive practices by business. (The term antitrust law is used in the United States; most other countries use the term competition law.) For example, if a group of companies agreed among themselves to set prices at a particular level, this would generally be an antitrust violation. In addition, a firm may not engage in predatory pricing, the practice of selling below cost to drive rivals out of business. If a company uses its market dominance to restrain commerce, compete unfairly, or hurt consumers, then it may be found guilty of violating antitrust laws.

The two main antitrust enforcement agencies in the United States are the Antitrust Divi- sion of the U.S. Department of Justice and the Federal Trade Commission. Both agencies may bring suits against companies they believe to be guilty of violating antitrust laws. They also may investigate possible violations, issue guidelines and advisory opinions for firms planning mergers or acquisitions, identify specific practices considered to be illegal, and negotiate informal settlements out of court. Antitrust regulators have been active in prosecuting price fixing, blocking anticompetitive mergers, and dealing with foreign com- panies that have violated U.S. laws on fair competition. In Europe, the European Commis- sion investigates antitrust violations for the European Union who may act to enforce EU laws, as seen in the Qualcomm example that follows.

One example of the European Union's antitrust regulatory oversight was evident when they imposed a €997 million ($1.23 million) antitrust fine on the U.S.-technology giant Qualcomm. The EU antitrust regulators accused Qualcomm of paying Apple billions of dollars over a five-year span, from 2011 to 2016. These payments were made to restrict Apple from purchasing from Qualcomm's rivals, those firms that sold chips that connected smartphones and tablets to cellular networks. “These pay- ments were not just reductions in price—they were made on the condition that Apple would exclusively use Qualcomm's baseband chipsets in all its iPhones and iPads,” said Margrethe Vestager, EU antitrust chief.21

If a company is found guilty of antitrust violations, what are the penalties? The govern- ment may levy a fine—sometimes a large one, as the EU did against Qualcomm. In the case of private lawsuits, companies may also be required to pay damages to firms or indi- viduals they have harmed. Sysco and U.S. Foods Holdings, two of the largest U.S. food dis- tribution companies, joined retailer Winn-Dixie Stores, in filing lawsuits for undisclosed damages against the chicken industry, accusing Tyson Foods, Pilgrim’s Pride, Sanderson Farms, and other poultry suppliers of manipulating wholesale chicken prices.22 In addition, regulators may impose other, nonmonetary remedies. A structural remedy may require the breakup of a monopolistic firm; this occurred when (the old) AT&T was broken up by gov- ernment order in 1984. A conduct remedy, more commonly used, involves an agreement that the offending firm will change its conduct, often under government supervision. For example, a company might agree to stop certain anticompetitive practices. Finally, an intel- lectual property remedy is used in some kinds of high-technology businesses; it involves disclosure of information to competitors. All these are part of the regulator’s arsenal.

Antitrust regulations cut across industry lines and apply generally to all enterprises. Other economic regulations, such as those governing stock exchanges, may be confined to

21 “Qualcomm Is Slapped with $1.23 Billion EU Fine for Illegal Payments to Apple,” The Wall Street Journal, January 24, 2018, www.wsj.com. 22 “U.S. Food Distributors Allege Tyson Foods, Rivals Fixed Chicken Prices,” Reuters, January 31, 2018, www.reuters.com.

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specific industries and companies. One recent example of a conflict over the application of antitrust laws to a proposed merger is discussed in Exhibit 7.A.

Social Regulations

Social regulations are aimed at such important social goals as protecting consumers and the environment and providing workers with safe and healthy working conditions. Equal employment opportunity, protection of pension benefits, and health care for citizens are other important areas of social regulation. Unlike the economic regulations mentioned above, social regulations are not limited to one type of business or industry. Laws concerning pollu- tion, safety and health, health care, and job discrimination apply to all businesses; consumer protection laws apply to all relevant businesses producing and selling consumer goods.

The Chilean government declared war on obesity in 2018. “They killed Tony the Tiger. They did away with Cheetos’ Chester Cheetah. They banned Kinder Surprise, the chocolate eggs with a hidden toy,” accounts The New York Times article. The Chilean government imposed multiple marketing restrictions, mandatory packaging redesigns, and labeling rules on the nation’s food producers and retailers aimed at transforming the eating habits of 18 million Chilean residents. Nutrition experts said this was the world’s most ambitious attempt to remake a country’s food culture and could be a model for how to turn the tide on a global obesity epidemic that researchers say contributed to 4 million premature deaths a year.23

23 “In Sweeping War on Obesity, Chile Slays Tony the Tiger,” The New York Times, February 7, 2018, www.nytimes.com.

The AT&T–Time Warner Merger of 2018

In 2018, a federal judge handed down what many economists believed to be a sweeping victory against governmental antitrust regulation by approving AT&T’s $85 billion acquisition of Time Warner. Judge Richard Leon ruled that the government—which had tried to block the merger—had failed to prove that the telecom company’s acquisition of Time Warner would violate antitrust law by leading to fewer choices for consum- ers and higher prices for television and internet services. With this final roadblock removed, the merger was expected to create a media and telecommunications powerhouse, reshaping the landscape of those industries. The combined company would join Time Warner’s library, including HBO’s hit “Game of Thrones” and channels like CNN, with AT&T’s vast distribution reach through wireless and satellite television services across the country. Media executives supported the AT&T–Time Warner merger deal, arguing that content creation and distri- bution had to be combined to compete successfully against technology companies like Amazon and Netflix. Although those companies had just started producing their own shows during the past several years, they were now spending billions of dollars a year on original programming. Their users could stream the video on apps in homes and on mobile devices, putting pressure on traditional media businesses. Yet, Makan Delrahim, the top antitrust official at the Justice Department said, “We continue to believe that the pay-TV market will be less competitive and less innovative as a result of the proposed merger between AT&T and Time Warner.” Antitrust experts predicted that the court ruling would lead to a flood of new merger proposals. Just days after the AT&T–Time Warner decision, Comcast bid to acquire 21st Century Fox, challenging Disney, which pre- viously had bid for 21st Century Fox’s assets. In response, Disney increased their offer to acquire 21st Century Fox. Both Comcast and 21st Century Fox made bids on acquiring Sky, a European media company.

Sources: “AT&T Wins Approval for $85.4 Billion Time Warner Deal in Defeat for Justice Department,” The New York Times, June 12, 2018, www.nytimes.com; and “Judge Approves $85 Billion AT&T–Time Warner Deal,” CNNMoney, June 13, 2018, money.cnn.com.

Exhibit 7.A

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The most significant social regulation in the United States since the 1960s was the comprehensive reform of health care coverage passed by Congress in 2009. It is described in Exhibit 7.B.

Who regulates? Normally, for both economic and social regulation, specific rules are set by agencies of government and by the executive branch, and may be further interpreted by the courts. Many kinds of business behavior are also regulated at the state level. Gov- ernment regulators and the courts have the challenging job of applying the broad mandates of public policy.

Figure  7.1 depicts these two types of regulation—economic and social—along with the major regulatory agencies responsible for enforcing the rules at the federal level in the United States. Only the most prominent federal agencies are included in the chart. Individ- ual states, some cities, and other national governments have their own array of agencies to implement regulatory policy.

There is a legitimate need for government regulation in modern economies, but regu- lation also has problems. Businesses feel these problems firsthand, often because the reg- ulations directly affect the cost of products and the freedom of managers to design their

The Affordable Care Act: Health Care Coverage Mandated for Americans

In 2010, led by President Obama, Congress passed the Affordable Care Act, often referred to as “Obamacare.” The basic purpose of the law was to hold insurance companies accountable for their costs and services to their customers, lower the rising health care costs, provide Americans with greater freedom and control over their health care choices, and ultimately improve the quality of health care in America. Its provisions would be rolled out over 10 years. In 2010, the government began giving subsidies to small businesses that offered health coverage to employees, insurance companies were barred from denying coverage to children with preexisting illnesses, and children were permitted to stay on their parents’ insurance policies until age 26. The health care reform law aroused strong passions on both sides. Proponents of the law argued that the more than 5.1 million people on Medicare would save over $3 billion in prescription drugs costs, 105 million Americans would no longer have lifetime dollar limits on their health care coverage, and approximately 54 million Americans would receive greater preventative medical coverage. Health care fraud would decline by $4.1 billion annually due to new fraud detection measures, and 2.5 million young adults would retain health care coverage under their parents’ plan. Most importantly, most Americans would now have health insurance coverage. But, opponents challenged the new law as filled with myths, untruths, and harmful consequences. Some believed that the act would do nothing to bring down the cost of health care. Business leaders worried that the burden of providing their employees with health care insurance would result in bankruptcy or cause employers to reduce the level of health care coverage for their employees. Many worried that the mandate infringed on individual rights—including the right to go without health insurance if they chose. Several states sued, saying the law violated the constitution. In 2017, repeated attempts by Congress to repeal all or part of the Affordable Care Act failed. By 2018, 11.8 million Americans had selected marketplace plans or been automatically enrolled under the act. Under the act, millions more Americans received preventive services, such as vaccines, cancer screenings, and annual wellness visits at no out-of-pocket cost, than ever before. In addition, Americans could no longer be denied or dropped from coverage because of preexisting conditions or because they hit an annual or lifetime cap in benefits. Josh Peck, co-founder of the pro-ACA group Get America Covered, said, “While enrollment remained steady because of high consumer satisfaction and more affordable premiums for those who qualify for tax credits, enrollment would have outpaced previous years’ if the administration had focused on signing people up instead of derailing open-enrollment efforts.”

Sources: “What’s in the Bill,” The Wall Street Journal, March 22, 2010, online.wsj.com; “Get the Facts Straight on Health Reform—A More Secure Future,” The White House, n.d., www.whitehouse.gov; and “The Affordable Care Act Is Working,” Department of Health and Human Services, www.hhs.gov. The quote by Josh Peck is from “Nearly 12 Million People Enrolled in 2018 Health Coverage under the ACA,” The Washington Post, April 3, 2018, www.washingtonpost.com.

Exhibit 7.B

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FIGURE 7.1 Types of Regulation and Regulatory Agencies

Economic regulatory agencies NRC FAA FCC FERC FRB CFTC FREDDIE MAC DOT USDA DOJ DOL FLRA

Nuclear Regulatory Commission Federal Aviation Administration Federal Communications Commission Federal Energy Regulatory Commission Federal Reserve Board Commodity Futures Trading Commission Federal Home Loan Mortgage Corporation Department of Transportation Department of Agriculture Department of Justice Department of Labor Federal Labor Relations Authority

Social regulatory agencies EEOC OSHA MSHA FTC HHS

Equal Employment Opportunity Commission Occupational Safety and Health Administration Mine Safety and Health Administration Federal Trade Commission Department of Health and Human Services

CPSC FDA EPA NHTSA CFPB

Consumer Product Safety Commission Food and Drug Administration Environmental Protection Agency National Highway Tra�c Safety Administration Consumer Financial Protection Bureau

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Federal Trade Commission Securities and Exchange Commission National Labor Relations Board Internal Revenue Service Bureau of Alcohol, Tobacco, Firearms and Explosives Federal Deposit Insurance Corporation Department of Energy National Transportation Safety Board

Social regulation

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business operations. In the modern economy, the costs and effectiveness of regulation, as well as its unintended consequences, are serious issues that cannot be overlooked. Each is discussed below.

The Effects of Regulation Regulation affects many societal stakeholders, including business. Sometimes the conse- quences are known and intended, but at other times unintended or accidental consequences emerge from regulatory actions. In general, government hopes that the benefits arising from regulation outweigh the costs.

The Costs and Benefits of Regulation

The call for regulation may seem irresistible to government leaders and officials given the benefits they seek, but there are always costs to regulation. An old economic adage says, “There is no free lunch.” Eventually, someone has to pay for the benefits created.

An industrial society such as the United States can afford almost anything, including social regulations, if it is willing to pay the price. Sometimes the benefits are worth the costs; sometimes the costs exceed the benefits. The test of cost–benefit analysis helps the public understand what is at stake when new regulation is sought.

Figure  7.2 illustrates the increase in costs of federal regulation in the United States since 1960. Economic regulation has existed for many decades, and its cost has grown more slowly than that of social regulation. Social regulation spending reflects growth in such areas as environmental health, occupational safety, and consumer protection. A rapid growth of social regulation spending occurred in the 1960s and again in the 2000s, but has slowed somewhat recently. The cost of regulation has its critics, especially when the costs to small businesses or manufacturing firms are considered.

In addition to paying for regulatory programs, it takes people to administer, monitor, and enforce these regulations. Although the numbers have gone up and down, depending on the approach of various administrations, the overall trend has been toward growth of the regulatory apparatus of government. In 1960, fewer than 60,000 federal employees moni- tored and enforced government regulations; by 2015, this number had grown to more than 277,000 employees. John J. DiIulio Jr., of the University of Pennsylvania and the

FIGURE 7.2 Budgetary Costs of Federal Regulation, 1960–2018

Source: Susan Dudley and Melinda Warren, “Regulators’ Budget Increases Consistent with Growth in Fiscal Budget,” Regulatory Studies Center, The George Washington University and Weidenbaum Center, Washington University in Saint Louis, May 2015, regulatorystudies.columbian. gwu.edu; and regulatorystudies. columbian.gwu.edu.

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Brookings Institution, criticized the size of government regulation when he said, “Today’s government is indeed big—3.5 times bigger than five and a half decades ago, but dispersed to disguise its size.”24

Continuous Regulatory Reform

The amount of regulatory activity often is cyclical—historically rising during some peri- ods and declining during others. Businesses in the United States experienced a lessening of regulation in the early 2000s—deregulation, then experienced a return of regulatory activ- ity in the late 2000s and early 2010s—reregulation. The cycle continued as the pendulum swung back to deregulation in the late 2010s under the Trump administration.

Deregulation is the removal or scaling down of regulatory authority and regulatory activities of government. Deregulation is often a politically popular idea. President Ronald Reagan strongly advocated deregulation in the early 1980s, when he campaigned on the promise to “get government off the back of the people.” Major deregulatory laws were enacted off and on in the United States from the 1980s to today, mostly dependent upon whether there was a Republican administration in power. Recently efforts to promote deregulation in the United States are described in Exhibit 7.C.

Proponents of deregulation often challenge the public’s desire to see government solve problems. This generates situations in which government is trying to deregulate in some areas while at the same time creating new regulation in others. Reregulation is the increase or expansion of government regulation, especially in areas where the regulatory activities had previously been reduced. The scandals that rocked corporate America in

24 ‘Big Government’ Is Ever Growing, On the Sly,” National Review, February 25, 2017, www.nationalreview.com.

Deregulation in the United States, Starting in 2017

In 2017, the Trump Administration began a policy toward deregulation across many industries.

• The Office of Management and Budget suspended a rule that required wage reporting broken down by ethnicity and gender, claiming it was too costly to companies.

• The lessening of the Volcker Rules that restricted banking activities. This change permitted banks to con- duct fewer audits of individual securities and derivative transactions, and generally to have more freedom to buy and sell securities.

• The Dodd-Frank Act of 2010, which attempted to guard against another financial crisis, had its restrictions seriously minimized when about two-dozen regional banks were released from strict rules requiring them to maintain large capital reserves.

• Under the leadership of the White House, the Republican-led Congress reversed a rule that made it easier for consumers to bring class action lawsuits against banks by requiring that consumers use arbitration to resolve disputes.

• President Trump froze the implementation of a rule that said contract poultry and livestock farmers would be able to sue dealers without having to prove that a practice harmed the entire industry, just showing harm to their specific business.

• The Transportation Department withdrew a rule proposed by the Obama Administration that would require airlines to disclose baggage fees to consumers along with fare and schedule information.

• The Labor Department froze a rule that would tighten standards for workplace exposure to beryllium, a light- weight metal used in manufacturing that is dangerous if inhaled via dust or fumes or if it is exposed to the skin.

Source: “How Donald Trump Has Remade the Rules for Business,” The Wall Street Journal, January 17, 2018, www.wsj.com.

Exhibit 7.C

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the 2000s—and the failure or near-failure of a number of big commercial and investment banks in the late 2000s—brought cries from many stakeholder groups for reregulation of the securities and financial services industries.

Regulation in a Global Context

International commerce unites people and businesses in new and complicated ways, as described in Chapter 4. U.S. consumers routinely buy food, automobiles, and clothing from companies located in Europe, Canada, Latin America, Australia, Africa, and Asia. Citizens of other nations do the same. As these patterns of international commerce grow more complicated, governments recognize the need to establish rules that protect the inter- ests of their own citizens. No nation wants to accept dangerous products manufactured elsewhere that will injure its citizens, and no government wants to see its economy dam- aged by unfair competition from foreign competitors. These concerns provide the rationale for international regulatory agreements and cooperation. At times, the issues themselves cut across national borders, so international regulation is needed.

In 2016, the International Civil Aviation Organization, representing more than 190 countries, adopted The Aviation Plan, designed to reduce the climate impact of international jet travel, which accounted for about 2 percent of the world’s emis- sions of greenhouse gases. The measure would require air carriers to take major steps to improve fuel economy in their routes and fleets, very likely accelerating the purchase of newer, more efficient planes. The plan was scheduled to take effect in 2021. “This measure addresses a growing source of global emissions, demonstrates the international community’s strong and growing support for climate action in all areas and helps avoid a patchwork of potentially costly and overlapping regional and national measures,” said John Kerry, then the U.S. Secretary of State.25

At other times, political conflicts spill over into economic regulatory actions, as described next.

In 2017, Iran, a long-time adversary of the United States, sanctioned 15 American companies in retaliation for restrictions imposed by the Trump administration on companies and people allegedly connected with Iran’s ballistic-missile program. Iran’s sanctions targeted American defense companies, including defense contractor Raytheon, and two firearms manufacturers, Magnum Research and Lewis Machine and Tool, for allegedly helping Israel and contributing to regional instability, according to the Islamic Republic News Agency. Future business dealings with these companies were prohibited by the Iranian government and their assets in the Islamic Republic were frozen, a common tactic used by the United States against companies from doing business with Iran.26

Whether at the local, state, federal, or international levels, governments exert their control seeking to protect society through regulation. The significant challenge involves balancing the costs of this form of governance against the benefits received or the prevention of the harms that might occur if the regulation is not in place and enforced. Businesses have long under- stood that managing and, if possible, cooperating with the government regarding regulation generally leads to a more productive economic environment and financial health of the firm.

25 “EU Halts Carbon Emission Fees for Airlines,” The Hill, November 12, 2012, www.thehill.com; and “Over 190 Countries Adopt Plan to Offset Air Travel Emissions,” The New York Times, October 6, 2016, www.nytimes.com. 26 “Iran Slaps Sanctions on 15 U.S. Companies as Animosity Grows,” The Wall Street Journal, March 26, 2017, www.wsj.com.

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