Business Finance - Management assignment busn 311

LAW, ETHICS, BUSINESS

An Introduction

Law must be stable, and yet it cannot stand still.

— ROSCOE POUND

Neither fire nor wind, birth nor death, can erase our good deeds.

— BUDDHA

Business has become, in the last half century, the most powerful institution on the planet. The dominant institution in any society needs to take responsi- bility for the whole.… Every decision that is made, every action that is taken, must be viewed in light of that kind of responsibility.

— DAVID KORTEN

• Law is not a static phenomenon, yet in certain ways it appears bounded and clear cut. Where it holds jurisdictional authority, law provides a set of rules for behavior. When these rules are broken, behavior is punishable. If you have been driving carelessly and hit another car, you might pay money damages. If you are caught stealing, you might go to jail. If you are caught polluting, you may be forced to stop. The creation of law and the delivery of sanctions for rule breaking are contested processes. How law is made, how it is enforced, and how it is inter- preted are always in dispute, constantly changing, and responsive to the power relations that surround it. Still, we can identify its purposes: law both sets behavioral standards and sets up a system for compliance with them. Within the reach of a legal system, we are on notice that we must meet its standards or risk penalty. Chances are we were not directly involved in the making of the rules—we may even disagree strongly with them—but we understand that the legal system shadows us anyway. It may be the closest we can get to a shared reality.

Ethics, on the other hand, presents a menu of options, often disconnected from official sanctions.1 While law concerns what we must do, ethics concerns what we should do. Suppose you work for an advertising agency and have just been offered a chance to work on a new ad campaign for a certain fast-food chain. Burgers, fries, and sodas are legal products. Under the First Amendment of the U.S. Constitution, fast-food companies have the legal right to get their messages out to consumers. But you may believe that their ads are particularly attractive to children, who are at risk of becoming accustomed and even addicted to the empty calories

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• 1 We distinguish ethics from “professional ethics,” which are binding on those with professional licenses for the practice of law or accounting, for example. Indeed, licensing authorities have enforcement powers not unlike those of legal authori- ties to sanction those who violate their professional codes of ethics.

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that make them fat and unhealthy. Although no law requires it, you may feel you should de- cline to participate in the campaign. Or suppose a company manufactures a pesticide that can no longer be sold in the United States because the Environmental Protection Agency has banned its primary ingredient, but that can be sold in places like India or Africa, where environ- mental regulations are far less stringent. Legally, the company is free to sell its pesticide overseas; but should it?

Ethical preferences are not preselected for us by legislators or by judges; they involve criti- cal consciousness, engaging each of us in a process of bringing reason and emotion to bear on a particular situation. The right way to behave is not necessarily a matter of aligning our ac- tions with the norm—a community or religious norm, for instance—although it may be. Yet we struggle to carve out some form of consensus on ethics, especially in areas where law does not seem to cover the significant bases. In the above examples, where the law allows people to profit in the marketplace by selling highly dangerous products, we may want to say that cer- tain “shoulds” are universally compelling.

The question of what should be done in a given situation, of the right way to live our lives, is complicated by divergent and overlapping cultural inputs. Within the borders of the United States, and in the global marketplace, we are confronted with a kaleidoscopic array of ethical traditions. Does this mean that there can be no such thing as consensus, no agreement about what is good behavior?

Then there is the “business environment.” Ever since Dutch and English explorers proved that private, entrepreneurial settlements across the oceans could be more robust than the pro- jects of mere kings and queens, private investment has been setting the pace of economic ex- pansion on the planet. European hegemony around the world was largely spear-headed in the seventeenth century by profit-seeking joint stock companies. In the mid-nineteenth century, the Union victory in the American Civil War showed that Northern capitalism could produce more guns, bullets, and blankets than the slave economy of the agrarian South. The defeat of fascism and the dissolution of the USSR in the twentieth century demonstrated the resources that the market economy could muster against competing systems.

Today, almost half of the 100 largest economies in the world are multinational corpora- tions. Comparing corporate revenues to the gross domestic product of nations, Wal-Mart, BP, Exxon Mobil, and Royal Dutch/Shell all generated more income than Saudi Arabia, Norway, Denmark, Poland, South Africa, and Greece in 2005.2 The largest 200 companies in the world account for more than one-fourth of the world’s economic activity. By 2002, they had twice the economic clout of the poorest four-fifths of humanity. Business has powerful effects on our natural environment. It strongly affects what we eat, how we transport ourselves, what our communities look like, and how we take care of ourselves when we are sick. In many ways, the impact of global business has been beneficial. Multinationals provide new jobs, pay higher taxes, and produce new or less expensive goods and services. They introduce technol- ogy, capital, and skills to their host countries and raise the standard of living. On the other hand, multinationals have been blamed for hastening the collapse of traditional ways of life; for taking advantage of weak and/or corrupt governments in some of the countries where they do business; for questionable safety, environmental, and financial practices; for addicting the world to unsustainable technologies while blocking technologies antithetical to their inter- ests; and for intensifying the disparities between rich and poor.

As bearers of a diverse set of cultural achievements, we need to find points of agreement, both in legal and ethical terms, as to how human societies can best flourish. And as participants in the global economy, we need to discover ways of tempering the tremendous power of the mar- ket, of shaping it to allow the planet and its inhabitants to thrive.

• 2 http://news.mongabay.com/2005/0718-worlds_largest.html

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For years U.S. firms had been shifting manufacturing and other blue-collar jobs to Asia where labor costs are much lower, but IBM’s plans made headlines because they were de- picted as part of a disturbing new trend: Job losses would now affect well-educated, white- collar employees. Having begun with call centers and information technology positions, offshoring had mushroomed to include accountants, production control specialists, industrial engineers, medical transcriptionists, and others. By late 2003 the U.S. Bureau of Labor Statis- tics estimated that half a million high-tech professionals had lost their jobs since 2001, a fig- ure that was expected to double by the end of 2004. Although many IT jobs had been eliminated due to the bursting of the dot-com bubble, U.S. corporate foreign outsourcing was predicted to be the main driver of future losses.

Late in 2003, Sam Palmisano, chairman of IBM’s board of directors and its chief executive officer, justified the company’s decision to move to India for skilled labor in a speech to the Council on Competitiveness in Washington, D.C. He stated that the nations of Asia not only provide low-cost labor, but also have heavily invested in their educational and communication infrastructure. It would only be fair to respond to what they offer:

China, India, South Korea, and other rapidly developing nations are replicating the structural advantages that historically have made the U.S. the center of innovation. We can’t—shouldn’t—regret improvements in other nations’ competitiveness. Their people deserve to participate fully in the benefits of innovations.

Was Sam Palmisano’s decision ethical? There are many different ways to answer this question. Ethical analysis, unlike much quan-

titative analysis, can be a messy, complex business, without a clear and definitive outcome. However, we do have tools at our disposal to help us make these complicated assessments.

First, let’s turn to an approach that will be familiar to you. It amounts to the bedrock princi- ple of strategic management; it underlies the entire free market system. This value system is so embedded in both business theory and business reality that we might fail to recognize it as not only an economic perspective, but also as an ethical one.

Free Market Ethics A basic assumption of classic microeconomic theory is that the overriding goal of any busi- ness is to be profitable. As trustees (fiduciaries) of the shareholders, managers have a primary responsibility to try to improve the value of shareholder investment. In fact, under the law of corporations, managers are answerable to the owners of a company—its stockholders—if they fail to take reasonable care in running it.

Milton Friedman, a well-known free market economist and a proponent of this view, has written:

In a free enterprise, private property system, a corporate executive is the employee of the owners of the business. He has a direct responsibility to his employers. That responsibility is to conduct the busi- ness in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of society, both those embodied in law and those embodied in ethi- cal custom…. In a free society, there is one and only one social responsibility of business—to use its re- sources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.9

Friedman argues it is wrong for managers to use corporate resources to deal with problems in society at large. Decisions regarding what might be best for society should be made in the polit- ical arena, and implementation of policies agreed upon there should be funded by tax dollars. For managers to make those kinds of decisions themselves, and to use corporate monies to pay for them, is the equivalent of theft—theft of stockholders’ resources.

• 9 “The Social Responsibility of Business Is to Increase Its Profits,” New York Times, September 13, 1970.

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Let’s apply Friedman’s thinking and free market ethical theory to Sam Palmisano’s decision to move several thousand IBM jobs to India. First we must ask: Will this choice be profitable for the company? The answer is yes. In India, chemists with doctoral degrees and employees in high-tech jobs earn one-fifth of the salaries of their American counterparts; a software program- mer in Bangalore will earn about one-third of what someone with comparable skills in the United States would earn. Even with extra communication costs, IBM would save at least 50 per- cent by hiring overseas. There are other profit factors. Offshoring yields capacity increases, pro- viding service more rapidly while taking advantage of time zone variations. Offshoring allows companies like IBM to concentrate on what they do best. Highly innovative work may still be done domestically, while maintenance chores, minor enhancements, and bug-fixing that make up most of what programmers do in a large software firm can be handled overseas.

Looking ahead, the flexibility offered by offshoring would seem to be the best way for IBM to remain competitive. In 2003, offshore outsourcing increased by 60 percent. Because other high-tech companies were participating in this trend10—it would seem to be in IBM’s best in- terests to position itself ahead of the curve.11

Using Friedman’s analysis we would also need to know whether the process of moving jobs to India was legal. At this writing, there are no legal impediments to outsourcing, other than a federal rule passed in January 2004 stating that any private contracting done for a fed- eral agency “may not be performed by the contractor at a location outside the United States” unless the work had been done outside the country previously. According to an IBM spokesper- son, its federal government contracts generally do not involve offshore work.12

In microeconomic terms then, the decision to move jobs to India should focus on share- holder interests and not be swayed by the interests of other stakeholders—except to the extent that these would impact profits. Sam Palmisano’s choice should not be made out of concern for the families dependent on jobs at IBM, for example, or out of concern for possible degrad- ing of educational systems dependent on local property taxes in those places—Dallas, Pough- keepsie, Boulder, and Raleigh—where the job losses will take place. Palmisano should not be troubled by the political storm that might be brewing as his company outsources to India. (Campaigning for president in 2004, John Kerry called executives who participated in off- shoring “Benedict Arnolds,” unpatriotic in the extreme.) He should not worry about contro- versy unless it reaches such a pitch that there is real public outrage. Only if offshoring becomes a focal point for consumer activism, and only if profits are likely to be significantly af- fected, would Friedman urge IBM to put the brakes on its plans.

The decision to move jobs to India could—in the long run—turn out better for all con- cerned. It allows IBM to react to market forces with minimal losses, to be flexible as it faces do- mestic and global competition, and may put the company in a better position to expand and create new jobs in the future. Since 2005, profits at IBM have risen steadily.13 In other words,

• 10 Cisco, Dell, General Electric, Accenture, EDS, Microsoft, and SAP are a few of these companies. 11 As of July 2007, IBM employed 53,000 people in India. The company continues to tap the global labor pool, and to auto-

mate wherever possible. As Sam Palmisano puts it, “We couldn’t keep building out labor. The long-term strategic an- swer was not to have a half a million people working for IBM.” IBM and other multinationals are making use of a network of employees around the world, globalizing services, much as they have already globalized manufacturing.

12 A politically hot topic in the election year of 2004, offshore outsourcing was the target of several proposed state laws banning or restricting such moves on the part of those contracting with government. At this writing, none of them had been enacted.

13 As of July 2007, it appeared that Sam Palmisano’s “huge reinvention” of the company was the right thing to do, at least for shareholders. As Steve Lohr of the New York Times put it: IBM has been reorganized from a classic multinational com- pany with country-by-country operations, working in isolation, to a more seamless global enterprise with centers of ex- pertise in industries and technical skills, scattered around the world, each a hub in a global network for delivering services. Its experience offers a textbook case of a company successfully navigating the twin challenges of globalization and rapid technological change.…So far, it seems to be working .“IBM Showing that Giants Can be Nimble,” New York Times, July 18, 2007.

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what works for IBM may have long-term benefits for many other stakeholders, but cost-benefit shareholder analysis of offshoring would not take such possibilities into account.

Notice that this analysis aligns with a belief in maximum freedom of choice for individuals— and minimal power of government to obstruct that freedom. This strand of thought, which we saw supporting the “no duty to rescue” rule, has been key in the development of both our market economy and our legal system. It would support both IBM’s freedom to invest where it can best make a profit and the freedom of IBM’s employees to leave their jobs and seek work elsewhere. The idea is that we can best progress as a society if we grant as much leeway as possible to pri- vate preference, allowing people (and private associations of people, like corporations) the right to do what they think is best with their property and their personal lives. This ethical perspective is deeply imprinted upon the economic and cultural lives of most people in the developed world.

Utilitarianism: Assessing Consequences Through much of our history, the most influential ethical reference point was religious; the rules to be followed were “written in the heavens” and were guidelines for achieving immortality of the soul. It was a radical break with tradition, then, for eighteenth-century philosopher and social thinker Jeremy Bentham to suggest an entirely new frame of reference. Ethical behavior, he ar- gued, was not a matter of pleasing God, but of bringing about as much happiness as possible for the greatest number of people. According to Bentham, the definitive moral standard is that of “util- ity,” requiring us to consider the consequences of an act (or a social policy) for all those affected by it. One of Bentham’s followers, nineteenth-century philosopher John Stuart Mill (discussed ear- lier), would become the best-known proponent of this ethical approach, known as utilitarianism.

According to the principle of utilitarianism, the right way to behave in a given situation is to choose the alternative that is likely to produce the greatest overall good. Cost-benefit analy- sis, the sort of efficiency calculation that is common to business decision making—what IBM CEO Sam Palmisano probably used as he chose to outsource thousands of jobs to India—is based on notions of utility. As an ethical theory, however, utilitarianism asks us to compare the harms and benefits of an action not just for the decider, but for all persons who will be af- fected by the decision. In the IBM scenario, this would mean, at the least, not only weighing the effects of offshoring upon IBM shareholders, but also looking at the consequences to IBM employees whose jobs were lost (and their families) and at those in India who were hired to re- place them (and their families). Since local communities in both the United States and India are affected, consequences to people in that wider circumference must also be assessed.

Hardest hit would have to be IT employees who are laid off. While job retraining pro- grams exist for manufacturing workers when their jobs move overseas, there is no such safety net for workers in IT or in other white-collar fields. According to the December 8, 2003 issue of Business Week, only about one-third of those Americans displaced by offshoring found jobs at the same or higher pay. The utilitarian calculation asks us to consider not only the immedi- ate and direct consequences, but also those that are indirect, and those that are foreseeable into the future. Suppose the offshoring job exodus continued—and most experts forecasted that it would, estimating that by 2005 some 600,000 IT jobs for American-based companies would be performed elsewhere. What would happen to a local community as many of its citi- zens lose well-paying jobs? As the tax base diminished, would its libraries, schools, police and fire forces experience cutbacks? There was concern too about another major ripple effect: Off- shoring, and the threat of offshoring, could become leverage, putting downward pressure on the salaries and benefits of all U.S. workers.

Yet some analysts saw a silver lining. As the Washington Post reported in September 2003, offshoring could be a “healthy trend”:

Some IT workers here may be forced to leave the “computer industry” and move into non- offshorable jobs, but this may not mean they give up doing computer work, because as our economy continues to shift away from manufacturing and toward services, we may see … many non-portable

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IT “support” jobs created.… The upshot: Even though hundreds of thousands of programming and other IT jobs are likely to leave the U.S. over the next few decades, the vast majority of U.S. IT work- ers will survive, and possibly even prosper in the end, although they may have new employers and work in new fields.

Quoting an editorial in the Silicon Valley’s San Jose Mercury News, the Post article highlighted how tricky it might be to track the consequences of offshoring for U.S. workers:

It is impossible to make a direct link between a job lost here and a job gained elsewhere. The econom- ics of labor are more complex. First, the savings incurred by U.S. companies when they hire low-paid workers overseas help generate profits used to hire workers, or make new investments, here. Second, Valley companies sell nearly two-thirds of their products overseas, so the rise in overseas markets helps boost their fortunes.

The extent of the threat to U.S. service jobs remained in dispute. There was a high tide of anxi- ety throughout 2004, the year after IBM made its announcement; more than 1,000 references to outsourcing appeared in the media that year. Then concern appeared to subside. In 2006, the director of the McKinsey Global Institute was stating that, by 2008, outsourcing would have affected less than 2 percent of all U.S. service jobs.14 Offshoring might end up boosting the American economy overall. According to McKinsey, “at least two-thirds of the economic benefit from sending jobs offshore will flow back to the U.S. economy in the form of lower pri- ces, expanding overseas markets for U.S. products, and fatter profits that U.S. companies can plow back into even more innovative businesses.”15 By 2007, most economists viewed the im- pact of offshoring as minimal or even positive in the long run, with savings to companies and increased productivity resulting in better cheaper services, and from there to more competi- tion, more innovation, and more growth.16

Then there are the benefits of offshoring, both short and long range, overseas. In India, rev- enue from U.S. outsourcing shot up 50 percent through 2003 to $3.6 billion, and was pre- dicted to do the same in 2004. Consider the positive effects as thousands of competent individuals begin to earn decent salaries in a country where half of the population lives on pen- nies a day. A critical mass of new wage earners materializes, each one in a position to pro- duce significant benefits for themselves and their loved ones. As they rise into the middle class, they create markets for refrigerators, cars, computers, and so on—to the benefit of produ- cers in India and elsewhere. And as this happens, there are cultural side effects. In her July 2004 New Yorker article, “The Best Job in Town,” Katherine Boo wrote about Office Tiger, a firm where college-educated Indians perform various types of data entry for U.S. companies:

[I]t was the possibility that one could rise up from a lowly position that had made Office Tiger one of the city’s status employers, a firm whose workers were so pleased by their affiliation that they put

• 14 Daniel Gross, “Why ‘Outsourcing’ May Lose Its Power as a Scare Word,” New York Times, August 13, 2006. Gross

quotes Princeton economist Alan Binder, who disagrees with the McKinsey estimates, arguing that as technology im- proves and offshore workers gain experience, the capacity to deliver services electronically will rise. He believes far more than 2 percent of jobs will migrate overseas.

15 Even within management ranks there is no consensus that offshoring makes sense long term, however. William J. Holstein, edi- tor of Chief Executive Magazine, recently noted that direct labor costs represent a shrinking percentage of the overall costs of production for many businesses, making the savings from offshoring less significant. He also pointed to less tangible negative ef- fects: “I don’t think of many things as more intrinsic to the long-range thrust of a company, to the development of a com- pany as a place of innovation and creativity … than the ability to design your own products and build your own products. You have to lovingly make them and care about their quality. It’s difficult to wrap numbers around that and prove it, but I think it’s central.” “Does Outsourcing Cost More Than It Saves, “New York Times, June 6, 2004. Links to articles with similar im- port can be found at http://www.yourjobisgoingtoindia.com, where a posted article included survey results of 100 executives re- presenting New York's largest companies who were not finding offshoring to be as cost efficient as they had expected it would be. Linda Prospero, “New York Survey Finds Outsourcing Not a Panacea,” Reuters, July 19, 2004.

16 “Offshoring has faded, like Y2K, Red Menace,” Philadelphia Inquirer, February 18, 2007.

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it on their wedding invitations, just below their fathers’ names. A foreign notion—that jobs should be distributed on the basis of merit—was amending the rules of society where employment had for millennia been allotted by caste, and great possibilities abounded.17

The utilitarian weighing of pluses and minuses becomes complex, especially because it is not simply a matter of numerical quantifying. How to assess the harm—the emotional hurt and anxiety—that a person feels when they lose a well-paid job in a “jobless recovery”? How much weight to give the loss of a job in Dallas, Texas? Might that be a city with plenty of other op- tions for IT professionals? Of the thousands of jobless in the United States, how can we know how each employee (and each family of each employee) will be affected? One person whose job has gone to Bangalore may be married to someone earning more than enough to comfort- ably support the family; another may be a single parent with no real backup. All of these im- measurables play havoc with neat measurement.

Although it is difficult to meaningfully assess comparative harms and benefits, our analysis does seem to suggest that IBM’s decision was ethical, given all the actual and potential bene- fits of offshoring, and given that relatively few people would be harmed by it. This outcome points to one of the problems with utilitarian theory. Consider another situation: The federal government requires that new drugs be tested on humans after they have been tested on ani- mals. Drug companies must advertise widely and offer to pay as much as $250 a day to at- tract test subjects. But one company, Eli Lilly, does not have to advertise and pays only $85 per day, because most of its subjects are homeless alcoholics recruited through word-of- mouth from soup kitchens, shelters, and prisons across the country.18 What happens when we run this arrangement through the utilitarian analysis? Where is the harm? New drugs are brought to market, benefiting the public—Lilly developed Prozac, for example. Cost savings may not be passed on to consumers, but they enhance corporate profits, benefiting the employ- ees and stockholders. Alcoholism in volunteers does not skew the company’s data, since those with severe liver disease will fail the initial screening process and be excluded in the first place. Even the test subjects are comfortable: Those who have participated in Lilly’s program describe themselves as happy with the “easy money” they can earn—as much as $4,500 when the testing continues over months. Is this an ethical outcome? Arguably it is, on utilitarian grounds. We might wonder if the homeless alcoholics are capable of making decisions that are truly voluntary. We may wonder if it is fair to use a small number of relatively desperate people in this way, even if the results benefit many more people.

Deontology: Rights and Duties In contrast to the utilitarian concern with maximizing social welfare, deontological19 ethics is marked by steadfastness to universal principles—for example, respect for life, fairness, telling the truth, keeping promises—no matter what the consequences. At the core of this approach to making ethical choices is the understanding that moral action should be guided by certain overriding rights and duties.

The most famous deontological thinker, eighteenth-century German philosopher Immanuel Kant, believed that human beings could reason their way to a set of absolute rules for right be- havior. A person should never lie, according to Kant, even when lying seems to produce a good result. Suppose someone running away from a murderer tells you where he is going to hide, and then the murderer rushes up to ask you where the first person went. Wouldn’t this be a good time to lie? Kant would say there is never a good time, even in this example.

• 17 More on the plus side: Some Indian companies have found that offshoring is creating a positive synergy, enabling them

to do more hiring of their own—even in the United States. By 2007, Indian high tech firms were recruiting Americans to work in India.

18 Laurie P. Cohen, “Stuck for Money,” Wall Street Journal, November 14, 1996, pp. 1, 10. 19 From the Greek deon, or duty.

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Moral behavior, then, is a matter of holding, without exception, to certain principles. Kant be- lieved that each person has the right to be treated with respect as the equal of every other, and that each person has the corresponding duty to treat everyone else with respect as an equal.

He arrived at this by means of his categorical imperatives. The first of these states that a people should be willing to have the reasons for their actions become universal principles. That is, people should be willing to live in a world where an action they chose to take would be repeated for the same reasons whenever the same situation arose, even if they wound up on the receiving end of such actions.

Think of IBM and offshoring. If we apply Kant’s first categorical imperative, the decision maker should ask: Would I want to live in a world where multinational corporations cut labor costs by replacing skilled white-collar U.S. employees with equally competent employees in other countries? Perhaps Mr. Palmisano would be comfortable with a universe of such behavior until it was his job that was eliminated. So, in Kantian terms, his action might not be an ethical one.

In another formulation of the categorical imperative, Kant states that we should have re- spect for the intrinsic value of other people and not just use them as means to achieve our own purposes. By this Kant did not mean that people should never use other people at all. Peo- ple “use” one another in mutually beneficial ways all the time. For example, in a typical contrac- tual transaction, each party to the agreement gives something up to get what it wants. Each party “uses” the other to get what it wants; if you purchase gasoline, you “use” the oil com- pany’s product and it “uses” you to pay for it. Kant would have no objection here. Rather, he believed it was unethical for people to use others only as a means to accomplishing their own purposes, with no mutual benefit attached. So, if the oil company uses slave labor to build an oil pipeline in Southeast Asia, it would be violating this Kantian categorical. Here one party— the more powerful one—is able effectively to remove the free will of the other, to make it do what it wants the way a puppeteer would pulls a marionette’s strings. What is lost—of great eth- ical value in deontology—is the right to autonomy, the right to make fully informed decisions for oneself about how to live one’s life. Consider IBM and offshoring. Was IBM manipulating its U.S. engineers? Think of the way the company expected them to spend several weeks train- ing their own replacements. This does appear to involve some manipulation. Were the en- gineers really in any position to make decisions for themselves?

In late 2003 the Wall Street Journal obtained IBM documents which indicated that IBM was also trying to conceal information as it offered pointers to its managers on how to “sani- tize” the offshoring process. “The words ‘offshore’ or ‘on-shore’ should never be used,” the company warned. “Do not be transparent regarding the purpose/intent” of offshore out- sourcing. Assuming the WSJ report is accurate, if IBM was attempting to cover up what was re- ally happening, we could say it was violating Kant’s categorical imperative.

So far the deontological approach appears to be leaning against the decision to go ahead with the offshoring. There can be real murkiness within this moral framework, though, when it comes to interpreting those universal rights and duties that Kant considered “absolute”— beyond compromise. In the offshoring scenario, for example, how should we interpret the duty to be “fair”? Sam Palmisano, we might say, is caught in a latticework of different versions of fairness. On the one hand, moving white-collar jobs away from well-educated American em- ployees is unfair to them and to their families. But not to go through with the offshoring plan is arguably unfair to IBM’s shareholders, who deserve the best possible return on investment, and to the well-qualified employees in India and their families. Recall how Palmisano himself used the concept of fairness when explaining offshoring:

China, India, South Korea, and other rapidly developing nations are replicating the structural advantages that historically have made the U.S. the center of innovation. We can’t—shouldn’t—regret improvements in other nations’ competitiveness. Their people deserve to participate fully in the benefits of innovations.

Another difficulty with deontology is the confusion created when different universal rights and duties crop up in the same ethical problem, and seem to conflict with one another. How does

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one decide which absolute value should prevail? These situations can get ugly. Consider the inten- sity of conflicting beliefs on the question of abortion. Both the right-to-life and the pro-choice fac- tions are convinced that their points of view derive from natural rights; both embrace referents that each of them consider beyond debate, beyond compromise. How do we resolve competing claims of this type? The “war on terror” presents us with other examples of clashing rights and duties, such as lengthy detentions under the USA PATRIOT Act of suspects not charged with any crime, proposals to allow the Pentagon to randomly monitor personal e-mail, and problems with prisoner abuse in Afghanistan and Iraq. Conflicting views here pit the right to life and safety against the right to privacy, the duty to be fair, and the categorical imperative to respect others—including those of Middle Eastern origin or beliefs—as equals.

Virtue Ethics: Habits of Goodness For some critics, both the utilitarian and deontological frameworks are inadequate in a fundamen- tal sense; while both set forth logical bases for deciding what might be called moral minima—the floor beneath which no one should drop in terms of ethical choices—they are silent on the con- cept of moral excellence. They also focus on the moral acceptability of actions. Virtue ethics, on the other hand, directs our attention to what human beings are capable of being, on how they can cultivate the habits of good character that will naturally lead them to their fullest potential.

This strand of thinking derives from Aristotle, who argued that people develop their moral abil- ities, called virtues, through training, by being repeatedly exposed to demonstrations of decent be- havior within families and communities. We learn to become courageous, generous, just, honest, cooperative, and cheerful gradually, as we become habituated to living in social settings where these qualities are exhibited and valued. Ethics, then, is not a matter of teasing out the correct choice given a series of knotty dilemmas; it is instead a lifelong conditioning process. In harmoni- ous relationship with their communities, people thrive, reaching the fullest unfolding of their po- tential, learning the habits that allow them to excel at everything they are capable of doing.

Virtue ethics does raise its own set of questions, however. What does it mean to define moral character in term of one’s community? What community? As the new millennium unfolds, too many Americans are living in family environments in which relatedness endures in spite of severe economic and psychological stresses. Half the population of the world lives in poverty. If children grow up in hardship, where the natural environment is harshly degraded and the social fabric is weakened, does the transmittal of virtuous habit become a luxury? If families cannot effectively teach virtue to their young, what are the alternatives? Schools? Religious communities? And when these are in such diverse forms—sometimes in sharp opposition—how do we judge which moral community is best? We call the men who flew into the World Trade Center terrorists, but at some schools in the deserts of the Middle East, boys memorize the Koran and learn the heroic sig- nificance of being a suicide bomber. Which system can claim moral hegemony?

And what do we mean by community in the business context? Where is the community touchstone in the IBM scenario? To answer this question about a large company like IBM, we must examine what is called “corporate culture.” Here one scholar describes what that is meant by the culture of an organization:

The pattern of basic assumptions that a given group has invented, discovered, or developed in learn- ing to cope with its problems of external adaptation and internal integration, and that have worked well enough to be considered valid, and, therefore, to be taught to new members as the correct way to perceive, think, and feel in relation to those problems.20

More colloquially, a company might describe its culture as “the way we do things around here.” In studies by Harvard corporate management guru John Kotter, as of 1987–1991, IBM was ranked at

• 20 Edgar H. Schein’s definition. Professor Schein is a management expert at MIT.

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number 8 (out of the more than 2,300 firms studied) in terms of the strength of its corporate cul- ture. We can see how it got that way by looking at its ascendancy under Thomas Watson, Sr., called “the greatest capitalist in history” by Fortune Magazine. It was Watson who named the com- pany International Business Machines in 1924. Originally a manufacturer of tabulating machines, IBM would move into electric punch-card accounting and then into early computers. Throughout its growth in the 1920s and 1930s, Watson posted the motto “T-H-I-N-K” in all offices and re- quired all his salesmen to wear blue suits and white shirts. An intense focus on sales and on a “buttoned-down” image would stay with the company throughout the twentieth century. Extremely charismatic, vain, and proud of his company, Watson built a corporate culture designed to instill loyalty and enthusiasm. IBM had company sports teams, family events, and was one of the first firms to offer workers paid vacations, life insurance, and survivor benefits. During the Depression, even as sales weakened, IBM managed to avoid mass layoffs. By mid-century the company had an unparalleled reputation as a fair employer. IBM continued to pay salaries to employees serving in WWII, while the company used weapons manufacturing profits to help widows and orphans of IBM employees killed in the conflict.21 The firm covered moving expenses for transferees, guaran- teed minimum resale prices on their homes, and paid for retraining. Most impressively, during this time IBM guaranteed lifetime employment for all employees. For years Watson told his people: “The IBM is not merely an organization of men; it is an institution that will go on forever.”

A powerhouse of the computer mainframe market, the company would continue to grow through the 1950s, 1960s, and 1970s. “Big Blue” was ranked the most admired company in the United States year after year. By 1984 it was the most valuable company in the world, famous for consistent stock and dividend growth. It stood for the best of American big business—for its stockholders, its consumers, and its workforce.

Then—a crisis. As technology advanced, the computer market changed. Personal comput- ers came to the fore, innovative upstarts such as Apple entered the field, and by the 1990s, IBM had suffered serious losses. As its stock lost half of its value, tens of thousands of work- ers were laid off. The very strength of IBM’s culture was blamed, in part, for this catastrophe. As one commentator put it:

The company, it seemed, had become the epitome of an overgrown, anonymous, monopolistic, bureau- cratic monster—outmatched in marketing and technology by swifter, nimbler competitors; too big to change, it appeared destined to collapse under its own ungainly weight.22

Although it recovered profitability by the late 1990s, IBM would never recover its former image as a benevolent giant, with a strong, paternalistic and compassionate corporate environment.

Returning to our question: If virtue ethics is a matter of moral characteristics ingrained within a community, and if CEO Sam Palmisano attends to the culture of his corporate com- munity, he would be guided by this ethical code, touted today by IBM.

The IBM Principles 1. The marketplace is the driving force behind everything we do.

2. At our core, we are a technology company with an overriding commitment to quality.

• 21 There were less salutary aspects to IBM’s activities during this period. Thomas Watson accepted a medal from the Nazi

regime in 1937, an event featured in Edwin Black’s recent book, IBM and the Holocaust. Although IBM was not alone in its willingness to do business with Hitler, Black tells how crucial its role was. IBM’s German subsidiary, acting “with the knowledge of its New York headquarters,” supplied the Nazis with a punch card system that organized, tabulated, and analyzed population data, making possible mass deportations and executions. From Black’s introduction: [D]azzled by its own swirling universe of technical possibilities, IBM was self-gripped by a special amoral corporate mantra: If it can be done, it should be done. To the blind technocrat, the means were more important than the ends. The destruction of the Jewish people became even less important because the invigorating nature of IBM’s technical achievement was only heightened by the fantastical profits to be made at a time when bread lines stretched across the world.

22 Steven Kotok, St. James Encyclopedia of Popular Culture, 2002 Gale Group. See http://articles.findarticles.com/p/articles/ mi_g1epc/is_tov/ai_2419100611

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3. Our primary measures of success are customer satisfaction and shareholder value.

4. We operate as an entrepreneurial organization with a minimum of bureaucracy and a never-ending focus on productivity.

5. We never lose sight of our strategic vision.

6. We think and act with a sense of urgency.

7. Outstanding, dedicated people make it all happen, particularly when they work together as a team.

8. We are sensitive to the needs of all employees and to the communities in which we operate.

As you review these guidelines, and Sam Palmisano’s speech to the Council on Competitive- ness, can you sense whether the culture of IBM supports offshoring?

What forces inside a company determine the type of culture that develops inside it? What forces outside a company might influence that process? Are there business virtues?23 What might they be?

Ethic of Care The elusive mystery of women’s development lies in its recognition of

the continuing importance of attachment in the human life-cycle … while masculine development litany intones the celebration of separation, auton- omy, individuation and natural rights.

— CAROL GILLIGAN

I hope I would have the guts to betray my country before I would be- tray my friend. — E.M. FORSTER, “WHAT I BELIEVE,” 1938

The ethical theories we have looked at so far assume that a decision about the right thing to do is ultimately a private decision, made by an individual in isolation. Whether using their in- tellectual powers or responding to trained habit, people act as autonomous beings, as free agents in this process. A different approach to ethics assumes that people are deeply con- nected to one another in webs of relationships, and that ethical decisions cannot be made out- side the context of those relationships. This alternative view holds that ethics is essentially a matter of nurturing and reinforcing the ties we have with one another. This has become known as the “ethic of care,” as it is based on caring for others.

The notion of an ethic of care was developed by feminist theorists such as Carol Gilligan, a psychologist who studied moral development. Her research led her to believe that men and women approach moral issues from different perspectives. While most men have an individual- istic focus on abstract rights and justice, women tend to focus on caring, on supporting human interconnectedness—an approach that Gilligan saw as undervalued, and which she characterized as “a different voice.” Over time this understanding has shifted: Rather than a split between male versus female ethics, it is thought that there are two different approaches to moral problem solving that can be accessed by either men or women.

In the following reading Leslie Bender, professor of law at Syracuse University, suggests a feminist reframing of negligence law and the “no duty to rescue” rule. She begins by referenc- ing Gilligan’s work.

• 23 Robert C. Solomon thinks so. He has written extensively about Aristotle and business. Included in his list of business vir-

tues are friendliness, charisma, fairness, heroism, style, toughness, and wittiness. See his book, A Better Way To Think About Business (New York: Oxford University Press, 1999).

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A PRIMER OF FEMINIST THEORY AND TORT Leslie Bender24

A Feminist Ethic of Caring and Interconnectedness

Gilligan recognized that there are two thematic approaches to problem solving that gener- ally correlate with gender, although she makes no claims about the origin of the difference.… When she asked what characterizes the different methods for resolving and analyz- ing moral dilemmas, Gilligan found that the “right” answers (according to the traditionally for- mulated stages of moral development) involve abstract, objective, rule-based decisions supported by notions of individual autonomy, individual rights, the separation of self from others, equality, and fairness. Often the answers provided by women focus on the particular contexts of the problems, relationships, caring (compassion and need), equity, and responsi- bility. For this different voice “responsibility” means “response to” rather than “obligation for.” The first voice understands relationships in terms of hierarchies or “ladders,” whereas the “feminine” voice communicates about relationships as “webs of interconnectedness.…”

While an ethic of justice proceeds from the premise of equality—that everyone should be treated the same—an ethic of care rests on the premise of nonviolence— that no one should be hurt.

Negligence Law: A Feminist Ethic of Care and Concern as a Basis for the Standard of Care

Our traditional negligence analysis asks whether the defendant met the requisite stan- dard of care to avoid liability.

In tort law we generally use the phrase “standard of care” to mean “level of caution.” How careful should the person have been? What precautions do we expect people to take to avoid accidents? We look to the carefulness a reasonable person would exercise to avoid impairing another’s rights or interest. If a defendant did not act carefully, reason- ably, or prudently by guarding against foreseeable harm, she would be liable. The idea of care and prudence in this context is translated into reasonableness, which is fre- quently measured instrumentally in terms of utility or economic efficiency.

When the standard of care is equated with economic efficiency or levels of caution, decisions that assign dollar values to harms to human life and health and then balance those dollars against profit dollars and other evidences of benefit become common- place.… The risk of their pain and loss becomes a potential debit to be weighed against the benefits or profits to others. The result has little to do with care or even with cau- tion, if caution is understood as concern for safety.

What would happen if we understood the “reasonableness” of the standard of care to mean “responsibility” and the “standard of care” to mean the “standard of caring” or “consideration of another’s safety and interests?” What if, instead of measuring careful- ness or caution, we measured concern and responsibility for the well-being of others and their protection from harm? Negligence law could begin with Gilligan’s articulation of the feminine voice’s ethic of care—a premise that no one should be hurt…

“No Duty” Cases

One of the most difficult areas in which questions of duty and the standard of care arise is the “no duty to rescue” case. The problem is traditionally illustrated by the drowning- stranger hypothetical and the infamous case of Yania v. Bigan.

• 24 38 J. Leg. Educ. 3 (1988), pp. 63–68.

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How would this drowning-stranger hypothetical look from a new legal perspective in- formed by a feminist ethic based upon notions of caring, responsibility, interconnected- ness, and cooperation?

If we put abstract reasoning and autonomy aside momentarily, we can see what else matters. In defining duty, what matters is that someone, a human being, a part of us, is drowning and will die without some affirmative action. That seems more urgent, more imperative, more important than any possible infringement of individual autonomy by the imposition of an affirmative duty.

If we think about the stranger as a human being for a moment, we may realize that much more is involved than balancing one person’s interest in having his life saved and another’s interest in not having affirmative duties imposed upon him in the absence of a special relationship.…

The drowning stranger is not the only person affected by the lack of care. He is not detached from everyone else. He no doubt has people who care about him—parents, spouse, children, friends, colleagues; groups he participates in—religious, social, athletic, artistic, political, educational, work-related; he may even have people who depend upon him for emotional or financial support. He is interconnected with others. If the stranger drowns, many will be harmed. It is not an isolated event with one person’s interests bal- anced against another’s. When our legal system trains us to understand the drowning- stranger story as a limited event between two people, both of whom have interests at least equally worth protecting, and when the social ramifications we credit most are the impositions on personal liberty of action, we take a human situation and translate it into a cold, dehumanized algebraic equation. We forget that we are talking about human death or grave physical harms and their reverberating consequences when we equate the consequences with such things as one person’s momentary freedom not to act.…

Bender goes on to write:

The duty to act with care for another’s safety, which under appropriate circum- stances would include an affirmative duty to act to protect or prevent harm to another, would be shaped by the particular context.

This is one of the hallmarks of the ethic of care, a willingness to be concerned with the particulars of a situation, and from there an interest in discovering compromise— creative ways to find a solution that might work for all the stakeholders.

How might the IBM offshoring decision look through the lens of the ethic of care? The strongest relational connection in the scenario must be between IBM and its employ- ees. Some of them may have survived the deep job cuts of the 1990s, but even if not, they were probably well aware of the effort the company had recently made to turn it- self around and become profitable again. What happens, though, when market pres- sures interfere with established relationships? How can we reconcile these apparently opposite forces, the urge to do the right thing for the people you know best, and the im- peratives of business? The ethic of care suggests that the specific context of offshoring at IBM receive attention. Who are these people about to lose their positions? How can IBM ease their transition? From what we know of the facts—that many employees will be told to train their replacements for weeks, and that most cannot expect to be re- hired anytime soon—these are a harsh set of particulars.

The ethic of care might lead Sam Palmisano to investigate how the offshoring process will be managed at IBM. If the process itself cannot be reversed, then the way it is to be im- plemented might be changed. What can IBM do to soften the blow? Are there any resources to retrain and/or rehire workers, to assist them in job searches? Open communica- tion can be very important, both for laid-off employees and for local communities. The ethic of care suggests that creative efforts be made, not just for the sake of “damage control,” but because there is value in relationships that have been nourished over time.

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Ironically, putting relationships first can end up positively affecting the bottom line. When his large textile mill burned to the ground just before Christmas 1995, owner Aaron Feuerstein perceived the tragedy as one for a network of stakeholders, his family, his employees, and the surrounding community. As he responded by including all of those affected in his plans for rebuilding, the network responded in turn. Donations came in from local businesses; customers such as Patagonia and Lands’ End pledged sup- port and promised to wait for their Polartec; citizens from neighboring New Hampshire donated Christmas trees and toys for idled workers. Once the rebuilt factory was in opera- tion, productivity rose 25 percent.

Problems arise with the ethic of care, though, as with the other theories. Sometimes there are several relationships at stake, and it becomes difficult to rank and care for them. The ethic of care can be troubling in another way. Suppose you have the responsi- bility of recommending someone from your work team for promotion. One of the team members is your friend. She’s a single parent and could really use the extra income. But she isn’t the most deserving person in your group. If you are fair, you’ll recommend the best person for the job—but the ethic of care might push you to recommend your friend, as care deteriorates into favoritism.

Why Ethical Theory? Having explored several approaches to ethics, we have seen potential flaws in each. We may feel unsettled by the journey, uncertain how useful it has been. Yet this unresolved aftertaste may be exactly appropriate. There are no easy answers at the intersection of law, ethics, and business. The best we can hope for may be a reflective approach, combining one or more frameworks to reach several possible solutions, and then comparing the solutions to see if they “agree.”

Ideally, familiarity with these theories will support you in at least two ways as you face busi- ness dilemmas in the future. First, the models for analysis can spark creative thinking, as you brainstorm ways of handling the dilemmas. Second, they offer you a means of explaining your decisions to others. Explanations can be useful. Suppose you are working for the pesticide manu- facturer that cannot sell certain of its products in the United States because they are hazardous by U.S. standards, yet the company plans to sell them overseas. Knowing the theoretical basis for ethical decision making could help you understand your own position, and help you articu- late it to your superiors, your co-workers, and those who report to you in the organization. There is a familiar “language” in the business world for most decision making: cost-benefit anal- ysis. Ethical theory offers you another language, making you “bilingual” in complex situations.

Corporate Governance l

Corporate Roles, Rights, and Responsibilities

Shareholders Shareholders are, collectively, the owners of a corporation. As their holdings rise in value, they profit; when their shares lose value, shareholders lose. They may be pri- vate shareholders—individual investors, both large and small—or they may be institu- tional shareholders, such as pension funds, mutual funds, insurance companies. The

c on t inu ed

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Although the structure outlined above appears to confer a degree of representative democracy to the corporate form, with investors having the ability to vote on proposals and to sue for

legal liability of shareholders is limited by law to the amount of investment they make in the company. Their rights include:

Receipt of true and accurate financial reports Dividends whenever dividends declared Attendance at shareholder meetings Vote (by proxy or in person) on

Membership of board of directors Significant mergers and acquisitions Changes in charter or by-laws Proposals by management or shareholders

Shareholders can also hold managers and directors accountable by bringing share- holder derivative suits (see below).

Board of Directors Board members are elected by shareholders from a slate provided by management. They can be “inside directors” with ongoing or previous contractual relationships with the company, or “outside” or “independent directors” with no financial relation- ship with the company other than as a member of its board. Directors are held by law to a duty of loyalty. They cannot interfere with corporate opportunities, com- pete with the corporation, take secret profits or engage in other forms of self-dealing at the company’s expense. They are also required to abide by a duty of care—to act in good faith and as reasonably prudent persons in their role as directors. These two duties are known as fiduciary duties, to be carried out by those who are entrusted with responsibility for other peoples’ investments.

The board may create committees and delegate certain powers to them; since the Sarbanes-Oxley Act of 2002, all public companies must have audit committees made up of independent directors, which hire independent public accountants to supervise the audit of company financial records.

In a broad oversight function, the board sets company policy and goals. In addi- tion, it:

Presents financial data to shareholders Hires and fires management Slates membership of the board and of its committees Is authorized to file lawsuits on behalf of corporation to recover damages

Officers and Management The chief executive officer (CEO or President) of a company and other officers are ap- pointed by the board of directors, and must report to the board about the ongoing op- erations of the corporation. Like the directors, management is held to both a duty of loyalty and a duty of care, and must.

Run the company on a day-to-day basis Implement decisions made by the board of directors Prepare reports for the board of directors and shareholders

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misconduct of managers and board members, the shareholders of a corporation have limited power to influence or control the decisions of corporate officers and directors. In Chapter 7 you will read about the hurdles shareholders face when they attempt to make proposals and bring them to a vote; their right to sue will meet resistance based on the way in which state cor- porate law is structured to protect the ability of officers and directors to run a company as they see fit.

A shareholders derivative lawsuit can be initiated by individual shareholders on behalf of the corporation as a whole against persons or entities that have harmed the company—most often one or more of its own directors or officers for breach of fiduciary duty. (In other words, shareholders attempt to bring a suit that they believe the board of directors should have brought.) First, however, they must give the board a chance to act by making a “de- mand” that the board pursue the suit. To a large degree the board has the power to refuse to do so. A board’s decision to reject the demand is seldom overturned by a court—the business judgment rule gives wide latitude to the board to make such a call. Under certain circum- stances, however, shareholders are excused from first making this demand. They can argue that doing so would be futile, because board members themselves are very much “part of the problem” that the shareholders derivative suit seeks to redress. But shareholders must allege specific facts that prove so-called demand futility. In most states, that means demonstrating why the board members who decided not to launch the suit were not “disinterested, informed and rational.” (A “disinterested” board member would be someone without any competing per- sonal stake in the situation.)

The next case is an example of a shareholders derivative suit that survived a motion to dis- miss. Note the interplay among shareholders, management and board, both in terms of what al- legedly happened, and in how the law structures their relationships.

Career Education Corporation (CEC) provides private, for-profit post-secondary education on dozens of campuses throughout the United States, Canada, France, United Kingdom, and United Arab Emirate, and an online university. According to shareholder Scott McSparran, the board of directors artificially inflated CEC’s stock price by enrolling students without complete fi- nancial aid, enrolling students who did not actually attend classes, and claiming inflated job- placement rates for CEC graduates. Much of the information that should have alerted directors to this fraud—newspaper articles, court papers, and stock analyst reports—was available to the public.

MCSPARRAN V. LARSON United States District Court, Illinois, 2006

2006 WL 250698

ANDERSEN, J. Z … According to the plaintiffs, defendants’ scheme enabled them to dispose of 2.8 mil- lion shares of CEC stock for proceeds of over $136 million.

The Complaint posits that the defendants knew exactly what was happening at CEC and lied about the extent of the problems CEC faced even after the accounting irregulari- ties came to light, all so that they could continue to sell stock at high prices….

Also detailed in the Complaint are the ties between CEC’s CEO and Chairman of the Board, and each and every other member of CEC’s Board of Directors. While CEC’s CEO and Chairman of the Board unquestionably had some degree of control over the com- pensation of officers of CEC, the Complaint does not allege other business relationships that would allow him to control the compensation of outside directors. Instead, the

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Complaint refers to general social and business ties and mentions fees paid to the direc- tors for their services.…

The Supreme Court of Delaware created a two-part test for demand futility in Aronson v. Lewis. Under this test, we ask whether “a reasonable doubt is created that: (1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.” Plaintiffs assert two main grounds for demand futility: (i) the Board of Directors is dominated and controlled by CEC’s CEO and Chairman of the Board; and (ii) a majority of the Board of Directors are interested in the outcome of this litigation because they face a substantial likelihood of li- ability for claims predicated on the fact their decisions were not protected by the busi- ness judgment rule. As such, the two-part test laid out in Aronson is distilled in the present case into questions of independence and interest.

Delaware courts have noted that “[a]t bottom, the question of independence turns on whether a director is, for any substantial reason, incapable of making a decision with only the best interests of the corporation in mind. That is, … cases ultimately focus on im- partiality and objectivity.” However, “neither mere personal friendships alone, nor mere outside business relationships alone, are sufficient to raise a reasonable doubt regarding a director’s independence.”

Nor does the fact that directors receive directorial fees destroy their independence. (“[T]he fact that each [director] is paid an annual retainer of $30,000 plus a fee of $1000 for each meeting attended and annual grants of stock options does not make them be- holden to [the company’s CEO].”)

There is no substantial reason to question the independence of a majority of CEC’s Board of Directors. Plaintiff has not put forth any allegations outside directors have their salary set by any board member, or are otherwise financially dependent upon other direc- tors. If mere social acquaintances and prior business relationships with other board mem- bers coupled with the receipt of directorial fees destroyed a board member’s independence, few boards would have any independent members.…

… A reasonable doubt regarding a director’s interest is raised when a corporate deci- sion “will have a materially detrimental impact on a director, but not on the corporation or the stockholders.”… As such, if plaintiffs’ Complaint pleads facts that indicate a major- ity of CEC’s Board of Directors face a “substantial likelihood” of personal liability, a de- mand upon the Board of Directors is futile.

Generally, board members are protected from individual liability by the business judgment rule, which provides a “presumption that in making a business decision the di- rectors of a corporation acted on an informed basis, in good faith and in the honest be- lief that the action taken was in the best interests of the company. Absent an abuse of discretion, that judgment will be respected by the courts.”… [As the Delaware Supreme Court determined in 1996, however,] individual liability for directors can result from two possible contexts: (i) … a board decision that results in a loss because that decision was ill advised , negligent, or intentionally adverse to the best interests of the company and (ii)… ”from an unconsidered failure of the board to act in circumstances in which due at- tention would, arguably, have prevented the loss.”

… [A] board’s extreme indifference or failure to act may create individual liability for board members. “[A] director’s obligation includes a duty to attempt in good faith to as- sure that a corporate information and reporting system, which the board concludes is ad- equate, exists, and that failure to do so under some circumstances may, in theory at least, render a director liable for losses caused by noncompliance with applicable legal standards.” Moreover, it is beyond dispute that a director who profits from confidential corporate information and takes actions adverse to the corporation’s best interest is per- sonally liable to the corporation. [As Delaware courts held in 1949,] “a person in a

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confidential or fiduciary position, in breach of his duty, uses that knowledge to make a profit from himself, he is accountable for such profit.”…

Plaintiffs’ Complaint contains two alternative allegations. Defendants were allegedly either active participants in a scheme to report false accounting of revenues and enroll- ment figures so that they could sell their holdings of CEC stock at inflated prices, or they failed to act in the face of evidence that should have prompted remedial measures. Either of these two scenarios could result in personal liability for the defendants. In sup- port of these allegations, the Complaint details company policy that should have brought CEC’s false accounting to the attention of the defendants, quotes from news arti- cles, court filings, and analyst reports that discussed allegations of false accounting, and names of two defendants who supposedly received comparisons of accurate informa- tion versus the inaccurate information that was provided to the public and the federal government. Additionally, the Complaint alleges that all defendants except for one sold sizable stock holdings while they knew, or should have known, of significant, non-public, problems with CEC’s reported financial and enrollment figures. In fact, the plaintiffs con- tend that the reason CEC was engaged in the reporting of false figures was primarily to allow defendants to profit from selling their holdings of CEC stock. The Complaint also ex- plains that the reporting of false figures to the federal government was extremely ad- verse to the interests of CEC due to the dire consequences a revocation of HEA loan eligibility would visit upon the company.…

At this stage in the litigation plaintiffs have met their burden of pleading with partic- ularly their reasons for demand futility. The plaintiffs have told us the “who, what, when, where, and how” of a story that a raises a reasonable doubt about the defendants’ per- sonal liability. Since the defendants may have personal liability, they are interested par- ties to any demand upon the Board of Directors to institute litigation. As such, plaintiffs are excused from making a demand upon the Board of Directors based on the doctrine of demand futility.…

[Held: Defendants’ motion to dismiss is denied.]

QUESTIONS 1. What is a shareholder derivative suit? On what grounds was such a suit brought against

CEC?

2. What is the business judgment rule? In what ways were defendants alleged to have vio- lated that rule?

3. The judge explains that the fact that members of the board have personal relationships with management, or receive considerable fees for serving does not destroy their status as “independent.” For about two weeks work a year, independent directors at Enron averaged $87,000 from cash and stock options.25 What effect might treating directors this well have on corporate governance? What ethical issues arise here?

4. Defendants argued that there were no damages to CEC, despite allegedly high legal fees and diminished business reputations. How would you articulate the shareholders’ claims that the behavior of its officers and directors amounted to harm to the corporation?

• 25 Robert Bryce, Pipe Dreams: Greed, Ego, and the Death of Enron (New York: Public Affairs, 2002).

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