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Table of Contents

Picasso’s Garçon á la

pipe was one of the most

expensive works ever

sold at more than $100

million.

Image courtesy of

Wikipedia,

http://en.wikipedia.org/

wiki/File:Gar%C3%A7on

_%C3%A0_la_pipe.jpg.

Chick-fil-A encourages

education through their

program that has

provided more than $25

million in financial aid to

more than twenty-five

thousand employees

since 1973.

Image courtesy of

SanFranAnnie,

http://www.flickr.com/p

hotos/sanfranannie/247

2244829.

Chapter 10 Leading an Ethical Organization: Corporate Governance, Corporate Ethics, and Social

Responsibility

L E A R N I N G O B J E C T I V E S

After reading this chapter, you should be able to understand and articulate answers to the

following questions:

1. What are the key elements of effective corporate governance?

2. How do individuals and firms gauge ethical behavior?

3. What influences and biases might impact and impede decision making?

TOMS Shoes: Doing Business with Soul

Under the business model used by TOMS Shoes, a pair of their signature alpargata footwear is donated

for every pair sold.

Image courtesy of Parke Ladd, http://www.flickr.com/photos/parke-ladd/5389801209.

In 2002, Blake Mycoskie competed with his sister Paige on The Amazing Race—a reality show

where groups of two people with existing relationships engage in a global race to win valuable

prizes, with the winner receiving a coveted grand prize. Although Blake’s team finished third in the

second season of the show, the experience afforded him the opportunity to visit Argentina, where

he returned in 2006 and developed the idea to build a company around the alpargata—a popular

style of shoe in that region.

The premise of the company Blake started was a unique one. For every shoe sold, a pair will be

given to someone in need. This simple business model was the basis for TOMS Shoes, which has

now given away more than one million pairs of shoes to those in need in more than twenty

countries worldwide.Oloffson, K. 2010, September 29. In Toms’ Shoes: Start-up copy “one-for-one”

model. Wall Street Journal. Retrieved from

http://online.wsj.com/article/SB1000142405274870411 6004575522251507063936.html

The rise of TOMS Shoes has inspired other companies that have adopted the “buy-one-give-one”

philosophy. For example, the Good Little Company donates a meal for every package

purchased.Nicolas, S. 2011, February. The great giveaway. Director, 64, 37–39. This business

model has also been successfully applied to selling (and donating) other items such as glasses and

books.

The social initiatives that drive TOMS Shoes stand in stark contrast to the criticisms that plagued

Nike Corporation, where claims of human rights violations, ranging from the use of sweatshops

and child labor to lack of compliance with minimum wage laws, were rampant in the 1990s.McCall,

W. 1998. Nike battles backlash from overseas sweatshops. Marketing News, 9, 14. While Nike

struggled to win back confidence in buyers that were concerned with their business practices,

TOMS social initiatives are a source of excellent publicity in pride in those who purchase their

products. As further testament to their popularity, TOMS has engaged in partnerships with

Nordstrom, Disney, and Element Skateboards.

Although the idea of social entrepreneurship and the birth of firms such as TOMS Shoes are

relatively new, a push toward social initiatives has been the source of debate for executives for

decades. Issues that have sparked particularly fierce debate include CEO pay and the role of today’s

modern corporation. More than a quarter of a century ago, famed economist Milton Friedman

argued, “The social responsibility of business is to increase its profits.” This notion is now being

challenged by firms such as TOMS and their entrepreneurial CEO, who argue that serving other

stakeholders beyond the owners and shareholders can be a powerful, inspiring, and successful

motivation for growing business.

This chapter discusses some of the key issues and decisions relevant to understanding corporate

and business ethics. Issues include how to govern large corporations in an effective and ethical

manner, what behaviors are considered best practices in regard to corporate social performance,

and how different generational perspectives and biases may hold a powerful influence on important

decisions. Understanding these issues may provide knowledge that can encourage effective

organizational leadership like that of TOMS Shoes and discourage the criticisms of many firms

associated with the corporate scandals of the late 1990s and early 2000s.

10.1 Boards of Directors

L E A R N I N G O B J E C T I V E S

1. Understand the key roles played by boards of directors.

2. Know how CEO pay and perks impact the landscape of corporate governance.

3. Explain different terms associated with corporate takeovers.

The Many Roles of Boards of Directors

“You’re fired!” is a commonly used phrase most closely associated with Donald Trump as he dismisses

candidates on his reality show, The Apprentice. But who would have the power to utter these words to

today’s CEOs, whose paychecks are on par with many of the top celebrities and athletes in the world?

This honor belongs to the board of directors—a group of individuals that oversees the activities of an

organization or corporation.

Potentially firing or hiring a CEO is one of many roles played by the board of directors in their charge to

provide effective corporate governance for the firm. An effective board plays many roles, ranging

from the approval of financial objectives, advising on strategic issues, making the firm aware of relevant

laws, and representing stakeholders who have an interest in the long-term performance of the firm

(Figure 10.1 "Board Roles"). Effective boards may help bring prestige and important resources to the

organization. For example, General Electric’s board often has included the CEOs of other firms as well

as former senators and prestigious academics. Blake Mycoskie of TOMS Shoes was touted as an ideal

candidate for an “all-star” board of directors because of his ability to fulfill his company’s mission “to

show how together we can create a better tomorrow by taking compassionate action today.”Bunting, C.

2011, February 23. Board of dreams: Fantasy board of directors. Business News Daily. Retrieved from

http://www.businessnewsdaily.com/681-board-of-directors-fantasy-picks-small-business.html

The key stakeholder of most corporations is generally agreed to be the shareholders of the company’s

stock. Most large, publicly traded firms in the United States are made up of thousands of shareholders.

While 5 percent ownership in many ventures may seem modest, this amount is considerable in publicly

traded companies where such ownership is generally limited to other companies, and ownership in this

amount could result in representation on the board of directors.

The possibility of conflicts of interest is considerable in public corporations. On the one hand, CEOs

favor large salaries and job stability, and these desires are often accompanied by a tendency to make

decisions that would benefit the firm (and their salaries) in the short term at the expense of decisions

considered over a longer time horizon. In contrast, shareholders prefer decisions that will grow the

value of their stock in the long term. This separation of interest creates an agency problem wherein

the interests of the individuals that manage the company (agents such as the CEO) may not align with

the interest of the owners (such as stockholders).

The composition of the board is critical because the dynamics of the board play an important part in

resolving the agency problem. However, who exactly should be on the board is an issue that has been

subject to fierce debate. CEOs often favor the use of board insiders who often have intimate

knowledge of the firm’s business affairs. In contrast, many institutional investors such as mutual

funds and pension funds that hold large blocks of stock in the firm often prefer significant

representation by board outsiders that provide a fresh, nonbiased perspective concerning a firm’s

actions.

One particularly controversial issue in regard to board composition is the potential for CEO duality, a

situation in which the CEO is also the chairman of the board of directors. This has also been known to

create a bitter divide within a corporation.

For example, during the 1990s, The Walt Disney Company was often listed in BusinessWeek’s rankings

for having one of the worst boards of directors.Lavelle, L. 2002, October 7. The best and worst boards:

How corporate scandals are sparking a revolution in governance. BusinessWeek, 104. In 2005, Disney’s

board forced the separation of then CEO (and chairman of the board) Michael Eisner’s dual roles.

Eisner retained the role of CEO but later stepped down from Disney entirely. Disney’s story reflects a

changing reality that boards are acting with considerably more influence than in previous decades when

they were viewed largely as rubber stamps that generally folded to the whims of the CEO.

Figure 10.1 Board Roles

© Thinkstock

Managing CEO Compensation

One of the most visible roles of boards of directors is setting CEO pay. The valuation of the human

capital associated with the rare talent possessed by some CEOs can be illustrated in a story of an

encounter one tourist had with the legendary artist Pablo Picasso. As the story goes, Picasso was once

spotted by a woman sketching. Overwhelmed with excitement at the serendipitous meeting, the tourist

offered Picasso fair market value if he would render a quick sketch of her image. After completing his

commission, she was shocked when he asked for five thousand francs, responding, “But it only took you

a few minutes.” Undeterred, Picasso retorted, “No, it took me all my life.”Kay, I. 1999. Don’t devalue

human capital. Wall Street Journal—Eastern Edition, 233, A18.

This story illustrates the complexity associated with managing CEO

compensation. On the one hand, large corporations must pay competitive

wages for the scarce talent that is needed to manage billion-dollar

corporations. In addition, like celebrities and sport stars, CEO pay is much

more than a function of a day’s work for a day’s pay. CEO compensation is a

function of the competitive wages that other corporations would offer for a

potential CEO’s services.

On the other hand, boards will face considerable scrutiny from investors if

CEO pay is out of line with industry norms. From the year 1980 to 2000,

the gap between CEO pay and worker pay grew from 42 to 1 to 475 to

1.Blumenthal, R. G. 2000, September 4. The pay gap between workers and

chiefs looks like a chasm. Barron’s, 10. Although efforts to close this gap

have been made, as recently as 2008 reports indicate the ratio continues to

be as high as 344 to 1, much higher than other countries, where an 80 to 1

ratio is common, or in Japan where the gap is just 16 to 1.Feltman, P. 2009.

Experts examine pay disparity, other executive compensation issues. SEC

Filings Insight, 15, 1–6. Meanwhile, shareholders need to be aware that

research studies have found that CEO pay is positively correlated with the

size of firms—the bigger the firm, the higher the CEO’s compensation.Tosi,

H. L., Werner, S., Katz., J. P., & Gomez-Mejia, L. R. 2000. How much does

performance matter? A meta-analysis of CEO pay studies. Journal of Management, 26, 301–339.

Consequently, when a CEO tries to grow a company, such as by acquiring a rival firm, shareholders

should question whether such growth is in the company’s best interest or whether it is simply an effort

by the CEO to get a pay raise.

Figure 10.2 CEO Perks

Images courtesy of Creative Tools, http://www.flickr.com/photos/creative_tools/4295718895/ (middle);

other images © Thinkstock.

In most publicly traded firms, CEO compensation generally includes guaranteed salary, cash bonus,

and stock options. But perks provide another valuable source of CEO compensation (Figure 10.2 "CEO

Perks"). In addition to the controversy surrounding CEO pay, such perks associated with holding the

position of CEO have also come under considerable scrutiny. The term perks, derived from perquisite,

refers to special privileges, or rights, as a function of one’s position. CEO perks have ranged in

magnitude from the sweet benefit of ice cream for life given to former Ben & Jerry’s CEO Robert

Holland, to much more extreme benefits that raise the ears of investors while outraging employees. One

such perk was provided to John Thain, who, as former head of NYSE Euronext, received more than $1

million to renovate his office. While such perks may provide powerful incentives to stay with a

company, they may result in considerable negative press and serve only to motivate vigilant investors

wary of the value of such investments to shop elsewhere.

The Market for Corporate Governance

Figure 10.3 Takeover Terms

© Thinkstock

An old investment cliché encourages individuals to buy low and sell high. When a publicly traded firm

loses value, often due to lack of vigilance on the part of the CEO and/or board, a company may become

a target of a takeover wherein another firm or set of individuals purchases the company. Generally, the

top management team is charged with revitalizing the firm and maximizing its assets.

In some cases, the takeover is in the form of a leveraged buyout (LBO) in which a publicly traded

company is purchased and then taken off the stock market. One of the most famous LBOs was of RJR

Nabisco, which inspired the book (and later film) Barbarians at the Gate. LBOs historically are

associated with reduction in workforces to streamline processes and decrease costs. The managers who

instigate buyouts generally bring a more entrepreneurial mind-set to the firm with the hopes of creating

a turnaround from the same fate that made the company an attractive takeover target (recent poor

performance).Wright, M., Hoskisson, R. E., & Busenitz, L. W. 2001. Firm rebirth: Buyouts as

facilitators of strategic growth and entrepreneurship. Academy of Management Executive, 15, 111–125.

Many takeover attempts increase shareholder value. However, because most takeovers are associated

with the dismissal of previous management, the terminology associated with change of ownership has a

decidedly negative slant against the acquiring firm’s management team. For example, individuals or

firms that hope to conduct a takeover are often referred to as corporate raiders. An unsolicited

takeover attempt is often dubbed a hostile takeover, with shark repellent as the potential defenses

against such attempts. Although the poor management of a targeted firm is often the reason such

businesses are potential takeover targets, when another firm that may be more favorable to existing

management enters the picture as an alternative buyer, a white knight is said to have entered the

picture (Figure 10.3 "Takeover Terms").

The negative tone of takeover terminology also extends to the potential target firm. CEOs as well as

board members are likely to lose their positions after a successful takeover occurs, and a number of

antitakeover tactics have been used by boards to deter a corporate raid. For example, many firms are

said to pay greenmail by repurchasing large blocks of stock at a premium to avoid a potential

takeover. Firms may threaten to take a poison pill where additional stock is sold to existing

shareholders, increasing the shares needed for a viable takeover. Even if the takeover is successful and

the previous CEO is dismissed, a golden parachute that includes a lucrative financial settlement is

likely to provide a soft landing for the ousted executive.

K E Y TA K E AWAY

Firms can benefit from superior corporate governance mechanisms such as an active board

that monitors CEO actions, provides strategic advice, and helps to network to other useful

resources. When such mechanisms are not in place, CEO excess may go unchecked,

resulting in negative publicity, poor firm performance, and potential takeover by other firms.

E X E R C I S E S

1. Divide the class into teams and see who can find the most egregious CEO perk in the last

year.

2. Find a listing of members of a board of directors for a Fortune 500 firm. Does the board

seem to be composed of individuals who are likely to fulfill all the board roles effectively?

3. Research a hostile takeover in the past five years and examine the long-term impact on the

firm’s stock market performance. Was the takeover beneficial or harmful for shareholders?

4. Examine the AFL-CIO Executive Paywatch website

(http://www.aflcio.org/corporatewatch/paywatch) and select a company of interest to see

how many years you would need to work to earn a year’s pay enjoyed by the firm’s CEO.

10.2 Corporate Ethics and Social Responsibility

L E A R N I N G O B J E C T I V E S

1. Know the three levels and six stages of moral development suggested by Kohlberg.

2. Describe famous corporate scandals.

3. Understand how the Sarbanes-Oxley Act of 2002 provides a check on corporate ethical

behavior in the United States.

4. Know the dimensions of corporate social performance tracked by KLD.

Stages of Moral Development

How do ethics evolve over time? Psychologist Lawrence Kohlberg suggests that there are six distinct

stages of moral development and that some individuals move further along these stages than

others.Kohlberg, L. 1981. Essays in moral development: Vol. 1. The philosophy of moral development.

New York, NY: Harper & Row. Kohlberg’s six stages were grouped into three levels: (1)

preconventional, (2) conventional, and (3) postconventional (Figure 10.4 "Stages of Moral

Development").

The preconventional level of moral reasoning is very egocentric in nature, and moral reasoning is tied

to personal concerns. In stage 1, individuals focus on the direct consequences that their actions will

have—for example, worry about punishment or getting caught. In stage 2, right or wrong is defined by

the reward stage, where a “what’s in it for me” mentality is seen.

In the conventional level of moral reasoning, morality is judged by comparing individuals’ actions with

the expectations of society. In stage 3, individuals are conformity driven and act with the goal of

fulfilling social roles. Parents that encourage their children to be good boys and girls use this form of

moral guidance. In stage 4, the importance of obeying laws, social conventions, or other forms of

authority to aid in maintaining a functional society is encouraged. You might witness encouragement

under this stage when using a cell phone in a restaurant or when someone is chatting too loudly in a

library.

The postconventional level, or principled level, occurs when morality is more than simply following

social rules or norms. Stage 5 considers different values and opinions. Thus laws are viewed as social

contracts that promote the greatest good for the greatest number of people. Following democratic

principles or voting to determine an outcome is common when this stage of reasoning is invoked. In

stage 6, moral reasoning is based on universal ethical principles. For example, the golden rule that you

should do unto others as you would have them do unto you illustrates one such ethical principle. At this

stage, laws are grounded in the idea of right and wrong. Thus individuals follow laws because they are

just and not because they will be punished if caught or shunned by society. Consequently, with this

stage there is an idea of civil disobedience that individuals have a duty to disobey unjust laws.

Figure 10.4 Stages of Moral Development

© Thinkstock

Corporate Scandals and Sarbanes-Oxley

Figure 10.5 Corporate Scandals

Images courtesy of Wikipedia, http://en.wikipedia.org/wiki/File:21rampell.xlarge1.jpg (top left); Hey Paul,

http://www.flickr.com/photos/heypaul/117224100/ (top middle); anyjazz65,

http://www.flickr.com/photos/49024304@N00/4427263275/ (bottom left); US Department of Justice,

http://commons.wikimedia.org/wiki/File:BernardMadoff.jpg (bottom right); other images © Thinkstock.

In the 1990s and early 2000s, several corporate scandals were revealed in the United States that

showed a lack of board vigilance. Perhaps the most famous involves Enron, whose executive antics were

documented in the film The Smartest Guys in the Room. Enron used accounting loopholes to hide

billions of dollars in failed deals. When their scandal was discovered, top management cashed out

millions in stock options while preventing lower-level employees from selling their stock. The collective

acts of Enron led many employees to lose all their retirement holdings, and many Enron execs were

sentenced to prison.

In response to notable corporate scandals at Enron, WorldCom, Tyco, and other firms, Congress passed

sweeping new legislation with the hopes of restoring investor confidence while preventing future

scandals (Figure 10.5 "Corporate Scandals"). Signed into law by President George W. Bush in 2002,

Sarbanes-Oxley contained eleven aspects that represented some of the most far-reaching reforms

since the presidency of Franklin Roosevelt. These reforms create improved standards that affect all

publicly traded firms in the United States. The key elements of each aspect of the act are summarized as

follows:

1. Because accounting firms were implicated in corporate scandal, an oversight board was created to

oversee auditing activities.

2. Standards now exist to ensure auditors are truly independent and not subject to conflicts of interest

in regard to the companies they represent.

3. Enron executives claimed that they had no idea what was going on in their company, but Sarbanes-

Oxley requires senior executives to take personal responsibility for the accuracy of financial

statements.

4. Enhanced reporting is now required to create more transparency in regard to a firm’s financial

condition.

5. Securities analysts must disclose potential conflicts of interest.

6. To prevent CEOs from claiming tax fraud is present at their firms, CEOs must personally sign the

firm’s tax return.

7. The Securities and Exchange Commission (SEC) now has expanded authority to censor or bar

securities analysts from acting as brokers, advisers, or dealers.

8. Reports from the comptroller general are required to monitor any consolidations among public

accounting firms, the role of credit agencies in securities market operations, securities violations,

and enforcement actions.

9. Criminal penalties now exist for altering or destroying financial records.

10. Significant criminal penalties now exist for white-collar crimes.

11. The SEC can freeze unusually large transactions if fraud is suspected.

The changes that encouraged the creation of Sarbanes-Oxley were so sweeping that comedian Jon

Stewart quipped, “Did Wall Street have any rules before this? Can you just shoot a guy for looking at

you wrong?” Despite the considerable merits of Sarbanes-Oxley, no legislation can provide a cure-all for

corporate scandal (Figure 10.6 "Sarbanes-Oxley Act of 2002 (SOX)"). As evidence, the scandal by

Bernard Madoff that broke in 2008 represented the largest investor fraud ever committed by an

individual. But in contrast to some previous scandals that resulted in relatively minor punishments for

their perpetrators, Madoff was sentenced to 150 years in prison.

Figure 10.6 Sarbanes-Oxley Act of 2002 (SOX)

© Thinkstock

Measuring Corporate Social Performance

TOMS Shoes’ commitment to donating a pair of shoes for every shoe sold illustrates the concept of

social entrepreneurship, in which a business is created with a goal of bettering both business and

society.Schectman, J. 2010. Good business. Newsweek, 156, 50. Firms such as TOMS exemplify a

desire to improve corporate social performance (CSP) in which a commitment to individuals,

communities, and the natural environment is valued alongside the goal of creating economic value.

Although determining the level of a firm’s social responsibility is subjective, this challenge has been

addressed in detail by Kinder, Lydenberg and Domini & Co. (KLD), a Boston-based firm that rates

firms on a number of stakeholder-related issues with the goal of measuring CSP. KLD conducts ongoing

research on social, governance, and environmental performance metrics of publicly traded firms and

reports such statistics to institutional investors. The KLD database provides ratings on numerous

“strengths” and “concerns” for each firm along a number of dimensions associated with corporate social

performance (Figure 10.7 "Measuring Corporate Social Performance"). The results of their assessment

are used to develop the Domini social investments fund, which has performed at levels roughly

equivalent to the S&P 500.

Figure 10.7 Measuring Corporate Social Performance

© Thinkstock

Assessing the community dimension of CSP is accomplished by assessing community strengths, such as

charitable or innovative giving that supports housing, education, or relations with indigenous peoples,

as well as charitable efforts worldwide, such as volunteer efforts or in-kind giving. A firm’s CSP rating is

lowered when a firm is involved in tax controversies or other negative actions that affect the

community, such as plant closings that can negatively affect property values.

CSP diversity strengths are scored positively when the company is known

for promoting women and minorities, especially for board membership and

the CEO position. Employment of the disabled and the presence of family

benefits such as child or elder care would also result in a positive score by

KLD. Diversity concerns include fines or civil penalties in conjunction with

an affirmative action or other diversity-related controversy. Lack of

representation by women on top management positions—suggesting that a

glass ceiling is present at a company—would also negatively impact scoring

on this dimension.

The employee relations dimension of CSP gauges potential strengths such

as notable union relations, profit sharing and employee stock-option plans,

favorable retirement benefits, and positive health and safety programs

noted by the US Occupational Health and Safety Administration. Employee

relations concerns would be evident in poor union relations, as well as fines

paid due to violations of health and safety standards. Substantial workforce

reductions as well as concerns about adequate funding of pension plans also

warrant concern for this dimension.

The environmental dimension records strengths by examining engagement

in recycling, preventing pollution, or using alternative energies. KLD would

also score a firm positively if profits derived from environmental products or services were a part of the

company’s business. Environmental concerns such as penalties for hazardous waste, air, water, or other

violations or actions such as the production of goods or services that could negatively impact the

environment would reduce a firm’s CSP score.

Product quality/safety strengths exist when a firm has an established and/or recognized quality

Previous Chapter Table of Contents

program; product quality safety concerns are evident when fines related to product quality and/or

safety have been discovered or when a firm has been engaged in questionable marketing practices or

paid fines related to antitrust practices or price fixing.

Corporate governance strengths are evident when lower levels of compensation for top management

and board members exist, or when the firm owns considerable interest in another company rated

favorably by KLD; corporate governance concerns arise when executive compensation is high or when

controversies related to accounting, transparency, or political accountability exist.

Strategy at the Movies

Thank You for Smoking

Does smoking cigarettes cause lung cancer? Not necessarily, according to a fictitious lobbying

group called the Academy of Tobacco Studies (ATS) depicted in Thank You for Smoking (2005).

The ATS’s ability to rebuff the critics of smoking was provided by a three-headed monster of

disinformation: scientist Erhardt Von Grupten Mundt who had been able to delay finding

conclusive evidence of the harms of tobacco for thirty years, lawyers drafted from Ivy League

institutions to fight against tobacco legislation, and a spin control division led by the smooth-

talking Nick Naylor.

The ATS was a promotional powerhouse. In just one week, the ATS and its spin doctor Naylor

distracted the American public by proposing a $50 million campaign against teen smoking,

brokered a deal with a major motion picture producer to feature actors and actresses smoking after

sex, and bribed a cancer-stricken advertising spokesman to keep quiet. But after the ATS’s

transgressions were revealed and cigarette companies were forced to settle a long-standing class-

action lawsuit for $246 billion, the ATS was shut down. Although few organizations promote a

product as harmful as cigarettes, the lessons offered in Thank You for Smoking have wide

application. In particular, the film highlights that choosing between ethical and unethical business

practices is not only a moral issue, but it can also determine whether an organization prospers or

dies.

In Thank You for

Smoking, lobbyist Nick

Naylor faces the difficult

task of making smoking

sexy in an era when the

health hazards of this

practice are well known.

© Thinkstock

K E Y TA K E AWAY

The work of Lawrence Kohlberg examines how individuals can progress in their stages of

moral development. Lack of such development by many CEOs led to a number of scandals,

as well as legislation such as the Sarbanes-Oxley Act of 2002 that was enacted with the

hope of deterring scandalous behavior in the future. Firms such as KLD provide objective

measures of both positive and negative actions related to corporate social performance.

E X E R C I S E S

1. How would your college or university fare if rated on the dimensions used by KLD?

2. Do you believe that executives will become more ethical based on legislation such as

Sarbanes-Oxley?

10.3 Understanding Thought Patterns: A Key to

Corporate Leadership?

L E A R N I N G O B J E C T I V E S

1. Know the three major generational influences that make up the majority of the current

workforce and their different perspectives and influences.

2. Understand how decision biases may impede effective decision making.

Generational Influences on Work Behavior

Psychologist Kurt Lewin, known as the “founder of social psychology,” created a well-known formula B

= ƒ(P,E) that states behavior is a function of the person and their environment. One powerful

environmental influence that can be seen in organizations today is based on generational differences.

Currently, four generations of workers (traditionalists, baby boomers, Generation X, Generation Y)

coexist in many organizations. The different backgrounds and behaviors create challenges for leading

these individuals that often have similar shared experiences within their generation but different sets of

values, motivations, and preferences in contrast to other generations (Figure 10.8 "Managing

Generational Differences"). Effective management of these four different generations involves a

realization of their differences and preferred communication styles.Rathman, V. 2011. Four generations

at work. Oil & Gas, 109, 10.

The generation born between 1925 and 1946 that fought in World War II and lived through the Great

Depression are referred to as traditionalists. The perseverance of this generation has led journalist

Tom Brokaw to dub this group “The Greatest Generation.” As a reflection of a generation that was

molded by contributions to World War II, members of this generation value personal communication,

loyalty, hierarchy, and are resistant to change. This group now makes up roughly 5 percent of the

workforce.

Photographer Dorothea Lange’s photo Migrant Mother, taken in 1936, embodied the struggles of the

traditionalist generation that lived during the Great Depression.

Image courtesy of Dorothea Lange, http://en.wikipedia.org/wiki/File:Lange-MigrantMother02.jpg.

The generation known as baby boomers was born between 1946 and 1964, corresponding with a

population “boom” following the end of World War II. This group witnessed Beatlemania, Vietnam, and

the Watergate scandal. College graduates should be aware that this group makes up the majority of the

workforce and that boomer managers often view face time as an important contribution to a successful

work environment.Fogg, P. 2008, July 18. When generations collide: Colleges try to prevent age-old

culture clashes as four distinct groups meet in the workplace. Education Digest, 25–30. In addition, a

realization that this generation wants to be included in office activities and values recognition is

important to achieving cohesiveness between generations.

Generation X,born between 1965 and 1980, is marked by an X symbolizing their unknown nature. In

contrast to the baby boomer’s value on office face time, Gen X members prize flexibility in their jobs

and dislike the feeling that they are being micromanaged.Burk, B., Olsen, H., & Messerli, E. 2011, May.

Navigating the generation gap in the workplace from the perspective of Generation Y. Parks &

Recreation, 35–36. Because of the desire for independence as well as adaptability associated with this

generation, you should try to answer the “What’s in it for me?” question to avoid the risk of Gen X

members moving on to other employment opportunities.

The generation that followed Generation X is known as Generation Y or millennials. This generation

is highlighted by positive attributes such as the ability to embrace technology. More than previous

generations, this group prizes job and life satisfaction highly, so making the workplace an enjoyable

environment is key to managing Generation Y.

Figure 10.8 Managing Generational Differences

© Thinkstock

Wise members of this generation will also be aware of the negative attributes surrounding them. For

example, millennials are associated with their “helicopter” parents who are often too comfortably

involved in the lives of their children. For example, such parents have been known to show up to their

children’s job orientations, often attempting to interfere with other workplace experiences such as pay

and promotion discussions that may be unwelcome by older generations. In addition, this generation is

viewed as needing more feedback than previous groups. Finally, the trend toward discouraging some

competitive activities among individuals in this age group has led millennials to be dubbed “Trophy

Kids” by more cynical writers.

Rational Decision Making

Understanding generational differences can provide valuable insight into the perspectives that shape

the behaviors of individuals born at different periods of time. But such knowledge does not answer a

more fundamental question of interest to students of strategic management, namely, why do CEOs

make bad, unethical, or other questionable decisions with the potential to lead their firms to poor

performance or firm failure? Part of the answer lies in the method by which CEOs and other individuals

make decisions. Ideally, individuals would make rational decisions for important choices such as

buying a car or house, or choosing a career or place to live. The process of rational decision making

involves problem identification, establishment and weighing of decision criteria, generation and

evaluation of alternatives, selection of the best alternative, decision implementation, and decision

evaluation.

Rational Decision-Making Model

Reproduced with permission from Carpenter, M., Bauer, T., & Erdogan, B. 2011. Principles of Management.

Irvington, NY: Flat World Knowledge.

While this model provides valuable insights by providing an ideal approach by which to make decisions,

there are several problems with this model when applied to many complex decisions. First, many

strategic decisions are not presented in obvious ways, and many CEOs may not be aware their firms are

having problems until it’s too late to create a viable solution. Second, rational decision making assumes

that options are clear and that a single best solution exists. Third, rational decision making assumes no

time or cost constraints. Fourth, rational decision making assumes accurate information is available.

Because of these challenges, some have joked that marriage is one of the least rational decisions a

person can make because no one can seek out and pursue every possible alternative—even with all the

online dating and social networking services in the world.

Decision Biases

In reality, decision making is not rational because there are limits on our ability to collect and process

information. Because of these limitations, Nobel Prize-winner Herbert Simon argued that we can learn

more by examining scenarios where individuals deviate from the ideal. These decision biases provide

clues to why individuals such as CEOs make decisions that in retrospect often seem very illogical—

especially when they lead to actions that damage the firm and its performance. A number of the most

common biases with the potential to affect business decision making are discussed next.

Figure 10.9 Decision Biases

© Thinkstock

Anchoring and adjustment bias occurs when individuals react to arbitrary or irrelevant numbers

when setting financial or other numerical targets. For example, it is tempting for college graduates to

compare their starting salaries at their first career job to the wages earned at jobs used to fund school.

Comparisons to siblings, friends, parents, and others with different majors are also very tempting while

being generally irrelevant. Instead, research the average starting salary for your background,

experience, and other relevant characteristics to get a true gauge. This bias could undermine firm

performance if executives make decisions about the potential value of a merger or acquisition by

making comparisons to previous deals rather than based on a realistic and careful study of a move’s

profit potential (Figure 10.9 "Decision Biases").

The availability bias occurs when more readily available information is incorrectly assessed to also be

more likely. For example, research shows that most people think that auto accidents cause more deaths

than stomach cancer because auto accidents are reported more in the media than deaths by stomach

cancer at a rate of more than 100 to 1. This bias could cause trouble for executives if they focus on

readily available information such as their own firm’s performance figures but fail to collect meaningful

data on their competitors or industry trends that suggest the need for a potential change in strategic

direction.

The idea of “throwing good money after bad” illustrates the bias of escalation of commitment,

when individuals continue on a failing course of action even after it becomes clear that this may be a

poor path to follow. This can be regularly seen at Vegas casinos when individuals think the next coin

must be more likely to hit the jackpot at the slots. The concept of escalation of commitment was

chronicled in the 1990 book Barbarians at the Gate: The Rise and Fall of RJR Nabisco. The book

follows the buyout of RJR Nabisco and the bidding war that took place between then CEO of RJR

Nabisco F. Ross Johnson and leverage buyout pioneers Henry Kravis and George Roberts. The result of

the bidding war was an extremely high sales price of the company that resulted in significant debt for

the new owners.

Providing an excellent suggestion to avoid a nonrational escalation of commitment, old school comedian W.

C. Fields once advised, “If at first you don’t succeed, try, try again. Then quit. There’s no point being a damn

fool about it.”

Image courtesy of Bain News Service,

http://wikimediafoundation.org/wiki/File:Wcfields36682u_cropped.jpg

Fundamental attribution error occurs when good outcomes are attributed to personal

characteristics but undesirable outcomes are attributed to external circumstances. Many professors

lament a common scenario that, when a student does well on a test, it’s attributed to intelligence. But

when a student performs poorly, the result is attributed to an unfair test or lack of adequate teaching

based on the professor. In a similar vein, some CEOs are quick to take credit when their firm performs

well, but often attribute poor performance to external factors such as the state of the economy.

Hindsight bias occurs when mistakes seem obvious after they have already occurred. This bias is

often seen when second-guessing failed plays on the football field and is so closely associated with

watching National Football League games on Sunday that the phrase Monday morning quarterback is a

part of our business and sports vernacular. The decline of firms such as Kodak as victims to the

increasing popularity of digital cameras may seem obvious in retrospect. It is easy to overlook the poor

quality of early digital technology and to dismiss any notion that Kodak executives had good reason not

to view this new technology as a significant competitive threat when digital cameras were first

introduced to the market.

Judgments about correlation and causality can lead to problems when individuals make

inaccurate attributions about the causes of events. Three things are necessary to determine cause—or

why one element affects another. For example, understanding how marketing spending affects firm

performance involves (1) correlation (do sales increase when marketing increases), (2) temporal order

(does marketing spending occur before sales increase), and (3) ruling out other potential causes (is

something else causing sales to increase: better products, more employees, a recession, a competitor

went bankrupt, etc.). The first two items can be tracked easily, but the third is almost impossible to

isolate because there are always so many changing factors. In economics, the expression ceteris paribus

(all things being equal or constant) is the basis of many economic models; unfortunately, the only

constant in reality is change. Of course, just because determining causality is difficult and often

inconclusive does not mean that firms should be slow to take strategic action. As the old business

saying goes, “We know we always waste half of our marketing budget, we just don’t know which half.”

Misunderstandings about sampling may occur when individuals draw broad conclusions from

small sets of observations instead of more reliable sources of information derived from large, randomly

drawn samples. Many CEOs have been known to make major financial decisions based on their own

instincts rather than on careful number crunching.

Overconfidence bias occurs when individuals are more confident in their abilities to predict an event

than logic suggests is actually possible. For example, two-thirds of lawyers in civil cases believe their

side will emerge victorious. But as the famed Yankees player/manager Yogi Berra once noted, “It’s hard

to make predictions, especially about the future.” Such overconfidence is common in CEOs that have

had success in the past and who often rely on their own intuition rather than on hard data and market

research.

Representativeness bias occurs when managers use stereotypes of similar occurrences when making

judgments or decisions. In some cases, managers may draw from previous experiences to make good

decisions when changes in the environment occur. In other cases, representativeness can lead to

discriminatory behaviors that may be both unethical and illegal.

Framing bias occurs when the way information is presented alters the decision an individual will

make. Poor framing frequently occurs in companies because employees are often reluctant to bring bad

news to CEOs. To avoid an unpleasant message, they might be tempted to frame information in a more

positive light than reality, knowing that individuals react differently to news that a glass is half empty

versus half full.

Satisficing occurs when individuals settle for the first acceptable alternative instead of seeking the

best possible (optimal) decision. While this bias might actually be desirable when others are waiting

behind you at a vending machine, research shows that CEOs commonly satisfice with major decisions

such as mergers and takeovers.

K E Y TA K E AWAY

Generational differences provide powerful influences on the mind-set of employees that

should be carefully considered to effectively manage a diverse workforce. Wise managers

will also be aware of the numerous decision biases that could impede effective decision

making.

E X E R C I S E S

1. Explain how a specific decision bias mentioned in this chapter led to poor decision making

by a firm.

2. Are there negative generational tendencies in your age group that you have worked to

overcome?

10.4 Conclusion

This chapter explains the role of boards of directors in the corporate governance of organizations such

as large, publicly traded corporations. Wise boards work to manage the agency problem that creates a

conflict of interest between top managers such as CEO and other groups with a stake in the firm. When

boards fail to do their duties, numerous scandals may ensue. Corporate scandals became so widespread

that new legislation such as the Sarbanes-Oxley Act of 2002 has been developed with the hope of

impeding future actions by executives associated with unethical or illegal behavior. Finally, firms

should be aware of generational influences as well as other biases that may lead to poor decisions.

E X E R C I S E S

1. Divide your class into four or eight groups, depending on the size of the class. Each group

should select a different industry. Find positive and negative examples of corporate social

performance based on the dimensions used by KLD.

2. This chapter discussed Blake Mycoskie and TOMS Shoes. What other opportunities exist to

create new organizations that serve both social and financial goals?