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Chapter 12

Corporate Governance and Business Ethics

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The AFI Strategy Framework

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Learning Objectives

Describe the shared value creation framework and its relationship to competitive advantage.

Explain the role of corporate governance.

Apply agency theory to explain why and how companies use governance mechanisms to align interests of principals and agents.

Evaluate the board of directors as the central governance mechanism for public stock companies.

Evaluate other governance mechanisms.

Explain the relationship between strategy and business ethics.

Case Study-Uber

Travis Kalanick founded the company in 2009 in SF

Disrupted taxi service as “ride hailing”

Market cap of $70B in 2017

Hertz w/ 500M cars, 150k employees = 1% of that value

Avoids the taxes of other cab companies

Gig economy job = freedom, but not benefits

Forced to resign in 2017 after fallout from investigation and video of him going off on Uber driver.

New CEO, Dara Khosrowshahi formerly of Expedia…apology tour.

Case Study -Uber

Ethically Challenged?

Early disregard for laws, rules and regulations

Dynamic pricing

Punking the competition

Punking their own drivers

Attacking critics

Culture of sexual harassment/gender discrimination

Waymo lawsuit

Flaunting local laws and ignoring injunctions

Surge pricing vs. price gouging, (snowstorms, etc)…matching supply with demand.

Uber ordered Lyft rides and then cancelled, causing lost business from legitimate customers

Lied to their drivers about laws preventing drivers from working for both Lyft and Uber

Poached/targeted Lyft drivers

Google’s sued Uber for trade secret theft. Waymo alleged one of its former engineers stole confidential trade secrets before leaving to form his own startup, Otto, in 2016. Waymo alleged Uber used that information to help advance Uber's self-driving tech once Otto was acquired in August 2016.

Public Stock Company: Four Benefits

Limited liability for investors.

Transferability of investor ownership through stock.

Legal personality, with rights and obligations.

Separation of legal ownership and management control.

Only liable for what you invest

Easily transfer of stocks

Public domain vs. family run…public firms has rights and obligations

Stockholders are owners who delegate authority.

For publicly held firms, in particular, it is important for management to keep in mind that it is acting as stewards for other people’s money and has public responsibilities.

The Public Stock Company: Hierarchy of Authority

Exhibit 12.1

Access the text alternate for slide image.

Two Viewpoints

Traditional View: (Friedman)

Shareholder capitalism: shareholders – the providers of the necessary risk capital and the legal owners of public companies – have the most legitimate claim on profits.

Shared Value View: (Porter)

Creating Shared Value, (CSV): obligations extend beyond the economic responsibility and include legal, ethical, and philanthropic societal expectations

Freidman-”There is one and only one social responsibility of business-to use its resources 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 competitions without deception of fraud.”

Porter-”The purpose of the corporation must be redefined as creating shared value, not just profit per se. This will drive the next wave of innovation and productivity growth in the global economy.”

Discuss in your group the contrasting perspectives of “shareholder versus stakeholder” governance. What benefits and drawbacks can you find in each view? Students need to understand the difference between shareholders and stakeholders. Shareholders focus on self-interest and profitability, while stakeholders emphasize responsibilities and all the parties involved. They must also realize that national and cultural differences play a role when designing the governance structure. What are the differences within countries in regards to layoffs?

“The social responsibility of business is to increase its profits.”

A survey was created:

For the (degreed) top 25% of income earners.

To assess various countries.

To inquire whether they agree with Friedman.

The results…

Global Survey of Attitudes toward Business Responsibility

Access the text alternate for slide image.

The Shared Value Creation Framework

Provides guidance to managers.

Helps reconcile gaining and sustaining competitive advantage with corporate social responsibility.

Creates a larger “pie” to benefit shareholders and stakeholders.

Creating Shared Value

Executives shouldn’t concentrate only on increasing firm profits.

Rather, they should focus on creating shared value.

- Economic value (for shareholders).

- Social value (address society’s needs and challenges).

Video on CSV image

The shared value creation framework provides help in making connections between economic needs and social needs in a way that transforms into a business opportunity.

What does this sound like?

Starbucks had the vet program 25k hires, refugee 10k hires, youth 10k hires. Rust proof plants for farmers

GE, for example, has strengthened its competitiveness by creating a profitable business with its “green” Ecomagination initiative. Ecomagination is GE’s strategic initiative to provide cleaner and more efficient sources of energy, provide abundant sources of clean water anywhere in the world, and reduce emissions. Jeffrey Immelt, GE’s former CEO, would often say, “Green is green,” meaning that addressing ecological needs offers the potential of gaining and sustaining a competitive advantage for GE.

Reconnecting Economic and Societal Needs

Reconceiving products and markets. Expand the customer base to bring in nonconsumers, (the largest and poorest groups).

Companies can meet customer needs while better serving society, within existing markets, accessing new ones, or lowering costs through innovation

Redefining productivity in your value chain. Expand traditional internal firm value chains to include more nontraditional partners.

For example, nongovernmental organizations (NGOs)

Companies can improve the quality, quantity, cost, and reliability of inputs and distribution while they simultaneously act as a steward for essential natural resources and drive economic and social development.

Focus on creating new regional clusters.

Look at ways to support industries related to your own

Chilecon Valley and Bangalore

Porter argues that these strategic actions will lead to a larger pie of revenues and profits that can be distributed among a company’s stakeholders.

CSV is about creating new business opportunities that create new markets, improve profitability and strengthen competitive positioning….Value

CSR is about responsibility…they overlap.

CSR is viewed more as a cost center, not a profit center, Porter’s is identify the profit capability in CSV.

One firm’s view

Corporate Governance

The mechanisms to:

Direct and control an enterprise.

Ensure that it pursues strategic goals successfully and legally.

Offers checks and balances.

Attempts to address the principal-agent problem, (next slide)

The separation of ownership and control is one of the major advantages of the public stock companies. This benefit, however, is also the source of the principal–agent problem. In publicly traded companies, the stockholders are the legal owners of the company, but they delegate decision-making authority to professional managers. The conflict arises if the agents pursue their own personal interests, which can be at odds with the principals’ goals. For their part, agents may be more interested in maximizing their total compensation, including benefits, job security, status, and power. Principals desire maximization of total returns to shareholders.

The Principal-Agent Problem

Managers, executives, and board members tend to have access to private information concerning important company developments that outsiders, especially investors, are not privy to. Often this informational advantage is based on timing—insiders are the first to learn about important developments before the information is released to the public. Although possessing insider information is not illegal and indeed is part of an executive’s job, what is illegal is acting upon it through trading stocks or passing on the information to others who might do so…this is known as information asymmetry.

The company's officers and board of directors, including Chairman Kenneth Lay, CEO Jeffrey Skilling and CFO Andy Fastow, were selling their Enron stock at higher prices due to false accounting reports that made the stock seem more valuable than it truly was.

Goldman Sachs and Real estate bubble. Another agency problem occurs when financial analysts invest against the best interests of their clients.

The Principal-Agent Problem

While the stockholders call on the managers to take care of the company, the managers may look to their own needs first.

P-A problem occurs when one person or entity (the "agent") is able to make decisions and/or take actions on behalf of, or that impact, another person or entity: the "principal". This dilemma exists in circumstances where agents are motivated to act in their own best interests, which are contrary to those of their principals

Agency Theory

A theory that views the firm as a nexus of legal contracts.

Conflicts that arise should be resolved legally.

The firm needs to design work tasks, incentives, and employment contracts…

To minimize opportunism by agents.

Senior executives, such as the CEO, face agency problems when they delegate authority. Employees who perform the actual operational labor are agents who work on behalf of the managers. Such frontline employees often enjoy an informational advantage over management. They may tell their supervisor that it took longer to complete a project or serve a customer than it actually did, for example. Some employees may be tempted to use such informational advantage for their own self-interest (e.g., spending time on Facebook during work hours, watching YouTube videos, or using the company’s computer and internet connection for personal business).

Adverse Selection and Moral Hazard

Both caused by information asymmetry.

Adverse Selection

An increased likelihood of selecting inferior alternatives.

Moral Hazard

When one party is incentivized to take undue risks or shirk responsibilities,

The costs are incurred to the other party.

The Board of Directors

Centerpiece of corporate governance.

Represent the interests of shareholders.

Tasked with providing oversight.

Consist of inside and outside directors.

Inside directors: usually consist of CEO, COO, CFO.

Outside directors: senior execs from other firms.

Are elected by the shareholders.

Shareholders vote to determine who is elected.

Responsibilities of the Board of Directors

Strategic oversight and guidance.

CEO selection, evaluation, compensation, succession.

Guide executive compensation.

Review, monitor, evaluate, and approve strategic initiatives.

Risk assessment and mitigation.

Ensuring financial statements are accurate.

Ensuring compliance with laws and regulations.

When Facebook acquired Instagram, the CEO, Mark Zuckerberg, did not even inform the board about the deal until it was done. Working on his own was undoubtedly faster than engaging the board and seeking their advice and approval, and speed may have made the difference in gaining the target. On the other hand, how well were the shareholders served in the absence of board oversight in the negotiations process? Ask students to debate the pros and cons of Mr. Z’s actions.

The practice of CEO/chairperson duality—holding both the role of CEO and chairperson of the board—has been declining somewhat in recent years. Among the largest 500 publicly traded companies in the United States, about 70 percent of firms had the dual CEO-chair arrangement in 2005 (before the global financial crisis), but this number had declined to some 50 percent of companies in 2018 (post global financial crisis). High-profile examples of the same person serving as CEO and chair of the board include Jeff Bezos (Amazon), Mark Zuckerberg (Facebook), Robert Iger (Disney), Mary Barra (GM), and Virginia Rometty (IBM).

Boys Club?

Why has representation by women on U.S. boards not increased over the past 10 years? What actions could be taken by companies to increase participation? What actions could be taken by women who seek to be directors?

Part of the problem is that women continue to be under-represented in the C-Suite executive offices.

Other Governance Mechanisms

Used to align incentives between principals and agents:

Executive compensation.

The market for corporate control.

Financial statement auditors, government regulators, and industry analysts.

1. Executive Compensation

Stock options are often part of compensation.

2019 Average CEO pay was about $21M.

The avg ratio of CEO to employee pay is 280:1

In 1980 it was 40:1

About 2/3 of CEO pay is linked to firm performance.

Incentives can negatively affect performance

Overall pay has gone up, but not necessarily performance

CEO pay has increased 940% since 1978

What are the potentially negative effects of this increasing disparity in CEO pay? Do you believe that current executive pay packages are justified? Why or why not?

Based on a survey of CEOs in the S&P 500 by The Wall Street Journal, the median annual compensation was about $11 million. The five highest paid CEOs were Thomas Rutledge of Charter Communications ($98.5 million), Fabrizio Freda of Estée Lauder ($48.4 million), Mark Parker of Nike ($47.6 million), Alex Molinaroli of Johnson Controls ($46.4 million), and Robert Iger of Disney ($43.9 million). Noteworthy are also the two lowest paid CEOs in the S&P 500: Warren Buffett of Berkshire Hathaway ($470,000) and Larry Page of Alphabet ($1, the minimum payment required).

CEO Pay 2019

Highest in 2019:

Elon Musk – Tesla, SpaceX ($2.2B) Patrick Smith – Axon Enterprise ($248M) David Zaslav – Discovery Comm ($128M) John Legere – T-Mobile ($66M) Robert Iger of Disney ($65M)

Lowest in 2019

Warren Buffet of Berkshire Hathaway ($100k)

Larry Page of Alphabet ($1.00)

Jeff Bezos of Amazon ($1.7M)

Craig Jelinek of Costco, ($934,000)

Obviously these guys make more in Stock, but their base pay is low relatively.

2. The Market for Corporate Control

An external corporate-governance mechanism.

Activist investors who:

Seek to gain control of an underperforming corporation.

Buy shares of its stock in the open market through buy-outs.

Defended by poison pill

In a leveraged buyout (LBO), a single investor or group of investors buys, with the help of borrowed money (leveraged against the company’s assets), the outstanding shares of a publicly traded company in order to take it private. In short, an LBO changes the ownership structure of a company from public to private. The expectation is often that the private owners will restructure the company and eventually take it public again through an initial public offering (IPO).

To avoid being taken over against their consent, some firms put in place a poison pill. These are defensive provisions that kick in should a buyer reach a certain level of share ownership without top management approval.

(Carl Icahn, Daniel Loeb, Wm. Ackman)

Whole foods was one such target and chose to “merge” with Amazon vs. investor driven change.

3. Auditors, Regulators and Industry Analysts

External-governance mechanisms.

To avoid misrepresentation of financial results:

Public financial statements must follow GAAP:

Generally accepted accounting principles.

Financial statements must be audited.

Industry analysts often base their buy, hold, or sell recommendations on:

Financial statements filed with the SEC.

Business news (WSJ, Forbes, CNBC, etc.)

Corporate-governance mechanisms play an important part in aligning the interests of principals and agents. They enable closer monitoring and controlling, as well as provide incentives to align interests of principals and agents. An industry has sprung up around assessing the effectiveness of corporate governance in individual firms. Research outfits, such as GMI Ratings, provide independent corporate governance ratings. The ratings from these external watchdog organizations inform a wide range of stakeholders, including investors, insurers, auditors, regulators, and others.

Ethics Scandals

Ethical decision making depends on the organization

Enron-Power Utilities – creating an inflated share price at any cost, employees observed and followed the behavior set by leaders. Ken Lay died weeks before entering prison, other C-levels imprisoned

Worldcom-Telecom – Bernie Ebbers imprisoned

Tyco-Security systems – Dennis Kowsloski imprisoned

Valeant/Turin – Pharma, CEO believed its sole purpose was to the shareholder, orphan drugs. Shreli in prison, Thompson free

HSBC – The drug cartel’s bank, money laundering. Paid a $2B fine, make 38B/yr.

Payday loan – legal loan shark, Scott Tucker in prison

Apology tours

Why are these ads being run? Unethical behavior

Has it changed your mind about using any of these companies?

WF https://www.youtube.com/watch?v=CjWnHmFYbEg

Fb https://youtu.be/Q4zd7X98eOs

Uber https://www.youtube.com/watch?v=WMZyw5lPKgE

Two Questions

Why does this unethical behavior happen repeatedly in the business world?

Is there a difference between Ethics and Business Ethics?

Does crime pay?

How many people go to jail for destroying trust, companies and people? Very few if any

Just because it is legal, does it make it right? Valeant buys smaller monopolistic drug companies to raise the price.

How to you rectify “business ethics”.

Business Ethics

An agreed-upon code of conduct in business

Provides training for:

Behavior that is consistent with the principles, norms, and standards of business practice that have been agreed upon by society.

Can differ in various cultures around the globe.

Universal norms include fairness, honesty, and reciprocity.

Law and ethics, however, are not synonymous. This distinction is important and not always understood by the general public. Staying within the law is a minimum acceptable standard. A note of caution is therefore in order: A manager’s actions can be completely legal, but ethically questionable.

When Facing an Ethical Dilemma

Is the action within acceptable norms of professional behavior?

As outlined in the organization’s code of conduct.

As defined by the profession at large.

Would you feel comfortable explaining and defending the decision in public?

How would the media react?

How would the company’s stakeholders feel about it?

Bad Apples vs. Bad Barrels

Bad Apples.

Individuals who act opportunistically.

Bad Barrels.

An unethical organizational climate.

To set the ethical tone, leaders must:

Set clear ethical expectations.

Put structure, culture and control systems in place.

Formal and informal culture must be aligned.

Executive behavior must adhere to the company vision and values.

The MBA Oath

As a business leader I recognize my role in society.

My purpose is to lead people and manage resources to create value that no single individual can create alone.

My decisions affect the well-being of individuals inside and outside my enterprise, today and tomorrow.

Therefore, I promise that:

I will manage my enterprise with loyalty and care, and will not advance my personal interests at the expense of my enterprise or society.

I will understand and uphold, in letter and spirit, the laws and contracts governing my conduct and that of my enterprise.

I will refrain from corruption, unfair competition, or business practices harmful to society.

I will protect the human rights and dignity of all people affected by my enterprise, and I will oppose discrimination and exploitation.

I will protect the right of future generations to advance their standard of living and enjoy a healthy planet.

I will report the performance and risks of my enterprise accurately and honestly.

I will invest in developing myself and others, helping the management profession continue to advance and create sustainable and inclusive prosperity.

In exercising my professional duties according to these principles, I recognize that my behavior must set an example of integrity, eliciting trust and esteem from those I serve. I will remain accountable to my peers and to society for my actions and for upholding these standards.

This oath I make freely, and upon my honor.

Exhibit 12.4

Developed by Harvard Business School students:

Helps anchor future managers to professional values.

A guideline for integrity in business.

Source: MBA Oath and Max Anderson.

The MBA Oath

As a business leader I recognize my role in society. My purpose is to lead people and manage resources to create value that no single individual can create alone.

My decisions affect the well-being of individuals inside and outside my enterprise, today and tomorrow.

Therefore, I promise that: I will manage my enterprise with loyalty and care, and will not advance my personal interests at the expense of my enterprise or society.

I will understand and uphold, in letter and spirit, the laws and contracts governing my conduct and that of my enterprise.

I will refrain from corruption, unfair competition, or business practices harmful to society.

I will protect the human rights and dignity of all people affected by my enterprise, and I will oppose discrimination and exploitation.

I will protect the right of future generations to advance their standard of living and enjoy a healthy planet.

I will report the performance and risks of my enterprise accurately and honestly.

I will invest in developing myself and others, helping the management profession continue to advance and create sustainable and inclusive prosperity.

This oath I make freely, and upon my honor.

End of Main Content

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The Paradox of Business Ethics: Nailing Jello to a Wall or Just Plain Common Sense?

Ethics on campus

“Pressure to succeed leading more students to cheat”

“Social Deviance Among Students”

“3 ways cheaters have scammed the college admissions game”

“86 percent of college students say they've cheated”

“Why Paying Bribes to Get Your Child Into College Is a Crime”

https://www.10tv.com/article/pressure-succeed-leading-more-students-cheat

Midterms 2017 Spring-Seattle Univ Two classes of 4890

What is the purpose of a midterm?

To determine how the class is tracking on the lessons and to provide feedback to the teacher that they are able to correctly communicate the information

Canvas - Decided to use the technology

None of the other teachers were using this tool, hmmmm

Exam results

Scores came in and they were awesome. Some had perfect scores. (I am a great teacher!)

I started re-reading the answers and discovered things were not looking correct in the answers.

Students using words like thus, therefore, and hence. Not words I found in their other course work.

Some of the answers were verbatim to the Power point and textbooks, including punctuation and fonts

Reached out to Canvas and learned you can activate “Quiz logs”.

Verified students were leaving Canvas numerous times.

Validated students were cutting and pasting answers directly from the textbook and other sources via the 7 sec screen shots views

to see when students were leaving Canvas, (why would you need to leave Canvas?). This showed that people were leaving the exam numerous times. I was also able to verify that people were cutting and pasting answers directly from the textbook and other sources via the 7 sec screen shots views, (apparently some people can type 60 words a minute, but…)

Response

Share findings with Class

Written spot quiz, (5 questions)

End class

a. Grade quizzes and compared to mid-term

b. Performed forensics on who/what/how

c. Discovered 35% of each class was cheating

d. Get pissed

Discuss with Dept head

- Cheating is apparently common, who knew? Rossen reports

Rethink my desire to teach

No one was aware that Canvas has the quiz log feature, so that was eye-opening.

I then performed a written spot quiz of 5 questions to see how they compared with the Canvas results. I dismissed the class so I could grade them immediately. The spot quiz results were not the same as Canvas exam for about 35% of the class.

I spent a lot of time on the validation.

https://www.today.com/video/rossen-reports-underground-world-of-college-cheating-31797315879

At this point I was feeling very depressed and disillusioned. Oh, this happened in both Spr classes.

Questions

Was there any value to my midterm feedback?

How important are grades to these students?

Is it more important to learn stuff than get the grade?

Are we creating a nation of cheaters?

What is the impact on society?, (Is this the new “sign of times”?)

If this is so prevalent, is Seattle U part of the problem?

How damaging is groupthink?

It is more important to me that you are getting the information than getting the grades. I believe I am allowing you the opportunity to get a good grade, but now I am worried about what type of people are graduating into this world.

What are you going to be doing in your careers? Look, the real world is not fair, but if we are grooming a society of cheaters and unethical people, where will that lead us? Some of you will succeed as cheaters, yes. Some of you have grown up with an unethical culture and those are the life lessons you have accepted as normal. You believe it is OK. You pay people to write your papers, you use pirated textbooks and the school turns a blind eye, why? Cuz they want your money…

Seattle U Academic Integrity Policy

A student found to have violated the Academic Integrity Policy shall be subject to penalties imposed by the faculty member reporting the violation and any additional penalties that may be imposed by the dean or the provost. Penalties include:

No class credit

Reprimand

Probation

Suspension

Expulsion

Denial of Recommendation

Options for Joe?

Let everything ride. (This allows the cheaters to succeed at the expense of the students who did their own work).

Ask for confessions and provide immunity, (0 points for midterm vs. failing class)

Throw the whole thing out and move the points to the final.

Redo the midterm in handwritten form

Retake on Canvas with observers, no one sits in the back. (How would that make you feel?)

The only person who’s test results I was sure were accurate is the student who took the test in the proctor center.

Options for Joe?

Let everything ride. (This allows the cheaters to succeed at the expense of the students who did their own work).

Ask for confessions and provide immunity, (0 points for midterm vs. failing class)

Throw the whole thing out and move the points to the final.

Redo the midterm in handwritten form

Retake on Canvas with observers, no one sits in the back. (How would that make you feel?)

I had spent too much time doing detective work and we needed to move forward.

Results

28 Students from both classes “confessed” and apologized.

Phone calls

Meetings

We wiped the slate clean and moved on, (0 was given as the grade).

Groupthink was a big factor in “why?” Students saw others cheating and didn’t want to be penalized for doing their own work.

Student reaction:

Some were mad at the cheaters who caused all this chaos

Some got away with it, (jerks will always be jerks).

Most realized it as a teachable moment because this occurred during Ethics Week

Trust was not an issue moving forward, but the final was on paper =)

I was thoroughly heartened by the student reaction. It impressed me, as the meetings with tears and smiles showed they truly cared. “You did not deserve this”

Business Ethics in a Nutshell

“The really creative part of business ethics is discovering ways to do what is morally right and socially responsible without ruining your career and company.”

Joanne B. Ciulla, Business Ethics as Moral Imagination in Business Ethics: The State of the Art

Vehicles

Expenses

Theft

Winning Business

The continual saga of well-paid people who make poor choices…and lose their jobs.

The continual saga of well paid people who make poor choices.

Cars, (Sheppard, Brazille, Hicks, Carozza, Cross)

Expenses, (Eccard, Spriggs)

Stealing, (Dumaines, Hester)

Winning Business, (Dreamworks, UCSF/Karl)

So due to a few bad apples, everyone gets punished. Company cars, corporate credit cards, customer entertainment---all lost due to the stupidity of selfish employees. Unethical behavior override ethical

5 Simple Rules for Business Ethics Thomas Hoolihan

What would your Mother say? (or Google, YouTube or the NY Times)

Tell the Truth – its Easier to Remember

It’s not the Crime – it’s the Cover-up

Be Nice and Respect Others, (sexual harassment, discrimination)

Don’t be a Whore, (what is your price?)

Story/Joke Everyone would agree to do anything for money, if the price was high enough. `Surely not, she said.' `Oh yes,' he said. `Well, I wouldn't,' she said. `Oh yes you would,' he said. `For instance,' he said, `would you sleep with me for... for a million pounds?' `Well,' she said, `maybe for a million I would, yes.' `Would you do it for ten shillings?' said Bernard Shaw. `Certainly not!' said the woman `What do you take me for? A prostitute?' `We've established that already,' said Bernard Shaw. `We're just trying to fix your price now!' “

The bottom line is “you aren’t that smart, most everyone gets caught”

There are a few things you own in life:

your choices…and the consequences that come about from those choices

your attitude…on how you deal with the challenges thrown at you in life

your integrity… is who you are, the person you present to the world.

Ethics Exercise

Scenario: You see someone in the class remove another student’s wallet from their backpack and put it into their own.