1. You need to complete this task in strict accordance with the detailed Requirements/Guidelines.

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In Chapter Four we explored the issue of ethics and financial reporting. We learned of the

importance of the Sarbanes Oxley Act of 2002 for ensuring accurate and trustworthy

reports. We also explored the role of the ethical auditor and the potential for conflicts of

interest during the financial auditing process. In Chapter Five we will explore the

corporate governance framework.

Chapter Five defines the concept of ethical leadership. After completing this session you

will be able to distinguish between transformational leadership and transactional

leadership. The material in Chapter Five explains the roles of ethics in corporate

governance matters; describes the board of director’s role and the core ethical values that

should guide the board.

We will also cover the transformation of a moral person to an ethical leader by viewing

examples of leadership styles. Now let’s get started!

Ethical leadership is leadership that is directed by respect for ethical beliefs and values and

for the dignity and rights of others.

Leaders know what they value. They also recognize the importance of ethical behavior. The

best leaders exhibit both their values and their ethics in their leadership style and actions.

Ethical leaders promote ethical conduct through:

• two‐way communication

• reinforcement

• decision‐making

A transformational leader is focused on developing a long term vision for the company.

Transformational leadership is based on inspirational motivation, idealized influence,

individualized consideration and intellectual stimulation. The transformational leadership

style is characterized by a strong positive ethical behavior which has a positive effect on the

firm. The transformational lead is the soul of the firm and the leaders’ beliefs, attitudes

and values influence the ethical environment of the company.

The principles of ethical power of the transformational leader are:

Purpose – which refers to the leader establishing a long term vision through personal sacrifice and established trust with employees

Perspective used to make decisions based on prudence and justice.

Patience and understanding that there will always be roadblocks to implementing an ethical vision.

Persistence to remain strong to the commitment of ethical regardless of setbacks.

Transactional leadership is based on the assumption that the interaction between the

transformational leader and his/her subordinates is based on the mutual benefit between

the two parties. Transactional leaders focus on operational and routine activities within

the company. Due to the compliance nature of the transactional role, this type of

leadership does not support ethical commitment. Transactional leaders use rewards and

manage by exception to get things done rather than through true leadership.

This slide shows a side by side comparison of the Ethical values of both leadership styles –

transformational and transactional.

The values. Motives and assumptions of the two leadership styles are based on two

different philosophical theories: teleological and deontological.

As you can see from this side by side comparison, from a business ethics perspective the

transformational leader is preferred.

LaRue Tone Hosmer proposed that managers must understand the various needs of the

firms stakeholders. Through identification and empathy to the stakeholders needs and

believe managers can be rewarded by the establishment of trust, commitment, and effort

from the firm’s employees and all the firm’s stakeholders. The ability of managers to

effectively identify and answer the questions related to moral problems moral reasoning

and moral courage guide the decision making process. Hosmer's model with the proposed

relation of trust, commitment and effort is depicted on this slide as in your text as Figure

5.1 on page 93.

A manager must be a moral person based on his or her own values and beliefs which can

be transferred to foster an ethical culture within a firm.

A weak moral person is a weak moral manager resulting in unethical leadership. These

unethical behaviors can permeate an organization getting employees to accept unethical

practices. This was the case with Jeff Skilling of Enron, Bernie Ebbers of WorldCom and

Dennis Kozlowski at Tyco.

The ethical leader has the core ethical traits of a moral person and transfer those behaviors

within the organization.

The hypocritical leader is a dangerous person as they crush the three critical traits of a

moral person, When a hypocritical leader says one thing about ethical values and does

something unethically, employees no longer view that manager as having integrity and no

longer trust them. Martha Steward is a prime example of a hypocritical leader as she built

her media empire on the correct way to entertain and treat people. Yes she was found

guilty of conspiracy, obstruction of justice and make false statements.

Now let’s more from the notion of moral and ethical leadership, to corporate governance –

the systematic approach for controlling and direct ethical behaviors within the day to day

operations of a firm.

Corporate governance is defined as the system that is used by firms to control and direct

their operations and the operations of their representatives, the employees. This definition

identifies both the broad and narrow focus of corporate governance. It is broad in the

sense that the firm has some freedom in its ability to design a control system in order to

help guide the actions and behavior of its employees. It is narrow in the sense that

although there is flexibility in the type of control system that can be adopted, there are

rigid requirements as to what specific type of behavior is to be controlled and monitored.

The Board of Directors represent the interests of the shareholders of the company.

Managers are considered agents of the stockholders because managers are in a decision

making role to benefit the shareholders. This consideration is called the Agency Theory

and it constitutes a corporate governance mechanism to ensure that the managers do

their job in maximizing the return for the investors.

Board members can be either inside members (having direct ties with the firm) or outside

members (no direct ties to the firm)

Because board members are steward for the assets of the company and

the interests of all the stakeholders', six core ethical values are

recommended to guide there behavior as board members. Honesty

Integrity

Loyalty

Responsibility

Fairness

Citizenship

Note that these six core values are in alignment with ethical leadership

traits.

There are several types of Board Directors and the characteristic of each type is based on

the level of involvement of the board members from least involved or passive to most

involved which is an operating board of directors. These 5 classification of Board of

Director’s was developed by David A Nadler in his Harvard Business Review article in 2004

“Building Better Boards”.

To ensure an ethical operation, Outside Board members have specific

duties. They are held accountable for ensuring:

• Annual evaluation of CEO by outside members only

• Outside members meet at least once per year without CEO present

• Set qualifications for membership of Board member and communicate

to shareholders

• Responsible for recruitment and selection of new board members

Shareholders also have duties from an ethical perspective for ensuring the company ‘s

corporate governance system is operating correctly. As active owners of the firm, they are

not involved in day to day operations but evaluate on an annual basis the performance of

the Board of director’s.

There is considerable evidence that a strong board of direct does have a positive impact on the performance of a company. Having good corporate governance supports the ethical requirements established by the stakeholders and the financial requirements establish by the shareholders.

In research conducted by the authors of your text book – Stanwick and Stanwick, there was no direct relationship between CEO compensation and financial performance of the company. In fact the reverse was true in many cases – highly paid CEOs with poor performing firms.

And finally from a corporate governance perspective, there are the requirements of the

company’s stakeholders. These requirements may often be in conflict.

• Employees, suppliers and community want and honest and transparent

relationship with the firm.

• Shareholders want the maximum return or their investment

• Governments require legal and financial compliance

• NGOs require respect for global human and worker rights

To minimize the amount of conflict among stakeholders, a firm should build an evaluation

system into its corporate governance system for guidance on which stakeholder

requirements can and should be met.

Chapter Four covers a lot of ethical issues around financial reporting. Two key critical constructs we will explore are corporate governance and corporate compliance. After completing this chapter you should be able to:

1. Define corporate governance and explain how it relates to ethics.

2. Identify and explain the role of the board of directors.

3. Explain the concept of “Creative” accounting

4. Describe potential conflicts that can occur in financial reporting.

5. Identify the ethical issues related to CEO compensation and explain how they can impact the firm.

6. Explain the history and components of the Sarbanes‐Oxley Act.

7 Identify the ethical issues related to corporate compliance.

8. Discuss corporate compliance from the perspective of global corruption

Corporate governance identifies ultimate accountability in the actions of

the firm (and its management) and is a visible representation to some of

the critical decision makers in the firm who can impact the ethical

perspective of the firm. Corporate compliance continues to be a critical

factor for firms. Based on legal standards and guidelines, corporate

compliance ensures that the global actions of the firm are acceptable to

the global stakeholders of the firm.