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Chapter 10: Ethical Decision-Making: Corporate Governance, Accounting, and Finance End of Chapter Questions, Projects, and Exercises 1. You have been asked by the board of a large corporation to develop a board assessment and effectiveness mechanism, which could be a survey, interviews, an appraisal system, or other technique that will allow you to report back to the board on both individual and group effectiveness. What would you recommend? Some helpful websites for this exercise: •From the Free Management Library (www.managementhelp.org) there are several links off of the Free Complete Toolkit for Boards (http://www.managementhelp.org/boards/boards.htm#anchor683160) to assist in Board evaluation: •For a Board Self-Evaluation: http://www.managementhelp.org/boards/brd_eval.htm •For Individual Board Member Self-Evaluation: http://nonprofit.adelphi.edu/files/2012/09/Individual-Board-Member-Self-Evaluation.pdf •For Individual Board Member Evaluation: http://www.selfhelpnetwork.wichita.edu/Board%20Development%20Stage%20Eight/Individual%20Board%20Member%20Evaluation%20Form.doc To develop a comprehensive board assessment and effectiveness mechanism for the large corporation, I would recommend a multi-faceted approach that combines several techniques to provide a holistic view of individual and group effectiveness. Here is a detailed plan: 1. Board Self-Assessment Survey: Develop a structured survey that covers key areas of board performance, including strategic oversight, risk management, financial stewardship, board dynamics, and individual director contributions. The survey should include both quantitative rating scales and open-ended questions to capture qualitative feedback. 2. Individual Director Interviews: Conduct one-on-one interviews with each director to gather in-depth insights into their perceptions of board effectiveness, their role in governance, and their views on areas for improvement. These interviews can provide valuable qualitative data to complement the survey results. 3. Peer Evaluation: Implement a peer evaluation process where each director evaluates the performance of their fellow board members. This can provide valuable insights into how directors perceive each other's contributions and dynamics within the board. 4. External Facilitated Board Effectiveness Review: Engage an external consultant or facilitator to conduct a comprehensive board effectiveness review. This can include observing board meetings, conducting interviews with directors and key stakeholders, and benchmarking the board against best practices in corporate governance. 5. Performance Appraisal System: Develop a performance appraisal system for individual directors that includes clear performance metrics tied to the company's strategic objectives. This can help align individual director performance with overall board effectiveness. 6. 360-Degree Feedback: Implement a 360-degree feedback process where directors receive feedback from stakeholders such as senior management, employees, customers, and shareholders. This can provide a well-rounded perspective on the board's effectiveness. 7. Board Effectiveness Report: Compile the data from the various assessment methods into a comprehensive board effectiveness report. The report should highlight strengths, areas for improvement, and actionable recommendations for enhancing board effectiveness. 8. Feedback Session with the Board: Present the board effectiveness report to the board in a feedback session where the findings are discussed openly. Encourage constructive dialogue and feedback from board members to foster a culture of continuous improvement. 9. Follow-Up and Action Planning: Develop an action plan based on the recommendations from the board effectiveness report. Assign responsibilities for implementing the action plan and establish timelines for review and follow-up assessments. 10. Regular Monitoring and Evaluation: Implement a process for regular monitoring and evaluation of the board's effectiveness, including periodic assessments and reviews to track progress against the action plan and ensure continuous improvement. By implementing this comprehensive board assessment and effectiveness mechanism, the corporation can gain valuable insights into the performance of its board and take proactive steps to enhance corporate governance, accountability, and overall effectiveness. 2. You have been asked to join the board of a large corporation. What are some of the first questions that you should ask and what are the answers that you are seeking? Refer students to the section in this chapter dealing with the duties of boards. When joining the board of a large corporation, it's essential to ask insightful questions to understand the organization's values, operations, and ethical practices. Here are some key questions to consider: 1. Mission and Values: What is the company's mission, and how are these values reflected in its daily operations and decision-making processes? 2. Ethical Culture: How does the company promote an ethical culture, and what mechanisms are in place to prevent unethical behavior? 3. Financial Integrity: How does the company ensure financial integrity, and what measures are taken to prevent fraud and corruption? 4. Corporate Governance: How is the board structured, and what is the level of independence and diversity among board members? 5. Risk Management: What are the company's risk management practices, particularly concerning financial, legal, and reputational risks? 6. Stakeholder Engagement: How does the company engage with its stakeholders, including employees, customers, and the community? 7. Compliance and Legal: How does the company ensure compliance with relevant laws and regulations, and how does it handle ethical dilemmas? 8. Transparency and Disclosure: How transparent is the company in its operations, and how does it disclose relevant information to stakeholders? By asking these questions, you can gain a comprehensive understanding of the company's ethical practices, governance structure, and commitment to social responsibility. 3. Scholars have made strong arguments for required representation on boards by stakeholders beyond stockholders such as employees, community members, and others, depending on the industry. What might be some of the benefits and costs of such a process? Students can do research to explore the benefits and costs of requiring representation on boards from all stakeholders. At a minimum, benefits may include increased dialogue with broad stakeholder groups that will inform decisions at the board level, thus allowing the firm to better anticipate long-term implications. Moreover, by involving these stakeholders at the decision-making level, firms are more likely to address issues at a time when they can be resolved rather than when it may be too late. In addition, the board can gain similar benefits to those earned by having a more diverse board from any perspective. To the contrary, however, when the board represents too many divergent interests, it risks a failure to reach any consensus at all, and the desire to please all parties when that might not be possible at all times. Benefits: 1. Enhanced Decision Making: Including stakeholders beyond stockholders can lead to more holistic and informed decision-making, considering a broader range of perspectives and interests. 2. Improved Accountability: Stakeholder representation can enhance transparency and accountability, as board members are accountable to a wider range of stakeholders, not just stockholders. 3. Long-Term Sustainability: By considering the interests of employees, communities, and other stakeholders, boards may be more likely to make decisions that promote long-term sustainability and positive societal impact. 4. Better Risk Management: Stakeholder representation can help identify and mitigate risks that may not be apparent from a purely financial perspective, leading to more effective risk management. 5. Enhanced Reputation: Demonstrating a commitment to stakeholder representation can enhance the company's reputation, leading to increased trust and support from stakeholders. Costs: 1. Complexity and Decision-Making Delays: Including additional stakeholders can make decision-making processes more complex and time-consuming, potentially leading to delays in strategic decisions. 2. Conflict of Interest: Stakeholder representatives may face conflicts of interest between the interests of their stakeholder group and the overall interests of the company, leading to potential biases in decision-making. 3. Resource Constraints: Providing representation for multiple stakeholder groups can be resource-intensive, requiring additional time, effort, and resources from the company. 4. Reduced Focus on Shareholder Value: There is a risk that by prioritizing the interests of multiple stakeholders, boards may lose focus on maximizing shareholder value, which could impact the company's financial performance. 5. Challenges in Implementation: Implementing stakeholder representation on boards may face legal, regulatory, and practical challenges, particularly in industries where such practices are not common. Overall, while including stakeholders beyond stockholders can offer several benefits, it also presents challenges that companies need to carefully consider and manage. 4. You are an executive at a large nonprofit. Some of your board members suggest that perhaps the company should voluntarily comply with Sarbanes-Oxley. What are some of the reasons the company might consider doing so or not doing so? Compliance with Sarbanes-Oxley has both benefits and costs. Students can refer to the Internet for arguments on both sides. Some websites providing discussion on the topic are: •From BDO Seidman, “Nonprofit Alert”: http://www.bdo.com/publications/industry/nonprof/np_apr_03/article1.asp •From Boardsource.org, “The Sarbanes-Oxley Act and its Implications for Nonprofit Organizations”: http://www.boardsource.org/clientfiles/Sarbanes-Oxley.pdf •“Critics say Sarbanes-Oxley’s costs are too high,” by Deborah Solomon, Wall Street Journal, October 17, 2005: http://accounting.pro2net.com/x50243.xml Reasons to Consider Voluntarily Complying with Sarbanes-Oxley (SOX): 1. Enhanced Governance: Voluntary compliance with SOX can signal a commitment to strong corporate governance, which can enhance trust and credibility with stakeholders. 2. Improved Financial Reporting: SOX compliance requirements, such as internal controls and financial reporting standards, can improve the accuracy and reliability of financial reporting, which is crucial for nonprofits to maintain donor trust. 3. Risk Management: SOX compliance can help identify and mitigate risks related to financial reporting and internal controls, reducing the likelihood of fraud or financial mismanagement. 4. Access to Funding: Some donors, investors, and grant-making organizations may require nonprofits to comply with SOX or similar standards to access funding, making voluntary compliance advantageous. 5. Reputation and Accountability: By voluntarily complying with SOX, nonprofits can demonstrate a commitment to accountability and transparency, which can enhance their reputation and attract more donors and stakeholders. Reasons Not to Consider Voluntarily Complying with SOX: 1. Costs: Compliance with SOX can be costly, particularly for nonprofits with limited resources. This includes costs associated with implementing internal controls, conducting audits, and hiring specialized personnel. 2. Complexity: SOX compliance requirements are complex and may be challenging for nonprofits to navigate, especially smaller organizations with fewer staff and resources. 3. Mission Focus: Nonprofits may argue that their resources are better spent on fulfilling their mission rather than on compliance with regulations that are primarily aimed at for-profit entities. 4. Limited Benefits: Some nonprofits may perceive limited benefits from SOX compliance, especially if they already have strong internal controls and governance practices in place. 5. Legal and Regulatory Burden: Compliance with SOX may subject nonprofits to additional legal and regulatory burdens, which could divert resources and attention away from their core activities. Ultimately, the decision to voluntarily comply with SOX should be based on an assessment of the potential benefits and costs, as well as the organization's overall mission and strategic objectives. 5. You are on the compensation committee of your board and have been asked to propose a compensation structure to be offered to the next CEO. Explore some of the following websites on executive compensation and then propose a structure or process for determining CEO compensation at your corporation. http://www.aflcio.org/Corporate-Watch http://www.ecomponline.com/ http://www.rileyguide.com/execpay.html http://www.eri-executive-compensation.com/?TrkID=479-82 http://www.tgci.com/magazine/97fall/exec.asp Engage students in a discussion about CEO compensation after they’ve visited these sites and conducted their research. When proposing a CEO compensation structure, it's essential to consider various factors, including market benchmarks, company performance, and ethical considerations. Here's a proposed process for determining CEO compensation: 1. Market Benchmarking: Research executive compensation data from reputable sources such as Glassdoor, Payscale, and the U.S. Securities and Exchange Commission (SEC) filings to understand the prevailing compensation practices for CEOs in similar companies and industries. 2. Performance Metrics: Define key performance indicators (KPIs) that align with the company's strategic goals and mission. These metrics could include financial performance, stock performance, employee satisfaction, and corporate social responsibility (CSR) initiatives. 3. Base Salary: Determine a competitive base salary that reflects the CEO's experience, qualifications, and responsibilities, taking into account market trends and internal equity. 4. Short-Term Incentives: Design a short-term incentive plan based on annual performance goals. This could include bonuses tied to financial targets, such as revenue growth, profitability, and cost management. 5. Long-Term Incentives: Develop a long-term incentive plan that aligns the CEO's interests with long-term shareholder value. This could include stock options, restricted stock units (RSUs), or performance shares tied to multi-year performance goals. 6. Benefits and Perquisites: Define the benefits and perquisites (perks) that the CEO will receive, such as health insurance, retirement plans, and executive perks like use of a company car or club memberships. 7. Ethical Considerations: Ensure that the proposed compensation structure is fair, transparent, and aligned with the company's values and culture. Consider the impact of the proposed compensation on employee morale and public perception. 8. Board Approval: Present the proposed compensation structure to the compensation committee and the full board for review and approval. Ensure that the process is well-documented and complies with legal and regulatory requirements. By following this process, the company can develop a CEO compensation structure that is competitive, performance-driven, and aligned with ethical principles. 6. What are the strongest, most persuasive arguments in favor of a board’s consideration of its social responsibility when reaching decisions? Refer students to the discussion in chapter 5 on the enlightened self-interest model. The strongest and most persuasive arguments in favor of a board's consideration of its social responsibility when reaching decisions are rooted in the long-term sustainability and reputation of the organization. Here are key points:1. Enhanced Reputation: Demonstrating social responsibility can enhance the organization's reputation, leading to increased trust and support from stakeholders, including customers, investors, and the community. 2. Risk Management: Addressing social issues proactively can help mitigate risks to the organization's reputation and operations, reducing the likelihood of costly legal, regulatory, or public relations challenges. 3. Competitive Advantage: Embracing social responsibility can differentiate the organization from competitors, attract customers who value ethical practices, and enhance employee morale and productivity. 4. Long-Term Sustainability: Considering social responsibility fosters a focus on long-term sustainability, ensuring the organization's continued success and relevance in a changing world. 5. Stakeholder Engagement: Taking social responsibility into account demonstrates a commitment to stakeholder engagement and can lead to valuable insights and partnerships that benefit the organization. 6. Legal and Regulatory Compliance: Addressing social issues can help the organization stay ahead of changing legal and regulatory requirements, reducing the risk of non-compliance and associated penalties. 7. Ethical Imperative: Acting in a socially responsible manner aligns with ethical principles and values, fulfilling the organization's moral obligation to contribute positively to society. 8. Investor Confidence: Socially responsible practices can attract socially responsible investors who prioritize environmental, social, and governance (ESG) factors in their investment decisions, potentially lowering the organization's cost of capital. In summary, considering social responsibility in decision-making is not only the right thing to do ethically but also makes good business sense by enhancing reputation, managing risks, and fostering long-term sustainability. 7. A press release has a significant negative impact on your firm’s stock price, reducing its value by more than 50 percent in a single day of trading! You gather from conversations in the hallway that the company’s fundamentals remain strong, aside from this one-time event. You see this as a great opportunity to buy stock. Is it appropriate to act on this and to purchase company stock? Does it make a difference whether you buy 100 shares or 1,000 shares? Is it OK to discuss the “dilemma” with family members and friends? What should you do if you do mention it to family and friends but then later feel uncomfortable about it? Refer to the definition of insider trading in this chapter. When faced with the scenario described, it's important to consider several ethical and legal implications before deciding whether to act on the opportunity to purchase company stock. Appropriateness of Acting: 1. Material Nonpublic Information: If the negative impact on the stock price is due to material nonpublic information, it would be inappropriate to act on this information as it could be considered insider trading. 2. Legal and Ethical Obligations: As a professional, you have legal and ethical obligations to act in the best interests of the company and its shareholders. Trading on nonpublic information could violate these obligations. 3. Company's Fundamentals: While the company's fundamentals may remain strong, trading based on nonpublic information about a one-time event could still be considered unethical and potentially illegal. Consideration of Actions: 1. Purchase Quantity: The appropriateness of purchasing 100 shares versus 1,000 shares would depend on the intent behind the purchase. If the intent is to take advantage of a temporary stock price dip due to nonpublic information, the quantity of shares purchased may not change the ethical or legal implications. 2. Disclosure to Family and Friends: Discussing the dilemma with family and friends could be risky, as it may inadvertently lead to the spread of nonpublic information. It is generally advisable to refrain from discussing such matters with individuals who could benefit financially from the information. Course of Action: 1. Avoid Insider Trading: To avoid the risk of insider trading, refrain from purchasing company stock based on nonpublic information. Wait until the information is publicly disclosed and has been fully digested by the market. 2. Seek Guidance: Consult with legal and compliance advisors within your organization to ensure that your actions are in compliance with relevant laws and regulations. 3. Rectify Mistakes: If you have already disclosed the information to family and friends and feel uncomfortable about it later, consider informing them of the ethical and legal implications and refraining from further discussion of the matter. In summary, it is crucial to act in accordance with legal and ethical standards when considering the purchase of company stock based on nonpublic information. Seeking guidance and refraining from trading on such information is the prudent course of action. 8. Modify slightly the facts of the previous question. Assume that you are also privy to the annual forecast of earnings, which assures you that the fundamentals remain strong. Stock analysts and investors are also provided this same information. Do your answers change at all? Refer to the definition of insider trading in this chapter. If you are privy to the annual forecast of earnings, which assures you that the company's fundamentals remain strong, and this information is also provided to stock analysts and investors, the ethical considerations regarding purchasing company stock may change. Here's how: Material Nonpublic Information: 1. Public Availability: If the information regarding the annual forecast of earnings is available to stock analysts and investors, it may be considered public information rather than material nonpublic information. 2. Market Reaction: Given that the information is public, the market may have already reacted to it, potentially mitigating the risk of insider trading. Ethical Considerations: 1. Legal and Ethical Obligations: While the information is public, it is important to still consider your legal and ethical obligations as a professional. Acting on the information solely for personal gain, without considering the impact on other shareholders, could raise ethical concerns. 2. Transparency and Fairness: Acting on public information in a transparent and fair manner, along with other investors, is generally considered ethical. Course of Action: 1. Purchase Decision: If you decide to purchase company stock based on the public information, consider the quantity of shares purchased and ensure that your actions are in line with your ethical principles and the company's code of conduct. 2. Continued Monitoring: Continuously monitor the situation and be prepared to adjust your actions if new information becomes available that could impact your decision. In summary, while the public availability of the annual forecast of earnings may change the ethical considerations regarding purchasing company stock, it is still important to act in a manner that is consistent with legal and ethical standards, and to consider the potential impact on other shareholders and the company's reputation. 9. In connection with the two previous questions, assume instead that you think something significant is about to be made public because all officers have consistently stayed late, a special board meeting has been called, you and your boss have been advised to be on call throughout the weekend, and various rumors have been floating throughout the company. You are not aware of the specifics, but you can reasonably conclude that it’s potentially good or bad news. You decide to call a friend in the accounting department who has been staying late to find out what she knows. In this situation, do your answers about what you might do change? Is it appropriate to partake in the “rumor mill”? Is it appropriate to discuss and confide your observations with family and friends? Is it appropriate to buy or sell company stock based upon these observations (you may rationalize that it is only speculation and you do not know the facts)? Refer to the definition and discussion of insider trading in this chapter. In the scenario described, where there are indications that something significant is about to be made public, but the specifics are not known, ethical considerations regarding actions related to company stock become more complex. Here's how: Participation in Speculation: 1. Rumor Mill: Engaging in the rumor mill by spreading or seeking unverified information can contribute to a culture of misinformation and speculation, which may be harmful to the company and its stakeholders. 2. Confidentiality and Trust: Calling a friend in the accounting department to inquire about the situation may breach confidentiality and erode trust within the organization. Discussion with Family and Friends: 1. Appropriateness: Discussing and confiding observations with family and friends may be inappropriate, as it may involve sharing potentially material nonpublic information that could be used for personal gain. Stock Transactions: 1. Trading Based on Speculation: Buying or selling company stock based solely on speculation and unverified information is generally considered unethical and could be illegal, especially if the information is material nonpublic information. Appropriate Course of Action: 1. Ethical Standards: Adhere to ethical standards by avoiding spreading rumors, seeking confidential information, or trading based on speculation. 2. Professionalism: Maintain professionalism by refraining from discussing potentially sensitive information with individuals outside the company. 3. Ethical Considerations: Consider the potential impact of your actions on the company, its stakeholders, and your own reputation, and act in a manner consistent with ethical principles and legal requirements. In summary, it is important to exercise caution and avoid engaging in speculative behavior, spreading rumors, or trading based on unverified information. Upholding ethical standards and maintaining confidentiality are paramount in such situations. 10. Have you ever been in, or are you familiar with, a conflict of interest situation? How was it resolved? Can you think of any rules or any practices that could have prevented the situation from occurring? Can you think of any initiatives, structures or procedures that could make it easy to avoid such conflicts in the future? Ask students who have experience working for or with publicly traded companies to share situations they’ve been exposed to that could have resulted in a conflict of interest. How did they handle the situation? What could have been done differently to alleviate the conflict in a more ethical way? How do today’s ethical standards differ from standards from previous decades? I haven't been in a conflict of interest situation myself, but I can provide a general response based on best practices and ethical principles. Resolution of Conflict of Interest: 1. Disclosure: The first step in resolving a conflict of interest is to disclose it to the relevant parties, such as supervisors, boards, or ethics committees. 2. Recusal: In many cases, individuals may need to recuse themselves from decision-making processes where a conflict exists. 3. Transparency: Maintaining transparency about the conflict and the steps taken to address it can help build trust and mitigate concerns. Prevention of Conflict of Interest: 1. Code of Conduct: Establishing a clear code of conduct that outlines expectations regarding conflicts of interest and provides guidance on how to handle them. 2. Training and Education: Providing training and education to employees on recognizing and addressing conflicts of interest. 3. Conflict of Interest Policy: Implementing a conflict of interest policy that requires disclosure and outlines procedures for addressing conflicts. 4. Independent Review: Having an independent review process for potential conflicts of interest can help ensure impartiality and fairness in decision-making. Initiatives for Future Conflict Avoidance: 1. Regular Review: Conducting regular reviews of potential conflicts of interest and taking proactive measures to address them. 2. Ethics Committees: Establishing ethics committees or boards to oversee and advise on ethical issues, including conflicts of interest. 3. Whistleblower Protection: Implementing whistleblower protection policies to encourage employees to report conflicts of interest without fear of retaliation. In conclusion, preventing conflicts of interest requires a combination of transparency, education, policy implementation, and independent oversight. By addressing conflicts of interest proactively and transparently, organizations can maintain integrity and trust among stakeholders. Chapter 10 Readings Main Points and Summaries Reading 10-1 “The Cultural Dependence of Corporate Governance,” by Bob Tricker Main Points •This article is from comments presented September 2011 at an international corporate governance conference hosted jointly by the Corporate Securities International Association (CSIA) and the Shanghai Stock Exchange. •A decade ago, it was widely thought that corporate governance practices around the world would gradually converge on the United States model. But, that was before the collapse of Enron, Arthur Andersen, the sub-prime financial catastrophe, and the ongoing global economic crisis. •Forces that are leading corporate governance practices around the world to converge include: o Corporate governance codes of good practice o Securities regulations for the world’s listed companies o International accounting standards o Global concentration of audit for major companies in just four firms o Globalization of companies o Raising capital on overseas stock exchanges o International institutional investors making explicit demands for corporate governance practices o Private equity funding changing the investment scene o Cross-border mergers of stock markets o Research publications o International conferences o Professional journals •Forces for differentiation include: o Legal differences in company law, contract law, and bankruptcy law o Standards in legal processes o Stock market differences o Ownership structures o History, culture and ethnic groupings producing different board structures and governance practices •The concept of the company was Western, rooted in the notion of shareholder democracy, the steward ship of directors and trust. But, today’s corporate structures have outgrown that simple notion. •The Western world has created the most expensive and litigious corporate regulatory regime the world has yet seen. This is not the only approach, and it is certainly not the best. •There is a need to rethink the underlying idea of the corporation and build on a pluralistic, rather than ethnocentric, foundation if it is to be applicable to the corporate groups and strategic alliance networks that are now emerging as the basis of the business world of the future. •A truly global model of corporate governance would need to recognize alternative concepts fro around the world. •The forces for convergence in corporate governance are strong at a high level, but a global convergences of corporate governance systems at any greater depth would need a convergence of cultures – this seems a long way away. Reading 10-2 “The Libor Scandal and Capitalism’s Moral Decay,” by David Rhode Main Points •In this article, David Rhode shares his thoughts on the Libor scandal and explains his opinion on the moral decay of capitalism. •The Libor scandal engulfing the financial industry is yet another sign that our business leaders no longer respect the rule of law and is an extraordinary example of the 1 percent stealing from the 99 percent, as well as our crumbling ethics. •He asserts that the Libor scandal is drawing little public attention and that in this situation, the middle class is being victimized and there is little protest. •Barclays agreed to pay $453 million to American and British authorities to settle allegations that it manipulated key interest rates for profit between 2005 and 2009, specifically the Libor. American and British investigators are now examining whether traders at a dozen other banks, including U.S. banks JPMorgan, Citibank and Bank of America, also manipulated rates. •The Libor is used to value some $360 trillion in loans and financial contracts worldwide. So, Barclays’ victims were not just other banks and traders – they include taxpayers paying mortgages, teachers and other public servants. •Banks are denying any wrong-doing and the true scope of the losses, and the role of American banks, won’t be known until the complex legal battles are fought. •Rhode explains that he admires business owners who innovate, create jobs and strengthen communities, but he still says that theft is theft, no matter who the perpetrator is or how they’re dressed. •But, he explains, the ethical decay stretches far beyond Wall Street. Ti spans industries, political parties and groups. In April 2012, systematic bribery by executives of Walmart was reported across Mexico, and in June 2012, American sports officials accused cyclist Lance Armstrong of engaging in a massive doping conspiracy (which he later admitted). •Around the world, a globalized economy is creating large profits and with that, relentless pressure. In a May survey by Ernst & Young, 500 chief financial officers around the world were questioned. The survey showed that a growing number of them were willing to pay bribes and falsify their firm’s financial performance to survive the financial downturn. •Ernst & Young’s follow-up on the survey said, “One of the most troubling findings of the survey is the widespread acceptance of unethical business practices.” •Corporate boards and overseers, meanwhile, appear to be looking the other way. 81% of survey respondents said that their companies had anti-bribery and anti-corruption codes of conduct in place, but nearly half of those said that they did not believe employees had ever been punished for violating those policies. •Rhode asserts that a liberal, capitalist democracy – and a middle class – can only thrive in a culture where the rule of law is respected, information is reliable and the playing field is as level as possible. Reading 10-3 “Libor and Capitalist Moral ‘Decay’,” by Chris MacDonald Main Points •Is the collapse of capitalism upon us? Are we facing a moral Armageddon in the marketplace? Is every scandal-driven headline another sign of impending apocalypse in the world of business? •MacDonald asserts that the evidence for a real moral crisis in business is pretty scarce, stating that “headlines don’t count as evidence.” •Business today is, in many ways, more accountable and better behaved than ever before in history, at least when you focus on the behavior of capitalism as a whole. •Critics, though, tend to focus on the personal ethics of various business people, rather than on the capitalist system as a whole. •It is crucially important to recognize a difference between our ethical evaluation of capitalists, on one hand (such as the bank employees accused of manipulating Libor) and our ethical evaluation of capitalism itself, on the other. •One of the major virtues of the capitalist system is that it is supposed to be able to produce good outcomes even if participants aren’t always squeaky clean. •It is worth noting that Adam Smith himself took a pretty dim view of businessmen. And yet, despite his dim view of capitalists, Smith remained a great fan of capitalism, or what he called “a system of natural liberty.” •Instead of focusing on the moral failings of individuals, we should focus on the institutional failings, like relying on what was obviously a badly flawed Libor system. •“Libor,” (short for the London Inter-Bank Offered Rate) is the most important singe number in the world of finance. However, this number is established by the banking industry itself, with no external verification of the numbers submitted by various banks. •Because Libor affects actual interest rates for so many financial instruments, banks can sometimes enhance profits, or reduce losses, by fudging their own numbers, in ways calculated to affect the final Libor calculation. •In other words, Libor is a system that relies on people being honest, in situations where they’re basic motivations point in another direction altogether. •A saner system would base the Libor on something more concrete and less open to self-serving manipulation. •Governments need to take corporate motives as they are and devise regulations that encourage appropriate behavior. And executives need to take the motives of their employees as they are and devise corporate structures (hierarchies, teams, incentive plans) that motivate those employees in constructive ways. •We need to keep working to find the right balance of regulatory carrots and sticks to encourage good corporate behavior. •And we need to figure out the right corporate governance policies and structures to foster good behavior within corporations as well. •We also need to think about the appropriate mechanisms to mitigate and remediate the effects of bad behavior. Reading 10-4 “How much compensation can CEOs permissibly accept?” by Jeffrey Moriarty Main Points •In 2006, the median total compensation of the top 150 U.S. CEOs was $10.1 million. This is 314 times the $32,142 earned by the median full-time private industry worker in the U.S. that year. •Like others who write on executive compensation, I am primarily interested in chief executive officer compensation. By ‘executive’, then, I mean principally ‘CEO’. However, most of what I say applies, with minor modifications, to the pay of other top executives. •I begin with the common assumption that executives are fiduciaries. •I further assume that CEOs are fiduciaries in a moral, not merely legal, sense. •Let us assume that shareholder value is maximized when firm value, which Jensen defines as “the market values of the equity, debt, and any other contingent claims outstanding on the firm” is maximized. If so, then executives should manage the firm so as to maximize its value. •Compensation produces value for the firm by attracting and retaining talented employees, and motivating them to do their best. But compensation is a cost. Other things equal – where “other things” includes the firm’s performance – the lower this cost is, the better. •I have argued for a new moral limit on CEO compensation: CEOs should not accept excessive compensation from their firms. In this section, I defend it against objections: •Objection 1. This moral limit is moot: a CEO will never accept excessive compensation, because it will never be offered to her. Response. This objection assumes that directors are highly powerful and knowledgeable with respect to the CEO. •Objection 2. When a CEO negotiates her compensation, she is not yet a member of the firm. Response. This objection does not apply to CEOs who are negotiating subsequent compensation packages with their firms. •Objection 3. CEOs are not required always to act so as to maximally benefit shareholders. Response. The claim that CEOs are required to maximize shareholder return only insofar as they are acting as managers is correct. •Objection 4. A party to whom a duty is owed can waive its performance, wholly or in part. Response. To be clear, the issue is not whether the CEO and directors (merely) recognize the application of the CEO’s fiduciary duty to the pay setting process. •Objection 5. According to commonsense morality, while people are sometimes required to benefit others at their own expense, they are not required to make enormous sacrifices for them. Response. This is simply implausible. Recall that excessive compensation is compensation in excess of the CEO’s MEC, which is in turn of a function of his next best option. •Objection 6. The prohibition against accepting more than one’s MEC discriminates against steward CEOs, i.e., CEOs who are intrinsically motivated by shareholders’ interests. Response. This objection misunderstands the definition of MEC. I said that a CEO accepts more than his MEC when he accepts more pay than is necessary to attract, retain, and motivate him to maximize firm value, assuming he is acting on self-interested motives only. •We see now why it makes sense to start, as we did, with the assumption that CEOs are agents. This minimizes the burden imposed on the CEO by the prohibition against accepting excessive pay. •Finally, it may be good not only for individual firms but for society as a whole if CEOs negotiate in their self-interest, at least to an extent. But society as a whole benefits when talented people occupy these important and demanding positions. •In sum, while the CEO’s fiduciary duty exerts downward pressure on her compensation by encouraging selfless negotiation over compensation, it is unlikely to tell in favor of her receiving very little pay. Solution Manual for Business Ethics: Decision Making for Personal Integrity and Social Responsibility Laura P. Hartman, Joseph R. Desjardins, Chris MacDonald 9780078029455, 9781259060588, 9781259417856
