CH-4 Practical Ethical Decision Making – Business and Professional Ethics for Directors, Executives and Accountants : Book Guide

Chapter 4 – Practical Ethical Decision Making Chapter Questions and Case Solutions Chapter Questions 1. Why should directors, executives, and accountants understand consequentialism, deontology, and virtue ethics? Directors, executives and accountants frequently encounter problems requiring decisions where the right action is not covered in law or a company’s code, or where the code is being created or re-examined. In those instances, the traditional philosophical approaches to ethical decision making can raise issues for consideration and provide guidance for ethical decisions. Understanding why the consequences of an act are importance, and how to assess them with regard to expectations of duty, observance of rights and fairness, and of virtues to be demonstrated, can provide important insights. In the future, decisions will be increasingly scrutinized for their ethicality as well as their legality and profitability, and must be, and be seen to be defensible according to traditional considerations. 2. Before the recent financial scandals and governance reforms, few corporate leaders were selected for their “virtues” other than their ability to make profits. Has this changed, and if so, why? Yes. With the recent revision and stiffening of governance requirements, directors are now expected to select and monitor senior executives (CEO and CFO at least) based in part on their ethicality as evidenced by their contribution of a wholesome “tone at the top”. Without proactive ethical leadership, a company’s ethics program (see Figures 5.7, 5.8 and 5.9) will not succeed. 3. Is it wise for a decision maker to take into account more than profit when making decisions that have a significant social impact? Why? Yes. An organization needs the support of its primary stakeholders to attain its strategic objectives in the long run. It cannot afford to ignore the interests of these stakeholders and those that they are influenced by. Profit is usually a short-term concept that needs to be stretched into a multi-period framework by considering more than just the next buck. 4. If a framework for ethical decision making is to be employed, why is it essential to incorporate all four considerations of well-offness, fairness, individual rights and duties, and virtues expected? It is possible for a set of stakeholders to be better off as a whole, but the proposed action may be grossly unfair to one group (say, the children involved) or may offend the rights of one or more groups (say, women or men) to a degree that may cause the decision to be considered unethical. Moreover, failure to consider expected duties and virtues will damage the corporation’s credibility and reputation, thereby weakening the support of various stakeholder groups and the organization’s ability to reach its strategic objectives. 5. Is the modified 5-question approach to ethical decision making superior to the modified moral standards or modified Pastin approach? Not really. The superior approach for a specific problem depends on the nature of the impacts involved. If future impacts of a subjective nature are involved, then cost-benefit analysis should be employed. If the ground rules of a company are expected to influence the implementation of a decision, then they should be canvassed. If a commons is at stake, then employing that concept may help the executives involved to analyze the proposed actions ethically. A particular executive’s preference or style may also have to be taken into account. The circumstances will dictate the approach which is most attractive/suitable. 6. Under what circumstances would it be best to use each of the following frameworks: the philosophical set of consequentialism, deontology, and virtue ethics; the modified 5question; the modified moral standards; and the modified Pastin approach? The traditional philosophical approaches - consequentialism, deontology, and virtue ethics – are time-honored approaches that have been refined into the modified 5-question; the modified Moral Standards; and the modified Pastin approaches for convenient decision making in those instances noted below. The philosophical approaches, taken as a set, can be applied to any problem rather than a specific sub-set, and they would be superior where there are strong expectations for the demonstration of duty and of virtues in the solution. Given what has been said in response to the last question, the modified 5-question approach seems best suited to short-term, profit-oriented problems that confront the law and impact the environment or require a tailored specific 5th question. The modified moral standards approach is suited to people-related or futureoriented problems where externalities are present that are not captured in the profit measure. Modified Pastin's approach suits problems internal to an organization. Each approach/or part thereof can be used on almost all problems. 7. How would you convince a CEO not to treat the environment as a cost-free commons? Depending on the person involved, they may be responsive to: altruism, the avoidance of big fines (corporate & personal) or jail; or to arguments that underpricing the use of the environment can lead to resource allocations which will look foolish in a few years because the cost structures will change, or that opportunities for opening up new markets or competitive advantages will be lost, or that whistle-blowing or activist groups will make things uncomfortable, etc. I would show the CEO what a cost-benefit or risk benefit analysis would look like that would bring such factors into the decision computation. The decision would be up to the CEO, but at least all the factors would be on the table, not hidden or forgotten. 8. How can a decision to downsize be made as ethically as possible by treating everyone equally? No. Equal treatment (laying off by seniority or age or?) may not be fair to those who can least withstand it. I would advise building in an appeals mechanism to any downsizing process to allow for such things as serious impacts on autistic children, or the disabled, who would be displaced, etc. Each case would have to be subject to the agreement of the unions involved, but I believe this approach would be received well if broached in advance. Recent studies have developed a concept of ethical renewal that involves a mechanism for fairly encouraging and evaluating opportunities to make the organization better. Part of the process involves developing trust among employees that they will be treated fairly and will not suffer in the process of continuous improvement. 9. From a virtue ethics perspective, why would it be logical to put in place a manufacturing process beyond legal requirements? Definitely. A manufacturing process that protected the environment or the workers involved would engender the support of key stakeholder groups such as environmentalists and workers, leading to cooperative government and media relations and the higher commitment of current employees to do their best, and future employees to join. Reputational factors are definitely sensitive to the demonstration of expected virtues. 10. List the companies that have faced ethical tragedies due the following failings in their ethical culture: a. Lack of ethical leadership: Livent, Enron, WorldCom, Tyco, Adelphia, Siemens, Parmalat, Goldman Sachs, Hollinger/Ravelston b. Lack of clarity about important values: Arthur Andersen, KPMG, E & Y (aggressive tax shelters), Ford, Firestone c. Lack of ethical awareness and expectations by employees: Dow Corning, MCI d. Lack of monitoring of ethicality of actions: Barings Bank, Société Générale e. Unethical reward systems: Sears (auto centers), Banker’s Trust, Royal Ahold, many brokers f. Unreasonable pressures for unrealistic performance: MCI, HealthSouth 11. Give an example of behavior that might be unethical even though ‘‘everyone is doing it’’. • Mechanics telling customers they need new tires before they really do. • Cell phone companies selling warrantee programs on the basis that they provide for every eventuality, but require sending your phone away for repairs for 3-4 weeks each time, multiple times before they will give you a new phone. • Selling products through unwarranted flattery • Blaming others for your own shortcomings Case Solutions 1. BP’s Gulf Oil Spill Costs What this case has to offer This case discusses the potential consequences of BP’s oil spill in the Gulf of Mexico. The costs derived from the spill could reach $80 billion, according to a Reuters’ estimate, or they could be around $40 billion, according to a BP’s estimate. This is a good case to discuss whether it is possible to estimate all the costs in a situation involving an ethical decision, including loss of life, health, environment, economic livelihood and reputation. Moreover, it may encourage the discussion about the ways to deal with uncertainty in determining expected total costs. This case is related to the following two other cases in the book: • BP’s Corporate Culture (Chapter 5), discussing the systemic problems with the company’s values; and, • BP’s Gulf Oil Spill Risk Management (Chapter 7), discussing the failures in the company’s operating controls and risk management process. Teaching suggestions I start discussing this case by asking students to put together a list of all potential costs that BP could face after the oil spill. Then I ask students to rank each item in the list by degree of uncertainty involved in determining the total cost (i.e. high, medium or low). Next, I ask them to try to determine the actual dollar amount for each item. Finally, with or without using a discount rate, I compare the class’ estimate versus Reuters’ or BP’s estimate of total costs. It might be also useful to ask students how BP could convey to investors and other stakeholders the uncertainty of the loss estimates from the oil spill. Discussion of ethical issues 1. What are the costs to other stakeholders in society beyond those that Reuters included? How would these costs be estimated? The case describes the Reuter’s estimates. BP’s 2011 Annual Report describes the company’s calculation of the financial consequences of the oil spill (p. 38) “Consequences of the accident for BP and its shareholders: Financial consequences The group income statement for 2010 includes a pre-tax charge of $40.9 billion in relation to the Gulf of Mexico oil spill. This comprises costs incurred up to 31 December 2010, estimated obligations for future costs that can be estimated reliably at this time, and rights and obligations relating to the trust fund, described below. Costs incurred during the year mainly related to oil spill response activities, which included the drilling of relief wells and other subsea interventions, surface response activities including numerous vessels, and shoreline response involving deployment of boom and beach cleaning activities. Under US law, BP is required to compensate individuals, businesses, government entities and others who have been impacted by the oil spill. Individual and business claims are administered by the GCCF, which is separate from BP. BP has established a trust fund of $20 billion to be funded over the period to the fourth quarter of 2013, which is available to satisfy legitimate individual and business claims administered by the GCCF, state and local government claims resolved by BP, final judgments and settlements, state and local response costs, and natural resource damages and related costs arising as a consequence of the Gulf of Mexico oil spill. In 2010, BP contributed $5 billion to the fund, and further quarterly contributions of $1.25 billion are to be made during the period 2011 to 2013. The income statement charge for 2010 includes $20 billion in relation to the trust fund, adjusted to take account of the time value of money. The establishment of the trust fund does not represent a cap or floor on BP’s liabilities and BP does not admit to a liability of this amount. BP has provided for all liabilities that can be estimated reliably at this time, including fines and penalties under the Clean Water Act (CWA). The total amounts that will ultimately be paid by BP in relation to all obligations relating to the incident are subject to significant uncertainty. BP considers that it is not possible to estimate reliably any obligation in relation to natural resource damages claims under the OPA 90, litigation and fines and penalties except for those in relation to the CWA. These items are therefore contingent liabilities. BP holds a 65% interest in the Macondo well, with the remaining 35% held by two joint venture partners. While BP believes and will assert that it has a contractual right to recover the partners’ shares of the costs incurred, no recovery amounts have been recognized in the financial statements.” Other costs, not included in the Reuter’s estimates may be: • Reduction in sales due to the loss of reputation across all the company’s brands; • Managerial time and attention consumed dealing with regulators; • Loss of investor confidence and difficulty raising funds or increased cost of funds raised for future projects; and, • Increase probability of litigation against the company in the future. 2. Has the cost of lost reputation been included by Reuters? If not, how could it be estimated? The cost of lost reputation has been partially included by Reuters, as “Added regulatory scrutiny – 10% of operating costs” and “Ban from future drilling site auctions – lost new oil”. The U.S. Congress was discussing a seven year ban from Gulf drilling for BP, resulting mainly from the company’s loss of reputation. Nevertheless, it is difficult to estimate the overall impact of the loss of reputation accurately. 3. Since there are so many uncertainties involved in analyses such as Reuters presented, are analyses like this useful? Why or why not? There is a high degree of uncertainty in the Reuters’ estimates; however, as soon as the reader is aware of that, the analysis provided by Reuters is useful because it portrays a relatively realistic picture about the costs of this problem. The Reuters’ analysis is beyond the company’s estimates, and is limited by GAAP definitions about contingent liabilities. On the other side, the Reuters’ analysis could be improved by categorizing costs by different degrees of uncertainty. For example, the $20 billion put by BP in a trust fund for damages are very certain, the present value of the production losses from the Macondo are less certain, and the additional cost of regulatory scrutiny (calculated as 10% of operating costs) are very uncertain. BP’s 2011 Annual Report describes the potential effects of loss of reputation (p. 27): “Moreover, the Gulf of Mexico oil spill has damaged BP’s reputation, which may have a long-term impact on the group’s ability to access new opportunities, both in the US and elsewhere. Adverse public, political and industry sentiment towards BP, and towards oil and gas drilling activities generally, could damage or impair our existing commercial relationships with counterparties, partners and host governments and could impair our access to new investment opportunities, exploration properties, operatorships or other essential commercial arrangements with potential partners and host governments, particularly in the US. In addition, responding to the Incident has placed, and will continue to place, a significant burden on our cash flow over the next several years, which could also impede our ability to invest in new opportunities and deliver long-term growth.” 4. Calculate the discounted value of BP’s estimated lost production for an appropriate time horizon using reasonable assumptions for discount rate and price of a barrel of oil. Justify your assumptions. In order to determine the present value of lost production, it is necessary to determine the following four items: 1. Expected total annual production of the well in number of barrels: According to the “Final Report on the Investigation of the Macondo Well Blowout” prepared by The Deepwater Horizon Study Group (DHSG) in 2011 the size of the well’s reserve was between 50 and 100 million barrels (p. 20): “Initial drilling of the Macondo well began on October 6, 2009, and was spudded in a water depth of approximately 5,000 ft. BP originally estimated that the Macondo field contained approximately 50—100 million barrels of oil. However, BP later stated that the size of the field was undetermined because engineers had not completed the relevant tests before the explosion on April 20, 2010.” From the total reserves, BP was entitled to 65% of the production (p. 103): “The Macondo well was a joint venture including BP (65%), Anandarko (25%), and MOEX Offshore 2007 (10%). As the major shareholder, BP was the operator, in charge of overseeing operations of the well.” There are different ways to incorporate uncertainty. One way is to set a minimum and maximum loss. Using the minimum estimated loss, the well contained approximately 50 million barrels, from which BP was entitled to 65% of the reserves, equivalent to 32.5 million barrels over the lifetime of the well (50 million barrels times 0.65). 2. Number of years that the well was expected to be producing It is difficult to estimate the number of years the well will be producing. Assume that the well will be in operation for 20 years and will produce an equal amount every year. This is equivalent to 1.625 million barrels per year (32.5 million barrels/20 years). 3. Future oil prices An estimate of future oil prices is provided in BP’s 2011 Annual Report. These estimates are used for valuing BP’s business subsidiaries for purposes of goodwill impairment tests (Note 11, page 173): “For 2010, the Brent oil price assumption was an average $85 per barrel in 2011, $88 per barrel in 2012, $89 per barrel in 2013, $89 per barrel in 2014, $90 per barrel in 2015 and $75 per barrel in 2016 and beyond.” 4. Discount rate There are several ways to determine a relevant discount rate. The first alternative is to use the discount rate that BP itself uses for valuing its business subsidiaries for purposes of goodwill impairment tests, based on the company’s weighted average cost of capital (Note 11, page 173): “The future cash flows are adjusted for risks specific to the cash-generating unit and are discounted using a pre-tax discount rate. The discount rate is derived from the group’s post-tax weighted average cost of capital and is adjusted where applicable to take into account any specific risks relating to the country where the cash-generating unit is located. The rate to be applied to each country is reassessed each year. Discount rates of 12% and 14% have been used for goodwill impairment calculations performed in 2010.” A second alternative is to use the 10% discount rate used in preparing the estimates disclosed in the “Supplementary information on oil and gas” disclosures on the BP’s 2011 Annual Report (p. 244-248). This is the same rate that Reuters used to prepare their estimates. A third alternative, applicable to firms with less detailed disclosures, is to estimate the company’s weighted average cost of capital using an estimate of the company’s cost of debt and equity. The cost of loss production is the present value of the future cash flow streams from annual production for the next 20 years: Year Barrels Price Cash Flow PV PV PV (in mill.) per Barrel (in mill.) (Rate 10%) (Rate 12%) (Rate 14%) 1 1.625 85.00 138.13 125.57 123.33 121.16 2 1.625 88.00 143.00 118.18 114.00 110.03 3 1.625 89.00 144.63 108.66 102.94 97.62 4 1.625 89.00 144.63 98.78 91.91 85.63 5 1.625 90.00 146.25 90.81 82.99 75.96 6 1.625 75.00 121.88 68.80 61.75 55.52 7 1.625 75.00 121.88 62.54 55.13 48.71 8 1.625 75.00 121.88 56.86 49.22 42.72 9 1.625 75.00 121.88 51.69 43.95 37.48 10 1.625 75.00 121.88 46.99 39.24 32.88 11 1.625 75.00 121.88 42.72 35.04 28.84 12 1.625 75.00 121.88 38.83 31.28 25.30 13 1.625 75.00 121.88 35.30 27.93 22.19 14 1.625 75.00 121.88 32.09 24.94 19.46 15 1625 75.00 121.88 29.18 22.27 17.07 16 1.625 75.00 121.88 26.52 19.88 14.98 17 1.625 75.00 121.88 24.11 17.75 13.14 18 1.625 75.00 121.88 21.92 15.85 11.52 19 1.625 75.00 121.88 19.93 14.15 10.11 20 1.625 32.500 75.00 121.88 SUM 18.12 12.63 8.87 1,117.59 986.17 879.19 Present values of future cash flows in the last three columns are calculated using the equation: PV = CASH FLOWSt / (1 + DISCOUNT RATE)n In the above equation, n is the number of years in the future after which the cash flows will be received, and t is the cash flows in each year. Based on the above estimates, the total present value of loss in production is between $879 million and $1.12 billion. Even without discounting to the present, 32.5 million barrels at the current price of $85 per barrels amounts to $2.76 billion. Interestingly, the potential revenue from the Macondo well is very small compared with the total costs of BP’s oil spill. A way to convey uncertainty in these estimates is by computing the total costs varying different assumptions, such as total reserves, discount rate or number of years in production. Also, probabilities could be given to different alternatives to arrive to a single estimate. 5. Why were BP’s early estimates so low? After all, as Reuters reports – BP had experience with two other recent cases? BP’s cost estimates are limited by the GAAP definitions of contingent liabilities. The $40 billion estimate provided by the company only includes those contingent liabilities that are probable and measurable. For example, BP considers that the cost of regulatory fines is too difficult to measure to include in that estimate. Moreover, the following items are not contingent liabilities under GAAP: • Added regulatory scrutiny – 10% of operating costs • Lost production of 30,000 barrels per day • Ban from future drilling site auctions – lost new oil BP’s 2011 Annual Report describes the uncertainty related to the company’s estimates as one of the company’s main risk factors (p. 27): “The Gulf of Mexico oil spill has had and could continue to have a material adverse impact on BP. There is significant uncertainty in the extent and timing of costs and liabilities relating to the Incident, the impact of the Incident on our reputation and the resulting possible impact on our ability to access new opportunities. There is also significant uncertainty regarding potential changes in applicable regulations and the operating environment that may result from the Incident. These increase the risks to which the group is exposed and may cause our costs to increase. These uncertainties are likely to continue for a significant period. Thus, the Incident has had, and could continue to have, a material adverse impact on the group’s business, competitive position, financial performance, cash flows, prospects, liquidity, shareholder returns and/or implementation of its strategic agenda, particularly in the US. We recognized charges totaling $40.9 billion in 2010 as a result of the Incident. The total amounts that will ultimately be paid by BP in relation to all obligations relating to the Incident are subject to significant uncertainty and the ultimate exposure and cost to BP will be dependent on many factors. Furthermore, the amount of claims that become payable by BP, the amount of fines ultimately levied on BP (including any determination of BP’s negligence), the outcome of litigation, and any costs arising from any longerterm environmental consequences of the oil spill, will also impact upon the ultimate cost for BP. Although the provision recognized is the current best estimate of expenditures required to settle certain present obligations at the end of the reporting period, there are future expenditures for which it is not possible to measure the obligation reliably. The risks associated with the Incident could also heighten the impact of the other risks to which the group is exposed as further described below. References British Petroleum.Annual Report. 2011.http://www.bp.com/extendedsectiongenericarticle.do?categoryId=9036021&contentId=706 6689 Deepwater Horizon Study Group (DHSG). “Final Report on the Investigation of the Macondo Well Blowout.” 2011.http://ccrm.berkeley.edu/pdfs_papers/bea_pdfs/DHSGFinalReportMarch2011-tag.pdf Useful Videos, Films & Links For video on the BP Deepwater Horizon’s Gulf of Mexico Oil Spill see http://www.bp.com/sectiongenericarticle800.do?categoryId=9036769&contentId=7067805 2. Tylenol Recalls (2010): It’s Still About Reputation What this case has to offer Johnson & Johnson (J & J) enjoyed a halo effect for many decades after their iconic precautionary recall of Tylenol capsules in 1982. That halo has now been lost due to the events that led to the company’s recall of children’s Tylenol and other children’s medicines in 2009 and 2010. Sadly, J & J executives seemed oblivious to the value of lost reputation due to the undermining of trust, and the real lost sales due to a government prohibition on sales. This case examines a number of weaknesses in the company’s internal control and a continuous disregard for safety practices. Teaching suggestions I ask students whether companies that act ethically in one significant instance will always continue doing so, and if so, why not? A good way to answer this question is discussing the J & J decision in 1982 and then discussing the recalls in 2009 and 2010, almost 20 years later. Two questions that are central to the discussion of this case are what happened and how did the company change its culture so drastically. Discussion of ethical issues 1. Who was really to blame for the lax procedures found? Although the U.S. FDA is partially responsible for not acting faster and tougher on J & J, it is the responsibility of the company’s top management to establish adequate internal controls. In this case, there were several operational controls that failed repeatedly. The internal control framework proposed by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) explains that: “internal control is a process, effected by an entity’s board of directors, management and other personnel. This process is designed to provide reasonable assurance regarding the achievement of objectives in effectiveness and efficiency of operations, reliability of financial reporting, and compliance with applicable laws and regulations. • Internal control is a process. It is a means to an end, not an end in itself. • Internal control is not merely documented by policy manuals and forms. Rather, it is put in by people at every level of an organization. • Internal control can provide only reasonable assurance, not absolute assurance, to an entity’s management and board. • Internal control is geared to the achievement of objectives in one or more separate but overlapping categories.” 2. How should this situation be remedied? A number of things have to change within the company: • Management needs to change its attitude towards internal control, including their views on product safety and quality. The company should not try to downplay the possible repercussions and seriousness of the recalls (McNeil has publically stated that the recalls are a precautionary measure and that the risk of serious adverse medical events is remote). • J & J Management should make a strong statement that this situation will be resolved and take the necessary steps to clean the company’s reputation. Even when the drugs recalled where produced by the McNeil division, it is the parent company’s reputation that is at stake. • The company needs to invest in quality control and commit to meet or exceed the cGMP regulations. • The company should establish a strong foundation for monitoring of internal controls, including: o Support from top management (part of what is known as “tone at the top”); o Assign monitoring roles to people with appropriate capabilities, objectivity and authority; o Set a starting point or “baseline” of known effective internal control from which ongoing monitoring and separate evaluations can be implemented (for example “meet the cGMP regulations”); o Design and implement monitoring procedures focused on key controls that mitigate risks; and, o Assess and report results, including the evaluation of the severity of any identified deficiencies and the reporting of the monitoring results to the appropriate personnel and the board for timely action and follow-up if needed. It is not easy to remediate severe internal control weaknesses. It takes a cultural shift, managerial time, and significant economic resources. From the pure cost-benefit perspective, the company has already suffered significant economic losses as a result of the drug recall. The problems that motivated the 2009 and 2010 drug recalls did not cause any serious health issues, but without major changes the situation could happen again and possibly be worse. Finally, the company needs to revise its values and policies in place to deal with ethical issues. In a subsequent legal action started by the FDA on May 2010, McNeil was found guilty of illegally promoting a drug called Topamax and of causing false claims to be submitted to government health care programs. The drug was promoted for a variety of psychiatric uses that were not medically accepted indications and therefore not covered by those programs. The company was sentenced to pay a criminal fine of $6.14 million. 3. How could the job done by the FDA be improved? In this case, the FDA failed to act quickly against the company. It also appears that the warnings from the Agency were not strong enough or did not come with tough enough penalties. For example, in the Warning Letter SJN-2010-01 sent to the company’s CEO in January 2010, after the inspection of the Las Piedras plant, the FDA states that: “It is your responsibility to ensure that your operations at this facility and all other facilities under your control are in full compliance with all applicable requirements of federal law and FDA regulations. You should take prompt action to correct the violations cited in this letter. Failure to promptly correct these violations may result in legal action without further notice, including, without limitation, seizure, and injunction. Other federal agencies may take this warning letter into account when considering the award of contracts. Additionally, FDA may withhold approval of requests for export certificates, or approval of pending new drug applications listing your facility as a manufacturer until the above violations are corrected. A re-inspection may be necessary. Within 15 working days of receipt of this letter, please notify this office in writing of the specific steps that you have taken to correct violations. Include an explanation of each step being taken to prevent the recurrence of violations, as well as copies of related documentation. If you cannot complete corrective action within 15 working days, state the reason for the delay and the time within which you will complete the correction.” This warning was not enough to motivate the company’s management to take prompt corrective actions. The FDA followed up with inspections of other plants and found similar concerns. In February 2010, the FDA held an extraordinary meeting with senior executives of J & J. At that meeting, the Agency discussed a number of serious compliance problems at McNeil. In addition, the FDA confronted the company’s executives about whether McNeil's corporate culture supported a robust quality system to ensure the purity, potency, and safety of its products. 4.J & J had lived under a positive halo due to their earlier recall of tainted capsules of Tylenol. Why did J & J people behave differently, almost 30 years later? There could be several reasons behind the change in the company’s response: • Lack of ethical leadership and clarity about the importance of product safety as a fundamental value for the company. • Management is narrowly focused on short-term profits: o Stock market pressures to deliver short-term profits might be stronger now than 30 years before. o Executive compensation might be more short-term oriented now than 30 years before. • J & J outsourced the production of these drugs to a subsidiary and executives might have thought that outsourcing somehow shielded the parent company from reputational issues. • A misguided understanding of business and ethical immaturity. • Soft penalties or weak enforcement by the FDA. 5. How would the total cost of this debacle be estimated? There are direct and indirect costs for the company. The most obvious direct costs are: • Litigation; • Fines; • Recall expenses; and • Cost of closing down plants to remediate quality issues. On top of those direct costs, indirect costs may be very large, including: • Reduction in sales due to the loss of reputation across all the company’s brands; • Managerial time and attention consumed dealing with regulators; • Loss of investor confidence and difficulty raising funds; and, • Increased length of time to receive FDA’s approval for new drugs developed by the company. Some of these costs can be estimated by asking relevant executives, such as for the costs of recalls, remediation, loss of time taken dealing with regulators, and the increased cost of borrowing, etc. Studies could also be done of the lost sales and related contribution margin based upon the experience of other companies, or the estimates from marketing personnel (see the Pinto Case Notes). References COSO Definition of Internal Control.http://www.coso.org/resources.htm 3. Vioxx Decisions – Were They Ethical? What this case has to offer This case offers the opportunity to apply ethical decision making approaches during their examination of some of the potential ethical issues related to Vioxx’ approval, marketing, and the decision to leave it on the market, as well as: How did Merck get into the dilemma? Could this have been prevented if Merck had and followed a stringent Ethical Decision Making (EDM) process? Did Merck drop the “ethical” ball? Court cases are being currently being decided which offer a rich opportunity for students to review the potential liability that can arise from hazardous products, particularly for manufacturers of pharmaceuticals and other products that can have a significant impact on life or health. It is interesting to speculate, as the students should, on whether there has been an overall net benefit to society and to Merck from its action in regard to Vioxx. Teaching suggestions There are many examples of the dangers of ignoring evidence of hazardous products or processes too long (Ford’s Pinto, Firestone tires, Union Carbide Bhopal, and Dow Corning’s silicone breast implant, to name a few) and Vioxx may be another of these. Students need to understand the dynamics facing management and directors during these decisions, and to learn from the mistakes made earlier. Consequently, it is useful to get the students to role play (say 2-3 students per side) a debate between Merck’s management and the representatives of patients who have begun a class action. The instructor can ask what the Merck directors would have said about issues debated when it has concluded. Following the debate, the analysis presented below can be discussed with the class. Alternatively, the two questions raised at the end of the case can be taken up using the analysis presented below. Discussion of Ethical Issues 1. Utilizing the information provided and available from web sources, use the ethical decisionmaking techniques discussed in the chapter to form an opinion about whether Merck’s decisions regarding Vioxx were ethical. Show your analysis. I have reproduced below Rahbar Rahimpour’s instructive analysis of the Vioxx case issues in the form of a response to Question 1. Analysis of Some Ethical Issues: Here we use a hybrid analysis of the Philosophical Approach and the Stakeholder Impact Analysis to suggest that Merck’s decision to market Vioxx had both quantifiable and nonquantifiable negative impacts on many of the stakeholders of the company. Initially, it appears that Merck may have neglected to ensure the fundamental interests of its stakeholders. Identification and prioritization of the stakeholders, and their respective interests (well-offness, rights, fairness), does not appear to have included patients and their respective families as top priority. Merck’s decision making process appears to have been less than comprehensiveness. Tunnel vision profit maximization may have led Merck to making a decision that has negatively impacted the company for a long time. Merck’s decision to market and its subsequent decision to withdraw Vioxx negatively affected: 1) Merck’s Stockholders and investors, 2) Merck’s Management, 3) Merck’s employees, 4) physicians and patients, 5) general public, and 6) the regulatory agencies (FDA and Health Canada) and others as shown in Exhibit 3. In November 2000, Merck’s own VIGOR studies indicated a significant increase in the risk heart attack and stroke in patients taking Vioxx, in a 12-month period and as compared to those taking naproxen . Despite knowing about these results it took Merck more than two years to withdraw Vioxx from the market. Were Merck’s decisions intended to benefit or harm any, or all, of the stakeholders? Are there lessons to be learned from what a seemingly improper decision to rush a drug to market only to withdraw later? Were the consequences of Merck’s decision beneficial to its stakeholders? Consequentialism view holds that whether an act is morally right depends only on the consequences of that act or of something related to that act. It is difficult to argue that any of Merck’s stakeholders are better off and have benefited in the long term. In the short run, Vioxx’ sales helped increase Merck’s revenues, benefited stockholders and management, as well as benefiting some patients. Through their short term vision, Merck’s management fell into ethical decision making pitfalls. Had Merck taken Pastin’s approach to re-prioritize its stakeholders and put patients first, and look at the long term consequences, the results may have been different. Merck’s decision to keep Vioxx on the market and not to present all scientific date to the FDA may seem unethical. However, Merck may argue that withholding scientific information from the regulatory authorities and marketing of Vioxx was based on its commitment to delivering better medicines to patients in need and with no treatment alternative. That is the greater benefit to patients was the ultimate desired consequence. Merck may also argue that Vioxx had a utilitarian impact on society and delivered a substantial health benefit to many patients and therefore its launch and marketing may be morally justified. However, the Company appears to have failed to minimize the net negative impact and harm to all patients. Merck was successful in delivering a high value medicine with tremendous utility to patients. But by apparent misrepresentation of selective data to the FDA it seems to have crossed the moral line. Furthermore, Merck had ample opportunity to withdraw Vioxx from the market (between 1999- 2004). Merck’s decision to keep Vioxx on the market appears not to have been fair or right for thestakeholders. Though the legality of Merck’s conduct will be decided in courts, it’s clear that short term consequences (profits) blinded Merck’s management to many long term moral and ethical issues. Were Merck’s decisions legal? Were Merck’s decisions fair, just, or right? Merck’s VIGOR data (1, 2) showed that Vioxx could cause death in some patients. ShouldMerck have withdrawn Vioxx from the market sooner that it did? If it is determined that Vioxx directly contributed to any death, and that Merck knowingly omitted certain data from its regulatory submissions or Merck held back information that could have prevented deaths, consequences may be enormous. Kant might argue that Merck’s omission of information would be deemed unfair, unjust, and unethical. Merck’s actions suggest that the company did not respect the rights and autonomy of individual patients. Merck might argue that staying in the market, for as long as they did might have maximized social benefits. In reality, Merck appears not to have attempted to minimize social injuries to those who did not benefit from Vioxx by issuing proper warnings about Vioxx. Pastin might argue that Merck thereby demonstrated a lack of social contract ethics, and hence was unfair. Transparency and information sharing of risks associated with Vioxx, would have allowed the physicians and patients to make a rational and informed decision thus respecting the autonomy of the patient. By Kant’s standards Merck used the patients to achieve an end (profits). Company profits clearly benefited some of the stakeholders. But many others suffered. Merck may contend that despite all transpired events the net benefit to society as a whole was worth the risks. The fact that Vioxx had serious adverse effects might have come into the risk-benefit analysis at Merck. As a result, some people were expected to develop complications or die. However, by Kant’s measures, an ethical decision should include the full respect of the individual’s right to choose, given all the information available. An increased level of transparency with scientific and clinical data would have had a different outcome. Overall, one may argue that the non-quantifiable impact of Merck’s decision has had a greater effect on the Company than those resulting from the drop in its market cap. Did Merck’s decisions demonstrate expected virtues? As a pharmaceutical company Merck’s reputation and public image had been built over many years. This reputation entailed implicit virtues of reliability, trustworthiness, compassion, caring, integrity, kindness, and responsibility. It does not appear that the decision to market Vioxx, or to stay in the market for much longer than expected, was based on the consideration of any of these expected virtues. In its attempt to satisfy the interests of a limited number of stakeholders, it appears that Merck failed to comprehensively examine, and therefore anticipate, all possible outcomes. Conversely, Merck might argue that its actions were the manifestation of its compassion for patients in need. However, in the public eye, this argument may not hold. One alternative option that would have resulted in securing Merck’s integrity might have been for Merck to be more transparent with the scientific findings and also to present sufficient warnings to the patients. Though Merck appears to have analyzed the profitability and legality of their decision, it seems unlikely that the Company had considered its full duty to all stakeholders. Nor did Merck consider the rights of patients to live without worry. Summary: In its decision making process, Merck failed to identify and prioritize all stakeholders, and to address their respective interests and rights. By marketing Vioxx, not only did Merck appear to have ignored the basic rights of many of its stakeholders but also to have eroded the virtues expected from a pharmaceutical company. Merck’s focus on short-term financial gains created an unhealthy ethical decision making environment. Consequently, its decision on Vioxx failed to result in sustainable profits in the long run. Merck’s estimated cost of litigation has had a negative impact on majority of its stakeholders, including: shareholders, management, and employees. We found the following text on Merck’s website. “We believe our emphasis on ethics benefits our business. It motivates our people, and helps to inspire confidence and trust among doctors who prescribe our medicines as well as regulators who approve them. We care deeply about the results we achieve–the drugs we discover, our financial performance and our employees’ satisfaction–but we also care about how we achieve those results, both inside and outside the walls of Merck. No matter how tough the business environment, our ethics and core values will continue to guide our success.” However, it appears that the company continues to ignore its most important stakeholder, the patient, as the word “patient” is not mentioned here. Exhibit 2: Performance of Merck’s stock following withdrawal of Vioxx from the market Exhibit 3: Merck’s stakeholders and their respective relationships In addition to Rahbar Rahimpour’s analysis, the students should appreciate the nature and structure of the court decisions that are appearing. At this early stage (May 2006), several decisions have appeared. On April 12, 2006, a jury in New Jersey awarded John McDarby, a 77year-old $4.5 million in compensatory damages and $9 million in punitive damages because “Vioxx had been a significant contributing factor to his heart attack and that Merck failed to warn adequately of the drug’s risks.”3 Punitive damage awards are capped at 5 times the compensatory damages in New Jersey. One analyst opined that the legal costs facing Merck might be “comparable to what Wyeth has faced with its withdrawn “fen-phen” diet drugs. Wyeth has already taken some $21 billion in charges.” It should be noted that the second plaintiff (Tom Cona) in the McDarby case received virtually no award. As at April 6th Merck had won two trials, and had been found liable in two others. About 10,000 lawsuits were still to be decided. 2. In order to protect the public more fully, what should the FDA do given the Vioxx lessons? The FDA could consider: • Requiring immediate notification by manufacturers and/or researchers of serious side effects • Immediate follow-up on such serious side effects • Immediate/very early public advisory about reports of and investigations of serious side effects • Sanctions for corporations and senior executives that: o delay in reporting serious side effects o coerce researchers not to disclose serious side effects or edit or hold back data to avoid clear disclosure of potential such effects. Note that, although the case does not speak to the issue of suppressing information on serious side effects, students will come across articles that allege such behavior. Update/Subsequent Events Feb. 28, 2008 – In settlement of lawsuits in Federal, California, New Jersey and Texas courts, Merck obligated to pay $4.85 billion to 44,000 eligible U.S. claimants, see http://www.officialvioxxsettlement.com/ For continuous company news releases, see http://www.merck.com/newsroom/vioxx/ For the Martin Report on the Conduct of Senior Management in the Development and Marketing of Vioxx, see http://www.merck.com/newsroom/vioxx/martin_report.html Useful Videos, Films & Links In order to access up to date Merck (VIOXX) litigation Information, scientific Information and company statements/protocols see http://www.merck.com/newsroom/vioxx/ C-Span “The Vioxx Settlement” American Enterprise Institute, January 7th 2008 http://www.cspanvideo.org/program/TheVio. Panel discusses the Merck settlement with Vioxx users. Although the panel is focused on legal aspects of the settlement the panel raises some ethical concerns associated with the settlement. “Merck Agrees To Vioxx Payout” CBS News Video November 9, 2007 http://www.cbsnews.com/video/watch/?id=3482855n Winstein, Keith & David Armstrong (2009). "Top Pain Scientist Fabricated Data in Studies, Hospital Says". The Wall Street Journal, March 11thhttp://online.wsj.com/article/SB123672510903888207.html?mod=loomia&loomia_si=t0:a16 :g2:r1:c0.0270612:b22894832 4. Just Do It – Make the Numbers! What this case has to offer This mini-case conveys the scenario that has been acted out in countless CFO or CEO offices. It offers the opportunity to consider – while using an ethical decision making (EDM) framework – the: • pressures and motivations that can come to bear on the CEO and CFO, • techniques that can be used to boost earnings and/or cash flow, • flawed prospect that manipulations will be self-cancelling when prospects improve, • consequences of manipulation on all the stakeholders, • professional accounting stance on manipulations, and why, • lessons learned from earlier manipulation cases, including: Enron, WorldCom, Waste Management, Sunbeam, Adelphia, Tyco, Nortel, HealthSouth, Parmalat, & Royal Ahold. A most interesting aspect of the EDM discussion is the opportunity to reveal the value of adding deontological and virtue ethics perspectives to the basic consequential or utilitarian framework that most business folk and accounting professionals naturally use. Clearly the deontological issues of rights, fairness and justice are important for fiduciary, legal and reputational purposes, and for professional accountants taking virtue expectations into account is critical. It is not surprising that some corporations are thought to hire non-accounting professionals (MBAs) as their CFOs, in order that they will not feel the professional ethical pressures that a CPA or CA or CMA would. Teaching suggestions Although the case can be taken up by the instructor, it would be helpful for a group of students to present their case solution to the class. The presentation could then be critiqued by other groups of students who were allocated the roles or issues bulleted above, such as: shareholder and other stakeholder impacts, possible techniques and the flawed assumption of self-rectification, professional accounting concerns and expectations, appropriate use of EDM approaches, lessons learned from earlier cases, and why are deontological and virtue ethics important. Discussion of Ethical Issues 1. What should Ron consider in making his decision? Ron, the CFO, should employ a full EDM analysis before making his decision – but rarely would there be enough time or the inclination for this in real life – so using this case in class will prepare the students for future challenges. This full EDM analysis could be similar in framework to that used in the Illustrative Application of Stakeholder Analysis of a Proposed Audit Adjustment included in Chapter 5 of the text. While the stakeholder impact analysis is necessary and useful to make sure all issues are canvassed, I would suggest that the traditional ethical approaches not be short-changed. Here are some thoughts on the bulleted items listed above: • pressures and motivations that can come to bear on the CEO and CFO, o incentives (greed), fear of losing one’s job, reputation erosion o its how the game is played – normal business practice (Ken Lay style) • techniques that can be used to boost earnings and/or cash flow, o capitalize and/or defer expenses, off-balance sheet transactions, misrepresentation • flawed prospect that manipulations will be self-cancelling when prospects improve, o profits rarely rise as expected, o inventory and/or other profit boosts do not automatically cancel the next year – they are usually additive, and require higher levels of manipulation to hide. • consequences of manipulation on all the stakeholders, o see Illustrative Case • professional accounting stance on manipulations, and why, o code of conduct discussion, professionalism, reputation concern, lessons from other manipulation cases • lessons learned from earlier manipulation cases, including: Enron, WorldCom, Waste Management, Sunbeam, Adelphia, Tyco, Nortel, HealthSouth, Parmalat, and Royal Ahold. o Enron – off-statement deals, sham transactions o WorldCom – capitalization of line costs and other expenses o Waste Management – capitalized and /or failed to record expenses, overstated environmental revenue reserves, understated provisions for income tax, etc. o Sunbeam – channel stuffing, misrecording of fees, false sales, … o Adelphia – misrepresentation of transactions o Tyco – misuse of benefit plans, unauthorized bonuses and compensation, improper credits o Nortel – misrecording the timing of revenue and expense, soft reserves (cookie jar accounting) o HealthSouth – recording of imaginary revenues o Parmalat – fake transactions o Royal Ahold – recording of non-existent commissions from suppliers I would conclude with a discussion of the importance of deontology (duty, respect for rights, and fairness) and the demonstration of the virtue expected of senior company officials and the related director oversight. While it is easy to argue that a utilitarian analysis may indicate no significant net harm from an action, an assessment of fair treatment among stakeholders is not included, nor is a forward looking assessment of the expectations of stakeholders and what will happen if they are not met. In this regard, it does not matter if those expectations are beyond what is currently embedded in law, the future support of stakeholder groups is far more important to the success of the corporation and the CEO and CFO themselves, not to mention the directors. 5. Smokers Are Good for the Economy – Really What this case has to offer The Smokers are Good case offers the opportunity for students to appreciate that: − Cost-benefit analyses (CBA) are useful, but they are susceptible to many flaws: − Prices/costs are hard to find exactly, and rarely are equivalent to the value of specific items or impacts – consequently it is quite possible “to find the price of everything, but the value of nothing”, and to be misled. − Frequently, CBAs do not capture the impact of an action on all stakeholders, particularly those on whom the impact is indirect. − What is incorporated in a more fulsome ethical analysis. Teaching suggestions I would recommend getting the students involved in the case by asking: − How many smoke now? − How many have recently quit? Then, to get at the issues of the case: − Why do people smoke? − Are these issues covered in the actuarial analysis (or CBA)? − What does a basic ethical analysis include? − What else would be covered in a full ethical analysis as opposed to a CBA? − What other issues beyond those in a full ethical analysis or a CBA should be continued? − Taking everything into account, is smoking good? Discussion of ethical issues 1. What does an ethical analysis add to Viscusi`s actuarial analysis? Using a stakeholder impact analysis framework, an ethical analysis: − Identifies all the relevant stakeholder groups affected by the activity − Identifies all significant impacts on these groups − Prioritizes the impact on each stakeholder group − Asks all the questions per Chapter 4 of the text relevant to the nature of the problem/impact so as to cover: rights, fairness and well-offness Yes. Viscusi’s analysis does not include the impact of smoking on all stakeholders affected, nor does it include all types of impact. For example, Viscusi does not include the impact on indirectly affected stakeholders such as families of losing a loved one, who is possibly a breadwinner, and there is no cost included for the pain and suffering of the family of the smoker. Nor is there a systematic and ranked consideration of the issues of rights, fairness and well-offness of all stakeholders. 2. Would an ethical analysis change the conclusion reached? Why? In this case, the product (cigarettes and cigars) is abnormal in that the nicotine included in it produces an addiction in the smoker, so it is difficult for a smoker to quit. Since the level of addiction is different and unknown for each smoker, the product may not be considered to represent a fair purchase and a continuing free choice even though a disclaimer “…harmful to your health” is printed on each package. Smokers smoke for relaxation and for satisfaction of their social or affinity needs. Leaving aside the craving for nicotine, what would smokers do if smokes were not available? Would they turn to drinking or drugs– with worse results? What would they do if taxes on smokes were increased significantly? Would this deprive low income families of money needed for sustenance? Is there really a good alternative to smoking? If not, is smoking not OK if not good? 6. Ford Pinto What this case has to offer The Pinto Case has become an icon in business ethics. It affords the opportunity to stress the importance of: 1. Using a framework for decision making which considers both financial and non-financial factors such as impacts on life and health. 2. Estimating and balancing future impacts with and against shortterm impacts, such as profit. 3. Recognizing that the social consciousness of society and executives has changed since the Pinto decision and will continue to do so. 4. Considering cost-benefit analysis to be a realistic and valuable addendum to profit analysis. Specifically, the case affords the opportunity to explore the following issues, among others, in a business context: Can/should a price be put on life? Why was the cost-benefit analysis deficient? Estimates of lawsuit settlements Lost reputation - how to measure it Discounting - why and how Didn't bring the future to the present When is product risk normal or abnormal, acceptable or not acceptable? Was disclosure an option? What is the general trend in social conscience over time? Teaching suggestions My approach to the Pinto Case depends on whether I use it to start a class on ethical decision making (EDM) frameworks, or to cement the framework issues that I have taught at the beginning of the class. Usually I use the Kardell Paper Case to introduce the "Five Question/Box" Framework in the first class on EDM. I begin the second with a discussion on the Moral Standards Approach (MSA) and cost-benefit analysis (CBA) which I cement with the Pinto Case. I then go on to deal with the variations in the MSA which are introduced in the Pastin Approach. Since the class has had a discussion on CBA, I launch right into the first question posed at the end of the case. This doesn't take long because the decision, in hind-sight, is so offensive to human life and health. Sometimes there is a bit of debate, but generally the class agrees and we can shift to the second question about the CBA. Since Ford's CBA does not support the view that the decision was unethical, it is natural to dismiss CBA as useless or to look hard to see why. Therefore most of the class are relieved when the CBA is quickly shown to be flawed. During the discussion about the flaws, I make a special point to underscore how a properly crafted CBA would have most helpfully brought future cash flows into the EDM to allow a complete picture to be assembled and a balanced decision to be made. Ignoring the future can be a perilous shortcoming. We finish with the last question which is designed to focus on the inappropriateness of thinking that disclosure of abnormal risks is practical or likely to be effective. In total, it usually takes about 30 minutes to deal with the case if it has been read in advance, which I require. Discussion of ethical issues 1. Was the decision not to install the rubber bladder appropriate? Use the 5 question/box framework to support your analysis. The five question framework suggests the identification and ranking of stakeholders and then employs the following challenges to proposed actions - in this case with the results indicated: Is the proposed action profitable? According to Ford's CBA - Yes Is the proposed action legal? Yes. But it is interesting to note that the Ford engineers knew that the Pinto would not pass 21 mph crash test which was expected to be introduced as the government's mandatory safety standard - an introduction which was "delayed" until the late 1970's after the bulk of the court work on this case was complete. Is the proposed action fair? No, certainly not to the people who died or were burned or to their families, provided it is decided that the product carried inherent risks which were greater than was reasonable for the buying public to expect. This sets up an interesting discussion of normal and abnormal product risk. Even baby's toys carry some risk to a user, but if there is a design flaw or a manufacturing flaw which presents some extra risk of significant harm, then that would be abnormal. Moreover, if this abnormal risk was known or should have been known to the company, its Directors or management, and they did nothing about it, then they can be considered negligent. In the Pinto case, the placement of the gas tank, etc., is usually considered, in hindsight, to create an abnormal risk. Can the executives be considered culpable? Most would say yes, but they forget that times were different when the decision was made. Social consciences were not as developed and executives were largely schooled to ignore personal matters in favor of financial ones. I usually play devil's advocate on the matter of culpability and force the class to argue their way through the normal/abnormal risk, cultural change issues. Sometimes this catches the traditionalists who side with me only to suffer the attention of their classmates. Is the proposed action right? No. It clearly offends the right to life, and to health, particularly if the abnormal risk/negligence argument goes against the Ford executives. Some people can't believe that anyone could make the tradeoff of $11 for a life (actually I believe the real cost was only $5.50 or so), but the fact that Lee Iacocca did it lends a strange credibility to the case. Is the proposed decision sustainable development or/? In this case, the issue of sustainable development doesn't appear to be as important other matters, and so can be ignored for the purposes of class discussion. Overall, the proposed action is shown to be unethical based on two challenges at least, so the power of an EDM framework is seen to be greater than the limited financial analysis that Ford was doing. Of course, Ford's analysis was faulty which leads to a discussion of the next question. The ranking of stakeholder's interests does not appear to be needed to reach the above conclusion. 2. What faults can you identify in Ford's cost-benefit analysis? The most frequent observations made in response to this question are: how can anyone put a value on a human life, settlement costs look low, Ford's reputation suffered but this not valued, and there is no discounting of future cash flows. Here are some comments on each. Putting a value on human life and suffering: Gruesome though it may be, courts do it all the time in damage cases, generally as a function of lost future earnings plus damages for pain and suffering discounted at a reasonable rate of interest. Consequently, it the EDM approach will be complete only if we do the same. Unpalatable and inaccurate though it may be, it appears to be useful for EDM purposes to use similar valuation techniques. After all, a perfectly safe car would look like a tank and be more costly than most could afford, so tradeoffs will have to continue to be made. Cost estimates look to low: True, but with hindsight everything is clearer. In fact, the total claims paid out ultimately was approx. $150 million. In the US judges are elected and, when the public learned more about the case it became outraged at Ford's conduct and the settlements skyrocketed. This is a pattern that has recurred since. No surrogate is included for lost reputation: We can't measure the value of lost reputation directly, but we can project the lost units of sales which might result from a poor decision. Having this number for each a series of future periods out to a time horizon of say 10 years, we can estimate the lost margin on each and discount the total for each year back to the date of our analysis at a reasonable rate (say 10%). If for example, Ford was to lose 200,000 units of sales for each of the 10 years, and each unit represented lost margin (sales price less variable manufacturing and marketing costs) of $100, then the first year's cost would be the present value of $20 million. Over the ten year time horizon, at a discount rate of 10%, the lost reputation valued on this basis would amount to $$122.9 million (see below). Discounting is not employed: Ask your class whether they would be more willing to take their pay now or defer it for a year or two. Clearly, there is a time value of money which ought to be reflected in a proper CBA by discounting both costs and benefits. Correcting for these flaws, a recast CBA might look like that set out below: Cost-Benefit Analysis of not installing the gas tank gasket: Benefits of: Installation and material costs: ($137,500,000/2 since cost = approx. $5.50 not $11 ea.) (Assume cost incurred evenly over 10 years) (Present value of $6,375,000 annuity at 10%)........................$ 39.174 mil Costs of : Burn deaths, injuries, vehicles, and legal costs: (Assume total payout is $150,000,000 over 10 years) (Present value of $15, 000,000 annuity at 10%)...................... 92.175 Lost reputation: (Lost margin of $20,000,000 per year over 10 years) (Present value of $20 million annuity at 10%).......................… 122.900 Total costs 215.075 Net benefits-costs ($175.001) Note: The income tax consequences of these cash flows have not be taken into account. If this picture of reality had been available to Ford executives, the decision would quite likely have been different. 3. Should Ford have given its Pinto customers the option to have the rubber bladder installed during production for, say $20? The impracticality of this suggestion is obvious, but it provides a jumping off point to discuss the common misperception that disclosure will make an unethical action all right. Somehow, telling a victim what is in store for him/her is expected to pass the from the manufacturer to the victim. However, when such communication can be done without severe consequences for the company's credibility, the victim can easily claim inability to understand, or not having the freedom to choose another alternate - in which case the manufacturer will still be stuck with the problem. Usually, asking the students how to compose the copy for the $20 option provides some levity at the end of the case. Once again, the students will find the case invigorating and instructive, and will marvel at the changes in social conscience over time. Useful Videos, Films & Links Dowie, Mark (1977) “Pinto Madness” Mother Jones September/October Issue http://motherjones.com/politics/1977/09/pinto-madness Grimshaw V. Ford Motor Co. (1981) 1119 CA3d 757 http://online.ceb.com/calcases/CA3/119CA3d757.htm 7. Kardell Paper What this case has to offer The Kardell Paper Co. Case involves decisions around the necessity to introduce a very expensive "closed loop" pollution control system in a pulp mill. This provides an excellent opportunity to: 1. Introduce and illustrate the stakeholder analysis approach as it deals with financial and non-financial issues with impacts in both the long and short term. 2. Get the students to grapple with the need for decisions based on partial or uncertain information. 3. Examine how a board of directors works in governing organizations, and how it ought to be constituted or operated to insure that all stakeholder interests are considered. 4. Learn to anticipate functional fixation, conflicts of interest and other forms of bias from lawyers and other advisors or decision makers. 5. Appreciate what "due diligence" requirements decision makers must keep in mind to minimize the impact of charges of negligence with regard to the treatment of the environment and the handling of hazardous waste. 6. Confront the downside (whistleblowing, fines, jail, closure) of suppressing information or debate at the decision making levels (executive and board) of the organization. 7. Appreciate the capacity of the stakeholder analysis approach to be used to refine a solution to produce a win/win, creative or better result. Teaching suggestions I use the Kardell Co. Case either after developing the 5-question/box Approach (5QA) with the students, or after developing the Moral Standards Approach (MSA) and the Pastin Approach (PA) as well. I start the discussion with a short scene-setting statement which raises the reality of the case setting - actually it is an embellished real case with changed names, and with sonox really being dioxin, a suspected carcinogen produces in the pulp making process. Then I ask the following questions, in order: 1. Who are the stakeholders here and what are their interests? 2. What are the major issues and how are the interests of each stakeholder group affected by them? 3. Which ethical decision making approach should be used: 5QA; MSA; PA? Why? 4. What are the major decisions to be made? 5. How should the stakeholder's interests be ranked? Why? 6. What facts and analyses would we like to have? 7. What decisions would the students make? 8. What was wrong with the quality of the debate at the board of directors? 9. What is the downside if the right decision is not made - consider economic factors and also what Jack might do? The discussion moves along quite quickly, taking 30-45 minutes. At the end of the case, students feel quite good about the decision making approaches and their understanding of corporate governance. Discussion of ethical issues 1.Who are the stakeholders involved and what are their interests? The discussion of stakeholders and their interests produces the expected list except that usually neither Jack, the technician who discovered the potential problem and who is most concerned with the impact of sonox, and the unborn, are mentioned. I usually have to probe for these, and sometimes I let the discussion proceed until the quality of debate at the board level comes up before asking who is going to raise their issues and argue for their interests. A satisfactory decision is unlikely unless they are recognized as stakeholders and their interests taken into account. You can delve into the issue of whether mothers can adequately represent the unborn or not, but remember that mothers may suffer from conflicts of interest in regard to the perceived short-term need for jobs for their families, etc. Similarly, the issue of whether the environment should be accorded status as a stakeholder in its own right, or simply as an extension of known human needs, is an interesting one. Pointing to the recent movie "Medicine Man" in which Sean Connery was trying to find a cure for the cancer in the Brazilian rain forest, but was prevented from doing so by efforts to clear for grazing cattle, is helpful here. 2. Which stakeholders and interests are the most important? Why? The ranking of stakeholders interests can be done after or in conjunction with the identification of the major decisions to be taken. Provided sonox is considered a health risk, the usual ordering of concerns by the public would be: life, health, quality of life, financial. I usually find that there is quite a debate in class over the primacy of shareholders concerns (financial) vs. those related to life and health. In the end, it usually boils down to how serious a health risk the student thinks that sonox is. This is an issue that is unresolved in the case due to lack of information (the same as in real life - dioxins are very harmful to monkeys, but science has not been able to make the same case for humans yet). Choosing an ethical decision making approach: Because the case involves the environment, most students want to use the 5QA which features the sustainable development question. It also appears to be the most simple and logical since the decisions appears to lies outside the confines of the organization. However, the students should be reminded that the profit challenge in the 5QA it deficient because it is often short run in focus and fails to consider externalities like harm to the environment. These issues call for the supplementation of the 5QA with cost-benefit analysis as in the MSA. Also, the issues of discovering Kardell's internal ground rules and employing social contract ethics may be helpful in shaping recommendations and encouraging decision makers to consider the downside of the health concerns. Since numbers are not available, augmenting the profit challenge with the concept of CBA usually proves to be desirable and reinforces the idea of fashioning a hybrid system where advisable. What decisions ought to be considered? What facts/analyses would we like to have?: Obviously the decision of whether to shut down and install the closed loop system is before the board. However, the class should realize that there are a number of variants which should be investigated, time permitting, with the ultimate decision depending on more information. For instance: • Is Sonox really a problem? • Are we polluting in sufficient quantities to cause a problem? • Are there alternative and less costly process modifications which would reduce, but not eliminate, our Sonox discharge? • The closed loop shut down and costs appear high: are their less disruptive/costly • approaches? • What are the costs of delay? As a result, an alternate decision would be to defer the closed loop decision and seek more info on one or more of the above. In the interim, several decisions arise: • Should the community be informed of the possible health risks? When? • Should bottled water be brought in? When? • Should the other competitors be brought into the discussions? Getting the class to make decisions: I usually force the class to vote on the closed loop decision right after the choice of ethical decision making approach. They resist doing so, and I ask why - then the other questions come out. I keep asking for a decision and this forces the group to think through each stage of the process. Ultimately the class is usually split between those wanting to take the ethical "high road" and install the loop right away, and those who what to move more slowly. 3. What was wrong with the quality of the board of directors’ debate? At this point, it is easy to see that the board was not sufficiently representative of the stakeholders to meaningfully present and understand the important issues facing the company. Moreover, there was no one with sufficient technical expertise to appreciate the significance of the health issues or the biological impact on the environment. The lawyer may have felt a conflict of interest, in that he was both a director and a paid counsel. In any event, his view was limited to current and past legal precedent, not to the future, or to non-legal perspectives. This is functional fixation which can mislead a corporation into short-range thinking. The result of this analysis should be the realization that to properly govern a company, the board should have effective representation from all important stakeholder groups, and/or effective access to and information from representative groups or ethics experts. This analysis will highlight the value in appointing "outside" directors (who don't rely on the organization for their livelihood) and also women directors to insure that all aspects of an issues will be understood and argued effectively. 4.What is the downside if the right decision is not made? Consider economic factors and also what Jack might do. Jack might blow the whistle if he thinks that the wrong decision is made or if the process is suppressed or if too much delay is involved. This would (did) involve regulatory sanction including fines, shut down, loss of market, loss of profit, and ultimately loss of control to creditors. If Jack doesn't blow the whistle, costs of ultimate clean-up and new process installation could rise. If the decision by the board is just to wait and see what happens, they will not be able to argue that they took "due diligence" measures to keep abreast of the health risk unless they initiate some research into the sonox problem, even if it is a periodic literature search or a retainer arrangement with a researcher to keep them advised. Similarly, they should continue to take readings in the river to monitor their discharge and try to identify other polluters. I finish the case by asking whether the interests of certain stakeholders can be examined to refine or produce better decision. Sometimes one of the more astute students will speculate on the possibility of arranging with government for support as a test project for the closed loop system, or to offset the cost of a shut down. Also, the approach to other competitors on the river can be examined, since they are likely to be in the same boat...as it were. Solution Manual for Business and Professional Ethics for Directors, Executives and Accountants Leonard J. Brooks, Paul Dunn 9781285182223