© Ram Mudambi, Temple University, 2006 Lecture 9 Governance and Business Ethics BA 950 Policy...

© Ram Mudambi, Temple University, 2006

Lecture 9Lecture 9

Governance and Business EthicsGovernance and Business Ethics

BA 950BA 950Policy Formulation and Policy Formulation and

AdministrationAdministration

© Ram Mudambi, Temple University, 2006 11-2

OutlineOutline

Stakeholder analysisStakeholder analysisCorporate governanceCorporate governance

The principal-agent problemThe principal-agent problemBusiness ethicsBusiness ethics


Stakeholders and Corporate Stakeholders and Corporate PerformancePerformance

Stakeholders are in an exchange Stakeholders are in an exchange relationship with the companyrelationship with the company

Contributions: they supply the organization Contributions: they supply the organization with important resourceswith important resources

Inducements: in exchange they expect their Inducements: in exchange they expect their interests to by satisfiedinterests to by satisfied

Stakeholders are individuals or groups with Stakeholders are individuals or groups with an interest, claim, or stake in the company, what an interest, claim, or stake in the company, what it does, and how well it performs. it does, and how well it performs.


Stakeholders and the EnterpriseStakeholders and the Enterprise

Contributions

Contributions

Inducements

Inducements

A single group can occupy more than one stakeholder role, e.g., ESOPs – employeesmay also be stockholders


Stakeholder Impact AnalysisStakeholder Impact Analysis

1.1. Identify stakeholdersIdentify stakeholders

2.2. Identify stakeholders’ interests and concernsIdentify stakeholders’ interests and concerns

3.3. Identify resulting claims stakeholders are Identify resulting claims stakeholders are likely to makelikely to make

4.4. Identify most important stakeholders (from the Identify most important stakeholders (from the organization's perspective)organization's perspective)

5.5. Identify the resulting strategic challengesIdentify the resulting strategic challenges

Usually the most important:Usually the most important:• Customers Customers •• Employees Employees •• Shareholders Shareholders


The Unique Role of ShareholdersThe Unique Role of Shareholders

Shareholders are a company’s legal owners Shareholders are a company’s legal owners and the provider of risk capital, a major and the provider of risk capital, a major source of capital to operate a business.source of capital to operate a business.

Value of risk capital – no guaranteed payment, no Value of risk capital – no guaranteed payment, no guarantee of capital preservationguarantee of capital preservation

Maximizing long-run profitability & profit Maximizing long-run profitability & profit growth is the route to maximizing returns to growth is the route to maximizing returns to shareholdersshareholders

Also helps to satisfy the claims of most other Also helps to satisfy the claims of most other stakeholder groups.stakeholder groups.


Shareholder ClaimsShareholder Claims

Shareholders receive their returns as:Shareholders receive their returns as: Dividend paymentsDividend payments Capital appreciation in market value of sharesCapital appreciation in market value of shares

ROIC is an excellent measure of ROIC is an excellent measure of profitability.profitability.

A company generatingA company generating positive ROIC is adding to positive ROIC is adding to shareholders’ equity and increasing shareholder shareholders’ equity and increasing shareholder value.value.


Agency TheoryAgency Theory

Principal-agent relationships arise whenever one Principal-agent relationships arise whenever one party delegates decision-making authority or party delegates decision-making authority or control over resources to another.control over resources to another.

PrincipalPrincipal: : person delegating authorityperson delegating authority Agent:Agent: person to whom authority is delegatedperson to whom authority is delegated

The agency problem:The agency problem: Agents and principals may have different goals.Agents and principals may have different goals. Agents may pursue their own goals that are not in the Agents may pursue their own goals that are not in the

best interests of their principals.best interests of their principals.


The Corporate Governance The Corporate Governance ProblemProblem• The evolution of the corporate enterpriseThe evolution of the corporate enterprise Owner-managed small enterprisesOwner-managed small enterprises PartnershipsPartnerships LimitedLimited liability joint stock corporations liability joint stock corporations

• Joint stock enterprises are characterized byJoint stock enterprises are characterized by Separation of ownership from managementSeparation of ownership from management Diffused stock holding Diffused stock holding

• The objectives of owners (The objectives of owners (principalsprincipals) and ) and managers (managers (agentsagents) may diverge ) may diverge


The Corporate Governance The Corporate Governance ProblemProblemOn-the-job consumptionOn-the-job consumption

Elaborate and expensive Elaborate and expensive perks for top management.perks for top management.

Excessive pay not linked Excessive pay not linked to performanceto performance

Down markets and upward spirals of executive pay.Down markets and upward spirals of executive pay.

Empire buildingEmpire building Buying additional businesses that increase the size of Buying additional businesses that increase the size of

the company without increasing shareholder wealth.the company without increasing shareholder wealth.


The Tradeoff Between ProfitabilityThe Tradeoff Between Profitabilityand Growth Rateand Growth Rate


Solving the Corporate Solving the Corporate Governance ProblemGovernance Problem Generic solutions to the agency problem Generic solutions to the agency problem involveinvolve

MonitoringMonitoring: Reducing asymmetric information : Reducing asymmetric information between principal and agent between principal and agent

IncentivesIncentives: Aligning the goals of the principal and the : Aligning the goals of the principal and the agent agent


Corporate Governance Corporate Governance Mechanisms - 1Mechanisms - 1Internal controls Internal controls Board of directorsBoard of directors

Elected by stockholdersElected by stockholders Legally accountableLegally accountable Monitors corporate strategy decisionsMonitors corporate strategy decisions Authority to hire, fire and compensateAuthority to hire, fire and compensate Ensures accuracy of audited financial statementsEnsures accuracy of audited financial statements Inside vs. outside directorsInside vs. outside directors

Auditors, SEC, GAAPAuditors, SEC, GAAP Stock-based compensationStock-based compensation

Pay for performancePay for performance Stock optionsStock options

– Exercise price, exercise dateExercise price, exercise date

MonitoringMonitoring

IncentivesIncentives


How Options Skew the Bottom How Options Skew the Bottom LineLine

Source: D. Henry and M. Conlin, “Too Much of a Good Incentive?” Business Week, March 4, 2002, pp. 38–39.


Corporate Governance Corporate Governance Mechanisms - 2Mechanisms - 2External controlsExternal controls

Corporate takeoversCorporate takeovers Takeover-imposed constraintsTakeover-imposed constraints Corporate raiders - LBOsCorporate raiders - LBOs GreenmailGreenmail

Internal / External controlsInternal / External controls Leveraged buyouts - MBOLeveraged buyouts - MBO

Managers offer to exchange equity for debt in a Managers offer to exchange equity for debt in a leveraged buyout (purchase of the company).leveraged buyout (purchase of the company).


Cascading agency relationshipsCascading agency relationships

Board of directorsBoard of directorsRepresents stockholdersRepresents stockholders

Top managementTop management

Senior executivesSenior executives

Middle managersMiddle managers

Corporate governanceCorporate governance

EmployeesEmployees

Strategic control Strategic control systemssystems


Strategic Control SystemsStrategic Control Systems To establish standards against which performance To establish standards against which performance can be measuredcan be measured To create systems for measuring and monitoring To create systems for measuring and monitoring performanceperformance To compare actual performance against targetTo compare actual performance against target To evaluate results and take corrective actionsTo evaluate results and take corrective actions Employee incentivesEmployee incentives

Employee stock options and stock ownership plansEmployee stock options and stock ownership plans Compensation tied to attainment of superior efficiency, quality, innovation, Compensation tied to attainment of superior efficiency, quality, innovation,

and responsiveness to customersand responsiveness to customers Up-or-out systemsUp-or-out systems

Balanced Scorecard model approach is used to Balanced Scorecard model approach is used to drive future performancedrive future performance


The Balanced Scorecard The Balanced Scorecard ApproachApproach


Ethics and Strategy – 1Ethics and Strategy – 1

Business ethics examines ethical rules and Business ethics examines ethical rules and principles within a commercial context principles within a commercial context The accepted principles of right or wrong The accepted principles of right or wrong governing the conduct of businesspeoplegoverning the conduct of businesspeopleEthical dilemmas occur when: Ethical dilemmas occur when:

There is no agreement over what the accepted There is no agreement over what the accepted principles areprinciples are

None of the available alternatives seem ethically None of the available alternatives seem ethically acceptableacceptable


Ethics and Strategy – 2Ethics and Strategy – 2

An ethical strategy is one that does not violate the accepted principles.

Many accepted principles are codified into laws:Many accepted principles are codified into laws: Tort laws – Tort laws – governing product liabilitygoverning product liability Contract law – Contract law – contracts and breaches of contractscontracts and breaches of contracts Intellectual property law – Intellectual property law – protection of intellectual propertyprotection of intellectual property Antitrust law – Antitrust law – governing competitive behaviorgoverning competitive behavior Securities law -Securities law - issuing and selling securitiesissuing and selling securities

Behaving ethically goes beyond staying Behaving ethically goes beyond staying

within the law within the law


Ethical Issues in StrategyEthical Issues in StrategyEthical issues are due to a potential conflict between the goals of the enterprise, the goals of the individual managers, and the rights of important stakeholders:

Self-dealingSelf-dealing Managers feather their nests with corporate moniesManagers feather their nests with corporate monies

Information manipulationInformation manipulation Distort or hide information to enhance competitive or personal situationDistort or hide information to enhance competitive or personal situation

Anti-competitive behaviorAnti-competitive behavior Actions aimed at harming actual or potential competitorsActions aimed at harming actual or potential competitors

Opportunistic exploitationOpportunistic exploitation Of other players in the value chain in which the firm is embeddedOf other players in the value chain in which the firm is embedded

Substandard working conditionsSubstandard working conditions Underinvest in working conditions or pay below market wagesUnderinvest in working conditions or pay below market wages

Environmental degradationEnvironmental degradation Directly or indirectly take actions that result in environmental harmDirectly or indirectly take actions that result in environmental harm

CorruptionCorruption Companies pay bribes to gain access to lucrative business contracts.Companies pay bribes to gain access to lucrative business contracts.

Are theseethicaldilemmas?


The Roots of Unethical BehaviorThe Roots of Unethical Behavior

Why do some managers behave unethically? Why do some managers behave unethically? No simple answers, but some generalizations:

MissionMission: Do not realize they are behaving unethically: Do not realize they are behaving unethically by failing to ask the right questionsby failing to ask the right questions

MentorMentor: Leadership promotes an organization culture : Leadership promotes an organization culture that de-emphasizes ethics and considers primarily that de-emphasizes ethics and considers primarily economic consequenceseconomic consequences

Unrealistic performance goals: encouraging and Unrealistic performance goals: encouraging and legitimizing unethical behaviorlegitimizing unethical behavior

MirrorMirror: Personal ethics code: Personal ethics code


The Friedman DoctrineThe Friedman Doctrine The only social responsibility of business is to increase The only social responsibility of business is to increase profits, profits, as long as the company stays within the law and as long as the company stays within the law and the rules of the game without deception or fraud.the rules of the game without deception or fraud.

Utilitarian and Kantian EthicsUtilitarian and Kantian Ethics The moral worth of actions is determined by its The moral worth of actions is determined by its consequences – leading to the best possible balance of consequences – leading to the best possible balance of good versus bad consequences.good versus bad consequences. Committed to the Committed to the maximization of good and the minimization of harm.maximization of good and the minimization of harm.

Philosophical Approaches to Philosophical Approaches to Ethics - 1Ethics - 1


Rights TheoriesRights Theories Recognizes that human beings have fundamental Recognizes that human beings have fundamental rights and privileges. rights and privileges. Rights establish a minimum Rights establish a minimum level of morally acceptable behavior.level of morally acceptable behavior.

Justice TheoriesJustice Theories Focus on the attainment of a just (Focus on the attainment of a just (fair and fair and equitableequitable) distribution of economic goods and ) distribution of economic goods and services.services.

Philosophical Approaches to Philosophical Approaches to Ethics - 2Ethics - 2


Thinking Through Ethical Thinking Through Ethical ProblemsProblemsA model of ethical decision makingA model of ethical decision making


SummarySummary

Stakeholder analysisStakeholder analysisWhy look beyond shareholders?Why look beyond shareholders?

Corporate governanceCorporate governanceThe agency problemThe agency problem

Strategy and ethicsStrategy and ethicsMorality and businessMorality and business

© Ram Mudambi, Temple University, 2006 Lecture 9 Governance and Business Ethics BA 950 Policy...

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