Corporate Performance, Governance, and Business Ethics Chapter Eleven Corporate Performance, Governance, and Business Ethics

Stakeholders and Corporate Performance Stakeholders are individuals or groups with an interest, claim, or stake in the company, what it does, and how well it performs. Stakeholders are in an exchange relationship with the company Contributions: they supply the organization with important resources Inducements: in exchange they expect their interests to by satisfied Companies should pursue strategies that maximize long-run shareholder value and must also behave in an ethical and socially responsible manner. Copyright © Houghton Mifflin Company. All rights reserved.

Stakeholders and the Enterprise Figure 11.1 Copyright © Houghton Mifflin Company. All rights reserved.

Stakeholder Impact Analysis Identify stakeholders most critical to survival: Identify which stakeholders The stakeholders’ interests and concerns Claims stakeholders are likely to make on the organization Stakeholders who are most important to the organization’s perspective Identify the resulting strategic challenges Usually the most important: Customers • Employees • Stockholders Companies must identify the most important stakeholders and give highest priority to pursuing strategies that satisfy their needs. Copyright © Houghton Mifflin Company. All rights reserved.

The Unique Role of Stockholders Stockholders are a company’s legal owners and the provider of risk capital, a major source of capital to operate a business. Risk capital – No guarantee to the stockholders that: They will recoup their investment Or earn a decent return ESOPs – Employee Stock Option Plans Employees may also be shareholders Maximizing long-run profitability & profit growth is the route to maximizing returns to shareholders, as well as satisfying the claims of most other stakeholder groups. Copyright © Houghton Mifflin Company. All rights reserved.

Profitability, Profit Growth and Stakeholder Claims To grow profits, companies must be doing one or more of the following: Participating in a market that is growing Taking market share away from competitors Consolidating the industry via horizontal integration Developing new markets through: • Diversification • Vertical Integration • International Expansion Stockholders receive their returns as: Dividend payments Capital appreciation in market value of shares ROIC is an excellent measure of profitability. A company generating positive ROIC is adding to shareholders’ equity and increasing shareholder value. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Agency Theory Agency relationships arise whenever one party delegates decision-making authority or control over resources to another. Principal-agent relationships Principal: person delegating authority Agent: person to whom authority is delegated The agency problem: Agents and principals may have different goals. Agents may pursue goals that are not in the best interests of their principals. Agents may take advantage of information asymmetries to maximize their interests at the expense of principals. It is difficult for principals to measure performance. Trust • On-the-job consumption • Empire building Copyright © Houghton Mifflin Company. All rights reserved.

The Tradeoff Between Profitability and Revenue Growth Rates Need to maximize long-run shareholder returns by seeking the right balance between company growth . . . and profitability and profit growth. Figure 11.2 Copyright © Houghton Mifflin Company. All rights reserved.

The Challenge for Principals Confronted with agency problems, the challenge for principals is to: Shape the behavior of agents so that they act in accordance with goals set by principals Reduce information asymmetry between agents and principals Develop mechanisms for removing agents who do not act in accordance with goals and principals Principals try to deal with these challenges through a series of governance mechanisms. Copyright © Houghton Mifflin Company. All rights reserved.

Governance Mechanisms Governance mechanisms serve to limit the agency problem by aligning incentives between agents and principals and by monitoring and controlling agents. The Board of Directors Elected by stockholders Legally accountable Monitors corporate strategy decisions Authority to hire, fire, and compensate Ensures accuracy of audited financial statements Inside directors Outside directors Stock-Based Compensation Pay-for-performance Stock options: The right to buy company shares at a predetermined price at some point in the future Financial Statements Auditors • SEC • GAAP The Takeover Constraint Limits strategies that ignore shareholder interests Corporate raiders Copyright © Houghton Mifflin Company. All rights reserved.

How Options Skew the Bottom Line Table 11.1 Source: D. Henry and M. Conlin, “Too Much of a Good Incentive?” Business Week, March 4, 2002, pp. 38–39. Copyright © Houghton Mifflin Company. All rights reserved.

Governance Mechanisms Inside a Company Important agency relationships also exist between levels of management within a company. Internal agency problems can be reduced by: Strategic control systems To establish standards against which performance can be measured To create systems for measuring and monitoring performance To compare actual performance against targets To evaluate results and take corrective actions Balanced Scorecard model approach is used to drive future performance Employee incentives Employee stock options and stock ownership plans Compensation tied to attainment of superior efficiency, quality, innovation, and responsiveness to customers Copyright © Houghton Mifflin Company. All rights reserved.

A Balanced Scorecard Approach Figure 11.3 Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Ethics and Strategy Business ethics are the accepted principles of right or wrong governing the conduct of businesspeople. Ethical dilemmas occur when: There is no agreement over what the accepted principles are None of the available alternatives seem ethically acceptable Many accepted principles are codified into laws: Tort laws – governing product liability Contract law – contracts and breaches of contracts Intellectual property law – protection of intellectual property Antitrust law – governing competitive behavior Securities law - issuing and selling securities Behaving ethically goes beyond staying within the law An ethical strategy is one that does not violate the accepted principles. Copyright © Houghton Mifflin Company. All rights reserved.

Ethical Issues in Strategy Ethical issues are due to a potential conflict between the goals of the enterprise, or the goals of the individual managers, and the rights of important stakeholders: Self-dealing Managers feather their nest with corporate monies Information manipulation Distort or hide information to enhance competitive or personal situation Anticompetitive behavior Actions aimed at harming actual or potential competitors Opportunistic exploitation Of other players in the value chain in which the firm is embedded Substandard working conditions Underinvest in working conditions or pay below market wages Environmental degradation Directly or indirectly take actions that result in environmental harm Corruption Companies pay bribes to gain access to lucrative business contracts. Copyright © Houghton Mifflin Company. All rights reserved.

The Roots of Unethical Behavior Why do some managers behave unethically? No simple answers, but some generalizations: Personal ethics code: will have a profound influence on behavior as a businessperson Do not realize they are behaving unethically: by failing to ask the right questions Organization’s culture: de-emphasizes ethics and considers primarily economic consequences Unrealistic performance goals: encouraging and legitimizing unethical behavior Unethical leadership: that encourages and tolerates behavior that is ethically suspect Copyright © Houghton Mifflin Company. All rights reserved.

Philosophical Approaches to Ethics Philosophical underpinnings of business ethics that can provide managers with a moral compass to help navigate through difficult ethical issues: The Friedman Doctrine Milton Friedman’s basic position is that the only social responsibility of business is to increase profits, as long as the company stays within the law and the rules of the game without deception or fraud. Utilitarian and Kantian Ethics The moral worth of actions is determined by its consequences – leading to the best possible balance of good versus bad consequences. Committed to the maximization of good and the minimization of harm. Rights Theories Recognizes that human beings have fundamental rights and privileges. Rights establish a minimum level of morally acceptable behavior. Justice Theories Focus on the attainment of a just distribution of economic goods and services that is considered to be fair and equitable. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Behaving Ethically To make sure that ethical issues are considered in business decisions, managers should: Favor hiring and promoting people with a well-grounded sense of personal ethics. Build an organizational culture that places a high value on ethical behavior. Make sure that leaders not only articulate but also act in an ethical manner. Put decision-making processes in place that require people to consider the ethical dimension of business decisions. Use ethics officers. Put strong corporate governance processes in place. Act with moral courage and encourage others to do the same. Copyright © Houghton Mifflin Company. All rights reserved.