Corporate Performance, Governance, and Business Ethics 11 Corporate Performance, Governance, and Business Ethics

Topics Stakeholder analysis: whose interest should we consider? Agency theory: how do we understand and manage relationship among key players, e.g. management and owners? Ethics: what ‘rules’ can or do we apply? Change management Business and society/government

Stakeholder Impact Analysis Identify the stakeholders most critical to survival Identify stakeholders. Identify stakeholders’ interests and concerns. As a result, identify what claims stakeholders are likely to make on the organization. Identify the stakeholders who are most important to the organization’s perspective. Identify the resulting strategic challenges. Usually the most important: Customers, employees, stockholders

Stakeholders and the Enterprise

Exercises 1st day (#1) Pick either the company in the Opening Case (Enron) or the Strategy in Action 11.3 (Barings): List relevant stakeholders and their interests.

The Unique Role of Stockholders Legal owners Providers of risk capital, a major source of capital No guarantee that stockholders will recoup their investment or earn a decent return Maximizing return to stockholders Employees as stockholders

Profitability and Stakeholder Claims Stockholders’ returns Dividend payments Capital appreciation in market value of a share Maximizing long-run ROIC Within limits set by law In a manner consistent with societal expectations

Relationship Between ROIC, Stakeholder Satisfaction, and Stakeholder Support

Poor Performance Poor management – each factor in list (next slides) by itself is not sufficient to bring a company down. Structural shifts are often ignored during good performance, blamed when no one management factor is clear Difficult to measure due to asymetry of information

The Causes of Poor Performance Poor management Sheer incompetence Neglect of core business Insufficient number of good managers Dominant, autocratic chief executive with passion for empire-building Autocratic manager who tries to do it all in the face of complexity and change

The Causes of Poor Performance Poor management (cont’d) Lack of balanced expertise at the top Lack of strong middle management Lack of succession planning Failure by board to monitor strategic decisions Unethical behavior

The Causes of Poor Performance (cont’d) High cost structure Low labor productivity Low capital productivity Inadequate financial controls Inadequate differentiation Poor product quality Lack of compelling product attributes

The Causes of Poor Performance (cont’d) Overexpansion Empire-building that adds little value Loss of control Declining profitability Structural shifts in demand and new competitors Technology Economic or political conditions Social and cultural norms

The Causes of Poor Performance (cont’d) Organizational inertia Distribution of power and influence in the organization Organization culture Preconceptions about the appropriate business model

Agency Theory Problems can arise in a business relationship when one person delegates decision making authority to another

Agency Theory continued Principal-agent relationships Agency relationship: when one party delegates decision-making authority to another Principal: person delegating authority Agent: person to whom authority is delegated Key issue: asymmetry of information

The Agency Problem Agents and principals may have different goals Agents may pursue goals that are not in the best interests of their principals Due to information asymmetry, principals may not know any better

The Agency Problem continued Difficult for principals to measure performance Trust On-the-job consumption Empire building

Exercise 1st day (#2) Refer to the Opening Case (Enron) and Strategy in Action 11.3 (Barings): Describe the Agency Problem. Who was (were) the principal(s)? Agent(s)? Assymetry of information

The Challenge for Principals Shape the behavior of agents so that they act in accordance with goals set by principals Reduce information asymmetry Develop mechanisms for removing agents who do not act in accordance with goals of principals

Governance Mechanisms 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

Governance Mechanisms (cont’d) Stock-based compensation Pay-for-performance Stock options The right to buy company shares at a predetermined price at some point in the future

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

Governance Mechanisms (cont’d) Financial statements and auditors SEC GAAP The takeover constraint Corporate raiders Greenmail

Governance Mechanisms Inside a Company Strategic control systems To establish standards against which performance can be measured To create systems for measuring and monitoring performance regularly To compare actual performance against targets To evaluate results and take corrective actions

A Balanced Scorecard Approach

Governance Mechanisms Inside a Company (cont’d) Employee incentives Employee stock ownership plans Stock options Compensation tied to attainment of superior efficiency, quality, innovation, and responsiveness to customers

The Purpose of Business Ethics To give people the tools for dealing with moral complexity in business Business decisions have an ethical component Ethical implications must be weighed before acting

Ethics and Strategy Ethical decision Unethical decision One that typical stakeholders would find acceptable because it aids stakeholders, the organization, or society Unethical decision One that a manager would prefer to disguise or hide because it enables a company or individual to gain at the expense of society or other stakeholders

Shaping the Ethical Climate of an Organization Top managers must use their leadership position to incorporate an ethical dimension into the values they stress Ethical values must be incorporated into the company’s mission statement Ethical values must be acted on

Comparing Utilitarian, Moral Rights, and Justice

Comparing Utilitarian, Moral Rights, and Justice

Comparing Utilitarian, Moral Rights, and Justice

Exercise 1st day (#3) Refer to the Closing Case: Chainsaw Al . . . . Explain the ethical situation in this case from the point of view of the Board of Directors. (Use the questions at the end as a guide.)

Exercises 2nd day (#1) NIKE: Discuss what the ethical challenge is? List relevant stakeholders and their interests. Applying model you are comfortable with, what is the ethical dilemma or challenge? What would be the ethical issue from the point of view of Chairman of NIKE?

Thinking Through Ethical Problems Does my decision fall within the accepted values or standards that typically apply in the organizational environment? Am I willing to see the decision communicated publicly to all stakeholders affected by it?

Thinking Through Ethical Problems Would the people with whom I have a significant personal relationship approve of the decision? Can I tell my mother?

Exercises 2nd day (#2) Refer to articles #1, 2, and 3. Define the list of relevant stakeholders and their interests. Apply a model you are comfortable with and describe the ethical decision(s) or challenge(s). What would you do if you were heading these companies?

Thinking Through Ethical Problems (cont’d) Step 1: Identify which stakeholders the decision would affect and in what ways Step 2: Judge the ethics of the proposed strategic decision given the information from Step 1 Step 3: Establish moral intent (resolve to place moral concerns ahead of other concerns) Step 4: Engage in ethical behavior

Strategic Change: Improving Performance Changing the leadership New leader is often from outside the company New leader must make difficult decisions, motivate, listen, and delegate Changing the strategy Redefine strategic focus Divest unwanted assets Improve profitability Make acquisitions

Strategic Change: Improving Performance (cont’d) Changing the organization Unfreezing the organization Big bang theory of change Senior managers must be committed to it Movement Speed Involving employees Refreezing the organization Culture, socialization, management education programs Hiring policies, control and incentive systems

CASE BRIEF Refer to articles # 4 & 5 (hand out 3/09). Discuss a key ethical issue common to both situations described in these articles, from the perspective of a member of the Board of Directors of the company or companies involved. Include in your discussion, what can agency theory tell us about the challenge or challenges, if any, posed by these situations to an ethically responsible member of the Board of Directors.

Exercise 2nd day NIKE’s attempt to improve on their corporate responsibility How much is enough? How can an organization contain unethical behavior? From a responsible board’s perspective? What does Agency theory tell us

Governance and ethics Finish articles on lobbying Business and government Role of government vis business Lobbying Implementing change

Business and government What is the role of business in the economy? Why lobby? Lobbying has been going on for years Objectives of these lobbying activities? Are these legitimate activities? Ethical issues?

Corporate Governance Examine the activities in each of articles 4 & 5 that were “questionable” Stakeholders and interests What laws were violated? Ethical challenge

Exercise 3rd day Pick either article #4 or #5. Take the perspective of senior management, i.e. CEO of the company Identify the stakeholders and their interest Which model do you use and what should be or should have been the course of action?

Exercise Refer to articles 1, 2, 3, 4, & 5: Which is illegal and unethical? Which is illegal? Explain!