1. Ethical problems of organizations (part 1) Geoffrey G. Bell, PhD, CA University of Minnesota Duluth November, 2003

2. Recent ethical problems Enron (phony accounting, phony business, unfair treatment of employees, etc.) WorldCom (phony accounting) Waste Management (questionable accounting) Arthur Andersen (facilitating accounting problems, ethics partners answer to clients, not partnership) Merrill Lynch (conflicts between investment banking and analysis, compensating analysts based on investment banking fees) Citigroup (enabled Enron with questionable banking products).

3. Stakeholder theory – an overview Freeman (1988; 1994) developed a normative “stakeholder theory of the firm” wherein all actors with a stake in the firm have a voice in its decisions. “Normative” implies “ought” – this is the ways firms ought to behave. “Normative” implies “ought” – this is the ways firms ought to behave. Many management scholars are interpreting this as a descriptive theory instead. Many management scholars are interpreting this as a descriptive theory instead. Stakeholders are people and groups who affect, or can be affected by, the firm’s decisions, policies, and operations. Includes both actors with direct stake in the corporation (e.g., employees, customers) and those affected by “public goods” nature of corporate decisions (e.g., local community and air pollution). Note that people who bear risk and people who benefit are not necessarily the same.

4. Primary & Secondary Stakeholders Primary Stakeholders Actors who are critical to firm’s existence and activities. Relationships occur in conjunction with the normal activities of the business. Secondary stakeholders Actors who are affected, directly or indirectly, by the firm’s activities and decisions. Relationships occur as a consequence of the normal activities of the business.

5. Who are “generally-accepted” Stakeholders? EmployeesSuppliersCustomers The community at large Shareholders Management’s role is to assess whose interests should predominate on any given issue.

6. Should we adopt a stakeholder view? The contrary position is advocated by neo- conservative economists like Milton Friedman, who state that: The only duty of management is to maximize shareholder wealth. Anything else is a tax imposed by unelected groups (consumer advocacy groups, women's’ rights groups, tree-huggers, etc). If other ends are socially desirable, they should be achieved via formal legislation, not response to some unaccountable “stakeholder” group.

7. What are the benefits and pitfalls of a stakeholder approach? BenefitsPitfalls

8. Consumer ethics Consumer protection legislation is fairly recent. In 1962 speech, President Kennedy outlined consumer rights: Safety Safety Be heard Be heard Choice Choice Be informed. Be informed. Products & services produced & delivered with due care.

9. What does due care mean? Design – products should meet all government regulations & be safe under all foreseeable circumstances, including consumer misuse. Materials – should meet government regulations and durable enough to withstand reasonable use. Production – no defects. Quality control – inspect for quality. Packaging, labeling, and warnings – safe packaging; clear, easily understood directions; clear description of hazards. Notification – for product recalls.

10. Conflicts of Interest @ Enron

11. Enron top management Fastow’s creation of partnerships placed him in conflict (he won only if Enron lost). Ken Lay told people to buy Enron stock while he was selling. Changed plan administrators for employee 401(k) plan, locking employees’ holdings in during last month when top management was bailing. Arthur Andersen Garnered large consulting fees, so couldn’t jeopardize them with audit results. Audit review partner answerable to local partner in charge of audit; not CEO of AA. Wall Street financiers Because Enron brought large investment banking fees, didn’t want to issue negative analysts’ opinions. Gained fees by developing instruments that helped Enron remove debt from books (& then sold same products to other firms). Law firms Firms advising Enron on legality of partnerships profited by developing them with the bankers & AA.

12. Costs of Enron debacle Text estimates costs of Enron failure at $35 billion. Arthur Andersen went out of business, leaving only 4 major accounting firms in US.

13. Other conflicts of interest on Wall Street Problems with IPO market. See video “don.con” for examples. Basically, firms went IPO too soon, before they were ready. Made them more risky than normal. Investment bankers purposely under priced IPO issues, leading to a big “pop” and increasing attractiveness of IPOs, but costing new IPO valuable start-up funds. Allocation of IPOs based on favors by investment banks, not on equal availability to all. Clear conflict, as market is not equal, but bankers can use IPO allocations to develop relationships. Clear conflict, as market is not equal, but bankers can use IPO allocations to develop relationships.