Chapter Eleven Corporate Performance, Governance, and Business Ethics

Chapter Eleven

Corporate Performance, Governance, and Business

Ethics

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Stakeholders and Corporate Performance

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

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

Companies should pursue strategies that maximize long-run shareholder value and

must also behave in an ethical and socially responsible manner.


Stakeholders and the Enterprise

Figure 11.1


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

Stakeholder Impact Analysis

Companies must identify the most important stakeholders and give highest priority to

pursuing strategies that satisfy their needs.


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

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

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.

The Unique Role of Stockholders


Profitability, Profit Growth and Stakeholder Claims

1. Participating in a market that is growing2. Taking market share away from competitors3. Consolidating the industry via horizontal integration4. Developing new markets through: • Diversification • Vertical Integration • International Expansion

To grow profits, companies must be doing one or more of the following:

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.


Agency Theory

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

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


The Tradeoff Between Profitability and Revenue Growth Rates

Figure 11.2Need to maximize long-run shareholder returns by seeking the right balance between company growth . . . and profitability and profit growth.


The Challenge for Principals

1. Shape the behavior of agents so that they act in accordance with goals set by principals

2. Reduce information asymmetry between agents and principals

3. Develop mechanisms for removing agents who do not act in accordance with goals and principals

Confronted with agency problems, the challenge for principals is to:

Principals try to deal with these challenges through a series of governance mechanisms.


Governance MechanismsGovernance 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


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.


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 • 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

Important agency relationships also exist between levels of management within a company. Internal agency problems can be reduced by:


A Balanced Scorecard Approach

Figure 11.3


Ethics and Strategy

Business ethics are the accepted principles of right or wrong governing the conduct of businesspeople.

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

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


Ethical Issues in StrategyEthical 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.


The Roots of Unethical Behavior

Why do some managers behave unethically?No simple answers, but some generalizations:1. Personal ethics code: will have a profound

influence on behavior as a businessperson2. Do not realize they are behaving unethically:

by failing to ask the right questions3. Organization’s culture: de-emphasizes ethics

and considers primarily economic consequences4. Unrealistic performance goals: encouraging

and legitimizing unethical behavior5. Unethical leadership: that encourages and

tolerates behavior that is ethically suspect


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.

Philosophical Approaches to Ethics


To make sure that ethical issues are considered in business decisions, managers should:1. Favor hiring and promoting people with a well-

grounded sense of personal ethics.2. Build an organizational culture that

places a high value on ethical behavior.3. Make sure that leaders not only articulate but also

act in an ethical manner.4. Put decision-making processes in place that require

people to consider the ethical dimension of business decisions.

5. Use ethics officers.6. Put strong corporate governance processes in place.7. Act with moral courage and encourage others to

do the same.

Behaving Ethically

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Chapter Eleven Corporate Performance, Governance, and Business Ethics