ETHICS AND GOVERNANCE

OVERVIEW

Objective

! To discuss personal, professional and organisational ethics, corporate

responsibility and governance.

ETHICS AND
GOVERNANCE

SOCIAL CORPORATE
GOVERNANCE ETHICS
RESPONSIBILITY

! Social responsibility ! Separate responsibility ! Business

! Duty of care ! Governance ! Professional
! Environmental lobby ! Legal
! Illustration ! Investors
! Dilemmas
! Diversity

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1 SOCIAL RESPONSIBILITY

1.1 Introduction

This section looks at the issues relating to the wider responsibility of the organisation
to society.

1.2 Social responsibility

Social responsibility refers to the expectation that business firms will act in the public
interest.

Businesses have always provided employment for individuals who make goods and
provide services for customers. Today there is a wider expectation that a business will
seek to preserve the environment, to sell safe products, to meet its financial obligations,
to treat its employees equitably, to be truthful with its customers, to train the long-term
unemployed, contribute to education and the arts, and help revitalise urban areas of
deprivation.

In reality, each business is part of the society in which it exists and its actions have
both economic and social effects. It would be practically impossible to isolate the
business decisions of corporations from their economic and social consequences. Top
managers may find a number of areas where their interests, various stakeholders’
interests and society’s interests are mutually compatible.

For example, a firm that pollutes the atmosphere because it fails to purchase costly
anti-pollution equipment is harming not only society but also its own stakeholders.
With a polluted environment, the quality of life of the firm’s stockholders, directors,
managers, employees, suppliers, customers and creditors suffers. Another example is
that if businesses do not contribute to the training and education of young recruits, they
will eventually experience a decline in the quality of their work force. This result
benefits none.

1.3 A duty of care

Many government regulations over business operations came into being because some
firms refused to be socially responsible. Had organisations not damaged the
environment, sold unsafe products, discriminated against some employees and engaged
in untruthful advertising, laws in these areas would not have been necessary.

The threat of increasing governmental regulation exists unless companies operate in a

manner consistent with the good of society.

Organisations that are socially responsible aim to be able to operate profitably whilst
simultaneously benefiting society. It is not always clear however what is actually good
for society. For example, society’s need for high employment and the consumer
products which result may be offset by the rapid usage of natural resources or the
creation of unpleasant waste.

Many firms in their annual reports express, at least in general terms, how they are
socially responsible. General Motors, for instance, has published an annual Public

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Interest Report for over twenty years. A recent issue described GM’s efforts in such
areas as clean air, ozone depletion, global warming, waste management, automotive
safety, minority programs, philanthropic activities, higher-quality products, and greater
operating efficiency.

1.4 The environmental lobby

Businesses frequently lobby against community regulation constraining “its” freedom

of action over

! use of natural resources - water, land, air, the living environment

! its treatment of the wastes from its operations.

New productive technologies adopted in 19th/20th century industrialisation have

increased waste products and impacted substantially on the fabric of the biosphere.
Mining, fishing and drilling exploit. Advanced chemical residues are discarded.
Weapons, new bacteria and pollutants affect the health of specific groups of people and
fauna/flora and raise the level of risk to life.

The profile of business's responsibility (general and for individuals) for environmental
stewardship is raised. “Business” has responsibility of a scale different from the
average citizen. An individual's business decisions may add to a trend particularly
where he/she controls potentially damaging technology.

1.5 Illustration

Areas in which business can act to protect and improve the welfare of society are
numerous and diverse. Perhaps the most publicised of these areas are urban affairs,
consumer affairs, environmental affairs, and employment practices. An example of
environmental affairs is The Body Shop.

Anita Roddick is the founder of The Body Shop, a successful chain of cosmetics shops
headquartered in Great Britain and spread across the world. Campaigning against
animal testing was the Body Shop’s prelude to educating the public in other areas of
environmental concern.

In 1985, the Body Shop sponsored posters for Green Peace, and used it’s own shop
premises as campaign platforms to raise public consciousness about endangered
species, the burning of tropical rainforests, acid rain and the receding ozone layer. The
shop has an environmental projects department which actively encourages trade with
the developing world, and many of the products are derived from materials used by the
people in these countries.

The Body Shop itself seeks to be socially responsible in the way it conducts its
business. Customers are discouraged from using conventional plastic carrier bags.
Reusable cotton bags are on sale, and recycled polythene is now used for free carrier
bags. Recycled paper is always used, whether it is toilet paper for staff rooms or
headed stationery for commercial purposes.

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2 CORPORATE GOVERNANCE

2.1 Introduction

The Cadbury Report (Committee on the Financial Aspects of Corporate Governance)

was published in December 1992 with a further Financial Reporting Council study in
June 1995.

2.2 Separate responsibility

The Cadbury report reported on the “propriety” of corporate governance particularly

public, quoted companies. It argued for clearly accepted division of responsibilities at
the head of a company, which will ensure a balance of power and authority, such that
no individual has unfettered powers of decision.

This reflects UK practice historically where the Chief Executive's and Chairman's
position are held by two people. The Chairman chairs the Board and oversees external
communications: with large investors and government, presenting the corporation's
public face etc. The CEO attends to executive and operational aspects - coordinating
the work of other executive directors and running the company internally.

This separation is a common UK model whereas the North America model tends to
position one person in a combined role.

2.3 Governance

The Organisation for European Co-operation and Development (OECD) Council,

meeting at Ministerial level on 27-28 April 1998, called upon the OECD to develop, in
conjunction with national governments, other relevant international organisations and
the private sector, a set of corporate governance standards and guidelines.

The Principles outlined below build upon experiences from national initiatives in
Member countries and previous work carried out within the OECD, including that of
the OECD Business Sector Advisory Group on Corporate Governance.

I. The rights of shareholders

The corporate governance framework should protect shareholders’ rights.
A. Basic shareholder rights include the right to: 1) secure methods of ownership
registration; 2) convey or transfer shares; 3) obtain relevant information on the
corporation on a timely and regular basis; 4) participate and vote in general
shareholder meetings; 5) elect members of the board; and 6) share in the profits
of the corporation.

B. Shareholders have the right to participate in, and to be sufficiently informed on,
decisions concerning fundamental corporate changes such as: 1) amendments to
the statutes, or articles of incorporation or similar governing documents of the
company; 2) the authorisation of additional shares; and 3) extraordinary
transactions that in effect result in the sale of the company.

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C. Shareholders should have the opportunity to participate effectively and vote in

general shareholder meetings and should be informed of the rules, including
voting procedures, that govern general shareholder meetings:
1. Shareholders should be furnished with sufficient and timely information
concerning the date, location and agenda of general meetings, as well as full and
timely information regarding the issues to be decided at the meeting.

2. Opportunity should be provided for shareholders to ask questions of the board

and to place items on the agenda at general meetings, subject to reasonable
limitations.

3. Shareholders should be able to vote in person or in absentia, and equal effect

should be given to votes whether cast in person or in absentia.

D. Capital structures and arrangements that enable certain shareholders to obtain a

degree of control disproportionate to their equity ownership should be disclosed.

E. Markets for corporate control should be allowed to function in an efficient and

transparent manner.

1. The rules and procedures governing the acquisition of corporate control in the
capital markets, and extraordinary transactions such as mergers, and sales of
substantial portions of corporate assets, should be clearly articulated and
disclosed so that investors understand their rights and recourse. Transactions
should occur at transparent prices and under fair conditions that protect the rights
of all shareholders according to their class.

2. Anti-take-over devices should not be used to shield management from

accountability.

F. Shareholders, including institutional investors, should consider the costs and

benefits of exercising their voting rights.

II. The equitable treatment of shareholders

The corporate governance framework should ensure the equitable treatment of all
shareholders, including minority and foreign shareholders. All shareholders should
have the opportunity to obtain effective redress for violation of their rights.
A. All shareholders of the same class should be treated equally.

1. Within any class, all shareholders should have the same voting rights. All
investors should be able to obtain information about the voting rights attached to
all classes of shares before they purchase. Any changes in voting rights should
be subject to shareholder vote.

2. Votes should be cast by custodians or nominees in a manner agreed upon with

the beneficial owner of the shares.

3. Processes and procedures for general shareholder meetings should allow for
equitable treatment of all shareholders. Company procedures should not make it
unduly difficult or expensive to cast votes.
B. Insider trading and abusive self-dealing should be prohibited.

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C. Members of the board and managers should be required to disclose any material
interests in transactions or matters affecting the corporation.

III. The role of stakeholders in corporate governance

The corporate governance framework should recognise the rights of stakeholders
as established by law and encourage active co-operation between corporations and
stakeholders in creating wealth, jobs, and the sustainability of financially sound
enterprises.
A. The corporate governance framework should assure that the rights of
stakeholders that are protected by law are respected.

B. Where stakeholder interests are protected by law, stakeholders should have the
opportunity to obtain effective redress for violation of their rights.

C. The corporate governance framework should permit performance-enhancing

mechanisms for stakeholder participation.

D. Where stakeholders participate in the corporate governance process, they should

have access to relevant information.

IV. Disclosure and transparency

The corporate governance framework should ensure that timely and accurate
disclosure is made on all material matters regarding the corporation, including the
financial situation, performance, ownership, and governance of the company.
A. Disclosure should include, but not be limited to, material information on:

1. The financial and operating results of the company.

2. Company objectives.

3. Major share ownership and voting rights.

4. Members of the board and key executives, and their remuneration.

5. Material foreseeable risk factors.

6. Material issues regarding employees and other stakeholders.

7. Governance structures and policies.

B. Information should be prepared, audited, and disclosed in accordance with high

quality standards of accounting, financial and non-financial disclosure, and audit.

C. An annual audit should be conducted by an independent auditor in order to

provide an external and objective assurance on the way in which financial
statements have been prepared and presented.

D. Channels for disseminating information should provide for fair, timely and cost-
efficient access to relevant information by users.

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V. The responsibilities of the board

The corporate governance framework should ensure the strategic guidance of the
company, the effective monitoring of management by the board, and the board’s
accountability to the company and the shareholders.
A. Board members should act on a fully informed basis, in good faith, with due
diligence and care, and in the best interest of the company and the shareholders.

B. Where board decisions may affect different shareholder groups differently, the
board should treat all shareholders fairly.

C. The board should ensure compliance with applicable law and take into account
the interests of stakeholders.

D. The board should fulfil certain key functions, including:

1. Reviewing and guiding corporate strategy, major plans of action, risk policy,
annual budgets and business plans; setting performance objectives; monitoring
implementation and corporate performance; and overseeing major capital
expenditures, acquisitions and divestitures.

2. Selecting, compensating, monitoring and, when necessary, replacing key

executives and overseeing succession planning.

3. Reviewing key executive and board remuneration, and ensuring a formal and
transparent board nomination process.

4. Monitoring and managing potential conflicts of interest of management, board

members and shareholders, including misuse of corporate assets and abuse in
related party transactions.

5. Ensuring the integrity of the corporation’s accounting and financial reporting

systems, including the independent audit, and that appropriate systems of control
are in place, in particular, systems for monitoring risk, financial control, and
compliance with the law.

6. Monitoring the effectiveness of the governance practices under which it operates

and making changes as needed.

7. Overseeing the process of disclosure and communications.

E. The board should be able to exercise objective judgement on corporate affairs

independent, in particular, from management.

1. Boards should consider assigning a sufficient number of non-executive board

members capable of exercising independent judgement to tasks where there is a
potential for conflict of interest. Examples of such key responsibilities are
financial reporting, nomination and executive and board remuneration.

2. Board members should devote sufficient time to their responsibilities.

F. In order to fulfil their responsibilities, board members should have access to

accurate, relevant and timely information.
Source: OECD

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3 ETHICS

3.1 Introduction

“A moral or ethical statement may assert that some particular action is right or wrong;
or that some actions of certain kinds are so; it may offer a distinction between good and
bad characters or dispositions; or it may propound some principle from which more
detailed judgements of these sorts might be inferred - for example that we ought always
aim at the general happiness or try to minimise the total suffering of all sentient beings,
or ....... that it is right and proper for everyone to look after himself. All such
statements express first order ethical judgements of different degrees of generality.”

J L Mackie 1977

On opposing ends of the ethical spectrum there are “deontologists” and “utilitarians”.
Deontologists weigh human rights as their main concern while advocates of utility look
at all possible consequences and the total happiness a particular action can produce.

3.2 Business ethics

A Code of Ethics for an organisation suggested by Kitson & Campbell includes the
following features:

! Conduct themselves in a manner which will merit the respect of the

community.

! Uphold the reputation of the organisation and the dignity of the profession.

! Ensure professional duties are carried out with integrity.

! Collect facts without bias.

! Care over the degree to which the views of others are allowed to influence
professional judgements and the presentation of material.

! Access to confidential information prevented for unauthorised staff or third

parties.

! Staff discouraged from using information acquired during a previous period

of employment in ways which are detrimental to their former employer.

! All material benefits enjoyed by employees will be declared.

3.3 Professional ethics

The ACCA publishes a set of rules for the conduct of students and members. This sets
out the ethical stance and code of the association. Other accounting bodies (and similar
bodies from other professions) do the same.

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3.4 Ethics legislation

In the European Union, national legislation has been supplemented by a series of EU

directives aimed at harmonising standards and practice. Some of these directives are
general, whilst others are specific to certain industries and practices. European
governments are anxious to avoid the possibility of less developed countries becoming
refuges for cheap and unsafe industrial processes.

An example of how this may occur is that a company operating within the private
sector, will be strictly profit orientated. Therefore will be less concerned with the
quality of their products in the short term. However, when taking into consideration
any long term effects, which may occur as a result of a product, the business may opt to
cease trading and operate under a totally new name and management. This eradicates
any liability it may be responsible for. On the other hand, if it is unaware of any
problems associated with the product, it may still be held accountable for the affects of
the product twenty to thirty years later, if the company is still in operation. The
European government needs to enforce export laws which ensure those products being
exported comply with legislation within the European Union.

In the UK, the Health and Safety at Work Act (1974), requires employers to fulfil their
ethical liabilities towards their employees by providing adequate health and safety
conditions at work. However, employees must co-operate with employers regarding
safety issues and take reasonable care for their own safety and that of others.
For example: particular attention has been paid to the dangers of asbestos,
radioactivity, effluents and passive smoking in recent years. The Act also defines
several criminal offences which may arise as a result of failure to exercise specific
duties, the breach of specific sections or non compliance with the requirements of an
Inspector enforcing the Act.

3.5 Ethical investors

Five years ago, socially responsible investing was beginning to look like one of the
dominant trends in the world of finance. Close to $500 billion was under ethical
management, according to the Council on Economic Priorities, which was able to claim
that “the careful research and long term view that characterise the principles of ethical
investing provide a growing number of investors with dual returns,” financial
investments that compared well to, and sometimes exceeded, the market as a whole,
and social rewards beyond mere dollars and cents.

Today, critics of socially responsible investing are questioning whether it produces

either of those two benefits. Business Ethics magazine, which tracks the 20 largest
ethical funds in the United States, reported in fall of 1996 that those funds had
produced roughly 27% returns compared to more that 32.5% for the market as a whole,
while some observers were beginning to suggest that ethical investments were failing
to produce any significant social impact.

The Social Investment Forum defines the term socially responsible investing (others
prefer ethical investing) as “the channelling of personal, community, or workplace
capital toward just, peaceful, healthy, environmentally-sound purposes and away from
destructible uses.”

Socially responsible investing (SRI) emerged as a force to be reckoned with in the ’60s,
and the focus then was on three issues: South Africa, the environment and the military-

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industrial complex. Socially responsible investors screened out companies that did
business in South Africa, were seen as polluters, or manufactured military equipment.

Today, socially responsible investors apply both negative screens (avoiding companies
they don't like) and positive screens (investing only in companies with progressive
values) to further their objectives. And the range of issues has increased, to include
tobacco, alcohol, gaming, animal rights, labour and community relations.

3.6 Ethical dilemmas

In any situation where you face an ethical dilemma, consider the:

! Magnitude of Consequences - how bad is situation?

! Probability of the Effect - how likely is it that the problem will affect
people?

! Social Consensus - What would be the opinion of society on this issue?

Would there be a high or low degree of social agreement on this issue?

! Temporal Immediacy - How long before the problem is apparent? Is there

time to take further advice, or wait for further developments, or is a decision
needed immediately?

! Proximity - How near is the decision-maker to the people affected by the

decision?

! Concentration of Effect – What is the number of people likely to be affected

and by what amount will it affect them?

This framework allows a manager to assess the size of the problem and also to consider
the implications of a decision. It can be helpful for a manager to consider the problem
in this way in order to get an overview of the situation.

Further guidelines to help the decision making process are:

! Is the problem / dilemma really what it appears to be? If you are not sure,
find out.

! Is the action you are considering legal? Ethical? If you are not sure, find out.

! Do you understand the position of those who oppose the action you are
considering? Is it reasonable?

! Whom does this action benefit? Harm? How much? How long?

! Would you be willing to allow everyone to do what you are considering

doing?

! Have you sought the opinion of others who are more knowledgeable on the
subject and who would be objective?

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! Would your action be embarrassing to you if it were made known to your

family, friends, co-workers or superiors? Would you be comfortable
defending your actions to an investigative reporter on the evening news?

Example 1

Discuss the following situation:

On arrival here this morning, your tutor reversed into a parked BMW. The tutor’s car
was not damaged, but the BMW suffered some scratches to the paintwork and part of
the trim on the door was torn away. What should your tutor do?

No solution is given for this example!

3.7 Ethical diversity

The area of ethics is complicated still further by the diversity of opinions between
individuals, industries, cultures and religions. What is perceived as unethical by one
group may be seen as perfectly acceptable to another. Ethics in business often becomes
a personal matter, rather than one for the organisation.

FOCUS

You should now be able to:

! evaluate the meaning of social responsibility

! discuss corporate social responsibility

! assess corporate conduct

! assess the governance framework

! discuss governance change

! distinguish between rights, duties and expectations of stakeholders

! review business ethics

! review ethical dilemmas

! describe the ethical spectrum

! discuss ethics at the national and international level

! explain ethics at the corporate level

! explain ethics at the manager level

! evaluate the cultural context of ethics.

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