Chapter Four

Ethical Theories:
Enlightened Self-interest Contractarianism Feminist Ethics Ethical Relativism and Absolutism
Copyright 2010 Pearson Education Canada / J A McLachlan

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Enlightened Self-interest
Thomas Hobbes

The natural condition of humans is constant conflict. We must impose moral and legal structures upon ourselves in order to live together.
This means subjecting our natural egoism to the following eight restraints:
(Continued)
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Enlightened Self-interest
1. Claim as much liberty as we are willing to grant to others. 2. Keep promises and perform contracts to which we have agreed. 3. Acknowledge the equality of all. 4. Do not demand of others what we are unwilling to do ourselves.
(Continued)
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Enlightened Self-interest
5. Things that cannot be divided should be shared in common. 6. People who disagree should submit their dispute to arbitrators. 7. Judges should be impartial. 8. We should not do to others what we dont want them to do to us.
(Continued)
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Enlightened Self-interest
It is in our own best interest that everyone, including we ourselves, lives by these restraints, in order to escape anarchy. Therefore, according to enlightened selfinterest, an action is morally acceptable if it benefits an individual (or organization) without intentionally harming others, and the benefits counterbalance the harm.
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Applying Enlightened Self-interest

Dr. Kevorkian was convicted and imprisoned for performing physician-assisted suicide on his terminally-ill patients at their request.

According to enlightened self-interest (an action is morally acceptable if it benefits an individual without intentionally harming others, and the benefits counterbalance the harm) were his actions ethical or unethical?
Copyright 2010 Pearson Education Canada / J A McLachlan

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Proponents and Critics View of Enlightened Self-interest

What are some arguments that someone who believed in enlightened self-interest would give to support this ethical framework? What are some arguments that someone who did not agree with enlightened selfinterest would make to criticize this ethical framework?
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Contractarianism
John Rawls

An implied agreement or social contract intended to ensure equality and justice for all members of a society. We reach this agreement by three steps:

1. Consider your contingent attributes (the physical, psychological, intellectual, cultural and social attributes which limit ones freedom and cause inequity between people.)
(Continued)
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Contractarianism
2. Imagine an unbiased original position (a condition of not yet knowing our personal contingent attributes.)

3. Determine what moral and legal rules you would agree to in a state of ignorance, to protect your primary goods.
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Rawls Three Primary Goods

1. Health (access to health care) 2. Liberty (freedom to pursue our interests within acceptable bounds) 3. Opportunity (to achieve secondary wants [wealth, etc.] through our own efforts)
Copyright 2010 Pearson Education Canada / J A McLachlan

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Applying Contractarianism
Consider a rule at work or in school, which you do not agree with.
Why do you consider it wrong? Under what circumstances (consider different contingent attributes) would you appreciate this rule? If you did not know what your contingent attributes would be, would you make this rule? If not, what rule would you make (from the original position) for this situation? Does your rule protect the primary goods of everyone concerned?

Copyright 2010 Pearson Education Canada / J A McLachlan

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Proponents and Critics View of Contractarianism

What are some arguments that someone who believed in contractarianism would give to support this ethical framework?

What are some arguments that someone who did not agree with contractarianism would make to criticize this ethical framework?
Copyright 2010 Pearson Education Canada / J A McLachlan

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Feminist Ethics
Ethics of Careintent is to strengthen relationships and sense of community Originated in Carol Gilligans studies of female moral development Emphasis is on sensitivity, caring and ones responsibility to others, rather than on objectivity and individuality
(Continued)
Copyright 2010 Pearson Education Canada / J A McLachlan

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Feminist Ethics
Rules must be substantively equal for women and men, and take into consideration the different roles and responsibilities men and women hold at work and also outside of work.

Copyright 2010 Pearson Education Canada / J A McLachlan

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Applying Feminist Ethics

Name some workplace issues that affect female employees. How might the following be perceived to be substantively unfair to women:

Equal numbers of sick days and personal leave days?

Hiring practices that rely on networking? Promotions and salary grids measured in months of work accrued?
(Continued)
Copyright 2010 Pearson Education Canada / J A McLachlan

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Applying Feminist Ethics

What policies would be substantively fair to all employees? Consider a current social issue, such as same-sex marriage. Which side of that issue shows a more caring approach to others? Which side promotes and strengthens relationships between people?
Copyright 2010 Pearson Education Canada / J A McLachlan

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Proponents and Critics View of Feminist Ethics

What are some arguments that someone who believed in feminist ethics would give to support this ethical framework? What are some arguments that someone who did not agree with feminist ethics would make to criticize this ethical framework?
Copyright 2010 Pearson Education Canada / J A McLachlan

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Ethical Relativism and Absolutism

Ethical relativism means that what is morally right or wrong is relative to the situation or to the culture you are in.

Ethical absolutism means that what is morally right or wrong is absolute, no matter what the situation is or what country or culture you are in.
Copyright 2010 Pearson Education Canada / J A McLachlan

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Absolutism
Moral truths are the same for everyone. All morals are absolute no matter what the situation. Some morals are absolute in any situation, others are relative to the situation.
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Copyright 2010 Pearson Education Canada / J A McLachlan

Cultural Relativism
Moral truths are relative to each culture but the same for everyone within the culture. All morals are relative to the culture.
Copyright 2010 Pearson Education Canada / J A McLachlan

Some morals are relative to the culture, others are absolute.

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Individual relativism
Moral truths are relative to each individual.

All morals are relative to the individual.

Some morals are relative to the individual, others are absolute.

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Copyright 2010 Pearson Education Canada / J A McLachlan

Theoretical Approaches
Deontological (duty or principles)

Teleological (ends or consequences) Socrates Healthy Soul

Utilitarianism (J. S. Mill Enlightened Self-interest Contractarianism (Rawls) Feminist Ethics

Divine Command Theory

Kantian Duty Ethics Virtue Ethics (Aristotle)

Absolutism
Copyright 2010 Pearson Education Canada / J A McLachlan

Relativism
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Normative and Descriptive Ethics

Descriptive ethics describes the ethical culture of an organization. Normative ethics sets a norm or standard for ethical behaviour. They are often used to analyze the current ethical climate or culture within an organization (descriptive) and to compare it to an ideal or desired standard of ethical behaviour (normative).
(Continued)
Copyright 2010 Pearson Education Canada / J A McLachlan

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Normative and Descriptive Ethics

Descriptive Ethics Observes and describes peoples actual behaviour Explains why people behave this way The behaviour we exhibit defines us
Copyright 2010 Pearson Education Canada / J A McLachlan

Normative Ethics Sets a standard for how people ought to behave

Justifies why people ought to behave this way Our conscious choices of action define us
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Corporate Governance
Corporate governance is:
A relationship among stakeholders used to determine and control the strategic direction and performance of organizations Concerned with making strategic decisions more effectively Used to establish order between a firms owners and its top-level managers whose interests may be in conflict
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Internal Governance Mechanisms

Ownership Concentration
Relative amounts of stock owned by individual shareholders and institutional investors

Board of Directors
Individuals responsible for representing the firms owners by monitoring top-level managers strategic decisions

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Internal Governance Mechanisms

Executive Compensation
Use of salary, bonuses, and long-term incentives to align managers interests with shareholders interests

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External Governance Mechanisms

Market for Corporate Control
Purchase of a firm that is underperforming relative to industry rivals in order to improve its strategic competitiveness

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Separation of Ownership and Managerial Control

Basis of the Modern Corporation
Shareholders purchase stock, becoming residual claimants Shareholders reduce risk by holding diversified portfolios Professional managers are contracted to provide decision making

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Separating Ownership and Managerial Control

Modern public corporation form leads to efficient specialization of tasks:
Risk bearing by shareholders Strategy development and decision making by managers

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An Agency Relationship
Hire

and create

Figure 10.1 31

Agency Relationship Problems

Principal and agent have divergent interests and goals Shareholders lack direct control of large, publicly traded corporations Agent makes decisions that result in the pursuit of goals that conflict with those of the principal It is difficult or expensive for the principal to verify that the agent has behaved appropriately Agent falls prey to managerial opportunism
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Managerial Opportunism
The seeking of self-interest with guile (cunning or deceit) Managerial opportunism is:
An attitude (inclination) A set of behaviors (specific acts of selfinterest)

Managerial opportunism prevents the maximization of shareholder wealth (the primary goal of owner/principals)
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Response to Managerial Opportunism

Principals do not know beforehand which agents will or will not act opportunistically Thus, principals establish governance and control mechanisms to prevent managerial opportunism

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Examples of the Agency Problem

Possible Problems
Product diversification Increased size, and relationship of size to managerial compensation Reduction of managerial employment risk

Use of Free Cash Flows

Managers prefer to invest these funds in additional product diversification (see above) Shareholders prefer the funds as dividends so they control how the funds are invested
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Agency Costs and Governance Mechanisms

Principals may engage in monitoring behavior to assess the activities and decisions of managers
However, dispersed shareholding makes it difficult and inefficient to monitor managements behavior

Boards of Directors have a fiduciary duty to shareholders to monitor management

However, Boards of Directors are often accused of being lax in performing this function
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Governance Mechanisms
Ownership Concentration (a)

Large block shareholders have a strong incentive to monitor management closely:

Their large stakes make it worth their while to spend time, effort and expense to monitor closely They may also obtain Board seats which enhances their ability to monitor effectively

Financial institutions are legally forbidden from directly holding board seats
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Governance Mechanisms (contd)

Ownership Concentration (b)

The increasing influence of institutional owners (stock mutual funds and pension funds)
Have the size (proxy voting power) and incentive (demand for returns to funds) to discipline ineffective toplevel managers Can affect the firms choice of strategies
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Governance Mechanisms (contd)

Ownership Concentration (c)

Shareholder activism:
Shareholders can convene to discuss corporations direction If a consensus exists, shareholders can vote as a block to elect their candidates to the board Proxy fights There are limits on shareholder activism available to institutional owners in responding to activists tactics 39

Governance Mechanisms (contd)

Ownership Concentration Board of Directors (a)

Board of directors
Group of elected individuals that acts in the owners interests to formally monitor and control the firms top-level executives

Board has the power to:

Direct the affairs of the organization Punish and reward managers Protect owners from managerial opportunism

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Governance Mechanisms (contd)

Ownership Concentration Board of Directors (b)

Composition of Boards:
Insiders: the firms CEO and other top-level managers Related Outsiders: individuals uninvolved with day-to-day operations, but who have a relationship with the firm Outsiders: individuals who are independent of the firms day-to-day operations and other relationships
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Governance Mechanisms (contd)

Ownership Concentration Board of Directors (c)

Criticisms of Boards of Directors include:

Too readily approve managers selfserving initiatives Are exploited by managers with personal ties to board members Are not vigilant enough in hiring and monitoring CEO behavior Lack of agreement about the number of and most appropriate role of outside directors

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Governance Mechanisms (contd)

Ownership Concentration Board of Directors (d)

Enhancing the effectiveness of boards and directors:

More diversity in the backgrounds of board members Stronger internal management and accounting control systems More formal processes to evaluate the boards performance Adopting a lead director role Changes in compensation of directors

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Governance Mechanisms (contd)

Ownership Concentration

Forms of compensation:
Salary, bonuses, long-term performance incentives, stock awards, stock options

Board of Directors

Executive Compensation (a)

Factors complicating executive compensation:

Strategic decisions by top-level managers are complex, non-routine and affect the firm over an extended period Other variables affecting the firms performance over time
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Governance Mechanisms (contd)

Ownership Concentration

Limits on the effectiveness of executive compensation:

Unintended consequences of stock options Firm performance not as important than firm size Balance sheet not showing executive wealth Options not expensed at the time they are awarded

Board of Directors

Executive Compensation (b)

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Governance Mechanisms (contd)

Ownership Concentration

Individuals and firms buy or take over undervalued corporations

Ineffective managers are usually replaced in such takeovers

Board of Directors

Executive Compensation Market for Corporate Control (a)

Threat of takeover may lead firm to operate more efficiently Changes in regulations have made hostile takeovers difficult
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Governance Mechanisms (contd)

Ownership Concentration

Managerial defense tactics increase the costs of mounting a takeover Defense tactics may require:
Asset restructuring Changes in the financial structure of the firm Shareholder approval

Board of Directors

Executive Compensation Market for Corporate Control (b)

Market for corporate control lacks the precision

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International Corporate Governance:

Japan
Important governance factors:
Obligation Family Consensus

Banks (especially main bank) are highly influential with

firms managers

Keiretsus: strongly interrelated

groups of firms tied together by cross-shareholdings
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International Corporate Governance

Japan (contd) Other governance characteristics:
Powerful government intervention Close relationships between firms and government sectors Passive and stable shareholders who exert little control Virtual absence of external market for corporate control
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Governance Mechanisms and Ethical Behavior

It is important to serve the interests of the firms multiple stakeholder groups!
Capital Market Stakeholders

Shareholders in this group are viewed as the most important stakeholder group
The focus of governance mechanisms is to control managerial decisions to assure shareholder interests Interests of shareholders is served by the Board of Directors
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Governance Mechanisms and Ethical Behavior (contd)

It is important to serve the interests of the firms multiple stakeholder groups!
Capital Market Stakeholders Product Market Stakeholders

Product market stakeholders (customers, suppliers and host communities) and organizational stakeholders may withdraw their support of the firm if their needs are not met, at least minimally

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Governance Mechanisms and Ethical Behavior (contd)

It is important to serve the interests of the firms multiple stakeholder groups!
Capital Market Stakeholders Product Market Stakeholders Organizational Stakeholders

Some observers believe that ethically responsible companies design and use governance mechanisms that serve all stakeholders interests Importance of maintaining ethical behavior is seen in the examples of Enron, WorldCom, HealthSouth, Tyco, Adelphi, and Ahold NV 52