Chapter

Eleven
Corporate
Performance,
Governance,
and Business
Ethics

Stakeholders
and Corporate Performance
Stakeholders are individuals or groups with an

interest, claim, or stake in the company, what it

does, and how well it performs.
Stakeholders are in an exchange relationship
with the company
Contributions: they supply the

with important resources

Inducements: in exchange they
expect their interests to by satisfied

organization

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

Stakeholder Impact Analysis

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 organizations perspective
Identify the resulting strategic challenges

Usually the most important:

Customers

Employees

Stockholders

Companies must identify the most important

stakeholders and give highest priority to
pursuing strategies that satisfy their needs.

The Unique Role of Stockholders

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

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.

Profitability, Profit Growth

Stakeholder Claims

and

To grow profits, companies must be doing one

or more of the following:
1.
2.
3.
4.

Participating in a market that is growing

Taking market share away from competitors
Consolidating the industry via horizontal integration
Developing new markets through:
Diversification Vertical Integration International Expansion

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

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

The Tradeoff Between Profitability

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

Figure 11.2

The Challenge for Principals

Confronted with agency problems,
the challenge for principals is to:
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
Principals try to deal with these challenges
through a series of governance mechanisms.

Governance Mechanisms
Governance 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. 3839.

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

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

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.
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

An ethical strategy is one that does not

violate the accepted principles.

Ethical Issues in Strategy

Ethical 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 businessperson
2. Do not realize they are behaving unethically:
by failing to ask the right questions
3. Organizations culture: de-emphasizes ethics
and considers primarily economic consequences
4. Unrealistic performance goals: encouraging
and legitimizing unethical behavior
5. Unethical leadership: that encourages and
tolerates behavior that is ethically suspect

Philosophical Approaches
to Ethics
Philosophical underpinnings of business ethics that can
provide managers with a moral compass to help
navigate through difficult ethical issues:

The Friedman Doctrine

Milton Friedmans 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.

Behaving Ethically
To make sure that ethical issues are considered
in business decisions, managers should:
1.
2.
3.
4.
5.
6.
7.

Favor hiring and promoting people with a

well-grounded sense of personal ethics.
Build an organizational culture that
places a high value on ethical behavior.
Make sure that leaders not only articulate but also
act in an ethical manner.
Put decision-making processes in place that require
people to consider the ethical dimension of business
decisions.
Use ethics officers.
Put strong corporate governance processes in place.
Act with moral courage and encourage others to
do the same.