Chapter 4: The Corporation and External Stakeholders

chapter 4

the corporation and external stakeholders.

Corporate Governance: From the boardroom to the marketplace

topics covered

4.1Managing Corporate Social Responsibility in the Marketplace

4.2Managing Corporate Responsibility with External Stakeholders

4.3Managing and Balancing Corporate Governance, Compliance, and Regulation

4.4The Role of Law and regulatory Agencies in Corporate Compliance

4.5Managing External Issues and Crises: Lessons from the Past (Back to the Future?)

lecture outline

4.1Managing Corporate Social Responsibilityin the Marketplace

Corporate social; responsibility (CSR) involves an organization’s duty and obligation to respond to its stakeholders’ and the stockholders’ economic, legal, ethical, and philanthropic concerns and issues. The basis of corporate social responsibility in the marketplace begins with a question: What is the philosophical and ethical context from which corporate social responsibility and ethical decisions are made? The roots of corporate social responsibility extend to the topic of what a “free market” is and how corporations should operate in free markets.

A.Free-Market Theory and Corporate Social Responsibility

1.Free-market theory holds that the primary aim of business is to make a profit.

As far as business obligations toward consumers, this view assumes an equal

balance of power, knowledge, and sophistication of choice in the buying and

selling of products and services. Consumers and corporations are protected and

regulated, according to this view, by Adam Smith’s “invisible hand.”

2.Free markets require certain conditions for business activity to help society. These conditions include: (1) minimal moral restraints; (2) full competitiveness with entry and exit; (3) relevant information needed to transact business available to everyone; (4) accurate reflection of all production costs in the prices that consumers and firms pay.

B.Problems with the Free-Market Theory

1.Although the free-market theory is currently popular and has validity,

controversy also exists regarding its assumptions about consumer-business

relationships:

  1. Most businesses are not on equal footing with consumers at large.
  1. Whether many firms’ advertising activities truthfully inform consumers about product reliability, possible product dangers, and proper product use is questioned.
  1. The “invisible hand” is often nonexistent for consumers in need of protection against questionable advertising and poorly manufactured products released to market.

2.Another important argument against free-market theory is based on what

economists refer to as imperfect markets, that is, markets in which competition

“is flawed by the ability of one or more parties to influence prices.”

C.Mixed Market Economies

1.Mixed economies include a balance between the private property systems and

the government laws, policies, and regulations that protect consumers and

citizens. In mixed economies, ethics become part of legal and business debates.

4.2Managing Corporate Responsibility with External Stakeholders

A.The Corporation as Social and Economic Stakeholder

1.The stakeholder management approach views the corporation as a legal entity

and also as a collective of individuals and groups.

2.Corporations are economic and social stakeholders. This is not a contradiction

but a leadership choice that requires balancing economic and moral priorities.

B.The Social Contract: Dead or Desperately Needed

1.The social contract between a corporation and its stakeholders is often based on

implicit as well as explicit agreements. It is based on mutual trust, with the

understanding that companies have the interests of consumers and investors in

mind.

2.One way to retain and to reinforce public confidence is by acting in an ethical manner, a manner that shows a concern for the investing public and the customers of the firm.

C.Balance between Ethical Motivation and Compliance

1.Ethics programs, as part of the social contract, are essential motivators in

organizations. Business relationships based on mutual trust and ethical

principles combined with regulation result in long-term economic gains for

organizations, shareholders, and stakeholders.

D.Covenantal Ethic

1.The covenantal ethic concept is related to the social contract and is also central

to a stakeholder management approach. Relationships and social contracts (or

covenants) between corporate managers and customers embody a “seller must

care” attitude, not only “buyer or seller beware.”

2.It may also be helpful to understand the concept of a covenantal ethic in an organizational context by pointing out how great leaders are able to attract and mobilize followers to a vision and beliefs based on the relationship they develop with those being led.

E.The Moral Basis and Social Power of Corporations as Stakeholders

1.Keith Davis reasons that the social responsibility of corporations is based on

social power and that “if business has the power, then a just relationship

demands that business also bear responsibility for its actions in these areas.” He

terms this view the “iron law of responsibility.”

2.Five broad guidelines or obligations business professionals should follow to be

socially responsible include:

  1. Businesses have a social role of “trustee for society’s resources.”
  1. Business shall operate as a two-way open system with open receipt of inputs from society and open disclosures of its operations to the public.
  1. “Social costs as well as benefits of an activity, product, or service shall be thoroughly calculated and considered in order to decide whether to proceed with it.”
  1. The social costs of each activity, product, or service shall be priced into it so that the consumer (user) pays for the effects of his consumption on society.
  1. Business institutions as citizens have responsibilities for social involvement in areas of their competence where major social needs exist.

F.Corporate Philanthropy

1.A corporation’s social responsibility also includes philanthropic responsibilities

in addition to its economic, legal, and ethical obligations. Corporate

philanthropy is an important part of a company’s role as a “good citizen” at the

global, national, and local levels.

G.Managing Stakeholders Profitably and Responsibly: Reputation Counts

1.Consumers are seeking assurances that the goods and services they are producing, financing, or purchasing are not damaging to workers, the environment, or communities by whom and where they are made.

2.Reputation remains one of the most powerful assets in determining the extent to which a company manages its stakeholders effectively. There is also evidence that socially responsible corporations have a competitive advantage in the following areas: (1) reputation, (2) successful social investment portfolios, (3) ability to attract quality employees.

3.The executive director of the Reputation Institute, Anthony Johndrow, noted, “Reputation is much more than an abstract concept; it’s a corporate asset that is a magnet to attract customers, employees, and investors…When people trust, admire and have a good feeling about a company, they are willing to support and recommend the company to others.

4.3Managing and Balancing Corporate Governance, Compliance, and Regulation

Corporations effectively govern themselves, to a large extent, through their own control systems and stakeholder relationships. A public corporation’s federal and state charters provide the legal basis for its board of directors, stockholders, and officers to govern and operate the company.

Self-governance doesn’t always work, however. A recent Forbes magazine study noted that outside directors from the five worst performing companies earned 1.6 times what outside directors earned at the five highest performing companies.

  1. Top Ten Companies: Best Corporate Board Governance Practices

1.Most corporate boards act responsibly toward their stakeholders and in the best interests of shareholders.

B.Sarbanes-Oxley Act

1.A summary of key sections of the Sarbanes-Oxley Act follows.

  1. Establishes an independent public company accounting board to oversee audits of public companies.
  1. Requires one member of the audit committee to be an expert in finance.
  1. Requires full disclosure to stockholders of complex financial transactions.
  1. Requires CEOs and CFOs to certify in writing the validity of their companies’ financial statements. If they knowingly certify false statements, they can go to prison for 20 years and be fined $5 million.
  1. Prohibits accounting firms from offering other services, like consulting, while also performing audits (conflict of interest).
  1. Requires ethics codes, registered with the Securities and Exchange Commission (SEC), for financial officers.
  1. Provides a 10-year penalty for wire and mail fraud.
  1. Requires mutual fund professionals to disclose their vote on shareholder proxies, enabling investors to know how their stocks influence decisions.
  1. Provides whistle-blower protection for individuals who report wrongful activities to authorities.
  1. Requires attorneys of companies to disclose wrongdoing to senior officers and to the board of directors, if necessary; attorneys should stop working for the companies if senior managers ignore reports of wrongdoing.

2.2002 Reforms include:

a. Separating the role of chairman of the board when the CEO is also a board member.

b. Setting tenure rules for board members

c. Regularly evaluating itself and the CEO’s performance

d. Prohibiting directors from serving as consultants to the companies which they serve.

e. Compensating directors with both cash and stock

f. Prohibiting retired CEOs from continuing board membership

g. Assigning independent directors to the majority of members who meet periodically without the CEO.

C.Pros and Cons of Implementing the Sarbanes-Oxley Act

1.Criticisms

  1. It is too costly.
  1. It impacts negatively on a firm’s global competitiveness.
  1. Government costs also increase to regulate the law.
  1. CFOs are overburdened and pressured by having to enforce and assume accountability required by the law.
  1. An exodus will occur of public companies returning to private ownership.

2.Counterclaims

  1. The costs are minimal compared to the costs of not implementing it.
  1. The data does not support the argument that the law presents a competitive disadvantage to global firms.
  1. The changes required to implement the law are difficult, but a majority of directors support it.
  1. Financial officers who complain about the requirements of Sarbanes-Oxley may in fact be suffering from the lack of internal controls they had before.
  1. If a company uses Sarbanes-Oxley as a reason to not go public, the firm should not go public or use investors’ funds.

D.Revised 1991 Federal Sentencing Guidelines

1.The 1991 Federal Sentencing Guidelines were passed to help federal judges set

and mitigate sentences and fines in companies that had a few “bad apples” who

had committed serious crimes. The guidelines changed the view of corporations

as entities that were legally liable and punishable for criminal acts committed

within their boundaries to the view of the corporation as a moral agent

responsible for the behavior of its employees.

2.Companies that acted to prevent unethical and criminal acts would, under the guidelines, be given special consideration by judges when being fined or

sentenced based on seven criteria.

  1. Established standards and procedures capable of reducing the chances of criminal conduct.
  1. Appointment of compliance officer(s) to oversee plans.
  1. Took due care not to delegate substantial discretionary authority to individuals who are likely to engage in criminal conduct.
  1. Established steps to effectively communicate the organization’s standards and procedures to all employees.
  1. Took steps to ensure compliance through monitoring and auditing.
  1. Employed consistent disciplinary mechanisms.
  1. When an offense was detected, took steps to prevent future offenses, including modifying the compliance plan, if appropriate.

4.4The Role of Law and Regulatory Agencies and Corporate Compliance

A.Government at the federal, state, and local levels also regulates corporations through laws, administrative procedures, enforcement agencies, and courts.

B.The role of laws and the legal regulatory system governing business serves five

purposes.

  1. Regulate competition.
  1. Protect consumers.
  1. Promote equity and safety.
  1. Protect the natural environment.
  1. Ethics and compliance programs to deter and provide for enforcement against misconduct.

C.Corporate scandals exemplify a failure of internal corporate governance and

self-regulation by all parties involved and can be caused by individual leaders’

greed, ineffective boards, all of which are part of the free market system.

Recent corporate scandals include:

  1. Enron Corporation—fraud, conspiracy, insider trading.
  1. WorldCom Inc.— conspiracy, accounting fraud estimated at more than $11 billion.
  1. Tyco International Ltd.—theft of $600 million.
  1. Adelphia Communications Corporation—conspiracy, band and securities fraud.
  1. Credit Suisse First Boston—obstruction of justice.
  1. HealthSouth Corporation—inflating earnings, conspiracy.
  1. Martha Steward Living Omnimedia—conspiracy, obstruction of justice, lying about personal stock sales
  1. Samuel D. Waksal – fraud, perjury and others for ImClone stock trades
  1. Qwest Communications International Inc. —conspiracy, securities fraud, wire fraud, making false statements to auditors.

D.Why Regulation?

Laws are designed to protect and prevent crime and harm, monopolies, and the negative effects of corporate activities, and to also promote social and economic growth, development, and the health, care and welfare of consumers and the public.

E.Laws and U.S. Regulatory Agencies

1.Sherman Antitrust Act, 1890

2.Clayton Act, 1914

3.Federal Trade Commission Act, 1914

4. Consumer Good Pricing Act, 1975

5. FTC Improvement Act

6. Antitrust Improvements Act, 1976

7.Trademark Counterfeiting Act, 1980

8.Digital Millennium Copyright Act, 1998

F.Laws Protecting Consumers

1.Pure Food and Drug Act, 1906

2.Federal Hazardous Substances Act, 1960

3.Truth and Lending Act, 1960

4.Consumer Product Safety Act, 1972

5.Fair Credit Billing Act, 1974

6.Telephone Consumer Protection Act, 1991

7.Children’s Online Privacy Protection Act, 1998

8. Do Not Call Implementation, 2003

G.Laws Protecting the Environment

1.Clean Air Act, 1970

2.National Environmental Act, 1970

3.Federal Water Pollution Control Act, 1972

4.Endangered Species Act, 1973

5.Safe Drinking Water Act, 1974

6.Toxic Substance Act, 1976

7.Food Quality Protection Act, 1996

4.5Managing External Issuesand Crises: Lessons From the Past (Back to the Future?)

Companies have made serious mistakes as several of the now-classic environmental, product- and consumer-related crises illustrate. Corporations have responded and reacted slowly and many times insensitively to injured customers and other stakeholders. Some of the major crises from the 1970s to the present are only now being resolved, including:

2001—Mitsubishi Motor Company paid $34 million to settle 300 sexual harassment lawsuits filed by women at its Normal, IL plant, and apologized for its 20-year cover-up of consumer safety complaints.

2001—American Home Products paid $11.2 billion in settlements to 50,000 consumer lawsuits related to the fen-phen diet drug combination.

1971-1974—A. H. Robins Company paid more than $314 million in settlements in response to 8,300 product liability lawsuits associated with its Dalkon Shield intrauterine device. It refused to consider a recall for nine years after the problem was known.

1980—Procter & Gamble pulled its Rely tampon from the market after 25 deaths were associated with its use.

1978—Firestone recalled 10 million tires and paid $7.85 million to settle the first case of product liability associated with 15 deaths and 12 injuries from defective tires. 200 injury and death lawsuits have been settled since the recall, and $50 million is estimated to settle the lawsuits.

Dow Corning Corporation received approval for a $4.5 billion reorganization plan, with $3.2 billion to be used to settle claims from recipients of the company’s silicone gel breast implants after rushing the product to market in 1975 without completing proper safety tests.

1