Chapter 11:Corporate Governance, Social responsibility, and Ethics

stock options

The right to purchase company stock at a predetermined price at some point in the future, usually within 10 years of the grant date.

takeover constraint

The risk of being acquired by another company.

information manipulation

When managers use their control over corporate data to distort or hide information in order to enhance their own financial situation or the competitive position of the firm

board of directors

is the centerpiece of the corporate governance system. Board members are directly elected by stockholders, and under corporate law they repre- sent the stockholders' interests in the company. Hence, the board can be held legally accountable for the company's actions. Its position at the apex of decision making within the company allows it to monitor corporate strategy decisions and ensure that they are consistent with stockholder interests. If the board believes that corporate strategies are not in the best interest of stockholders, it can take measures such as voting against

The purpose of strategic control systems is to

(1) establish standards and targets against which performance can be measured, (2) create systems for measuring and monitoring performance on a regular basis, (3) compare actual performance against the established targets, and (4) evaluate results and take corrective action if neces- sary. In governance terms, their purpose is to ensure that lower-level managers, as the agents of top managers, act in a way that is consistent with top managers' goals, which should be to maximize the wealth of stockholders, subject to legal and ethical constraints.

Confronted with agency problems, the challenge for principals is to

1) shape the behavior of agents so that they act in accordance with the goals set by principals, (2) reduce information asymmetry between agents and principals, and (3) develop mechanisms for removing agents who do not act in accordance with the goals of prin- cipals and mislead them. P

anticompetitive behavior

A range of actions aimed at harming actual or potential competitors, most often by using monopoly power, and thereby enhancing the long-run prospects of the firm.

information asymmetry

A situation where an agent has more information about the resources he or she is managing than the principal has.

greenmail

A source of gaining wealth whereby corporate raiders either push companies to change their corporate strategy to one that will benefit stockholders, or charge a premium for stock when the company wants to buy it back.

on-the-job consumption

A term used by economists to describe the behavior of senior management's use of company funds to acquire perks (lavish offices, jets, and the like) that will enhance their status, instead of investing the funds to increase stockholder returns.

business ethics

Accepted principles of right or wrong governing the conduct of businesspeople.

ethics

Accepted principles of right or wrong that govern the conduct of a person, the members of a profession, or the actions of an organization.

external stakeholders

All other individuals and groups that have some claim on the company. (Customers Suppliers Creditors Governments Unions Local communities General public)

substandard working conditions

Arise when managers underinvest in working conditions, or pay employees below-market rates, in order to reduce their production cost

corruption

Can arise in a business context when managers pay bribes to gain access to lucrative business contracts.

risk capital

Capital that cannot be recovered if a company fails and goes bankrupt

outside directors

Directors who are not full-time employees of the company, needed to provide objectivity to the monitoring and evaluation of processes.

code of ethics

Formal statement of the ethical priorities to which a business adhere

personal ethics

Generally accepted principles of right and wrong governing the conduct of individuals.

stakeholders

Individuals or groups with an interest, claim, or stake in the company—in what it does and in how well it performs.

self-dealing

Managers using company funds for their own personal consumption

environmental degradation

Occurs when a company's actions directly or indirectly result in pollution or other forms of environmental harm.

inside directors

Senior employees of the company, such as the CEO.

ethical dilemmas

Situations where there is no agreement over exactly what the accepted principles of right and wrong are, or where none of the available alternatives seems ethically acceptabl

internal stakeholders

Stockholders and employees, including executive officers, other managers, and board members.

opportunistic exploitation

Unethical behavior sometimes used by managers to unilaterally rewrite the terms of a contract with suppliers, buyers, or complement providers in a way that favors to the fir

Principals put governance mechanisms in place to

align incentives between principals and agents and to monitor and control agents. The purpose of governance mecha- nisms is to reduce the scope and frequency of the agency problem; that is, to help ensure that agents act in a manner that is consistent with the best interests of their principals.

Strategic control systems

are the primary governance mechanisms established within a company to reduce the scope of the agency problem between levels of management. These systems are the formal target-setting, measure- ment, and feedback systems that allow managers to evaluate whether a company is executing the strategies necessary to maximize its long-term profitability and, in par- ticular, whether the company is achieving superior efficiency, quality, innovation, and customer responsiveness.

Agency theory

looks at the problems that can arise in a business relationship when one person delegates decision-making authority to another. It offers a way of under- standing why managers do not always act in the best interests of stakeholders and why they might sometimes behave unethically, and, perhaps, also illegally.

how the agency problem can be reduced within a company by using two complementary governance mechanisms to align the incentives and behavior of employees with those of upper-level management:

strategic control systems and incentive systems.

four main types of governance mechanisms for aligning stock- holder and management interests:

the board of directors, stock-based compensation, financial statements, and the takeover constraint.

1. Stakeholders are individuals or groups that have an interest, claim, or stake in the company—in what it does and in how well it performs. 2. Stakeholders are in an exchange relationship with the company. They supply the organization with important resources (or contributions) and in exchange expect their interests to be satisfied (by inducements). 3. A company cannot always satisfy the claims of all stakeholders. The goals of different groups may conflict. The company must identify the most important stakeholders and give highest priority to pursuing strategies that satisfy their needs. 4. A company's stockholders are its legal owners and the providers of risk capital--a major source of capital resources that allow a company to op- erate its business. As such, they have a unique role among stakeholder groups. 5. Maximizing long-term profitability and profit growth is the route to maximizing returns to stockholders, and it is also consistent with satis- fying the claims of several other key stakeholder groups. 6. When pursuing strategies that maximize profit- ability, a company has the obligation to do so within the limits set by the law and in a manner consistent with societal expectations. 7. An agency relationship is said to exist whenever one party delegates decision-making authority or control over resources to another party. 8. The essence of the agency problem is that the interests of principals and agents are not always the same, and some agents may take advantage of information asymmetries to maximize their own interests at the expense of principals. 9. Numerous governance mechanisms serve to limit the agency problem between stockhold- ers and managers. These include the board of directors, stock-based compensation schemes, financial statements and auditors, and the threat of a takeover. 10. The term ethics refers to accepted principles of right or wrong that govern the conduct of a per- son, the members of a profession, or the actions of an organization. Business ethics are the ac- cepted principles of right or wrong governing the conduct of businesspeople, and an ethical strategy is one that does not violate these ac- cepted principles. 11. Unethical behavior is rooted in poor personal ethics; the inability to recognize that ethical is- sues are at stake; failure to incorporate ethical issues into strategic and operational decision making; a dysfunctional culture; and failure of leaders to act in an ethical manner. 12. To make sure that ethical issues are considered in business decisions, managers should (a) fa- vor hiring and promoting people with a well- grounded sense of personal ethics, (b) build an organizational culture that places high value on ethical behavior, (c) ensure that leaders within the business not only articulate the rhetoric of ethical behavior but also act in a manner that is consistent with that rhetoric, (d) put decision- making processes in place that require people to consider the ethical dimension of business decisions, (e) use ethics officers, (f) have strong corporate governance procedures, and (g) be morally courageous and encourage others to be the same.

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