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Effective Corporate Governance and Ethics: Building an Ethical Organization

Learn about the key elements of effective corporate governance, the stages of moral development, corporate ethics, and social responsibility. Explore case studies on corporate scandals and legislative responses. Discover dimensions of corporate social performance and understand decision biases impeding effective decision-making.

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Effective Corporate Governance and Ethics: Building an Ethical Organization

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  1. Mastering Strategic ManagementChapter 10.1 & 10.2Leading an Ethical Organization: Corporate Governance, Corporate Ethics, and Social Responsibility

  2. Learning Objectives • Key elements of effective corporate governance • Know the 3 levels & 6 stages of moral development • Corporate Ethics • Corporate scandals, Canada & USA Legislative responses • Know dimensions of corporate social performance • Know the 4 generations currently in the workforce, and key influences that have influenced them • Understand how decision biases may impede effective decision making

  3. Oliberte Shoes (Canada) • Fair Trade Certified • 1% of profits for the Planet • B Corps (Best) - creates higher quality jobs and improve the quality of life in our communities • Factory in Ethiopia

  4. Corporate governance: The processes, policies, & laws that govern an organization, establishing accountability & reducing conflicts of interest associated with principle-agent issues Board of directors: A group of individuals, either elected or appointed, that oversees the activities of an organization or corporation

  5. Boards of Directors • Board outsiders: Most members of the board of directors are employed outside of the organization • Board often includes members with special skills sets (Lawyer, Accountant) to assist Board in managing • Major Owners sit or appoint representatives on Board • Institutional investors, that have invested large sums of money may also have representation on Board • Board insiders: Members of the Board of Directors that employed inside of the organization • CEO is usually member, often non-voting • Few others… (to avoid inherent conflict of interest)

  6. The Board • Under Canadian & Provincial laws, Boards have certain legal responsibilities • Taxation (CRA) • Employment Laws • Hold AGMs • Represent stakeholders • Act in best interests of the Corporation • Boards will typically: • Hire (& fire) the CEO, set overall org structure • Approve annual Budget, & hire auditors • Contribute to setting overall strategic direction • Approve high level policies & procedures

  7. The Agency Problem • Agency problem: Exists when interests of individuals that act as agents to manage company, do not align with interest of the firm’s stockholders • The composition of the board is critical because the dynamics of the board play an important part in resolving the agency problem

  8. The Principal–Agent Problem The principal–agent problem is the problem of devising compensation system that induce an agent to act in the best interests of a principal • owners (stockholders) are the principals and the executive managers of the firm are their agents • Historically owners worked in their firms and balanced short and long term needs • Executive managers who typically work in a job/firm for ~ 5 or 6 years, have a much shorter focus • Creates a conflict

  9. The Board Most Boards have 1 (one) Employee – the CEO Why? CEO duality: Occurs when the CEO also chairman of the board, known to create bitter divide within corp.

  10. CEO Pay • Board of Dir sets CEO pay, generally includes: • Guaranteed salary • Cash bonus • Stock options • Perks • Corp. must pay competitive wages for scarce talent required to manage $B corp, competitive environment… • Boards face increasing scrutiny from investors / AGMs when CEO pay out of line with industry norms, & when bonuses paid when losing money / performing poorly • CEO salary not well correlated with firm success, but highly correlated with firm size...

  11. CEO Perks • Range from free ice-cream to life-time use of corporate jet • Can be effective CEO retention strategy, but potential for negative press when perceived by (buying) public as excess • In publically trade & public companies, CEO pay generally public information…

  12. Poor Corp. Governance Under-performing firms can be tempting target for takeover

  13. Key Takeaways • Firms benefit from strong corporate governance including an active board that monitors CEO actions, provides strategic advice, and helps to network to other useful resources • When such mechanisms are absent, CEO excess may go unchecked, resulting in negative publicity, poor firm performance, and even potential takeover by other firms

  14. 10.2 Stages of Moral Development Psychologist Lawrence Kohlberg suggested 6 distinct stages of moral development grouped into 3 levels: • Pre-conventional • Stage 1 - individuals focus on the direct consequences that their actions will have—for example, worry about punishment or getting caught • Stage 2 - right or wrong is defined by the reward stage, where a “what’s in it for me” mentality is seen

  15. Stages of Moral Development(Level 3 & 4) Conventional level • moral reasoning - morality is judged by comparing individuals’ actions with the expectations of society. • In stage 3, individuals are conformity driven and act with the goal of fulfilling social roles. Parents that encourage their children to be good boys and girls use this form of moral guidance. • In stage 4, the importance of obeying laws, social conventions, or other forms of authority to aid in maintaining a functional society is encouraged

  16. Stages of Moral Development (Level 5 & 6) Post-conventional level, or principled level, occurs when morality is more than simply following social rules or norms • Stage 5 considers different values and opinions. • Thus, laws are viewed as social contracts that promote the greatest good for the greatest number of people • In stage 6, moral reasoning is based on universal ethical principles. • For example, the golden rule illustrates one such ethical principle. At this stage, laws are grounded in the idea of right and wrong. Thus individuals follow laws because they are just and not because they will be punished if caught or shunned by society. • Consequently, with this stage there is an idea of civil disobedience that individuals have a duty to disobey unjust laws.

  17. Corporate Scandals In 90s and early 2000s, a number of corporate scandals in Canada & USA revealed a lack of board vigilance In Canada, Nortal was the worse, and arguably the most famous involves Enron who used accounting loopholes to hide billions of dollars in failed deals. Before their scandal was discovered, top management cashed out millions of stocks, but many ended up in prison… In response to these scandals at Canada passed X and USA passed Sarbanes-Oxley Act to tighten the financial standards for the boards of public and accounting firms

  18. Corporate Scandals

  19. Corporate Scandals

  20. Corporate Ethics & Social Responsibility - USA • Sarbanes-Oxley Act of 2002: set new or increased standards for boards of public USA companies and accounting firms • response corp. scandals at Enron, WorldCom,& Tyco • 11 aspects represented some of the most far-reaching reforms in 70 years • 2010 the USA enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act • Significant increase govt control of financial markets

  21. Corporate Ethics & Social Responsibility - Canada • In 2002, Canadian securities regulators pressured to adopt similar reforms as USA to maintain investor confidence in the Canadian regulatory system & protect integrity of Canadian capital markets • However, lower sense of urgency in Canada since, at the time, Canada had yet to experience corporate fraud on the same scale as in the United States.  • Canadian regulators did seize opportunity (of Sarbanes-Oxley) to introduce desired & long-delayed corporate and securities law reform in 2003 • Many changes introduced in Canada Securities Act & Not-for-Profit Corporations Act and (Omnibus) Bill 198

  22. Fair Trade • Defined as when all members of the supply chain (from growers on…) are paid a fair, living wage • Often requires only a small increase in final price • Fair Trade acts as to confirm accuracy of claim • Good public awareness of certification, marketing • One example of Social Ethics

  23. Corporate Social Performance (CSP) • Social entrepreneurship: Entrepreneurial actions where both economic and social value creation occur • Corporate social performance (CSP): The degree to which a firm's actions honor ethical values that respect individuals, communities, and the natural environment • Kinder, Lydenberg and Domini & Co. (KLD), a Boston-based firm that rates firms on a number of stakeholder-related issues with the goal of measuring CSP • Also impacts firm’s ‘Social license to Operate’

  24. Corporate Social Performance

  25. Corporate Social Performance

  26. Corporate SP - Metrics • Assessing the community dimension of CSP is accomplished by assessing community strengths such as charitable or innovative giving that supports housing, education, or relations with indigenous peoples, as well as charitable efforts worldwide such as volunteer efforts or in-kind giving. • CSP diversity strengths are scored positively when the company is known for promoting women and minorities, especially for board membership and the CEO position. Employment of the disabled and the presence of family benefits such as child or elder care would also result in a positive score by KLD.

  27. Corporate SP – Metrics (con’t) • The employee relations dimension of CSP gauges potential strengths such as notable union relations, profit-sharing and employee stock-option plans, favorable retirement benefits, and positive health and safety programs • The environmental dimension records strengths by examining engagement in recycling, pollution prevention, or the use of alternative energies. KLD would also score a firm positively if profits derived from environmental products or services were a part of the company’s business.

  28. Key Takeaways • The 6 stages of moral development • Corporate scandals, and Canada / USA legislative responses • Corporate Social Performance, and objective measures of both positive and negative actions related to CSP

  29. Add 4 years in 2015…

  30. Generations in the Workplace • Traditionalists - born between 1925 and 1946, fought in World War II and through The Great Depression. This generation is now mostly retired • Baby boomers - born between 1946 and 1964, corresponding with a ‘boom’ of population following the end of World War II • Generation X - born between 1965 & 1980; Gen X symbolizes the unknown nature of this generation • Generation Y - born after 1981, this group is also known as Millenials as well as “The Trophy Generation” is now entering the workplace

  31. Generational Influences on Work Behavior

  32. Generational Y Purchasing Power • Parents play a major role in shaping children’s attitudes about debt, saving & spending. But 15-25 yr have a sizeable impact on parents’ spending, particularly technology (InSites Consulting) • 51% say they influence the technology parents’ adopt • 41% influence parents’ purchase of products & services • 31% influence parents’ decisions on where to shop • So what appeals to the Gen Y market? Survey respondents listed the five most important characteristics for a brand or product as: 1. Up to date 2. Own style 3. Real/authentic 4. Uniqueness 5. Clean reputation • Coolness & trendiness ranked much farther down list,Gen Y looking for substance over form, & originality not cookie-cutter

  33. Rational Decision-Making Model(only problem, we’re not Rational…)

  34. Key Takeaways Generational differences provide powerful influences on the mind-set of employees that should be carefully considered to effectively manage a diverse workforce.

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