Ethical problems of organizations (part 1)

1. Ethical problems of organizations (part 1) Geoffrey G. Bell, PhD, CA University of Minnesota Duluth November, 2003

2. Recent ethical problems • Enron (phony accounting, phony business, unfair treatment of employees, etc.) • WorldCom (phony accounting) • Waste Management (questionable accounting) • Arthur Andersen (facilitating accounting problems, ethics partners answer to clients, not partnership) • Merrill Lynch (conflicts between investment banking and analysis, compensating analysts based on investment banking fees) • Citigroup (enabled Enron with questionable banking products).

3. Stakeholder theory – an overview • Freeman (1988; 1994) developed a normative “stakeholder theory of the firm” wherein all actors with a stake in the firm have a voice in its decisions. • “Normative” implies “ought” – this is the ways firms ought to behave. • Many management scholars are interpreting this as a descriptive theory instead. • Stakeholders are people and groups who affect, or can be affected by, the firm’s decisions, policies, and operations. • Includes both actors with direct stake in the corporation (e.g., employees, customers) and those affected by “public goods” nature of corporate decisions (e.g., local community and air pollution). • Note that people who bear risk and people who benefit are not necessarily the same.

4. Primary & Secondary Stakeholders Primary Stakeholders • Actors who are critical to firm’s existence and activities. • Relationships occur in conjunction with the normal activities of the business. Secondary stakeholders • Actors who are affected, directly or indirectly, by the firm’s activities and decisions. • Relationships occur as a consequence of the normal activities of the business.

5. Who are “generally-accepted” Stakeholders? • Employees • Suppliers • Customers • The community at large • Shareholders • Management’s role is to assess whose interests should predominate on any given issue.

6. Should we adopta stakeholder view? • The contrary position is advocated by neo-conservative economists like Milton Friedman, who state that: • The only duty of management is to maximize shareholder wealth. • Anything else is a tax imposed by unelected groups (consumer advocacy groups, women's’ rights groups, tree-huggers, etc). • If other ends are socially desirable, they should be achieved via formal legislation, not response to some unaccountable “stakeholder” group.

7. Benefits Pitfalls What are the benefits and pitfalls of a stakeholder approach?

8. Consumer ethics • Consumer protection legislation is fairly recent. • In 1962 speech, President Kennedy outlined consumer rights: • Safety • Be heard • Choice • Be informed. • Products & services produced & delivered with due care.

9. What does due care mean? • Design – products should meet all government regulations & be safe under all foreseeable circumstances, including consumer misuse. • Materials – should meet government regulations and durable enough to withstand reasonable use. • Production – no defects. • Quality control – inspect for quality. • Packaging, labeling, and warnings – safe packaging; clear, easily understood directions; clear description of hazards. • Notification – for product recalls.

10. Conflicts of Interest @ Enron

11. Conflicts of Interest @ Enron Enron top management • Fastow’s creation of partnerships placed him in conflict (he won only if Enron lost). • Ken Lay told people to buy Enron stock while he was selling. • Changed plan administrators for employee 401(k) plan, locking employees’ holdings in during last month when top management was bailing. Arthur Andersen • Garnered large consulting fees, so couldn’t jeopardize them with audit results. • Audit review partner answerable to local partner in charge of audit; not CEO of AA. Wall Street financiers • Because Enron brought large investment banking fees, didn’t want to issue negative analysts’ opinions. • Gained fees by developing instruments that helped Enron remove debt from books (& then sold same products to other firms). Law firms • Firms advising Enron on legality of partnerships profited by developing them with the bankers & AA.

12. Costs of Enron debacle • Text estimates costs of Enron failure at $35 billion. • Arthur Andersen went out of business, leaving only 4 major accounting firms in US.

13. Other conflicts of intereston Wall Street • Problems with IPO market. • See video “don.con” for examples. • Basically, firms went IPO too soon, before they were ready. Made them more risky than normal. • Investment bankers purposely under priced IPO issues, leading to a big “pop” and increasing attractiveness of IPOs, but costing new IPO valuable start-up funds. • Allocation of IPOs based on favors by investment banks, not on equal availability to all. • Clear conflict, as market is not equal, but bankers can use IPO allocations to develop relationships.