Understanding Business Ethics Peter Stanwick Instructor's Manual

Type:

Instructor Manual

Resource:

Understanding Business Ethics

Edition:

1st Edition

Author(s):

Peter Stanwick Sarah Stanwick

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Sample Syllabus for a Semester Class Date

Monday

Wednesday

WK 1

Chapter 1: The Foundation of Ethical Thought

Chapter 2: Contemporary Issues in Business Ethics

WK 2

Chapter 3 : Stakeholders and Corporate Social Responsibility

Case: Boeing: How Low Can They Fly?

WK 3• Chapter 4: Corporate Governance and Corporate Compliance

Case: Adelphia: What’s Wrong With This Picture?

WK 4•

Case: McWane: A Dangerous Business•

Exam 1

WK 5

Chapter 5: Ethics and the Environment

Case: Interface: More Than Just a Carpet Company

WK 6

Chapter 6: Health Care Ethics

Case: Merck’s Vioxx: How Would You Interpret the Data?

WK 7

Case: HealthSouth: The Rise and Fall of the Scrushy Empire

Chapter 7: Ethics and Information Technology

WK 8

Chapter 8: Strategic Planning and Corporate Culture

Exam 2

WK 9

Case: Perfect Payday: How Apple Computer and Others Learned to Love Stock Options

Chapter 9: Ethics and Financial Reporting

WK10

Chapter 10: Establishing a Code of Ethics and Ethical Guidelines

Chapter 11: Evaluating Corporate Ethics

WK11

Case: Music Industry: Ethical Issues In a Exam 3 Digital Age

WK12

Case: Livedoor: Ethical Issues in Japan

WK13

Case: Enron: Were They The Crookedest Case: Tyco: I’m Sure That It’s A Really Nice Guys in the Room?

Shower Curtain

WK14

Case: Wal-Mart: But We Do Give Them A 10% Employee Discount

Case: WorldCom: Can You Hear The Lawsuits Now?

WK15

Case: Google: Don’t Do Evil Unless…

Case: Martha Stewart and ImClone: What Color Goes with Prison Gray?

Case: Ahold: Is That The Dutch Translation of Enron?

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Understanding Business Ethics Stanwick and Stanwick 1st Edition Chapters and Corresponding Cases Matrix

Case Name

Adelphia Ahold Blue Bayou Boeing Bre-X Conrad Black Enron Google HealthSouth Herman Miller Interface Livedoor Lucent Martha Stewart McWane Vioxx Music Parmalat Payday Tyco VW Wal-Mart WorldCom

Chapter 1

Chapter 2

Chapter 2

Chapter 3

Chapter 3

Chapter 4

Chapter 4

Chapter 5

Individual Ethical Duty

Individual Ethical Integrity

Unrealized Unethical Behavior

Stakeholder Relationships

Corporate Social Responsibility

Corporate Governance

Corporate Compliance

Environmental Issues

X

Z

X Z X X Z X

X

Z Z X Z

Z X Z Z Z Z

Z Z

X X X X Z X

X

X

Z

Z Z Z X

Z

X

X

X X Z

Z

Z Z Z

Z

Z

Z Z X

Z Z X X

Legend: Z= Primary Topic X= Secondary Topic

Z Z X X

Z Z Z Z

Chapter 6 Health Care Issues

Chapter 7 Information Technology

Z Z Z

X X Z X

Z

Z Z Z Z Z Z Z Z Z

X X

Z

Z Z Z

X

X Z

X

Z X Z Z Z Z Z

X Z Z Z Z X X X X Z Z Z

Z X Z Z Z

Chapter 8

Chapter 8

Chapter 9

Corporate Culture

Financial Reporting

X X X X X X

X

Z Z Z

X X X X

Z X Z Z

X X X X

Z X X X

X X X X Z X X Z Z

Z Z X Z Z Z Z Z Z

Strategic Planning

Z X Z

Chapter 10 Code of Ethics

Chapter 11 Evaluation of Corporate Ethics

X

X X

Z

Z

Z

Z

X Z

X Z

Z

Z

X

X

X X

X X

X Z Z Z

X X

X X

Z

X X

X X

X X

Z

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Chapter 1 The Foundation of Ethical Thought The purpose of this chapter is to give the students a broad overview of the theoretical foundation that supports ethical decision making. It is from this theoretical grounding that the students can understand how their decisions related to ethical issues can impact not only themselves but others as well. In addition, this chapter introduces the structure of the textbook which allows the instructor to also explain his or her structure for the class.

Key Learning Points There are a number of key learning points which can be accomplished when this chapter is presented to your students. These learning points include: 1. The chapter introduces the student to the concepts of ethics and business ethics.

2. Ethics is a complex concept to describe. Different philosophies have used different theories in order to help explain and guide ethical behavior.

3. Although some of the theories presented in this chapter were developed over two thousand years ago, they are appropriate and applicable to today’s business environment.

4. This chapter demonstrates that the eight underlying principles presented in the Global Business Standards Codex are interrelated with each other as well as with the major philosophical theories related to ethics.

5. The “Utilitarian Ethics: One Playground at a Time” shows that one person can have an impact on many others by doing “the right thing”.

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Utilitarian Ethics: One Playground at a Time An 8:10 minute video highlighting the PlayPumps program can be found on the Frontline World web site.(http://www.pbs.org/frontlineworld/rough/2005/10/flwrc11.html?&c=3wm). There are a number of other videos and other valuable information about this program at playpumps.org.

This is a good case to foster discussion during the first class period. Here are a number of potential questions that could be asked to help extend the discussion. There is also additional background information available on the Frontline web site (http://www.pbs.org/frontlineworld/rough/2005/10/south_africa_th.html#) 1. Ask the class how many of them have volunteered for a non profit organization.

Follow up with those who respond positively by asking them why they volunteered. An additional follow up question would be to ask if those same students would consider volunteering in the future.

2. Why did Trevor Field volunteer his services to develop the playground pump?

Mr. Field probably felt that since there were no other solutions being developed, he put it upon his own shoulders to help the villages. There would certainly be self satisfaction in achieving a goal of providing clean cool water to these villages. In addition, as a former executive he probably viewed the issues of providing clean water similar to the business challenges he faced when he was working.

3. Explain the title of the case “Utilitarian Ethics: One Playground At a Time”.

The title highlights the link between the actions of Mr. Field and the utilitarian approach to ethical behavior. Mr. Field viewed resolving the issue of poor drinking water not for his own self interest such as Ethical Egoism, but for the benefit of many - Utilitarianism.

In fact, Mr. Field received no physical benefit from the develop of the playground pump.

Therefore Mr. Field was intrinsically motivated to resolve the issue. Intrinsic motivation takes place when the person performs an act for internal satisfaction and not for extrinsic or material rewards.

Definition of Ethics and Business Ethics To introduce the concepts of Ethics and Business Ethics to the students in the classroom, a good starting discussion point would be to ask the students what kind of ethical dilemmas have they faced in the past. A follow up discussion point would be to ask them what type of ethical dilemmas do they think they will face in their jobs after they have graduated.

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Types of Ethical Examinations Descriptive-the presentation of facts that relate to a specific set of circumstances related to an ethical issue.

Analytical-Using the facts of the ethical situation to try and understand or analyze the actions of the decision makers as related to the ethical issue.

Normative-A prescribed course of action that is recommended to avoid unethical behavior is in future.

Example Using Enron Descriptive-Ken Lay and Jeff Skilling were found guilty of fraud based on their actions as top executives at Enron Analytical-Ken Lay and Jeff Skilling, through their cognitive lens, believed that they were doing nothing wrong. In addition, if they were doing something wrong doing, they were not aware of it and/or did not bother to ask about it. Alternatively, Ken Lay and Jeff Skilling knew exactly what they were doing in a calculated attempt to defraud Enron’s stockholders. Furthermore, they actively tried to conceal their behavior in order to try to avoid prosecution by the federal government.

Normative-Need to have a code of ethics that creates real consequences if unethical behavior is detected. Try to ensure that power is not concentrated at the CEO level by having a separation of the CEO and the Chairman of the Board. Have the appointment of a Chief Ethics Officer who reports to the Board of Directors and is accountable to ensure the ethical conduct of all the employees within the firm. Revise the selection and reward system for employees to try and ensure that ethical people are selected and rewarded for their positive ethical behavior.

Teleological Frameworks Ethical Egoism-Each individual’s own self interests drive them. On balance, there are more positive than negative results Utilitarianism-Each individual’s actions will be based on providing the greatest good to the greatest number of people Sidgwick’s Dualism-The middle ground between Ethical Egoism and Utilitarianism.

Sidgwick argues that self interest can be included in determining the greatest good for the greatest number and that the other two theories are not mutually exclusive.

After these three theories have been presented, a good leading discussion point would be to discuss what drives a free market system. If it is individual self interest, is it an

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Ethical Egoism based system? If this is true, then why are there so many non profit organizations? Could Sidgwick’s Dualism be the answer - that a free market system is driven both by the extrinsic rewards by the accumulation of material goods as well as the intrinsic rewards of helping others? This would support Sidgwick’s argument that individual actions need to be explained from the rational benevolence aspect of Utilitarianism and the prudence aspect of Ethical Egoism. At this point you can refer back to the opening Case on the playground pumps in South Africa.

Deontological Frameworks Existentialism-The only person who can determine right and wrong is based on the free will of the person making the decisions. As a result, duty is connected with actions each individual determines the value of his/her actions.

Contractarianism (Social Contract Theory)-All individuals agree to social contracts to be members within society. As a member of society, each individual agrees to certain social norms. As a result, the values and norms developed by society must be fair to everyone who is a member of society.

Kant’s Ethics-Individual free will to make decisions needed to be converted into universal free will. It attempts to bridge the gap between existentialism and contractarianism by proposing that each individual would act in the same manner as anyone else in society if they also had to address the same set of circumstances.

Using WorldCom as an Example Existentialism Bernie Ebbers claimed that he did nothing wrong. Even upon his conviction he stated that he did not know what type of fraudulent activities were occurring at WorldCom. From an existentialism perspective, Mr. Ebbers is justifying his actions based on his individual interpretation of the value of his actions. His interpretation is that he did not do anything wrong; therefore, he will continue to believe he did nothing wrong.

Contractarianism By being a publicly traded company, WorldCom agreed to certain social norms. Those norms included being truthful when disclosing the financial performance of their firm and identifying any actual of potential problems to the owners and employees of WorldCom. This norm of transparency assures society that the information that was presented by WorldCom is accurate and timely. Of course, WorldCom broke that trust by violating this norm by not being transparent.

Kant’s Ethics Cynthia Cooper would be a good example of Kant’s Ethics. By ignoring the requests by her superiors, Ms. Cooper began an investigation into financial transactions occurring at WorldCom. She uncovered the massive fraud that was occurring at WorldCom. This

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would be considered a Kant’s Ethics approach since she believed that her actions would be done by others as part of a universal will under the same set of circumstances in order to discover the fraud.

Mixed Frameworks Intuitionism and Love Seven Guiding Principles 1. Fidelity-an individual needs to keep explicit and implicit promises 2. Reparation-an individual must act on repairing the consequences of previous wrongful acts 3. Gratitude- an individual must be able to show gratitude for the kindness that others have given him or her.

4. Justice-an individual should try to see that any goods are fairly distributed 5. Beneficence-an individual should focus on trying to improve the lives of others 6. Self-improvement-an individual should improve oneself by focusing on virtue and intelligence.

7. Noninjury-any individual should not cause harm to others.

Links with previous ethical philosophies include: Ethical Egoism-self-improvement Utilitarianism-beneficence and noninjury Existentialism-fidelity and self-improvement Contractarianism-fidelity and justice

Global Business Standards Codex Fiduciary Principle- Similar to agency theory, the fiduciary principle states that managers have a legal responsibility to protect the interests of the stakeholders.

Property Principle-Each employee needs to respect the property of the firm and the property of others.

Reliability Principle-Each employee must honor his/her commitments to the firm.

Transparency Principle-Each employee should conduct business in a truthful and open manner.

Dignity Principle-Similar to the Golden Rule, the dignity principle states that employees should treat others with dignity.

Fairness Principle-Stakeholders who have a vested interest in the business decisions made by management should be treated fairly.

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Citizenship Principle-Every employee should act as a responsible citizen in the community.

An example which could be used in class is the European Training and Coaching firm Energizers which lists how they use the 8 principles to help guide their decisions in an ethical manner. (http://www.energizers.eu/gbs_codex.html)

Questions for Thought 1. Choose an event in your life where you believe you acted ethically. Discuss the event in terms of the teleological frameworks discussed in the text.

After the student has described the event, have the student determine whether the act was based on Ethical Egoism, Utilitarianism or Sidgwick’s Dualism. Ask other members of the class if they agree with the student’s conclusion.

An additional discussion point would be to ask the students how the PlayPump story could be changed so that is would be considered Ethical Egoism or Sidgwick’s Dualism instead of Utilitarianism.

Ethical Egoism example would be that Mr. Field would make a personal financial profit from the operation. The play pump still benefits others but instead of viewing from an utilitarianism perspective it would be used as just “satisfying the news of his customers”.

As a result, his own personal self interests would be satisfied with financial compensation and the fresh drinking water would still come to the villages.

Sidgwick’s Dualism example would be that Mr. Field would not receive any financial profit from the playpumps but he would be allowed to advertise for free his company’s products on the water towers if he had his own businesses not related to the water pump. This could be an example of the middle point between the self interests of Ethical Egoism and the greatest good for the greatest number of Utilitarianism. Mr. Field would not receive any direct financial benefits from the pumps but would receive the indirect benefit of being able to make potential customers aware of his other products. However, the net result would be that the pumps would be installed at no charge to the communities around South Africa.

2. Using the same event you chose in question 1 above, discuss the event in terms of the deontological frameworks discussed in the text.

Existentialism-From this perspective, ask the student how he/she judged his/her behavior during the event. Is the judgment of the behavior now the same as it was when the event was occurring. If the answer is no, this could highlight one of the limitations of existentialism. Upon reflection the validation of the activity may not be so clear cut. As a result, existentialism relies on determining right and wrong based on free will at that point in time but the decision maker may change their perspective over time. The follow

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up question to enforce the point is to ask the student whether he/she would behave in the same manner if the event occurred again in the future.

Contractarianism- From this perspective, ask the student whether his or her actions were based, in part, on the actions of others. Did he or she believe it was okay to act that way because his or her friends were also acting that way? This discussion would eventually lead to the “If your friends jumped off a cliff, would you do it also?” question.

Ask the class how important is it to have acceptance from their peers when they are doing any activity.

Kant’s Ethics-From this perspective, ask the student whether the student’s free will or the peer pressure from others lead to the final determination of the ethical event. The student may reply that both individual free will as well as fitting into social norms were considered when the activity took place. At this point ask the student whether certain friends would be more influential in the decision making process.

3. Choose any Fortune 500 Company. Locate the company’s code of ethics published on the company’s web site. Evaluate the code of ethics in terms of the Global Business Standards Codex.

This would be a good first written assignment for your students. You may want everyone in the class to select a different company and have them present their analysis in a following class period. In addition, you also may want to have the students select both a US based and Non US based company from the same industry possibly ranked in the Global Fortune 500 listing. This would be a good exercise to show the students that firms in different companies may take a different approach to addressing ethical policies and procedures.

4. Using the principles set forth in the Global Business Standards Codex, find an example of a company that does or did not follow one of the principles. Discuss the implications of the company’s action.

You could use the previous example given of the firm Energizers which lists how they use each of the 8 principles (http://www.energizers.eu/gbs_codex.html). You also may start discussion by asking whether the students would rank each of the 8 principles as having the same level of importance. If they do not feel they should be ranked equally, have the students rank them for you and have them justify their rankings. If a student brings in an example of a company which doesn’t address all 8 of the principles in their ethical policy, ask them why wouldn’t they. Also ask them whether the omission of the principle(s) would impact whether you would: invest in the company, buy products from the company or work for the company.

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Chapter 2 Contemporary Issues In Business Ethics The purpose of this chapter is to present a general summary of current issues that are related to business ethics. This chapter allows the instructor to further entrench the value of strong positive ethical behavior in a business setting. The chapter also highlights that it can be difficult to determine and interpret what is ethical and unethical behavior based on the potential internal biases of every person.

Key Learning Points 1. Student realizes that even famous pop stars such as Bono may exercise behavior that to outsiders may be considered unethical and is inconsistent with the person’s own beliefs pertaining to aiding the less fortunate.

2. The History of Business Ethics highlights the longevity of unethical behavior.

As was stated in the beginning of the Preface of the textbook, unethical behavior is as old as commerce itself. As long as there are a finite amount of resources, some people will continue to try to obtain those resources by whatever means possible.

3. The discussion on integrity helps student understand the distinction between legal and ethical behavior. While some students will always state that their ethical values will be based on the legal standards, the role of integrity in the decision making process allows students to see that there are benefits to moving beyond the minimum legal standard.

4. The Ethical Cycle is a simple model in which students can understand the logical path in the decision making process to decide what actions would be considered morally acceptable.

5. The discussion on using ethical decisions to build character and the ability of ethical managers to make their own rules allows the students to understand that the positive aspects of ethical behavior go beyond the net result. The ethical decision making process enhances the ethical means which will yield the ethical ends via an ethical decision.

6. Is everyone unethical can be linked directly to the Bono case at the beginning of the chapter. It is important for the students to understand that their perceptions may not correspond with the perception of others. This discussion could lead to a general discussion on heuristics and “rules of thumb” and their role in making ethical decisions. The discussion could also lead to how decision makers can rationalize unethical behavior.

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7. Monitoring reputations can show the students the direct link between the ethical activities of the company and how the company is perceived by their stakeholders. The students should understand that there are direct financial consequences if there are disclosures of unethical activities with the firm.

Bono: I Still Haven’t Found The Tax Rate That I’m Looking For (p. 14) This case allows for a good opening discussion on contemporary issues in business ethics. The title is a take-off of the U2 hit song “I Still Haven’t Found What I’m Looking For” and relates to U2’s quest to find the lowest tax rates for their royalties.

1. The first question to ask is that although other artists are mentioned in the case, including three members of the Rolling Stones, why was U2 and, specifically, Bono selected as the focus of the article.

Bono was selected because of his apparent hypocritical approach to tax avoidance. The members of the Rolling Stones have never gone to developed countries asking them to contribute more aid to those countries that are poorer.

Elvis Presley never stated the role of government was to help end poverty. Bono is the focus because he has volunteered to be evaluated based on higher ethical standards then other rock stars. Bono’s actions beg the question why should governments give more aid to developing countries when he and the other members of U2 are purposely trying to reduce the level of money that is given to governments.

2. Why do you think that Bono fails to see the inconsistencies of his actions?

Bono has appeared to have done an excellent job in departmentalizing his decision making. It appears as if his public appeals for more aid do not have a direct link to his own personal wealth. In addition, it appears that Bono is using the argument that the legal standard is the ethical standard as it pertains to taxes. There is nothing wrong with using the legal standard as the ethical standard if you do NOT have a reputation of presenting higher ethical goals than others. Again, Bono’s actions do not appear to correspond with his arguments.

3. What could Bono do now to help correct this perceived hypocritical behavior?

The best alternative for Bono may be to establish a trust fund for the difference between his tax payments and his potential tax payments if the royalties were still being taxed in Ireland. By accumulating the difference in these two tax rates, Bono could present the money in the trust fund to directly aid developing countries that need financial help.

In February 2008, Bono was in the news again with another apparent hypocritical stance related to the expansion of a hotel he owns with U2 guitarist, the Edge, in

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Dublin. He wants to expand the 177 year old Clarence Hotel but failed to convince an independent planning watchdog in Dublin of his plans even after a lunch which included several bottles of wine. The 150 million Euro proposed renovation (220 Million $US) would triple the size of the hotel. “The Clarence demolition is an old-fashioned money-driven, anti-environmental exploit… Bono is behaving like just another private-jet-addicted property speculator feeding on Ireland’s greedy zeitgeist” stated Michael Smith who is a member of the independent planning watchdog organization. The Dublin planning committee had approved the renovation in November 2007 stating that the revocation would improve the economy in Dublin. In addition, U2 also wants to develop a 394 foot tower in the Dublin’s docklands called the U2 tower. It is expected to be completed in 2011 and would be the city’s largest building. Another critic of the two projects, Ian Lumley, stated that “Taken together, these are two egomaniacal projects”. In January 2008, Bono was asked about his apparent inconsistencies related to what he says and his actions. He concluded that there was not a conflict between his social activism and his financial investments. “I long since grew out of the idea that artists good, businessmen bad…I got over than one when I was 22” stated Bono.1 History of Business Ethics (p. 15) The purpose of this section is to highlight that unethical behavior is as old as commerce. As long as there are items of value that are finite, some people will try to obtain those items unethically. Early “unethical” commerce dealing include “giving” companies established by a country (e.g., England) exclusive rights to newly discovered land in order to “English” colonies. Not only did this strategy limit options available to customers but it “forced” a predetermined culture and beliefs into a new country setting. The 1960’s highlighted unethical activities by companies that were related to areas such as discrimination and illegal drug use in the workplace. The 1970’s was highlighted with scandals related to defense contractors, human rights and the natural environment. In the Gordon Gekko era of the 1980’s, scandals related to savings and loans fraud and the role of corporate raiders moved to the forefront in issues related to ethical concerns.

The 1990’s shifted toward ethical dilemmas facing multinational firms including outsourcing issues in developing countries. The end of the 1990’s and the beginning of the 2000’s was the pinnacle of unethical behavior by major corporations in both the United States (Enron, WorldCom and Tyco) and around the world (Ahold, Parmalat and Hollinger International) The net result was increased government intervention globally with the centerpiece legislation in the United States being the Sarbanes-Oxley Act that was passed in 2002.

Doyle, Dara. Bono’s Dublin Hotel Plan Pits Rocker Against Preservationists. Bloomberg News. February 21, 2008. pp 1-2.

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The Role of Integrity (p. 16) Students must understand that integrity is a foundation belief that must be incorporated in the decision making process in order to ensure that ethical decisions are made. Decision makers must take into account a number of factors to insure their decisions are made with integrity including: possessing humility, maintaining concern for the greater good, the ability to be truthful, being able to fulfill commitments, strive for fairness, be able to take responsibility for your own actions, having respect for the individuals, be able to celebrate the good fortune of others, help aid in the development of others, be able to reproach unjust acts, be forgiving in their actions, help others when they are in need and encourage other individuals to learn how to develop ethical behavior. This would be a good opportunity for a learning point with the students by asking them whether they have ever made a decision that was based on integrity. Follow up by questioning being whether another individual made a decision that impacted them that was not based on integrity.

The Ethical Cycle (p. 19) The presentation of the Ethical Cycle allows the student to understand the ethical decision making process from a linear perspective. The students should be able to quickly grasp the sequential step process in making ethical decisions. It should be stressed that it can be open to interpretation of the “facts” that are collected at each step in the Ethical Cycle.

Moral Problem Statement The identification of the moral problem could be viewed differently by different decision makers. For example, those issues which may be “legal” but may not be “ethical” could result in some decision makers determining that there is not a moral problem. For example, if India “allows underage” girls to sew garments together is there a moral issues since this could be the legal age of work in India.

Problem Analysis The problem analysis step in the ethical cycle sets the tone for the decision maker to incorporate factors beyond simply using his or her heuristics to develop a solution. It is critical that the students understand that decision makers must consider others who are impacted by their decisions. That is why stakeholder theory is intertwined within all the chapters of the textbook. Decision makers must understand the wants and needs of other vested parties to their decision process. Furthermore, the decision process must have boundaries in order to help guide the course of action. Therefore, the decision must be within the boundaries of the moral values of the individual and the firm. The third critical point is determination of the relevant facts. Again, this can be a subjective process. Each individual will make their own determination of what facts are

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“relevant” and which facts are not. As a result, a different interpretation of “relevance” can result in a different analysis of the problem.

Options For Action The students must understand that options for action should not be considered “lightly” in this analysis. Different viable alternative courses of action must be considered by the decision maker. Each decision must result in obtainable results that can be measured against the overall goals and objectives of the firm.

Ethical Judgment It is the responsibility of the decision maker to “maximize” the level of satisfaction for the stakeholders of the firm. As a result, the decision maker must always reconcile his or her actions with the demands of the stakeholders which occur during the ethical judgment step in the Ethical Cycle.

Reflection Reflection is a time in which the decision maker pauses the process to reflect on how the decisions were made and how the decisions will be impacted by others.

The reflection stage allows the decision maker one more chance to ensure that the course of action developed to resolve the moral problem is in the best interest of all the vested stakeholders of the firm.

Using Ethical Decisions to Build Character (p. 20) When ethical decisions are made, they build character in the decision maker by creating defining moments. Defining moments are decisions which can impact all the subsequent ethical decisions made by the individual. These defining moments could be compared to “forks in the road” in which the individual must decide which path to follow. Both of the paths can be the plausible and acceptable, however, the decision of which path to take aids in the direction of future decisions of the individual.

Who Am I? Defining moments can help determine the core values of the decision maker. It is during the “Who am I” defining moment that the decision maker must address conflicting feelings and intuition in the decision making process. It is also during this stage that the individual ethical values come to the surface as part of the decision making process Furthermore, it also forces the decision maker to think “outside the box” for new and innovative approaches to addressing ethical issues.

Who Are We? Defining moments can help incorporate the individual’s ethical beliefs with those of other employees within the firm. By addressing the questions of: (1) what are the different interpretations or points of view that can be used to develop an effective course of action, (2) what point of view would most closely align with the

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“general or majority” view of the employees within the firm and (3) how can the manager ensure that his or her interpretation of the ethical value will be supported by his or her subordinates and peers.

Who Is the Company?

Defining moments can be used as tools to help clarify what ethical paths should be taken by executives within the firm. Questions at this stage include asking the executive whether he or she has done everything within his/her power to develop a proper ethical course of action; have the decision makers considered nontraditional approaches in order to address the ethical issues and what individuals create ideas that can be used to convert a proposed course of ethical action into an implemented course of ethical action.

Ethical Managers Are Able to Make Their Own Rules (p. 21) The underlying position of this section is that if a manager is ethical in his or her actions, he or she can control the rules of the game. In other words, strong ethical decision making will eliminate consideration of questionable ethical actions since those actions would not be considered as a viable course of action.

An example is the owner of Cadbury’s who refused to support the war but wanted to support the troops. The owner was able to make his own rules by establishing the ethical conditions in which he was going to do business with the British government. By putting ethics in the forefront of the decision making process, managers are able to seamlessly incorporate strong ethical values in each decision they make.

Is Everyone Unethical? (p. 22) This question should lead to a lot of lively classroom discussion. The key component of this section is that the students may be “guilty” of these heuristics and not even being aware of it. It is through the illusion of objectivity that individuals convince themselves that they are being fair and ethical while others would not agree with that conclusion. It is during this section of the chapter that you can link Bono’s actions with the concepts. Bono appears to believe there is no contradiction with his actions and his viewpoint. This shows that even very public figures can be caught in the “unintentional unethical conduct” web.

Implicit Prejudice In this case, the person has unconsciously already evaluated the validity of the information and/or actions of others based on pre conceived stereotypes which the decision is not aware of. A good example to explain this concept is the current investigation pertaining to illegal steroid use of major league baseball players. Does the student either believe or not believe the baseball player based on whether that student is a fan of the team the player played on in the past. If the student is a “loyal” fan of the player, do they believe them regardless of the

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evidence? Alternatively, if they do not like the baseball player, do they believe he is guilty regardless of the evidence?

In-Group Favoritism This is a very common occurrence due to human nature. As humans, we like to interact with people who share our same interests. As a result, we are more likely to spend time with people who share our same interests which can result in the unethical concept of in-group favoritism. If, for example, a subordinate went to the same fraternity/sorority, grew up in the same neighborhood, likes the same sports and sports teams, it would be very likely that this social connection would result in more time spent with each other. It could also result in the subordinate helping out the employee because they have become social friends. The net result is that other employees that are not included within that specific social network would not receive the same “benefits” from the subordinate.

Claiming Credit for Others’ Actions A very common issue is to evaluate your own contribution to a task as significantly higher than others contributions. Since you only have complete information pertaining to your own contribution, you will evaluate yourself highly since you can present to yourself all the areas where you made a contribution.

However, you do not have complete information about the actions of others so you assume that their contribution is less.

Conflicts of Interest A conflict of interest occurs when there are personal benefits for making a decision which are not available to others. The “conflict” is based on the idea that the decisions made by the manager should represent the interests of the company and the stakeholders instead of purely the interests of the decision maker.

Ten Myths About Business Ethics (Table 2-1) These ten myths can be a good discussion point during the lecture. It is expected that the students will relate to a number of these myths. You may want to ask the students whether they thought these myths were true when they started the class at the beginning of the term. You may also ask the students why they think these myths have been developed over time related to business ethics.

On page 24, a listing of 10 benefits for paying attention to ethical issues in the workplace is listed. A good classroom exercise would be to ask the students to rank in order the top 3 or 5 on list as the most important benefits for paying attention to ethical issues. This should generate a good discussion since different students may have different rankings. As a result, it would be an excellent opportunity for the students to realize that even if the ethical programs and training are standard within the organization, the employees may perceive the benefits can be different.

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Knowing “Right” From “Wrong” (p. 24) In order to understand the distinction between “right” and “wrong”, the students must understand who will be impacted by a decision made by a manager. It is through stakeholder theory that students can understand that “right” and “wrong” include not what is just right and wrong for the stockholders but what is right and wrong for all the various stakeholders of the company.

Rationalizing Unethical Behaviors (p. 25) Three ethical tests can be used for a business decision: Transparency-refers to the ability for others to have access to the same information so that they can understand how the decision was made Effect- who will be affected by this decision? What will be the short term and long terms effects of the decision?

Fairness-will the decision be considered fair by those that are impacted by it?

This incorporates the interests of the stakeholders in the decision making process.

Eight Rationalizations for Ethical Compromise (Table 2-2) These rationalizations should all be considered red flags when a decision maker tries to convince himself/herself of their actions. It should be stressed to the students that these rationalizations can make for convincing arguments to do unethical activities especially if a peer and/or superior aid in the presentation of the rationalizations. Upon reflection, the decision maker must ensure that these rationalizations are not used in order to justify their actions.

Discretionary Actions-actions that can be adjusted or compromised within established boundaries.

Nondiscretionary Actions-actions that can not be changed under any circumstance. There is only one correct course of action which includes laws and government regulations.

Red Flags to Spot Ethical Dilemmas (Table 2-3) These eight “red flags” also should generate a lively classroom discussion. You should ask the students whether they have used any of these additional rationalizations when making a decision. It is expected that everyone in the class, at some point, succumbed to peer pressure as is highlighted in “Everybody else id doing it, so why should I be the exception?” In addition, it is expected that if they have had previous work experience, that the red flag of “Since I was told

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what to do, I did it.” would apply. You may add that the “just following orders” was not acceptable at the Nuremburg trials for the former Nazi officers and it not a legitimate excuse.

Monitoring Reputations (p. 27) Self-monitoring is critical to ensure proper ethical conduct. However, as was mentioned earlier in the chapter under “Is Everyone Unethical”, it is a continuous challenge to monitor oneself since each individual has their own perceptions and heuristics that are included in the monitoring process. The students must understand that ethical conduct at an individual as well as at a corporate level has a direct impact on the image of the individual and firm. Therefore, a reputation that could take decades to develop can be destroyed within a matter of months if unethical behavior is tolerated. This point leads into the listing of questions for an Ethics Self-Assessment (Table 2-4). One of the critical points of the listing is to demonstrate to the students how “easy” it is to move “off course” from an ethical path to an unethical path. What starts as “little white lies” quickly can snowball into multiple ethical violations.

Striving For Ethical Behavior (p. 28) The challenge of striving for ethical behavior starts with multiple courses of actions. Since there may be no one “correct” solution to an ethical dilemma, it is the responsibility of the decision maker to gather information pertaining to the dilemma and pick the “most appropriate solution” to the dilemma.

Internal and External Current Ethical Issues (p. 29) The five top reasons why managers try to make sure their firms operate in an ethical manner relate to stakeholder theory. By being concerned about their external image, by doing the right thing, by establishing and maintaining customer and investor loyalty and trust, and by protecting public recognition, firms are addressing individually and collectively the needs and desires of various vested stakeholders on the operations of the firm.

The rankings of the five top reasons that drive business ethics in 2005 and 2010 show how respondents have shifted their perceptions as to what are the most critical ethical issues currently as opposed to most critical ethical issues in the future. Therefore, the rankings are: 2005 1. Corporate scandals 2. Marketplace competition 3. Demands by investors 4. Pressure from customers 5. Globalization

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2010 1. Globalization 2. Marketplace competition 3. Pressure from customers 4. Corporate Scandals 5. Demand by investors The rankings show that mangers do not feel that corporate scandals and demands by investors will drive the ethical decision making of firms in the future.

The reason for this could be that the managers believe that government regulations such as the Sarbanes-Oxley Act and intense media coverage of the individual and corporate consequences of unethical behavior have established strong formal boundaries of what is considered acceptable and unacceptable behavior.

Questions For Thought 1. Do you personally think ethics is an important topic to discuss in business schools? Explain.

An answer to this question would be that ethics need to be taught so that the students understand the costs and benefits of ethics. The benefits of strong ethical behavior are that this is the desired action wanted by the firm and individuals will be rewarded if they are committed to a positive ethical focus. In addition, from a corporate perspective, the teaching of ethics is critical in order for each employee to be able to “buy in” to executing decisions that support positive ethical behavior. The cost of having a negative ethical presence also needs to be presented to the students. The reputation, image, trust, credibility and the potential to ultimately their jobs could be lost through unethical behavior.

From a firm perspective, the costs of having a negative ethical climate would result in potentially permanent damages to the image and reputation of the firm.

Furthermore, a negative corporate image can result in a negative image for employees who work for the firm even if they were not involved in the unethical activities. For example, you could ask your students how easy do they think it would be for a former employee of Enron to find a new job even though the employee had no link with the unethical activities of the top management at the firm.

2. Examine the myths given in Table 2-1. Do you agree that these are all valid myths? Why or why not?

Myth 1. Business ethics is more of a focus on religion than on effective management.

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There will be some students who will believe that what is moral and ethical is what is taught in a religious setting. This in itself in not a myth, however, the chapter highlighted that there are many variables to consider when making a decision and it is not always easy to know what the “right” course of action should be.

Myth 2. Companies assume that they select and train ethical employees who will always do the right thing.

It could be argued that this is a very common myth. The underlying assumption is that if the employees are properly selected and trained, they should always be ethical. Of course, this is not true since the selection and training process are only two initial steps in the process to ensure ethical behavior. Over time, employees may start to believe that the company “owes” them more because of long hours, high stress, limited time away from work related activities, resulting in the justification of unethical behavior in order to be compensated “equitably”.

Myth 3. Business ethics is a theoretical and abstract philosophical concept.

There are probably many students when they started the class believed this myth. This myth was reinforced with the presentation of the major philosophical theories in Chapter 1. A conscious effort was made by the authors to move beyond the theoretical aspects of business ethics and present ethics from an applied and practical viewpoint. As a result, as the students move further along in the class, they will realize that this myth is not accurate.

Myth 4. Business ethics is based solely on the belief that you will always do the right thing.

As was presented in this Chapter and Chapter 1, it is not always easy to identify what is the “right thing to do”. The decision makers must take into account the vested interests of the firm’s stakeholders as part of the decision making process. In addition, there may be multiple “right” courses of action which still result in a subjective evaluation of the optimal course of action.

Myth 5. Business ethics is used by ethical people to correct what unethical people do.

One of the problems with this myth is the cause and effect aspect to the action.

The underlying assumption is that unethical behavior has to occur first before any action is taken by the firm. In addition, it places the burden on the correction of unethical activities on the shoulders of others. This myth assumes that the firm does not have the proper preventative activities (training, monitoring) in place to try to stop the unethical behavior before it takes place.

Myth 6. Business ethics is based on legal compliance.

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This myth is widely held by students who believe that the value of ethics is that is stops illegal behavior. The problem with this myth is that the decision makers are letting governments determine their ethical values. If the legal standard is also the ethical standard, the decision makers have let government determine their ethical value system. An example you can give the students is that if countries in the far east allow “underage” girls to sew garments and assemble running shoes would they also want that to be their “ethical” standard. How would the firm’s various stakeholders view that decision?

Myth 7. Business ethics cannot be managed by company supervisors and executives.

As with the other myths, there are elements of validity with this statement but not completely. Company supervisors and executives can implement monitoring and control processes in order to try and ensure ethical behavior. However, if an employee is determined to do unethical things, the monitoring process will not be enough of a deterrent for the employee. The employee will just develop a course of action in which he or she will not be “detected via the monitoring systems”.

There is no guarantee that a firm monitoring and controlling systems will be 100 percent effective.

Myth 8. Business ethics equals corporate social responsibility.

Business ethics is a component within corporate social responsibility but they are not equal concepts. Corporate social responsibility incorporates the vested interests of the stakeholders in the decision making process. However, every “ethical” decision does not always have to address the needs of the entire stakeholder even though it would certainly be advantageous to do that.

Furthermore as will be highlighted in Chapter 3, corporate social responsibilities (CSR) incorporate: economic, legal, ethical, and discretionary responsibilities as components of CSR. Myth 9. Because the company does not have any criminal investigations pending, the company is ethical.

This myth is the same argument that is presented in Myth 6. Unethical activity does not always equal illegal activity. There are many legal activities such as the example in Myth 6 that could be considered unethical.

Myth 10. There is little practical relevance in supervisors’ managing subordinates on business ethics in the workplace.

This myth is a dangerous one to accept. The underlying assumption is that managing ethics in a business setting is not viable. Supervisors play a critical role in managing the day to day ethical standards of their departments. By

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leading by example, supervisors give a clear message to the subordinates what is acceptable and unacceptable behavior.

3. Assuming everyone makes mistakes in life, are ethical mistakes considered the worst mistakes to make? Explain.

This question addresses the intent of the decision maker. Ethical or any other type of mistakes in themselves can not be ranked based on which ones are “worst”. However, an evaluation of the actions or mistakes can be made based on the intent of the mistake. If the decision maker made a decision in which he or she did not think they would be caught or that there were be no negative consequences of the decision that would be considered “worse” than a decision maker who made an “ethical” violation due to ignorance. Although ignorance is not a justification for unethical activity, the distinction is that the decision was not malicious in nature and the decision was not made based on the personal self interests of the decision maker. Therefore accidental mistakes which cause loss of life or significant impact on human life would be considered the worst mistakes but could be ethical in nature. For example, a bus going the speed limit hits debris on the road and spins out of control with loss of life occurring as the result of the accident. This is a horrendous mistake but the bus driver did not perform any unethical action.

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Chapter 3 Stakeholders and Corporate Social Responsibility The purpose of this chapter is to expose the students to the interconnection between stakeholder theory and corporate social responsibility in ethical decision making. This chapter presents concepts to highlight who has a vested interest in the company and outlines what the firm’s responsibilities are in addressing those interests. The chapter also discusses how firms should address issues related to human rights both domestically and globally.

Key Learning Points There are a number of key learning points which can be accomplished when this chapter is presented to the students. These include: 1. Defining what a stakeholder is and explaining how stakeholders’ needs should be addressed by the firm.

2. How communications should be established between the stakeholders and the firm.

3. The role of employees as stakeholders.

4. The role of suppliers as stakeholders.

5. The role of customers as stakeholders.

6. The role of the government as a stakeholder.

7. The role of society as a stakeholder.

8. The role of corporate social responsibility.

9. The role of human rights.

When Is Fair Trade Not Fair? (p. 33) 1. What is the definition of Fair Trade?

The general definition of Fair Trade is that the farmers who grew the crop receive a “fair wage” for their efforts. As a result, the product usually has a higher selling price to compensate this “higher wage rate”.

2. Why is “Fair Trade” an ethical issue?

Fair trade is an ethical issue because it relates to the treatment of the firm’s suppliers. This case is a good example to use to distinguish between legal and ethical behavior related to stakeholder theory. It is expected that if the firms are try to serve the needs of the stakeholders, they will trying to have a strong positive relationship with the suppliers. As a result, the “ethical” thing to do would be to move beyond paying the legal wage rate and give the farmer a fair wage rate.

3. What are the competitive advantages of “Fair Trade”?

The competitive advantages for fair trade occur at both ends of the supply chain.

By paying the farmer fair wages, the farmer will want to sell as much of his coffee as he can to the companies that will pay him a “premium” for his work. As a result, a strong loyal positive relationship will take place between the firm and the farmers. The second advantage occurs when the coffee is sold by the retailers.

By presenting the coffee with a certified Fair Trade logo, the coffee will be differentiated versus coffee that does not have a logo. Therefore, customers that are aware of the Fair Trade issue and want to support Fair Trade will buy the coffee that has been certified.

4. What are the potential problems with Fair Trade?

As was highlighted in the case, one critical problem is to ensure that the farmers are receiving the fair wage premium. If, as was presented in the case, the middlemen are receiving the premium instead of the farmer, the ethical value of the fair wage premium is gone. In addition, if the retailers charge much higher prices than are warranted to compensate for the fair trade wage, the ethical value of the program has been diluted.

The second major issue is whether customers care about fair trade. The underlying assumption is that customers would be willing to pay a higher price for coffee with the end result being that the farmers receive more money for their efforts. However, customers may not care about the issue and, therefore, would not be willing to pay a “fair wage” premium in order to buy the coffee. The net result would be that the fair trade program would no longer be considered a competitive advantage but would be considered a competitive disadvantage.

A description of Green Mountain Coffee Roaster’s Fair Trade program can be found at: http://www.greenmountaincoffee.com/ContentPage.aspx?Name=bbw-workingfair-trade-certified&DeptName=bbw-working-together-for-change.

Using Fair Trade As a Competitive Advantage1 A March 2008 Wall Street Journal article highlighted how small firms are using fair trade “vacations” as a major component of their competitive advantage. As large retailers such as Wal-Mart and Starbucks embraced Fair Trade coffee, the competitive advantage for small fair trade coffee roasters was greatly weakened.

As a result, the smaller companies organize tours for owners of stores who buy coffee from these small manufacturers so they can see first hand how a fair trade farm operates. For example, Just Coffee Cooperative in Madison, Wisconsin organizes trips to Guatemala for their customers to observe fair trade farms who are suppliers to the cooperative. The net result is the entrenching of the customer’s loyalty to the cooperative. After the co-owner of Red Rooster Coffee House in Aberdeen, S.D. went on a Just Coffee Cooperative tour she stated that “it would be really, really hard for us to go somewhere else for our coffee.” The net result is that Red Rooster Coffee House now recommends the Guatemalan coffee from Just Coffee Cooperative and declines offers from other coffee roasters to try their samples.

In 2006, 65 million pounds of fair-trade coffee was imported into the United States. This represented a 45 percent increase from 2005 and a 100 percent increase from 2004, What Is A Stakeholder? (p. 34) Although a number of the students may not be familiar with the term stakeholder, it needs to be stressed that stakeholder theory is one of the underlying foundation concepts for the textbook. Stakeholders can be defined as any group of individuals who have a vested interest in the day to day operations of the firm and the subsequent long-term operations of the firm. How firms act is directly related to how they are serving the needs of others. It is through stakeholder theory that different components of a firm’s ethical commitment can be integrated together.

It is important to note that stakeholder theory is not a new concept. As is highlighted in the textbook, the origins of stakeholder theory can be traced back to the 1930s when the issue was debated in the Harvard Law Review by Berle and Dodd. Milton Freedman made the next significant contribution to stakeholder theory be defining a very narrow scope to the term and supporting the view of Berle. By arguing that the role of the firm is to increase its profits, Freedman identified the investors as the only relevant stakeholder. As a result a continuum had been established in which serving the needs of only one stakeholder, the

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Covel, Simona. Enterprise: Tours to Fair-Trade Farms Help Coffee Sellers Spread Word; Trip Takers Embrace Mission—and Become Devoted to the Products. The Wall Street Journal. March 11, 2008 p. B5

stockholder, is at one end and serving the needs of all the relevant stakeholders is at the other end.

The Stakeholder Model (Figure 3-1; p. 35) shows the interconnecting relationship between the firm and the various stakeholders. Each of those stakeholders has an active interest in the firm’s operations and each of those stakeholders will present their discontent of the firm if their needs are not being served.

Stakeholders for the firm include: Government, Suppliers, Trade Associations, Investors, Employees, Political Groups, Customers and Communities.

Management’s Response to Stakeholders (p. 35) Moral Management and Stakeholders Managers can display three different moral viewpoints based on their individual viewpoints. By focusing on moral, amoral and immoral behavior, students can learn that two managers in the same company can react very differently to the exact same set of circumstances. While it may be easy for the students to grasp the concept of a moral and immoral manager, the amoral manager may be more difficult to envision. As a result, it is important to highlight the potential ethical problems with an amoral manager. By not including ethical values in the decision making process, an amoral manager exposes him or herself to potential unintentional problems. As was mentioned in the textbook, physical requirements for job applicants may seem “necessary” in order to fulfill the commitment of the job. However, firms are also required to make accommodations when possible in order for potential applicants to be able to be considered for the position. In addition, an amoral perspective uses the legal standard as the default ethical standard. The limitation of this philosophy is that certain actions which are legal could also be considered unethical. For example having “underage” children sew clothing together in a developing country even though they are within the legal guidelines of that country represents this type of philosophy.

Table 3-1 (p. 36) presents a good summary highlighting the differences in stakeholders interaction among the moral, amoral and immoral managers. One thought provoking question which you could ask is whether a manager has a “hybrid” relationship with stakeholders. In other worlds, could a manager act as an “immoral” manager with the local community, act as an “amoral” manager with their customers and act as a “moral” manager with the firm’s stockholders. The simple answer is yes. Managers may not be consistent in their moral values. As was highlighted in “Is Everyone Unethical” in chapter 2, the manager may not even be aware of his or her inconsistent actions. As a result, how could the manager ensure that his or her actions are consistent among of the stakeholders? A simple solution would be to ask each of the stakeholders to evaluate the moral behavior of the manager. The feedback from the stakeholders

could be used to verify the level of consistency of the actions of the manger to all the vested stakeholders.

Which Stakeholders Are More “Important”? (p. 37) The relative “importance” of various stakeholders is based on the belief that there are contingency attributes that could require more attention by the managers.

The role of power is a two edged sword. Just as the firm can exercise power over the stakeholders, the reverse is also true. Stakeholders have the legal power to sue and legally disrupt the operations of a firm based on unethical activities of the firm. This leads into the concept of legitimacy. Stakeholders have a vested interest to monitor the activities of the firm since they are directly impacted by these activities. As a result, stakeholders can ensure that the activities of the firm are “legitimate”. Urgency is usually based on usually crisis activities which must be resolved within a set time frame. As a result, a strike by the workers of the firm increase the level of importance of the employees as a stakeholder since it directly impacts the current operations of the firm.

Four Roles Through Which Stakeholders Impact Organizations: (p. 38) 1. Stakeholders establish expectations (explicit or implicit) about corporate performance.-The challenge occurs when the expectations of the stakeholders do not coincide with the expectations of the firm. Whether it is the treatment of the employees, the financial performance of the firm, or the type of suppliers who provide the raw materials, there is always the potential for disconnect between the expectations of the stakeholders and management.

2. Stakeholders experience the effects of corporate behaviors-By definition, stakeholders will be directly impacted by the behavior of the firm since they have a vested interest in the operations of the firm. As a result, stakeholders will try to ensure that their “needs” are satisfied by the actions of the firm.

3. Stakeholders evaluate the effects of corporate behaviors on their interests or reconcile the effects of those behaviors with their expectations.-As a continuation of number 2, if stakeholders believe their “needs” are not being satisfied, they will either try to make the firm adjust their actions or they will adjust their expectations concerning what are acceptable actions by the firm.

4. Stakeholders act upon their interests, expectations, experiences, and evaluations.-This is by far the most comprehensive and, therefore, the most difficult stakeholders’ actions to anticipate from the firm’s perspective. By relying on their interests, expectations, experiences and evaluation, there is a potential for large gaps in the perceptions of the stakeholders and the perceptions of the firm. Since each of the stakeholders could have varying interests, expectations, experiences and evaluations, there could be inconsistencies among the stakeholders as to what is considered to be serving the needs. Therefore, the

axiom “you can’t be all things to all people” applies in that it would be impossible to satisfy all the expectations of every stakeholder. Therefore, firms must use the utilitarian philosophy of trying to serve the greatest good for the greatest number.

Johnson and Johnson Credo (p. 38) The Johnson and Johnson Credo is one of the best known “Codes of Ethics” in part because it was one of the first corporate codes of ethics and it has been considered a benchmark which firm’s use to evaluate their own code of ethics. In 1982, the Johnson and Johnson Credo was put to the test when one of its products, Tylenol was tampered with and contained cyanide which killed 7 customers. Even though Johnson and Johnson was not responsible for the deaths since the tampering occurred at the retail shelves, Johnson and Johnson voluntarily withdrew an estimated 31 million bottles of Tylenol from the marketplace at an estimated cost of $100 million.

General Electric’s Nine Guiding Principles for Open Dialogue with all Stakeholders (p. 39) 1. Maintain a culture that makes performance with integrity the bedrock principle of the Company. Corporate Culture plays a critical role in the formulation and implementation of ethical values within the firm. Corporate Culture is addressed in more detail in Chapter 8.

2. Set high standards of performance. This links back to the previous discussion on “Four Roles Through Which Stakeholders Impact Organizations” The expectations of performance by the stakeholders and the firm must be consistent. It is through the establishment of high standards of performance that both the stakeholders and the firm are satisfied with the overall operations of the organization.

3. Make compliance a core operating principle. This relates to having the proper ethical compliance and monitoring system in place within the firm. Corporate compliance is addressed in Chapter 4 and ethical monitoring systems are discussed in detail in Chapter 11 which addresses the evaluation of corporate ethics.

4. Build exceptional governance with a strong Board. Corporate Governance and the role of the board of directors are discussed in Chapter 4.

5. Be open and transparent. Clarity of a firm’s actions is paramount from the view of the firm’s stakeholders. It is through a transparent lens that stakeholders can make a fair objective evaluation on how the firm is addressing the needs of the stakeholders.

6. Develop great leaders with the right incentives. It is imperative that the firm’s managers have a high level of commitment to ethical values in order to create an effective liaison with its stakeholders. Managers should be rewarded for doing the “right thing” and be punished for doing the “wrong thing”. However, the managers must also buy in to the non financial rewards of being a strong ethical leader. It is through their intrinsic rewards that management can effectively match the actions of the firm with the expectations of the stakeholders.

7. Make a business out of solving the world’s toughest problems. This statement shows the visionary foresight of General Electric. In order to move forward in addressing the expectations of stakeholders, a pioneering ethical company will look at future business opportunities that will address future stakeholder needs.

Solving global problems such as poverty, climate change, and energy depletion usually involves great financial needs but would also result in huge financial rewards which would also satisfy the needs of the firm’s stakeholders.

8. Take ethical actions beyond what the rules require that are in the long-term interest of stakeholders and the Company. This relates back to the previous point. By envisioning future stakeholder issues, the firm is able to serve not only the current interests of the stakeholders but also the future interests.

9. Give back to communities through philanthropy and volunteerism. By focusing on the local community as a critical stakeholder, the firm ensures continued support by the community as it expands its business operations.

The Role of Stakeholder Communications (p. 39).

Triple bottom line reporting formalized the communication methods used by firms to present information to their stakeholders. By establishing not only financial reports, but also environmental and social reports, firms allow information to be communicated to those stakeholders that are interested in the information. The internet has allowed stakeholders to raise their expectations pertaining to the quantity, quality and speed in which information is available to them pertaining to the activities of the firm. The triple line reporting and the internet have also allowed firms to be able to present a comprehensive detailed narrative of their commitment to their stakeholders and their needs.

Employees as Stakeholders (p. 40) Employees are the backbone of any organization and if they are not treated fairly, they may be more likely to be engaged in unethical behavior. This equitable balance is addressed in Equity Theory. In equity theory, each employee evaluates his or her inputs (effort, commitment) and outputs (compensation, promotion) versus the inputs and outputs of other employees. If the employees believe they are not being treated equitable (e.g. what they receive for the effort is less than other employees) the employees will try to

correct the “imbalance” by demanding more outputs and or reducing their effort.

However, another result of an “imbalance” versus other employees is to do unethical activities such as stealing property or submitting false expense reports in order to “compensate” for this imbalance. As is shown in the list presented on page 41, the imbalance perceived by the employee could be based, in part, on the mixed messages that are sent via top management based on their actions. If management is not consistent with their actions, it adds to the confusion and potential inequitable evaluation given by the employee pertaining to the worth of their inputs as it related to their outputs.

A number of different government regulations have been established in order to protect the rights of the workers and are presented on page 41 and 42: Equal pay, civil rights, age discrimination in the 1960s, health and safety in the 1970s, and Americans with disabilities in the 1990s. As was mentioned in Chapter 1, the ebb and flow of the decades will help the students understanding the underlying causes which the government determined need legislation to protect employees’ rights. As the perceptions of society change, so do what is expected of the government in order to protect the employees from harm and unfair treatment.

One question to ask the students from the Merrill Lynch sexual discrimination example (p. 42) is how a major financial institution such as Merrill Lynch can accept this type of behavior. One explanation could be the firm’s corporate culture. The culture at Merrill Lynch may be “male dominated” and, therefore, discrimination against women may be firmly entrenched in the corporate climate of the firm.

A “male centric” culture may also explain why sexual harassment conditions were “allowed” at the Denver mint (p. 43). Various activities that were used to demean women appeared to be considered as “acceptable” behavior since seventy one women filed a complaint to their EEOC officer.

These two examples highlight how unethical values and beliefs can be so common within an organization that it is considered an “acceptable” practice.

This type of discrimination and harassment not only can lead to low morale and legal problems, but, these organizations have established a reputation for these activities which would result in women not even considering applying for jobs with these firms.

The example of professor and associate dean John Nemecek (p. 43) highlights the fine line between discrimination and protecting religious beliefs. As is mentioned in the example, religious organizations are allowed to have a “ministerial exception” to the requirements of the Civil Rights Act. As a result, the Catholic Church is legally allowed to exclude women from being priests.

However, the Civil Right Act does not explain what is legally acceptable pertaining to transgender issues. This is a good example to highlight the differences between the legal and ethical standards. As was stated previously,

an amoral firm is neutral about ethical issues and, therefore, the legal standard becomes the ethical standard for the firm. However, what should be done when there is not legal standard? Tell your students to disregard whether transgender discrimination is legal or not. Ask them to present an argument as to what is the ethical thing to do. One way in which a solution could be guided is to ask whether Professor Nemecek performs the functions of his/her job effectively. If yes, does the personal decisions made by Professor Nemecek impact his ability to do his/her job and, therefore, should he be punished for his physical appearance.

The age discrimination lawsuit (p. 44) of the national law firm of Sidley Austin Brown & Wood demonstrated that even experts in the law are vulnerable to discrimination issues. As a law firm, they should be acutely aware of the Age Discrimination in Employment Act. The disabilities lawsuit against Wal-Mart (p. 45) highlights that the firm is responsible for their actions even when they attempt to “correct” the problem.

Wal-Mart had hired a pharmacist with two years experience to work at one of their stores but based on THEIR evaluation, the pharmacist was not able to do the job and was transferred after one day to collect shopping carts and garbage.

This transfer showed that Wal-Mart was cognitive of the disabilities laws and realized that they would be sued if he fired the new pharmacist. However, transferring the pharmacist to the physically demanding job of moving shopping carts and garbage highlighted that Wal-Mart believed that the pharmacist had the physical capabilities to do one job but not the job he was trained to do.

Is Discrimination Based on Image Legal? (p. 45) This example of a sorority at DePauw University should provide some lively discussion in the classroom. Students who are members of sororities and fraternities should be very vocal about the facts to the example and the ultimate solution. Again, a discussion could take place to compare the legal perspective and the ethical perspective and explain how the two perspectives are different.

By “purging” the “socially awkward” members of the sorority, it is assumed that Delta Zeta violated the conditions of its charter of a sorority. To compound the problem, the national office of Delta Zeta were also actively involved in the unethical activities with the net result being the sorority is no longer recognized as part of the Greek system at DePauw.

Suppliers as Stakeholders (p. 47) The discussion on the relationship with suppliers should allow the students to understand that the firm must also monitor the activities of other companies who have a direct and indirect impact on its operations. Since the firm’s reputation and image can be directly impacted by the operations of other companies, it is imperative that firms view suppliers as critical stakeholders. For example,

companies will provide specific requirements to all of its suppliers in order for the supplier to be in compliance with their view. Three components are important: 1. The supplier must be in strict compliance with the law.

2. The supplier must have respect for competition.

3. The supplier must not have any actual or perceived conflicts of interest with any other party.

The Ethics of Outsourcing (p. 47) With recent incidents such as the use of lead based paint by Chinese suppliers in the manufacturing of toys for Mattel, outsourcing continues to play a dominant role in raising issues of ethical standards. The listing of the nine countries where outsourcing plays a dominant role in the manufacturing process (p. 48-49) highlights how global firms continue to move manufacturing to areas where labor is relatively inexpensive. Of course, the danger with this strategic move is that firms such as Mattel are linked based on the decision made by these third party companies. As a result, use of child labor, poor and unsafe working conditions, use of toxic materials, discrimination and labor violations become associated with the firm whose brand name is on the product. As a result, firms must provide continuous due diligence in order to ensure that their suppliers comply with the ethical requirements established by the firm.

Customers As Stakeholders (p. 49) Customers obviously play a critical role as stakeholders since this is the major source of revenue for the firm. Firms must be able to identify and then satisfy the needs of the customers. In addition, the firms must ensure that factors such as the relationship with the suppliers coincide with the expectations of the customers. Again, the Mattel example highlighted how quickly customers demanded action once the information was available that some of the toys produced by outsourced suppliers had unacceptable levels of lead in the toy’s paint.

The issue of outsourcing from a customer’s perspective is incorporated in the first of four critical areas pertaining to the firm’s relationship with the customer. The four areas are: 1. The manufacturing process 2. Sales and quotes 3. Distribution 4. Customer service It is through these four direct relationships with the customer that the firm can “show” the customer that there is a good faith relationship that has been established between the two parties. By providing ethical guidance at each of the four steps in the relationship with the customer, the firm has added potential

value to the relationship. As a result, the firm can establish brand loyalty by ensuring that the customers’ needs are met in each of the four areas. If the firm does not provide value by ensuring that high ethical standards are maintained in addressing these four areas, there could be significant financial penalties. For example, Mattel’s stock price dropped by 7 percent in the month after the use of lead paint in toys became public.2 Government As a Stakeholder (p. 50) The government will always be a leading stakeholder for any organization since they set the legal standards of operations. The issue of ethical standards impacting government regulations is two fold, Firstly, government regulations become the default ethical standards if the firm does not develop its own ethical standards. Secondly, government regulations can vary significantly from one country to another so that “acceptable ethical actions” in one country could be considered “unacceptable” in another country. This is due not only to the variance in laws governing other countries but also the culture of the country.

The acceptable ethical values are based on the cultural values of the country.

Local Community and Society as Stakeholders (p. 50) Local communities and society as a whole play active roles in monitoring the operations of a firm. Traditional monitoring activities include pollution levels, treatment of citizens of local and broad based communities, and fair and equitable benefits for the costs of economic development.

The Role of Corporate Social Responsibility (p. 50) Corporate social responsibility (CSR) can be defined as the obligation companies have to develop and implement courses of action that aid in social issues that impact society, CSR can be tied directly with the relationship the firm has with the stakeholders. It is through these courses of action that firm is able to identify and satisfy the needs of the stakeholders. The firm must have the ethical commitment to move beyond focusing on a single stakeholder (stockholders) and evolve into a fully encompassing corporate social citizen. It is through CSR developed strategies that firms can demonstrate their commitment to social issues that relate to their stakeholders.

A very good quick summary of a firm’s commitment of CSR can be found at McDonald’s web site titled McDonald's Corporate Social ResponsibilityMaking Progress (http://www.mcdonalds.com/corp/podcasts.html). The video is 5:12 minutes in length and McDonalds also has a fact sheet to supplement the video at the same web site.

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Casey, Nicholas. Mattel Issue Third Major Recall; Top toy Brands Barbie, Fisher-price Are Latest Facing Lead-Paint Issues. The Wall Street Journal. September 5, 2007. p. A3.

Components of Corporate Social Responsibility

Economic Responsibilities A firm is created to generate economic value. The underlying premise of any corporation is to generate a profit. However, the assumption that a firm can not be profitable and be socially aware is incorrect. Profitable firms can also be good corporate citizens and being a good corporate citizen can lead to higher levels of profitability.

Legal Responsibilities A firm has a legal requirement to abide by all the related laws and regulations that govern their operations in every country in which they do business. As was mentioned previously, legal responsibilities are the minimum standards established by a firm to dictate what acceptable and unacceptable behavior is.

By relying on legal requirements, the firm allows an external party, the government, to control the ethical decisions made by the firm.

Ethical Responsibilities As is stated in the textbook, ethical responsibilities of the firm shift with the changes in society. What was considered acceptable and unacceptable in the past may be viewed differently by today’s society. As a result, the firm must have an effective communication flow between its global stakeholders and itself. A significant challenge for firms is to ensure consistency of ethical responsibilities.

As was stated previously, different countries have different societal norms and values. As a result, firms must be aware of not only the blatant but also subtle differences in the different societies of the firm’s operations.

Discretionary Responsibilities The discretionary responsibilities can be the most challenging for firms to recognize and properly serve. By being discretionary, these responsibilities are determined by the firm based on their own ethical vision and commitment. By supporting a charity or providing funding for local community social programs, firms are able to differentiate their activities from their competitors. As a result, discretionary responsibilities give the firm the opportunity to enhance their competitive advantage based on the social commitment relative to their competitors.

A summary of the priority given these Corporate Social Responsibilities is shown in Figure 3-2 presented by Carrol (p. 53). This pyramid shows the order of priorities of a firm is to be profitable (Economic Responsibilities), obey the law (Legal Responsibilities), be ethical (Ethical Responsibilities) and finally being a good corporat citizen (Philanthropic Responsibilities). You could argue that this pyramid is similar to Maslow’s Hierarchy of Needs. The firm’s basic or physiological needs to survive are based on being profitable. The long term

survival of the firm is based on the financial ability to compete in the future. The firm’s safety needs are equivalent to the firm being a law abiding citizen. It is through the legal actions of all firms that the stakeholders will be treated in a safe manner. The ethical responsibilities of the firm could coincide with the social and esteem needs of the firm. In order to implement an effective ethical commitment the firm must recognize the social benefits of having a positive relationship with its stakeholders as well as enhancing its own self esteem by respecting the needs and concerns of the various stakeholders. Being a good corporate citizen would be equivalent to Maslow’s self actualization. The pinnacle of both pyramid represent the final achievement of serving the needs of oneself and others. SelfActualization allows the individual to “think beyond the box” and be creative and innovative with their thoughts. Being a good corporate citizen is identifying the firm’s discretionary or philanthropic responsibilities. This level allows the firm to be creative in how it can become a better corporate citizen based on its own creative ideas.

Maslow’s Hierarchy of Needs Self-Actualization-Creativity, Spontaneity, Personal Growth, Fulfillment Esteem Needs-Achievement, Status, Respect for Others, Confidence Social Needs-Family, Friendships, Affection, Love Safety Needs-Protection, Security, Law and Order Physiological or Basic Needs-Water, Food, Shelter, Warmth, Sleep A Firm’s Strategic Response to Social Issues Figure 3-3 (p. 53) highlights the different categories of social responsiveness as a continuum from reactive to proactive. The reactive position would coincide with the firm just addressing its economic responsibilities. A defense position would coincide with the firm meeting its legal responsibilities. The accommodative position would coincide with the firm acknowledging its ethical responsibilities and the proactive stance by the firm would correspond with the firm’s philanthropic responsibilities.

The twenty elements that can be used in assessing corporate policies (p. 54-55) could be used as an outline for an assignment for your students. You could ask the students to evaluate a company’s ethical commitment on their web site based on these 20 criteria. An additional exercise would be to have the students rank the criteria of level of importance and present the rankings in class to see how much variance is evident in the results of the rankings.

The Ten Commandments of Social Responsibility shown in Table 3-2 (p. 56) can be a good starting discussion point pertaining to the day to day relevance of CSR. One question to ask is how often the students think that managers consider the ten commandments when they are making decisions. Again, another question would be to rank order the commandments to see if the

students have a varying opinion on the relative importance of the ten commandments. Furthermore, the pyramid of corporate social responsibility (Figure 3-2 p. 53) can be used as a framework to categorize the ten commandants. You can ask the students where each of the ten commandants should be classified based on the four CSR responsibilities.

The Role of Human Rights (p. 56) An interesting debate on whether China should have been able to host the 2008 Olympic Games based on their human rights record is highlighted in a video clip from BBC News Newsnight called is China Fit to Host the Olympics? The video clip is 8:50 minutes in length and is available at (http://news.bbc.co.uk/player/nol/newsid_7240000/newsid_7244900/7244944.st m?bw=bb&mp=rm&news=1&bbcws=1).

As with any type of “ethical enforcement”, the challenge facing firms who address issues of human rights is in the consistency of the enforcement. The firms are more likely to ensure ethical enforcement of human rights in their own country and in other countries where various stakeholders such as the government and local communities are more vocal than other countries. It is in countries where human rights issues are not discussed where the firm can potentially be “caught” with the lack of proper enforcement of their human rights guidelines.

The examples of human rights issues at BP in Table 3-3 (p. 57) highlight how one global multinational addresses human rights concerns. It is interesting to note that BP addresses human rights issues from not just the employee perspective but also from the local communities and security perspective.

Questions For Thought 1. Evaluate the Johnson & Johnson credo by researching the Tylenol Scare.

A good summary of the Tylenol Scare can be found at: (http://en.wikipedia.org/wiki/1982_Chicago_Tylenol_murders).

On September 29, 1982 the first of seven people died in the Chicago area from ingesting Extra Strength Tylenol medicine capsules that contained potassium cyanide poison. The tampering of the product did not take place in the manufacturing process since the contaminated bottles came from different factories and it would be highly improbable that the tampering would be isolated in one city since the manufacturing facilities ship the product all around the country. As a result, it was determined that the tampering occurred on the store shelves by someone who took the package from the shelf, added the tainted capsules into the bottle and put the bottle back on the shelf.

Johnson & Johnson warned hospitals and their distributors of the problem and stopped all Tylenol production and advertising. On October 5, 1982, Johnson & Johnson issued a nationwide recall of all 31 million bottles of Tylenol products.

The estimated retail value of the recalled bottles was $100 million.

The market share for Tylenol fell from 35 to 8 percent during the scare but Johnson & Johnson was able to recover the market share loss within a year due to their actions. Tylenol introduced triple sealed tamperproof packaging and along with heavy advertising was able to eventually become the market leader in over the counter analgesic market in the United States.

This experience can be linked directly to the opening sentences of the Johnson & Johnson credo: “We believe our first responsibility is to the doctors, nurses, and patients, to mothers and fathers and all others who use our products and services. In meeting their needs, everything we do must be of high quality.”

2. When examining the working conditions in countries other than the United States, what ethically should be done to help change these conditions?

The underlying assumption this question asks is whether companies should be global with their ethical practices. The answer is, of course, since it is the only way in which the firm can present a clear and consistent message pertaining to their ethical commitment. Some students will argue that as long as the firm follows the laws of the country in which it has operations, there is nothing unethical about their decisions. The limitation of this argument relates back to utilitarian principle of providing the greatest good to the greatest number. If the firm provides higher wages then the minimum, provides safer and cleaner working conditions, makes sure that underage children are not working in the factories, makes sure there is in no sexual discrimination and harassment, the reward will be multi-fold. The employees GLOBALLY will be happy since the firm’s image will be positive based on their treatment of all employees, customers will be happy since they are buying goods from a company that is socially aware, the government of all the countries will be happy that the firm is abiding by the laws and actually moving beyond the laws to help the citizens of the country, the stockholders will be happy since the positive image and reputation of the firm will enhance the competitive advantage of the firm which will lead to higher levels of profits and sales.

3. When reviewing the notion of human rights, why would this be considered an ethical issue? Explain.

Human rights would be considered an ethical issue since every human being has value and contributes to a global social and economic network. As a result, every

person should be able to have basic fundamental rights as it pertaining to their working conditions. Why should citizens of developed countries have preferred treatment related to safety, health, compensation, and discrimination and harassment issues? Why should a worker in England or the United States be considered to be more “valuable” than a worker in India or China?

As Shylock states in the Shakespeare’s Merchant of Venice (Act III Scene I) “I am a Jew. Hath not a Jew eyes? Hath not a Jew hands, organs, dimensions, senses, affections, passions? fed with the same food, hurt with the same weapons, subject to the same diseases, healed by the same means, warmed and cooled by the same winter and summer, as a Christian is? If you prick us, do we not bleed? If you tickle us, do we not laugh? If you poison us, do we not die?

And if you wrong us, shall we not revenge?”

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Chapter 4 Corporate Governance and Corporate Compliance The purpose of this chapter is to present two critical constructs to your students corporate governance and corporate compliance. Although initially dictated by government rules and regulations, corporate governance has moved beyond merely attempting to meet the needs of the stockholders. Corporate governance identifies ultimate accountability in the actions of the firm (and its management) and is a visible representation to some of the critical decision makers in the firm who can impact the ethical perspective of the firm. Corporate compliance continues to be a critical factor for firms. Based on legal standards and guidelines, corporate compliance ensures that the global actions of the firm are acceptable to the global stakeholders of the firm.

Key Learning Points There are a number of key learning points which can be accomplished when this chapter is presented to the students. These include: 1. Define corporate governance and explain how it relates to ethics.

2. Identify and explain the role of the board of directors.

3. Explain how the board of directors has different functions which are represented in the creation of different board committees.

4. Identify the structure of the board of directors and highlight the benefits of having a strong ethically positive board of directors.

5. Identify the ethical issues related to CEO compensation and explain how they can impact the firm.

6. Explain the history and components of the Sarbanes-Oxley Act. 7. Explain the responsibilities of the Public Company Accounting Oversight Board.

8. Explain the components of the Cadbury and Combined Code.

9. Identify the ethical issues related to corporate compliance.

10. Explain the components of the U.S. Federal Sentencing Guidelines for Organizations and the U.S. Foreign Corrupt Practices Act. 11. Discuss corporate compliance from the perspective of global corruption.

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12. Explain the relationship between corporate governance and stakeholders.

But I Fired You First (p. 59) 1. What is meant by an “insider” dominated and “independent” dominated board of directors?

An insider dominated board is one in which a majority of the board members have a financial connection with the firm. Inside board members are usually employees of the firm. However, it could also include individuals who have financial contracts or receive financial support in ways that are not related to being compensated for the duties of being a board member.

An independent or outside dominated board of directors is one in which the majority of the board members have no financial relationship with the firm. The only payment an independent board member receives is compensation for performing the duties of the board member.

2. What is CEO duality?

CEO duality occurs when the CEO is both the Chief Executive Officer of the firm and also is the Chairman of the Board of Directors. The potential danger of CEO duality is that power is concentrated in one individual, the CEO. As a result, there are not as many checks and balances that can ensure that the CEO has the stakeholder’s needs in consideration when it controls the board meetings as the chairman of the board.

3. Who has the authority to fire the CEO? The ultimate responsibility of firing the CEO belongs to the Board of Directors.

Since the Board of Directors represent the direct interests of the stockholders and the indirect interests of all stakeholders, the board has the authority to fire the CEO. However, when the CEO is also the chairman of the board as is the case with Atmel, the procedure used to fire the CEO can become confusing. The Chairman of the Board must present and follow the procedures established by the charter of the firms in the dismissal of the CEO. As a result, since the CEO is also the Chairman in this case, the CEO disputed whether the proper procedures were followed since he (the chairman) did not initiate the procedure to fire the CEO. 4. Who has the authority to fire a member of the board of directors?

Although it can vary from firm to firm, the traditional authority of the firing of board member belongs to the CEO with support for the other board members. Although technically, the CEO could be the only person who has the absolute authority to

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fire a board member, it is usually done through agreement by a majority of the other board members. Of course, this procedure would not be valid if the CEO wanted to replace more than one board member. Again, this can create a confusing procedural process since most firms do not have guidelines for the dismissal of multiple board members.

Ethics and Corporate Governance (p. 60) Corporate governance is defined as the system that is used by firms to control and direct their operations and the operations of their representatives, the employees. This definition identifies both the broad and narrow focus of corporate governance. It is broad in the sense that the firm has some freedom in its ability to design a control system in order to help guide the actions and behavior of its employees. It is narrow in the sense that although there is flexibility in the type of control system that can be adopted, there are rigid requirements as to what specific type of behavior is to be controlled and monitored.

Board of Directors (p. 60) The role of the board of directors is to be “agents” of those individuals who have invested capital in the firm. It is through this agency theory that the board of directors is required to look out for the best interests of the stockholders. This governance structure has evolved over time to include not only the interests of the stockholders but also the interests of the vested stakeholders. The rationale of this expanded focus is that if the other stakeholders are not satisfied, it could have a negative impact on the financial performance of the firm, which is the primary interest of the stockholders. Furthermore, the board of directors is also responsible for communicating the actions of the firms, the establishment of ethical systems and code of ethics, and the selection of the firm’s external auditor.

Six Values of Board Members (p. 60) The six values of board members: honesty, integrity, loyalty, responsibility, fairness and citizenship are excellent characteristics of not only board members but all members of the organization. It is through these positive ethical values that firms can feel comfortable that they are having a positive impact with their relationship with their stakeholders.

Recommendations for board members to make sure the interests of the stakeholders are represented in their decision making process: 1. The board of directors should make at least an annual evaluation of the CEO based on the established goals and strategies of the firm. It seems like a simple requirement to evaluate how well the CEO is achieving the goals of the firm.

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However, performance appraisal can become quite complicated for a CEO in that there are multiple metrics to consider when evaluating the performance of the CEO and the firm. In addition, not having the correct alignment between the goals of the CEO and the goals of the firm can create a financial disconnect.

2. The evaluation of the CEO should be done solely with outside board members.

This recommendation would be very effective if it were implemented more frequently. Since the CEO has a vested self interest on his or her own evaluation, he or she will “stack the deck” whenever it is feasible. As a result, the CEO will try to have as much of a “home court” advantage as possible when he or she is being evaluated. Of course, the CEO will argue that only “inside” board members truly know how hard the CEO works since they interact with the CEO on a day to day basis. By having a majority of insider members evaluating the CEO, it is likely that the CEO will receive a more favorable evaluation than if only outside board members did the evaluation.

3. All the outside board members should meet at least once a year without the presence of the CEO. The purpose of this recommendation is to ensure that the board members are not unduly influenced by the CEO when they are developing strategic decision pertaining to the operations of the firm. By omitting the presence of the CEO, outside board members would probably be more likely to be outspoken and honest about the actual performance of the firm and of the CEO. 4. The members of the board should ensure that there are clear and appropriate listings of qualifications for proposed membership to the board, and those qualifications should be made available to the shareholders. The listing of qualifications establishes a formal document and procedure in order to evaluation the capabilities of each board member. This evaluation process would ensure that bias and/or favoritism should not impact the selection of board members.

5. Outside board members should be members who are responsible for the recruitment and selection of new board members based on the established qualifications. This recommendation is to ensure that the policies and procedures in the recruitment and selection process for a new board are followed correctly.

Recommendations for shareholders: 1. Institutional shareholders should view themselves as active owners of the firm, not just investors. Since institutional shareholders have a high level of concentrated power due to the number of shares their investment represents, this recommendation suggests that these investors should not be passive but be aggressive in ensuring the needs of all the stockholders and stakeholders are met.

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2. The shareholders should not be involved in or question the day-to-day activities of the firm’s operations. The shareholders are not responsible to micro manage the operations of the firm. By investing in the firm, the shareholders have given the managers the authority to make the decisions related to day-today operations.

3. Shareholders should use the rights to evaluate annually the performance of the members of the board. Through proxy statements, shareholders have the ability to vote board members in or out. However, for most firms only a very small percentage of the individual investors actually use their right to vote.

4. Shareholders need to be informed when the firm does an evaluation of the board members. This refers to the level of transparency of communication between the firm and the shareholders. The more transparent a firm is, the more information is available for the shareholders to help them evaluate the performance of the board members and the firm.

5. Shareholders need to understand that a common goal of all shareholders is to support the firm so it continues to be an ongoing corporate concern. This recommendation highlights the underlying principle of why a firm is created in the first place, in order to become profitable to survive as a long term viable entity.

Typical Decisions Made by the Board of Directors (p. 62) The typical decisions highlighted on page 62 demonstrate the “big” picture viewpoint of the board of directors. The decisions made by the board focus primarily of overall strategic issues that impact the firm as a whole. As a result, issues related to ethical materials should not only be considered by the board but positive ethical values should be incorporated in all the strategic decisions of the board.

The different board of directors committees highlighted on page 62 and 63 show the type of diversity related to responsibility of the board members. Board members are “members at large” when they are not serving on a specific committee and are committee members when they have been assigned to a specific committee. Board members can and often do belong to more than one committee. The number of members on a committee can depend on the total number of members on the board of directors.

The Role of the Board of Directors (p. 63) Figure 4-1 on page 64 highlights the continuum of involvement by the board members.

The passive board is also called a “rubber stamp” board because they will approve whatever is presented to them. On a “rubber stamp” board, the

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approvals come so quickly it is like having the board stamping each proposal with their approval and the stamp “bouncing up in the air” and quickly stamping the next proposal like a rubber stamp. This type of board involvement was very common in the past since there was a lack of transparency of the actions of the board and the stockholders and stakeholders did not demand accountability of the board.

The certifying board is a step forward pertaining to being involved in the strategic decisions of the firm. The role of the certifying board is similar to the mandate of an enforcement officer. The certifying board verifies the legality of the actions of the board but does not move beyond this responsibility. As a result, employees of the firms would still be allowed to make unethical decisions as long as they were legal.

The engaged board moves one step closer to becoming a fully involved board.

An engaged board is proactive and is not just responding to ideas proposed by management but offers their own ideas of the future course of the firm. An engaged board becomes actively involved with the CEO in the formulation of strategic ideas which also ensured that ethical issues are incorporated in the decision making process An intervening board considers themselves to be of equal stature as it pertains to the decision making process within the firm. An intervening board becomes actively involved in all major decisions pertaining to the firm.

An operating board is the highest level of involvement by the board of directors.

The key distinction between the operating board and the intervening board is the operating board controls the decision making process. As a result, the CEO only has one vote when decisions are made. Therefore, the CEO’s decision may not always be implemented by the firm if the majority of the board does not agree with the decision.

Ethics and the Structure of the Board of Directors (p. 65) This section of the chapter highlights the ethical limitations of having a board of members which have a majority of inside board members. By having a concentration of power in board members who have a direct relationship with the firm and the CEO, an inside dominant board is more likely not to challenge the status quo and usually is located in the low end of the involvement continuum.

The underlying reason for their lack of active involvement is that the power is concentrated with the CEO who is usually also the Chairman and who is also considered the superior of the board members. As a result, it would be a risky career move to disagree with the ideas presented by the CEO.

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The Benefits of a Strong Board of Directors (P. 65) Stanwick and Stanwick found that having a strong board of directors resulted in a positive impact on the performance of the firm. By having a board that was: dominated by outsiders, had a large personal financial investment in the firm, and having the board members be limited to the number of other boards they could be a member resulted in the firm having a higher financial performance, This empirical study gave validity to the theoretical concept that boards can make a difference in the performance of the firms if they are structured in an effective manner.

Role of CEO Compensation (p. 65) In the United States during 1982, the total average level of compensation of a CEO was 42 times higher than that of the average worker. As a result, if the average worker was getting $20,000 per year, the average compensation of the CEO was $840,000. In 1990, that number had increased to 107 to 1 and by 2004 it had reached 431 to 1. Therefore, by 2004, the compensation for the average CEO for one calendar day was more than the yearly income of the average worker. An interesting discussion could result from discussing the actual worth of a CEO. There will be some students who will argue that CEO salaries are based on the free market and their compensation has been calculated based on their contribution. The limitation of this argument is that it is not always true.

CEO compensation is agreed upon in the compensation committee of the board of directors. The board will usually hire external compensation consultants to develop a report to be used to determine the CEO compensation. A fatal flaw of this approach is that the consultants try to determine a benchmark and median value of CEO compensation. In addition, factors such as the size of the firm, what competitors are paying their CEOs and the previous compensation histories of the CEOs are considered. As a result, the level of compensation could be determined WITHOUT considering the ACTUAL performance of the firm. This is why it is very common for a CEO to receive a pay increase even when the financial performance of the firm has decreased within the evaluation period.

Another flaw with the consultant method is that every CEO tries to convince the board that they are not mediocre or just average. As a result, the board will most likely agree to compensation levels above the median or average rate since THEIR CEO is not average. Therefore, this creates a perpetual increase in CEO compensation since every year every CEO argues that they deserve above the median which of course results in a continuously escalating median levels of compensation.

CEO Compensation and Ethical Reputation (p. 66) Stanwick and Stanwick found that there was not a direct relationship between CEO compensation and the financial performance of the firm. Although this result

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was shown in previous research, Stanwick and Stanwick extended work in the area by examining the CEO of the 100 corporate citizens based on a ranking done by Business Ethics magazine. As a result, Stanwick and Stanwick assumed that if any CEOs would want to make sure that their compensation was tied directly to the performance of the firm, it would be firms that have a high ethical reputation. The study did find a direct relationship with the level of compensation and the ethical ranking of the firm but the most interesting result was that CEOs of firms that had LOST money actually received, on average, a higher level of compensation than the CEOs of firms that were profitable. This result highlighted the apparent disconnect between the actions of the CEO related to the strategic focus of the firm and the actions of the CEO related to his or her own compensation levels. It is expected that CEOs of firms that lost money would certainly accept and should even volunteer to accept lower levels of compensation to match the poor performance of the firm.

Ethical Viewpoints Explaining CEO Compensation (p. 66) The use of Kantian ethics can help justify the self interest behavior of CEOs. Using the rationale that everyone would make the same decision under the same set of circumstances gives creditability to this argument. However, an enlightened CEO should view compensation from another perspective of Kantian ethics. Instead of viewing justification for the compensation from the perspective that everyone will take advantage of the opportunity to generate high levels of compensation since they are given this opportunity, an enlightened CEO would use Kantian ethics to claim that he or she would refuse this high level of compensation because of the belief that anyone else in this same position would also refuse this high level of compensation.

As is stated in the textbook from an ethical egoism perspective, a CEO is rewarded when his or her performance is based on the performance of the firm.

However, as was shown in the Stanwick and Stanwick study, there is not always a link between CEO compensation and the financial performance of the firm. As a result, it could be proposed that there is a disconnect between the reward system of the CEO and the goals and objectives of the firm. If the CEO is also the chairman of the board, he or she selects membership on the compensation committee. If membership on the compensation committee is composed of a majority of inside board members, the CEO has effectively “stacked the deck” in his or her favor. As a result, it could be concluded that in many incidences there is not an ethical component in the calculation of a CEO’s compensation. Again, this point highlights the difference between the legal and ethical standard. It may be legal to pay a CEO over 400 times the compensation of an average worker in the firm, but is it ethical? Can any human being justify that his/her contribution to any organization is 400 times greater than any other employee within the organization?

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Components of the Sarbanes-Oxley Act (p. 67) The Sarbanes-Oxley (SOX) Act was passed in 2002 and was a direct response to the high profile scandals that took place at Enron and WorldCom. An interesting question to ask your students is whether SOX could be passed today.

It could be argued that SOX would not have passed at any time before 2002 and would also not have passed at any time after 2003. This statement is based on the argument that there was a perfect storm related to ethical issues and corporate accountability and the stakeholders of the firms were demanding governmental regulations. The primary reason why this could have been the only time when this act could have been passed is due to political lobbying. Each industry and many individual corporations have lobbyists who are constantly in contact with members of Congress trying to present their viewpoint to any potential new regulations. In the past, the corporate lobbyists would have been strong enough to stop any future regulations on the activities of corporations in the United States. However, the public outrage based on the Enron and WorldCom scandals weakened the bargaining power of the lobbyists. In other words, the constituents demanded change in the form of tighter regulations. As a result, Congress moved forward in supporting SOX. It could be argued that the pinnacle of voter frustration of the actions of corporate America may have reached their peak in 2002 and, therefore, the lobbying efforts by corporations would now again be strong enough to try and block this type of regulation.

Evidence of this viewpoint can be seen by recent attempts by lobbyists to try and “weaken” parts of SOX with proposed subsequent legislation to curtail the power given the federal government under SOX. The components of SOX primarily deal with previous weaknesses in the corporate governance for United States based firms. SOX specifically addresses accountability issues pertaining to the role of the board of directors and the CEO and CFO. Since the CEO and CFO must sign off on all financial documents sent to the SEC, the excuse that I did not know what was going on can no longer be used as a valid defense. However, must to the surprise of many experts, former CEO of HealthSouth, Richard Scrushy, was one of the first CEOs to be charged under SOX and was able to use the defense of pleading ignorance of the actions of others. The complete HealthSouth case is located later in the textbook.

An internet website dedicated to “SOX” television can be found at: (http://sox.mashnetworks.com). This website requires a free subscription to obtain access to the various video clips explaining the different components of SOX. In addition, this three minute video shows Congressman Oxley talking about the origins of the SOX legislation http://www.youtube.com/watch?v=FOw22y-S6iE. Public Company Accounting Oversight Board (p. 69)

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The introduction of the Public Company Accounting Oversight Board was a significant blow to the accounting profession. This government controlled board took control away from the accounting profession in being able to voluntarily self regulate themselves. The accounting profession was proud that they were able, up until 2002, be able to police themselves through voluntary agreements. The lack of effective auditing procedures and the exposed conflicts of interest that took place between the accounting firms and the firms committing fraud forced the government to seize control of establishing the accounting standards that are required by publicly traded firms.

Section 404-Internal Controls (p. 69) Section 404 is by far the most talked about and the most open for interpretation of all the components of SOX. Section 404 states that all publicly traded firms must have in place specific internal controls so that a monitoring process can be implemented to track financial information within a company. However, much discussion has taken place to consider whether SOX refers to internal controls on all aspects of the firm’s operations (e.g., technology investment, manufacturing and supply chain issues) instead of just focusing on monitoring financial information.

The Cost of Compliance with the Sarbanes-Oxley Act (p. 71) The cost of compliance with SOX can be misleading. For example the estimated costs in Table 4-3 seem overwhelming with over 12,000 average people hours to comply with Section 404 and $700 million to pay for external consulting, software changes and other vendor charges for Section 404. However, these are estimated initial costs. What the firms quickly realized was that once the monitoring systems were put into place for SOX compliance, the overall costs started to decrease. In addition, the benefit of learning curves allowed employees to become more familiar with the forms and information needed to comply with SOX which would result in a increased level of productivity.

The Cadbury and Combined Code (p. 73) The Cadbury and Combined Code is an example of corporate governance controls implemented in the United Kingdom. The Cadbury Code established in 1991 has a number of recommendations that were adopted in some aspect with the SOX Act. Recommendations such as having an outside dominated board, controls on the external auditors, having a formal procedure for releasing financial information are also incorporated in the SOX Act a decade later. An important recommendation made by the Cadbury Committee which was not adopted in the United States was the separation of the CEO and the Chairman of the Board. As was mentioned previously in this chapter, the elimination of CEO duality can help disperse the power of the CEO. The Combined Code continues

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on by extending the recommendations related to the relationship between the board members and the CEO and evaluation criteria for board committees.

Ethics and Corporate Compliance (p. 73) As Deloitte & Touche states at the beginning of this discussion, corporate compliance should be viewed as an opportunity and not just as burdensome cost of doing business. Corporate compliance moves beyond simply ensuring that the firm is following all government regulations to include the ability of firms to reduce risk and revise their policies and procedures to be consistent with their ethical vision. The five step process highlighted on page 74 demonstrates how implementing an effective corporate compliance program can become a linchpin for the firm’s ability to effectively implement their ethical vision.

Step 1: Risk/Cultural assessment-This assessment is needed in order for the firm to understand the underlying philosophy of the employees as it pertains to compliance issues. This assessment helps tailor the components and the comprehensiveness of the compliance system.

Step 2: Review of the current compliance system ensures that what ever revisions are made to the current system correspond with the overall compliance vision of the top managers of the firm.

Strep 3: Review of current ethical policies and procedures ensures that the compliance system complements the ethical policies and procedures of the firm.

Step 4: Review of communication, training and implementation process for the compliance system ensures that employees are well informed of their responsibilities as well as held accountable for their actions.

Step 5: Self-assessment of the compliance system is based on the belief that the compliance system is not static and must be constantly reviewed in order to ensure consistency with the current vision of top level managers within the firm.

Table 4-5 (p. 74) highlights the difference between the legal and ethical approaches to corporate compliance. This comparison is an excellent way to present the differences between the legal and ethical standards that can be established by the firm. While the legal view of ethics focuses on restricting and creating requirements, the ethical view is based on an agreed upon set of principles. While the legal objective is to not break the law, the ethical objective is to behave in a responsible manner. The legal method examines rules and the implementation of regulations while the ethical method considers ethics as an integrated part of the decision making process and therefore does not need to be considered in isolation. The behavior assumption assumes opposite outcomes while the legal view wants to control negative consequences. The ethical view

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considers the positive results on incorporating ethical values in the decision making process.

The U.S. Federal Sentencing Guidelines for Organizations (p. 75) The U.S. Federal Sentencing Guidelines for Organizations was the first major formal document that presented potential specific organizational consequences for specific organizational crimes. The Federal Sentencing Guidelines required firms to establish an effective compliance program. The critical aspect of the Federal Sentencing Guidelines was that it allowed the United States government to present potential legal remedies for unethical activities such as fraud, environmental violations and anti trust actions. By presenting specific guidelines for potential jail time and fine amounts, the Federal Sentencing Guidelines helped establish uniform penalties for lack of corporate compliance. In addition, the Federal Sentencing Guidelines gave a clear message to top level mangers that the United States government will closely monitor their activities.

Corporate Compliance Systems and Global Corruption (p. 76) The Corruption Perceptions Index is developed by Transparency International.

Transparency International is a global organization that examines the level of corruption around the world. Transparency International has over 90 local chapters that monitor the level of corruption in different countries. Table 4-6 (p.

77) highlights the Corruption Perceptions Index for 2006. It is interesting to note that Scandinavian countries are well represented at the top of the index which represents the lowest level of corruption. In addition, while the United Kingdom and Canada did respectively well on their rankings (eleventh and fourteenth), the United States was ranked a distance twentieth.

The United States does better on the ranking of the Bribe Payers Index also created by Transparency International. In the BPI rankings for 2006, the United States came in ninth with Canada coming in fifth and the United Kingdom coming in sixth. A question to ask the students is whether they are surprised by these rankings and if they are, can they explain them. One explanation could be that the countries that are ranked near the top of both indexes have more comprehensive monitoring systems in place to track the activities of government officials.

The U.S. Foreign Corrupt Practices Act (p. 78) The U.S. Foreign Corrupt Practices Act (FCPA) is the government regulation that defines and explains the consequences of employees of United States based firms giving bribes to aid in doing business in another country. A common complaint of FCPA by US companies is that it gives them an unfair disadvantage as compared with non US based firms that do not have this restriction. Critics point out that common customs in other countries is to give your “foreign

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partners” expensive gifts as a token of their long term professional and personal relationships. In addition, in many countries it is expected that financial incentives will begin to government officials in exchange for receiving favorable treatment from the government. The argument against this behavior supports the distinction between the legal and ethical standard. It is quite true that US firms would be at a competitive disadvantage if they can not offer “bribes” because they would not be playing on a “level playing field”. However, an underlying component of any effective ethics program is consistency across all the countries in which the firm does business. The managers of the firm can not pick and chose which countries and under which scenarios they would apply a different ethical standard.

Furthermore stakeholders in other countries such as customers and suppliers would welcome a US based firm when it is expected that the partnership would be based on a strong ethical commitment.

Corporate Governance and Stakeholders (p. 79) Figure 4-2 (p. 79) summarizes the relationship between stakeholders and corporate governance. The figure shows that the stakeholders drive the corporate governance system by ensuring that the needs and expectations are met by the firm. In addition, the figure shows that the corporate governance system needs to address the issues of global image through eliminating corruption and acknowledging the role of global compliance standards. It is also imperative that the vision of the top level managers is incorporated into the corporate governance system. Without the vision and commitment of top level managers, the corporate governance system could not be successfully created and/or implemented. The net result of a strong and effective corporate governance system is an acceptable and satisfactory level of governance and compliance performance by the firm. This figure is imperative from the student’s perspective to ensure that the students understand the interdependent relationships that must take place is order to have a effective and successful firm based on its corporate governance and corporate compliance.

Questions for Thought 1. A variety of board committees are discussed in this chapter. Search the Web pages of five companies to see if you can identify any other types of committees.

The purpose of this question is two fold. The first is for the students to understand that board members have multiple responsibilities through their membership on various sub committees. The second purpose is that although a number of committee are common across most or all firms due to government regulations and stakeholder expectations, firms still have the freedom to create additional committees that serve the specific needs of the firm. For example, a firm in a high technology sector may have a research and development or

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technology committee or a firm in consumer products may have a marketing board committee. Furthermore, firms in different countries may require, to some degree, different types of committees. However, the students also must be aware that different firms can give different names to the committees that serve the same function for the firm.

2. Explain how the Sarbanes-Oxley Act has changed public reporting of financial information.

One critical component of the Sarbanes-Oxley Act that has changed the role of reporting financial information has to do with specific accountability. By having the CEO and the CFO signing off on all financial documents submitted to the SEC, there is specific accountability of the actions of the top level managers. As a result, submitting inaccurate financial statements is considered to be fraud and if they are sent electronically to the SEC it is considered wire fraud.

A second critical component is the level of transparency of financial reporting.

SOX has raised the expectations for all the firm’s stakeholders as it relates to financial transactions. As a result, stakeholders are demanding that they are able to obtain an understanding of how the financial information of the firm has been generated. Therefore, through the SOX requirements previous activities such as giving the CEO a personal loan from the company coffers is no longer allowed.

As a result, there is now a firewall between the financial transactions of the CEO and other top managers and the financial transactions of the firm. This firewall helps in eliminating the potential opaqueness of these hybrid transactions which were part personal and part corporate.

3. Evaluate the impact corporate governance issues have on the stakeholders identified in Figure 4-2.

A starting point is the information that is summarized under the Corporate Governance and Stakeholders section of the instructor’s manual. From a stakeholders perspective, Figure 4-2, highlights that even though the interests of the various stakeholders may be diverse, they become congruent when it address issues related to corporate governance. Each stakeholder group expects the firm to act in a way that is not only meeting the legal standard but also reinforces their ethical commitment. On the surface it would seem that it would be difficult to align the interests of the various stakeholders. However, that is not the case since regardless of their own personal wants and needs, all of the stakeholders want to be able to TRUST the firm. The only way that this trust can be developed and maintained is if the firm has in place a corporate governance system that ensures not only legal compliance but positive ethical values. This trust is the cornerstone of the integrity which stakeholders such as the employees, suppliers and the local community demand from the firm. As a result, a firm with a strong corporate governance system and a high level of integrity would be able to satisfy a diverse set of needs from different stakeholders.

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Chapter 5 Ethics and the Environment The purpose of this chapter is to highlight the ethical issues that can pertain to firms when they make decisions impacting the natural environment. The students will be presented material which explains the ethical challenges of addressing natural environment issues. In addition, students will be exposed to how companies can use the natural environment to enhance their competitive advantage and can be directly included in the firm’s performance evaluation as part of the triple bottom line. Furthermore, current environmental issues such as environmental sustainability and climate change will also be addresses in the chapter. The chapter also addresses how firms can use climate change as a strategic option.

Key Learning Points There are a number of key learning points which can be accomplished when this chapter is presented to the students.

1. Explain the concept of Tragedy of the Commons and integrate it with environmental ethical issues.

2. Identify the responsibilities of the firm when the natural environment is considered a stakeholder.

3. Explain how the natural environment can be used to enhance a firm’s competitive advantage.

4. Explain why it is beneficial for firms to voluntary seek environmental compliance as well as the cost of environmental noncompliance.

5. Examine the role of employees and NGOs as stakeholders.

6. Identify how firms communicate their environmental commitment to their stakeholders.

7. Explain the role of the government and the Environmental Protection Agency (EPA).

8. Explain the role of environmental justice and sustainability 9. Discuss the evaluation of a firm’s performance based on the triple bottom line: financial, social and environmental.

10. Explain the implications of climate change and explain how firms can use climate change as a strategic option.

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Is It Just Me Or Is It Getting Hotter In Here? (p. 82) 1. What should the role of oil companies such as Exxon Mobil be in searching for alternative energy sources?

The answer is complex to this very simple question. The simple answer is that every company regardless of the industry should become more actively involved in alternative energy sources and focus on the reduction of greenhouse gases (GHG). However, it is apparent by the description of Exxon’s response that it will certainly move at a very slow pace in focusing on alternative energy. A simple rationale is that alternative energy is not their expertise. Their experience is in traditional energy sources and, therefore, they will continue to focus their efforts on oil and gas because that is the strategy of the company.

2. What role does culture play in embracing environmental issues?

Culture plays a significant role in the decision making process of natural commodity based industries such as the oil industry. Founded by John D. Rockefeller in 1870 as Standard Oil, what is now known as Exxon, has always tried to have as much control as possible one the oil and gas market. Within 8 years, Standard Oil, with the help of collusion with other Rockefeller controlled businesses, was able to obtain 85 percent of the market share in the United States. 1 As a result, the descendents of the Exxon tradition have always believed that they know what is right for the industry and what is right for the stockholders since they were so successful in the past. Currently, there does not seem to be any financial incentive for Exxon to move forward with alternative energies and so without that motivation, they will only spend the bare minimum on research and development in this area.

3. Does Exxon believe in triple bottom line reporting?

The simple answer to this is no. Exxon appears to have a monolithic approach to stakeholder theory. As long as the stockholders are satisfied, Exxon is satisfied.

The critical nature of Exxon’s products obviously gives Exxon the upper hand in its relationship with its stakeholders. Since traditional energy is critical for the ultimate survival of their stakeholders, Exxon holds the bargaining power in this relationship. As a laggard in environmental commitment, Exxon would only focus on social and environmental issues if there are positive financial advantages for those investments.

4. Why does the philosophy of Exxon contradict the philosophy of other oil companies such as Shell?

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The answer can be found in Shell’s rationale for their investment in alternative energy. Shell is making these investments not for short term returns but as an “insurance” policy for its long term strategy. This critical difference explains how two competitors can view the natural environment from very different perspectives. As a proactive leader in alternative energy research, the long term benefit for Shell is that as technology advances and creates less expensive alternatives for oil and gas, those companies that have invested in the leading edge technology will have the competitive advantage. With a barrel of oil now over $100, alternative energy research which in the past was not cost effective is now viable.

5. Why is the compensation package of the former CEO of Exxon presented in this case?

There are two reasons why a discussion of Lee Raymond’s compensation was presented as part of the case. The first is that the level of compensation ties in directly with the discussion in chapter 4 about CEO compensation. As was mentioned in chapter 4, can any human being justify receiving $51.1 million in one year based on their performance? What about a retirement package that is valued at $400 million? Can that amount be justified?

The second reason was that it is quite clear from how the compensation package was designed for Lee Raymond that only one objective must be reached and that is the firm’s overall profitability. With profit levels of $36.13 billion in 2005 and an historic $39.5 billion in 2006, CEOs at Exxon focus only on stockholders because that is how they are rewarded for their performance.

The Tragedy of the Commons (p. 83) The tragedy of the commons highlights the underlying challenge it is to have collective society be protective pertaining to the natural environment. The tragedy of the commons is based on the concept that free access with unrestricted use of any finite resource will ultimately ruin the resource through overexploitation. It is important for students to understand that there is real value in these “free” resources. As a result, there has to be a protection system in place to safeguard the value of these free resources. One question you could ask your students is how much they would be willing to pay for clean air. If you HAD to buy pure oxygen, it would cost approximately $62 for 42 liters based on one medical supply company’s product.2 How much is the free air now worth to the students?

How much is clean water worth to a student? You can point out that when students buy drinking water in a bottle, if a bottle of drinking water (16 ounces) costs $1 than the water would cost $8 per gallon. Now ask them again how much they would be willing to pay for clean water. This example will prove to the students that EVERYONE takes for granted clean air and clean water. If we became a society in which we had to PURCHASE air and water, only the most 2

http://www.cramerdeckermedical.com/category.php?category_id=2

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affluent members of society would be able to survive. A video of Garrett Hardin explaining the Tragedy of the commons can be found at (http://www.youtube.com/watch?v=L8gAMFTAt2M)

Natural Environment As a Stakeholder (p. 83) As the textbook states, the natural environment could be considered a stakeholder without a voice. By definition the natural environment should be considered a stakeholder since it has a vested interest the operations of the firm.

Even though it can not “think”, the natural environment reacts both favorably and unfavorably when actions are taken by the firm that have a direct impact. The natural environment “rewards” proactive environmental strategies by providing clean natural resources. Alternatively, the natural environment punishes firms that are “reactive” by having the firms address clean up and other additional associated costs of production when the natural environment is polluted.

Following the axiom “it’s not nice to fool Mother Nature”, a proactive environmental commitment heightens the ability of the firm to survive in the long term based on environmental sustainability. Alternatively, those firms that view the environment as a “common” may be able to make short term financial gains, but will result in negative impacts in the long term.

Since the natural environment does not have a voice by itself (its proxy is environmental NGOs), decision makers may not value it as a stakeholder.

However, as is stated in the textbook, when a firm impacts the natural environment there is also potential impact for other stakeholders. The section concludes with the argument that traditional ethical theory such as utilitarian and Kantian ethics do not include consideration for the natural environment since it is not a human being. It is therefore argued that what should be done is redefine a stakeholder, if a stakeholder is a living being then utilitarian and Kant’s ethics would include the natural environment by considering the greatest good for the greatest number of living beings and it should be a human’s duty to consider the impact on all living things.

Natural Environment As A Competitive Advantage (p. 84) This section is valuable to the students since it demonstrates the positive value added of considering the natural environment could be if it is integrated into the strategic focus of the firm. By focusing on the 4 strategic options, students will understand that there are many financial benefits of considering the natural environment to be a strategic stakeholder.

Strategy 1: Eco-efficiency focuses on the design process and the re-evaluation of the design of the product. By considering all by products in the manufacturing process as a “waste” product, designers can look at more eco friendly ways to design and manufacture new products. A video clip that could be used to

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highlight eco design is by the architect and professor at UC Berkeley Sim Van der Ryn (http://www.bigpicture.tv/videos/watch/7eabe3a16). The net competitive result of implementing an eco-efficiency strategy is that it lower the overall cost structure of the firm, resulting in higher profit margins.

Strategy 2: Beyond Compliance Leadership-This strategy gives empirical proof to the firm’s stakeholders of their environmental commitment. Through the use of an environmental management system (EMS) or certification by the International Standards Organization (ISO 14000) firms are able to generate documentation that shows how they have integrated the natural environment in the manufacturing process. The competitive advantage of implementing a formal EMS and/or being ISO 14000 certified is that it allows the firm to differentiate its products and services based on these systems. The large caveat with this strategic focus is the underlying assumption that consumers acknowledge that there is value added by having the firms implementing these control systems. If the customers do not care whether the firms has an EMS in place or if the firm is ISO 14000 certified, then the customer would not be willing to pay a premium for goods and services that are produced by the firm. Another issue is to ensure that there is consistency in the monitoring of the environmental systems. As was demonstrated in the textbook, Shell Oil faced a large negative backlash when it dumped the Brent Spar oil rig in the North Sea. If the firm uses the natural environment to differentiate their products, they must ensure that the news is always positive as it relates to environmental issues.

Strategy 3: Eco-branding is based on the concept that firms use their overall corporate environmental commitment to help brand their products as eco-friendly from a firm that is eco-friendly. It is through this branding that firms would be able to help differentiate their products from their competitors. As was the case with strategy 2-beyond compliance leadership, eco-branding will only succeed if the customers put a premium value on the products and services based on their environmental commitment. The Timberland nutrition label highlights the amount of energy used to make a pair of shoes. This “out of the box” thinking brings interest and positive press reports for Timberland and again can be used to help enhance their competitive advantage. An example of the actual label can be found in the USA Today article about Eco-Marketing found at (http://www.usatoday.com/money/advertising/2007-06-22-cannes-greenusat_N.htm).

Strategy 4: Environmental Cost Leadership is based on the belief that the reduction of manufacturing costs related to environmental pro-activeness can be converted into lower prices for products and services. Although similar to strategy 1- eco-efficiency, the difference is that environmental cost leadership uses the cost savings in the manufacturing process not to increase the profit margin per unit but to lower the price of the goods and services. The net result is a lower profit margin per unit but the assumption is that this will be more than compensated by the volume increase in the number of units sold.

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Voluntary Environmental Compliance (p. 87) Voluntary environmental compliance is adopted by firms that want to show the “evidence” to their stakeholders that they are in compliance but do not want to go through a formal process such as the ISO certification. The thirteen recommendations presented by Ramus are traditional areas in which firms could focus initially on environmental issues. From developing an annual environmental report to training the employees on environmental issues, voluntary environmental compliance gives the firms the freedom to pick and choose which areas they would like to focus on to support their environmental commitment.

This “buffet” approach gives the firms the flexibility to adopt a combination of activities which best matches the environmental vision of the top management within the firm.

The Cost of Noncompliance (p.87) It needs to be stressed that the cost of noncompliance is not primarily the financial cost related to penalties and fines for noncompliance. The true cost of noncompliance is the negative image that is created about the firm. From a stakeholder’s perspective, noncompliance means that the stakeholders have lost their TRUST in the firm. As a result, it is very difficult for the firm to regain that level of trust with the stakeholders. The negative image could also relate to the “halo effect”. The halo effect occurs when a firm is involved with an action which has a negative impact on the firm. If the firm has a positive environmental reputation, stakeholders usually will give the firm the benefit of a doubt and accept the firm’s one time explanation of the negative action. However, if a firm has a negative environmental reputation, a negative event will only reinforce the negative image of the firm and fortify the lack of trust the stakeholders have pertaining to the actions and the explanation of the action of the firm.

Examples of Environmental Commitments (p. 88) The example of environmental commitments by Johnson & Johnson highlight the potentially broad scope environmental commitment can have within a firm. A good written exercise for the students would be for them to evaluate an environmental sustainability report using the criteria which Johnson & Johnson uses.

Employees As Environmental Stakeholders (p. 89) Catherine Ramus states that a major reason that proactive environmental initiatives fail is the lack of commitment by the employees. Her remedy is to include employees in the development of the environmental strategy of the firm.

1. Initiatives that decrease the environmental impact of the company through the policies of reuse and recycling. This can be called the first easy baby step of

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getting employees’ commitment. This is a simple task to complete yet the employees will be the first to see the results of their efforts. Furthermore, this task will instill pride in the employees by being able to claim to their friends and family that they have started a reuse and recycling program.

2. Initiatives that solve an environmental problem such as hazardous substance use reduction. This second level of initiatives is more complex and time consuming than the first initiative. However, the employees will further enhance their commitment to environmental issues AND their commitment to the firm because their ideas have moved beyond simple recycling strategies to become actively involved in the design and manufacturing process of the product. It is through the design and manufacturing that the reduction and substitution of hazardous material can take place.

3. Initiatives that develop a more eco-efficient product or service that uses fewer resources and/or less energy. This initiative extends the commitment and the ideas presented in initiative 2. Instead of making incremental adjustments in the design and the manufacturing process which occurs in initiative 2, initiative 3 makes a quantum jump in the process. By actively being involved at the origin stage of the design and manufacturing process, the employees are now the driving force of innovation and research and development of the firm. As a result, participation in these initiatives allows the ideas of the employees to help drive the future environmental direction of the firm.

NGOs As Environmental Stakeholders (p. 90) Nongovernmental Organizations (NGO) have played a significant role in increasing the level of awareness of environmental issues. The Keep America Beautiful campaign is a classic example of how the environment moved into the forefront of people’s consciousness. The pinnacle of the campaign was the Public Service Announcement in 1971 which featured Chief Iron Eyes Cody.

Here is the clip from YouTube (http://www.youtube.com/watch?v=X3QKvEy0AIk) that can allow your students to evaluate the effects of this Public Service Announcement Greenpeace (p.90) Greenpeace is one of the best known environmental NGOs. It is active in 40 countries and does not rely on donations from governments or corporations.

Although some view that Greenpeace is an “extreme” environmental group by blocking fishing boats and strapping themselves to old forest trees, the impact of Greenpeace’s message resonates around the world. It believes that these tactics are necessary in order to get their message across. A good way to evaluate Greenpeace’s image is to do a word association game with your students. Tell them to tell you the first thoughts that come to their mind when you mention

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Greenpeace. The words used and the description of Greenpeace’s actions would be a good starting point for a lively discussion.

Sierra Club (p. 90) Again use word association with Sierra Club and the students will probably give you a different type of description. While Greenpeace may be described as “radical” and “extreme”, Sierra Club is probably viewed more of a mainstream NGO that tries to make change within the rules of society. As a result, the image of Sierra Club reinforces the conventional and traditional NGO. Environmental Defense Fund (p. 91) The environmental defense fund is a NGO that was created by a small group of scientist who were motivated to resolve environmental issues after Rachel Carson’s book Silent Spring was published. In the book, Carson warned that the overuse of pesticides and other chemicals would have such a negative impact on plants and wildlife that the eventual result will be a time when there will no longer be any song birds to sing in the spring. From this foundation, the environmental defense fund has continued with its mandate to use science and advanced technology to resolve current environmental issues.

Friends of the Earth (p. 91) Friends of the Earth could be considered to be the middle ground between Greenpeace and the Sierra Club. While they continue to challenge the status quo and social norms, they try to make changes within the system by using current laws to aid their cause. The example in the textbook highlights Friends of the Earth examining the financial statements of publicly traded companies to see how they account for environmental investments as well as resolving environmental issues.

Communicating the Firm’s Environmental Commitment to Its Stakeholders Stanwick and Stanwick empirically examined the relationship between the firm’s environmental disclosures and its financial performance. They found that firms that had both an environmental policy and a detailed description of their environmental commitment had higher levels of financial performance than low performing firms. Two conclusions can be inferred from these results. The first is that there appears to be proof that firms that are environmentally proactive are rewarded with higher financial performance. The second conclusion is that communicating environmental information to stakeholders enhances the firm’s financial performance. The second conclusion could be due to the fact that stakeholders have a strong positive communication channel with the firm which addresses not only environmental issues but also other firm issues. As a result, the firm enhances the trust of the stakeholders and is also able to make

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adjustments to its strategy based on the feedback from its stakeholders. The results of the study also showed that firms that had a medium level of financial performance had the highest incidence of environmental policies and description pertaining to their environmental commitment. This result also supports the belief that firms use the natural environment as a way to enhance their competitive advantage and for firms that want to move into the high financial performance category, they believe that being proactive pertaining to the environment can help the firm achieve that goal.

Government Regulations (p. 92) The summary of United States environmental regulations highlights that even though people assumed that the government began to become involved in monitoring environmental issues in the 1970s the origin dates back to the 1930s.

The variety of government regulations over the past seventy years shows how not only how the type of government regulations evolved over time but so did the types of environmental issues which the regulations were designed to address.

Voluntary Partnerships With the EPA (p. 93) A voluntary partnership with the EPA is another opportunity for a firm to demonstrate its environmental commitment. By agreeing to the voluntary guidelines established by the EPA, firms are able to “advertise” that their products are environmentally friendly since they comply with the EPA regulations. A listing of the EPA voluntary programs can be found at (http://www.epa.gov/partners2/programs/).

Environmental Accounting Issues (p. 94) The financial accounting aspect of environmental issues highlights the gray area in which firms interpret the impact of an environmental issue. If the firm does believe that the environmental issues have a “material” impact of the financial statements of the firm, they will not report with the same rigor as an issue that is considered material. The critical component of this type of reporting is a potential subjective evaluation by the firm and the firm’s external auditor. If the materiality of the issue is open to interpretation, the firm will probably want to classify the issue as not material.

Environmental Justice (p. 94) Environmental justice can be defined as the systematic equal allocation of environmental benefits and burdens. The underlying premise is that certain demographic areas within United States cities were receiving a disproportional negative environmental impact without any positive impact to counterbalance the relationships. For example, incinerators, waste treatment facilities, heavy polluting manufacturing plants would be located in urban areas that were

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primarily represented by a certain ethic group and/or by a certain income level. In addition, there would be no effort in these areas for funding to improve the natural environment in the surrounding community. The NIMBY or Not In My BackYard philosophy continues to hold true where certain communities will continue to battle to block any environmental activity that would negatively impact the local community. An example of how the citizens of the community of Chester PA fought back against environmental injustice is found at (http://www.youtube.com/watch?v=5Opr-uzet7Q) which is part of the 1996 documentary "Laid to Waste" by R. Bahar & G. McCollough.

Environmental Sustainability (p. 95) Environmental sustainability is the ability of an organization or a country to protect the use of future resources by properly maintaining and protecting the resources that are currently being used.

Sustainability can be defined based on three major components: 1. A system to ensure that sustainable management of the earth’s natural resources.

2. The development of social and institutional structures that would support the sustainable management of the natural resources.

3. Changes in the economic framework so it would support the sustainable management of the earth’s natural resources.

Therefore, it can be concluded that the viability of all firms and the natural environment in the “long-term” is based on being a steward of sustainability. As Hart argues, the approaches to sustainability can vary significantly from country to country. Gil Friend from National Logic Inc. explains some of the country specific differences in sustainability at http://www.bigpicture.tv/videos/watch/69adc1e10. In addition, Adam Davis of the Sustainable Land Fund talks about sustainability as a forward looking community movement.

The Major Challenges to Sustainability (Table 5-4; p. 96) presents alternative approaches to sustainability based on financial strength of the country and three critical sustainability issues: pollution, depletion and poverty. As is shown in the table, many countries in the world (survival and emerging economies) can not afford to make the same type of financial investments as developed economies to enhance their level of sustainability.

Triple Bottom Line The triple bottom line was developed by John Elkington and refers to how firms evaluate their performance. While the traditional single bottom line of financial performance is the norm, Elkington recommends that firms also evaluate themselves based on their level of corporate social responsibility and the

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commitment to environmental issues. Therefore, by focusing on three sets of objectives - financial, social, and environmental, firms would not only have a much more well rounded evaluation process, they would also help ensure that the needs of all the stakeholders are satisfied. A two part video series which presents John Elkington explaining the origins and the philosophy of triple bottom line reporting can be found at: Part 1: http://www.bigpicture.tv/videos/watch/00411460f and Part 2: http://www.bigpicture.tv/videos/watch/bac9162b4.

Equator Principles (p. 96) The Equator Principles are voluntary guidelines used by financial institutions when they evaluate a new corporate loan application. The Equator Principles try to ensure that there is not undue social and/or environmental risk with the loan application. By using the criteria established in the Equator Principles, the financial institutions are sending a message to both their existing and future customers that Equator Principles Financial Institutions will consider all environmental and social impacts before they will loan money to a corporate customer.

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Chapter 6 Health-Care Ethics The purpose of this chapter is to highlight the ethical issues that pertain to the Health-Care Industry. Health care expenses are increasing at very rapid pace in many countries around the world. As these expenses continue to consume more and more of the financial resources available to a country, the opportunity for increased levels of unethical activities also increases. The students will be exposed to the role of medical and biomedical ethics in the decision making process. The chapter also addresses the relationship between the health-care industry and its various stakeholders. Furthermore, the students will be exposed to a comprehensive discussion pertaining to issues related to the pharmaceutical industry.

Key Learning Points There are a number of key learning points which can be accomplished when this chapter is presented to the students. These include: 1. The Role of Medical Ethics 2. The role of Biomedical Ethics 3. Identify and explain the relevant issues related to Bioethics 4. Explain the role of the doctor with various stakeholders 5. Identify and explain different health-care codes of ethics 6. Identify and explain the different components of the Health Insurance Portability and Accountability Act (HIPAA) 7. Identify and explain ethical issues related to the pharmaceutical industry 8. Identify and explain the relationship between the stakeholders and the health-care system.

$50,000 a Day, Not a Bad Payday (p. 101) 1. What would be considered “excessive” compensation for a doctor?

The students in the class will certainly derive different levels and definitions of what “excessive” compensation would be. Some may argue that $50,000 a day could be an acceptable level of compensation for the specific skill and expertise which the doctor who is consulting the company. Alternatively, there

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will be some students that will state that it is absurd to consider $50,000 a day as an acceptable level of compensation. If the doctor worked 8 hours for the $50,000 that would equal: $6,250 per hour; $104.17 per minute and $1.74 per second.

2. If the money is being paid to the doctors for consulting and for using the company’s products, what is the problem?

The problem is that this rationale is not ethical. As soon as there is compensation tied directly to the use of a specific product, there will be changes that take place in the decision making process. The doctors will automatically move toward using products for which they will be financially rewarded. The doctors will rationalize the decision making process in these steps: a. The patient needs spinal surgery. b. The product that Medtronic is “pushing” can be used in the patient’s surgery. c. The quality of the product is acceptable so what difference does it make which product is used.

Here is the problem with this rationale: The rationale could be used regardless of the specific circumstances surrounding the patient’s condition. Since the doctor is not “conditioned” to select a Medtronic product for the surgery, it will be considered first by the doctor. The problem with this decision making process is that is does not consider alternatives that may be even a better solution for the patient’s specific problems.

3. What are the true motives of the whistleblower at Medtronic?

It appears from the information provided in the case that the whistleblower, Jacqueline Kay Poteet had a number of motives for filling the lawsuit against Medtronic. Ms. Poteet may say her first motive was to correct the illegal behavior occurring at Medtronic but the details of Ms. Poteet’s involvement with Medtronic are more complex. Since she was forced to leave the company with an injury and Medtronic was disputing disability payments to Ms. Poteet, it appeared that Ms. Poteet’s primary driving force could have been financial compensation. Even though her case with Medtronic was settled before the lawsuit was filled, it could be that Ms. Poteet stepped forward with her claims since she would have received a percentage of the savings based on her information.

The Role of Medical Ethics (p. 102) The six underlying values of medical ethics are: Beneficence, Nonmalfeasance, Autonomy, Justice, Dignity, Truthfulness and Honesty. It is through these six values that health-care issues are evaluated for their ethical merit. These values ensure that the patients should be treated fairly and effectively and that the

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patient has options available as to how he or she will be treated. From an ethical perspective, these six values move beyond the legal standard of evaluating the activities of health-care professionals. Furthermore, values such as dignity can be open to extreme differences in its interpretation. For one individual in one hospital in one country of the world the level of “dignity” may be very different for another patient dealing with the same medical issues in another country. In addition, for countries which have national health programs and have very limited resources that everyone in the country has access to, there could be many interpretations as to what is considered a “just” decision based on allocation of resources.

Biomedical Ethics (p. 103) Overlapping the values presented in medical ethics, biomedical ethics focuses on four the same values: autonomy, beneficence, nonmalfeasance and justice. The procedural justice approach presented by Nelson is a good evaluation technique to evaluate the ethical merit of the decision made by health-care professionals.

1. Clarify the ethical conflict-It is critical that all the relevant information is gathered before any action is taken. Within detailed information pertaining to the ethical conflict, an effective decision can not be made.

2. Identify all the affected stakeholders and their values. It is through the use of stakeholder theory that the decision maker can ensure that the decision is utilitarian in perspective. By making a decision that provides the greatest good for the greatest number, the decision maker is able to satisfy the needs and requirements of the stakeholders.

3. Understand the circumstances surrounding the ethical conflict. This point refers back to point #1. In order to understand the circumstances surrounding the conflict, the decision maker must collect relevant data pertaining to the conflict.

4. Identify the ethical perspectives relevant to the conflict. In order to understand the ethical implications of the conflict the decision maker must go back to the six underlying values of medical ethics and the code of ethics that have been established by his or her medical organization.

5. Identify the different options for action. The alternative courses of action allow the decision maker the flexibility to consider the different courses of action. It is imperative that the decision maker consider seeking advice from others in order to consider the full gambit of opportunities.

6. Select among the options. As these steps are interrelated, this step must coincide with step 2 referring to stakeholder theory. The correct option is the course of action that best satisfies the needs of all the stakeholders.

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7. Share and implement the decision. Once the course of action has been decided upon, the decision maker must inform those individuals that are impacted by the decision and must ensure that there is an effective implementation of the decision.

8. Review the decision to ensure it achieved the desired goal. The evaluation of the course of action serves two purposes; the first being to ensure that the stakeholders are satisfied with the decision; and two, it gives the decision maker an opportunity to learn from decision making process to help aid future ethical dilemmas.

A good example of a discussion pertaining to bioethics is demonstrated in the “Is it Ethical for Parents to Choose Their Child’s Sex? video available at http://www.youtube.com/watch?v=rqzXa7Z0HN4.

What Questions Should Be Asked Pertaining To Bioethics? (p. 104) There are six relevant questions that should be asked pertaining to bioethics: What is the value? What interests are being served? Who is the owner? Can life be reduced to a commercial and economic value? Does the manipulation of DNA result in the lost of human dignity? Is the focus on genetic engineering reducing all discussions to an economic dialogue? Is DNA the underlying linkage of all of humanity?

These six questions should raise a lot of interesting comments from the students.

Some students may couch the questions based on their religious beliefs. Other students may base their comments on using a scientific approach for addressing the issues. Of course, each method used to synthesize these questions is valid and relevant. The opposing viewpoints based on these questions should allow the students to understand that there are not always clear cut answers to ethical decisions. You should point out in class the challenge facing an organization when decision makers approach these questions from very different viewpoints.

The Doctor-Patient Relationship (p. 105) The doctor-patient relationship is based on the development of four models.

Engineering model-The doctor provides the information and the patient makes an informed decision based on the information. Of course, the underlying assumption is that the patient receives all the relevant information when making the decision.

Priestly model-Under this model, the patient takes a passive role in the decision making process and leaves the decisions up to the expert who is the doctor.

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Collegial model-This model considers the relationship between the doctor and the patient to be a partnership. As a result, both the patient and the doctor actively participate in the decision making process. In the collegial model, it is important that each partner be allowed to present their viewpoint before a decision is made.

Contractual model-This model focuses on the doctor-patient relationship as a legal agreement in which both parties have voluntarily entered the agreement.

Since they have voluntarily entered the agreement, they could also voluntarily leave the agreement without punishment.

As is mentioned in the textbook, examples such as asking a doctor for alternative non traditional treatments or relying on the internet for medical advice can open up a number of ethical issues. Again, depending on which model represents the relationship between the doctor and the patient, the response to alternative treatments and expert advice from the internet can vary.

Alternative Treatments: Engineering model-The doctor would provide the patient with alternative treatments if applicable with the underlying assumption that the doctor would provide the benefits and limitations of the alternative treatments.

Priestly model-The doctor would probably not consider alternative treatments since they probably would not be considered under this model. Since the doctor is making the decision, he or she will recommend treatments which he or she is comfortable/familiar with.

Collegial model-Similar to the engineering model, the doctor would provide information and a cost benefit analysis for alternative treatments.

Contractual model-The doctor would provide information that would be required under the contractual agreement. In other words, the doctor would provide the bare minimum information necessary for any alternative treatment.

Advice from the Internet: Engineering model-The doctor could consider advice from the Internet as a second opinion and would explain why that additional advice would be valid or not.

Priestly model-The doctor would probably immediately dismiss anonymous advice since the doctor would know the correct action to take.

Collegial model-Again, similar to the engineering model, the doctor would discuss the merits and limitations of an alternative opinion

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Contractual model-The doctor would probably provide limited commentary on an external opinion. In this case, the doctor would validate that alternative option. may be considered but would explain why his or her recommendation should be the course of action for the patient.

Health-Care Codes of Ethics (p. 106) The health-care codes of ethics all draw on the original six underlying values of: beneficence, nonmalfeasance, autonomy, justice, dignity and truthfulness, and honesty. How the specific codes of ethics develop is based on who the constituents are developing the code and the philosophy of these constituents on how to address the needs of their various stakeholders.

Furthermore, factors such as government regulations and professional standards also impact the specific areas that are addressed in an organization’s code of ethics. In addition, there would also be differences in the codes of ethics based on whether the country has a privatized system like the United States or a nationalized system like Canada and the United Kingdom. Under a nationalized system, everyone in the country has the right to “free” health care since the system is subsidized with tax revenues of the national government.

Health Insurance Portability and Accountability Act (HIPAA) (p. 110) HIPAA was passed by the United States government in 1996 to address ethical issues related to patient privacy. Under HIPAA, health-care organizations are required to protect the privacy of patient’s medical data. Although there are certain exceptions when health-care providers can release information to a third party (p. 110-111), the release of the information is based on the discretion of the provider. Therefore, the subjective nature of the interpretation of a valid reason to release information can create conflicts between patients and different healthcare providers. While one provider may interpret the reason as valid to release the information, another provider may interpret the information differently and refuse to release the information. As a result, the health-care organization’s code of ethics provides a critical link to the decision making process. If the circumstance is open to different interpretations, the resolution to the issue should be based on the formalized ethical guidelines presented in the organization’s code of ethics. A general video that explains the different components of HIPAA can be found at the Southeastern Center Medical Hospital web site. Southeastern Center is located in Wilmington, NC (http://www.secmh.org/poc/view_doc.php?type=doc&id=3090).

Another video which may be of interest to your students pertains to Dr. Phil visiting Britney Speers and claiming that Britney needs medical help. Although it is a celebrity case, it does give a good practical application to HIPAA issues.

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(http://video.msn.com/dw.aspx?mkt=en-us&from=truveo&vid=31e5cae9-299744d1-8009-e4c6ac002e26).

Pharmaceutical Issues (p. 112) As was shown in the beginning of the chapter, the pharmaceutical and medical supply industries have a strong interdependent relationship with doctors and other health-care professionals. Since the doctors are the gatekeepers for who uses pharmaceutical and other medical products, their recommendation is critical to the success or failure of these products. As a result, these industries will try to encourage the decision makers of the merits of their products. Unfortunately, the line where encouragement moves from ethical to unethical is blurry. As is highlighted in the Merck Vioxx case found later in this textbook, the decisions made by pharmaceutical companies can be life or death for patients that use their products. A good short video showing the potential conflict of interest is shown in “Free Gifts=Bad Medicine at ABC news Gifts = Bad Medicine? (http://abcnews.go.com/Video/playerIndex?id=4550657).

The Rise of E-Drugs (p. 113) The ability to obtain prescription drugs via the internet has opened up many new market opportunities to both the manufacturers and distributors of drugs. By being able to refill a prescription without leaving the patient’s residence, it allows flexibility for the patient to obtain their medications. However, as the textbook highlights, there are also many risks involved in this method of distribution. A good starting discussion point would be to ask your students whether they have ever ordered any medications from the internet. Based on their response ask those that have done so whether they had any concerns about the process. In addition, also ask those students that have said no why they have not ordered any medication over the internet. Follow up by asking the students whether their parents and/or grandparents have ordered any prescription drugs. Explore why if their response is yes (probably due to cost issues) or no (probably because they are afraid to give personal information on the internet).

Stakeholders and the Health-Care System (p. 114) Figures 6-1 and 6-2 highlight the relationship between a physician and his or her various stakeholders. Figure 6-1 shows the specific critical stakeholders a doctor must satisfy as it treats a patient. It is important to note that factors such as the patient’s family and friends as well as the doctor’s union play a role in the relationship the doctor has with the patient. It is also important to note that the organizations that drive the cost structure in the industry are also critical stakeholders: health insurance companies, managed care, health-care providers and pharmaceutical companies. One interesting question to ask the class would be how would Figure 6-1 change if the country had a nationalized health-care

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system instead of a privatized system. The major change with the figure under a nationalized health-care system would be that the managed care, health insurance companies, hospitals, other health-care providers, and the pharmaceutical companies would not be a sub group within the Government box since they are regulated by the government.

The accountability of the physician figure (Figure 6-2) highlights the large number of critical stakeholders which have a direct impact on the decision made by the doctor. It is easy to understand when a physician states he or she is being pulled from all directions because that is an accurate representation of the figure. It is important to note that although the patient is a critical consideration in all the decisions made by the physician, it can be a tight rope act to service all the needs of the patient as well as to satisfy all the needs of the various stakeholders.

Questions for Thought (p. 115) 1. Comment on the stakeholders in Figure 6-1. Are any of them more important than another group?

An initial discussion of Figure 6-1 is presented above. It could be argued that the patient’s family and friends may be the most critical stakeholder. The reason is that this stakeholder is the initial judge of how well a doctor performs his or her job. As a result, if the family is not satisfied with the effort of the doctor, a lawsuit could result which would impact the health insurance companies, managed care and the hospitals, and other health-care providers. The hospitals and health-care providers may be considered the second most important since if the doctor is not a self employed physician, a hospital would be his or her employer. The next four stakeholders could all probably be group together in the next level of importance.

They would be: managed care, health insurance companies, pharmaceutical companies and government Medicare and Medicaid. These could be considered by the cost/benefit focused stakeholder. This would leave the doctor’s union as the least important stakeholder.

2. Do codes of ethics work in the health-care industry? Explain.

The simple answer to this question is yes. A more comprehensive answer would start by stating that the underlying assumption of any organization is that we have high ethical people with some rare outliers. The code of the ethics ensures that everyone knows what is expected of them and that when an outlier does participate in unethical activities, there is a specific recourse that can be taken. In the health-care industry, the codes of ethics can be much more specific and detailed than those of other industries. The primary reason for this is that when you are dealing with the well being of an individual, there must be very specific policies and procedures to protect the health and privacy of the individual.

Furthermore, health-care codes of ethics allow the many different stakeholders

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an understanding of how each organization will be able to address ethical issues on a patient by patient basis.

3. Is there a difference in “health-care” ethics versus “business” ethics? Explain.

This difference was referred to in question 2, but to continue the discussion, yes there is a significant difference between “health-care” ethics versus “business” ethics. If you fail in business ethics, the company may go bankrupt; if you fail in health-care ethics, a human being may die. As a result, the consequences of unethical behavior can be drastically different. Furthermore, if a firm fails, the impact may affect thousands of people who lose their jobs. If there is unethical behavior, for example, in a drug with harmful side effects, the impact can be in the millions of people. Another primary difference is that the stakeholder which businesses “must keep happy” is the stockholders while the stakeholder which health-care organizations “must keep happy” are the patient and the family and friends of the patient.

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Chapter 7 Ethics and Information Technology The purpose of this chapter is to highlight the ethical issues that relate to information technology. This chapter should provide a lot of interesting discussion with your students. Since the students of today are much more technology savvy than previous generations, technology is embedded in their day to day activities. Therefore, after discussion of the information in this chapter, the students will realize that it is very easy to do unethical activities with the use of technology. The students will be exposed to issues such as why they need to study information technology, how firms can monitor computer and telephone communications, the privacy rights of employees and customers, the role of government regulations and the USA PATRIOT Act. Key Learning Points There are a number of key learning points which can be accomplished when this chapter is presented to the students. These include: 1. Understanding why studying ethical issues pertaining to information technology is important.

2. Explaining information technology ethical issues using different philosophical approaches.

3. The role of management in information technology ethical issues.

4. Privacy issues pertaining to customers and employees.

5. Monitoring issues related to computers, telephones and other technologies.

6. The ethical challenges of technology.

7. The role of government regulations.

8. Types of technology based frauds.

9. Type of internet attacks.

10. The USA PATRIOT Act

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We Thought You Wanted The Extra Pillow (p. 116) 1. What are the ethical issues of collecting personal preferences on hotel guests?

On the surface, there seems to be no harm in collecting information such as a customer’s favorite wine or whether the guest always wants extra pillows.

However, it becomes an ethical issue for two reasons. The first reason is that the guests are not informed that this personal data is being collected. As a result, it could be considered an invasion of privacy. The second ethical issue is that it is difficult to draw a line as to what type of information should be selected. As was the case of keeping the name of the wife for one guest who had gotten a divorce and returned to the hotel with his girlfriend who was referred to as his ex-wife. In addition, some guests may not want the same services time and time again and the hotel is assuming that there should be a constant pattern of the behavior of the guest.

2. Should a hotel be able to transfer these personal preferences to other hotels in their chain?

Again, the issue is privacy and it could be argued that transferring information compounds the problem of invasion of privacy. Since the guests are not aware of what information is transferred, the guest does not have any control over this personal information. Furthermore, the information may not be accurate. The analogy that could be used concerns credit ratings. Since it is claimed that many credit rating contain inaccurate information that has been reported by a third party to the credit agencies, it is the similar exercise when a third party (the hotel) is reporting the activities of the guests without verification.

3. Are there unique ethical problems with Hilton’s radio frequency identification program?

Yes, there are a number of unique ethical problems with this program. By storing the information electronically, individuals not employed by the hotel could potentially have access to the information if the card is lost or stolen.

Furthermore, it is hard to imagine that a guest would want to have every single activity within the hotel to be monitored without his consent.

Why Are Information Technology Ethical Issues Important? (p. 117) The results of the survey done by the American Management Association and the ePolicy Institute should create quite a reaction from your students. They would probably find it hard to believe that 26 percent of the firms in the survey had to fire an employee due to misusing the Internet. At this point of the discussion, you can make it very clear to the students that in a work environment, the firm owns the computers and other devices and, therefore, they can control

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what activities are considered acceptable when the devices are used. To stress the point to the students, the survey showed that 76 percent of the firms monitored the employee’s activities on the Internet to determine which Web sites were displayed. Furthermore, 36 percent of the firms monitored the content, the keystrokes used and the amount of time spent of the computer. As a result, firms are trying to ensure that “slacker” activities do not occur either on the computer or by not using the computer. In addition, 50 percent of the firms reviewed computer files of employees and 55 percent reviewed e-mail message that were sent and received by the employees. As a result, not only is every minute monitored but what is being created electronically on the computer from a content perspective is also monitored. The survey also showed that 20 percent of the firms had employee e-mail that was subpoenaed for legal cases and 13 percent of the firms had to address workplace lawsuits that were the result of employee e-mail. These two facts can be used in the classroom discussion to stress that every employee must be careful what is sent on e-mail. Sensitive information can be used against the firm and the employee. You could also stress that if you think the information sent via e-mail will offend one person, then that e-mail should not be sent.

Another fact that may surprise the students is the level of monitoring of employee’s activities by the firm. Fifty-one percent of the firms reported using video monitoring to observe the activities of the employees within the office.

Furthermore, 5 percent of the firms used global positioning systems (GPS) to track cell phones and 8 percent of the firms used GPS to track company vehicles and the employees themselves using Smartcard technology. The net result of this tracking is based on two reasons: legal and performance. The legal reason is that video monitoring and other tracking can be used when employees become involved in illegal activities. These monitoring systems can be presented as proof of the behavior by capturing data that support the claims made by the firm. The second reason is that the firms want the employees to be as productive as possible. Therefore, these monitoring systems are used to help ensure that the employees are performing their jobs to the best of their ability.

A good video which shows the monitoring and tracking of employees is found on Youtube.com (http://www.youtube.com/watch?v=grHB4K_6qBs&feature=related) under the title of “No one can hide. Track Anyone, Anywhere, Thieves Get Caught”.

Four Schools of Ethical Thought (p. 119) Figure 7-1 (p. 119) highlights the comparison of the four schools of thought relating to ethical issues in information technology. Ask your students which of these four schools of ethical thought they would follow as it pertains to information technology issues.

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Collective Rule-based Ethics-ethical behavior is guided by rules that have been developed from rational, logical thought. Therefore, illegal downloading of software and music files violated copyright agreements because the action is in violation with universal rules.

Individual Rule-based Ethics-The individuals knows him or herself what is the correct course of action to take. It is from these heuristics or “gut feelings” that the individual makes ethical decisions pertaining to information technology. The caveat with this approach is that an individual can “convince” him or herself of their actions even if the “gut feelings” may recommend another course of action.

Therefore, if the individual has convinced him or herself that illegal downloading of music files is okay because the files are available and there are thousands of other people that do it, the action can create legal and ethical problems.

Collective Consequentialists- Similar to utilitarianism, collective consequentialists believe that their decisions should be based on how they impact others.

Collective consequentialist would argue that monitoring of employees would negatively impact the liberty of the greatest number. However, collective consequentialists would also argue that any activity should be considered based on the universal impact. Therefore, it could be argued that if changes in the perceptions of society change, then the trade of the safety of monitoring versus the loss of liberty must be examined.

Individual Consequentialists-Each individual needs to determine his or her selfinterests to help guide ethical behavior. An interesting question you could ask the students is how you think an Individual Consequentialist would change their belief based on which side they support in an ethical debate. For example, an Individual Consequentialist may believe that it is in his or her self-interest to download “free” software regardless of its origin. Would the Individual Consequentialist believe the same way if it was his or her own work which was being downloaded freely by others without compensating the individual?

Management Issues and Policy Areas for Information Technology (p. 121) Privacy-How much information should a manager have access to? Should firms try to “force” employees to stop smoking and join an exercise program or face having to pay higher insurance premiums? Should the same information be collected pertaining to managers as is collected for the subordinates? Should the same information be collected for the top level managers of the firm?

Ownership-Who is the legal owner of the information? If new inventions are created within the firm’s lab, who owns the information? If the answer is the firm, would there be circumstances where the answer would change to the inventor?

Control-Control refers to not only controlling information flow but also controlling the movements of the employees within a firm. When does control stop and

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privacy rights start? Does the ethical impact of control depend on the specific set of circumstances? Are there areas of control that are always unethical?

Accuracy-It is dangerous to assume that all information collected by a firm is accurate. Since the content of the information can have a direct impact on the evaluation of an individual and or the firm, the firm must ensure that the information is accurate. There must be safeguards in place to ensure that data is checked for accuracy before it is considered valid.

Security-Security is probably the number one challenge for firm as it pertains to data collection. Since data can hold personal and “valuable” information, individuals outside the organization may attempt to attack the information technology system of the firm to obtain access to the data.

The Next Step: Critical Analysis (p. 123) Stakeholder Analysis-How can the content of the IT issue impact stakeholders in different degrees? The stakeholders could be categorized based on either having a direct or indirect impact on the IT decision.

Utilitarian Goal-based Analysis- After the distinction between the direct and indirect impact on the stakeholders have been determined, the manager must ensure that the goal will satisfy the greatest number for the greatest good.

Rights-based Analysis-By examining the rights of the various stakeholders, the management can ensure that each stakeholder is being considered when the decisions are being made. Furthermore, rights based analysis ensures that both the legal and ethical standards of the firm are included in the decision making process.

Duty-based Analysis-As a reinforcement to the rights based analysis, the duty based analysis confirms that the decisions made by the managers coincide with the ethical duties of the manager.

Privacy of Employees (p. 124) The focus on e-mail privacy can be presented simply to the students. The only email that is private is e-mail that is sent from their own private system using their own private technology device during their own time. If the e-mail is sent from the firm machine, the employee has no privacy. If the e-mail is sent using a firm’s email address, the employee has no privacy. If the e-mail was sent during working hours, the firm would probably have legal access to the e-mail. It is also important to stress to the students that a “deleted” e-mail is not really “deleted”. A file is only truly deleted if another file overwrites on that exact space on the hard drive. As a result, it is highly improbable that an e-mail or any file actually disappears from the hard drive. The only two ways in which an individual can be

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sure that the file has disappeared is to have the hard drive swept clean which eliminates all files on the drive or physically destroying the hard drive.

Table 7-3 (p. 125) highlights the costs and benefits of using email. The benefits for the firm are enormous with valuable cost savings and increased efficiency through this “free channel” of communication. The costs of legal and time consuming issues usually do not outweigh the significant benefits. As a result, firms encourage and support the use of email as a means of communication. Of course, one critical ethical issue which remains is the proper storage and security of the information that is transferred back and forth using email.

Types of Computer Monitoring (p. 125) The six criteria used to help determine whether an invasion of privacy is justified helps define the blurry line between ethical and unethical behavior as it is related to information technology (p 126).

1. For what purpose is the undocumented personal knowledge sought?-The legal and ethical argument for tracking the employees activities whether they are aware of the monitoring or not is based on the justification ensuring the employees fulfill the requirements for their job. Through these tracking mechanisms, employers can ensure that the employees are doing the activities within their job description which they are being compensation for.

2. Is this purpose a legitimate and important one?-Using the same justification as in #1, the underlying purpose of this monitoring is to ensure the employee is performing the required activities for his or her job. Therefore, the purpose would be both legitimate and important. Of course, there are always examples whether the monitoring would not be legitimate and important if, for example, the employer monitored the activities within a restroom, changing room or any other private location within the firm’s building.

3. Is the knowledge sought through invasion of privacy relevant to its justifying purpose?-This question asks the management of the firm to determine the “cost/benefit” analysis of acquiring this information. If the information pertaining to personal safety and/or of critical interest to the firm and the country then the managers have to decide “how far” they are will to go to acquire the information.

Again, the lines become blurry as to what extent management show go in order to obtain information.

4. Is invasion of privacy the only or the least offensive means of obtaining the knowledge?-This is also a judgment call by management within the firm. Again, the decision has to be based on what are the valid legitimate alternatives of acquiring the same information.

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5. What restrictions or procedural restraints have been place on the privacyinvading techniques?-This question raises the issue of what are the legal boundaries of acquiring the information. It is assumed that management is well versed in what the legal standards are for acquiring the information. Of course, if they are not well versed it is likely that they would become well versed after employees started filing lawsuits against the firm for illegal invasion of privacy.

6. How will the personal knowledge be protected once it has been acquired?-The safeguards that are in place to control the safety of the information is the direct responsibility of the firm. Since the firm has taken the steps to acquire the information, they also must take the steps to ensure that the information is protected from being acquired by unauthorized individuals.

Telephone Monitoring (p. 127) While telephone monitoring within a firm setting has been a traditional method to observe the activities of employees at work, cell phone monitoring has greatly broadened the ability of firms to monitor the activities of their employees. Since cell phones have become multi-media devices, voice communication is just one component within a cell phone that can be monitored. GSP tracking can be included within a cell phone so that the employers know exactly where the employee is. In addition, the same monitoring software that can be used to track computer activities at work can be used to track those same functions on an employees’ cell phone.

Privacy of Customers (p. 127) The basic underlying concept pertaining to the relationship between a firm and its customers is trust. If the customers give the firm personal and confidential information, it is expected and required by law that the firm safely keeps that information and dispose of it in an acceptable manner when it is no longer needed. A good example to demonstrate how this trust has been broken is highlighted in the following video which was from a local NBC station in Cleveland, Ohio. The investigative report found thousands of confidential financial documents thrown into a public garbage dumpster. The report is shown at: (http://www.msnbc.msn.com/id/21134540/vp/23394805#23394805) One of the many dangers pertaining to controlling customer’s data is what happens to the data if the firm goes bankrupt. If the firm is struggling financially, they would try to sell their assets to reduce the financial losses if they believe the firm is going bankrupt. As a result, firms will try to sell anything of value in order to obtain much needed cash. One of the last remaining assets of a firm is the firm’s customer list. Since this list is the source of their revenue, it also can be a source of potential revenue for other companies. As a result, a firm can not sell information pertaining to its customers, without the customer’s consent and knowledge. This would result in having potentially confidential information

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pertaining to customers in the hands of a third party that does not have any formal or implied agreement pertaining to the management of this data.

An interesting assignment for your class would be to ask your students to compare the privacy agreement among different companies. If they make the comparison among firms in the same industries but located in different countries there may be significant differences in the privacy policies due to governmental and societal differences. This would bring home the point to the students that there are no universal or global guidelines and rules pertaining to privacy policy.

There is a lot of flexibility and, therefore, variance in how firms address the issue of privacy for their customers.

The Challenge of Technology (p. 131) One of the critical underlying challenges of technology and the internet is the anonymous nature of the forum. Since there is usually no absolute way to confirm who you are corresponding to be the actual person they say they are corresponding to, a matter of trust must again be involved in the process.

Stakeholders must trust what is been said about the actions and the philosophy of the firm must be accurate and truthful. Customers must trust that the items pictured and described on the internet corresponding to the items they will receive. Employees must trust that they are being told the truth about the strategic focus and true motives of the decision of the managers that are relayed through e-mails and internal intranets. The government trusts that firms will self report any government violations since it is required of them. The local communities will trust the firm’s web site when it addresses issues of health and safety that can have a direct impact of the life of citizens of local communities where the firm’s plants are located. Ask your students if they were ever “cheated” by a transaction that occurred online. If so, how did it change their behavior? In general, how would the behavior of the student change if they could not “trust” the firm with their online transactions?

The speed of technology is also a significant challenge. The expectations are so high for quick responses to information that individuals expect instant responses to any information requests. Ask your students how long do they expect it should take a professor to respond to an e-mail? How long should it take their parents?

How long should it take a firm to respond to an e-mail? What do you do if it is taking longer than you thought to get a response?

The globalization of technology is also a significant challenge. Ask your students whether they would like the firm they work for to give them a Blackberry or other technical device as part of their job. For those who said yes, which will probably be most of the students, ask them what would be the acceptable hours for their boss to contact them on the Blackberry. What about if the student is waiting for a Chinese supplier to e-mail which could occur at 3 am? Would it be acceptable for the firm to expect the employee to instantly respond to a 3 am e-mail?

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The Role of Government Regulations (p. 133) What should be the role of government regulations pertaining to the internet?

This could be an initial question to ask your students to create a discussion.

Some students would argue that there should be no government regulations since the internet was designed as a free forum for ideas and discussion without the control of the government. Others would probably argue that government regulation may not be bad but would not know what regulations should be implemented. Other students could state that government regulations are needed in order for ecommerce to continue to grow in the future. While some global treaties attempt to protect copyright property from been illegally “shared” on the internet, specific countries such as the United States has attempted to pass legislation to control privacy issues, electronic monitoring, child protection and other safety issues as it relates to the government. The quick answer to this question is that is appears to depend on the philosophy of the government and the norms and customs of the culture of the country to help determine what type of government action, if any, is used to help protect the users of the internet, Technology-Based Fraud (p. 134) Technology based fraud activities creates new opportunities for illegal use of private information and creates additional concerns for individuals who use the Internet for online transactions. Ask your students if they have ever been directly involved in an internet fraud or know someone who has been involved. It probably would be quite surprising the number of people who raise their hand. If you make the assumption that “traditional” students are in their early twenties, they have been comfortable with technology all their lives. They probably always have had access to computers at school and they probably don’t really think of a time when they didn’t communicate on the internet. As a result, they are very comfortable with communicating online and are probably more comfortable with giving personal information. One only has to look at the explosion of information available on social networks such as MySpace and Facebook to realize that these students are not afraid to post very private information about themselves in a public forum. As a result, they are probably more likely to become involved in Internet fraud schemes since they are traditionally more trusty pertaining to communicating on the Internet.

An interesting question to ask you students is whether they have received junk mail in their apartment or dorm room mailbox. The answer is yes, of course since everyone receives junk mail. Now ask they how did these companies gain access to their name and correct address. This question starts the students to think about who controls the data. The obvious answer is that since a legitimate company that the student has done business with has “sold” the student’s name and address to a direct marketing firm who then has sold the name and address to clients. As a result, as the information is sold again and again, more and more

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businesses will have direct access to the student’s name and address. Now ask the student whether they have supplied information such as their social security number, date of birth and/or driver’s license number to an online web site. Now go through the same scenario and the students will quickly realize that they have lost control of this highly confidential information which could lead directly to identify theft. You can then refer to Table 7-9 (p. 136) to highlight the potential problems data theft can have on individuals who are purely victims. They are purely victims because they did not even know that information pertaining to them was being used for illegal activities.

Internet Attacks (p. 137) Cyberterrorism is a continuous worrisome threat for both businesses and individuals. It is continuous since once authorities have “plugged up” one way which hackers attack a computer system, the hackers develop another method.

The use of Spyware can mean that individuals could actually lose control of their computer and/or allow hackers into their individual hard drive. The use of Spyware that backfired on a company occurred at Sony. Sony wanted to include software with their music CDs to stop multiple copying of the music from the CD. The net result was that computer which the Spyware was attached became vulnerable to hacker attacks and in some cases; the hard drive of the computer was ruined. A complete description of this example is included in the “Music Industry: Ethical Issues in a Digital Age” case.

Ask your students what kind of security software they have to protect their computers. Now ask them what security software they have to protect their cell phones and other PDA (personal digital assistant) such as a Blackberry. They probably stated they have security software for their computer but maybe not for their cell phones and PDAs. If so, ask them why. If they said they don’t need it or did not think they need it, you can say they have just fallen into the trap the hackers wanted to set. Hackers will look for the weakest security system to try to invade. If there is not proper security on these portable devices, the individuals become vulnerable for attacks.

Another issue the students need to be aware of is the use of “free Wifi” located in businesses such as coffee shops, airports and malls. Wireless Fidelity or Wifi is a great convenience but also poses a great danger. Every time an individual inputs a user name and password into a computer in a free Wifi zone, there is a potential for a hacker to copy that information. Software is available to collect and store user names and passwords that are used in a free Wifi zone. As a result, individuals need to ensure their computers have the proper encrypted coding software so that this critical information is not captured by another person.

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The USA Patriot Act (p. 138) In direct response to the terrorist attack on September 11, 2001, the United States Congress passed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (PATROIT) Act. This act allowed the United States government broad interpretation of what is considered critical information and also gave them broad abilities in their methods in order to obtain information. For example, this act gave the United States government expanded ability to monitor and record electronic communications if, in the opinion of the government, there could be potential terrorist activities. It also required financial institutions and other firms included within the guidelines of the act to have detailed monitoring mechanisms in place to track their customer’s activities. After reading the summary of the act, ask your students what circumstances would they believe monitoring electronic communications would be justified under the act. Also ask them under what conditions would this monitoring not be considered justified. You can relate this back to the utilitarian belief of trying to provide the greatest good to the greatest number.

Questions for Thought (p. 139) 1. In the opening scenario for this chapter, hotel chains are described as collecting data about customers without their knowledge. Do you view this as a violation of your rights? Why or why not?

Parts of this question are answered with the questions and answers posted at the beginning of this chapter. To reiterate, the general focus of the scenario, this example highlights the blurry line between where customer service stops and invasion of privacy starts. One simple solution is to explain the purpose of the collection of the data and give every guest the option of allowing the collection to take place or not. By having an “opt in and opt out” alternative, the individual guest can decide from him/herself what they are comfortable with in the collection process by the hotel chains.

2. Analyze the costs and benefits of using e-mail presented in Table 7-3.

These pertain to an employer’s perspective. Prepare another table that presents the employee’s perspective.

From the employer’s perspective, the benefits outweigh the cost of using e-mail.

This simple conclusion is based on the fact that employers have the ability and the means to control the costs of e-mail. Through computer monitoring software, employers can monitor whether there are any offensive communications and whether the e-mail system is used purely for business matters. Information overload is another matter since firms use e-mail because it is quick, cheap and efficient. Therefore, it would be a lot harder to control information overload.

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From the employee’s perspective, the benefits of the company’s e-mail system are not as strong. Since it is controlled and monitored by the firm, the benefits shown from the employer’s perspective means that e-mail will continue to grow as a critical communication tool by firms. Therefore, the benefits for the employees are that they are able to be more efficient with their job, they are able to be kept better informed about the matters pertaining to the firm and they can show evidence of their productivity based on the content of the e-mail and when the e-mail was sent. If an e-mail is sent to a supervisor at 2 am, it demonstrates the total commitment of the employee. The costs are that the e-mail system is used purely for business related functions and, therefore, becomes a bigger part of the everyday activities of every employee.

3. One of the biggest issues facing technology is that of illegally downloading music from the Internet. Survey ten people about illegal downloading. Ask them the following: a. Have you ever downloaded music from the Internet? b. Why or why not? c. Summarize your findings.

Again, based on the assumption that the majority of the students in the class are “traditional” students who are in their early 20s, the findings may vary little in their surveys. The students will likely survey their friends and their friends probably have had the same types of experiences with downloading music. For a majority students that did download illegally, it probably occurred when they were in high school because their friends were doing it, they did not see anything wrong with doing it and there were really very few legal alternatives for downloading music. It could be assumed that those students today probably download legally using itunes or another online service, but there probably will still be some students who download illegally.

Again, a full summary of the evolution of music downloading can be found in the case “Music Industry: Ethical Issues for a Digital Age”.

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Chapter 8 Strategic Planning and Corporate Culture The purpose of this chapter is to highlight the ethical issues that relate to strategic planning and corporate culture. After the material is presented in this chapter, the students should have a better understanding on the critical role strategic planning and corporate culture have in the formulation and implementation of an effective ethics program. It should become clear to the students that ethical decision making should be integrated at every step of the decision making process. Therefore, firms should view all decision making as being equal to ethical decision making. Some of the issues that will be examined in this chapter include the benefits of including ethics in the decision making process and the costs of having an unethical corporate culture. Furthermore, the chapter addresses other relevant issues such as how a firm can recover from an ethical crisis and/or disaster and how changes in the corporate culture may be necessary in order to implement a more effective ethics program for the firm.

Key Learning Points There are a number of key learning points which can be accomplished when this chapter is presented to the students. These learning points include: 1. The role of ethics and strategic planning.

2. How managers can develop trust and commitment with their employees from an ethical perspective.

3. The role of power and influence in ethical decisions.

4. The problems that can occur if the firm has an unethical culture.

5. The role of ethical decision making from a global perspective.

6. How to evaluate a firm’s corporate culture from an ethical perspective.

When Ethics Drive a Change in Strategy (p. 141) 1. Why do you think it was important for Sanford Weill to stay on as Chairman of the Board after Charles Prince was picked as the new CEO? Weill’s justification for staying with Citigroup was to make sure the company was being steered “in the right direction for the future”. What that phrase means is that Weill wanted to make sure that the strategic goals and ideals which he had established as CEO would continue to be the goals for Citigroup. In addition, by remaining as Chairman of the Board, Weill still had significant power in the

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company and could challenge and reject the strategic direction proposed by Prince if Weill did not believe it was the correct direction. As was discussed in Chapter 4 on Corporate Governance, when the CEO and Chairman of the Board are two separate individuals, the power of the CEO is weaken since the CEO does not control the agenda of the Board of Directors. When CEO duality occurs which is when the CEO is also the Chairman of the Board, this one individual has significant control over all of the operations within the firm.

2. Why did three top level employees at Citigroup want to leave after two years with Prince as CEO? The simple answer is that they did not agree with the direction Prince was steering Citigroup with its shift in strategic focus. One of the areas where it appeared that Prince made a fundamental change was the shift from a mono shareholder to a multi shareholder focus. The goals set by Sanford Weill were all financial in nature. As a result, Weill was catering to only the needs of the investors. By including corporate reputation and comprehensive ethics programs in the strategic decision making at Citigroup, Prince viewed all the stakeholders as valuable groups whose needs should be identified and met.

3. Why do you think there were multiple ethical problems at Citigroup when Prince took over as CEO? The multiple ethical problems appear to be caused by focusing solely on the stockholders in their decision making process. One of the dangers of focusing solely on financial returns is that managers may not ask (or want to ask) how the financial results were achieved as long as the goals were met. Under a “don’t ask, don’t tell” financial philosophy, managers are not as concerned about the means to get to the financial goals as long as the ends are met. Therefore, as long as Citigroup was growing in size and profitability, everyone within Citigroup was “happy”.

Update on Charles Prince In an ironic twist, Charles Prince was forced to resign as CEO in November 2007 due to a $5.9 billion write off of subprime mortgage loans that Citigroup was carrying. There are a number of ethical issues related to subprime mortgages issued by financial institutions including whether ethically these financial institutions should have been involved in mortgage which were too difficult for the customers to pay off. In addition, it was alleged that a number of financial institution did not fully disclosed all the terms and conditions of these subprime loans. However, Charles Prince did not leave Citigroup as a poor man. Mr. Prince had earned $53.1 million during his four year tenure at Citigroup and also

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had stock holdings of Citigroup that were valued at $94 million when he was forced to resign.1 Ethics and Strategic Planning (p. 141) In order for the students to understand the interconnectedness between ethics and strategic planning, a learning tool that could be used is the Ethical SWOT analysis. The Ethical SWOT analysis allows the decision maker to visualize the pros and cons of a decision that could have ethical implications.

SWOT stands for Strengths, Weaknesses, Opportunities and Threats Strengths- these are the internal strong characteristics within the firm that can be used to help implement the ethical decision. Some examples of strengths could be: Strong corporate reputation Positive image Corporate ethical philosophy Ethical vision of top managers The results of previous ethical decisions A formal code of ethics Having an effective ethics training program Having an ethics officer Having a strong relationship with stakeholders Using a triple line evaluation of performance Having a strong financial performance which allows continued ethics based investments.

Weaknesses-these are internal weak characteristics within the firm that need to be resolved. Some examples of weaknesses could be: Negative corporate reputation and image No ethical vision for top level managers Zero or minimal ethics based training for the firm’s employees Ignoring the needs and expectations of at least some of the stakeholders Focusing solely on financial goals No formal code of ethics No formal ethics training program No ethics officer No ethics evaluation process.

Opportunities-these are future courses of action which the company can take to enhance their ethical standing. Some examples of opportunities include: 1

Eric Dash and Landon Thomas Jr. Citigroup Chief Is Set to Exit Amid Losses. The New York Times.

November 3, 2007.

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Resolve the ethical weaknesses that are listed in the Ethical SWOT Benchmark ethical performance against the industry and an ethical trend setter Give employees incentives to suggest improvements in their current ethics programs Give employees incentives to identify ethical violations to the responsible party with the firm Use state of the art technology to help facilitate the monitoring and ethical control procedures of the employees Establish liaisons with government agencies which monitor the firm’s industry Establish membership in voluntary industry based organizations that support strong ethical standards Review how both domestic and international competitors address the same ethical issues.

Threats-these are external factors that can impact the ethical standards of a firm.

Some examples of threats are: Change in government regulations Change in competitor’s focus Addition of new competitors Downturn in the economy of the countries in which the firm competes in Changes in technology which the firm has failed to adopt Changes in customer’s perceptions of the image of the firm Change in other stakeholder’s perceptions of the image of the firm Change in the demands and expectations of the stakeholders.

A Manager’s Ability to Develop Trust, Commitment and Effort (p. 143) What is duty?-moral problems-Trust What is right?-moral reasoning-Commitment What is integrity?-moral courage-Effort In Figure 8-2 presented on page 144, the model of Trust, Commitment and Effort is presented. One of the questions you could ask your students is whether these three constructs need to be presented simultaneously to the firm’s employees or could they be sequential in nature. It could be argued that management could have an opportunity to establish these three attributes in a sequence. The first would be trust because without this foundation the rest of the model would collapse from the employee’s perspective. After trust is established, the goal of the manager is to get the “buy-in” by the employees via commitment. The employees must be active and not passive as it relates to the ethical vision of the firm. After trust and commitment have been established, the subsequent effort of the employees can be capitalized on by the firm. The firm has established the

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foundation of trust and commitment so that the employees want to work in establishing the ethical vision of the firm.

The Role of Power and Influence in Ethical Decisions (p. 144) “With great power comes great responsibility” Even though this quote is from a comic book character, a lot of your students will immediately be familiar with it. Using a quote from Spiderman allows the students to understand that ethics can take place even in the make believe world of Peter Parker and Uncle Ben. This reinforces the ideal that ethics impact not only the decisions they make as employees but also as citizens of the world.

A Machiavellianism Approach to Decision Making A discussion on Machiavellianism should yield some interesting points with your students. You can start the discussion asking whether they have ever manipulated some one in order to achieve their own goal. The follow up question would be whether they have every felt that they had been manipulated by some one is order for a person to achieve his or her goal.

An example of a scenario you could ask your students to consider is you are shopping with your friend and your friend grabs an item (e.g. Shirt, purse, CD, shoes, book) and there is only one of these items. You convince your friend that he or she should not buy it and you return later to the store and buy it yourself, is that ethical? Is that Machiavellianism?

How to Control Power and Influence The challenge of trying to control power and influence is to realize the level of power and influence you could have over other employees. It does not matter whether the power is legitimate or implied, managers must understand that what they say and how they act can greatly influence the behavior of his or her subordinates. From an ethical perspective, power and influence can be used to ensure the employees are committed to the ethical philosophy of the firm.

The Curse of Unethical Cultures (p. 146) The curse of unethical cultures refers to the permanent problems that can arise if the corporate culture supports unethical behavior. If behavior is not monitored and controlled, the net result will be a continued treat of legal consequences based on criminal and civil charges. In addition, an unethical culture negatively impacts employees by encouraging a hostile work environment which would lead to low morale of the employees and the departure of some of the employees.

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The Responsibility of Managers (p. 146) The foundation of the role managers should play in the decision making process was established by Chester Barnard in his book The Functions of the Executive.

In his book, Barnard argues that managers have a moral responsibility for every decision they make. Therefore, Barnard assigns not only responsibility but also accountability to managers for their actions.

Table 8-1 on page 147 highlights the importance of management leadership and employee commitment in the ethical strategic planning process. It should be noted that Dollar General refers to not only the commitment of rights of the employees but also realizes the value of humor in the workplace. From an ethical perspective, management tools such as humor are invaluable in relaying the ethical beliefs of the firm. If there is humor in the workplace, there is probably a more relaxed atmosphere in the workplace. If there is a more relaxed atmosphere, employees are more willing to protect the relaxed atmosphere. If they are willing to protect the relaxed atmosphere, they will stop any actions that can threaten the relaxed atmosphere such as unethical behavior of the employees.

Ethics can be used by firms to differentiate themselves in the marketplace. As is the case with the firm’s reputation, a firm’s ethical commitment can separate themselves from their competitors which could enhance their competitive advantage. The obvious caveat with this strategy is that if the firm uses its ethical commitment as a competitive advantage, the firm must make sure that the correct control and monitoring systems are in place to ensure that the employees are not involved in unethical activities. Therefore, if ethics is a critical factor in the firm’s competitive advantage, it should also be a critical factor in ensuring proper ethical compliance.

How to Address Ethical Decision Making From a Global Perspective (p.

148) The Mapping of the Ethical Philosophies presented in Figure 8-3 highlight the different ethical philosophies that can be observed globally. It is very important for a manager to understand that different countries have different cultures which can lead to different ethical philosophies. As a result, it is a critical error to assume that everyone in the world acts in the same manner and agrees to the same ethical philosophy. In the United States, the ethical philosophy that would represent the majority of people would be one focusing on serving self interest from an ethical perspective. Therefore, ethical egoism would most closely match this belief pattern. Alternatively, countries in the Pacific Rim would probably more coincide with a group or utilitarianism approach. Therefore, when a global corporation designs their ethical philosophy and training program, they must take these cultural differences into account. Ethical training programs may be

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changed or altered depending on the country in which the ethical training takes place.

How to Address Ethical Crisis and Disaster Recovery (p. 149) The ethical crisis and disaster recovery typology presents a good set of guidelines for firms to follow when they are facing an ethical crisis. Have your students look over the examples for each of the four categories in Table 8-2. Ask them which of those examples would, in their opinion, be more harmful for the long term survival of the firm. Now, ask them which of those examples would least likely to have any long term impact on the firm. The next set of questions refers to reducing the risk of having theses crises occur. For each of the four quadrants, ask what specifically can be done to reduce the probability that each of those examples would not occur. Some potential answers could be: Internal-Normal Product failure or recall-tight quality control Sexual harassment-comprehensive policy and training with zero tolerance Workplace violence- comprehensive policy and training with zero tolerance Vandalism-comprehensive monitoring systems Strike-partnership relationship with employees Internal-Abnormal Corporate scandal-comprehensive ethics training and monitoring Information theft-comprehensive information technology security Copyright infringement-aggressive legal action Records tampering-employee monitoring and controls External-Normal Supplier failure-have backup suppliers available Industrial espionage-comprehensive security systems Product category failures-high quality control Industry-wide technology attacks, membership in voluntary industry associations and high information technology security External-Abnormal Terrorism-Comprehensive security in all phases of the firm’s operations Industry deregulation-strong liaison with government agencies and officials Reputation issues-aggressive legal action Natural disasters-risk analysis of probability of occurrence

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Ethical Leadership: A Link Between Strategic Planning and Corporate Culture (p. 150) Figure 8-4 summarizes the role ethical leadership can have with strategic planning and corporate culture. You could present the concepts in Figure 8-4 from this perspective. In order for managers to be proactive in the role as ethical leaders, they need to first have the traits of a moral person. As a result, integrity, honesty and trustworthiness are the cornerstone of the foundation of ethical leadership. It is these traits that drive the behaviors and decision making of the manager. Therefore, once the core has been established, the ethical behaviors and decision making will logically follow. Without the moral traits, the manager can not become an effective moral manager. Since the role of the moral manager is to be a role model, to help in the decisions pertaining to rewards and punishment and to communicate the ethical values of the firms, the grounding of these actions also started with the underlying traits of the moral person.

Figure 8-5 on page 152 highlights the four quadrants related to moral person and moral manager. One question to ask your students is whether it is possible for a manager to move from one quadrant to another. The simple answer to this question is yes, but the shift probably could occur more frequently in certain quadrants. The “easiest” shift is from an Ethical to a Hypocritical Leader and from an Inconsistent to an Unethical leader Ethical Leader to Hypocritical Leader In order for this shift to take place, the manager starts to ignore his or her ethical responsibilities as a manger. As a result, what is told to his or her subordinates is no longer consistent with his or her actions. Therefore, it could be argued that this shift took place with Martha Stewart. She was initially an ethical leader and then became a hypocritical leader after lying to the FBI. Inconsistent Leader to Unethical Leader In order for this shift to take place, the manager who initially had the traits of a strong moral person has lost those traits. This scenario could take place if the manager does not place the moral traits in high regard. This may be the case since the inconsistent manager is not transferring the value of those traits to his or her supervisors. As a result, since these traits are not being transferred, they may no longer be considered of value to the manager which would lead him or her to becoming and unethical leader.

It would be very difficult for a manager to go in the opposing direction than the previous two examples. Since both the hypocritical and unethical leader has weak moral traits as a person, it is not expected for those traits to change. In addition, once the managers have established a reputation as being hypocritical or unethical, it would be hard to convince employees that they have “turned over

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a new leaf”. As a result, it would be highly unlikely that a hypocritical leader could become an ethical leader or an unethical leader could become an inconsistent leader.

Corporate Culture (p. 153) Corporate culture plays a critical role in the establishment and maintenance of a strong ethical belief system for the employees. The shared values and beliefs of the employees must coincide with the ethical vision of the firm. As a result, managers must ensure that the corporate culture is supportive of a positive ethical climate. Therefore, referring back to the characteristics of a moral manger, the responsibility of being a good model, the ability to reward positive ethical behavior and punish unethical behavior and the ability to communicate the ethical vision of the manager can only be accomplished if the corporate culture supports these characteristics. As a result, the corporate culture is the “glue” that holds together the guidance needed by the mangers in order to ensure that the firm has a positive ethical climate. In order to ensure that the corporate culture is supportive of the firm’s ethical belief, the firm must “protect” the corporate culture from threats that can have a negative ethical impact on the firm.

How Managers Can Change A Corporate Culture (p. 154) From an ethical perspective, the challenge of changing a corporate culture occurs when there has been an ethical crisis and/or failure. If the firm has a strong positive, ethical supportive culture, the culture does not need to be changed. However, if an ethics scandal hits the firm, the firm’s corporate culture must change. For some firms such as Enron, the financial collapse which was included with the ethical collapse was too great to recover from. For other firms such as WorldCom, the change in culture also includes the change in the name of the company. By changing its name from WorldCom to MCI, the top level managers have given a signal to the marketplace that not only has the company culture changed, but so has the company. Other companies such as Tyco are able to make corporate culture changes within the framework of their existing organization. The opening scenario in Chapter 10 highlights how Tyco changed its corporate culture as it recovered from its corporate scandal.

Whichever option the firm selects in order to change the culture of the firm, the trust and commitment of the employees must take place before the change can be executed. Based on Figure 8-2 that was referred to previously on page 144, employee trust and commitment is critical before managers can expect effort by the employees. Therefore, employees must be involved in the culture change, they must have input on what changes will take place and they must agree to their new responsibilities based on the execution of the culture changes. It is only after these steps have taken place that the firm can expect a significant change in culture to support new ethical focus.

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Evaluation of Corporate Culture (p. 156) From an ethical perspective, it is very simple to evaluate the firm’s corporate culture. The managers of the firm must go through a checklist similar to the one presented by Deloitte & Touche on page 156. Part of the ethics training process should include an evaluation of the ethical knowledge of the employees.

Employees should be well versed on what the ethical philosophy of the firm is as well as what their responsibilities are to ensure the ethical integrity of the firm is maintained. Managers must remember that code of ethics, ethics training, and ethics learning are continuous events that evolve over time. As a result, the code of ethics is a “living document” that can change as the view of society changes.

Economic and social conditions around the world can impact the content of the presentation of ethics from a training perspective. Furthermore, all employees need to be involved in the learning process as it relates to corporate ethics.

Questions for Thought 1. Identify and explain a situation where you have seen Machiavelli’s framework at work.

If students are not clear of a situation that could be considered Machiavellian, it may be easier to ask the students whether they have seen someone being manipulated or have ever felt manipulated by another person. If they had felt they had been manipulated, ask them how they felt after the manipulation has taken place.

2. Explain why ethical decision making is so important in the strategic planning process.

A major focal point of this chapter is for students to understand that ethics should not be considered a stand alone issue when strategic planning takes places.

Ethics should be fully integrated in the decision making process to the point that it does not even have to be identified. If ethics is effectively integrated in the strategic planning process, ideas will automatically be accepted or rejected based on their ethical merits.

3. Explain corporate culture in light of ethical conduct.

Again, one of the underlying concepts in this chapter is that corporate culture and ethics are intertwined. As a result, for a firm to be sustainable in addressing the needs of its stakeholder, positive ethics must be fully incorporated in the corporate culture of the firm. Therefore, it is critical for managers to understand the critical role corporate culture plays when adjustments are needed in the ethical philosophy of the firm. Adjustments can not be made to the ethical beliefs of the employees if the corporate culture of the firm is not changed.

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Chapter 9 Ethics and Financial Reporting The purpose of this chapter is to highlight the ethical issues that are related to financial reporting. One of the critical lessons that the students need to learn in this chapter is that management is responsible for the accuracy of the firm’s financial statements. The external auditors are hired to verify the results but it is the firm itself that creates the financial statements that are ultimately submitted to the government regulatory agency (the SEC in the United States). Therefore, students must understand that management’s decisions determine the composition and the content of the firm’s financial statements. Some of the issues that will be addressed in this chapter include the concept of “creative accounting” The role of financial reporting and ethics, the responsibility of the external audits, the role of government regulations related to financial reporting, and common ways in which managers can manipulate the firm’s financial statements are also covered.

Key Learning Points There are a number of key learning points which can be accomplished when this chapter is presented to the students. These include: 1. The role of creative accounting.

2. The link between ethical philosophies and accounting issues.

3. The role of financial reporting.

4. The role of auditors and the audit.

5. The role of government regulations.

6. How firms can manipulate their financial statements.

When Is a Doughnut Hole a Real Doughnut Hole? (p. 160) 1. What do you think is the underlying reason why Krispy Kreme started having ethical problems?

The underlying issue is that their financial goals related to their growth rate.

Whenever a firm establishes very high growth rates, the firm forces itself into a corner. High growth rates lead to high expectations from investors which lead to high stock prices. However, once their growth rates and stock prices have been established, the expectations of the investors are that growth will continue to

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occur in the firm’s financial performance and the firm’s stock price. Therefore, if the CEO and other top managers “promised” continued high growth, they will then look to whatever means are possible to present this continued growth to the investors.

2. How does shipping equipment manipulate Krispy Kreme’s financial statement?

The physically shipping of the doughnut making equipment is not the source of the manipulation. It was how the “sale” of the equipment to the franchise owners was recognized or reported in their financial statements that was an illegal manipulation. There is a disconnect that took place in this transaction which is a violation of standard accounting procedures. When Krispy Kreme shipped the equipment to the franchise owner, they immediately recognized or recorded it as a sale which would increase their revenues. However, since the franchise owners only paid for the equipment when they needed it, it could be months before Krispy Kreme received payment of the equipment. This mistiming within the transaction is not allowed since Krispy Kreme should only recognize or record the sale once they have received payment or established terms of repayment with the franchise owner.

3. What is unethical about the CEO receiving perks from Krispy Kreme?

There is nothing illegal or unethical about a CEO receiving benefits from the firm.

However, what could be considered to be unethical and illegal is if these benefits were “rewards” based on the financial performance of the firm. CEOs and other top managers can be issued millions of dollars in bonuses and stock options based on the stock price and level of profitability of the firm. The problem with this incentive system occurs when the financial statements are inaccurate. As a result, there is a financial incentive for the CEO to become involved in illegal and unethical activities if it is linked directly to his or her level of compensation.

Update on Krispy Kreme123 In January 2005, Scott Livengood “retired” from his CEO position and remained with the company as a consultant at a monthly salary of $48,833 plus expenses.

Financially, Krispy Kreme was crippled by the accounting scandal. They were unable to borrow money and their stock has fallen from a high of $49.74 in August 2003 to $9.61 in January 2005. Krispy Kreme hired a new interim CEO, Stephen Cooper who had helped Enron in their attempt to turnaround. In March 2006, Cooper was replaced by Daryl Brewer who was head of Kraft’s North American snacks and cereal unit. In January 2008, Brewer was replaced by 1

Norris, Floyd. Krispy Kreme Picks Turnaround Specialist. The New York Times. January 19, 2005 Burritt, Chris. Shakers: Kraft CEO is Ousted as Company Struggles. International Herald Tribune. June 27, 2006.

3 Anonymous. Brewster Resigns As Krispy Kreme. CEO. Associated Press. January 7, 2008 2

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Kristy Kreme’s Chairman of the Board, James Morgan when Brewer resigned for personal reasons. James Morgan became the third CEO for Krispy Kreme in three years. Morgan had been a Krispy Kreme director since 2000 and had become Chairman of the Board in 2005. The announcement of Morgan’s appointment shot up the price of Krispy Kreme shares by 11 percent.

Unfortunately, the 11 percent translated to 32 cents and the stock rose to $3.15.

The Role of Creative Accounting (p. 161) Creative accounting is just another way of saying that management has stepped outside the “box” related to certain accounting issues. The key aspect of creative accounting is to know where the ethical and legal interpretations of the accounting rules stop and the unethical and illegal interpretations of the accounting rules begin. The humorous example of the Producers can be a good opening discussion for class. There may have been a number of students who have either seen the play or the movie and can understanding what is meant by creative accounting. If you want some additional humorous examples, there are four potential video clips that can be shown in class. The first is called the Chartered Accountant Dance (A Chartered Accountant or a CA is a British term and is equivalent to a Certified Public Accountant in the United States (http://www.youtube.com/watch?v=4T_eRLmekD0&feature=related). In addition, Monty Python has three very funny skits that refer to CAs in Great Britain with the following themes: Vocational Guidance Counselor (http://www.youtube.com/watch?v=XMOmB1q8W4Y&feature=related); Accountants betting who will jump off the building next (http://www.youtube.com/watch?v=j5aN0VmvFn4&feature=related) and The Audit (http://www.youtube.com/watch?v=mkAfl2RmAZc&feature=related).

Ethical Philosophies and Accounting Issues (p. 161) Table 9-1 which is shown on page 162 highlights the link between ethical philosophies and accounting issues. Ask your students how many are accounting and finance majors. For those who raised their hands, ask them whether they agree with these linkages. Table 9-1 is an effective table to re-enforce the philosophical ethical theories that were presented in Chapter 1. In addition, the table demonstrates how those philosophical ethical theories can be directly linked to a practical application which is development of financial reports.

Therefore, it is from this foundation that managers have a philosophical ethical duty to present correct financial statements and those financial statements need to be transparent so that the entire firm’s stakeholders can understand how the financial statements were created.

Table 9-2 extends the philosophical theories by presenting five presuppositions of external financial reporting. You could ask your accounting and finance students whether they would agree with these five presuppositions. They

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probably will answer that they do not feel as comfortable with these presuppositions as opposed to the philosophical theories presented in Table 9-1.

Where Were the Auditors? (p. 163) One of the most common questions asked during the recent corporate scandals was ‘where were the auditors during the years and years of false financial information”. Hired by the firm to evaluate the validity of the financial statements, external auditors are responsible for identifying and potentially resolving unethical and illegal interpretation of the Generally Accepted Accounting Principles or GAAP. The textbook highlights the potential conflicts of interest that allow for less rigorous auditing of the firm’s financial statements. Since the auditing fee is paid by the firm, the firm is the client and the object of the audit.

Therefore, conflict of interest can occur if the auditors want to make sure the managers are happy and they will select the same auditor in the future.

Therefore, creative accounting at its limits may be considered acceptable to the auditors since the employee of the audit firm are evaluated based on the number of bookable hours that are charged to the client. One of the components of the Sarbanes-Oxley Act is that auditing firms are no longer allowed to also generate revenue by being a consult and to the firm in which it is doing an audit.

In addition, auditors may have a personal conflict of interest if they have a personal financial investment in a firm in which they are performing an audit.

As part of the domino effect, the auditors want to make management happy and management wants to make shareholders happy. Shareholders are happy if there is a “clean” audit which means there are no outstanding issues that impact the validation of the financial statements.

Steps of An Audit (p. 165) The steps of an audit show the students the proper procedure in reviewing the financial statements of a firm. The auditing process can involve numerous employees and can take hundreds of man hours depending on the complexity of the business. In addition, auditors must ensure that Generally Accepted Accounting Principles are followed throughout all the transactions that pertain to the firm’s financial statements.

Current Trends In Auditing (p. 167) The risk-based audit was a trend that was introduced in the 1990s and could be considered a factor in the increase of large scale accounting frauds. A risk based audit assumes that low risk areas within a firm need less attention than high risk areas. As a result, auditors would invest a disproportional amount of time and resources on high risk areas which left low risk areas receiving a bare minimum review by the auditors. Since the auditors would ask managers to identify high

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risk areas, the managers were allowed, in part, to manipulate the auditing process. Therefore, if the managers are unethical, they could steer the auditors away from the transactions that were unethical and illegal. To compound the effect of the risk based audit, the same firm that audited the company would also be a consultant to the company. As a result, another arm of the same company could also give input into the determination of the low and high risk areas. Since the consulting arm of the firm was rewarded based on review generated by billable hours, the consulting arm also did not want to upset the firm and would support the firm’s interpretation of high and low risk auditing areas.

Even though the auditors and the audit committees are quite detailed and comprehensive responsibilities (p. 168-170), there is “room” for interpretation of specific duties that coincide with the responsibilities. It is still up to the moral person within the managers, auditors and audit committee to make the final determination as to what is acceptable and unacceptable based on their responsibilities. When high growth and a rapid escalating stock price dominate the strategic focus of a company such as Krispy Kreme, the net result is that management will rationalize their decisions to make sure they satisfy the needs and expectations of the investors. The pressure to make stockholders expectations will be transferred from management to the auditors by way of trying to ensure a “clean audit” takes place even though there were “dirty” transactions. The audit committee has a fiduciary duty to serve the needs of the stockholders while ensuring the legal and ethical standards of the firm are maintained. However, as was mentioned in Chapter 4, if the CEO is also the Chairman of the Board, he or she can control what information is given to the board and controls the agenda of the board meetings. As a result, the audit committee may never be privy to the “dirty” transactions that have been executed by managers within the firm.

Role of Government Regulations (p. 171) After the stock market collapsed in 1929, the United States government enacted a number of different pieces of legislation to protect the interests of the investor including the creation of the Securities and Exchange Commission in 1934. After 1940, the next major piece of legislation that was passed to protect the rights of shareholders occurred sixty two years later with the passage of the SarbanesOxley Act. An excellent video which highlights a number of ethical issues related to financial reporting is an interview with John Bogle who was the former CEO of Vanguard mutual funds in which he discusses his book “The Battle for the Soul of Capitalism” The video is produced by the Massachusetts School of Law and can be found at (http://video.google.com/videoplay?docid=9091574967491272154&q=John+Bogle&total=61&start=0&num=10&so=0&type =search&plindex=0).

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Risk of Manipulation of Financial Statements (p. 174) The manipulation of financial statements is at the cornerstone of how unethical managers try to conceal their fraudulent activities. If management implements actions that are unethical and illegal, they have to try and “cover up” the illegal actions from a financial perspective. Manipulation of the financial statements can be defined as the unethical and potentially illegal adjustments made to the report of the financial status of the firm to enhance the self interests of parties who are responsible for the integrity of the financial statements. Some managers rationalize the illegal adjustments similar to a gambler who has lost money. They think to themselves “if I just make these changes this quarter, next quarter we will be able to correct the deficits and get back on track”. Other managers may feel that they will never be caught as long as they can properly “hide” the problems.

One factor that seems to eventually “expose” the manipulation is the issue of cash flows. If the financial statements are inaccurate, the presentation of false revenues and sales may not have an immediate impact on the day to day operations of the firm. However, if the profits are not real, the presented cash flows coming into the company also are not real. This misrepresentation can only continue as long as the company can pay its suppliers. If the cash flow reaches a point where the cash outflows becomes larger than the cash inflows, the firm can no longer pay its suppliers. As a result, the firm would have to borrow money just to pay off the day to day expenses. This borrowing would raise questions if the firm continues to report robust sales and profits yet needs money to pay its expenses. This is what occurred in the Parmalet case. The firm had reported a large balance of cash yet needed to borrow money to pay its suppliers. This action raised red flags and left Parmalet’s stockholders wondering what the problem with the firm’s financial statements was. Furthermore, a firm may eventually lose their ability to borrow which would mean they would become financially insolvent.

Major Components of a Firm’s Financial Statements (p. 175) Hopefully, your students have taken an introductory class in Accounting and are familiar with the four major financial statements are: balance sheet, income statement, statement of retained earnings and statement of cash flows. As was mentioned in a previous section, if manipulation of these statements occurs, the value of the statements has been compromised. In addition, the impact of inaccurate financial statements does not only impact the investors but also the managers. If the financial statements are inaccurate, the managers no longer can make effective strategic decisions based on the financial performance of the firm.

From a management perspective, the financial statements serve two critical purposes. The first purpose is to evaluate how well the firm’s current strategy is being executed. The second purpose is to identify what the firm can afford to invest in the future based on their current financial position. Obviously, if the financial statements are not accurate, they do not provide any guidance for the managers on these two issues. Therefore, once the manipulation of the financial

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statements occurs, management has lost the ability to evaluate the financial performance of the firm. As a result, it is very common for significant reductions to take place in employees and facilities once a firm goes bankrupt after a fraud, not only to help control the cost but so that identification can take place of the inefficient operations of the firm once the financial statements have been restructured to reflect the true financial position of the firm. The re-creation of the financial statements of the firm that has manipulated financial statements is the responsibility of forensic accountants. These specialized accountants attempt to reconstruct the financial statements from when the manipulation first took place.

Depending on the number of years and complexity of the firm, this reconstruction can take thousands of hours to get to accurate financial statements.

Accounting Shenanigans or Tricks of the Trade (p. 176) Revenue Recognition is by far the most common manipulation of a firm’s financial performance. Since companies in different industries acquire revenue from different methods, revenue recognition can easily become a “gray” area when it comes to interpretation. For example, at Enron, the Mark to Market accounting for revenue allowed Enron to recognize the revenue for the complete amount of a contract even if the contract was over multiple years. This approach which was approved by Enron’s external auditor, Arthur Andersen, allowed Enron to manipulate its revenues on a quarterly basis to ensure they corresponded with Enron’s forecast. Revenue recognition was also the manipulation issue discussed with the Krispy Kreme scenario at the beginning of the chapter.

One-Time Charges are allowed when a financial event occurs one time only.

Since this event is not expected to occur again, it is treated as a one-time charge. Firms that want to manipulate their financial statements can continue to categorize an event as a one time charge when, in actuality it will likely occur again in the future. It was alleged that when Tyco would buy companies, they would have the acquiring company to take “one time” charges to reduce cash flow before they were merged with Tyco. These charges were not one time in nature but Tyco incorporated these charges in place so that when they became part of Tyco, the new division would quickly report higher earnings and cash flow after the deal was completed to make management look good.4 Raiding the Reserves or Cookie Jar Accounting occurs when the firm manipulates cash reserves in order to increase or decrease the reported revenue for the time period. In 2004, Fannie Mae was accused of using “cookie jar” accounting to manage their revenues. It was alleged that current expenses were deferred on the financial statements so that profitability would be higher resulting

4

Berenson, Alex. The Markets: Market Place; 2 Tyco Officials Sold Stock By Returning It To Company.

The New York Times. January 30, 2002.

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in the executives receiving bonuses due to Fannie Mae meeting its profitability targets.5 Lease Accounting deals with the specific criteria in which leases are recorded on the firm’s balance sheet. Currently, leases are classified as capital or operating leases. If a lease is classified as capital, the asset value must be reported as an asset and the required payments must be classified as a liability. For operating leases, no asset or liability values need to be recorded and only the expense amount of the lease payments are reported every year. As a result, firms can effectively leave off millions of dollars in debt if they should be classified as a capital lease but are recorded as an operating lease.

Off-Balance Sheet financing creates separate legal entities from the parent company. Former Enron CFO Andy Fastow used off-balance sheet transaction to eliminate a massive amount of debt from Enron’s balance sheet. Enron’s debt was transferred to partnership companies established by Fastow. The net result was that Enron was “able” to report much higher financial performance than was actually the case.

Earnings Management is similar in scope to the cookie jar reserves. Earnings management is the ability of the managers of the firm to manipulate the account balances in various items on the firm’s financial statements. Through this management process, managers can control what the final balances will be in these accounts and then can report these “accurate” numbers to their investors.

Earnings management is usually used to ensure that the firm meets the forecasted results for the quarter or for some other time period. How common is earnings management? It appears to be much more common than people realize. A study by Myers, Myers and Skinner titled “Earnings Momentum and Earnings Management” reported that almost 600 companies in their study reported increases in earnings for 20 consecutive quarters over the past four decades, although the professors concluded that not all of the companies may have committed fraud and that there could be legitimate reasons for their amazing growth record. They also assumed that a number of firms in the study did consciously manipulate their quarterly number to ensure the steady growth pattern over time.6

Questions for Thought 1. Which stakeholders would be most concerned with? a. the income statement? b. the balance sheet?

5

Lee, Jennifer. Fannie May Said to Be Focus of a Criminal Investigation. The New York Times. October 1, 2004.

6 Hulbert, Mark. How Many Quarters in a Row Can Earnings Really Grow? The New York Times.

September 23, 2007.

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c. the statement of retained earnings? d. the statement of cash flows For shake of brevity, it can be assumed that stockholders would be concerned with all 4 financial statements since the price of their stock is directly impacted by the results of all four statements. Here is the response to which other stakeholders would be most concerned with a through d. a. Income Statement Employees: since the firm must be profitable in order to pay their compensation Suppliers: since the firm must be profitable in order to pay their invoices government: would be interested in the level of taxes owed to the firm based on their level of profitability b. Balance Sheet Local community: since the balance sheet shows the potential long term viability of the firm customers: since it shows how much the customers “owe” the firm suppliers: since it shows how much the firm “owes” them c. Statement of Retained Earnings NGO and other interest groups: since they want to see how much accumulated earnings the firm has for potential social investments employees: since they want to make sure that earning reserves are available if needed d. Statement of Cash Flows employees: to make sure there is enough cash flow to pay salaries suppliers: to make sure there is enough cash flow to pay invoices government: to make sure there is enough cash flow to pay taxes NGO and local communities: to make sure there is enough cash flow to invest in socially responsible projects

2. Why is earnings management considered a trick of the trade? Explain.

As was discussed previously, earnings management allows managers to manipulate the financial results of the firm to ensure they meet whatever financial projections as well as satisfy any financial criteria established as a condition for personal financial rewards.

3. In all the accounting scandals of the past decade, where were the auditors? Explain.

This is the question that is asked again and again by investors of these companies. The auditors have a fiduciary duty to do their job of checking the

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validity of the firm’s financial statements. The standard response by the accounting firms was that they were not given the information needed to discover the fraud. The investor’s response to that would be that it should have been part of the auditors’ job to uncover this information as part of the audit. The net result was that the auditors had become too “close” with their clients. The clients loved that the auditors were no longer comprehensive in their audits and the auditing firms loved all the money they saved by not doing a comprehensive audit.

Furthermore, for a number of companies, the auditing firm was also doing consulting for the firm which created a direct conflict of interest. As a result, the auditing firm had a double vested interest in the firm and, therefore, would do whatever it took to satisfy the needs of its client. The net result was both sides were happy but none of the other stakeholders were happy. As these firms moved closer to bankruptcy, payments to suppliers and employees became threatened and the government was receiving financial information that was not true.

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Chapter 10 Establishing a Code of Ethics and Ethical Guidelines The purpose of this chapter is to help students understand the importance of having a code of ethics, as well as to give examples on how a firm can establish or revise their existing codes of ethics. This chapter will highlight the linkages between the code of ethics and the various stakeholders. This important integration is necessary for the firm to fulfill the needs and expectations of the stakeholders. In addition, by understanding the benefits of a good comprehensive code of ethics, firms are able to capture positive goodwill as well as potentially enhance their competitive advantage. In addition, the chapter presents some examples of “good” code of ethics and explains why these codes move these companies to the forefront of linking their ethical philosophy with the needs of their stakeholders. Furthermore, the chapter also demonstrates how one stakeholder, the government, can significantly influence the content of a code of ethics. The chapter concludes with some examples of global codes of ethics which can be used as a starting point for firms as the move from a domestic to a multinational corporation.

Key Learning Points There are a number of key learning points which can be accomplished when this chapter is presented to the students. These include: 1. The role of a code of ethics in the decision making process of a firm.

2. The link between a code of ethics and the firm’s stakeholders.

3. The benefits of having a code of ethics.

4. The content of a code of ethics.

5. The role of total responsibility management and a code of ethics.

6. The steps needed to develop an effective code of ethics.

7. The role of government regulations.

8. Some examples of global codes of ethics.

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How We’re Fixing Up Tyco (p. 180) 1. Why do you think Eric Pillmore would take on the job of trying to fix Tyco?

The underlying reason why anyone would be involved in Tyco after the scandal would be based on the challenge that would be given to the men and women trying to correct the problems. In addition, it could be considered a relatively low risk operation. Since many people had written off Tyco as a non-entity like WorldCom and Enron, there would not be a lot that would be expected from the people trying to turnaround the company. In addition, if Eric and others are successful with the turnaround, there would be a large positive upside in their careers since they helped “steer” Tyco in the correct direction.

2. What would be the easiest and hardest part about trying to change the ethical values at Tyco?

The easiest part is that the “hardest” part is already done. The hardest part was getting rid of the unethical managers at the top of Tyco who were either directly involved in the fraud or were indirectly responsible by not taking proper responsibility and stopping the fraud. With the replacement of the board of directors and the CEO, Tyco now has a clean slate of top level managers who should be willing to correct the negative image at Tyco.

The hardest part would be to build up the trust of the employees. While working in an unethical culture such as Tyco’s, employees begin to lose trust in anyone since there is a hostile environment in which everyone tries to protect their own interests. As a result, the employees can be very protective and guarded with others within the company. So, when a “new team” comes on board, it may take some time for the employees to trust the new team. As a result, the hardest challenge for Eric Pillmore is to get a complete commitment of the Tyco employees for the ethical changes.

3. How effective do you think vignettes are as an ethical training tool?

As with any training process, you must have commitment and interest of the employees for any level of effectiveness. That being said, vignettes are a good visual example for employees to understand what acceptable and unacceptable behavior is. It would not be worthwhile to show vignettes of obvious unacceptable behavior such as walking out of the office with a company computer since all employees know that this is unacceptable. If you have these obvious vignettes, employees will start losing interest in watching for them since the creditability of the vignettes have been compromised by the type of content presented.

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Role of Code of Ethics (p. 180) Figure 10-1 (p. 181) highlights the integration of different components to develop the ethical standards for the firm. This figure would be a good discussion point in which you could ask the students which of the four components would have the greatest impact on changing the ethical standards. One answer could be the social values of society. The social norms will always drive what is considered acceptable and unacceptable behavior. Whether it is new government regulations, or a shift in consumers’ tastes, a change is social values will also bring a significant change in ethical standards. Of the three factors within the shaded box, the institutional and organizational factors would be least likely to change since they have become firmly entrenched in the firm’s value system. As a result, the personal factors would probably have the highest probability to change over time which would also result in a change in the ethical standards of the firm.

Code of Ethics and Stakeholders (p. 181) The use of the four values of integrity, justice, competence and utility help explain how firms integrate meeting the needs and expectations of their stakeholders with the ethical strategic focus. One question to ask your students is whether each of those four values needs to be equal from a stakeholder perspective; it could be argued that utility is the most important since it is this value which addresses specifically the needs of the stakeholders. Another question to ask your students is whether stakeholders are truly concerned about the ethical strategic focus of the firm. As with other issues related to stakeholder interactions, it could be assumed that stakeholders would be constantly monitoring the ethical strategic focus of the firm unless there has been information released about potential unethical activities and/or the firm is performing poorly and has not been able to satisfy the needs of the stakeholders from a financial or other goal perspective.

Benefits of a Code of Ethics (p. 182) The benefits of a code of ethics are stakeholder driven. Having a comprehensive code of ethics helps create a positive work environment which makes the employees highly motivated. It also increases the potential competitive advantage of the firm which makes the customers happy. With these stakeholders being satisfied, it makes the managers happy. The net result is that the benefits of having a comprehensive code of ethics make it an easy decision whether every firm should have a code or not. The benefits would outweigh any time and financial costs involved in implementing a comprehensive ethical strategic vision.

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The Role of Total Responsibility Management and Code of Ethics (p. 184) Total Responsibility Management (TRM) is a useful tool for the students to use to understand how ethics management is a continuous process. Just as TQM looks for ways to continuously improve the performance of the firm, TRM serves the same purpose from an ethical management perspective. Students need to realize that ethics management requires continuous investment of time and resources by the firm so that the firm’s ethical vision can evolve with the changing perceptions of the stakeholders.

It would be useful to draw a simple three step model to highlight the states of TRM

Inspiration----------→ Integration------------------→ Innovation Process Process Process

The inspiration process is the first and most critical step in the model. It is the most critical step since the decision made at this step drive the other two steps. It is the responsibility of the top level managers to not only embrace their ethical vision but to consider ideas that are not usually within the norm of the decision making process. That is why this step is called the inspiration process. It is in this step that managers should be allowed to step outside the box in not only what their ethical vision should be but also how it should be formulated and implemented. It is also important to note that the stakeholders are integrated into the decision making process at the inspiration process stage. Again, it is during this stage that creative ideas are encouraged; helping satisfy the needs and expectations of the firm’s various stakeholders.

The integration process addresses the ethical strategic formulation and implementation stage of the process. It is through the integration process that the ethical visions of the top level managers are transferred into viable courses of action. By examining the strategic focus, human resource capabilities and current management systems, the firm can adjust the vision to fit the strategic capabilities of the firm.

The innovation stage examines how well the strategic vision has been implemented and looks to see where improvements can be made when the inspiration process starts once again Steps for an Effective Code of Ethics (p. 186) The purpose of this section is to expose to the students to the idea that there are many different ways in which an effective code of ethics can be developed. The underlying theme from each of these methods is that the method must align with

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the ethical beliefs of the top level managers. It is from this alignment that the steps are created in order to develop an effective code of ethics. Each code of ethics should be specialized and customized to the specific needs of the firm and the needs of the stakeholders of the firm.

Value of a Code of Ethics (p. 189) The listing of reasons why a code of ethics should be adopted (developed by Bondy, Matten and Moon) highlight both the external and internal reasons why it is beneficial for the firm to adopt a code of ethics. Again, the specific justification for each firm depends on the ethical vision and beliefs of the firm’s top level managers. Furthermore, enlightened firms continue to adjust their code of ethics to generate positive benefits for their stockholders, employees and other stakeholders. In addition, these same firms understand how a strong positive ethical image can enhance their competitive advantage.

Examples of Codes of Ethics (p. 190) The examples of codes of ethics extend the value of a code of ethics section in the textbook. By giving specific guidance in what should be considered in a code of ethics, the students will realize that a code of ethics may incorporate a number of different areas in which they may not have realized that there could be potentially unethical activity from the firm’s employees. Furthermore, the examples of the codes of ethics show how the specific content of the code reinforce the ethical vision of the firm. Therefore, the code of ethics is a written representation of the ethical commitment the firm has for its various stakeholders.

The comparison of the value statements given by two CPA firms in Table 10-2 highlight the subtle differences in a firm’s code of ethics. Although there is an overlap in certain concepts in the two value statements, the differences should be stressed to the students because it is these differences that separate the firms from each other as they are evaluated on the ethical commitment by their stakeholders.

Role of Government Regulations (p. 192) The role of government regulations is critical in any development of a firm code of ethics. The government plays an active role is helping shape and determine what should be included in a code of ethics. Government regulations and guidelines can dictate, in part, what should be included in a code of ethics along with the level of detail in describing the firm’s ethical commitment in certain areas. For example, bribery is illegal for United States based firms but the firm has to determine when a genuine gift ends and a bribe begins. Is taking a client out to dinner a bribe? How about giving a client a watch with the firm’s logo on it?

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There are a couple of sample questions you could ask your students. State they are responsible for writing the specifics of the bribery section in their firm’s code of ethics. What would they write? What would be their justification? Would other students agree with that justification? The students will quickly understand that there are a lot of “gray” areas which must be addressed in what may have been considered black and white in the code of ethics.

Global Code of Ethics (p. 194) The presentation of the global code of ethics helps the students understand that ethical issues are global issues and how they are resolved can vary based on where the ethical issues take place. The comparison of the CRT, OECD and UN code of ethics highlights that NRO put a significant level of emphasis on how firms conduct business around the world. In addition, this set of global codes of ethics demonstrates that NGOs are certainly stakeholders which firms must consider when they are developing and implementing their ethical vision. The global code of ethics also show that what in the United States would be considered simple human rights are not necessarily so in other countries. As a result, it is important to stress to the students that human rights are not protected in other parts of the world and that there is a large disconnect between how employees are treated in the developed world versus how they are treated in the developing world.

Questions for Thought 1. Do you think codes of ethics really make a difference in an organization?

Explain.

The simple answer is a qualified yes. Code of ethics makes a difference if the firm WANTS them to make a difference. Again, it is based on the ethical vision as to how worthwhile and beneficial a code of ethics is. Enron had a code of ethics that was over 60 pages long but if there was no commitment and support by the top level managers, then it does not make a difference what was on those 60 pages. The value of a code of ethics depends, in part, on the actions of the top level managers. The most important action a manager can do is lead by ethical example. Subordinates will always watch the action of the superior to interpret what is acceptable and what is considered unacceptable behavior. If a manager is hypocritical or unethical the code of ethics has no meaning.

A critical underlying value of any code of ethics is that it not only presents a formal presentation of the ethical philosophy of the firm but it gives written guidance to all the employees as to what is considered acceptable and unacceptable.

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2. Comment on the topics addressed in JCPenney Code of Ethics (p. 182).

Do you feel the code adequately achieves its purpose? Is the Code as valid today as it was in 1913?

1. To serve the public. As nearly as we can, to its complete satisfaction This is an obvious reference to not only customer service but recognizing customers as a valued stakeholder of the firm.

2. To expect for the service we render a fair remuneration and not all the profit the traffic will bear.

This is a subtle swipe on the strategic focus of profit maximization. In other words, JCPenney will be price sensitive even when they do not have to be for competitive reasons. There is certainly an ethical component of this point since JCPenney is not ranking the stockholders above the customers in stakeholder preference.

3. To do all in our power to pack the customer’s dollar full-of-value, quality, and satisfaction.

Again, the direct reference is to customer service but the presentation of overall value leads to JCPenney’s development of their competitive advantage strategic focus.

4. To continue to train ourselves and our associates so that the service we give will be more and more intelligently performed.

The key word in this statement is “intelligently”. It would be interesting to see if your students could find a single code of ethics that would use this world. Again the director focus is on satisfying one stakeholder, the customer, by investing in another stakeholder, the employee. The more and more intelligently performed could be considered the forerunner to TQM. In other words, JCPenney could have been the first company to present a code of ethics in which it is a given that improvement would be needed and the firm would learn from those improvements not only from a competitive standpoint but also from an ethical value standpoint.

5. To improve constantly the human factor in our business.

Again the reference to continuous improvement or TQM. However, the difference in statement #5 is that is refers to the interaction of the stakeholders. A broad definition of the “human factor” is how the employees at JCPenney interact with all the various stakeholders of the firm and those interactions should constantly be improving over time.

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6. To reward men and women in our organization through participation in what the business produces.

The direct reference is to productivity and other financial goals but # 6 indirectly refers to how the employees behave and their interactions with the other stakeholders which would be an extension of statement # 5.

7. To test our every policy, method, and act in this wise: “Does it square with what is right and just”.

Statement # 7 refers directly to the ethical vision and beliefs of the executives at JCPenney. In addition, # 7 is all the guidance employees need in interacting with the various stakeholders. Similar to the golden rule, “does it square with what is right and just” refers to both sides benefiting from the transaction and neither side “winning” while the other side “loses”.

These seven points do an excellent job in serving the purpose of identifying the critical stakeholders for JCPenney and providing specific guidance on how to treat their stakeholders.

The code would certainly be as valid today as in 1913. However, due to the increasing expectations of JCPenney’s stakeholders and the comprehensive demands of the firm from the government via government regulations and guidelines, JCPenney would probably need to have some additional points to address some of the more specific issues in their current code of ethics.

3. Many companies ignore or overlook differences in translating codes of ethics into other languages. Why is it important to have codes of ethics translated into the native languages of the countries in which the company may operate?

It is critical to have the code of ethics translated into the native language of other countries since the code of ethics is a critical reference document that needs to be consulted by all the employees of the firm. In addition, the translation of the code of ethics must occur by someone who is familiar with the potential subtle differences in the meaning and descriptions of words. It can be disastrous if someone from the home country makes the translation into another language because some words do not translate well into another language. This person must be someone who is experienced in that language that can create a meaningful translation of the code of ethics.

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Chapter 11 Evaluating Corporate Ethics The purpose of this chapter is to highlight the methods in which the ethical vision of the firm can be evaluated. One component is the effective implementation of an ethics training program. Another area that is presented in the chapter is how to establish a global ethics training program. Furthermore, the chapter also examines the link between enforcement and the ethics training program. The important role ethics officers have in ensuring the ethical standards are met within the firm is also examined. Furthermore, the chapter also addresses the issues of ethical audits and whistle-blowing. The role of government regulations and the impact on other stakeholders is also examined in the evaluation process of the firm’s ethical vision.

Key Learning Points There are a number of key learning points which can be accomplished when this chapter is presented to the students. These include: 1. Why firms need ethics training programs 2. How to establish an effective domestic and global ethics training program.

3. The role of enforcement and the ethics training program 4. The role of the corporate ethics officer.

5. The components of ethical auditing 6. The role of whistle-blowing and ethics 7. The role of government regulations and whistle-blowing 8. The evaluation of the firm’s ethical vision and the needs of the firm’s stakeholders.

But We Did Get The Red Eye Out (p. 197) 1. What is the ethical issue in “But We Did Get The Red Eye Out”?

The ethical issue relates to EastmanKodak, through their online EasyShare Gallery web site, ordering the director of engineering to alter the pictures stored on the web site. Since each picture takes a certain amount of memory, it is very easy for the memory to fill up quickly on the web site. Therefore, EastmanKodak ordered the director of engineering to compress the pictures so they would not

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take as much memory to store on the web site. There are two problems with this decision. The first problem is that is can compromise the quality of the picture when the customer wants to view and/or print the picture. The second problem is that EastmanKodak did not inform the customers that they were going to compress the pictures.

2. What was EastmanKodak’s response to Maya Raber, the director of engineering, when she complained about the compressing of the pictures?

EastmanKodak fired her. She was fired without warning even through her previous performance appraisal ranked her as exemplary. EastmanKodak did not officially fire her but she was laid off during a downsizing. She was the only person laid off during the restructuring. This is a classic example of a whistleblower being punished for challenging the decisions made by top management.

In fact, she should have protection from being fired based on only the components within the Sarbanes-Oxley Act. 3. What was EastmanKodak’s official explanation of their actions?

EastmanKodak explained that they had received permission from every individual whose pictures were compressed. In addition, Kodak stated that they believed that they had acted in good faith and in a manner that was consistent with its ethics and corporate policies.

Why Firms Need Ethics Training Programs (p. 198) The results of the survey by PricewaterhouseCoopers in 2005 should yield a number of interesting discussions for the students in the classroom. In general terms, there is a significant amount of fraud occurring within every type of firm in every type of industry. It would be useful to list some of the specific percentages and ask for comments from the students. After some discussion, open up the next line of questioning with this inquiry: “Do you think there is more fraudulent activity now versus 10 years ago; 20 years ago; 30 years ago? If they respond positively ask them to speculate why has there been an increase in fraudulent activity over the years. Some reasons could be: it is easier to commit fraud with current technology, there are more opportunities to acquire goods so there are more demands for additional money; as the population increases there may be less feeling of being part of a community; with multinational firms, employees in subsidiaries may feel isolated and believe they would be less likely to be caught than if they worked in the corporate headquarters.

Have your students to look at Table 11-1 and ask them, based on the percentages given in the table, who would do business in Western Europe, Central & Eastern Europe… Africa? If you have a small number of students who would conduct business in Africa, ask they why they would not do business there if there answer is that their is a 77 percent fraud weight in Africa, you can

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respond with that once you know that information is there anything that can be done to make sure fraud is not committed in your operations in Africa. The answer is yes. The key part of the discussion is that if you know before entry whether a country has a high or low fraud rate, you can make the necessary precautions before you make the investment. Use the analogy of certain cities, for example Rome is known for pickpockets. If you know there are a lot of pickpockets in Rome, do you avoid visiting Rome or do you prepare yourself for the pickpockets and visit Rome? From a firm’s perspective they can prepare themselves when investing in a high fraud area by having a detailed comprehensive ethics training program and a very strict and continuous monitoring system in place to track the activities of the employees.

Establishing An Ethics Training Program (p. 202) It is important for the students to understand that firms can use ethics training programs as part of a control system. An ethics training program is a useful tool for a firm to ensure that the employees behave properly and appropriate in the workplace setting. The combination of compliance oriented and values oriented training programs can provide the right mixture of “stick and carrot” as it relates to ethical issues. One question to ask the students would be whether the stick or the carrot would be a more effective means to get their attention related to ethical issues. It could be that for the students they may perceive the carrot as being more effective because they may have never had to receive punishment for unethical behavior. As a follow up question, ask the students which method would be more effective if you were 50 years old with a family to support.

An interesting assignment for your students would be for them to select a company and ask them to develop an ethics training program for that company.

You would give them guidelines such as: a budget, how long the program should be who should have input for the ideas, and how the student would measure the success of the program.

Establishing a Global Ethics Training Program (p. 204) The students need to realize that as a company broadens their strategic position globally they must also broaden their ethics training program. The firm must be aware that different cultures warrant different approaches on how to address ethical issues. Not only must the firm move beyond rule formalism and provide universal human rights guidelines, the firm must embrace the differences in the different country cultures in the ethics training program. This is why it is critical to stress the global cultural dimensions listed in Table 11-4.

These global dimensions help the students understand that not everyone communicates the same way and not everyone understands communications in the same way. In addition, traditional culture values such as respecting elders and only meeting with people at the same professional level can have a

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significant impact on not only what is said in the training programs but who says it. For example, in some Pacific Rim countries it would be considered an insult for a low level human resource employee from the corporate headquarters to present the ethics training programs to vice presidents of one of the firm’s subsidiaries.

Corporate Ethics Officers (p. 209) Corporate Ethics Officers play a critical role as the link between the ethical vision of the firm and the acceptance of that vision by the firm’s employees. The corporate ethics officer roles are presented in Figure 11-1 highlight the many “hats” which they must wear. In the role of company security, counselor and compliance officer the corporate ethics officer has to be both “good cop” and “bad cop” depending on the circumstances. As a result, it is imperative that the corporate ethics officer is able to establish strong trusting relationships with the firm’s employees.

An assignment that would show the multiple skills needed to be a corporate ethics officer would be to ask the students to write up a job description and the desired skills for applicants to be hired as a corporate ethics officer. You could have the student present their summaries to the rest of the class and have the students compare and constrast both the job descriptions and the necessary skills. You could even take the assignment one step further by creating a background for 5 top candidates who have applied to be a corporate ethics officer and require the students to select one of the 5 finalists. As part of the assignment, the student would have to justify the selection and explain their decision process which resulted in their decision.

You could also use Figure 11-2 as a model to determine what characteristics are needed in order to be an effective ethics officer. Again, you could present the background of 5 finalists and based on the framework in Figure 11-2, have the students go through each step in the model to help explain which of the 5 finalists would be selected based on their decision making process.

Ethical Auditing (p. 210) Ethical Auditing is a useful tool used by management to access the current validity of their ethical training program and the level of compliance of the ethical standards established by the firm. Through written and oral feedback, an ethical audit can help ascertain whether adjustments need to take place in the training programs as well as evaluate the level of knowledge the employees has pertaining to the ethical commitment of the firm.

An interesting assignment would be to ask your students to search the internet to see if they could find companies that have disclosed that they have done an

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ethics audits and what actions were taken by the firm to address the results of the ethical audit.

Whistle-Blowing (p. 212) Whistle-Blowing is an interesting concept since it is very easy to understand but without real working experiences the students may have a hard time understanding why it is so difficult being a whistle-blower.

You could start the discussion by asking if anyone has watched the movie “The Insider” (1999) starring Russell Crowe and Al Pacino. If you have not seen the movie, it is well worth the time. The Insider is the story of Jeffrey Wigand who was a senior Vice President of research at Brown and Williamson tobacco company. Dr. Wigand was forced to resign from B & W when he started challenging the idea that tobacco and nicotine were not addictive. During the course of the movie, it follows Dr. Wigand as he tries to tell his story to Mike Wallace on 60 Minutes. This movie captures the essence of whistle-blowing in that one decision to provide information against a current or former employer may come at a heavy personal price for the whistle-blower. The net result is that very few people are willing to be a whistle-blower because of the personal risks.

However, if whistle-blowing leads to financial compensation such as receiving a percentage of the money saved by whistle-blowing, the participation rate would be much higher.

Hotlines (p. 214) Hotlines are a critical tool used to aid the transfer of confidential information from a whistle-blower. Hotlines need to be anonymous so that employees do not feel they will be personally identified as “snitches” by informing on other employees. It is important to remember that whistle-blowers usually deal on a day to day basis with the people they inform on. As a result, it is critical that the identification of the source of information is never made public or else the whistle-blower may face reciprocal punishment from the violator.

A question to ask your students would be whether they would be willing to be a whistle-blower if they saw unethical activity. What about if the person is a close personal friend? Would they ever tell the violator “if you watch my back, I will watch yours”?

If they were to inform on a fellow employee, which method would they prefer from Table 11-8: In-house; Outsourced; Hybrid?

Government Regulations and Whistle-Blowing (p. 216) The passage of the Sarbanes-Oxley Act in 2002 became a foundation step in the protection of Whistle-Blower rights. With the passage of SOX, whistle-blowers

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were protected in that they could not be discharged, demoted, suspended, threatened, harassed or discriminated against because the employee provided information showing unethical behavior. It is important to understand that in cultures that value group effort instead of individual effort, it is very difficult to be a whistle-blower. This is the case because the whole team takes responsibility for the actions of each member within the team. As a result, if a team member does something unethical, it is equivalent of the whole team doing something unethical. Therefore, with this corporate culture it would probably be more likely that the group tries to resolve the unethical issue instead of reporting it to a supervisor.

Table 11-10 demonstrates that whistle-blowing is a global issue which requires global protection. By having a number of countries passing legislation to protect the rights of whistle-blowers, it highlights how important whistle-blowing can be in the identification of unethical behavior.

Evaluation of Ethics and Stakeholders (p. 220) The framework presented in Figure 11-3 highlights the relationship between the firm’s stakeholders and the strategic focus of the firm. The stakeholders are the first step since they are the driving forces for the ethical vision of the firm. It is by satisfying the ethical expectations of the stakeholders that the firm is able to have an effective ethical performance.

Based on the demands from the stakeholders, the firm can develop its strategic ethical formulation which would include the firm’s code of ethics and other ethical policies and procedures. Once the formulation stage has been established, the firm then moves to the execution or implementation of the ethical vision via the firm’s ethics training program. Once the training program has been implemented, a monitoring system must be used to evaluate the overall effectiveness of the ethical vision including the formulation and implementation aspects of the ethics strategy.

A very comprehensive assignment for your students would be to have them use the framework to design a complete ethical vision of a company. You could have them select an industry and state that they are the CEO of a new company in this industry and their job is to go through each of the 5 steps in the framework to develop the ethical vision of the firm.

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Questions for Thought 1. Why do you think that many firms establish ethics policies but do not enforce them?

This is similar to a hypocritical moral leader. The firms states one thing in their written documents but do not abide by it in their actions. The simple reason for having an ethics policy is that SOX requires that publicly traded firms must have a code of ethics that is AT LEAST binding to the top level executives. As a result, firms are now required to have a code of ethics but it is similar to the old saying “You can take a horse to water but you can’t make him drink”. Just because the code of ethics policy has been developed does not mean the employees agree or abide by the content of the code of ethics. Therefore, without the commitment of the employees, the code of ethics is a worthless document.

2. Can a company be ethical without having a formal ethics policy? Explain.

The answer is yes but it is probably rare. A company does not need a formal document to guide its behavior. A positive ethical culture within the firm will help guide the employees whenever there is a question of which course of action to take by the employees. In addition, employees may have mentors who can help advise them when they are faced with an ethical dilemma. However, if the firm has a positive strong ethical culture and has a supportive system to ensure everyone does the proper action; it is highly likely that the firm will also have a formal code of ethics to reinforce the positive ethical culture of the firm.

3. Do you believe that CPAs would be the best group to perform ethics audits? Why or why not?

You could argue both yes and no for this question. Because of their training, CPAs have a strong analytic perspective on issues and are able to “ask the right questions” when it appears that there is something out of the ordinary. In addition, due to their training in financial auditing, they would have a number of heuristics which would help them as they sort through the information pertaining to the ethics audit.

On the other hand, an ethics audit may require a different perspective than a traditional financially trained cognitive lens. Since there could be a number of areas that are open to interpretation, it may be more advantageous to have a person who is not trained to focus on black and white solution to gray area problems.

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4. Do you think hotlines for reporting ethical violations work? Explain your answer.

Hotlines could be considered one tool but not necessarily a way to guarantee the reporting of ethical violations. As was mentioned earlier, hotlines make the assumption that every employee would not be intimidated enough to inform on a colleague and potentially a close friend. It could very well be that there could be ethical violations that occur all the time within a facility and they are never reported. Part of the explanation is that the employees do not want to “rat” on a friend and the other reason could be that if I have some information about you and not report it, you will not report any unethical information pertaining to me to my supervisor.

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Case 1: Adelphia: What’s Wrong with This Picture?

Case Summary John and Gus Rigas started their cable company in 1952. The company, Adelphia, grew quickly through various acquisitions. At its peak, Adelphia had sales of $3.5 billion. In 2002 members of the Rigas family (father John and sons Timothy, Michael and James) were accused of using Adelphia funds for their own personal gains. The Rigas family controlled the company by retaining all the class B stock which had ten votes per share.

Questions started to be asked when analysts could not understand how the Rigas family could afford to buy large amounts of Adelphia stock. Adelphia put a footnote in the quarterly results stating that the Rigas family had obtained $2.3 billion in loans from the company through off-balance sheet transactions. Adelphia then announced that it would be making a restatement of reported earnings for the years 1999 through 2001. Shortly after the announcement, John Rigas resigned as chairman of the board and CEO of Adelphia. His three sons also resigned from their positions at Adelphia. It was discovered that a $167 million loan given to the Rigas family by Adelphia had not been paid back.

The Rigas family had also withdrawn $175 million from Adelphia’s “cash management account” in order to pay off margin calls. The cash management account was sent up to include revenue from Adelphia’s cable business and other Rigas owned enterprises which were used by the family to pay for their own personal expenses. It was estimated that the Rigas family had taken out over $2.5 billion from Adelphia without any reimbursement.

Adelphia would record service call expenses as capital investments in order to artificially inflate their revenues and assets. Adelphia also inflated their revenue numbers buy paying Scientific Atlanta and Motorola $26 above the price of the digital converter boxes sold by the two companies. This $26 would then turn around and be paid back to Adelphia which would record it as marketing support. Even though the net result was zero, Adelphia would record the amount paid to the suppliers as a capital expense (which would be $26 per unit higher than the actual cost) which could be spread out by Adelphia over a number of years. However, the $26 in “marketing support” given to Adelphia by the suppliers would be recorded as a contra-expense which would immediately have a positive impact on Adelphia’s earnings.

Adelphia filed for Chapter 11 bankruptcy in June 2002. At the Adelphia trial, former vice president and assistant treasure Michael Mulcahey admitted that Adelphia had two sets of books but there was nothing illegal with having an “external” and “internal” set of books.

Former VP of finance, Jim Brown admitted that every quarter management would review the financial performance of the company and manipulate the numbers if Adelphia was no longer in compliance with the covenants of their loans. After he was found guilty of conspiracy and fraud, John Rigas continued to state his innocence and his belief that he did nothing wrong. The stock price had fallen from a high of $32 in 2002 to 35 cents in August 2004. The market capitalization had fallen from $8 billion to $75 million.

Adelphia paid the SEC $715 million in penalties.

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Players in the Adelphia Fraud Name

Title

Charges

Sentence

John Rigas

Founder and CEO

conspiracy and fraud

15 years

Timothy Rigas

Former CFO

conspiracy, bank fraud securities fraud

10 years

Michael Rigas

Executive VP of Operations

securities fraud

10 months home confinement 2 years Probation

James Rigas

Executive VP of Strategic Planning none

none

Links with Chapters Primary Chapter 2-Individual Ethical Integrity and Unrealized Unethical Behavior Chapter 9-Financial Reporting Secondary Chapter 1-Individual Ethical Duty Chapter 3-Stakeholder Relationships Chapter 4-Corporate Governance and Corporate Compliance Chapter 8-Strategic Planning and Corporate Culture Teaching Points The Adelphia case is a good example to discuss in the classroom to stress the importance of perceptions in ethical decision making. John Rigas continued to claim he did nothing wrong even when he was ready to start serving his prison sentence (see Update). One teaching point that should be stressed is the unique culture of a privately controlled yet publicly traded company. This culture will support whatever the perceived ethical beliefs of the controlling family are. Another teaching point is that Adelphia’s ethical perceptions “forced” their suppliers to abide by the same unethical guidance. Adelphia used its bargaining power with its suppliers to “negotiate” unethical behavior pertaining to the cable converter boxes with Motorola and Scientific Atlanta. The third teaching point is to focus on how the family mixed personal and company funds into one “pot” in which there were no controls. This fact begs the question of why didn’t the board of

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directors and/ or the auditors disallow this action. The response is that the board of directors was controlled by the Rigas family and the rigors of a comprehensive external audit by Deloitte & Touche were not present. Former VP and Assistant treasurer of Adelphia, Michael Mulcahey, admitted that Adelphia had two sets of books and Deloitte& Touche were welcome to examine them at any time.

Questions at the End of the Case 1. What made the Rigas family members believe that Adelphia owed them so much?

One word comes to mind, entitlement. The Rigas family believed that even though Adelphia had become a multi-billion dollar publicly traded company, it was still considered a family business. With shares that had 10 times more votes per share than external investors, the Rigas family was able to keep the decision making process within a close knit circle of friends and family members. As a result, there was no challenge to the family when personal expenses were paid off using company funds. As was mentioned in the case, significant decisions were still being made at the Rigas’ kitchen table without input or awareness from other executives within the firm. Furthermore, there was no check and balance system in place pertaining to Adelphia’s corporate governance system. The board of directors was stacked with family members and close friends who would not challenge what the Rigas family was proposing. By establishing the cash management account, the Rigas family continued to view Adelphia as one big pool of available money that could be used at their discretion. It appears that the family viewed the account the same was they would view an ordinary bank account. Deposits were made from various sources which would be used to pay the expenses.

2. Under what circumstances are officers and top management justified in behaving as the Rigases did?

The short answer in never. The longer answer starts with explaining the difference between the perception of an action and the action itself. Even after he was sentenced to 20 years in prison, John Rigas continued to state that he did nothing wrong. From his cognitive perspective, he was just running HIS business the way HE wanted to. One of the dangers of having a closely held company such as Adelphia is that it is very difficult to allow alternative perspectives into the decision making process. This is especially true for a family controlled business in which the “head” of the family will make decisions that directly and indirectly impact all the members of the family. The other family members reaped the benefits of John Rigas’ decisions. Furthermore, John’s sons were indoctrinated in their father’s belief system at an early age. As a result, the corporate culture not only allowed this type of behavior but also positively supported it. The other family members knew that the manipulation of the financial statements was an on-going requirement in order for the Rigas family to financially survive from the loans that were given to them by Adelphia.

3. Explain the concept of “piercing the corporate veil.” Does this concept apply in this case?

Piercing the corporate veil is a corporate law term that refers to privately controlled companies. As is the case with Adelphia, “piercing the corporate veil” is the legal means in order to identify specific stakeholder(s) who should be accountable for the overall

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actions of the firm. In privately controlled companies, this “piercing” allows the public to view with clarity and transparency, information pertaining to transactions which previously may not have been available publicly. When the legal argument of “piercing the corporate veil” is made in court, the judge would consider factors such as was there “looting” of company funds, whether management considered company assets as their own, whether the company was being used as a front for the personal transactions of one stockholder, whether there was a manipulation of assets and liabilities. A comprehensive listing of “piercing the corporate veil” conditions can be found at (http://en.wikipedia.org/wiki/Piercing_the_corporate_veil). Based on the above criteria, the answer would be yes. The concept of “piercing the corporate veil” certainty applies in the Adelphia fraud.

Critical Stakeholder Analysis Stockholders- Obviously stockholders were hugely impacted by the actions of the Rigas family. All the cards were stacked against the individual investors getting a fair return for their money. The Rigas family controlled the voting of every corporate issue since each share of their stock was worth 10 votes to 1 vote of the individual investor. In addition, the board of directors was filled with family members and close friends who lacked the independence needed to question the activities of the Rigas family. The net result was financially devastating downward spiral in Adelphia’s stock price and market capitalization. As was mentioned earlier, the stock price had fallen from a high of $32 in 2002 to 35 cents in August 2004. The market capitalization had fallen from $8 billion to $75 million during that same time period.

Employees- It appears there were two “sets” of employees: those that had connections with the Rigas family and those that did not. It appears from the case the Rigas family let very few other Adelphia employees have access to their decisions. As a result, it appears that only top level managers were actively involved in the participation of the fraud. As a result, the lower level employees were unfairly punished by the unethical behavior of top management. By going into Chapter 11 bankruptcy, Adelphia had to release a significant number of employees as they addressed their re-organization. In addition, it would be expected that the former employees would have a difficult time finding a new job after having previously worked at Adelphia.

Suppliers- As was shown in their relationship with Motorola and Scientific Atlanta, Adelphia used their superior bargaining position to help facilitate the fraud. The net result for the suppliers was that they either had to agree to the unethical conduct presented by Adelphia or they would lose Adelphia as a customer Customers- The manipulation of the financial statements by the top management at Adelphia could have had an indirect impact on the customers. Since management was focusing on transactions that inflated their revenue and earnings, they may not have spent enough time focusing on trying to reduce the costs of their operations which could have resulted in a net reduction in the cost of services for their customers.

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Local Community- Coudersport, Pennsylvania had a population of less than three thousand when Adelphia started. The impact of Adelphia’s unethical activities was significant for this community. Not only were local citizens employees of Adelphia, but having the corporate headquarters of what was to become one of the largest cable companies in the United States gave the community a sense of pride and stature. As Adelphia went financially downward into Chapter 11 as the unethical activity became public, Adelphia shifted from being a source of pride to being a source of embarrassment of the local community.

Update In May 2007, Motorola paid the SEC $25 million to settle the digital converter box transactions with Adelphia. Of the $25 million, $18 million was the return of improperly earned funds and $7 million was interest.1 In a USA Today article published on August 5, 2007, John Rigas continued to plead his innocence of all charges against him. He stated that he would not plea bargain with prosecutors since he did nothing wrong and that he did not want to compromise his values and wanted to be a good example to his grandchildren. He stated that the government’s case was not about fraud occurring at Adelphia because fraud did not occur but he just happened to be in the wrong place at the wrong time2. On August 13, 2007, John and Timothy Rigas reported to a low security prison in Butner North Carolina. Days before he entered prison, Timothy Rigas married the mother of his young daughter.3 In March 2008, the Supreme Court denied the appeal of John and Timothy Rigas ending the last legal avenue for the father and son.4

Hughes, Siobhan. “Motorola, SEC Settle for $25 Million”. The Wall Street Journal. May 9, 2007.

Cauley, Leslie. “John Rigas Tells his Side of the Adelphia Story”. USA Today. August 5, 2007.

3 McGeehan, Patrick. “Getting Too Big For His Own Taxes?” The New York Times. August 26, 2007 4 Taub, Stephen. “Rigas Father and Son Lose Final Appeal”. CFO.com. March 3, 2008.

1 2

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Case 2: Ahold: Is That the Dutch Translation of Enron?

Case Summary Royal Ahold was established in 1887 in the Netherlands and is the world’s largest food distributor. It became a publicly traded company in 1948 and the controlling family released control of the company in 1989. After it became a management controlled firm, Ahold’s strategic focus shifted toward aggressive growth with an annual goal of 10 percent growth in EPS. Furthermore, another aggressive goal was that Ahold was expected to double its profits and sales every five years. As a result, Ahold had to constantly acquire more and more companies in order to achieve these aggressive goals.

Being a management controlled firm allowed the concentration of power of a few stockholders (the family) to dissolve and it led to a weak governance structure since there was no longer a core group of stockholders that had sufficient power to help direct the decision making process of top management.

Differences in accounting standards between the Netherlands and the United States allowed Ahold to apply goodwill obtained from an acquisition against Ahold’s stockholders equity so there would be no net impact on Ahold’s reported profitability.

This approach is not allowed in the United States where Ahold would have had to amortize the acquired goodwill over a time period up to 40 years which would have a direct impact on Ahold’s profitability. This accounting standard was in effect at this time.

In 2002, Ahold admitted that they had been involved in off-balance sheet transactions which were considered “material” from an accounting perspective.

In February 2003, Ahold released reports of profit levels which were much lower than expected. This lower profit level was due primarily to Ahold’s involvement in promotional allowances. One of Ahold’s subsidiaries in the United States, U.S. Foodserve was recording promotional allowances from suppliers before they had actually received the money. It was estimated that the allowances had been incorrectly recorded to the value of approximately $850 million. Promotional allowances are rebates given by suppliers in order for a retailer to promote its products. Ahold would record promotional allowances so that they would reduce Ahold’s costs which would increase their reported level of profits. This is not the correct way to book these allowances. Ahold then generated falsified information that the suppliers were forced to sign to show its external auditors when they reviewed the transactions between Ahold and its suppliers.

In January 2005 the United States Justice Department filed criminal charges against nine vendors who committed the allowance fraud with Ahold. Ahold’s CEO Cees van der Hoeven and CFO A. Michiel Meus resigned after they were charged with fraud and conspiracy to commit fraud. The total amount of the fraud was estimated to be $30 billion in sales, $3.3 billion in operating income and $829 million in net income.

The new CEO of Ahold, Anders Mobery, was the former CEO of Ikea and organized a shareholder’s meeting in March 2003 that focused solely on corporate governance issues and Ahold. During the same time period, the new corporate governance standards were established in the Netherlands called the Tabaksblat Code. In September 2003, Ahold

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paid the Dutch government $10 million in fines for the fraud and another $10 million in September 2004 for presenting fraudulent financial statements. In November 2005, Ahold paid $1.1 billion to settle all outstanding stockholder claims. In May 2006 a Dutch court found both van der Hoeven and Meurs guilty of fraud and fined them each $287¸430 (225,000 Euros). They both received a nine month suspended sentence.

Players in the Ahold Fraud Name

Title

Charges

Result

Cees van der Hoeven

Former CEO

fraud, conspiracy

Nine month Suspended Sentence (225,000 Euros) Fine

A. Michiel Meurs

Former CFO

fraud, conspiracy

Nine month Suspended Sentence (225,000 Euros) Fine

Barry Schofield

Food Distributor Owner

insider trading, fraud conspiracy

Six Months Home Detention ($741,232) Fine, 3 years Probation

Michael Resnick

Former CFO of Ahold’s U.S. Foodservice

conspiracy

6 months Home Detention 3 years Probation

Mark Kaiser

Former Head of fraud, conspiracy, Marketing Ahold’s false financial U.S. Foodservice filings

7 years in Prison ($50,000) Fine

Suzanne Brown

Former Controller Of Ahold’s U.S. Foodservice

($100,000) Fine, 5 year ban on being an officer or Director, 5 year suspension from Practicing Accounting

Fraud

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Links With Chapters Primary Chapter 3-Stakeholder Relationships Chapter 9-Financial Reporting Secondary Chapter 2-Individual Ethical Integrity Chapter 4-Corporate Compliance Chapter 8-Strategic Planning

Teaching Note Ahold is an excellent example of the firm’s strategy driving its ethical beliefs. After it became a management controlled company, Ahold had unrealistic goals for long term results. As a result, it manipulated their financial reports so that those unrealistic goals could be obtained. Instead of admitting that the aggressive goals were not sustainable in the long run, Ahold quickly became caught in a web of unethical activity so that the financial results could be achieved. Furthermore, there appeared to be a lack of questioning from the corporate headquarters about the U.S. Foodservice approach for increasing sales in profits. As was mentioned in the case, Ahold’s aggressive acquisition strategy did not allow corporate management time to properly evaluate either the acquired firms or their existing firms. As a result, the firms were run as separate entities with very little monitoring and control by corporate headquarters. Ahold's subsidiaries were quick to realize this monitoring weakness and capitalized on it when necessary. As a result, if the U.S. Food Service needed to manipulate the numbers, there belief was that corporate managers would not ask questions about the transactions and really did not want to know information pertaining to the transactions. Corporate managers were fixated on the revenue and sales figures and did not seem concerned as to how the subsidiaries were able to generate those numbers. Another question that could be asked is why the players in the Ahold fraud received such varying degrees of punishment. The former CEO and CFO received no prison time, yet the former head of marketing at Ahold’s U.S. Foodservice operations received 7 years in prison. Does this seem like an equitable distributing of guilt and punishment?

Questions at the End of the Case 1. Identify some of the benefits of moving from a family-run business to a management-controlled business.

One major benefit of moving from a family-run to a management-run business is that it can broaden the perspective of the managers. By having managers with diverse backgrounds, it should yield a comprehensive list of different options available to the firm. If a firm is family-run, the risk is that all the family members have the same cognitive framework in which to draw on when decisions are made for the firm. In addition, closely related family members may be prone to have a Groupthink mentality.

Groupthink occurs when all the decision makers start to view decisions as a group instead of individuals. As a result, Groupthink allows for quick consensus of the ideas but does

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not allow for challenges to the perceptions given by the decision makers. For example, it is important for decision makers to consider “What If” scenarios and play the devil’s advocate to make sure that all the possible alternative courses of action are considered. In a Groupthink setting, these challenges to the Status Quo of decision making do not take place.

A management run business also gives financial flexibility for the firm. Financial control of the firm is also given to the managers when there is a shift in power. As a result, management run firms would consider more alternative options pertaining to future financing than may be considered under the previously family-run structure. Furthermore, management-run firms may be able to acquire more highly skilled managers than a family-run firm. This could be true for two reasons: 1. moving beyond the immediate family greatly increases the pool of candidates for any position and 2. a management run firm does not have the risk of Nepotism having a negative impact on the firm. The people in the top level management positions are based on their skill sets and potential contributions and not because they have the same last name as the founder.

2. There were several other large corporations involved with the wrongdoings at Ahold.

What made the individuals involved at these other companies feel that they were not a part of the fraudulent activities at Ahold?

Multinational (MNC) companies such as General Mills, Tyson Foods and Sugar Food (maker of Sweet ‘N Low) became entangled in the unethical activities with Ahold. The first question to ask is "do these MNCs have their own ethical code and training program?' The answer would be yes and the instructor could find these documents from the company’s web sites. The next question is why they would be willing participants in this fraud. The likely broad rationale has to do with the relative bargaining power the suppliers have with Ahold. Even though the fraud occurred in the United States operations, Ahold has global operations which the suppliers need to sell their products.

As a result, Ahold would have superior bargaining power over these firms. Furthermore, a more detailed rationale would be that the specific sales managers of these firms that sell their food stuffs to U.S. Foodservice are under constant pressure to increases sales and profitability. It could be assumed that Ahold did not give any alternatives for these suppliers. They either agreed to the conditions or they would find some else that would agree to those conditions. As a result, the sales managers rationalized that this would just be considered “standard” business practices in order to ensure that they keep their customer satisfied.

3. Why did the management at Ahold continue to think that many of the issues were not material?

It appears the perception of the top management at Ahold believed that whatever fraud had taken place was isolated and a one time event. Ahold may have believed that these “isolated” incidents were just the result of the actions of one or two rogue employees.

Therefore, they failed to acknowledge that fraud and deception were much more wide spread than it appeared. Without acknowledging the problem through their financial reporting, Ahold fooled themselves into believing that it was not a critical issue that needed to be resolved quickly. The net result was that the fraud grew like a cancer within

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their U.S. Foodservice operations and Ahold was too busy making acquisitions and focusing on their aggressive goals and objectives to spend the time and money to review the fraudulent activities.

Critical Stakeholder Analysis Stockholders The stockholders were both positively and negatively impacted by the Ahold scandal.

The stock price went down which resulted in a financial loss for the stockholders.

However, the fraud did force Ahold to change its ways. The Shareholder’s meeting in March 2004 resulted in Ahold having a much more comprehensive and transparent corporate governance system. The net result was that Ahold took the final step to sever their former family run philosophies. By having a strong independent corporate governance system and guidelines (Tabaksblat Code), Ahold was able to move forward as a stockholder responsive firm. In addition, Ahold paid $1.1 billion in order to settle stockholder claims against the company.

Employees In 2004, the number of people employed by Ahold was 206,441 and that number has dropped to 164,078 in 20061. Although it is difficult to determine how many of the over 42,000 employees that left the company over that two year time period were the result of the fraudulent activities at Ahold. However, it could be assumed that the fraudulent activities did distort the true contribution of the employees and once the financial statements had been adjusted, management was better able to evaluate what the most efficient number of employees would be throughout the company.

Suppliers As was mentioned previously, the suppliers became entangled in Ahold’s fraudulent activities. By being a willing partner to the fraud, the suppliers had to face not only criminal charges and fines but also a negative image for their firm. By allowing Ahold to manipulate their ethical commitment, the suppliers became just another way in which Ahold could achieve their aggressive growth and revenue goals.

Customers The fraud generated a negative image on the customers by potentially not having the greatest value presented to them from Ahold. The fraudulent activities resulted in the manipulation of what types of products would be available to the customers through the use of promotional allowances. As a result, suppliers that were not involved in the promotion allowance negotiations did not receive the same benefits when working with Ahold. Therefore, the customers may not have had the same food selection opportunities available to them based on the fraudulent transactions between Ahold and a select number of suppliers.

Update In December 2006, two private equity firms, Clayton Dubilier & Rice Inc. and Kohlberg Kravis Roberts & Co., started talks with Ahold to acquire the U.S. Foodservice unit

1

http://annualreport2006.ahold.com/other_financial.html

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through a leveraged buyout for more than $5 billion.2 In April 2007, Ahold CEO Anders Moberg announced that he would resign on July 1, 2007 to pursue other interests related to his career.3 In May 2007, Ahold announced it would sell its U.S. Foodservice unit to the two private equity funds for an estimated $7.1 billion.4 In December 2007, the former CEO of Ahold’s U.S. Foodservice subsidiary, James Miller, agreed to pay Ahold $8 million. The $8 million was based on Miller’s bonuses and a “small part” of his salary during the time he ran U.S. Foodservice.5

Sender, Henny. “Private-Equity Firms Consider Bid for Ahold’s U.S. Foodservice Unit”. The Wall Street Journal. December 16, 2006.

3 Simons, Stefan. “Ahold CEO Moberg to Resign”. The Wall Street Journal. April 30, 2007.

4 Rose, Josee and Simons, Stefan. “Ahold Agrees to Sell U.S. Foodservice Unit”. The Wall Street Journal.

May 3, 2007.

5 Kanner, Joram. “Ahold to get $8 Million in Settlement over Scandal”. The International Herald Tribune.

December 19, 2007.

2

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Case 3: Blue Bayou Case Summary Bayou Management LLC was a hedge fund company established in 1996 by Samuel Israel and James Marquez. The underlying ethical issue of Bayou was that the two founders had established a Ponzi scheme in which money was paid to original investors from money received by subsequent investors. The net result was that the investment money given by the new investors became the “profit” for the original investors. Named after Charles Ponzi, the Ponzi scheme allowed the unethical founders to keep the money from the investors instead of investing it in the promised high yield investments. The net result is that some of the original investors got their money back and more and the founders receive a large percentage of the money given by the new investors. The exit strategy of a Ponzi scheme is very simple. You take the money and run. As was the case with Bayou, a Ponzi scheme can only survive for a short period of time before the new investors start complaining that they have not received any profits. At this point, the Ponzi organizers pull the plug on Bayou and tried to disappear.

The critical selling point for any Ponzi scheme is that the founders have guaranteed above average returns on the investment. Any person who is familiar with finance theory knows that it is IMPOSSIBLE to guarantee ABOVE AVERAGE returns. This is a promise that can not be kept. However, the Ponzi organizers realize that the greed within the investors convinces the rational side of the investor that Bayou DOES have the answers on how to beat the market continuously.

The Bayou collapse occurred by accident. Arizona officials became suspicious when Samuel Israel had transferred $100 million from Bayou in his own name to another financial management company, Majestic Capital Management. The suspicion was raised when the principal owner of Majestic Capital Management, Karl Johnson, went to number financial firms trying to deposit money from Majestic Capital Management and gave a different reason why he had the money at each financial institution.

The net result was that Bayou quickly started losing their financial strength since they were unable to sustain the payouts to its investors. On September 30, 2005, both Bayou’s CEO, Samuel Israel and CFO Daniel Marino plead guilty to fraud. On May 31, 2006, Bayou filed for bankruptcy protection to help investors try to recover $250 million. On December 14, 2006, Bayou’s other founder, James Marquez pleaded guilty to conspiracy to defraud investors.

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Players in the Bayou Fraud Name

Title

Charges

Result

Samuel Israel

CEO/Co-founder

Conspiracy Investor Advisor Fraud Mail Fraud

*20 years prison *$300 million fine

James Marquez

Co-Founder

Conspiracy

*51 months prison *$6.2 million fine

Daniel Marino

CFO

Conspiracy Investor Advisor Fraud Mail Fraud Wire Fraud

*20 years prison

Links With Chapters Primary Chapter 1-Individual Ethical Duty Chapter 2-Individual Ethical Integrity Chapter 9-Financial Reporting Secondary Chapter 3-Stakeholder Relationships Chapter 4-Corporate Compliance Chapter 8-Strategic Planning Teaching Note The Bayou case is a great example to show how a Ponzi scheme works. Although it was developed in the 1920s, it is still an effective tool to use to commit fraud. One question to ask your students is how a Ponzi scheme can still work if it has been around for over 80 years. The simple answer is greed. The reason why a Ponzi scheme works is the same reason why some people are willing to give their bank account information to a dying heir in Africa who can get access to $40 million if they could just transfer the money. The fraud artists realize that some people will just focus on the end result which is the high financial payout and suppress any uncomfortable feelings they may have about how to obtain the money.

Another question to ask is why the investors weren’t suspicious about the guaranteed high rates of returns. The answer to this question is two fold. The first part is that Bayou did an excellent job in presenting a rationale as to why they can beat the market. Based on their skills and expertise, they are able to find investment opportunities that are

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overlooked by others. The second reason is that by focusing on the promised returns, the investors may not care how the returns were obtained as long as they were guaranteed.

Another question is how the fraud occurred for such a long time period. For any Ponzi scheme, there is only a limited amount of time in which the fraud can work before too many people start asking too many questions. Bayou did a good job shifting money to the investor so they could not complain. However, this constant shifting required more and more new investors in order to subsidize the existing investors. Bayou was able to “buy” time by effectively shifting money back and forth between different bank accounts and investors accounts. The irony was that it was by sheer chance that the Arizona officials stumbled onto Bayou’s operations and started questioning their actions.

Questions at the End of the Case 1. What protections do the NASD and the SEC provide to investors?

The underlying protection of these agencies is based on the presentation of guidelines which must be followed by firms that agree to be governed by the NASD and SEC. Neither the NASD nor the SEC can stop fraudulent activities before they happen. They are not responsible for the monitoring of the activities within the firm, which is the responsibility of the firm. They are responsible for establishing the “rules” of the game and like a referee can “punish” a firm for breaking the rules. Therefore, stating that you are regulated by the NASD and SEC does not guarantee that fraud can not be committed.

In addition, since the information is self reported, managers who commit illegal acts can just omit the illegal transactions from the reports. As a result, the NASD and SEC usually can only do a post hoc investigation of illegal activities.

2. As an investor in Bayou, what would your reaction have been to the letter from Israel stating 100 percent of the money that you had invested in the company would be returned to you?

An investor’s response is that you can’t lose “a sure thing”. If I have am guaranteed to receive all my money back, where is the risk? There is no risk and, therefore, everyone would want to become an investor when all you get is “profits” with no downside of risk.

The 100 percent guarantee allowed Bayou to stay afloat for a while because they were able to continue to catch “gullible fish” with this false guarantee.

3. What would be your reaction to finding a “suicide” note for someone who could be living?

You don’t know if this is a scene from CSI or Candid Camera. The gravity of the note highlights two things. First of all, the writer of the note was trying to explain his actions to try to remove some of his guilt. The second factor is the suicide note highlights the enormity of his actions and the subsequent impact they had on many investors. Finding the suicide note would be one additional red flag showing that things are not proceeding in a normal business manner.

4. Explain a Ponzi scheme. What are the ethical implications of a Ponzi scheme?

The details of a Ponzi scheme were presented earlier in this teaching note. The ethical implications of a Ponzi scheme include committing fraud in the presentation of the investment plan, committing fraud by transferring money from one account to another

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and committing fraud by trying to cover up the illegal activities by manipulating the financial statements generated for use by the investors.

Update On January 22, 2008, Bayou co-founder, James Marquez was sentenced to 51 months in prison and ordered to pay $6.2 million for his role in the Bayou fraud. Marquez told the court that he took the easy way out when things became difficult.1 A week later, on January 29, 2008, former Bayou CFO Daniel Marino was sentenced to 20 years in prison with 3 additional years of supervised release following his prison term. The judge described Marino as the “linchpin of the fraud”.2 In April 2008, Samuel Israel was sentenced to 20 years in prison and ordered to pay a fine of $300 million for his role in the Bayou fraud. The judge stated she could have sentenced Israel to up to 30 years in prison.3

Anonymous. “Hedge Fund Co-Founder Gets 51-Month Sentence”. The Toronto Star. January 23, 2008.

Taub, Stephen. “Big Times for Bayou Fund CFO”. CFO.com. January 30, 2008 3 Reuters. “Founder Gets 20 Years for Bilking Investors”. The New York Times. April 14, 2008 1 2

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Case 4: Boeing: How Low Can They Fly Case Summary The Boeing case can really be considered to be four mini-ethics cases under the Boeing umbrella. The first mini-case pertains to the relationship between Boeing employees and the United States Air Force. It was alleged that a high ranking acquisition manager for the Air Force, Darleen Druyun gave some “sweetheart” deals to Boeing in exchange for being hired by Boeing after she retired from the Air Force. Of course these types of relationship violated the codes of conduct at both Boeing and at the Air Force, but these deals were not discovered until after Druyun had retired from the Air Force and started her position at Boeing. It was alleged that Druyun not only made sure the Boeing received the military contracts, but she also made sure Boeing receive a large profit on the sale and she disclosed information about Boeing competitor’s, Airbus, bid for the same contract. Both Druyun and her contact at Boeing, CFO Mike Sears, were fired by Boeing once contradicting evidence was presented pertaining to Druyun being involved in the negotiations as an Air Force employee even though she had already started discussions with Boeing for a job after she retired by the Air Force. Druyun was sentenced to nine months in prison and Sears was sentenced to four months in prison.

The second mini case relates to Boeing obtaining 35,000 pages of documents from one of its critical competitors, Lockheed Martin. A top executive at Boeing, Larry Satchell was charged with obstruction of justice and conspiracy to violate U.S. procurement laws. It was also discovered that Boeing, in the past, had obtained proprietary information from another critical competitor, Raytheon. After Boeing's acquisition of the Lockheed Martin documents has been made public, the Pentagon withdrew $1 billion in military contracts.

Boeing was also accused of manipulating its financial statements during its merger with McDonnell Douglas to make the merger look more attractive. Similar to Enron’s mark to market approach, Boeing recorded the operating profit when a program was still being developed. This “smoothing” of financial results made the overall numbers more attractive when the merger did take place.

Another ethical issue of merit related to Boeing is its treatment of women and minorities.

Boeing faces a class-action lawsuit by 38 women claiming discrimination based on how they were compensated. It was also determined the Boeing was giving lower levels of compensation to Asian and Black workers as compared with White workers. In addition, Boeing’s CEO Philip Condit had been romantically linked with Boeing employees.

Condit eventually was forced to resign due, in part, to the ethical problems at Boeing This leads to the fourth ethical issue which was the new CEO, Harry Stonecipher. In less than a year as CEO, Stonecipher resigned after having an extramarital affair with a Boeing employee.

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Major Players in the Boeing Case Name

Title

Charges

Result

Mike Sears

CFO

Conflict of Interest

*4 months prison *2 years probation *$250,000 fine *200 hours service

Darleen Druyun

Acquisition Officer Air Force

Conspiracy

Philip Condit

CEO

None

*9 months prison *7 months community confinement *150 hours service *$5,000 fine *Forced to Resign

Harry Stonecipher

CEO

None

*Forced to Resign

Links With Chapters Primary Chapter 1-Individual Ethical Duty Chapter 2-Individual Ethical Integrity Chapter 8-Corporate Culture Secondary Chapter 3-Stakeholder Relationships Chapter 4-Corporate Compliance Chapter 8-Strategic Planning Chapter 10-Code of Ethics Chapter 11-Evaluation of Corporate Ethics Teaching Note The case is a classic example of a firm’s culture gone wrong. For the examples given in the case, Boeing has developed a corporate culture where they will win bids at any cost, pay off their “friends” who help them achieve their objectives and potentially treat employees unfairly if you are not a white man. This “good old boy” culture supports the narrow viewpoint that the top decision makers know all the answers and see nothing wrong with the way they treat others. In addition, the close relationship Boeing has established with the United States military re-enforces the value of friendships over competence when the value of employees are considered. The net result was that Boeing created a very hostile environment for women and minorities and it appeared that Boeing had little concern over this treatment. In addition, two CEO both dated Boeing employees while maintaining the top positions within the firm. Again, from the CEO’s perspective,

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they apparently believed that there was nothing wrong with their actions and were forced to resign only after these affairs became public knowledge.

This case is an excellent example of how the CEO’s vision does drive the ethics of the firm. Unfortunately, if the CEO is unethical, this signal quickly becomes the norm on how to treat employees within the firm. Furthermore, it appears that Boeing also had no concerns about employees acquiring propriety information from competitors via written documents or a contact at the U.S. Air Force. Again, the ethical values of the top managers drive how the ethical standards are accepted and implemented throughout the organization.

Questions at the End of the Case 1. Identify the stakeholders in this case.

The dynamics within the various stakeholders creates very complex relationships in the Boeing case.

Customers: The customers for Boeing are airlines for their airplanes and the United States Military for their defense systems. However, the customer relationship with Boeing is based on negotiations since it is a bid based process. Since the lowest bid will win the contract, it is critical for Boeing to have a strong positive relationship with the military. In addition, it is always helpful if you can also figure out what the competitors will bid based on insider information or the accumulation of thousands of pages of written documents.

Government: The government wears two stakeholder hats for Boeing. The government is a primary customer for Boeing. However, the government also establishes the rules and regulations pertaining to how Boeing can compete in the market place. Even though the military component is separate from the regulatory component, they are components of the United States government. As a result, Boeing depends greatly on having a positive favorable relationship with the government not just to ensure they are not doing any illegal activities but also to ensure they keep their major customer satisfied.

Suppliers: There are two types of suppliers that are needed for Boeing’s production process, critical and non critical. Critical suppliers will have raw materials which can not be easily found in the market place such as electronic systems and missiles systems, while non critical supplier would supply common raw materials such as steel, rubber, glass. Again Boeing must establish strong positive relationships with the critical material suppliers to ensure they will continue to have access to these raw materials which help enhance their competitive advantage.

Employees: As was shown in the case, employees are treated very differently depending on who you are. It appears that white men receive different compensation levels as compared with

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minorities and women. If this is accurate, it can be assumed that this inequitable treatment is not just isolated to pay levels. It appears that Boeing discriminates against minorities and women in different areas within the firm.

Stockholders: From a stockholder perspective, it could be difficult for Boeing to separate the ends and the means. The stockholder want continued financial growth and that can only take place at Boeing if they continue to win big contracts from the U.S. Military. In order to win the contracts from the U.S. Military, Boeing must have a close relationship with the decision makers. Therefore, many investors may not question how Boeing receives the contracts as long as it continues to yield higher financial growth for the company. This could be another application to the “Don’t Ask, Don’t Tell” motto.

Local Community: The local communities which have a Boeing plant have a significant vested interest in the firm. Since Boeing is involved in large scale manufacturing with long term contracts, thousands of local residents who work for Boeing can be severely impacted if Boeing does not continue to grow financially. The net result could be similar to the stockholder where the local residents are more fixated at Boeing’s end objectives instead of the means to reach those ends.

2. What is the Procurement Integrity Act? What are the ethical implications of the act?

What is its relevance to this case?

There are four basic components to the Procurement Integrity Act. Those four components are1: 1. A ban on government officials disclosing procurement information to a contractor 2. A ban on government officials from obtaining procurement information which is not required in the bidding process 3. A requirement that any government procurement officer must report any employment contacts with any competing contractor.

4. A ban of one year for working on specific government bid contracts if a former government employee receives employment by a contractor.

The ethical relevance of this Act is that the United States government has a clear regulation controlling the type of information that should be shared between a contractor such as Boeing and the government. In addition, the act clearly states that if the government employee is seeking work with a contractor, they must report it immediately.

Therefore, both of these issues raise ethical questions as they pertain to the relationship Darleen Druyun had with Boeing.

1

http://www.uah.edu/research/resadmin/information/integrity.html

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3. The cover-up of an unethical action always seems worse than the crime. Do you agree or disagree? Why? As Sir Walter Scott once wrote: “Oh what a tangled web we weave, when first we practise to deceive!” A cover-up of previous acts by definition has to start with misrepresenting information to others. By lying, the cover-up quickly becomes larger and larger since more lies have to support the previous lies. Therefore, a cover up often times can be much worse than the crime. For example, Martha Stewart was not convicted of the crime of insider trading but was convicted of obstruction of justice by trying to “coverup” the insider trading. In addition, a cover up can require many more people to be involved than were involved in the unethical actions. As a result, there are usually a lot more people to “manager” and to ensure they “tell” the same story.

Update In January 2008, Boeing again was trying to get a large contract from the Air Force to build refueling tankers. Ironically, Boeing had initially won the contract but the deal was cancelled since Darleen Druyun had been negotiating for the Air Force when negotiation for a new job with Boeing. The contract value was $40 billion and Boeing was anxious to win since there are very few opportunities for contracts of this size. One Boeing spokesman said that “We want to win ethically. We want to win the right way”2 The Air Force had changed its decision process after the Druyun affair. Instead of one person making the final decision as Druyun did, the Air Force had the acquisition officer meet and receive input from advisors. A representative of the Air Force stated that “We want to be more transparent, have more communication, more checks and balances to improve our process and credibility”.3 On February 29, 2008, the Air Force had made it decision.

The winning bid when to Northrop Grumman in a partnership with European based Airbus.

2

Hedgpeth, Dana. A Mission to Rebuild Reputations: Upcoming Deals to Test Reforms at Air Force, Boeing. The Washington Post. January 17, 2008.

3 Hedgpeth, Dana. A Mission to Rebuild Reputations: Upcoming Deals to Test Reforms at Air Force, Boeing. The Washington Post. January 17, 2008.

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Case 5: Bre-X: All That Glitters Isn’t Gold Case Summary “A gold mine is a hole in the ground with a liar at the top and a fool at the bottom” is a great opening quote for this case. Although Mark Twain is claimed to have said it, the truth is the statement is a valid today as when it was written. By its very nature, dealing in precious metals commodities is a highly speculative business. It is highly risky because each investor is betting on the future production of the find. Whether it is oil and natural gas, diamonds, silver or gold, precious commodities are a gamble as an investment because the discovery of a gold “vein” does not mean the vein is very long or very depth.

It is from this backdrop that the Bre-X case in presented. Since you can not prove the total amount of any one gold deposit you can also not DISPROVE the claim unless you have direct access to the deposit. Therefore, David Walsh and his partner John Felderhof were able to develop one of the greatest frauds in Canadian history. Walsh was the businessman who was in charge of promoting Bre-X stock. Felderhof was the geologist who would provide, via his subordinates, the false data to show one of the largest gold discoveries in the world.

It appears from the beginning the goal was to try and boost Bre-X stock to an astronomical level and then try to sell their shares before the truth was discovered. This is a commodities based version of the old “pump and dump” fraud which is having someone trying to create a huge demand for a stock even though it was not warranted.

After the stock has reached a very high price, the fraudsters would start selling the stock and capture a quick profit. In November 1994, Bre-X stock was selling for $2.80. By September 1996, the stock had reached a high of $280.

If nothing else, there was certainly drama in the Bre-X case. The chief geologist of the Indonesian mine committed “suicide” by jumping out of a plane, yet 8 years later money was withdrawn from one of his bank accounts. David Walsh died of a brain aneurysm before he could testify in a court of law.

In addition, there were numerous red flags that should have concerned any investor (See Table 1 in textbook). From a fire at the mining site, to a large volume of insider trading, the corporate culture at Bre-X appeared to support a risk taking perspective. This perspective spilled into their development of the moral compass. As was the case with Boeing, Bre-X is an example where the ends are more important than the means. As a result, investors did not want to see the red flags or ignored the red flags as long as the stock price continued to increase.

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Major Players in the Bre-X Fraud Name

Title

Charges

Result

David Walsh

CEO

*None

*Died from Brain Aneurysm

John Felderhof

Chief Geologist

*Insider Trading *Releasing False Information

*Not Guilty

Mike de Guzman

Geologist Busang Mine

*None

*Committed Suicide

Jeannette Walsh

Corporate Secretary *None

Links With Chapters Primary Chapter 2-Individual Ethical Integrity Chapter 3-Stakeholder Relationships Chapter 4-Corporate Governance and Corporate Compliance

Secondary Chapter 1-Individual Ethical Duty Chapter 8-Strategic Planning and Corporate Culture Chapter 10-Code of Ethics Chapter 11-Evaluation of Corporate Ethics

Teaching Note The Bre-X case is similar to the Ponzi scheme presented in the Bayou case. As with any extended fraud operations, the two critical elements are information and time. If you are committing the fraud, you need to make sure the information does not run out before you have time to “capture” the winnings from the fraud. For Bre-X executives, they certainly had enough time when the stock had risen from $2.80 to $280 to sell their stock during the rise in the stock price to cash in. However, whenever a stock price increases this dramatically (100 times), there are going to be a lot of losers as well as winners. Of course, the winners are those that sell Bre-X stock up to the peak and the losers are those who bought at or near the peak and could not get rid of their stock quick enough.

One underlying question that you need to ask your students is: “Who controls the information”. The answer to this question explains the rapid decent of the stock price. As long as Bre-X had complete control of the information that was being released to the

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public, the stock price can continue to rise because there would always be glowing reports about what was found at the mine. However, once other parties became involved, the deception was finished. Both Freeport-McMoRan and Barrick Gold did not believe there was any large gold deposit at the mine based on their testing. This was critical for two reasons. The first was that it was the first challenge to the information provided by Bre-X and secondly both of these companies are experts in mining so they would not come independently to the same conclusion unless there was validity to it.

Did David Walsh know all the unethical and illegal activities occurring at the mine?

Maybe or maybe not. It does not matter since the CEO is ultimately accountable regardless of whether he or she knew or not. It is highly likely that David Walsh did not want to know what was going on in the mine. He may even believe, to some extent, Felderhof and de Guzman that there could be some gold deposits in the mine. Whether or not he knew there were no gold deposits, it did not matter to Walsh’s job. His job was to tell everyone in the world that Bre-X had discovered one of the largest gold deposits in the history on mining. The only information he needed was to tell the investors how many ounces of gold are predicted to be in the mine. He was not responsible for discussing the technical issues of the gold deposit. That was the responsibility of his two top geologists.

Questions for Thought 1. Determine the stakeholders in this case. Rank them according to importance and explain your reasoning.

Stockholders (Ranked #1) The stockholders would be ranked number one in importance from Bre-X’s perspective.

However, their importance is based on trying to satisfy the needs of the stockholders and their importance is based on making sure there are new investors that continued to increase the price of Bre-X stock. So, they are number one but for an unethical reason.

Since the discovery was a fraud and all the documents related to the discovery of the gold was a fraud, the stockholders continued to receive information that was neither true nor representative of the true conditions of the mine.

Government of Indonesia (Ranked # 2) The government of Indonesia would be ranked second. They are ranked highly since they had the ultimate control and, therefore, were the ultimate decision makers pertaining to the Busang mine. As a result, Bre-X also had to continuously lie to the Indonesian government to keep the fraud going. Therefore, from Bre-X’s perspective, the Indonesian government needed to continue to receive information which they wanted to hear pertaining to the performance of the Busang mine.

Local Community near Busang (Ranked # 3) The local community around the Busang mine would be ranked third. This “discovery” brought with it great promise of economic growth for this area of Indonesia. As a result, local residents would have employment opportunities and if the gold reserves actually did exist, there would be endless financial opportunities to create wealth for the local people of the region.

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Employees (Ranked #4) Related to #3, employees of the local region would be greatly impacted by the Busang mine. In addition, Bre-X employees in general and specifically the top level managers who had access to large amount of stock from stock purchasing and stock options were greatly impacted by the gold “discovery”. As was stated previously, the top level managers were able to dump their Bre-X shares before the bottom fell out of the stock so they could capture high level of immediate financial gains.

Suppliers (Ranked #5) The supplier had relative little impact from the Bre-X fraud. The only major impact could have been if the suppliers had anticipated large increases in equipment orders as Bre-X started to remove the gold from the Busang mine.

2. Examine the red flags identified in Table 1. Explain which of these red flags investors could have reasonably ignored.

Points 1 through 6 should have been of great concern to any investor. Points 7 through 11 may have been less troubling for an investor. Points 1 through 6 highlight the high level of suspicious activities occurring at a major gold discovery.

1. Having a mysterious fire started certainly would lead to questions of how did this occur and what was destroyed.

2. Having top management dump large amounts of stock should be enough of a red flag to make any investor sell his or her stock.

3. Having the Indonesian government withdraw mining permits also should have raised concern with any investor and begs the question…What does the Indonesian government know that I don’t know?

4. Not having an updated prospectus shows that either Bre-X can not properly calculate their future financial forecasts or they don’t WANT to show their future financial forecasts.

5. Having complete control of information could be justified but it still should raise suspicions from investors 6. When Barrick walked away from a partnership, it should have been another sign to investors to sell the stock immediately. (See question asked about the Indonesian government.)

Points 7 through 11 are more technical red flags which may or may not raise suspicions with investors.

7. It could be possible to have a major deposit without any surface evidence.

8. The efficiency of the Bre-X employees may explain their rapid drilling procedure.

9. The Bre-X geologist may not have to be physically present to have detailed knowledge about the operations.

10. It could concern investors for Bre-X not to follow the industry standards with the opening of the core samples, but the investors may have given them the benefit of the doubt without knowing about the other red flags 11. It is probably possible but highly unlikely that one deposit could yield 8 percent of the world’s gold reserves.

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3. What, in your opinion, motivated Felderhof to return to Toronto to defend the charges against him, especially because they were not considered extraditable charges?

It is safe to assume that Felderhof has a large ego that could lead to a high level of confidence. If he knew that no evidence of the fraud could be traced back directly to him, he may have thought he was smart enough to explain all his actions. As a result, without any physical evidence, it would be hard to convict him. In addition, the two critical eyewitnesses to the fraud are dead. Since both Walsh and de Guzman had “died”, there was not an eyewitness the prosecution could present that would swear under oath of the illegal actions of Felderhof. In addition, the Ontario Securities Commission, the regulatory agency which charged Felderhof, has had a long history of failing to convict high profile white collar criminals. Felderhof may have just thought his odds were pretty good (See Update).

Update On July 31, 2007, John Felderhof was acquitted of all charges brought against him by the Ontario Securities Commission. Felderhof was found not guilty of selling $84 million worth of Bre-X shares illegally. The trial lasted seven years.1The Ontario Securities Commission decided not to appeal the verdict. In September 2007, Felderhof stated that he still believes there is gold in the Busang mine and would be willing to help anyone find it.2 Additional Resources The Canadian Broadcasting Corporation (CBC) has an excellent web site called “Stranger Than Fiction: The Bre-X Gold Scandal” (http://archives.cbc.ca/economy_business/business/dossier/1211/) This web site includes a number of excellent video and audio clips that go through the different phases of the Bre-X fraud.

Waldie, Paul and McFarland, Janet. “The End of the Trail” The Globe and Mail. August 1, 2007.

Brieger, Peter and Hutchinson, Brian. Felderhof offers to Revisit Bre-X Gold Find”. The Financial Post.

September 18, 2007.

1 2

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Case 6: Conrad Black and Hollinger International: All the News That’s Fit to Sell Case Summary The Conrad Black case is truly an international case. While headquartered in Canada, Hollinger International had spanned the global with its operations and its questionable conduct. Born into wealth and privilege, Black acted like royalty from a very early age.

His questionable conduct while seizing control of Ravelston, Argus and eventually Hollinger Incorporated or even by selling stolen exam papers when he was a student certainly foreshadowed his strategic focus. He will get want he wants through any means possible.

This is a classic case where the CEO has taken complete control of the firm and believes that only he knows what is best for the firm. Of course, what is best for the firm is also what is best for him. The uncontrolled power of Black highlights the complete lack of corporate governance in this case. As a result, this would be an example case to demonstrate a number of concepts mentioned in Chapter 4 on Corporate Governance and Corporate Compliance. As is shown in Table 1, it appears that the board members were selected not because of their knowledge of the newspaper industry but because of the “A list” status in social circles. Having former governors, secretary of states, an assistant secretary of defense and a former ambassador of the Soviet Union would not be an ordinary pool of candidates to help guide the strategic focus of a newspaper empire. As was mentioned in the case, the board would spend more time talking about politics over their lunch than they would at the actual board meeting. It could be argued that this lack of corporate governance could be considered the zenith of a rubber stamp board. The evidence is not only the lack of questions asked during the meetings but the complete claim of ignorance of what Black and his partners were doing after the fraud was discovered. By perceiving that Hollinger’s money was his money, Black found an easy rationale for buying FDR papers or fixing up his Rolls Royce or giving a party for his wife (and board member Barbara Amiel Black) as legitimate purchases because since he was the CEO and he controlled the voting shares of the Hollinger stock (see Table 2).

His ego may have reached a pinnacle when he was awarded the title Lord Crossharbour and became a member of the House of Lords. That was going to be as close as he was going to get to be considered royalty.

Black worked hand and hand with David Radler to make Hollinger International a two man show. Black was the image of Hollinger while Radler was in charge of the day to day operations. Even though they were involved in the fraud together, there certainly could have been actions where neither knew what the other was doing. The partnership between Hollinger and Radler is very common in a large scale corporate fraud since the CEO usually needs a right hand person to help with the different parts of the fraud.

In December 2005, Black pled not guilty to fraud charges and by May 2006 the last trances of Black’s influence were erased when Hollinger International changed its name to Sun-Times Media Group.

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Major Players in the Hollinger International Fraud Name Conrad Black

Title CEO

Charges Fraud Racketeering Obstruction of Justice

Result *6 ½ years Prison *Forfeit $6.1 Million *S125, 000 Fine

David Nadler

President

Fraud

*29 months Prison *$250,000 Fine

Peter Atkinson

VP/Lawyer

Fraud

*24 years Prison *$3,000 Fine

John Boultbee

CFO

Fraud

*2 ¼ years Prison *$152,000 Fine

Barbara Amiel Black

Board Member

Civil Charges

*Part of $50 Million Settlement

James Thompson

Board Member

Civil Charges

*Part of $50 Million Settlement

Richard Burt

Board Member

Civil Charges

*Part of $50 Million Settlement

Marie-Josee Kravis

Board Member

Civil Charges

*Part of $50 Million Settlement

Henry Kissinger

Board Member

Civil Charges

*Part of $50 Million Settlement

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Henry Kravis

Board Member

Civil Charges

*Part of $50 Million Settlement

Links With Chapters Primary Chapter 1-Individual Ethical Duty Chapter 2-Individual Ethical Integrity and Unrealized Unethical Behavior Chapter 4-Corporate Governance Chapter 8-Corporate Culture

Secondary Chapter 3-Stakeholder Relationships Chapter 4-Corporate Governance Chapter 8-Strategic Planning Chapter 9-Finanical Reporting

Teaching Note This case should result in a lot of discussion from your students. There will be some students that will argue about Conrad Black’s sentence for his actions. Other students would have expected a much longer sentence. One question to ask is when does the entrepreneurial drive of a family run or privately held company stop for the founder or in this case the son of the founder. This is a good opening question. The simple answer is that the drive never stops because there is no separation between the person running the company and the company itself. Therefore, Black believed that he was doing nothing wrong because he was doing what he “thought” was right for Hollinger and he should be rewarded for his actions.

Another question to ask is why it took one individual shareholder, Christopher Browne from Tweedy Browne Co., to start asking questions about Hollinger. Why didn’t the SEC or some of the large institutional investors question where the money was going? The explanation could be, in part, that Hollinger’s stock price was increasing. When things are going well financially, there appears to be less scrutiny about the activities of senior level management.

Another question to ask your students was how were Black and his wife able to get away with all the expenditures that were reported in the special report on Hollinger International. The explanation could be that there were no checks and balances on how Hollinger’s money was spent and the lack of effectiveness of the board of directors would

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encourage any unethical top level managers to try an capture as much of the firm’s money as was possible.

Questions For Thought 1. Conrad Black continues to maintain his innocence. Can you explain his reasoning, given the facts presented in the case?

Conrad Black may have truly believed that he did not do anything wrong. The unfortunate fact for him was that the rest of society has a different measurement criterion for what is legal and illegal and what is ethical and unethical. Within his own cognitive lens, Black could rationalize any of his purchasing using Hollinger’s money since: 1) it was his company and 2) he was doing a good job and he should be rewarded for doing a good job. In addition, there appeared to be no checks and balances in place to challenge his behavior. It was also beneficial for Black to rely on David Radler to ensure courses of action were implemented that would help support Black’s actions and viewpoint.

2. Why did it appear that the board of directors continually overlooked the wrongdoings by Black?

The boards of directors appear to follow the philosophy of see no evil, speak no evil, hear no evil. They appeared to have minimal interests in any of the operations of Hollinger. To them, Hollinger was a great way to receive compensation while talking about politics enjoying their sandwiches. Of course, Black loved this type of board and greatly encouraged their lack of interest. To him, the board members were just a legal requirement that took up valuable socializing time with good friends. From the board perspective, it was a very easy job to accept at face value whatever Black and Radler presented since it did not take any effort to agree with everything that was presented.

Therefore, it was a win-win-lose proposition. The winners were the board of directors and Black and his colleagues and the losers were the stockholders.

3. Explain corporate kleptocracy. Can you think of any other companies that could be described using this term.

On page 262, kleptocracy was defined as “an organization that is so corrupt it does not even pretend to be honest in its dealings”. A firm that is described as a kleptocracy has a corporate culture that is firmly entrenched in the belief that they know what is right and wrong and no one can tell them otherwise. The corporate culture condones and rewards unethical behavior since the sole focus of the firm is the end and not the means. As a result, nothing will stop these firms and the CEOs in charge from achieving their own personal goals which of course, are usually heavily weighted toward personal financial goals. CEOs of kleptocracies use money as the scorecard to determine winners and losers. The money in itself is not the goal, but the goal is to have MORE money than others so that you are a WINNER. Other firms that could be considered kleptocracies with their CEOs would be: WorldCom and Bernie Ebbers, Tyco and Dennis Kozlowski, and Enron with Ken Lay and Jeff Skilling.

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4. Conrad Black, for the third time, won the Business Newsmaker of the Year Award.

Shouldn’t this award recognize someone who represents more ethical business operations?

Yes, of course, Black was not worthy of the award. It is important to note that the award was given by the Canadian Press and Broadcast News. For better or worse, Conrad Black is one of the best know celebrities in Canada. As a result, many Canadians would have a halo effect pertaining to Black. A halo effect occurs when a person has such a strong positive image of someone they will discount negative information pertaining to him.

There are still many Canadians that feel that Black should have been found not guilty of the charges. It is probably safe to say that Black would have at least have received a much less sentence if he was convicted in Canada or he could have been found not guilty.

Of course, the irony is that Black gave up his Canadian citizenship in order to become a member of the House of Lords so no longer represents Canada in the global arena. In an additional ironic twist of fate, the British Parliament is now considering legislation barring any convicted felons from remaining as members of the House of Lords. The net result is that Black will soon be a man without a country and without a title.

Update On July 13, 2007, Conrad Black was convicted of three counts of mail fraud and one count of obstruction of justice. He was sentenced to 6 ½ years in prison of which he must serve 85 percent. Black was also ordered to forfeit $6.1 million and was ordered to pay a fine of $125,000.1 On March 3, 2008, he became prisoner 18330-424 at the Coleman Federal Prison in Ocala, Florida. He will work at a job that will pay him between 12 cents and 40 cents an hour.2 On December 10, 2007, other top level Hollinger executives were sentenced to prison after being convicted of fraud charges. Former vice president and lawyer, Peter Atkinson, was sentence to 24 months with an additional 3 years of supervised release. He was also fined $3,000. John Boultbee, former Hollinger CFO, was sentenced to 2 ¼ years of prison with three additional years of probation and a fine of $152,000.3 On December 17, 2007, David Radler was sentenced to 29 months in prison and ordered to pay a fine of $250,000 after pleading guilty to one count of fraud.4 He started serving his sentence on February 26, 2008. As a Canadian citizen, Radler will be allowed to be transferred from serving his sentence at the Moshannon Valley Prison in Pennsylvania to a minimum level security prison in British Columbia with a change of being paroled as early as 6 months after the start of his sentence.

In March 2008, Hollinger agreed to pay the Securities and Exchange Commission $21.3 million to settle charges brought against the firm.

1

Fulford, Robert. 6 ½ Years; Enemies Need Charming, Too. The Financial Post. December 11, 2007 Leigh, David. Hand in Hand With His Wife, Conrad Black Goes to Prison. The Daily Mail. March 4, 2008.

3 Vallis, Mary. Kipnis gets Probation; Prison for Co-defendants; Atkinson Tells Judge He Was “too trusting”. The Financial Post. December 11, 2007 4 Vallis, Mary. Ex-Hollinger Executive Radler Expected to Receive 29 Months; Sentencing is Today for Businessman Who Testified Against Conrad Black. The Montreal Gazette. December 17, 2007.

2

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Case 7: Enron: Were They the Crookedest Guys in the Room?

Case Summary Enron has become the classic case on business ethics. Enron formed after the merger of Internorth Incorporated and Houston Natural Gas in 1985. On January 1, 1987, as part of the merger agreement, Ken Lay became the new CEO. In 1990, Ken Lay hired Jeffrey Skilling from McKinsey and Company as the Head of Enron Finance. By 1995, Enron had become the largest independent natural gas company in the United States. In 1997, Skilling became president and Chief Operating Officer at Enron. Ken Lay’s goal was for Enron to have the same brand recognition as AT&T. Enron’s long term strategy depended on convincing the public and the federal government that deregulation of the energy industry would create a more competitive marketplace. Energy deregulation effectively “unbundled” the industry value chain so that companies were free to choose which parts to operate. Firms didn’t have to generate or transport energy in order to trade in energy. In July 2000, Enron released its Code of Ethics policies to its employees. The document was 63 pages long with two additional blank pages for notes. From 1998 to 2000, the total compensation paid to the top 200 executives at Enron went from $193 million to $1.4 billion. The top three executives pay went from tens of million in 1998 to over $100 million each by 2000. In December 2000, Enron announced president and chief operating officer, Jeffrey Skilling, would take over as chief executive from Kenneth Lay in February 2001. Ken Lay would remain as chairman. At this time, Enron stock hit a 52-week high of $84.87.

In March 2001, Bethany McLean from Fortune magazine wrote an article titled “Is Enron Overpriced?” Ms. McLean asked a simple question, how does Enron make its money?

Enron had shifted from a traditional gas-pipeline business to “wholesale energy operations and services”. On August 14, 2001, Jeff Skilling resigned as CEO and president. Ken Lay stated that there was no accounting, trading or reserve issues that were related to Skilling’s resignation. Enron was in its strongest financial shape in history. After Skilling resigned, Ken Lay asked employees to write him if they had any concerns. Sherron Watkins sent him a letter with the question “Was Enron too risky to work for?” Ms. Watkins worked in the Accounting Department and had a number of concerns about CFO Andrew Fastow’s partnerships that related to off balance sheet transactions. Fastow used Special Purpose Entities (SPEs) to move assets and liabilities off the balance sheet. As a result, Limited Liability Partnerships were formed by Fastow to transfer debt and risk “off line”. The net result was that Enron was able to produce lower debt levels and hide losses in their financial statements. In addition, the deals were financed using Enron stock.

On October 16, 2001, Enron reported a $618 million third-quarter loss and disclosed a $1.2 billion reduction in the value of the shareholders' stake in the company, partly related to the partnerships run by Fastow. Andy Fastow resigned as CFO on October 24, 2001 after the SEC announced they were going to investigate the financial reporting at Enron. By November 2001, it was disclosed that Enron had potentially hidden billions of dollars in debt and that Enron’s financial statements had not been accurate for years. Ken

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Lay’s response to the off balance sheet transactions from Fastow was that they were over Lay’s head so that Lay could not explain them.

When Enron filed for bankruptcy on December 2, 2001, it was the final event of the downward spiral for a company that was once ranked 7th in size with 25,000 employees.

On January 9, 2002, the Justice Department confirmed it has begun a criminal investigation. On January 23, 2002, Ken Lay resigned as CEO but remained on the board.

On February 4, 2002, Lay resigned from the board. On March 14 2002, former Enron auditor, Arthur Andersen, was indicted for destroying Enron-related documents. Later, the firm was convicted of obstruction, sentenced to probation and fined $500,000. On October 2, 2002, Andrew Fastow was charged with fraud and agreed to ten years in jail in return for co-operating with the government. On May 1, 2003, Fastow’s wife Lea was also charged with fraud and was sentenced to one year in jail. On February 19 2004, Skilling was indicted on fraud charges. On July 8, 2004, Ken Lay was charged with fraud and insider trading. On January 30, 2006, the trial of Ken Lay and Jeff Skilling started.

On May 25, 2005, Ken Lay and Jeff Skilling were found guilty of conspiracy and fraud.

Major Players in the Enron Scandal Name

Title

Charges

Result

Kenneth Lay

CEO/Chairman

*fraud *conspiracy

*found guilty *died before sentencing

Jeffrey Skilling

President/CEO

*fraud *falsifying documents/ *insider trading

*24 years *4 months in prison

Richard Causey

Chief Accountant

*securities fraud

*5 ½ years in prison

Andrew Fastow

CFO

*fraud *conspiracy *money laundering

*6 years in prison

Lea Fastow

Andrew’s wife

*conspiracy *fraud

*1 year in prison

David Delainey

Head of wholesale Energy-trading unit

*manipulation of earnings

*2 ½ years in prison

Paula Rieker

Corporate Secretary *insider Trading

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Links With Chapters Primary Chapter 2-Unrealized Unethical Behavior Chapter 3-Stakeholder Relationships Chapter 4-Corporate Governance Chapter 8-Corporate Culture Chapter 9-Financial Reporting Chapter 10-Code of Ethics Chapter 11-Evaluation of Corporate Ethics Secondary Chapter 1-Individual Ethical Duty Chapter 2-Individual Ethical Integrity Chapter 4-Corporate Compliance Chapter 8-Strategic Planning

Teaching Note As was mentioned in the case summary, the Enron case has become a classic for any business ethics discussion. It is probably the best known example of corporate fraud from one of the largest companies in the Fortune 500. As is common with a number of cases, corporate culture plays a critical role in this case. From the rank and yank evaluation of the employees to the singular focus on Enron’s stock price, every activity at Enron focuses on increasing the market capitalization of the company through growth in its stock price. As a result, there was a very simple understanding at Enron: You will be rewarded very well but you have to produce every day to earn your money.

As was the case in other firms in this textbook, the collapse of Enron was due in part to the lack of cash flows coming into the company. Enron used the gambler’s strategy of “if I just transfer the money this quarter I will earn (or gamble) it back next quarter”. The unfortunate circumstances for Enron were that it ran out of quarters to borrow from. Once the stock prices started to decrease, the off balance sheet transactions became due which led to a continuing downward pressure on the stock price and the vicious circle was formed. As the same time, Ken Lay, like Nero fiddling while Rome burned, publicly stated how strong Enron was while the company was burning up in flames. Lay must have just forgotten that he was dumping his own Enron stock while presenting glowing future projections for Enron.

There is much irony in the death of Ken Lay. Many people believe that he cheated justice by not being able to serve his term. Other critics believe that he got what he deserved and that his untimely death was quick justice for what he did to Enron employees. Regardless of individual beliefs, as was stated in the case, he was acquitted of all charges since he did not have a chance to appeal his conviction.

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Questions for Thought 1.What are “cookie jar” reserves? Explain Enron’s use of this concept.

Cookie jar reserves are funds set aside by a firm to be used to adjust the financial performance in any given point of time. The purpose of the reserve is that it allows the firm to increase its financial performance by transferring the reserves into the current period financial statements to help control the financial performance of the firm.

Enron is the perfect example of using these reserves because of two very favorable factors. The first is that Enron dealt in long term energy contracts which are difficult to calculate a true market value. As a result, Enron had the opportunity to create all the years of the contract within a one year window allowing them to manipulate the financial statements. This manipulation would only work if you have a co-operative external auditor. David Duncan of Arthur Andersen was very accommodating to Enron in this manner and accepted this type of aggressive accounting.

2. Identify as many stakeholders as you can in this case. For each, explain how they were affected by the events surrounding the demise of Enron.

Employees The employees were devastated by the demise of Enron. Not only did they lose their jobs, but for a vast majority of the employees all of their retirement funds were in Enron stock.

They were not allowed to sell the stock during the quick fall so they ended up with virtually nothing in their retirement accounts at the end of Enron.

Stockholders The stockholders also were severely impacted by the demise of Enron. The freefall of the Enron stock until it was worthless than $1 ensured that the stockholder endured heavy losses in their Enron investment.

Government After a sluggish start, the SEC became very involved in the operations of Enron. A number of top level executives were tried by the justice department as well as millions of dollars recovered in restitution to help pay for the losses endured by the employees and the stockholders.

Suppliers The suppliers also were left with little recourse once Enron went bankrupt. All the top priority secured creditors would get the first chance to recover their money from Enron.

Unless the supplier was a secured creditor, they may have received very little from Enron once it declared bankruptcy.

Local Community The Houston community was severely impacted by the demise of Enron. Not only was Houston a home for a number of Enron employees, but the image of the city was negatively impacted by the demise of Enron. It also did not help that the professional baseball park was called Enron Field (it is now named after fruit juice producer, Minute Maid).

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3. Summarize the main points of this case in one succinct paragraph.

The case is about greed in the highest order. The company from its origin quickly focused on increasing market capitalization at any cost. Employees were selected based on how well they could play the game. The winners were rewarded handsomely and the losers were fired. The corporate culture was one in which it was Enron against the world and Enron kept on winning. However, like a Trojan horse, the true Enron was hollow inside.

Once the house of cards collapsed, it was left to the stockholders and the employees to pick up the pieces.

Update In 2007, Credit Suisse paid $61.5 million, UBS agreed to pay $115 million and Deutsche Bank agreed to pay $25 million to settle litigation pertaining to their role in the Enron fraud.12 In January 2008, former lead auditor at Arthur Andersen, David Duncan, agreed to settled allegations filed by the SEC that he had violated securities law by signing audit reports that were false and misleading. No fine was issued but Duncan was barred from appearing before the SEC as an accountant.3 In March 2008, Citigroup settled litigation claims against it for it actions during the Enron scandal for $1.66 billion.4

1

The Associated Press. UBS Agrees to $115 Million Enron Payment. The New York Times. June 7, 2007.

Reuters. Enron Case Settled. The New York Times. December 19, 2007 3 Reuters. Accountant and S.E.C. Reach Deal in Enron Case. The New York Times. January 29, 2008.

4 Dash, Eric. Citigroup Resolves Claims That It Helped Enron Deceive Investors. The New York Times.

March 27, 2008.

2

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Case 8: Google: Don’t Be Evil Unless…

Case Summary The Google case is separated into six major ethical issues. They are: the privacy of Gmail; the privacy of individuals; Google in China; Refusing Requests from the Justice Department; Scanning Copyrighted Material; and the Role of Click Fraud The Privacy of Gmail The ethical issue related to Google email system Gmail is that Google searches the content of the free e-mail service and inserts online ads within the text of incoming emails that would correspond to a key word or word within the e-mail. Google claims that this is a completely automated system in which no Google employee actually reads the email. A legal issue pertaining to the insertion of advertising is that the Electronic Communications Privacy Act forbids Internet Service Providers (ISPs) or any other organization from monitoring the content of electronic communications unless they are specifically allowed to do so.

The Privacy of Individuals The ability of Google to find specific detailed information about any subject is Google’s competitive advantage. This laser like searching capability was evident when a reporter from CNETNews.com obtained a wealth of personal information of Google’s CEO, Eric Schmidt. Of course, there is nothing illegal about this search capability but it appeared that Mr. Schmidt did not like having the table turned on him and banned for a year any reporter from CNET to be able to talk to anyone at Google.

Google in China The ethical issue for Google in China is the freedom of search which is related to freedom of speech. Google prides itself on doing no evil, yet when they expanded in China they agreed with the terms of the Chinese government to filter search results by Chinese citizens using Google.cn. Words such as human rights and democracy were filtered from search results with the net result being that the individual would have a very limited number of controlled websites resulting from searches for these terms.

Refusing Requests from the Justice Department In January 2006, Google refused to agree to the request by the Department of Justice to provide information on Internet searches done on Google by individuals. The purpose of the information was to aid the Justice Department in defending the Child Online Protection Act of 1998. The data that the Justice Department wanted to obtain from Google would have been used to determine the effectiveness of filtering software as compared with the protections that were supported in the 1998 act. The Justice Department would have used the data in aggregate and tested the filtering abilities of the software without any specific identification to any individual user.

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Scanning Copyrighted Material Google announced that it would scan the pages of books in libraries such as Harvard, Stanford, the University of Michigan and Oxford and have these books available for free online. The problem with this “Google Print for Libraries” program is that Google is purposely infringing on the copyrights of the books. By having these books available free online, Google would have a large negative impact on the book publishers and book authors. As a result, both authors and book publishers sued Google for copyright infringement. Google also had copyright problems in Belgium when they published online copyright material from Belgian newspapers without permission. Furthermore, Google faced copyright issues when they acquired YouTube which would upload copyrighted videos without receiving permission.

The Role of Click Fraud Google receives their revenue whenever an individual clicks on a sponsor’s web site on the Google web site. Each click corresponds to a payment which the sponsor will give Google. Therefore, the more clicks that occur on a sponsor’s ad, the more revenue for Google. Click fraud occurs when an individual clicks on an ad on Google’s website with no intention of considering buying anything from that web site. An unethical competitor could commit click fraud by continuously clicking on a competitor’s ad with no intention of buying any products or services. The net result would be the competitor would have to pay Google for “fraudulent” clicks. This is a critical problem for Google since their whole business model is based on advertising revenue through sponsors’ clicks. If the sponsors no longer trust the integrity of the calculation of clicks used on their web site, they may either refuse to pay a portion of their charges and/or may no longer use Google as an advertising outlet.

Links With Chapters Primary Chapter 3-Stakeholder Relationships Chapter 7-Information Technology

Secondary Chapter 8-Strategic Planning and Corporate Culture

Teaching Note The students should like this case since they all enjoy discussing companies they are familiar with and all probably use Google everyday. The use of Gmail and the privacy issues may not be a concern to them. When this issue is discussed in class, the students seem very aware of what Google was doing and do not seem to have a problem with it.

The privacy of individuals may also not be a concern for a number of students. Since most of the students are comfortable with doing a number of transactions online, they may not see a problem with searching for private information, especially in the era of Facebook and MySpace. However, they may not realize that the information they have

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been given online can be used by third parties without their knowledge. The students need to understand that information that is submitted on-line is no longer in their control.

Refusing the Justice Department and Google in China go hand and hand because they represent ideas at opposite ends of the privacy spectrum. Google was fiercely protecting the rights of their users by not allowing the United States government access to aggregate information. However, at the same time, Google was working with the Chinese government to control and filter the type of search results available to the Chinese users.

This apparent hypocritical behavior by Google should be stressed in the classroom discussion. Why should Google be allowed to pick and choose when it protects individual human rights?

The scanning of copyrighted material appears to be a blatant disregard for the individual and collective rights of the publishing companies as well as video producers. This would be a good time to raise the point to your students whether the “EGO” of Google is driving some of these decisions. It appears that Google is reading its own press clippings and has decided they are above everyone else in their business model; so, why should they also be above confining copyright regulations?

Click fraud is a huge concern of Google. As was mentioned previously, online advertising is Google’s business model and if the creditability of that model is threatened Google’s future growth opportunities would be severely limited.

Questions for Thought 1. Given its mission of providing information to the world, should Google censor searches in China?

The simple answer to this is no. The contradictory message these two ideas imply results in Google looking hypocritical in its actions. The question is why Google succumbed to the wishes of the Chinese government. The easy answer is 1.3 billion people. Google’s astronomical stock price (almost $600 per share at the time of this writing) is in large part due to the built in long term growth potential of the stock. As a result, Google is under continuous pressure to grow at a large percentage every year to support the high stock price. If Google said no to the Chinese government, that would be 1.3 billion customers that Google’s sponsors would not have access to.

2. Why do you think Google was adamant in not wanting to supply information requested by the government concerning the Child Online Protection Act? Explain your position.

Google was probably adamant to put on display to its users that they would protect the individual rights of their users regardless of who was asking for the information. It also could have been a stance to block future requests. Google may have been worried that if they complied with this request the government would quickly come back with another request and so on. Again, as was mentioned in the teaching note, the net result of this stand was that it made Google look foolish to be so adamant for human rights in the United States and be so willing to look the other way in China.

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3. What do you think Google’s rationale was for starting its Google Print for Libraries program?

The rationale of Google could have been two fold. Google may have thought of themselves as the “enlightened” company that was going to bring wisdom and knowledge to the masses. In addition, as was mentioned in the teaching notes, Google may have thought that since this was such a noble effort that copyright laws would not restrict the program. Both of these rationales lead back to the ego of Google. Google has had unprecedented financial success so they may believe that they could do no wrong even if the action is against the law.

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Case 9: HealthSouth: The Rise and Fall of the Scrushy Empire Case Summary As was the case with Conrad Black, Ken Lay, Jeff Skilling, and Bernie Ebbers, Richard Scrushy became one with his company. As is the case with the other CEOs, Scrushy used his aggressive business strategy and his subsequent ego dominated the decision making at HealthSouth. Richard Scrushy started as a respiratory therapist and realized that a lot of money could be made if certain services performed in hospitals could be shifted to outpatient services.

As has been illustrated time and time again in this textbook, short term quarterly results were driving the decision making at HealthSouth. Scrushy would set an EPS target and then he would make sure that HealthSouth always met or exceeded this benchmark. This continuous winning streak actually became a red flag that competitors had complained about since HealthSouth was the only firm in the industry to be able to constantly hit their financial targets. HealthSouth would manipulate their figures through accounts such as the contractual adjustment account which is used to estimate the variance between the amount billed to a patient and the amount insurance will pay. This account was used since it was based on estimates and it was very hard to verify any balances within the account. As a result, every quarter, HealthSouth would generate fraudulent financial statements that were sent to the Securities and Exchange Commission. The statements would always match the financial forecast presented by Scrushy.

Despite statements from all the previous HealthSouth’s CFOs that Scrushy was involved in the financial statement manipulation, Scrushy went with an ostrich defense that he did not know about any wrongdoing and that it was all the fault of the subordinates. By the time Scrushy went on trial in January 2005, the estimated level of the fraud had reached $5 billion. Despite the guilty pleas of lower level employees and the conviction of others, Scrushy was able to walk away a free man. He was found not guilty on June 28, 2005 on all 36 criminal counts against him. However, almost exactly one year later, on June 29, 2006, Scrushy was convicted of giving a $500,000 bribe to then governor of Alabama, Don Sigelman.

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Major Players in the HealthSouth Fraud Name Richard Scrushy

Title CEO

Charges Result *Conspiracy to *Not Guilty Commit Fraud *Filing Inaccurate Financial Statements *Securities, Mail and Wire Fraud

Aaron Beam

CFO (1984-1997)

*Bank Fraud

*3 Months Prison *$10,000 Fine *$275,000 Forfeited

Michael Martin

CFO (1997-2000)

*Fraud

*3 Years Prison *$25,000 Fine *$2.4 million Forfeited

William Owens

CFO (2000-2001)

*Fraud

*5 Years Prison *$1.4 million Payment

Weston Smith

CFO (2001)

*Fraud

*27 Months Prison *$6.9 Million Payment

Malcolm “Tad” McVay

CFO (2002)

*Fraud

*6 Months Home Detention *5 Years Probation

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Links With Chapters Primary Chapter 2-Individual Ethical Integrity and Unrealized Unethical Behavior Chapter 3-Stakeholder Relationships and Corporate Social Responsibility Chapter 4-Corporate Governance Chapter 6 Health-Care Issues Chapter 8-Corporate Culture Chapter 9-Finanical Reporting Secondary Chapter 1-Individual Ethical Duty Chapter 4-Corporate Compliance Chapter 8-Strategic Planning Chapter 10-Code of Ethics Chapter 11-Evaluation of Code of Ethics Teaching Note As was stated in the case summary, HealthSouth is a classic example where the power of the CEO becomes the determining factor in the decision making of the firm.

HealthSouth’s culture was developed by founder Richard Scrushy and through rewards and punishment, the employees quickly learned that you do not say no to Richard Scrushy. Scrushy was so proud of HealthSouth’s ability to hit its financial mark every time that again the ends justified the means. HealthSouth did whatever it took to make those financial forecasts.

Scrushy became a big fish in Birmingham and in Alabama since he was in control in one of the largest companies in the state. The net result was that his power extended beyond HealthSouth to the state of Alabama. As was mentioned in the case, a number of buildings and other landmarks were named after Scrushy in Birmingham.

A question to ask the students is why it took so long for the fraud to be discovered. As with any fraud, it only works as long as there is money to finance it. Cash flows will shut down a fraud when the firm can no longer pay the bills. When this takes place, questions start to be asked about the company and the curtain is lifted on what was really going on in the firm.

Just as Enron was able to use accounting procedure that was unique to their industry, HealthSouth was able to use industry specific accounts to hide the fraud. By using the contractual adjustment account, HealthSouth was able to bury the fraud for years since this account is almost impossible to verify. Therefore, even if the external auditors were doing a full due diligence on HealthSouth’s records, the firm could still hide the fraud from the auditing firm.

What started as a simple fraud inquiry about Medicare became a $5 billion investigation which impacted all aspects of the firm. It is very common for one innocent sounding

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question about a specific transaction to start the avalanche to information pertaining to the corporate wide fraud occurring within the firm.

HealthSouth was one of the first companies to be charged with violations under the Sarbanes Oxley Act. One of the restrictions put in place via SOX was that CEOs no longer could use the ostrich defense during fraud investigations. It did not matter whether the CEO was aware of the fraudulent activities or not, he or she is still responsible. This is why, in part, the complete acquittal of Scrushy was stunning since he was charged with submitting fraudulent financial statements after the passage of SOX. It is still difficult to understand how Scrushy was not guilty of this charge since it was clearly stated that lack of knowledge pertaining to the fraud was not a defense.

It would also be an interesting discussion to compare the sentences of the former CFO’s at HealthSouth. Even though they all had the same position, their punishment does not seem equal. Ask your students to speculate why the sentences and fines varied so much for the CFOs. Questions For Thought 1. Is it reasonable to think a CEO would not be aware of fraud of this magnitude?

Explain.

If you use the common man assumption, the answer is no. A common man would not belief that it would be reasonable for a CEO to be completely aware of any fraudulent activity pertaining to a fraud at this scale. With all the former CFOs testifying against Scrushy, it would seem logical that Scrushy was well aware of what was going on in the company that he had founded.

2. Identify the stakeholders in this case. Explain the impact of the fraud on each of the stakeholders.

Customers As with most fraud cases, the customers of HealthSouth were severely penalized by the actions of the firm. Through the manipulation of insurance filings, customers would be billed for services that did not take place. In fact, it was the fraudulent billing of Medicare patients that serve as the first red flag used to question HealthSouth’s operations. It started with one Medicare patient in Texas who claimed that HealthSouth used “unqualified personnel” for physical therapy. Of course with these fraudulent billings, the burden was on the customer to prove that there did not receive the services that they were billed for.

Suppliers The suppliers always feel the impact of the fraud at the later stages of the fraud. It is during the later stages that the firm committing the fraud runs out of money. As a result, the suppliers became one more stakeholder which HealthSouth tried to avoid dealing with since they requested money that HealthSouth probably did not have.

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Government The government played an active role in the HealthSouth case. First of all, the government was the first to be hit by the fraud with the incorrect Medicare billings. The government also played a role in governing the actions of HealthSouth in the healthcare industry. The government used HealthSouth as the first high profile case to come under the scrutiny of the Sarbanes-Oxley Act. Of course, the government was also directly involved in the fraud since the Securities and Exchange Commission was the recipient of the fraudulent financial statements.

Stockholders As with any fraud, the stockholders suffered severely financially from the HealthSouth fraud. The reduction of the stock price had a direct impact on the stockholders’ financial investment in HealthSouth. In addition, a financial recovery can take an extended period of time and is based on how poor the financial position of HealthSouth was when it reached its financial and ethical bottom.

Local Community Birmingham, Alabama was significantly impacted by the HealthSouth fraud. HealthSouth was one of the largest employers in Birmingham and in the state of Alabama. In addition, as was mentioned in the textbook, HealthSouth and Scrushy contributed significant amounts of money of local community projects in the Birmingham area.

1. Update the case. Where is Richard Scrushy today?

An update follows this question including how Richard Scrushy ended up behind bars.

In April 2007, Scrushy settled with the Securities and Exchange Commission for $81 million which was composed of $77.5 million in forfeiture and $3.5 million in fines. In addition, Scrushy agreed not to serve as an officer or a director of a publicly traded company for at least 5 years. 1 In June 2007, HealthSouth announced that it would sell its Birmingham headquarters for $60 million. The headquarters which had a Scrushy room of memorabilia and a private elevator so that Scrushy did not have to interact with his employees on the way up to his penthouse office was the last tangible asset representing the Scrushy era at HealthSouth.2 In October 2007, HealthSouth received a tax refund of $400 million when it overpaid its inflated profits during the years when the company created fraudulent financial statements. 3 On June 28, 2007, former Governor Donald Sigelman was sentenced to seven years and four months in prison for accepting a bribe from Richard Scrushy.4 On March 27, 2008 former Governor Donald Siegelman was ordered released from prison while his appeal 1

Whitmire, Kyle. Scrushy to Pay $81 Million to Settle S.E.C. Lawsuit. The New York Times. April 24, 2007.

2 Anonymous. Today in Business: HealthSouth Sells Headquarters. The New York Times. June 2, 2007 3 Whitmire, Kyle. Profits Aren’t Real, but the Refund Is. The New York Times. October 21, 2007.

4 Nossitier, Adam. Former Alabama Governor Gets 7-Year Sentence in Bribery Case. The New York Times.

June 29, 2007.

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goes through the court system.5 Richard Scrushy was not released since he is considered to be a flight risk. In February 2007, it was alleged the Scrushy was trying to flee the country in his 92 foot yacht, Chez Soiree, when bad weather kept him from reaching the open water. He explained that he had permission to travel to South Florida because the court had approved a family visit to Disney World. He did not tell his probation officer he was traveling by yacht to Miami because the probation officer was not specific enough. (In addition, last time a map was consulted, Disney World wasn’t near Miami!)

Based on this little sailing trip, the judge ordered Scrushy to wear a GPS device for all future trips out of Alabama and forbid him from using private travel. He was also ordered to submit in writing a detailed itinerary of all future trips.6 In March 2008, HealthSouth CEO Jay Grinney estimated that the fraud cost the company $1 billion. His estimate was based on legal settlements and associated expenses. It also included $164 million spent on lawyers and accountants to reconstruct the financial statements. By 2008, HealthSouth had employed 22,000 employees, a drop from a high of 52,000 in 2002.7

5

Adam Nossiter. Ex-Governor of Alabama is Ordered Released. The New York Times. March 28, 2008 Whitmire, Kyle. Openers: Suits; Did Anyone Ask About a Yacht? The New York Times. April 15, 2007.

7 Hubbard, Russell. CEO Puts Recovery From Fraud at $1 Billion. The Birmingham News. March 27, 2008.

6

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Case 10: Herman Miller: Eddie, Get Off That Chair Case Summary The Herman Miller case shows how a stakeholder issue such as the natural environment can be firmly entrenched in the decision making process of a firm. With a commitment from its founder, D.J. De Pree, Herman Miller has been a pioneer is focusing on environmental sustainability. The establishment of the Environmental Quality Action Team (EQAT) highlights another example where the concepts from Total Quality Management have been adjusted to serve other needs by the firm. Herman Miller incorporates a number of critical components in its EQAT program including eco-design, ISO 14000 certification, pollution reduction strategies and energy reduction.

The design for the environment program uses a cradle to cradle (instead of cradle to grave) approach for new product development. Herman Miller has taken complete ownership of its products which means they have made themselves responsible to ensure that their products can be easily broken down and recycled when they are no longer in use.

The Eames chair shows Herman Miller’s commitment to their environmental sustainability strategy. When the company realized that one of their most famous chairs, the Eames chair, used tropical forest rosewood, Herman Miller decided to substitute walnut and cherry for the rosewood to re-enforce their environmental commitment.

Links With Chapters Primary Chapter 4-Corporate Social Responsibility Chapter 5-Environmental Issues Chapter 8 Corporate Culture Chapter 10-Code of Ethics Chapter 11-Evaluation of Corporate Ethics Secondary Chapter 3-Stakeholder Relationships Chapter 8-Strategic Planning

Teaching Note Both the Herman Miller case and the Interface case are good examples to complement Chapter 5 on the natural environment. The long term commitment Herman Miller has to environmental sustainability has moved the company beyond mere environmental compliance to being a forerunner in progressive strategies pertaining to environmental sustainability. You can ask the students whether they were surprised to see a relatively short in length environmental policy statement for a highly environmentally committed

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firm. The answer to this question is that if the goals are aggressive enough and broad enough, there does not need to be a lot of content in the environmental policy statement.

The decision of the Eames chair is an excellent example of a firm not only “talking the talk” but also “walking the walk”. Herman Miller is so committed to sustainability that the company was willing to disrupt the composition of one of their most famous products, the Eames chair, which was shown on the Today Show and Frasier. (If you did not watch Frasier, the name of the dog on Frasier was Eddie, hence the subtitle “Eddie Get off that Chair”). You could ask the students if they could name an example of another company that was willing to risk one of its most popular products in order increase their level of environmental sustainability.

Questions for Thought 1. Why should companies focus their efforts on sustainability issues?

There are two major reasons why companies should focus their efforts on sustainability issues. The first reason is that their stakeholders are demanding a high level of environmental sustainability. Whether it is the government, the customers, the suppliers, or the local community, the stakeholders want firms to become more and more environmentally sustainable. The second reason is to satisfy the stockholders of the firm.

By definition environmental sustainability means that the firm has long term access to the raw materials and other components in the manufacturing process to continue to make the products and provide services that the company offers. Therefore, stockholders expect long term growth opportunities for the firm and those opportunities will come when the firm has been able to lock in a long term environmentally sustainable supply of materials needed to generate a profit.

2. What stakeholders should companies such as Herman Miller focus on when adopting sustainability initiatives?

As was mentioned in Question 1, all the stakeholders would be addressed as it relates to the issue of environmental sustainability.

Customers From a sustainability standpoint, customers are demanding more environmentally sustainable products. As a result, firms can continue to use environmental sustainability as a way to enhance their competitive advantage.

Suppliers The suppliers are on the same page as Herman Miller. In order for Herman Miller to progress with their sustainability commitment, they must be on the same page as Herman Miller. Therefore, Herman Miller’s suppliers must agree to be as committed to environmental sustainability as Herman Miller is.

Government Herman Miller is also in agreement with the government in the long term level of sustainability of the firm. Government regulations continue to move the discussion away from voluntary sustainability commitments and toward required sustainability

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commitments. As of this writing gasoline in the United States is close to $4 a gallon and both firms and the government are looking at avenues available to increase the long term sustainability of energy products and demand for fossil fuels continues to skyrocket.

Local Communities The local communities also embrace long term environmental sustainability because this course of action would reduce the negative environmental impact in their communities.

For example, if pollution reduction and byproduct elimination are incorporated in the manufacturing process, local communities may not be as defensive in presenting a NIMBY defense if a new facility is developed in their local area.

Stockholders As was mentioned in the previous question, stockholders have a vested financial interest in environmental sustainability. Stockholders are always looking for future growth opportunities for the firm. If the firm has incorporated environmental sustainability into their strategic decision making process, the firm can “guarantee” that the resources will be there in the future to continue to produce the products and services needed to generate sales and profits.

3. Comment on Herman Miller’s proactive stance concerning rosewood in its Eames chairs.

As was mentioned previously, the Eames chair decision it the classic example Herman Miller can show any doubters pertaining to their environmental commitment. By taking the risk of changing a critical component in the chair to address its environmental sustainability philosophy, Herman Miller has shown that without hesitation that environmental sustainability will supersede any current strategic focus of the firm.

Additional Resources A complete summary of Herman Miller’s environmental commitment can be found at Herman Miller’s web site: http://www.hermanmiller.com/CDA/SSA/Category/0,1564,a10-c382,00.html.

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Case 11: Interface: More Than Just a Carpet Company Case Summary Interface is considered a shining beacon when it comes to discussing environmental sustainability. Interface is one of the best known examples of a firm that has a complete dedication to sustainability. Started as an epiphany by its founder Ray Anderson, Interface has become the model in which other firms have tried to copy or imitate. After reading Paul Hawken’s The Ecology of Commerce and Ishmael by Daniel Quinn, Anderson established an “Eco Dream Team” that was composed of some of the leading experts on environmental sustainability. It is from this Eco Dream Team that integrated ideas were created that would be implemented throughout all of Interface’s operations.

Since Interface is a carpet manufacturing company, one of the benefits for the company was that is was very simple and easy to observe how eco friendly changes could impact the manufacturing process. With the use of synthetic materials and numerous dyes, carpet manufacturing can easily become an environmentally “toxic” area if a firm is not committed to environmental sustainability.

In addition, Interface visualized the eco challenges by using the analogy of Mount Sustainability which the employees must climb. Through the seven phases of waste elimination, benign emissions, renewable energy, closing the loop, resource-efficient transportation, sensitizing stakeholders and the redesigning of commerce, Interface is able to reduce its environmental footprint on the world.

An inexpensive and effective way Interface reduces waste is through the Quality Utilizing Employee Suggestions and Team (QUEST) program. By allowing employees to make suggestions which are implemented through the firm, Interface not only saves money ($300 million in 2005), but it also allows the employees to buy in and become committed to the environmental sustainability program with Interface.

Interface has moved beyond the 7 faces of Mount Sustainability to embrace other sustainability issues such as the use of renewable energy and the reduction of greenhouse gases.

Links With Chapters Primary Chapter 3-Corporate Social Responsibility Chapter 5-Environmental Issues Chapter 8-Corporate Culture Chapter 10-Code of Ethics Chapter 11-Evaluation of Corporate Ethics Secondary Chapter 3-Stakeholder Relationships Chapter 8-Strategic Planning

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Teaching Notes A good three minute video which presents an overview of Interface’s environmental commitment produced by the Sundance channel and can be found at http://www.youtube.com/watch?v=BerHLW6KhRY. In addition, there are two other excellent videos in which Ray Anderson describes Interface’s Mount Sustainability found at http://www.bigpicture.tv/videos/watch/e00da03b6 and http://www.bigpicture.tv/videos/watch/1385974ed. The showing of both videos together would be a good way in which you could open up the discussion on the Interface case.

Since the focus of Interface is on Mount Sustainability, one assignment you could consider giving your students is for them to evaluate another company, maybe even a competitor, on the seven criteria used by Interface. This comparison would help the students understand that there are probably very few firms that have the complete environmental commitment that Interface has. Furthermore, you could ask how Interface is using the environmental sustainability commitment as a way to enhance their competitive advantage.

Questions for Thought 1. Identify and research the companies that are part of the Envirosense Consortium.

Do you believe that any of these companies are as committed to sustainability as Interface?

There are currently seven members of the Envirosense Consortium which are: Airsept, Bentley Prince Street, The Center for Health Design, InterfaceFLOR, Interface, Inc, Rocky Mountain Institute and Southface Energy Institute.

Airsept (http://www.airsept.com) Airsept creates products for air conditioning and air treatments. In addition, it has developed a spray which reduces air odor.

Bentley Prince Street (http://www.bentleyprincestreet.com) Bentley Prince Street is a subsidiary of Interface and is also a carpet manufacturer for both residential and commercial use. All of their products are Environmentally Preferable Product (EPP) certified for carpet. Not surprisingly, employees at Bentley Prince Street also climb up Ray Anderson’s Mount Sustainability.

The Center for Health Design (www.healthdesign.org) The Center for Health Design is a non profit research and advocacy organization that focuses on improving the environments of healthcare settings through better building design. The Center helps architects and other building designers to present more “healing” layouts of buildings.

InterfaceFLOR (http://www.interfaceflor.com) Interface FLOR is also a subsidiary of Interface and abides by the same environmental commitment as Interface does.

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Rocky Mountain Institute (http://www.rmi.org) The Rocky Mountain Institute works with firms and community groups to improve the use of resource efficiency. The Rocky Mountain Institute has developed the Green Development Services (GDS) which helps architects and real estate developers create more energy efficient and eco friendly designs.

Southface Energy Institute (http://www.southface.org) The Southface Energy Institute’s mission is to provide assistance in the development of sustainable homes and workplaces.

Since three of the seven members are part of Interface, it is safe to say that Interface has the largest level of commitment to the Envirosense Consortium. Since three of the other four members are involved in building design, it is apparent that Interface has been able to establish a competitive advantage with its long term focus on environmental sustainability.

2. Interface makes its commitment to sustainability issues seem so simple. Why don’t other companies follow its example?

A trait of a well run company is that they make everything seem so simple. By having complete commitment of every employee within the company, it is very easy to implement any strategy since each employee knows exactly what their job is in the execution of the strategy and every employee is motivated to do the best job he/she can in fulfilling the firm’s strategy. It could be argued that other firms may have tried some of the sample sustainability actions as Interface but may have given up do to the lack of total commitment of the employees. For Interface, their corporate culture is critical to ensure the long term commitment of environmental sustainability. As founder Ray Anderson has firmly entrenched, a corporate culture not only supports sustainability, but demands sustainability.

3. Define sustainability. What’s so important about sustainability from a business perspective?

The definition of Environmental Sustainability in Chapter 5 (p. 95) is “the ability of an organization or a country to protect the use of future resources by properly maintaining and protecting the resources that are currently being used”.

As was stated in Chapter 5, sustainability is critical in that is serves the needs of all the stakeholders. Stockholders want environmental sustainability since it will guarantee future profits; suppliers want environmental sustainability since these businesses depend on the long term success of the firm; the employees want environmental sustainability since it could help them be employed by the firm for the long term; the government wants environmental sustainability because it means less time and money going after violations; and the local community wants environmental sustainability since it could protect the environmental integrity of the area.

Additional Resources Interface is included in a number of parts of the documentary, The Corporation. You may want to consider using clips from this documentary in your class. Most, if not all, the

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parts of the documentary are available on YouTube. A more detailed description of Interface’s environmental sustainability commitment can be found at their web site (http://www.interfaceinc.com/).

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Case 12: Livedoor: Ethical Issues In Japan Case Summary Livedoor is an example of how the founder of the company Takafumi Horie manipulated the financial statements for his own benefit. Horie was considered an outsider in Japanese business circles since he was very aggressive in his business strategies and did not follow the traditional business norms of Japan. Livedoor’s business model was to provide Internet based products for its customers. The products included: online consulting; telecommunications; Internet advertising; online dating; and software development. From 2001 to 2004, Livedoor had acquired thirty companies and its stock had split four times during that same time period.

Horie would use the inefficiency of the stock exchanges in Japan in order to try and manipulate the stock price. He also introduced a number of stock splits which also put upward pressure on Livedoor’s stock. While the products of Livedoor were high technology, the fraud was the old original “pump and dump” strategy. Horie would do whatever it took, including providing fraudulent financial statements, to increase the stock price. He would then sell the stock at the peak and take the “winnings” while others would suffer the losses. On January 23, 2006, Horie was arrested by Tokyo police on the suspicion of releasing false financial information to purposely mislead investors.

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Major Players in the HealthSouth Fraud Name

Title

Charges

Result

Takafumi Horie

Founder/CEO

*False Financial Statements *Securities Law Violations *Accounting Fraud

*2 ½ Years Prison

Ryoki Miyauchi

CFO

*Fraud/False Financial Statement

*20 Months Prison

Fumito Okamoto

Board Member

*Fraud

*1 ½ Years Prison *3 Years Suspended Sentence

Osanari Nakamura

Livedoor’s Finance Company’s President

Taishin Hisano

External Auditor

*Aiding Falsifying *10 Months Financial Statements Prison

Motoshi Kobayashi

External Auditor

*Aiding Falsifying *12 Months Financial Statements Prison *Suspended Sentence

*1 ½ Years Prison *3 Years Suspended Sentence

Links With Chapters Primary Chapter 2-Individual Ethical Integrity and Unrealized Unethical Behavior Chapter 7- Information Technology Chapter 9-Finanical Reporting Secondary Chapter 1-Individual Ethical Duty Chapter 3-Stakeholder Relationship Chapter 4-Corporate Compliance Chapter 8-Strategic Planning and Corporate Culture

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Teaching Note Livedoor is a classic example of a renegade entrepreneur who not only introduces a new business model but also introduces ways to exploit the traditional ways of doing business in Japan. Horie realized that by not playing by the rules, he could manipulate the stock price of Livedoor by continuously announcing stock splits and buying stock after hours.

Again, these actions were not considered part of a normal strategic focus of a traditional Japanese company and Horie knew this. As a result, it gave him an opportunity to commit fraud under the disguise of a new business model which was difficult to evaluate.

However, the increase in stock price put pressure on the financial results of Livedoor so Horie also had to manipulate the financial statements in order to “justify” the high stock price. Of course, the goal of any fraud is to capture the “profits” which Horie did by selling the stock at a higher and higher price.

One question to ask your students is why didn’t someone come out earlier and challenge Horie. Couldn’t some of the established business leaders who took exception to his brashness start to ask questions pertaining to Livedoor’s operations? The simple answer to this could be that the business leaders did not want to be any part of Livedoor and they felt by commenting on its operations, all they were doing was adding creditability to Livedoor’s business model.

Another question to ask is why Horie thought he could get away with the fraud. Again, as is the case with a number of CEOs in this textbook, Horie probably thought he was smarter than other people so he could hide the fraud and as long as the people helping in the fraud are rewarded with money, they would not co-operate with the authorities. The one problem with that assumption is that all the collaborators do not have a conscience.

Questions For Thought 1. Many of the strategies used by Horie were considered contrary to the Japanese style of doing business. Comment on the perceived use of these techniques by Horie.

From the beginning Horie wanted to be different and separate from the traditional business leaders. This could be due, in part, to his ego and in part his belief that being different makes you stand out and, therefore, it can be converted into generating new customers and investors. Furthermore, Horie realized that if he played by the rules, the fraud would have been much more difficult to implement and certainly much more difficult to cover up. This could be that since his business strategies were different, he could “fool” traditional investors and the monitoring government agencies by stating that the “traditional” methods of analyzing a business were not relevant at Livedoor.

2. Comment on the ethical issues surrounding the after-hours buying of stock to take over another company.

Again, this is an example of Horie not playing by the “rules” established by the traditional business leaders. It is not that Horie was the only one to realize that this type of trading could take place. It could be that there was, in essence, a gentleman’s agreement that we all realize that this is a limitation of the stock exchange and it is agreed that no one will take advantage of it. Of course, Horie did not listen to the business

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establishment before, so there certainly would not be any reason for him to listen to them now.

3. What, in your opinion, led to the ethical dilemmas at Livedoor?

It could be perceived that Horie was looking at this whole process as a game in which Livedoor is his entry into the marketplace. The objective of the game is to accumulate as much money as you can as quickly as you can. It was an additional bonus for Horie to be young so that he could say at this age I was worth this much and at this age I was worth this much. This could explain why Horie had a fixation on market capitalization instead of the traditional revenue. Market capitalization equals net worth.

Update On March 16, 2007, Takafumi Horie was found guilty of securities fraud and was sentenced to two and one half years in prison.1 On March 23, 2007, Livedoor was ordered to pay a fine of $2.4 million (280 million Yen) which was the highest in Japanese corporate history for violating securities laws. In addition, its marketing subsidiary was ordered to pay a fine of $338,000.2

1 2

Onishi, Norimitsu. Ex-Internet Tycoon in Japan Guilty of Fraud. The New York Times. March 16, 2007.

Associated Press. Livedoor Given Japan Largest Corporate Fine. The New York Times. March 24, 2007.

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Case 13: Lucent Technologies: What Does FCPA Stand for Again?

Case Summary The Lucent Technologies case is an excellent example to show how the actions by one party to guarantee a contract from another party can slowly move from being “helpful” to giving bribes. Lucent Technologies was very “helpful” to Dr. Ali Al-Johani by flying him from Saudi Arabia to Seattle for cancer treatment and donated $2 million to the cancer center. Dr. Al-Johani was in charge of making the decisions on the type of telecommunications that would be used in Saudi Arabia. One of Lucent’s former partners in Saudi Arabia, Silki-La-Silki sued Lucent because Lucent had taken over the subcontracting function that Silki-La-Silki had previously performed. Silki-La-Silki claimed that Lucent used its influence it had with the Saudi government to have the Saudis cancel the subcontract with Silki-La-Silki. Silki-La-Silki claimed that Lucent was guilty of extortion and bribery by paying decision makers within the Saudi government in order to receive preferred treatment when telecommunications contracts were going up for bid.

The United States governed the investigation of the action taken by Lucent to determine whether Lucent was in violation with the Foreign Corrupt Practices Act (FCPA). As mentioned in Chapter 4, FCPA bans any United States based company from offering financial incentives in return for securing business from another party. The investigation focused on the fact that Lucent had been able to secure $5 billion in contracts from the Saudi government and it appeared that Lucent always “won” the large contracts with the Saudi government. It was alleged that Lucent had paid Dr. Al-Johani between $15 and $21 million over an eight year time period from 1995 to 2003. After Siemens had complained that Lucent had been receiving all the contracts, the next set of decisions included Lucent still receiving the bulk of the contracts but some additional contracts were given to Siemens.

In addition, Lucent’s CEO, Richard McGinn resigned in 2000 after it was discovered that Lucent had misrepresented its financial statements by incorrectly recognizing quarterly revenue by more than $670 million in September 1999. Lucent also had problems with bribes when nine former Lucent employees were charged with giving customers illegal financial incentives in return for increased orders for the customers. Furthermore, Lucent fired two of its top executives in a Chinese subsidiary for allegations of bribery.

Links With Chapters Primary Chapter 2-Individual Ethical Integrity Chapter 3-Stakeholder Relationships Chapter 4-Corporate Governance

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Secondary Chapter 1-Individual Ethical Duty Chapter 7-Information Technology Chapter 8-Strategic Planning and Corporate Culture Chapter 10-Code of Ethics Chapter 11-Evaluation of Code of Ethics Teaching Note As was stated in the case summary, this case is an excellent example to use with Chapter 4. By identifying how Lucent “helped” the decision makers for the Saudi government, the students will realize how easy it is to try to influence the decision making process through financial incentives. To highlight how much control Lucent had in the decision making process, it appeared that Lucent became almost a consultant for the Saudi government on how to deal with telecommunication bids. In fact, it appeared that the head of Lucent’s Saudi operations advised the Saudi government to give the additional contracts to Siemens in order to silence their protest. One mistake they made was giving all the major contracts to Lucent. This raised justifiable concerns from Lucent’s competitors asking how they were always able to win the Saudi’s contracts.

You could ask your students what they would and would not do in order to secure a favorable long term relationship with one of the wealthiest nations in the world. If the Saudi minister had told them that they needed the corporate jet to fly to Seattle for cancer treatment, what would their response be? It is important for the students realize that it is very difficult to draw a line in the sand (excuse the pun) as to what is acceptable and what is not acceptable. In other words, giving financial incentives is a slippery slope in which there is no turning back. As soon as you okay one favor you have to okay the next favor because you okayed the first favor. You could also ask what should happen to the head of Lucent’s Saudi operations, John Heindel, and the CEO, Richard McGinn, since they were both involved directly in the decisions pertaining to the relationship with the Saudi government.

Questions for Thought 1. Explain the Foreign Corrupt Practices Act. The description of the Foreign Corrupt Practices Act (FCPA) can be found on pages 78 and 79 in Chapter 4. FCPA forbids United States based firms and their subsidiaries from giving foreign government officials any financial incentives in exchange for either obtaining or retaining any government business in that country. FCPA is the only major government regulation in the world that makes it illegal to pay bribes in order to receive favorable actions from government officials.

2. Why would Lucent’s top management get involved with these types of arrangements?

There are two reasons why top management would get involved. The first reason is that the Saudi government probably demanded that top management get involved. The Saudi government wanted to deal with the decision makers at Lucent. As a result, only top level

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managers would have the authority to make instant decisions when needed in order to expedite the contract process. The second reason is that top management probably wanted to be involved. It is very important for Lucent to have these strong long term relationships with governments that have a lot of money to spend on telecommunication contracts. Therefore, the top mangers wanted to make sure they controlled the negotiations and the transfer of information from Lucent to the Saudi government.

3. Do you think Lucent’s top management properly examined the consequences of their actions? Explain.

The answer to this could be yes and no. No, in that top managers probably started to lose the “big picture” focus of these negotiations. When the Saudi government moved from being a customer to being a friend, the objectivity of the top managers at Lucent disappeared. As a result, it is much easier to rationalize helping a friend as opposed to helping a customer. The answer also could be Yes since top management may have made a calculated risk in providing these financial incentives. They could have calculated the probability of getting caught, the probability of going to trial and the probability of serving prison time and decided that the risk was worth it. In hindsight, there calculations were correct (See Update).

Update The two major players in the case, head of Lucent’s Saudi operations John Heindel and former CEO Richard McGinn, appeared to come our on top after all. Based on current research, neither man was ever charged with the allegations of bribery while they were employed at Lucent. In addition, after McGinn resigned from Lucent he received a severage package that included a one time payment of $5.5 million and Lucent paid off his $4.3 million in bank loans. In addition, McGinn received a $1 million a year pension for life from Lucent and Lucent vested and bought back $3.7 million in stock options from McGinn.1 McGinn is currently a partner with the venture capital firm, RRE Ventures.

On August 1, 2005, PECO II announced the appointment of a new President and CEO, John G. Heindel. PECO II is a manufacturer of telecommunication power systems and provides different types of equipment for the telecommunication industry. James L Green who stepped down as CEO of PECO II stated that “John Heindel is a strong leader whose demonstrated success in delivering revenue and profit growth in competitive arenas is ideally suited for PECO II as it takes advantage of markets that appear to be increasingly favorable…With our stable operation, cash flow and balance sheet, and major new contracts in place, we now embark on an exciting period under his direction”.2 Heindel became Chairman of the Board in June 2006…an exciting period indeed.

Taub, Stephen. Phone Bill: Lucent’s Hopkins Receives Hefty Severance Package. CFO.com August 14, 2001.

2 http://www.secinfo.com/d14D5a.z4m66.b.htm 1

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Case 14: Martha Stewart and ImClone: What Color Goes With Prison Gray?

Case Summary In one of the most high profile ethics cases over the past ten years, the Martha Stewart case is unique in a number of ways. While Martha Stewart was tried and convicted, it wasn’t for the initial crime of the investigation. In addition, her crime did not have a direct relevance to the operations of her company, Martha Stewart Living Omnimedia.

Martha Stewart had become good friends with a CEO, Samuel Waksal, of a small biopharmaceutical company called ImClone. Through this relationship, Stewart had bought ImClone shares. While travelling to a vacation in Mexico for New Year’s Eve in 2001, Stewart checked her phone messages and there was a message from her broker, Peter Bacanovic. Stewart called the office and was not able to get in touch with Bacanovic so she talked to Bacanovic’s assistant, Douglas Faneuil. The information that Bacanovic had was that Waksal and his daughter were dumping their ImClone stock just as the FDA was deciding whether to approve ImClone’s cancer drug to treat neck, head and colon caner. Bacanovic realized that Waksal had been told that the FDA was not going to approve the drug.

Stewart ordered Faneuil to sell 3,928 shares of ImClone stock to avoid a subsequent loss of $45,673 since the following day the FDA would announce that ImClone’s cancer drug, Erbitux, was not approved. The only reason this transaction came to light was that House Energy and Commerce Committee was investigating the time delays involved in the FDA approving drugs and ImClone asked to attend a hearing to explain their experience.

During that time period Peter Bacanovic informed the SEC that both he and Stewart agreed to sell their ImClone stock when it reached $60. Stewart went to the U.S. Attorney’s office and told investigators that she did not receive any insider information pertaining to her ImClone transaction. At the point, the focus of the committee shifted from the approval process of experimental drugs to Stewart and Bacanovic’s stock transactions involving ImClone stock. Waksal resigned as CEO and refused to testify before Congress and was subsequently arrested for insider trading.

In October 2002, Faneuil pled guilty to accepting money in return for withholding information from the authorities and Waksal pled guilty to fraud, perjury and obstruction of justice. In January 2004, Stewart was indicted for obstruction of justice, perjury and making false statements. She was not charged with insider trading which was the original focus of the investigation. All of the charges she faced were based on her actions to cover up her insider trading allegations.

The two critical pieces of evidence at Stewart’s trail was the ‘60’ notation in Bacanovic’s working papers on Stewart’s ImClone holdings which appeared to be written in a different ink than the rest of the working papers. The second key piece of evidence was the alleged tampering of the phone log from Stewart that stated that Bacanovic’s believed the stock price was going to fall. On March 4, 2004, Martha Stewart was found guilty of one count of conspiracy, one count of obstruction of justice and two counts of making

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false statements. Peter Bacanovic was found guilty of conspiracy, obstruction of justice, making false statements and perjury. Both were sentence to 5 months in prison and 5 months of house arrest with Stewart paying a fine of $30,000 and Bacanovic paying a fine of $4,000.

Major Players in the Martha Stewart Scandal Name

Title

Charges

Result

Martha Stewart

Founder/CEO

*Obstruction of Justice *Conspiracy *Making False Statements

*5 Months Prison *5 Months House Arrest *$30,000 Fine

Peter Bacanovic

Stock Broker

*Perjury *Obstruction of Justice *Making False Statement *Conspiracy

*5 Months Prison *5 Months House Arrest *$4,000

Douglas Faneuil

Stock Broker

*Accepting Money For Withholding Information

*$2,000 Fine

Samuel Waksal

CEO

*Fraud *Perjury *Obstruction of Justice

*7 Years and 3 Months Prison *$4 Million Fine

Links With Chapters Primary Chapter 1-Individua Ethical Duty Chapter 2-Individual Ethical Integrity and Unrealized Unethical Behavior Chapter 4-Corporate Compliance Secondary Chapter 3-Stakeholder Relationships Chapter 4-Corporate Governance Chapter 8-Strategic Planning Chapter and Corporate Culture

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Teaching Note The Martha Stewart case is an excellent example to demonstrate that the cover-up can be worse than the crime. The fact that she was even investigated was random luck on the part of prosecutors based on a Congressional hearing on the approval process for experimental drugs. Instead of either telling the truth or refusing to answer based on her 5th Amendment rights, Stewart lied to government officials including the FBI. She quickly learned you do not lie to the FBI. The net result was that she was never charged with insider trading. In fact, insider trading is not commonly brought to trial since it can be very difficult to prove a direct link of information from the insider to the person making the stock transaction. The Stewart case was an example of this strategy by prosecutors. It is apparent the prosecution believed they had a much strong case on the cover up than insider trading so they never charged her with insider trading even though that was the original focus of the investigation.

With a cover up, the most difficult aspect is to keep all the co-conspirators telling the same story and not giving any valuable information to the prosecution. The problem with this strategy in the Martha Stewart case was that all the people involved did not have as high a stakes in the outcome of the trial as Stewart did. Since she was a high profile celebrity, any conviction would be crippling for her reputation. This was not the case for Bacanovic and Faneuil. Their motive was just to get the case over with and try to have as lenient punishment as possible. Furthermore, if you are going to cover up your actions, you probably do not want to brag about your connections with insiders at Christmas parties.

A good question to ask the students would be if your broker told you to sell stock quickly today without any explanation would they do it. Would they still do it if the broker said he heard a rumor about the FDA not approving a critical drug? How about if the broker saw that the founder was selling stock but the broker did not have any information as to why he was selling his stock? This line of questioning can show the gray area of insider trading. The next set of questioning would be after the insider trading had taken place what would they tell the FBI. What would they tell the FBI if there was a 99 percent they could get away with it? Again, this pattern can highlight the slippery slope that can be taken by the decision maker.

Questions For Thought 1. For $45,673, a very public figure ruined her image. Why? It is quite clear that Stewart first of all thought she was never going to get caught and once caught thought she could successfully cover up the crime. In addition Stewart could be called a dual Ego personality. By being both a CEO and a high profile celebrity, she is used to favors and information. As a CEO, she is privy to confidential information everyday. In her mind, it could have been one more example of receiving propriety information. As a celebrity she is used to having favors given to her. As a result, it would be very natural for her to expect to receive preferred treatment from her broker just as she would expect it from any service she uses. Therefore, since she is close friends with the

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CEO of ImClone and is a preferred client at Merrill Lynch it is EXPECTED that she would receive information before anyone else.

2. Perjury is a serious charge. Was five months in jail enough time to ser for perjury?

Of course, you can continue to have discussions on what is the fair punishment for any criminal act, including perjury. However, as the question mentions perjury is serious in that it is the underlying fabric of the justice system. It is not only expected but it is a mandatory requirement that witnesses tell the truth under oath in the legal system.

Without this safeguard, the justice system would fail to function. That being said, Stewart probably received a relatively generous sentence, in part, because of her celebrity status and in part as was mentioned in question 1, the negative impact on her reputation was much more significant than her prison time.

3. How many cases of insider trading really occur within the time span of a year?

As was mentioned in question 1, there are probably numerous cases of insider trading occurring all the time in the marketplace. The difficulty is to prove that insider trading has taken place. From using code words to have discussions outside a work setting, it is very easy to transfer information from one party to another without being detected.

Update In May 2007, Martha Stewart and her company, Martha Stewart Living Omnimedia, settled a class action lawsuit with its shareholders for $30 million for money that the shareholders loss during ImClone scandal. Of the $30 million, Martha Stewart agreed to pay $5 million.1 In January 2008, Abbott Laboratories sued ImClone for patent infringement. Abbott claimed that ImClone’s only drug Erbitux was developed using a patented method for creating antibodies that was developed by Abbott.2 All things seem to be back in equilibrium in the Martha Stewart empire. Even though she can not be CEO due to the terms of her conviction (she is chief creative officer), her vision continues to expand the business opportunities of her company. She introduced a new line of textiles for Macy’s in the fall of 2007; a line of fine China in November 2007; and she acquired the rights for Emerill Lagasse’s franchise in February 2008. In addition, as of this writing Martha Stewart’s Cookies recipe book is in The New York Times Best Seller list. Speaking of cookies, if you want to show Martha almost killing Cookie Monster, show this clip (http://youtube.com/watch?v=-FYvxa9RKp0&feature=related).

In addition, at some point in your discussion you have to show “I just want to focus on my salad” clip from the CBS Early Show where Jane Clayson from The Early Show wants to ask Martha some hard hitting questions during Martha’s cooking segment.

Listen for how loud the chopping to the lettuce is at the beginning of the clip…Enjoy. (http://www.cbsnews.com/sections/i_video/main500251.shtml?source=nav_video) If this link does not work you can go to CBS.com and type “Martha Stewart on ImClone” in the video search function (May 21, 2004).

1 2

Reuters. Settlement for Martha Stewart Investors. The New York Times. May 31, 2007.

Olson, Elizabeth. Vans and Skeechers, squaring Off In Court. The New York Times. January 6, 2008

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Case 15: McWane: A Dangerous Business Case Summary The origin of this case comes from an award winning documentary of the same name on PBS’s program Frontline. McWane: A Dangerous Business was a joint investigation from The New York Times, Frontline and the Canadian Broadcasting Corporation (CBC). The program was first broadcasted in 2003 and highlights the horrendous working conditions within the plants of the pipe manufacturer, McWane. A privately held company headquartered in Birmingham, Alabama, McWane not only kept private information pertaining to their financial performance, but they also attempted to use their privately held status to not disclose numerous labor violations within their plants.

The violations were so egregious that McWane held the dubious title have having more work related injuries from its employees than all its major competitors combined. The injuries included not only broken bones and sprained muscles but also amputations of limbs and in some cases death. The major foundation of management’s philosophy of McWane came from the beliefs of disciplined management practices. Disciplined management was based on the same beliefs of McGregor describing a Theory X manager. While at MIT, Douglas McGregor developed Theory X and Theory Y management philosophies. Theory X assumes that all workers are lazy and dislike work and will do whatever they can to avoid putting effort in their work. As a result, management must constantly monitor and evaluate the workers (usually very harshly) in order to improve efficiency. On the other hand, McGregor’s Theory Y is the direct opposite philosophy and belief in which management believes that employees can motivate themselves and do not have to be constantly monitored by management.

From the information in the case, it appears that McWane not only was aware of the working violations but would try to purposely delay the visit of the OHSA inspectors until they tried to correct some of the more blatant violations. As a result, McWane appeared to use the potential penalties and fines from the government as just another cost of production. The fines and penalties did not influence McWane in changing the way they did business in the United States and Canada.

Furthermore, the case also highlights McWane’s lack of regard of environmental violations in both the United States and Canada. As was presented in the case, McWane was accused of dumping toxic waste into waterways, including in their hometown of Birmingham, and violations related to the release of pollutants into the air and within the plant facilities.

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Links With Chapters Primary Chapter 3-Stakeholder Relationships Chapter 4- Corporate Governance and Corporate Compliance Chapter 5- Environmental Issues Chapter 8-Corporate Culture Secondary Chapter 2-Unrealized Unethical Behavior Chapter 3-Corporate Social Responsibility Chapter 8-Strategic Planning Chapter 10-Code of Ethics Chapter 11-Evaluation of Corporate Ethics Teaching Note The best way to approach this case is to take two class periods to present the material.

The students need to watch the Frontline program before they discuss the case. The program is available free online at (http://www.pbs.org/wgbh/pages/frontline/shows/workplace/). In addition, there are a number of supplement materials also available on the Frontline website including the original New York Times articles, the transcripts of the programs, the role of OHSA and the government, the cost of work related injuries and reactions to the program.

The corporate culture at McWane drives the decision making process. The culture was established based on the original beliefs of Frederick Taylor’s Scientific Management of the early 1900s. Taylor would time each operation performed by a worker then calculate the amount of time in which that function should be performed. Therefore, scientifically, managers could increase efficiency within a plant by giving specific time requirements for each function within the worker’s job responsibility. By constantly evaluating and monitoring the employees, management can make the workers much more productive.

This philosophy continues today and as was stated in the case summary, Taylor’s beliefs were converted by McGregor into management styles of Theory X and Theory Y managers.

This scientific method to management allows McWane to blur the lines between work related violations and good efficiency. If one worker can work four machines simultaneously why should McWane not assign this responsibility, even if it would increase the potential risk of a work related injury? Furthermore, McWane could argue that they are not indentured individuals but are free to leave McWane any time they want if they do not like the working conditions or the way they have been treated.

In addition, Frontline went back to McWane in 2008 to update the story to see if the working conditions had changed (http://www.pbs.org/wgbh/pages/frontline/mcwane/).

Again, the program is available for free viewing on the Frontline website. The update

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shows that McWane appears to have made much progress in their treatment of the workers and includes additional features such as an update on some of the workers, McWane’s “current” management philosophy and various interviews. An interesting question to ask your students is which stakeholder or stakeholders influenced McWane to change their management philosophy. Was it the government? The employees? The stakeholder which probably should receive the most credit for changing McWane’s philosophy is the media. It appears that the 2003 Frontline documentary was the root cause for McWane to re-evaluate their treatment of their workers. This re-evaluation may have made McWane aware that they had unrealized unethical behavior that only became realized after it was shown on Frontline.

The two class periods are needed if you want to compare then and now for McWane. You could assign the students to view both programs at their leisure but have them discuss the original program and the case before asking them to view the update program. This would allow the students the opportunity to make a first dramatic impression of McWane’s operations. One starting question to ask the students is how could any company in the twenty first century treat its workers this way in the United States? How could they get “away” with it? Why was the government not more concerned about it?

Why didn’t the workers leave when they realized the working conditions and how they were being treated? The next step could be to have a comparison of the working conditions based on the 2003 Frontline report and the subsequent 2008 report. You could have listed the issues raised in the 2003 report in one column and then the subsequent conditions in 2008 in another column.

Questions For Thought 1. Explain the concept of disciplined management. Has it worked at McWane?

As was mentioned previously, disciplined management has its underpinning from Frederick Taylor’s work on efficiency. The underlying assumption of disciplined management is that a worker is just another tool to be used in the manufacturing process like a stamping machine or a conveyor belt. McWane is paying them to do their job and nothing more. As a result, nothing more is expected or given by the employees. The employees count the hours until they can go home again just so they can start the process all over again tomorrow. As you can see, a circular argument of “Catch 22” develops from this process. The workers are not motivated because of the way they are treated and they are treated terribly because they are not motivated. The critical weakness of disciplined management is the assumption that management has all the answers and the workers have none of the answers. By not asking for intellectual input and instead focusing solely on physical input, McWane is wasting their greatest resource, their employees.

2. Identify the ethical issues associated with the McWane Corporation.

There are three basic categories of ethical issues associated with McWane. The first is McWane’s lack of regard for the needs and expectations of its stakeholders, The second major category is McWane’s treatment of their employees and the third major category is McWane’s treatment of the natural environment.

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Stakeholder Analysis Employees As was mentioned previously, McWane’s horrendous treatment of their employees is the major focus of the case, from broken backs to amputations and in some cases death. After the death of one of the workers, the following bumper sticker was seen in a McWane plant parking lot “Pray for me. I work at Kennedy Value.” Some entertainment critics state the best humor is based on fact. If that is the case, here is your proof. The total disregard for the health and safety of its workers presented such a negative image pertaining to McWane that as was stated in the case, McWane would recruit just released prisoners for jobs because no one in the local community would want to work for them.

Suppliers Suppliers probably had a love hate relationship since McWane would be a dependable client. However, McWane would order less than the previous owners of a plant acquired

by McWane and McWane would only order the bare minimum amount of supplies in order to increase the efficiencies of the operations.

Government The case shows the weak enforcement capabilities of the government. Without the ability to enforce significant fines and sanctions against the company, McWane will view the current level of punishment as a minor inconvenience and just another cost of production Local Community The local community is impacted negatively in two ways based on McWane’s strategic focus. The first is that the negative image of the company creates a negative halo image of the community in which the plant is located. The local citizens are not proud that the plant is located in their town and probably resist working for the company. The local community also faces the continued threat of pollution from the plant impacting the surrounding air, water and land areas.

Stockholders Since McWane is privately held, it is not accountable to external stockholders. This could also be a reason why McWane may have been oblivious to their actions. Since there were no external perspectives in their strategic decision making process, Group Think may develop in which everyone agrees to the course of action since everyone approaches the issue from the same perspective.

3. Research the McWane Corporation. Identify some of the good things it has done.

The updated Frontline program highlights a number of areas in which McWane has made improvements to its ethical focus. In addition, a catalog of areas in which McWane is addressing the needs of its stakeholders can be found at their revised web site (http://www.mcwane.com/index.cfm).

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Case 16: Merck’s Vioxx: How Would You Interpret the Data?

Case Summary The Vioxx case is an excellent example of the kinds of ethical issues addressed in Chapter 6, Health-Care Ethics. The case presents the development and marketing of a major new drug of the pharmaceutical company Merck. As the case states, Merck needed a new blockbuster drug since their existing drugs were going to quickly lose their proprietary patents which would mean they can be developed by other companies as generic versions of Merck’s drugs. It was under this intense pressure that Merck launched Vioxx although the data in the test trials had already raised concerns. Although the potential side effects could lead to death of the patient, Merck continued to move forward with the global marketing of its new painkiller. This is the distinct difference between the pharmaceutical industry and other industries related to potentially “defective” products.

While customer injury could be common with other defects, it would not reach the same range of potential deaths as could take place with a “defective” drug. One ironic point of the Vioxx controversy is that consumers already had the benefits of Vioxx through over the counter (OTC) painkillers such as ibuprofen and naproxen. The benefit of Vioxx is that it would not create a potentially negative impact on the stomach lining of the user as could be the case with continuous use of these OTC products. Therefore, Vioxx patients that could have died due to the direct impact of the drug may still be living if they took a medication that did not require a physician’s prescription.

It appears that, internally, Merck knew from the beginning that there were potential serious problems with Vioxx and these concerns continued once the product was introduced to the public. This could be an example of Escalation of Commitment.

Developed by Barry Staw, escalation of commitment is based on the premise that the decision maker will continue to make decisions that are considered irrational based on previous rational decisions. Escalation of Commitment is commonly used to explain an expansion of resources during a war. In the case of Vioxx, escalation of commitment is based on the rational belief that Merck has a new blockbuster drug to capture the painkiller market. Based on the millions of dollars spent on Research and Development that was approved by top management, top level managers are now committed to Vioxx.

In addition, the potential sales and profit estimates have already been included in the future financial forecasts of the firm. Therefore, the top level managers may have also shown unrealized unethical behavior because they only wanted to accept data that supported the positive aspects of Vioxx and they wanted to ignore the negative aspects of Vioxx. As Paul Simon wrote in The Boxer “Still a man hears what he wants to hear and disregards the rest”.

The escalation of commitment continued when Merck proposed that Vioxx could be used to help children with juvenile rheumatoid arthritis. Merck asked the authors of an academic paper about a clinical trial sponsored by Merck and Harvard Medical School to alter the results of the study to make them less negative.

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In September 2004, Merck finally stopped their escalation of commitment by withdrawing Vioxx from the market place and the legal problems for Merck started. The number of lawsuits were quickly multiplying and ran into the thousands within months.

Merck’s legal strategy was to try each case separately based on their belief that each of the patients had a specific set of health issues that could have contributed to their medical problems that were not related to Vioxx.

Links With Chapters Primary Chapter 3-Stakeholder Relationships Chapter 4-Corporate Compliance Chapter 6-Health-Care Issues Chapter 8-Corporate Culture Secondary Chapter 3-Corporate Social Responsibility Chapter 4-Corporate Governance Chapter 8-Strategic Planning Chapter 10-Code of Ethics Chapter 11-Evaluation of Corporate Ethics

Teaching Note The Vioxx case should bring a lot of lively discussion in the classroom because it highlights how a free market system interacts directly with the health of its consumers.

Although Merck is cognizant of its various stakeholders, it appears that they are making decisions to purely satisfy the needs of the stockholders. It certainly seems that Merck has created undue risk in its customers by putting a product in the market place that can cause permanent damage and even death to its consumers. From an employee perspective, it appears that Merck employees at every stage were well aware of the importance of Vioxx and were either directly or indirectly instructed to ignore the red flags. As is evident from the “Dodge Ball Vioxx” campaign, even the sales representatives were well aware of the risks of Vioxx and kept the company line by agreeing to change the subject when there were questions pertaining to the potential risks of Vioxx. Furthermore, Merck was directly and indirectly involved in medical academic studies in which they allegedly asked for the results of the studies to be changed to give more favorable results related to the consumers’ use of Vioxx. There are a number of questions you could ask to start a good discussion. Is Vioxx a rare issue that is the exception to the rule? How would Merck change its strategy if the United States was under a universal health-care system such as the United Kingdom and Canada? What are Merck’s ethical responsibilities to its patients? What role should Merck have in the publication of the results of medical studies based on one of their products? How should drugs with dangerous and potentially fatal side effects be marketed to the public? At what

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point is a drug to risky to be introduced in the market place? Should Merck have tried to expand their customer base by positioning Vioxx to children?

Questions For Thought 1. What are the ethical implications of the “Dodge Ball Vioxx” document given to sales representatives?

The “Dodge Ball Vioxx” document is certainly one smoking gun in which Merck has to explain its actions. To the layman, the dodge ball campaign is a blatant attempt by Merck to avoid discussing the dangerous side effects of Vioxx. By not only having this as a policy of Merck, but being used to coach the responses of the sales representatives would certainly create outrage to any family whose loved one may have died due to the effects of Vioxx.

2. Do you think this is a case of putting profits first? Explain.

The simple answer is yes. This appears to be a clear cut case in which profits were driving all the decisions made on the introduction and marketing of Vioxx. By ignoring the potential fatal side effects, Merck may have been gambling that there may not be “enough” deaths to create a global outcry over Vioxx. Similar to Ford calculating the cost/ benefit of changing the location of the fuel tank in the rear of its Pinto after a series of fires took place after car crashes, Merck may have calculated the cost benefit of introducing Vioxx in relation to the potential lawsuits of patients and families who claimed that Vioxx had negative impacts on the patients.

3. It took Merck five years to remove Vioxx from the market. Why? This question goes back to the Escalation of Commitment argument. Merck needed Vioxx to turnaround its slow financial growth. Merck had already announced to the market place and the industry that this will be the new blockbuster drug. Therefore, it was very hard to pull the plug on Vioxx. In addition, Merck may have hoped that once the drug actually reached the marketplace, the number of deaths may not have been as high as they had calculated.

Update

By August 2007, Merck had spent over $1 billion in legal fees to defend itself in Vioxx cases. As part of its legal strategy, Merck automatically appealed any judgment against it which not only gives it a potential additional opportunity to present their case but it is not required to make any payments in judgments against the company until after the appeal.

Therefore, two years after Carol Ernst won the first Vioxx case against Merck for the death of her husband Robert, neither she nor any of the 45,000 other plaintiffs have received any money from Merck. In the two years after the initial legal judgment against Merck, its stock price has increased by 80 percent and the estimated legal liability for Merck had decreased from $25 billion to $5 billion. The legal counsel responsible for Merck strategy pertaining to the lawsuits, Kenneth Frazier, was promoted to president of global health division which is in charge of Merck’s marketing and sales forces and includes approximately 30,000 employees.1 1

Berenson, Alex. Plaintiffs Find Payday Elusive in Vioxx Cases. The New York Times. August 21, 2007.

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One month later in September 2007, the Supreme Court of New Jersey rejected a class action lawsuit against Merck for its Vioxx litigation. The Supreme Court ruled that a nationwide class action lawsuit was not appropriate. The ruling was a huge victory for Merck since it was now allowed to continue to try each case separately instead of having the plaintiffs’ resources pooled in a class action motion. The shares of Merck rose over 2 percent to $50.47 after the ruling was announced.2 In what could be considered one of the greatest legal bargains in corporate history, on November 8, 2007, Merck agreed to settle 27,000 Vioxx lawsuits covering approximately 47,000 plaintiffs for $4.85 billion or approximately $100,000 per lawsuit. Therefore, each plaintiff would receive just over $100,000 before legal fees and expenses which can be equivalent to between 30 and 50 percent of the payment. As a result, the average plaintiff will receive between $50,000 and $70,000.3 By March 2008, 44,000 of the 47,000 plaintiffs had signed up to be part of the $4.85 billion settlement.4 In February 2008, Merck agreed to pay $671 million to settle civil legal claims by the government that Merck had overcharged Medicaid health programs for four of its drugs.

In addition, Merck was accused of offering doctors fees and gifts in exchange for the doctors prescribing their drugs. Merck’s response was that there was just “a disagreement” over the rules of the Medicaid rebate program.5 In April 2008, it was released that Merck had drafted numerous research studies pertaining to Vioxx. In other words, Merck representatives had written the research papers and then gave credit to other authors. In one research paper that Merck wanted to have a well known researcher as the lead author, the lead author’s name is not on the paper with the comment “External author?” instead. Merck acknowledged that it would occasionally hire external medical writers to help draft research papers which would be given to doctors whose name would eventually appear on the article. Merck also stated that the authors of the paper were actively involved in the research and/or analysis of the data in the paper. The Journal of the American Medical Association (JAMA) examined published articles pertaining to Vioxx in which they concluded that “It is clear that at least some of the authors played little direct roles in the study or review, yet still allowed themselves to be named as authors”6 In May 2008, Merck paid $58 million to settle civil claims that it down played the health risks of Vioxx in its marketing campaigns. In addition, Merck also agreed to submit all future television commercials to review by the Food and Drug Administration first before

2

The Associated Press. Court Denies Class Status for Plaintiffs Against Merck. The New York Times.

September 7, 2007.

3 Berenson, Alex. Merck Agrees to Settle Vioxx Suits for $4.85 Billion. The New York Times. November 9, 2007 4 The Associated Press. Vioxx Settlement on Track as 44,000 Sign Up. The New York Times. March 4, 2008.

5 The Associated Press. Merck to Settle U.S. Claims for $671 Million. The New York Times. February 8, 2008.

6 Saul, Stephanie. Merck Wrote Drug Studies for Doctors. The New York Times. April 16, 2008.

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they are aired for the next seven years.7 Also in May 2008, Carol Ernst’s $26 million verdict in the first plaintiff Vioxx victory in 2005 was overturned by a state appeals court in Texas. The appeals court found that the plaintiffs had not proven that Vioxx caused Carol husband’s death.8

7 8

The Associated Press. Merck Agrees to Settlement Over Vioxx Ads. The New York Times. May 21, 2008.

Berenson, Alex. Courts Reject Two Major Vioxx Verdicts. The New York Times. May 30, 2008

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Case 17: Music Industry: Ethical Issues in a Digital Age Case Summary This case highlights the stormy relationship between the music industry and its stakeholders. The case shows that the music industry has tried to adapt (sometimes unsuccessfully) to changes that occur in the expectations and needs of its stakeholders, in part, related to the advancement of technology. The case is separated into three major categories: the protection and underpayment of music royalties; using software to limit the copying of songs; and the role of payola in the music industry.

Music Royalties The issue of music royalties is complex and ever changing based on the advancement of digital technologies. The underlying issue related to music royalties is mistrust. The music labels always want the artists to produce more songs in any given recording session and the artists always question whether they are being paid in full for their royalties. This level of mistrust is due, in part, to the structure of the music industry. Once an artist has signed with a music label, they are legally obliged to produce a certain amount of output over a specific time period. This could put significant time pressure on the artists. Furthermore, since the music label markets and sells the music of the artist, ONLY the music label has initial access to how many units of music have been sold by the artist. Therefore, the artist has to take at face value the calculation that is given by his/her label. The problem is that unless the artist challenges the calculation and hires an external auditor to review the sales of the music by the artist, the artist has no method to verify the accuracy of the calculation. Of course, the record label realizes this and if they are unethical, they can underpay the artists their royalties and the artists would never know it. Furthermore, as it highlighted in the case, underpaid is a common practice in the industry and when a label is discovered to have underpaid, their “penalty” is to pay the full amount of the royalties. As a result, there is no risk involved in the underpayment of royalties by the record label.

Using Software to Limit the Ability of Copy CDs The case highlights how Sony’s attempt to limit the ability of the user to make copies of the music from specific CDs backfired. By trying to reduce the consumer’s ability of “casual piracy”, Sony made a number of mistakes, including not notifying the consumers of the software and making it difficult to correct the software problems that were developed once the software was loaded unto a computer. The underlying problem is that Sony views the consumer as the enemy and not an ally. By assuming that all consumers are involved in casual privacy, Sony has made it difficult for the consumers to trust them when they purchase a CD. The Role of Payola Paying to have specific songs played on the radio could be as old as the commercial radio industry. Since the music label want high exposure of their artists through airplay and the radio stations want to have a strong relationship with their suppliers, the record label, there will always be a close relationship between these two parities. The easy rationale

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for payola is that “it is a good song anyway; I just will receive a “bonus” for playing it”.

As the case highlights, even though payola was supposedly wide spread in the 1950s and resulted in government regulations, the issue seems to have reappeared every decade since the 1950s. The high concentration of radio stations within a select few firms has allowed the power of radio play to be determined by a select few individuals which could lead to continued payola abuses in the future.

Links With Chapters Primary Chapter 3-Stakeholder Relationships Chapter 7-Information Technology Secondary Chapter 4-Corporate Compliance Chapter 8-Strategic Planning and Corporate Culture Chapter 9-Financial Reporting

Teaching Note As was mentioned in the case summary, this case highlights the love hate relationship the music industry has with its stakeholders Employees The industry can not survive without the artists however; the treatment of the artists in the past has not always been fair. The industry would try any means possible to reduce the level of royalties given to the artist (See Table 3: Estimated Royalty Payment for a New Band). This mentality may be based on the monopolistic nature of the industry.

Once an artist has signed with a record label, they are indentured to that label. In addition, the artists are not allowed to adjust the contracts that may be warranted after the initial success of the band. Therefore, the record label can legally control the actions of the artists and there is very little recourse for the artists.

Customers Again, the industry has a love hate relationship with the customers. They want the customers to buy as much music as possible but assume that all customers will try to avoid paying for their music if possible. It is ironic that the Recording Industry Association of America (RIAA) targeted the customers with thousands of illegally downloaded songs on their computers for the first wave of lawsuits. Of course, it is logical to target the most blatant abuses but these users are also obviously potential customers who love music in order to take the time to download those thousands of songs. As a result, before ITunes, the industry did not offer a legal method of downloading music and to continue the ironic theme, it took one college student at Northeastern University to develop the method to download music. Why weren’t the music labels working on this digital solution? One explanation could be that the industry had viewed the internet as a threat and not as an opportunity.

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Suppliers The relationship between the music labels (suppliers) and the radio stations (customers) also generated unethical problems. The music labels initial themselves and then through third parties “encouraged” radio stations to play their music. As was mentioned in Chapter 4 of the textbook, where is the line drawn between giving a gift to a friend thanking them end and a bribe or payola begins?

Government The government has played an on - again off again role in the music industry. While the government became actively involved in areas such as payola, they let the music industry associations such as RIAA address copyright infringement policies. Furthermore, the government has not played a proactive role in protecting copyright issues globally. As a result, the industry has had to take on the burden of the responsibility of enforcing the intellectual property of their artists.

Questions for Thought 1. Comment on how widespread illegal transferring is on college campuses.

Even with the advent of ITunes, it is expected that widespread illegal downloading continues globally. People have come to expect to receive content free on the internet.

Whether it is the current news, television programs or music videos, consumers have a strong resistance to pay for internet content. Therefore, if music files are still available on the internet to be downloaded for free, there will still be consumers that will seek that alternative to obtain their music files.

You may want to ask your class if there are any students that download music for free and if so why.

2. Should payola be allowed? What is the real ethical problem with it?

As was mentioned in the teaching note, it can be difficult to determine where a gift ends and a bribe starts. From an ethical perspective, there are certainly more egregious unethical activities that take place than giving a disc jockey a free television set.

However, the real ethical issue is that it gives an unfair competitive advantage to the larger music labels that can afford high price gifts. For smaller labels that have artists which deserve the same opportunity to be played on the radio, payola is an effective tool to shut out the competition.

3. Why do you think Eliot Spitzer became involved in the music industry’s problems?

Eliot Spitzer was a hero to all those artists that received royalties that were withheld by their record label. In addition, he single-handedly brought payola back to the forefront in 2004. Unfortunately, like a Greek tragedy, Spitzer had is own personal ethical issues after he became Governor of New York and some of the luster has come off his accomplishments as Attorney General of New York. It could be said the Spitzer saw the music industry as just another opportunity to increase his “political capital” for his run as

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governor. However, maybe it was just because he saw a wrong that needed to be corrected.

Update In October 2007, Jammie Thomas became the first individual to go to trial for illegally downloading music. The jury found Thomas liable for copyright infringement and was ordered her to pay $222,000 for illegally downloading24 songs. The RIAA has sued over 20,000 users for copyright infringement.1 In May 2008, Barry Gitarts was convicted of conspiracy to commit criminal copyright infringement. Gitarts was charged with setting up a computer server so that an underground file sharing group could trade music files.

The evidence showed that he received payments from the group to maintain the server.

He faces up to 5 years in prison, a fine of $250,000 and complete restitution with the record labels.2

1

Kravets, David. Judge Says First-Ever RIAA Piracy Trail May Need a Do-Over. Wired.com. May 15, 2008 2 Van Buskirk, Eliot. Guilty Verdict In First Online Music Piracy Trail Means Up to Five Years In Jail.

Wired.com. May 23, 2008.

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Case 18: Parmalat: Can You Sue Over Spilled Milk?

Case Summary The Parmalat case is a classic example of how the founders of the firm believe that they are entitled to the financial benefits of the firm, regardless of whether they are entitled to the benefits or not. On many points, the Parmalat case is similar to the Adelphia case.

The grand matriarch of the firm presides over the decisions, which are completely intertwined with the personal benefits given to himself and his family. Calitso Tanzi inherited Parmalat in 1961 and quickly started expanding the commercial reach of Parmalat.

As is almost always the case with financial fraud, questions start to arise when the firm has cash flow problems and/or problems with the releasing of their financial statements.

This is certainly the case with Parmalat which had reported high levels of debt and high cash reserves. It does not take a financial wizard to question why those two facts are inconsistent. Firms try to have as little cash on hand as possible since there are very low financial returns to retaining cash. Furthermore, there is absolutely no reason to have a large cash balance when the firm reports large levels of debt. It is just common sense for a firm to use the cash available to pay down the debt which would yield them a realized return of whatever the interest rate was on the debt.

A Timeline of the Decline of Parmalat In March 2003, Italy’s governmental agency for stock markets (Consob) asked why Parmalat had reported a high level of cash reserves as well as a high level of debt.

On March 28, 2003, Parmalat’s CFO Fausto Tonna resigned while Parmalat reported an increased profit of 15 percent. In August 2003, Consob asked Parmalat to provide all the auditing work done by Deloitte and Touche and Grant Thornton for 2002.

In October 2003, Deloitte and Touche stated they did not have enough relevant information to certify Parmalat’s financial statements for the first two quarters of 2002.

In November 2003, Parmalat announced that they had a significant investment in a Cayman Islands hedge fund called Epicurum.

In December 2003, the CFO of Parmalat, Luciano del Soldato resigned after taking the position less than a month earlier. Parmalat liquidated their investment in the Epicurum fund but stated that they did not receive close to $590 million that was expected from the liquidation. The $590 million was equivalent to 25% of Parmalat’s market value and was due to be paid in December 2003. During the same month, Parmalat announced they had available cash of $610 million. This number had been adjusted downward from $5.14 billion in November 2003. On December 15, 2003, Parmalat’s founder Calisto Tanzi resigned as CEO after leading the company for over 40 years.

The alleged fraud at Parmalat started in the late 1980’s. Parmalat started an acquisition binge so they could grow large enough to become a global player in dairy and food products. Parmalat needed more and more capital in order to finance their acquisition strategy. In a strategy similar to Enron’s, when Parmalat went public in 1987, they

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established shell companies in the Netherlands Antilles to transfer liabilities from Parmalat’s balance sheet. Parmalat would create matching assets that did not exist in order to transfer the liabilities. The estimated losses that were hidden amounted to between $20 million to $540 million from 1995 to 2001. On December 23, 2003, it was estimated that the fraud at Parmalat was over $8 billion. The following day the estimate had be revised upward to approximately $11 billion. The CFO admitted that the fraud had occurred in a systematic manner for the previous 15 years. On December 27, 2003, Parmalat was declared financially insolvent. On December 28, 2003, former CEO Calisto Tanzi was arrested for fraud. Prosecutors alleged that Tanzi had misappropriated at least $600 million during his tenure as CEO. On December 29, 2003, the SEC charged Parmalat with fraud by promoting $1.5 billion in Parmalat bonds that were issued in the United States from 1998 to 2002 based on the fraudulent asset value of the company.

On December 29, 2003, former founder and CEO Tanzi admitted to misappropriating $620 million while prosecutors had raised their estimated to $1 billion. In January 2004, it was disclosed that almost $630 million was transferred from Parmalat to various Tanzi run companies while he was CEO. By January 7, 2004, it was estimated that $1.9 billion was transferred from Parmalat to one Tanzi run business, Parmatour, which was run by Tanzi’s daughter, Francesca.

From 1990 to 2002, it was estimated that former CEO Calisto Tanzi misappropriated at least $1.1 billion of Parmalat’s money. On June 22, 2004, Parmalat filed for bankruptcy protection in the United States to shield its assets from creditors. An estimated $2.8 billion was taken from Parmalat’s cash reserves by Tanzi and his associates. It was estimated that Parmalat’s operating units had a combined loss of close to $2 billion. On August 19, 2004, Parmalat sued Grant Thornton and Deloitte and Touche in the United States for $10 billion for failing to detect the fraud when they performed audits on the firm. Parmalat alleged that Grant Thornton employees not only ignored the fraud but were active participants in the fraud by helping Parmalat managers set up fake companies.

Major Players of the Parmalat Scandal are shown in Table 1.

Links With Chapters Primary Chapter 1-Individual Ethical Duty Chapter 2-Individual Ethical Integrity and Unrealized Unethical Behavior Chapter 3-Stakeholder Relationships Chapter 4-Corporate Governance Chapter 8-Corporate Culture Chapter 9-Financial Reporting Secondary Chapter 4-Corporate Compliance Chapter 8-Strategic Planning

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Teaching Note As was mentioned in the case summary, the Parmalat case should be compared with the Adelphia case because of the many similarities with how the founder controlled both the ethical and unethical operations of the firm. By having a single source of power with the support staff made up of close friends and family members, Lord Acton’s warning of “power tends to corrupt, and absolute power corrupts absolutely” is very appropriate for this case. A good question to start the discussion with in the classroom is how do these founders believe that they could get away with fraud? Did they honestly believe that at no point in time the fraud would be discovered? In addition, as the fraud expands throughout the organization it becomes a cancer that taints all the firm’s operations. As a result, corporate culture plays a key role in discussing the unethical decision making at Parmalat. Whether Tanzi’s subordinates believed the actions were unethical or not, they were ordered to perform the task as part of the Parmalat “family”. One twist to the Parmalat fraud was the low tech use of tools to commit the fraud. It is certainly not expected that a multi-billion dollar company would use a scanner and copied letterheads to commit fraud. In addition, the order to physically destroy computer hard drives seems to have a “primitive” ring to it. It seems that even the most basic of tools can be used to steal millions of dollars away for stockholders.

Questions for Thought 1. Describe the stakeholders in this case. Does one group appear to be more negatively affected than another?

Whenever there is financial fraud committed within a firm, the stockholders will always be the group that receives the largest negative impact. Since fraud is the illegal transfer of funds from one entity to another, the firm and, by ownership, the stockholders are always the most severely impacted by the fraud. A close second group would be the employees.

Based on the consequences and repercussions of corporate fraud, a firm usually has to declare bankruptcy (as was the case for Parmalat in the United States) in order to stop the financial bleeding and get back on course. It is during the re-organization process that takes place during a bankruptcy that some employees permanently lose their jobs while other may only temporarily lose their positions. The third group with the largest impact is the suppliers since a bankrupt firm negotiates with its suppliers for re-payment of goods.

In addition, during the bankruptcy and the re-structuring, Parmalat would not need the same volume of materials as was the case before the financial troubles started. The government in the Parmalat case played a secondary role since it seems that the Italian legal system does not appear to be as aggressive in dealing with corporate fraud as the United States system.

2. Parmalat’s long-shelf-life milk never caught on in the United States. Why not?

The cultural differences between the United States and Italy explain why this type of dairy product would not be successful. In the United States, all dairy products are expected to be refrigerated because that has been the only method of delivery of these products. As a result, generation after generation has entrenched the belief that dairy products must be cold and must be kept in the refrigerator so they would not spoil. In

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Italy, this firmly entrenched belief system has not taken place and Italian customers are more open to have room temperature dairy products. This example show that firms must adjust their products to suit the customers’ tastes from country to country.

3. It seems as the lawsuits continued to be filed, Parmalat began to sue those it felt were involved. For example, Parmalat filed suit against Citigroup. Explain these interactions of continuously trying to find others to blame.

This tactic is commonly used by any firm in which fraud has taken place. By suing others including external auditors and financial institutions that “supported” the fraud, the firm accomplishes two goals. The first goal is to present a defense for its actions. If they can find other who have been identified to be involved in the fraud, it would decrease the impact of the firm’s involvement in the fraud. The second goal is financial. Since most of the firms addressing financial fraud are in poor financial condition, suing is a relatively inexpensive way to try and capture additional capital for the firm. By seeking financial restitution from others, the firm can increase its chances to become financially solvent again.

Update In June 2007, an Italian judge ordered that four banks (Citigroup, Deutsche Bank, Morgan Stanley and UBS) to stand trial for market manipulation based on their actions during the Parmalat fraud. The banks were accused of developing financing for Parmalat even though the banks knew Parmalat had been falsifying their financial accounts. In addition, thirteen executives from the four banks were also required to stand trial for their actions to secure Parmalat funding.1 In May 2008, Parmalat settled a civil shareholder lawsuit in the United States for 24 million euros ($37 million) in Parmalat stock.2

Sylvers, Eric. Trial Ordered in Italy for 4 Big Banks in Parmalat’s Failure. The New York Times. June 14, 2007.

2 Bloomberg News. Parmalat Settles U.S. Shareholder Suit. The New York Times. May 3, 2008.

1

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Case 19: Perfect Payday: How Apple Computer and Others Have Learned to Love Stock Options Case Summary The Wall Street Journal published an article in March 2006 titled "Perfect Payday". In the article, the authors examined companies who had "backdated" stock options in order for their top executives to receive huge financial gains. A stock option gives the recipient of the option a legal right to purchase a set number of shares at a specific price. The set price is called the exercise or strike price. The exercise price is determined by either taking the closing price of the stock the day the option was issued or taking the closing price the day before. Backdating occurs when the stock option stock price is determined based on previous activity in the stock price. Backdating allows the recipients to maximize their gains by selecting the lowest stock price during any given time period.

If a company allows backdating, then it would face additional expenses since the “instant” gain of the backdating is considered equivalent to a bonus to the executive which is considered an expense. After the passage of SOX in 2002, companies were required to report all stock option grants within two day of issuance. As a result, this requirement reduced the ability to backdate options.

UnitedHealth Group UnitedHealth Group was the first firm to be in the spotlight after the Wall Street Journal article of March 17, 2006. UnitedHealth Group focuses on providing health plans to employers and Medicare beneficiaries. A total of twelve stock option grants to UnitedHealth’s CEO William McGuire were investigated in which the calculated odds that the options were issued at the lowest stock price in the reporting period were at least 1 in 200 million that the options were issued by chance. UnitedHealth admitted that it allowed the CEO to pick the stock option dates. It is unlawful to have anyone other than the Board of Directors’ compensation committee determine stock option dates. In April 2006, the SEC announced it was going to investigate UnitedHealth for stock option manipulations.

The SEC released information that showed that at least 11 executives from UnitedHealth profited from backdating stock options. On April 17, 2006, it was announced that Dr. McGuire, UnitedHealth’s CEO had accumulated $1.6 billion in unrealized gains from stock options. On April 18, 2006, Dr. McGuire stated that all issuing of stock options should stop at UnitedHealth but Dr. McGuire refused to give back any of his stock options. When asked whether his stock options had been backdated, Dr. McGuire stated cryptically that they had been issued in a “thoughtful” manner and everyone on the board could sleep well at night. On May 11, 2006, UnitedHealth announced that it would have to restate their financial statements by $286 million for at least three years due to stock options grants. Dr. McGuire agreed to leave UnitedHealth by December 2006.

Affiliated Computer Services Affiliated Computer Services (ACS) works with businesses to help organize accounting, data management and paperwork functions. Affiliated’s CEO Jeffrey Rich was given six

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stock option grants in which there were about a 300 billion to one odds that the options always were at the lowest price by chance. Mr. Rich stepped down as CEO in September 2005. As part of his settlement, ACS paid the difference to Mr. Rich between the exercise price of his 610,000 shares and the closing price the day he resigned. On May 10, 2006, ACS admitted that had issued stock options that it had effective dates before the actual approval date. ACS estimated that they would have to restate their financial statements by $40 million to take into account the expenses of the stock options.

Brooks Automation Brooks Automation is a semiconductor-equipment manufacturer who gave its CEO, Robert Therrien, seven stock option grants that had odds of nine million to one to have the low price by chance. On May 11, 2006, Brooks announced that it would restate seven years of financial information to correct unrecognized expenses from the stock option policy. On May 18, 2006, Brooks announced that two board members that received the favorable May 2000 stock options date had resigned from the board.

Comverse Technology Comverse Technology is a manufacturer of telecom systems and software. The company awarded its CEO, Kobi Alexander, eight grants with odds of 6 billion to 1 that the low price of the stock options happened by chance. On April 17, 2006, Comverse announced that it would have to restate its financial statements for at least five years because of the stock options. On April 30, 2006, Kobi Alexander resigned as CEO. On May 4, 2006, the federal government started a criminal investigation into Comverse’s stock option policy.

He is now a fugitive by the U.S. government living in Namibia, Africa.

Vitesse Semiconductor Vitesse Semiconductor is a computer chip manufacturer who gave its CEO, Louis Tomasetta, nine stock options with a probability of 26 billion to 1 that the low price of the stock options was due to chance. On April 18, 2006, Mr. Tomasetta was put on administrative leave pending the outcome of the internal investigation. Louis Tomasetta was fired on May 17, 2006.

Apple Computer Steve Jobs and other Apple Computer executives were accused of taking advantage of backdating stock options. The initial investigation found that Steve Jobs had one stock option “backdated” but it was cancelled before Jobs could receive any financial gain.

However it was also revealed that Jobs received five million shares of restricted stock in exchange for the cancelled stock option. On December 28, 2006, it was reported that Steve Jobs had been given 7.5 million stock options in 2001 without authorization from Apple’s board of directors.

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Links With Chapters Primary Chapter 1-Individua Ethical Duty Chapter 2-Individual Ethical Integrity and Unrealized Unethical Behavior Chapter 3-Stakeholder Relationships Chapter 4-Corporate Governance Chapter 8-Strategic Planning Chapter and Corporate Culture Chapter 9-Fiancial Reporting Secondary Chapter 4-Corporate Compliance Chapter 10-Code of Ethics Chapter 11-Evaluation of Corporate Ethics Teaching Note This case is an excellent example to demonstrate how government regulations should play a role in the decision making process of top level managers. Since the disclosure requirements were lax on the reporting of stock options before 2002, over 140 firms are now under investigation for allegedly backdating stock options for the personal gain of the CEO and other top level executives. After the passage of SOX in 2002, the requirement that any stock options have to be reported to the SEC within two days of issuance has eliminated for most firms the temptation to manipulate the stock option issuing price. Of course, if an executive wants to commit fraud through backdating, SOX will not always be enough of a determent to stop the fraud to take place.

This case is also an example of ethical duty, integrity and behavior. The backdating of stock options appears to be greed at its highest level. If the purpose of stock options is to create a motivation for the CEO to increase the financial performance of the firm so the stock price increases, then backdating stock options serves the reverse purpose. CEOs were motivated to have a very low stock price during a reporting period so that that date could become the backdated stock option date. Based on this case, it raises the question as to whether stock options are needed for CEOs. If a CEO believes in the future financial growth of his or her company, why does the CEO need a subsidy (e.g., lower price stock options) in order for the CEO to buy stock in the firm?

Questions for Thought 1. Why did reporting of stock options go “unnoticed” for so long? Explain your view.

The reporting of stock options appeared to be a low priority for the two major stakeholder groups that should have been interested in their issuance: the government and the stockholders. As long as the stock price increases, stockholders probably have very few concerns about the actual operations of the firm and/or the compensation system in place for the top level executives. It is during a decrease in stock price that questions start to arise. During the time period when the backdating occurred (mid 1990s to early 2000),

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the United States stock market had rapid growth in stock price and market capitalization.

Therefore, the stockholders were just happy to go along with the ride. The government and the SEC do not have that excuse and they should be questioned as to why they did not see this pattern. It begs the question why did it take a newspaper to discover this pattern? It should have been on the priority list of the SEC since it impacts the integrity of the stock market and of stockholder’s investments. As a result, since the firms knew no one was “watching” them, they thought they could get away with backdating the stock options.

2. Should Steve Jobs step down as Apple’s CEO? Why or why not?

Based on the evidence presented in the case, there would be a strong argument for Jobs to step down since it appears that he financially benefited from backdating stock options.

However, Steve Jobs has the benefit of the halo effect. The halo effect occurs when a firm or individual has been able to craft an image that becomes entrenched in the beliefs of the various stakeholders. For Steve Jobs, visionary of the Apple Computer and of the IPOD, he is viewed very favorably by Apple’s stakeholders. As a result, Jobs is given the benefit of the doubt when a negative event is attached to his actions. Therefore, there has not been the swift and sudden demand for Jobs to resign which occurred in the other examples in the case.

3. Examine the list of companies in Table 1. How many of the companies do you recognize? How many of the companies do you recognize as “ethical” companies?

This question would be a good written assignment for your class. Have each student select a different company on the list and have them write up a description of the company and the incidence of backdating. The students would be surprised by the listing of such well known companies as: Barnes and Noble, Bed Bath and Beyond, Cheesecake Factory, Children’s Place, GAP, Home Depot, Pixar, Research in Motion and Sharper Image.

Update UnitedHealth In March 2007, UnitedHealth completed the restatement of their earnings based on expensing the backdated stock options. The total of the earnings restatement was approximately $1.5 billion.1 In December 2007, William McGuire agreed to forfeit $418 million to settle claims based on backdating stock options. The $418 million was in addition to a previous $198 million that McGuire had agreed to pay back to UnitedHealth. The settlement included McGuire paying a $7 million fine and the barring of him serving as a director of a publicly traded company for 10 years. McGuire was allowed to keep the stock options that were valued at over $800 million.2 Affiliated Computer Services In November 2007, five directors of Affiliated Computer Services (ACS) resigned in protest based on the firm’s chairman Darwin Deason trying to take over the company and make it privately held. Deason who was the founder and chairman during the backdating 1 2

Reuters. Insurer Wraps Up Restatement. The New York Times. March 7, 2007.

Dash, Eric. Former Chief Will Forfeit $418 Million. The New York Times. December 7, 2007.

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stock option scandal had tried to buy ACS for $8.2 billion with funding from a private equity firm. The five directors wrote “We could fire you and the entire management team…but that would not help our shareholders, customers or employees.”3 Comverse Technology As of this writing, Jacob Alexander is still fighting extradition from Namibia to the United States while a former top lawyer was sentenced to one year and one day in prison for his role in the backdating scandal. William Sorin pled guilty to conspiracy to commit securities fraud, mail fraud and wire fraud. Mr. Sorin was also ordered to pay $51.8 million in restitution.4

3

Sorkin, Andrew Ross and de la Merced, Michael J... A Bitter Rift When a Boss Is the Buyer. The New York Times. November 2, 2007.

4 Reuters. Ex-Comverse Lawyer Going to Jail in Options Backdating Plan. The New York Times. May 11, 2007.

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Case 20: Tyco: I’m Sure That It’s a Really Nice Shower Curtain Case Summary Tyco is a company that will forever be linked with bathroom fixtures. Tyco is a story not only of greed, but excess and arrogance to the nth degree. Former CEO Dennis Kozlowski not only used Tyco money for his own wants and desires, but his desires seem that they came from the era of Caligula: Having a birthday party for his wife where everyone dressed in Roman togas while an ice sculpture of David urinates Vodka into a crystal bowl. You may want to show the class a copy of the invitation that can be found at SmokingGun.com (http://www.thesmokinggun.com/archive/0617051tyco1.html).

Kozlowski was a CEO who wanted the best things in life but did not necessarily want to pay for them and certainly did not want to pay taxes on them. The whole Tyco scandal started when Kozlowski did not want to pay New York sales taxes on an Impressionist painting he was buying in Manhattan. Instead of paying taxes on the painting, he had the clerk write out the bill of sale so it appeared the painting was sent to Tyco’s United States headquarters in New Hampshire. As was the case with Martha Stewart, Kozlowski was not immediately under investigation and only became entangled in an investigation when New York City started a general investigation into why it was not receiving enough tax revenue from New York based art galleries.

For this investigation, Kozlowski’s other dubious investments came to light: the $6,000 shower curtain; the $2.1 million 40th birthday party on the island of Sardinia; a one of a kind umbrella stand that looked like a dog for $15,000 (it could be said that it was a one of a kind since two people in the world would not be stupid enough to buy a $15,000 umbrella stand).

It was discovered that Kozlowski and CFO Mark Swartz worked as a team to shift expenses so that Tyco was paying for their own personal items. In addition, Tyco had sent up generous allowances and moving compensation for employees to make sure they stayed a part of the Tyco family. Tyco’s board also enjoyed a close relationship with Kozlowski and had numerous financial links to Tyco that created conflicts of interest.

The net result was that Kozlowski and Swartz were sent to trial for fraud in September 2003. The first trial resulted in a mistrial when one juror gave the okay to the defense table and one of the jurors had complained to the judge that the juror was being pressured into convicting the two Tyco executives. The two executives were retried in May 2005 and were convicted in June 2005 of fraud, grand larceny and conspiracy and falsifying business records. They were both convicted of 22 criminal charges. They were accused of stealing over $150 million from Tyco in illegal bonuses and payments of personal loans.

During the trial, Kozlowski could not explain why a $25 million bonus given to him by Tyco was not included on his personal tax return.

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Major Players in the Tyco Scandal Name

Title

Charges

Result

Dennis Kozlowski

CEO

*grand larceny *conspiracy *securities fraud *falsifying business records

*8 years and 4 months to 25 years in prison *$70 million fine

Mark Swartz

CFO

*grand larceny *conspiracy *securities fraud *falsifying business records

*8 years and 4 months to 25 years in prison *$70 million fine

Mark Belnick

Legal Counsel

*grand larceny *securities fraud *falsifying business records

*Acquitted on all charges *$100,000 fine

Links With Chapters Primary Chapter 2- Unrealized Unethical Behavior Chapter 3-Stakeholder Relationships Chapter 4-Corporate Governance and Corporate Compliance Chapter 8-Corporate Culture Chapter 9-Financial Reporting Secondary Chapter 1-Individual Ethical Duty Chapter 2-Individual Ethical Integrity Chapter 4-Corporate Compliance Chapter 8-Strategic Planning Chapter 10-Code of Ethics Chapter 11-Evaluation of Corporate Ethics

Teaching Note As is the cases of Enron and WorldCom, a discussion of corporate business ethics would not be complete without talking about Tyco. As was stated in the case summary, the

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sheer magnitude of the financial fraud and the ostentatious items acquired illegally by defrauding the company is enough to create an outrage in every individual who reads the case. As is shown time and time again, Lord Acton continues to effectively summarize the role top level managers’ play in controlling power with his famous quote “power tends to corrupt, and absolute power corrupts absolutely”. As is the case with the other CEOs presented in this textbook, Kozlowski continues to state that he has done nothing illegal and it was a great injustice that he was convicted of crimes that he did not commit.

A very good “update” of Kozlowski in jail can be seen in this 60 minutes segment. (http://www.cbsnews.com/stories/2007/03/22/60minutes/main2596123.shtml). Note he still claims that he has done nothing wrong.

Another parallel you may want to talk about is between Kozlowski and Martha Stewart.

Both were caught up in investigations that originally did not target them and both gambled their career and image on a relatively small amount: $45,000 for Stewart and $1 million in taxes for Kozlowski.

Questions for Thought 1. What do you think Kozlowski’s motivation for trying to avoid sales taxes on his art purchases was? Explain.

It appears that Kozlowski just hated paying taxes. By developing this elaborate scheme to avoid state sales tax, Kozlowski risked everything and lost. This tax avoidance strategy also explain why Kozlowski moved the corporate headquarters to Bermuda to avoid paying United States corporate taxes on the profits of Tyco’s operations.

2. Explain the concept of commingling assets with respect to the Tyco case.

Commingling assets is usually used in a legal setting and is often a major focal point in divorce proceedings. Commingling assets can be defined when two parties accumulate assets over an extended period of time to the extent that it is difficult to determine which party has ownership to which specific assets. Since they are commonly shared both parties have claim to the assets. In the Tyco case, Kozlowski and Swartz definitely saw a commingling of assets. Even though they are not correct and legally they would have no claim, both former Tyco executives saw Tyco assets as also their own assets. Therefore, from their perspective it did not matter who paid for the bills since both Tyco and the executives “owned” the Tyco money. The commingling of assets could explain why Kozlowski still presents the argument that he did nothing wrong while he was the CEO of Tyco.

3. Would it have been possible for the board of directors to see the adjustments taking place in the many different programs at Tyco? Explain.

The simple answer is no since Kozlowski was the Chairman of the Board. As was mentioned in Chapter 4, CEO duality creates a disproportional amount of power in one person. By having a CEO who is also the Chairman of the Board, Kozlowski had complete control of the board. The chairman decides what information is presented to the board, what issues will be discussed at the board meeting, how long each issue will be discussed and can control the discussion at the board meeting. Therefore, the board

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would not be privy to any information that Kozlowski did not want the board to be aware of. As a result, the board probably only received minimal, if any, information pertaining to the different types of loan programs that were being executed at Tyco.

Update In May 2007, Tyco agreed to pay almost $3 billion to settle investor based class action lawsuits against the firm. It is considered to be the largest amount spent to settle a class action shareholder lawsuit. The stock price after the announcement went up 19 cents to $32.38. The stock price had reached a low of $6.98 during the scandal in July 2002.1 In July 2007, PriceWaterhouseCoopers agreed to pay Tyco investors $225 million to settle their legal claims. PriceWaterhouseCoopers was Tyco’s external auditor during the scandal and PWC’s lead auditor for Tyco, Richard Scalzo, was barred by the SEC from auditing publicly traded companies.2

1

Norris, Floyd. Tyco to Pay $3 Billion to Settle Investor Lawsuits. The New York Times. May 16, 2007.

Norris, Floyd. PriceWaterhouseCoopers to Pay Tyco Investors $225 Million. The New York Times. July 7, 2007 2

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Case 21: Volkswagen: Herbie Takes Investors for a Ride Case Summary The Volkswagen case is interesting for a number of unique reasons, including the origins of the company. Formed by Adolf Hitler when he was the head of the Nazi party, Volkswagen became a symbol of global excellence for the Third Reich. When Volkswagen tried to back away from its origins by having research done on the history of the company, the results of the research backfired on Volkswagen. Instead of being a reluctant participant in the Nazi movement, Volkswagen appeared to be more than a willing commercial force to support the Nazis.

The second unique component of the Volkswagen case is that it highlights the incestuous interaction between Volkswagen and Porsche. Since Ferdinand Porsche was asked to develop the Volkswagen for Hitler, the tie between Porsche and Volkswagen has always been there and was considered to be a close family linkage. As a result, for three generations, Porsche has attempted to take over control of Volkswagen.

The third unique aspect of the case is that it highlights the two boards of directors that are required for German companies. There is a management board that is controlled by the management of the company and is headed by the CEO. This board focuses on the dayto-day operations of the firm. The supervisory board, which focuses on the overall strategic decisions of the company, is composed of fifty percent employee representatives and fifty percent shareholder representatives. The purpose of the fifty/fifty split is to ensure that the workers have an equal voice in the overall strategic focus of the firm.

The case focuses on using bribes and pleasure trips to ensure that the worker representatives voted along the same lines as management on the supervisory board.

These illegal incentives gave Volkswagen the power to implement sweeping changes pertaining to the employee’s work environment without any real challenge from the worker representatives on the board.

During the same time period, Porsche started to make a hostile bid for a controlling interest of Volkswagen. This bid raised questions of conflicts of interest since Ferdinand Porsche’s grandson, Ferdinand Piech, was a former CEO of Volkswagen and was still the chairman of the supervisory board. By December 2006, Porsche had become Volkswagen’s largest shareholder with 27.4 percent of the outstanding share.

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Links With Chapters Primary Chapter 3-Stakeholder Relationships Chapter 4-Corporate Governance and Corporate Compliance Chapter 8-Corporate Culture Secondary Chapter 3-Corporate Social Responsibility Chapter 8-Strategic Planning Teaching Note The Volkswagen case is a good example to expose how companies are structured differently in different countries. By having two different boards of directors, Volkswagen should be able to address the various needs of all the relevant stakeholders.

By having worker representatives comprise fifty percent of the supervisory board, the needs and expectations of the workers should be properly served. However, this assumption is only true if the representatives truly represent the interests of the workers.

This case shows that if the worker representatives are persuaded by illegal financial and personal incentives by management they can be coerced into voting in the same manner as management. As a result, for a few thousand dollars (or Euros), Volkswagen’s management team can implement significant changes in the working conditions of the firm without an objection for the workers’ representatives.

In addition, this case shows that the danger of interlocking directorates. An interlocking directorate occurs when board members serve on each other’s company boards.

Therefore, a Porsche board member serves on the Volkswagen board and a Volkswagen board member serves on the Porsche board. This interlocking directorate creates the problem of potential conflicts of interest. Can these board members really serve two masters? Would they not want what is best for their own company first and then try to serve the interests of the other firm in which they are a board member? The net result is that though the power of Volkswagen’s board, Porsche was able to manipulate the process so that they would eventually become the largest shareholder in Volkswagen.

Questions for Thought 1. Do you view Piech’s position as chairman of the supervisory board as a conflict of interest? Why or why not?

Yes. Piech should not be allowed to remain as chairman of the supervisory board once Porsche started their takeover bid. As was mentioned in the teaching note, Piech has only one real master to report to and that is the Porsche stockholders. As a result, Piech was able to use his power and, more importantly, his access to propriety Volkswagen information to be able to develop an effective aggressive takeover bid of Volkswagen.

Volkswagen should have forced Piech to resign as soon as Porsche became involved in taking over Volkswagen.

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2. Define corporate governance. Identify the corporate governance issues at Volkswagen.

In Chapter 4, corporate governance is defined as the system that is used by firms to control and direct their operations and the operations of their representatives, the employees. Corporate governance is required in order to guarantee the interests of the stakeholders and traditionally the stockholders are well represented in the decision making process of the firm. When there is an ineffective corporate governance structure, the board of directors has failed to perform its duty. This is the case at Volkswagen. By allowing the interests of Porsche to supersede the interests of Volkswagen, the board member of Volkswagen have failed to perform their fiduciary duties to their stakeholders.

3. Comment on Piech’s neglect in not telling the board about Porsche buying Volkswagen shares. What is the significance of this event?

This is a critical issue for Volkswagen. The issue was specifically discussed at a board meeting and Piech’s silence implied that he did not know why the price of Volkswagen stock was rising. This highlights why Piech should not have been involved in the Volkswagen board when “his” company, Porsche, was starting its hostile bid for the company. As was mentioned previously, Piech had access to not only Volkswagen confidential strategies, but had the power to influence the decisions so that they would benefit Porsche.

Update In February 2008, former Volkswagen chief employee representative, Klaus Volkert, was found guilty of fraud by receiving almost $4 million in illegal bonuses.1 In March 2008, Porsche won approval from its supervisory board that allowed it to increase it investment in Volkswagen to over fifty percent from the current thirty one percent. The increased investment must be approved by the European Commission.2

1 2

Lander, Mark. Sentence in Volkswagen Scandal. The New York Times. February 23, 2008.

Lander, Mark. Porsche Closer to a Takeover of Volkswagen. The New York Times. March 4, 2008.

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Case 22: Wal-Mart: But We Do Give Them a 10 Percent Employee Discount Case Summary Wal-Mart stirs a lot of emotions from many people. People either love or hate the store and its influence has significantly impacted global retailing. Wal-Mart’s very simple strategy of Everyday Low Prices drives every single decision at Wal-Mart. As a result, payroll expenses are always monitored and evaluated, especially with close to 1.5 million employees worldwide. Therefore, there are huge financial benefits for Wal-Mart to cut every corner they can when it can reduce the cost structure of its business model.

Examples such as “off the clock work” are not only present at Wal-Mart, but could also be considered an industry wide issue. In any setting in which a time clock records the number of hours worked by an employee, there is always the opportunity to abuse the system. While an innocent request such as “can you tidy up that shelf before you leave” may not have any cost impact, Wal-Mart appears at times to abuse the loyalty of its employees by asking them to work long after they have clocked out. Health benefits are another area where Wal-Mart has been able to minimize their cost structure for the employees. Placing hurdles for eligibility and having high level of deductibles allows Wal-Mart to block some of its employees from signing up for health coverage while others only accept minimum coverage.

The issue of sexual discrimination has been a major stumbling block for Wal-Mart as it moves to being a global presence. It could be hypothesized that the “good old boy” culture established by Sam Wilton in rural Arkansas did not condemn managers who perceived that female employees should not be able to have a career at Wal-Mart. The recent legal class action lawsuits may have given Wal-Mart the impetus it needed to change its corporate culture.

Again, based on its “good old boy culture”, Wal-Mart has never looked favorably on unions. They believe that only Wal-Mart knows what is best for their employees. WalMart is still actively involved in stopping unions from being formed for its workers in the United States. Of course, the ironic twist is that when Wal-Mart started in China, the Chinese government made it a requirement that every employee be unionized.

The net result is that Wal-Mart has always walked a fine line between ethical and unethical behavior when it examines the relationships between treatment of employees and reducing costs.

Links With Chapters Primary Chapter 3-Stakeholder Relationship and Corporate Social Responsibility Chapter 4-Corporate Compliance Chapter 8-Strategic Planning and Corporate Culture

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Secondary Chapter 10-Code of Ethics Chapter 11-Evaluation of Corporate Ethics Teaching Note You can start the discussion by asking how many students go to Wal-Mart on a regular basis, assuming you are near a Wal-Mart. If you are, ask them why they go. The universal answer probably with be because everything is cheaper at Wal-Mart. You can then ask should Wal-Mart do whatever they can to reduce their prices. Again they would say yes within the law. At this point you could ask why don’t the employees quit if they are not been treated properly. The likely response is that for many of these workers this could be the only job available and/or the highest paying job in the local community. The thread of the discussion is that the employees need Wal-Mart and Wal-Mart needs the employees.

The only difference is that Wal-Mart has absolute bargaining power with its employees like it does with its suppliers. Every single supplier and employee needs Wal-Mart more than Wal-Mart needs the employee and the supplier. Of course, Wal-Mart knows this and, therefore, will always negotiate for a position of power. Wal-Mart makes it very clear when an associate is hired that the firm is committed to lower the cost of production. As a result, no employee should be surprised when Wal-Mart does whatever it can to reduce costs.

Questions for Thought 1. Are the ethical issues Wal-Mart faces really any different from other large retailers?

The simple answer is no. These issues occur not only at other retailers but in other industries as well. Wal-Mart will always be the target of any attack since they are the biggest and have the most employees that can be affected by these decisions. Not only are they the largest retailer in the world, but every year they are either number one or number two on the Fortune 500 listing. With sales of over $1 billion a day globally, Wal-Mart has a significant impact on global retailing. Therefore, Wal-Mart will always have the highest level of visibility in any actions that are implemented by the firm.

2. Wal-Mart officials have stated that they don’t feel women are interested in management positions at the company. Do you agree or disagree?

Of course, this is an outlandish statement. Of course, women are interested in management positions if they are given the opportunity. In the past, women at Wal-Mart were not always given the opportunity to become managers. Hopefully, this type of discrimination has been permanently eliminated from the corporate culture at Wal-Mart since it has no place in the values and beliefs of the firm. In addition, any manager who continues with this belief should be severely punished which would include dismissal if that belief is told to another Wal-Mart associate.

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3. Wal-Mart is continually criticized for its health-care policy. Is this really an ethical issue? Why or why not?

The health care coverage may be considered an ethical issue rather than a legal issue.

Wal-Mart is doing nothing illegal by offering minimal health care coverage and having specific requirements before the associates are eligible for health care. It could be considered an ethical issue because Wal-Mart has the capability to provide better health care coverage at a high cost to the firm. Therefore, while it could be perceived to be unethical, it is consistent with their strategic focus on reducing costs.

4. Should Wal-Mart be concerned about unionization of stores since allowing unionization of workers in China?

Yes. Wal-Mart should be very concerned about unionization. As Wal-Mart enters the future, the dominant focus on growth is international since that is where the highest growth opportunities lie. As Wal-Mart continues to saturate the United States market, their long term growth will almost be exclusively internationally. In many countries in the world, the government not only protects unions but actively guarantees that the workers are unionized in industries such as retailing. Therefore, Wal-Mart will only see increased pressure by both governments and employees of other countries to allow unions to be formed within the Wal-Mart stores.

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Case 23: WorldCom: Can You Hear the Lawsuits Now? Case Summary WorldCom will forever be linked with Tyco and Enron as part of the big three corporate scandals to hit the United States. WorldCom and Enron were used as the basis to draw from when the Sarbanes-Oxley Act was being developed.

Long Distance Discount Service (LDDS) started in Hattiesburg, Mississippi in 1983.

Bernie Ebbers gained control of the company which would be renamed as WorldCom. Bernie Ebbers started an aggressive acquisition program. WorldCom bought MCI in 1997 for $37 billion. On February 1, 2002, Bernie Ebbers made a repayment of over $180 million in loans from Bank of America. During the same time period, WorldCom had $28 billion in debt. In March 2002, the SEC launched inquiries into WorldCom's accounting practices. It was disclosed that WorldCom had given Bernie Ebbers a loan of $366 million at an interest rate of 2.14%. On April 4, 2002, WorldCom announced that it would lay off 4% of its employees (3,700) due to a slowdown in the economy and excess capacity of the industry. On April 29, 2002, Bernie Ebbers was forced to resign as CEO, president and company board member. On June 25, 2002, WorldCom unveiled its $3.8 billion accounting fraud.

WorldCom’s CFO, Scott Sullivan, was fired after the results of the probe were released.

WorldCom’s auditor, Arthur Andersen, stated that Sullivan gave them false information.

WorldCom’s VP of internal auditing, Cynthia Cooper, discovered the fraud by spot checking the bookings in the capital expenditure account. One of WorldCom’s biggest expenses, charges paid to local telephone systems to complete a phone call was recorded as capital expenditures and not expenses. WorldCom’s competitors had complained to the SEC about how everyone in the telecommunication industry was losing money except WorldCom. Andersen used a “risk based” model of auditing. Risk based auditing is based on the assumption that problems are most likely to occur in high risk areas, so that the auditors would focus most of their time on these areas. On June 28, 2002, WorldCom announced it would lay off 17,000 employees to reduce costs. On July 1, 2002, an internal review concluded that the fraud may have started in 1999 instead of 2001. On July 21, 2002, WorldCom declared bankruptcy. It was the largest bankruptcy in the history of American Commerce. WorldCom had assets of $107 billion. On August 1, 2002, CFO Scott Sullivan and Controller David Myer were charged with fraud. The estimated level of fraud had escalated to $7.6 billion. By November 2002, the fraud estimate had increased to $9 billion. In February 2003, WorldCom announced it would lay off another 5,000 employees. In March 2004, Ebbers was indicted on fraud charges and Scott Sullivan pled guilty.

Under Chapter 11 protection, WorldCom changed its name to MCI and emerged from bankruptcy on April 20, 2004. On May 10, 2004, MCI announced that would lay off 7,500 additional employees. On March 15, 2005, a Jury found Ebbers guilty of

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conspiracy, fraud and making false financial statements. Bernie Ebbers was sentenced to 25 years in prison. Scott Sullivan was sentenced to 5 years in prison and former Controller, David Myers, was sentenced to one year plus one day in prison.

Major Players in the WorldCom Scandal are shown in Table 2 of the case

Links With Chapters Primary Chapter 2-Unrealized Unethical Behavior Chapter 3-Stakeholder Relationships Chapter 4-Corporate Governance and Corporate Compliance Chapter 8-Strategic Planning Chapter and Corporate Culture Chapter 9-Financial Reporting Secondary Chapter 1-Individual Ethical Duty Chapter 2-Individual Ethical Integrity Chapter 10-Code of Ethics Chapter 11-Evaluation of Corporate Ethics Teaching Note As was the case with Enron and Tyco, the fraud committed by WorldCom was not a one person operation. Dennis Kozlowski had Mark Swartz, Ken Lay had Jeff Skilling and Bernie Ebbers had Scott Sullivan. It highlights that in order to be able to establish and continue a fraud over an extended period, the CEO needs to form an unethical partnership with another high ranking executive, usually the CFO. The obvious choice is the CFO since this person has not only access to the financial transactions made by the firm, but also has the ability to alter the recording of those transactions if desired. It is the ability to continuously manipulate the financial statements that allows the fraud to continue without being discovered. Of course, as has been mentioned previously, a fraud will remain undetected as long as the firm’s cash flows legitimately “support” the fraudulent actions. Once the firm has run out of cash, even the best hidden fraud will be exposed.

As was the case with Ken Lay and Dennis Kozlowski, Bernie Ebbers wanted to keep score on his success. For CEOs with large egos, keeping score means trying to accumulate as much personal wealth as possible. As a result, the self-perceived value of the CEO is based on the total amount the personal assets that have been accumulated by the CEO. The only problem with this type of scoring is that the game never ends. If a CEO is competing against other CEOS based on personal net worth, there will never be a point in which someone “wins” the net worth game.

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Questions for Thought 1. Why do you suppose Bernie Ebbers was treated more like a leader of a cult than as a CEO? Explain.

In order to be able to be promoted to the position of CEO, the individual must have a clear vision of the firm and must have an outgoing charismatic personality. Bernie Ebbers was no exception to that requirement. By having charisma, Ebbers was able to effectively transfer his vision of WorldCom to its employees. The name of the company should give a hint as to what Ebbers ultimate vision of the company was. As a result, WorldCom employees became very loyal to the company and to Ebbers and truly believed in its leader.

2. Evaluate the recommendations in the Breeden report. Will these accomplish the objectives they are supposed to achieve?

The overall objectives of the Breeden report were to establish a comprehensive evaluation and monitoring system of the corporate governance system at WorldCom. Under this mandate, the report has done a good job achieving this goal. By specifically outlining the responsibilities of not only the board but also the board members, the report has eliminated any ambiguity into what is expected from the board and the board members. The Breeden report was well received by the stockholders at WorldCom and became a model for other firms when they tried to improve their level of corporate governance.

3. Do you view Cynthia Cooper as an ethics exemplar in this case? Explain.

Yes, very much so. Even though her position was in internal accounting at WorldCom, she went well above the normal expectations for her position. By staying late at night and being able to get access to the financial transactions after Scott Sullivan had blocked her access, Cooper was determined to identify and expose the fraud. As a result, she did not buy into the cult like behavior of her colleagues. By “not drinking the Kool-aid”, Cooper was able to present undisputable evidence of the fraud even when executives above her tried to stop her from investigating the fraud. It was stated that the whistle blowing section of the Sarbanes Oxley Act was in direct reference to Cynthia Cooper’s actions.

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