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According to freeman, the responsibility principle is compatible with the separation fallacy.

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COMMONWEALTH OF AUSTRALIA


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This material has been reproduced and communicated to you by or on behalf of University of Queensland pursuant to Part VB of the Copyright Act 1968 (the Act).


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Course of Study: (FINM7401) Finance


Title of work: Ethical theory and business, 9th ed. (2013)


Section: Pages 46-68: CORPORATE RESPONSIBILITY pp. 46--68


Author/editor of work: Arnold, Denis G.; Beauchamp, Tom L.; Bowie, Norman E.


Name of Publisher: earson Education


NINTH EDITION


ETHICAL THEORY


AND BUSINESS


Edited by


DENIS G. ARNOLD


University of North Carolina, Charlotte


TOM L. BEAUCHAMP


Georgetown University


NORMAN E. BOWIE


University of Minnesota


PEARSON


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PEARSON ISBN 10: 0-205-24131-X ISBN 13: 978-0-205-24131-6


2


CORPORATE


RESPONSIBILITY


46


INTRODUCTION


This chapter focuses on corporate responsibility and ethical organizations.The socially responsible corporation is the good corporation. Over 2,000 years ago, the Greeks thought that they could answer questions about the goodness of things by knowing about the pur­ pose of things. These Greek philosophers provided a functional analysis of good. For ex­ ample, if one determines what a good racehorse is by knowing the purpose of racehorses (to win races) and the characteristics-for instance, speed, agility, and discipline-horses must have to win races, then a good racehorse is speedy, agile, and disciplined. To adapt the Greeks' method of reasoning, one determines what a good (socially responsible) cor­ poration is by investigating the purpose corporations should serve in society.


Stockholder Management Versus Stakeholder Management For many, the view that the purpose of the corporation is to make a profit for stockholders is beyond debate and is accepted as a matter of fact. The classical U.S. view that a corpora­ tion's primary and perhaps sole purpose is to maximize profits for stockholders is most often associated with the Nobel Prize-winning economist Milton Friedman. This chapter presents arguments for and against the Friedmanite view that the purpose of a corpora­ tion is to maximize stockholder profits.


Friedman has two main arguments for his position. First , stockhold­ ers are the owners of the corporation, and hence corporate profits belong to the stockholders. Managers are agents of the stockholders and have a moral obligation to manage the firm in the interest of the stockholders, that is, to maxi­ mize shareholder wealth. If the management of a firm donates some of the firm's in­ come to charitable organizations, it is seen as an illegitimate use of stockholders' money. If individual stockholders wish to donate their dividends to charity, they are free to do so, since the money is theirs. But managers have no right to donate corporate


HAl'lL!Z CUIZPOI\AI IU:_\l'ONSIL\!LiTY


funds to charity. If society decides that private charity is insufficient to meet the needs of the poor, to maintain art museums, and to finance research for curing diseases, it is the responsibility of government to raise the necessary money through taxation. It should not come from managers purportedly acting on behalf of the corporation.


Second, stockholders are entitled to their profits as a result of a contract among the corporate stakeholders. A product or service is the result of the productive efforts of a number of parties-employees, managers, customers, suppliers, the local community, and the stockholders. Each of these stakeholder groups has a contractual relationship with the firm. In return for their services, the managers and employees are paid in the form of wages; the local community is paid in the form of taxes; and suppliers, under the con­ straints of supply and demand, negotiate the return for their products directly witH the firm. Funds remaining after these payments have been made represent profit, and by agreement the profit belongs to the stockholders. The stockholders bear the risk when they supply the capital, and profit is the contractual return they receive for risk taking. Thus, each party in the manufacture and sale of a product receives the remuneration to which it has freely agreed.


Friedman believes that these voluntary contractual arrangements maximize economic freedom and that economic freedom is a necessary condition for political freedom. Po­ litical rights gain efficacy in a capitalist system. For example, private employers are forced by competitive pressures to be concerned primarily with a prospective employee's ability to produce rather than with that person's political views. Opposing voices are heard in books, in the press, or on television so long as there is a profit to be made. Finally, the existence of capitalist markets limits the number of politically based decisions and thereby increases freedom. Even democratic decisions coerce the opposing minority. Once society votes on how much to spend for defense or for city streets, the minority must go along. In the market, each consumer can decide how much of a product or service he or she is willing to purchase. Thus, Friedman entitled his book defending the classical view of the purpose of the firm Capitalism and Freedom.


The classical view that a corporation's primary responsibility is to seek stockholder profit is embodied in the legal opinion Dodge v. Ford Motor Company included in this chapter. The Court ruled that the benefits of higher salaries for Ford workers and the ben­ efits of lower auto prices to consumers must not take priority over stockholder interests.


According to Dodge, the interests of the stockholder are supreme.


Some have criticized Friedman on the grounds that his view justifies anything that will lead to the maximization of profits, including acting immorally or illegally if the manager can get away with it. We think that this criticism of Friedman is unfair. In his classic article reprinted in this chapter, Friedman says:


In such a society, "there is one and only one social responsibility of business-to use its resources and engage in activities designed to increase its profit so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud:' (1970, p. 126)


Thus, the manager may not do anything to maximize profits. Friedman's arguments presume the existence of a robust democracy in which citizens determine the rules of the game, and businesses do not unduly influence the process by which those rules are determined. Unfortunately, Friedman never fully elaborated on what the rules of the game


47


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Supreme court, Dodge v. Ford Motor Co. on


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CH1\l'TER l: CURl'Oi<.ATF RFSl'ONSII\IIITY


in a capitalist economy are; and some of his followers have argued for tactics that strike many as unethical. For example, Theodore Levitt has argued in defense of deceptive ad­ vertising' and in favor of strong industry lobbying to have the government pass laws that are favorable to business and to reject laws that are unfavorable.2 Albert Carr has argued that business is like the game of poker and thus, just as in poker, behavior that is unethical in everyday life is justified in business.3 (Carr does admit that just as in poker, there are some moral norms for business.)


Others have criticized Friedman on the grounds that the manager should use em­ ployees, customers, and suppliers as mere tools if, by doing so, he can generate profit. Therefore, if wages can be cut to generate profit, they should be cut. Theoretically, that may indeed follow from Friedman's view, and some managers and CEOs even behave that way. But as a practical matter, the manager can usually generate profits only if she treats employees, customers, and suppliers well. This insight has spawned an entire field of aca - demic study called positive organizational scholarship, as well as popular books such as Jeffery Pfeiffer's Competitive Advantage through People and Frederick F. Reichheld's book The Lqyalty Effect. In 1953, the legal system acknowledged the connection between cor­ porat� philanthropy and goodwill. In the case of A.P Smith Manufacturing v. Barlow et al., a charitable contribution to Princeton University was deemed to be a legitimate exer­ cise of management authority. In the appeals case reprinted in this chapter, Judge Jacobs recognized that an act that supports the public welfare can also be in the best interest of the corporation itself. The implication of this discussion is that, in terms of behav­ ior, there may be no discernible difference between an "enlightened" Friedmanite and a manager who holds to the view that the purpose of the corporation involves more than the maximization of profit. The difference, to put it in a Kantian context, is in the mo­ tive. The enlightened Friedmanite treats employees well in order to generate profit. The non-Friedmanite treats employees well because that is one of the things a corporation is supposed to do.


Nearly all business ethicists concur with the general public that one of the purposes of a publicly held firm is to make a profit, and thus making a profit is an obligation of the firm. Although many people also believe that the managers of publicly held corporations are legally required to maximize the profits for stockholders, this is not strictly true. Even in the most traditional interpretation, managers have a fiduciary obligation to the cor­ poration, which is then interpreted as a fiduciary obligation to stockholder interests. But many U.S. states have laws that permit managers to take into account the needs of the other stakeholders; and in Europe and Japan, consideration for employees, the commu­ nity, and the environment are not only permitted but are expected.


Although managers may not be obligated to maximize profits, they certainly do have an obligation to avoid conflicts of interest where it appears that they benefit at the ex - pense of the stockholders. Many groups that defend stockholder rights are legitimately concerned with serious issues of corporate governance. Issues such as excessive executive pay, especially when it is not linked to performance, overly generous stock options, golden parachutes in case of a hostile takeover, and even friendly acquisitions such as the recent purchase of the failing Countrywide Financial mortgage company by Bank of America (where the CEOs were known to be friends), have all legitimately come under scrutiny.


Stockholders need to be concerned about more than conflicts of interest. Managers like to keep information secret, as well. Even if a case can be made for charitable contribu­ tions on the part of corporations, it would seem that stockholders have a right to know


C:HAl) T!:l, :2: CORl'(W,ATF Rbi'ON\lt,IL!TY


which charities receive corporate funds. But corporations have opposed a law that would require disclosing such information to shareholders.4


An alternative way to understand the purpose of the corporation is to consider those affected by business decisions, who are referred to as corporate stakeholders. From the stakeholders' perspective, the classical view is problematic in that all emphasis is placed on one stakeholder-the stockholder. The interests of the other stakeholders are unfairly subordinated to the stockholders' interests. Although any person or group affected by cor­ porate decisions is a stakeholder, most stakeholder analyses focused on a special group of stakeholders: namely, members of groups whose existence was necessary for the firm's survival. Traditionally, six stakeholder groups have been identified: stockholders, ewploy­ ees, customers, managers, suppliers, and the local community. Managers who rrlanage from the stakeholder perspective see their task as harmonizing the legitimate interests of the primary corporate stakeholders. In describing stakeholder management in his original contribution to this chapter, R. Edward Freeman argues that managers have an ethical duty to manage the organization for all stakeholders.


Both in corporate and academic circles, stakeholder terminology has become very fashionable. For example, many corporate codes of conduct are organized around stake­ holder principles.


However, many theoretical problems remain. Stakeholder theory is still in its early developmental stage. Much has been said of the obligations of managers to the other corporate stakeholders, but little has been said about the obligations of the other stake­ holders, for instance, the community or employees, to the corporation. Do members of a community have an obligation to consider the moral reputation of a company when they make their purchasing decisions? Do employees have an obligation to stay with a company that has invested in their training even if they could get a slightly better salary by moving to another corporation?


Perhaps the most pressing problems for stakeholder theory are to specify in more de­ tail the rights and responsibilities that each stakeholder group has, and to suggest how the conflicting rights and responsibilities among the stakeholder groups can be resolved.


Which View Is Better?


Is the Friedmanite view that the purpose o,f the firm is to maximize profits or the stake­ holder view that the firm is to be managed in the interests of the various stakeholders more adequate? In his article, What's Wrong-and What's Right-with Stakeholder Man­ agement, John Boatright presents additional difficulties for the stakeholder position.


Boatright concedes that the purpose of the firm is to benefit every stakeholder group. However, he argues that management decision making is an inefficient means of protect­ ing the interests of nonshareholder stakeholders and that a system of corporate gover­ nance marked by shareholder primacy better serves the interests of all stakeholders. Such a system of governance, he believes, most efficiently maximizes the welfare of all stake­ holder groups. As Boatright points out, stockholders have been given special attention because lawmakers have believed that it was in the public interest to do so. Despite his generally negative assessment of stakeholder theory, Boatright argues that the theory actu­ ally complements the stockholder view in two ways. First, it reminds managers that they have an obligation to correct for such things as market failures and externalities to ensure


49


50 C:HJ\1'1.ER l'OR1\iT RESi',,NSI Iii I Y


that markets work as they should to produce benefits for all. Second, stakeholder man­ agement can be seen as a guide for the ethical management of the firm rather than as an alternative system of corporate governance.


What is one to conclude with respect to this dispute? It seems that stockholders are in a special relationship with respect to profits, but the relationship is not so special as has been traditionally thought. Moreover, it may not even be in the public interest to retain the traditional idea about the preeminence of the stockholder. Critics have argued that U.S. managers are forced to manage to please Wall Street, which means they are forced to manage for the short term. These critics have gone on to argue that the focus on the short term has led to inordinate cutbacks in employees and frayed relationships with top man­ agers of corporations and the rank and file employees. However, if a shift is made to con­ sider long-term profitability, then there is a greater likelihood that, in terms of managerial behavior, the stockholder theory and the stakeholder theory will coincide.


The next article in this section by Wayne Cascio compares the management of Sam's Club, a warehouse retailer that is part of Wal-Mart, and its competitor Costco. Wal-Mart and Sam's Club are famous for low prices that make products affordable for customers who latk ample financial resources. However, Wal-Mart has come under sustained criti­ cism in recent years for allegedly unfair and illegal labor practices such as underpayment of earnings, sexual discrimination against women, the use of illegal alien workers, and transferring the burden of employee health care costs to taxpayers. Cascio points out that Costco is an aggressive and highly successful competitor to Wal-Mart. Over a 5-year pe­ riod, Costco's stock rose 55 percent while Wal-Mart's declined 10 percent. At the same time, Costco was taking extraordinarily good care of its employees and customers and had excellent relationships with other stakeholders. Cascio argues that if Costco can be profit­ able while ensuring that all its stakeholders are treated well, Wal-Mart should be able to do the same.

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