Managing business ethics 7th edition

Managing Business Ethics

Straight talk aBout how to Do it right

Seventh Edition

Linda Klebe Treviño Distinguished Professor of Organizational Behavior

and Ethics

Smeal College of Business

The Pennsylvania State University

and

Katherine A. Nelson Instructor

Fox School of Business

Temple University

VP AND EDITORIAL DIRECTOR George Hoffman

EDITORIAL DIRECTOR Veronica Visentin

EXECUTIVE EDITOR Lise Johnson

SPONSORING EDITOR Jennifer Manias

EDITORIAL MANAGER Gladys Soto

CONTENT MANAGEMENT DIRECTOR Lisa Wojcik

CONTENT MANAGER Nichole Urban

SENIOR CONTENT SPECIALIST Nicole Repasky

PRODUCTION EDITOR Bharathy Surya Prakash

COVER PHOTO CREDIT © Stuart Monk/Shutterstock.com

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Library of Congress Cataloging‐in‐Publication Data Names: Treviño, Linda Klebe, author. | Nelson, Katherine A., 1948‐ author. Title: Managing business ethics : straight talk about how to do it right / Linda Klebe Treviño, Katherine A. Nelson. Description: Seventh Edition. | Hoboken : Wiley, [2017] | Revised edition of the authors’ Managing business ethics, [2014] | Includes bibliographical references and index. Identifiers: LCCN 2016053351| ISBN 9781119194309 (pbk. : alk. paper) | ISBN 9781119298519 (epub) Subjects: LCSH: Business ethics. | Business ethics — Case studies. Classification: LCC HF5387 .T734 2017 | DDC 174/.4 — dc23 LC record available at https://lccn.loc.gov/2016053351

The inside back cover will contain printing identification and country of origin if omitted from this page. In addition, if the ISBN on the back cover differs from the ISBN on this page, the one on the back cover is correct.

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iii

Preface xv

Acknowledgments xix

Brief Contents

Section I Introduction

Section II Ethics and the Individual

Section III Managing Ethics in the Organization

Section IV Organizational Ethics and Social Responsibility

1

2

3

4

5

6

7

8

9

10

11

Introducing Straight Talk about Managing Business Ethics: Where We’re Going and Why 2

Deciding What’s Right: A Prescriptive Approach 38

Deciding What’s Right: A Psychological Approach 72

Addressing Individuals’ Common Ethical Problems 114

Ethics as Organizational Culture 158

Managing Ethics and Legal Compliance 218

Managing for Ethical Conduct 257

Ethical Problems of Managers 295

Corporate Social Responsibility 326

Ethical Problems of Organizations 362

Managing for Ethics and Social Responsibility in a Global Environment 399

Index 447

v

Preface xv

Acknowledgments xix

Section I Introduction

1 Introducing Straight Talk about Managing Business Ethics: Where We’re Going and Why 2

Introduction 2 The Financial Disaster of 2008 4

Borrowing Was Cheap 4 Real Estate Became the Investment of Choice 5 Mortgage Originators Peddled “Liar Loans” 5 Banks Securitized the Poison and Spread It Around 6 Those Who Were Supposed to Protect Us Didn’t 7

Moving Beyond Cynicism 10 Can Business Ethics Be Taught? 14

Aren’t Bad Apples the Cause of Ethical Problems in Organizations? 15 Shouldn’t Employees Already Know the Difference between Right and Wrong? 16 Aren’t Adults’ Ethics Fully Formed and Unchangeable? 17

This Book is About Managing Ethics in Business 20 Ethics and the Law 21 Why Be Ethical? Why Bother? Who Cares? 22

Individuals Care about Ethics: The Motivation to Be Ethical 23 Employees Care about Ethics: Employee Attraction and Commitment 24 Managers Care about Ethics 25 Executive Leaders Care about Ethics 26 Industries Care about Ethics 26 Society Cares about Ethics: Business and Social Responsibility 27

The Importance of Trust 28

Contents

vi Contents

The Importance of Values 30 How This Book Is Structured 31 Conclusion 32 Discussion Questions 33 Exercise: Your Cynicism Quotient 34 Notes 35

Section II Ethics and the Individual

2 Deciding What’s Right: A Prescriptive Approach 38 Ethics and the Individual 38

Ethical Dilemmas 38 Prescriptive Approaches to Ethical Decision Making in Business 39 Eight Steps to Sound Ethical Decision Making in Business 53 Practical Preventive Medicine 59

Conclusion 62 Discussion Questions 62 Exercise: Clarifying Your Values 64 Introducing the Pinto Fires Case 64 Case: Pinto Fires 65 Short Cases 70 Notes 70

3 Deciding What’s Right: A Psychological Approach 72 Ethical Awareness and Ethical Judgment 72 Individual Differences, Ethical Judgment, and Ethical Behavior 76

Cognitive Moral Development 77 Locus of Control 84 Machiavellianism 85 Moral Disengagement 86

Facilitators of and Barriers to Good Ethical Judgment 88 Thinking about Fact Gathering 89 Thinking about Consequences 90 Thinking about Integrity 92 Thinking about Your Gut 94 Unconscious Biases 95 Emotions in Ethical Decision Making 96

Contents vii

Toward Ethical Action 99 Revisiting the Pinto Fires Case: Script Processing and Cost–Benefit Analysis 104 Cost–Benefit Analysis 106

Conclusion 108 Exercise: Understanding Cognitive Moral Development 108 Discussion Questions 109 Short Case 109 Notes 110

4 Addressing Individuals’ Common Ethical Problems 114 Identifying Your Values—and Voicing Them 115

People Issues 118 Discrimination 118 Harassment, Sexual and Otherwise 122

Conflicts of Interest 126 What Is It? 126 How We Can Think about This Issue 130 Why Is It an Ethical Problem? 131

Customer Confidence Issues 132 What Is It? 132 How We Can Think about This Issue 136 Why Is It an Ethical Problem? 137

Use of Corporate Resources 137 What Is It? 137 How We Can Think about This Issue 142 Why Is It an Ethical Problem? 143

When all Else Fails: Blowing the Whistle 143 When Do You Blow the Whistle? 146 How to Blow the Whistle 146

Conclusion 151 Discussion Questions 151 Short Cases 152 Notes 153

Section III Managing Ethics in the Organization

5 Ethics as Organizational Culture 158 Introduction 158 Organizational Ethics as Culture 159

viii Contents

What Is Culture? 159 Strong versus Weak Cultures 159 How Culture Influences Behavior: Socialization and Internalization 160

Ethical Culture: A Multisystem Framework 161 Alignment of Ethical Culture Systems 162

Ethical Leadership 163 Executive Leaders Create Culture 163 Leaders Maintain or Change Organizational Culture 164

Other Formal Cultural Systems 174 Selection Systems 174 Values and Mission Statements 175 Policies and Codes 177 Orientation and Training Programs 179 Performance Management Systems 180 Organizational Authority Structure to Support Responsibility 182 Decision‐Making Processes 186

Informal Cultural Systems 187 Role Models and Heroes 188 Norms 189 Rituals 190 Myths and Stories 190 Language 191

Organizational Climates: Fairness, Benevolence, Self‐Interest, Principles 193 Developing and Changing the Ethical Culture 194

How an Ethical Culture Can Become an Unethical Culture 195 Becoming a More Ethical Culture 196

A Cultural Approach to Changing Organizational Ethics 199 Audit of the Ethical Culture 199 Cultural Systems View 199 A Long‐Term View 200 Assumptions about People 200 Diagnosis: The Ethical Culture Audit 201 Ethical Culture Change Intervention 203

The Ethics of Managing Organizational Ethics 204 Conclusion 205 Discussion Questions 205

Contents ix

Case: Culture Change at GM? 206 Case: Culture Change at Texaco 207 Case: An Unethical Culture in Need of Change: Tap Pharmaceuticals 209 Case: “Bad to the Bone” 211 Notes 213

6 Managing Ethics and Legal Compliance 218 Introduction 218 Structuring Ethics Management 218

Making Ethics Comprehensive and Holistic 222 Managing Ethics: The Corporate Ethics Office 222 Ethics and Compliance Officers 222 The Ethics Infrastructure 224 The Corporate Ethics Committee 225

Communicating Ethics 225 Basic Communications Principles 226 Evaluating the Current State of Ethics Communications 228 Multiple Communication Channels for Formal Ethics Communication 230 Interactive Approaches to Ethics Communication 232 Mission or Values Statements 235 Organizational Policy 237 Codes of Conduct 238 Communicating Senior Management Commitment to Ethics 240 Formal and Informal Systems to Resolve Questions and Report Ethical Concerns 245

Using the Reward System to Reinforce the Ethics Message 248 Evaluating the Ethics Program 248

Surveys 248 Values or Compliance Approaches 249 Globalizing an Ethics Program 250 Conclusion 251 Discussion Questions 251 Short Case 252 Appendix: How Fines Are Determined under the U.S. Sentencing Guidelines 253 Notes 255

x Contents

7 Managing for Ethical Conduct 257 Introduction 257 In Business, Ethics is about Behavior 257

Practical Advice for Managers: Ethical Behavior 258 Our Multiple Ethical Selves 258

The Kenneth Lay Example 259 The Dennis Levine Example 261 Practical Advice for Managers: Multiple Ethical Selves 261

Rewards and Discipline 262 People Do What Is Rewarded and Avoid Doing What Is Punished 262 People Will Go the Extra Mile to Achieve Goals Set by Managers 263 How Goals Combined with Rewards Can Encourage Unethical Behavior 264 Practical Advice for Managers: Goals, Rewards, and Discipline 265 Recognize the Power of Indirect Rewards and Punishments 266 Can Managers Really Reward Ethical Behavior? 268 What About the Role of Discipline? 269 Practical Advice for Managers: Discipline 271

People Follow Group Norms 272 “Everyone’s Doing It” 272 Rationalizing Unethical Behavior 273 Pressure to Go Along 273 Practical Advice for Managers: Group Norms 273

People Fulfill Assigned Roles 275 The Zimbardo Prison Experiment 275 Roles at Work 277 Conflicting Roles Can Lead to Unethical Behavior 277 Roles Can Also Support Ethical Behavior 278 Practical Advice for Managers: Roles 278

To Authority: People Do What They’re Told 278 The Milgram Experiments 279 Obedience to Authority at Work 281 Practical Advice for Managers: Obedience to Authority 282

Responsibility is Diffused in Organizations 282 “Don’t Worry—We’re Taking Care of Everything” 282 Diffusing Responsibility in Groups 283

Contents xi

Diffusing Responsibility by Dividing Responsibility 284 Diffusing Responsibility by Creating Psychological Distance 285 Practical Advice for Managers: Personal Responsibility 286

Stressed‐Out Employees are More Unethical 286 Practical Advice for Managers: Stress 287

Conclusion 287 Am I Walking My Ethical Talk? 287

Discussion Questions 288 Case: Sears, Roebuck, and Co.: The Auto Center Scandal 289 Short Case 291 Notes 292

8 Ethical Problems of Managers 295 Introduction 295

Managers and Employee Engagement 295 Managing the “Basics” 298

Hiring and Work Assignments 298 Performance Evaluation 300 Discipline 303 Terminations 305 Why Are These Ethical Problems? 307 Costs 308

Managing a Diverse Workforce 308 Diversity 309 Harassment 311 Family and Personal Issues 312 Why Are These Ethical Problems? 315 Costs 315

The Manager as a Lens 315 The Buck Stops with Managers 316 Managers Are Role Models 319

Managing Up and Across 319 Honesty Is Rule One 320 Standards Go Both Ways 321

Conclusion 322 Discussion Questions 322 Short Cases 323 Notes 324

xii Contents

Section IV Organizational Ethics and Social Responsibility

9 Corporate Social Responsibility 326 Introduction 326 Why Corporate Social Responsibility? 326 Types of Corporate Social Responsibility 334

Economic Responsibilities 334 Legal Responsibilities 335 Ethical Responsibilities 335 Philanthropic Responsibilities 336

Triple Bottom Line and Environmental Sustainability 339 Is Socially Responsible Business Good Business? 343

The Benefit of a Good Reputation 344 Socially Responsible Investors Reward Social Responsibility 344 The Cost of Illegal Conduct 345 The Cost of Government Regulation 346 What the Research Says about Social Responsibility and Firm Performance 349 Being Socially Responsible Because It’s the Right Thing to Do 352

Conclusion 354 Discussion Questions 354 Case: Merck and River Blindness 355 Short Case 357 Notes 357

10 Ethical Problems of Organizations 362 Introduction 362 Managing Stakeholders 363 Key Stakeholder Groups 365

Ethics and Consumers 365 Ethics and Employees 369 Ethics and Shareholders 371 Ethics and the Community 372

Key Ethical Issues Involving Multiple Stakeholders 373 Product Safety 373 Pricing Issues for Prescription Medications 378 Environmental Catastrophes 380 Additional Environmental Bombshells 381

Contents xiii

Why Are These Ethical Issues? 382 Costs 382

Classic Ethics Cases 383 First: The Less-than-Ideal Examples 383 Models to Consider and Admire 388

Conclusion 390 Short Cases 391 Discussion Questions 395 Notes 395

11 Managing for Ethics and Social Responsibility in a Global Environment 399

Introduction 399 Focus on the Individual Expatriate Manager 399

The Difficulties of Foreign Business Assignments 400 The Need for Structure, Training, and Guidance 400 Foreign Language Proficiency 401 Learning about the Culture 401 Recognizing the Power of Selective Perception 403 Assumption of Behavioral Consistency 404 Assumption of Cultural Homogeneity 404 Assumption of Similarity 405 How Different Are Ethical Standards in Different Cultures—Really? 412 Development of Corporate Guidelines and Policies for Global Business Ethics 414

The Organization in a Global Business Environment 418

Deciding to Do Business in a Foreign Country 418 Development of a Transcultural Corporate Ethic 428

Conclusion 431 Discussion Questions 432 Short Case 433 Case: Selling Medical Ultrasound Technology in Asia 433 Case: Google Goes to China 436 Notes 441

Index 447

xv

Why Does the World Need Another Business Ethics Text?

The popular business press is replete with feature stories describing ethical meltdowns and how those corporate misdeeds have eroded the public trust of business leaders and their organizations. As most of us learned at our parents’ knees, trust and reputation are built over many years and take but an instant to be destroyed. So here we stand at a crossroads. Is it going to be business as usual for business? Or are businesspeople going to commit to regaining the trust of our peers, our families, and our fellow citizens?

In response to this crisis of trust, universities across the country have designed new courses that incorporate leadership, communication skills, the basics of human resources management, and ethics. That’s why we wrote this book; we want to make the study of ethics relevant to real‐life work situations. We want to help businesspeople regain the trust that’s been squandered in the last few years. This book is different from other business ethics texts in several key ways. First, it was written by an unusual team. Linda Treviño is Distinguished Profes- sor of Organizational Behavior and Ethics in the Management and Organiza- tion Department of the Smeal College of Business at the Pennsylvania State University. Her prolific research on the management of ethical conduct in organizations is published in the field’s best journals and is internationally known and referenced. She has more than 25 years of experience in teaching students and executives in university and nonuniversity settings, and she also has experience as a corporate consultant and speaker on ethics and manage- ment issues. Kate Nelson is a full‐time faculty member at the Fox School of Busi- ness at Temple University in Philadelphia, where she teaches management, business ethics, and human resources to undergraduates. Before joining Tem- ple’s faculty, Kate worked for more than 30 years in strategic organizational communication and human resources at a variety of companies including Citi- corp, Merrill Lynch, and Mercer HR Consulting. She also has worked as a con- sultant specializing in ethics and strategic employee communications and has designed ethics programs for numerous organizations. We think that bringing together this diverse mix of theory and practice makes the book unique.

Second, the approach of this book is pragmatic, and that approach is a direct response to complaints and suggestions we have heard from students, employ- ees, and corporate executives. “Make it real,” they have said. “Tell us what we need to know to effectively manage people. Take the mystery out of this subject that seems so murky. Get to the point.” This book starts with the assumption

PREFACE

xvi Preface

that ethics in organizations is about human behavior in those organizations. Research finds that behavior results from a number of factors, many of which can be influenced by managers and the organizations themselves. As a result, this book is organized into sections about individuals, managing in an organiza- tional context, organizations in their broader environment, the ethical dilem- mas managers face, and how they might solve them. It also features philosophical and psychological factors of decision making, ethical culture, how managers can influence employees’ behavior through ethical leadership, what corporations are doing to encourage ethical behavior and corporate social responsibility, and international business ethics.

Third, we have used a different mix of examples than is found in conven- tional business ethics texts. Most texts focus on high‐level, corporate dilemmas: “Should senior executives be paid at a particular level? Should this industry do business in China? Should American environmental laws apply to American companies operating overseas?” Although these are interesting issues, the vast majority of students and employees will never have to face them. However, they will have to hire, manage, assess performance, discipline, fire, and provide incentives for staff, as well as produce quality products and services and deal effectively and fairly with customers, vendors, and other stakeholders. As a result, although we do feature some classic and recent corporate ethics cases, many of the cases in this book center on the kinds of problems that most people will encounter during the course of their careers. All of the “hypothetical” cases in this text are based on actual incidents that have happened somewhere—it’s the real stuff that goes on every day in offices across the country.

Fourth, this book was developed with the help of students at a number of universities and with guidance from numerous managers and senior executives from various corporations and organizations. We have incorporated the latest research on ethics and organizational behavior into this text, and much of the material that appears within these pages has been tested in both university and corporate settings.

Fifth, we believe this book is easy to use because it is organized to be flexible. It can be used alone to teach an ethics course, or it can be used as a supplement to a more conventional, philosophical text. The sections in this book basically stand alone and can be taught in a different sequence than is presented here, and the book also has many cases and vignettes you can use for class discussion. Wiley will create custom versions of the text with selected chapters if requested to do so. To help teach this course, the instructor’s guide provides resources such as outlines, overheads, discussion questions, and additional cases for class discussion; it also supplies references to many other resources that can be used to teach the course.

A Note to Students

This book was written for you. We have listened to your complaints and your wish lists and have tried to pare this complicated subject down to a digestible size. The cases that appear in this book all happened to people just like you,

Preface xvii

who were not as prepared to deal with the dilemmas as you will be after taking this course. Before you get into this book, we have one suggestion: know that regardless of how large an organization you find yourself in, you’re not some little cog in a giant wheel. You have the power to change not only your own behavior and knowledge of ethics but also the behavior and knowledge of the people you work with. Use that power: the job you save may be your own.

We also want to suggest that when interviewing for your next job, you try to make sure that you’re joining an organization that values ethics. Are ethics and values described in the firm’s recruiting materials? Do organizational repre- sentatives talk about ethics and values during their interviews with you? When you ask about how their organization demonstrates ethics and values, does your interviewer respond enthusiastically, or does he or she look like a deer caught in headlights so you instantly know that he or she has never even considered this question before? It’s much easier to get into an ethical organization in the first place than try to get out of an unethical one later on.

xix

It takes a lot of work by a lot of people to make a project like this come together. We begin with some joint thank‐yous. Then, because this process has been so meaningful for each of us, we separately share our more personal thanks.

We both offer our heartfelt appreciation to current and former executives who helped us with this and previous editions, in particular, Larry Axline, Jeffrey Braun, Jacquelyn Brevard, Earnie Broughton, Craig Cash, Frank Daly, Kent Druyvesteyn, Dennis Jorgensen, John O’Byrne, Kevin O’Connor, Joe Paterno, Robert Paul, Jo Pease, Shirley Peterson, Vin Sarni, Carl Skooglund, Phil Tenney, and George Wratney. All shared their valuable time and advice, some of them on multiple occasions. Their wisdom can be found throughout this book but especially in Chapter 6. They helped bring the subject of manag- ing business ethics to life.

We also wish to thank Gary Weaver (University of Delaware) for being our philosophy adviser for the first edition, and Dennis Gioia (Penn State faculty member and dear friend) for sharing his Pinto fire case and especially his reflections.

John Wiley & Sons, Inc. is a fine publisher with a superb team. These people encouraged, nudged, nudged, and nudged again. We have many Wiley people to thank for helping to make this book a success.

The book’s past and present reviewers also contributed significantly to mak- ing this a better book, and we thank them as well. We also thank our students and particularly Penn State undergraduate, MBA, and Executive MBA students who provide us with excellent feedback and advice semester after semester.

SPECIAL ACKNOWLEDGMENTS—FROM LINDA K. TREVIÑO

I have always wondered what makes people do especially good and bad things. As the child of Holocaust survivors, I have a unique perspective on and curiosity about such issues. My parents and their families escaped Nazi Germany before Hitler began killing Jews en masse, but not before my maternal grandfather was severely beaten and not before my fraternal grandfather was taken to a concen- tration camp (euphemistically referred to as a “work camp” at the time). My father’s family received papers allowing them to emigrate from Germany to the United States shortly before the war began (in spring 1939), allowing my grand- father to be released from the camp where he was being held (once they were able to find him!). Both families landed in New York, where they survived through sheer grit, perseverance, and belief in the American dream. Although

acknowledgments

xx Acknowledgments

my family never dwelled on their experiences in Germany, I grew up with a spe- cial sensitivity and concern for equality and fair treatment.

I traveled to Germany with my dad and brother about 35 years ago. We visited the tiny towns where Mom and Dad were born and met some wonderful German people who had helped them or at least tried to. I walked through a German village holding hands with the elderly woman who had been my maternal grand- mother’s best friend and who urged the family to leave Germany because she anticipated the worst. I met another elderly woman who had cared for my father and aunt when they were children and who tried to take care of their home when they were forced to leave everything behind. These were special people, and the opportunity to connect with them holds a special place in my heart. So my family and background influenced me in ways I can’t fully grasp with my mind but in ways that I feel in my soul. And I know that my quest to understand what makes people do good and bad things has something to do with that influence.

Many special people have helped along the path that brought me to the writ- ing of this book. I’ll begin by thanking my mentors in the doctoral program at Texas A&M University’s management department. Many thanks to Stuart Youngblood (now retired from Texas Christian University), Don Hellriegel, Richard Woodman, Dick Daft (now at Vanderbilt University), and Mary Zey, who encouraged my early theorizing and research in business ethics. They told me to go with my gut and to do what was important, and they supported my every step despite the fact that the topic was viewed as risky for my career at the time. My exceptional colleagues in the Management and Organizational Department at Penn State have also been supportive all along the way. They have read my papers and challenged me to think harder and make my work ever better.

My thanks also to the colleagues and doctoral students who have worked with me on ethics‐related research over the years and who have been partners in learning about the management of business ethics: particularly Gail Ball, Derron Bishop, Michael Brown, Ken Butterfield, Niki den Nieuwenboer, James Detert, David Harrison, Laura Hartman, Jennifer Kish Gephart, Glen Kreiner, Don McCabe, Bart Victor, Gary Weaver, Jim Detert, Celia Moore, David Mayer, and more. This shared learning has contributed to the book in important ways. I should also thank colleagues whose work fills the pages of the book. The behavioral ethics field has blossomed in recent years and the book has bene- fited as a result.

Shortly after becoming a faculty member at Penn State, I had the good for- tune to meet my friend and coauthor, Kate Nelson. I was intrigued by a brief Wall Street Journal article about Kate’s work at Citibank (you’ll read more about that later). We met and became fast friends, who (believe it or not) loved talk- ing about business ethics. We decided to write an article together, and the rest, as Kate says, is history. Kate brought the real world into this book. She was also willing to tell me when I was getting too academic (not her words exactly). It became clearer and clearer to me that we were supposed to write this book together, and I’m very glad we did. Thanks, Kate!

Acknowledgments xxi

The article became a book proposal that we first shared with publishers at the Academy of Management meeting in 1992 (25 years ago now). Shortly thereafter, Bill Oldsey (formerly publisher at John Wiley & Sons, Inc.) showed up in my office at Penn State. His enthusiasm for the book was immediate and infectious, and he talked us into writing a textbook rather than a trade book. I want to thank Bill for the special part he played.

Over the years, Penn State colleagues, administrators, and donors have con- tinued to support my efforts in the area of business ethics. I am grateful to the Cook family, especially the late Ann Cook, for supporting business ethics at Smeal and the Cook Fellowship that I held for a number of years. My thanks also to Mrs. Mercedes Shoemaker (and her late husband, Albert) for support- ing the Shoemaker program in Business Ethics that has brought us wonderful speakers on the topic of business ethics year after year. Finally, I am especially grateful to Dean James Thomas for naming me Distinguished Professor of Organizational Behavior and Ethics. My association with the Ethics and Compli- ance Initiative’s (formerly the Ethics Resource Center) Fellows program (see www.ethics.org) has connected me with executives who manage ethics in large business organizations as well as consultants and those in government who are interested in making the business world (and the rest of the world, for that mat- ter) a more ethical place. I appreciate the relationships and the learning that have come from this association as well as the time these executives have shared with me. In particular, I appreciate the funding that this group has provided for research that has found its way into this book, especially research on executive ethical leadership.

My heartfelt thanks also go to family members, colleagues, and many dear friends not only for cheering me on (as usual) but also for their many contribu- tions to this book. They have served as readers and interviewees. They have provided clipping services, helped me make contacts, and offered ideas for cases. They were there when I was overwhelmed. I can’t thank them enough. Finally, I thank the light of my life, Dan, for the inspiration, love, and support he provides every day of my life and for being one of the most ethical human beings I know.

SPECIAL ACKNOWLEDGMENTS—FROM KATHERINE A. NELSON

I began to learn about ethics and integrity as a very young child in a family where “doing it right” was the only option. I was blessed to grow up hearing about how your reputation is priceless and you must always guard it and act in ways that enhance that reputation. As a result, my biggest debt is to my parents, the late Harry R. and Bernadette Prendergast Nelson (formerly of New Hartford, New York), and my brother, James V. Nelson of Pasadena, California. My par- ents worked tirelessly to set Jim and me on the right path, and Jim’s generosity and enthusiastic support encouraged me not only to teach ethics but also to write this book. (Jim proved to me that one can be an investment banker and

xxii Acknowledgments

have high ethical standards, and I’m very proud of him.) I’m also grateful to Jim’s wife, Susan, for her many encouraging words of support and for giving our family its two most precious additions, Conor Vincent and James Patrick Nelson. Recently, I was delighted to hear one of my nephews opine about business suc- cess. He said, “I want to work for a good company and when I say ‘good,’ I don’t mean just profitable. I mean I want to work for a company that does good things.” He could not have made me happier.

Thanks to my dearest friends, for their friendship, love, and support: Debra Besch, Loren Hart, Elizabeth Dow, Carol Dygert, and Gail Martin. Thanks also to the educational institutions that provided me with a sound footing in values: Utica Catholic Academy (UCA) in Utica, New York, and the College of Mount St. Vincent in Riverdale, New York. A special thank you to Rev. Laurence Kennedy, who not only taught me philosophy and ethics at UCA, but who also corresponded with me afterward, trying to answer this young girl’s questions about morality and our obligations to others.

If I had ever known how much fun it is to teach, I might have made the tran- sition to academia much earlier. Many thanks to the deans at the Fox School of Business at Temple University—including Moshe Porat, Rajan Chandran, Diana Breslin Knudson, and Debbie Campbell, who took a chance on my teaching ability—and thanks to my many students past and present, who have enriched my life in ways I could not have imagined. Sincere thanks also to my many col- leagues at Temple, who were so welcoming to this corporate refugee and who make me feel so much a part of this wonderful institution, especially Deanna Geddes, John McClendon, Andrea Brooks Lopez, Debbi Casey, and Kathleen Voss.

Thanks go to the many executives who, each in his or her own way, taught me that business ethics need not be an oxymoron: Christopher York, Don Armiger, Peter Thorp, Judith Fullmer, Jerry Lieberman, and Jane Shannon—all formerly with Citicorp in New York City; and Eugenie Dieck, Charlie Scott, and Lea Peterson, all formerly with Mercer HR Consulting in Philadelphia and Boston. And thank you to Allan Kennedy, the coauthor of the groundbreaking book from the late 1970s, Corporate Cultures. While working at Citicorp as a McKinsey consultant back in 1985, Allan was the very first person who encouraged me to go into ethics by helping me germinate the idea of designing an ethics game for Citicorp.

The most important thank‐you goes to my wonderful husband, Stephen J. Morgan—an honorable man if there ever was one—who inspires and loves me every day. This book and my teaching would not be possible without his unfail- ing support, wisdom, and encouragement.

Of course, a final thank‐you goes to my coauthor, Linda Treviño, for her dear, dear friendship and for working with me to produce this book in what, in comparison to accounts from other writing teams, was an almost painless experience.

S e c t i o n i

Introduction

2

Chapter 1

Introducing Straight Talk about Managing Business Ethics: Where We’re Going and Why

Introduction

Back in 1993, when we sat down to write the first edition of this book, people wondered if business ethics was just a fad. At that point, companies were just beginning to introduce ethics into new‐hire orientations and management training programs. In academia, business ethics was just beginning to gain trac­ tion as a subject for serious academic study, and some business schools were going so far as to require a business ethics course to graduate.

Back then there was still the feeling among many experts that business ethics—like time management, quality circles, and other management buzz­ words of the day—would soon become a footnote in texts that described busi­ ness fads of the late twentieth century. Despite multiple waves of scandal over the years, these have often been portrayed as temporary blips. For example, one prominent business writer for Fortune Magazine wrote an article in 2007 titled “Business is Back!” Here’s a choice excerpt: “It must be said: The shaming is over. The 51⁄2 year humiliation of American business following the tech bubble’s burst and the Lay‐Skilling‐Fastow‐Ebbers‐Kozlowski‐Scrushy perp walks that will forever define an era has run its course. After the pounding and the ridicule, penance has finally been done. No longer despised by the public, increasingly speaking up and taking stands, beloved again by investors, chastened and much changed—business is back.”1 Could he have been more wrong? Business man­ aged to outdo itself on the shame index yet again just about a year later with the collapse of the financial markets. We’ve seen these ethical debacles occur regu­ larly for the past 30 years. As a result, we’re convinced that business ethics is far from a fad. It’s an ongoing phenomenon that must be better understood and managed and for which business professionals must be better prepared.

We tell our students that serious ethical scandals often result from multiple parties contributing in their own small or large ways to the creation of a catas­ trophe. As you’ll read later on in this book, Enron’s collapse in 2001 was not just the failure of Enron executives and employees, but also the failure of Enron’s auditors, the bankers who loaned the company money, and the lawyers who never blew the whistle on Enron’s shenanigans. However, no scandal of recent

Introduction 3

years—not even Enron—matches the financial industry debacle in 2008. Like Enron, many players contributed to this colossal failure. But the financial crisis was unparalleled in its scope and has fueled public outrage like no other busi­ ness disaster in our lifetime. The aftermath had people around the world angry and mistrustful of companies, governments, regulators, rating agencies, and the people who work in them. If there was ever a crisis of trust and confidence, this is it. It is also a textbook‐perfect example of how numerous people’s actions (and inactions) can conspire to spawn an almost unimaginable calamity.

Recent business history has proven beyond any doubt that divorcing business from ethics and values runs huge risks. Rushworth Kidder,2 the highly regarded ethics writer and thinker who died in 2012, wrote about the financial debacle and the resulting public anger. He eloquently described how free marketers cite Adam Smith’s Wealth of Nations to justify a breed of capitalism that abhors regu­ lation and focuses on short‐term profits over long‐term stewardship. Kidder wisely noted that 17 years before his more famous book, Smith wrote another one titled The Theory of Moral Sentiments. Smith’s first book deserves more atten­ tion because he always presumed that the messages from these two books would go hand in hand. Smith’s “moral sentiments” work rests on the assumption that human beings are empathetic; they care about others, and they derive the most joy from human love and friendship. His book opened with the following state­ ment: “How selfish soever man might be supposed, there are evidently some principles in his nature, which interest him in the fortune of others. . . .”3 Smith believed that a good life derives from the expression of “beneficence,” not from material wealth. He proposed that self‐love (which he also acknowledged) can spur the individual to better his own condition by besting competitors. But he argued that this must be done in a just manner and in the spirit of fair play as judged by an informed, ethical, and impartial spectator. We care what others think of us because we are first and foremost social beings. But we also are moral beings who want to do the right thing because it is the right thing to do (not just to win the praise of others). According to Smith, virtuous persons bal­ ance prudence (mature self‐love), strict justice, and benevolence, and ideal societies are comprised of such persons. Finally, a flourishing and happy society is built upon a foundation of justice and rules of conduct that create social order. Smith was confident that humankind would progress toward this positive ethical state; he called on leaders to avoid the arrogance of power and, instead, to be virtuous statesmen. Kidder’s point was that capitalism will succeed only when firmly tethered to a moral base, and he reminds us that Adam Smith— that hero of free marketers—knew this better than anyone.

We completely agree. We began this book more than 20 years ago with the firm belief that business isn’t just “better” when companies and businesspeople are ethical, but rather that good ethics is absolutely essential for effective business practice. This is not just empty rhetoric. Work is essential to life, and most peo­ ple work for a business of some kind. How we work and the standards we uphold while we are working affect much more than just commerce. Our business behavior also affects our personal and company reputations, politics, society at large, and even our national reputation. For example, the 2008 financial crisis,

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while global in scope, had its roots in the United States, and the nation’s reputa­ tion has suffered because of the behavior of individuals and companies. Simi­ larly, China’s reputation has suffered because of contaminants found in Chinese exports such as infant formula, drywall (used in construction), and children’s toys. So corporate misbehavior does not happen in a vacuum, and it’s not just corporate reputations that suffer as a result. These scandals cast long shadows, and they often affect entire industries and countries. In this complex and increasingly transparent world, where reputation influences everything from who wants to hire you or trade with you to who buys your products to who finances your debt—and much more—unethical behavior in business is a very big deal indeed. So let’s take a closer look at the elephant in the room: the near collapse of the financial markets in 2008 and what it has to do with busi­ ness ethics.

The Financial Disaster of 2008

The implosion of the financial markets in 2008 was largely not the result of illegal behavior. For the most part, the activities that brought down the U.S. economy and others around the world were not against the law, at least not yet (government regulators and the legal system often play catch‐up after ethical debacles in business). Many of those activities, however, were unethical in that they ultimately produced great harm and were contrary to a number of ethical principles such as responsibility, transparency, and fairness. Let’s start with some of the factors that laid the groundwork for the disaster in the United States.

Borrowing Was Cheap

First, borrowing money became really cheap. In 2000, stocks in high‐technology companies had soared to unsustainable heights, and that bubble finally burst. To soften the effects on the U.S. financial markets, Alan Greenspan, who headed the Federal Reserve at that time, lowered the Federal Funds rate (the rate banks charge each other for overnight loans, which has a direct impact on short‐term interest rates, including the prime rate) to almost zero. That move, seemingly innocent at the time, injected huge amounts of money into the U.S. financial system. It made the cost of borrowing so low that it fueled a glut of consumer borrowing. Suddenly, it was amazingly cheap to buy a new car, a wide‐screen television, a backyard pool, a larger home, a second home, and all sorts of designer goodies. There was even encouragement to indulge. Following the ter­ rorist attacks in September 2001, President George W. Bush told people that if they wanted to help the economy they should go shopping. And people did. Household debt levels rose to $13.9 billion in 2008, almost double what house­ holds owed in 2000, and savings dipped into negative territory. Responsible borrowers should have thought about what they could afford rather than what bankers would lend to them. And responsible lenders should have established that borrowers could actually afford to pay back the loans before lending them money.

The Financial Disaster of 2008 5

Real Estate Became the Investment of Choice

Of course, people also want to invest in something safe, and what could be safer than real estate? There had been relatively few instances of real estate values declining, and when they did the declines were generally shallow and short‐ lived. A point of pride in the United States was the high percentage of Ameri­ cans who owned their own homes. Investing in a home traditionally had been a very safe investment and one that was slow to appreciate in value. But suddenly in the early 2000s, real estate investing became a real moneymaker. With a back­ drop of historically low interest rates, real estate became such a popular way to invest that demand soon outstripped supply and prices soared. The value of homes skyrocketed—homes that were selling for $300,000 in one year sold for $450,000 the next. Prices rose so fast that speculation grew tremendously. People bought houses with almost no down payment, remodeled them or waited a few months, and then resold the houses for a quick profit. A number of popular television programs showed viewers how to “flip” real estate proper­ ties for profit.

Because the cost of borrowing was so low and home equity had grown so quickly, many consumers borrowed on the equity in their homes and purchased additional real estate or a new car or financed a luxury vacation. For example, suppose someone purchased a house for $500,000 in 2003. By 2005, the home might have been worth $800,000. The home owner refinanced the mortgage— borrowing as much as the entire current worth of the house (because its value could only go up, right?), which resulted in a $300,000 cash infusion for the home owner. This practice was very popular, and it laid the groundwork for a huge disaster when the housing values fell off a cliff in 2008 and 2009. Imagine the home owner who refinanced the home just described. Imagine that he took the $300,000 and purchased a summer home and a sports car and paid for his children’s college educations. Suddenly, home values plummeted and his house lost 30 percent of its value, which was common in markets such as California, Florida, Nevada, and Arizona, where the real estate bubble was particularly inflated. After the real estate bubble burst, his house was worth $560,000. Now suppose he loses his job and needs to sell his house because he can’t afford the mortgage payments. He can’t get $800,000 for his home, which is what he owes on his mortgage. His only choice is to work with the mortgage holder (probably a bank) to refinance (unlikely) or declare bankruptcy and walk away from the house. This is what a lot of home owners have done, and it is one of the factors at the heart of the current financial crisis. Lots of folks were in on this bubble mentality, getting what they could in the short term and not thinking very much about the likelihood (or inevitability) that the bubble would burst.

Mortgage Originators Peddled “Liar Loans”

In the early 2000s, as housing investments increased in popularity, more and more people got involved. Congress urged lenders Freddie Mac and Fannie Mae to expand home ownership to lower‐income Americans. Mortgage lenders began to rethink the old rules of financing home ownership. As recently as the

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late 1990s, potential home owners not only had to provide solid proof of employ­ ment and income to qualify for a mortgage, but they also had to make a cash down payment of between 5 and 20 percent of the estimated value of the home. But real estate was so hot and returns on investment were growing so quickly that mortgage lenders decided to loosen those “old‐fashioned” credit restric­ tions. In the early 2000s, the rules for obtaining a mortgage became way less restrictive. Suddenly, because real estate values were rising so quickly, borrowers didn’t have to put any money down on a house. They could borrow the entire estimated worth of the house; this is known as 100‐percent financing. Also, bor­ rowers no longer needed to provide proof of employment or income. These were popularly called “no doc” (no documentation) or “liar loans” because banks weren’t bothering to verify the “truth” of what borrowers were claiming on their mortgage applications.

This complete abandonment of lending standards opened the mortgage market to rampant fraud, and it was not exactly a secret. The FBI warned of an “epidemic” of mortgage fraud back in 2004, four years before that epidemic torpedoed the financial industry.4

Banks Securitized the Poison and Spread It Around

At about the same time liar loans were becoming popular, another new practice was introduced to mortgage markets. Investors in developing countries were looking to the United States and its seemingly “safe” markets for investment opportunities. Cash poured into the country from abroad—especially from countries like China and Russia, which were awash in cash from manufacturing and oil, respectively. Wall Street bankers developed new products to provide investment vehicles for this new cash. One new product involved the securitiza­ tion of mortgages. (Note: structured finance began in 1984, when a large num­ ber of GMAC auto receivables were bundled into a single security by First Boston Corporation, now part of Credit Suisse.) Here’s how it worked: Instead of your bank keeping your mortgage until it matured, as had traditionally been the case, your bank would sell your mortgage—usually to a larger bank that would then combine your mortgage with many others (reducing the bank’s incentive to be sure you would pay it back). Then the bankers sold these mortgage‐backed securities to investors, which seemed like a great idea at the time. Real estate was traditionally safe, and “slicing and dicing” mortgages divided the risk into small pieces with different credit ratings and spread the risk around.

Of course, the reverse was also true, as the bankers learned to their horror. This method of dividing mortgages into little pieces and spreading them around could also spread the contagion of poor risk. However, starting in 2002 and for several years thereafter, people couldn’t imagine housing values falling. So much money poured into the system, and the demand for these mortgage‐ backed security products was so great, that bankers demanded more and more mortgages from mortgage originators. That situation encouraged the tradi­ tional barriers to getting a home mortgage to fall even farther. These invest­ ment vehicles were also based upon extremely complex mathematical formulas

The Financial Disaster of 2008 7

(and old numbers) that everyone took on faith and few attempted to under­ stand. It looks like more people should have followed Warren Buffett’s sage advice not to invest in anything you don’t understand!

Add to that toxic mix the relatively new idea of credit‐default swaps (CDS). These complex financial instruments were created to mitigate the risk financial firms took when peddling products such as securitized mortgages. CDS are insurance contracts that protect the holder against an event of default on the part of a debtor. One need not own the loan or debt instrument to own the protection, and the amount of capital tied up in trading CDS is very small com­ pared to trading other debt instruments. That is a very significant part in the increase in the popularity of CDS at sell‐side and buy‐side trading desks. The insurance company AIG was a huge player in this market, and so were the large banks. The firms that were counterparties to CDS never stepped back from the trading frenzy to imagine what would happen if both the structured finance market and the real estate bubble burst (as all bubbles eventually do) at the same time. Both underwriters and investors would be left holding the bag when the music stopped playing—and the U.S. taxpayer has had to bail out most of the financially stressed firms to save the entire financial system from collapse. Please note that all of this happened in a part of the market that was virtually unregulated.

Those Who Were Supposed to Protect Us Didn’t

One protection against financial calamity was thought to be the rating agencies, including Standard and Poor’s, Fitch Group, and Moody’s. They rate the safety or soundness of securities, including those securitized mortgage products. A credit opinion is defined as one which rates the timeliness and ultimate repay­ ment of principal and interest. But, like everyone else, the rating agencies say they didn’t foresee a decline in housing prices; and consequently, they rated the mortgage securities as being AAA—the highest rating possible, which meant that the rating agencies considered these securities to be highly safe with little risk.

The agencies are the subject of much criticism for their role in the crisis. If they had done a better job analyzing the risk (their responsibility), much of the crisis might have been avoided. But note that these rating agencies are hired and paid by the companies whose products they rate, thus causing a conflict of interest that many believe biased their ratings in a positive direction. So people who thought they were making responsible investments because they checked the ratings were misled.

Another protection that failed was the network of risk managers and boards of directors of the financial community. How is it that one 400‐person business that was part of the formerly successful insurance behemoth, AIG, could invest in such a way that it brought the world’s largest insurance company to its knees? The risk was underestimated all around by those professionals charged with anticipating such problems and by the board of directors that didn’t see the problem coming. The U.S. government (actually taxpayers) ended up bailing

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out AIG to the tune of $170 billion. The risk managers and boards of other financial firms such as Citigroup, Merrill Lynch, Lehman Brothers, Bear Stearns, and Wachovia were similarly blind.

On Wall Street, there were other contributing factors. First, bank CEOs and other executives were paid huge salaries to keep the price of their firms’ stocks at high levels. If their institutions lost money, their personal payouts would shrink. As a result, bank executives focused on short‐term financial results often to the exclusion of long‐term planning or organizational strategy. Because their compensation packages were directly tied to the company stock price, they were paid handsomely for their efforts to bolster short‐term profits. The Wall Street traders were similarly compensated—they were paid multimillion‐dollar bonuses for taking outsized risks in the market. What seemed to matter most were the short‐term profits of the firm and the short‐term compensation of those making risky decisions. The traders took risks, the bets were at least tem­ porarily successful, and the bankers walked off with multimillion‐dollar bonuses. It didn’t matter that the risk taking was foolish and completely irresponsible in the long run. The bonus had already been paid. Consequently, a short‐term mentality took firm root among the nation’s bankers, CEOs, and boards of directors.

In addition, most of the big investment banks went public in the 1990s. Before becoming public companies, these firms were mostly partnerships. If the partners wanted to make a bet on the markets, they were risking their own money. If they won the bet, they reaped the rewards as individuals. If they lost the bet, the loss came out of their personal assets. In other words, they had “skin in the game.” After these firms went public, the money used to make bets no longer came from the partners; it came from shareholders. The profits and losses from these bets enriched the company directly, not the individuals who ran it (who would benefit only indirectly). These executives no longer had “skin in the game” to anywhere near the degree that they had when these firms were partnerships. It’s much easier to get careless with other people’s money than it is your own.5

If you thought that bankers’ behavior would change as a result of the finan­ cial debacle, think again. In 2012, JPMorgan Chase—which in the wake of the financial crisis was described by many experts as being the best managed U.S. bank—suffered a huge loss at the hands of a rogue trader in its London office. The initial losses were estimated to be $2 billion, but later revised to be per­ haps as high as $9 billion—in the same exact type of investments that created the financial catastrophe just a few years earlier.6 Between 2008 and 2014, JPMorgan Chase has paid more than $70 billion in fines for a variety of ques­ tionable activities. They are not alone. Bank of America has paid fines of $120 billion over the same period and Citigroup has paid more than $38 billion in fines.7

Finally, we cannot examine the financial crisis without questioning the role of regulatory agencies and legislators. For example, for a decade, investor Harry Markopolos tried on numerous occasions to spur the Securities and Exchange Commission to investigate Bernard L. Madoff. The SEC never did uncover the

The Financial Disaster of 2008 9

largest Ponzi scheme in the history of finance. The $65 billion swindle unrave­ led only when Madoff admitted the fraud to his sons, who alerted the SEC and the U.S. attorney’s office in New York in December 2008.

Others who are culpable in the financial crisis are members of the U.S. Con­ gress, who deregulated the financial industry, the source of some of their largest campaign contributions. Among other things, they repealed the Glass‐Steagall Act, which had been passed after the U.S. stock market crash in 1929 to protect commercial banking customers from the aggression and extreme risk taking of investment bank cultures. The act created separate institutions for commercial and investment banks, and they stayed separate until Citicorp and Travelers merged to form Citigroup in 1998. The two companies petitioned Congress to eliminate Glass‐Steagall, claiming that it was an old, restrictive law and that today’s markets were too modern and sophisticated to need such protection. And Congress listened.

Those 1930s congressmen knew that if the two banking cultures tried to exist in the same company—the staid, conservative culture of commercial banking (our savings and checking accounts) and the razzle‐dazzle, high‐risk culture of investment banking—the “eat what you kill” investment bank culture would win out. Some said that staid old commercial banks turned into “casinos.” But, interestingly, casinos are highly regulated and are required to keep funds on hand to pay winners. In the coming years, we expect to learn more about the behavior that led to this crisis. As we noted earlier, much if not most of it was probably legal because of the lack of regulation in the mortgage and investment banking industries. But look at the outcome! If only ethical antennae had been more sensitive, more people might have questioned products they didn’t under­ stand, or spoken out or refused to participate in practices that were clearly ques­ tionable. As just one tiny example, could anyone have thought it was ethical to sell a product they called a liar loan, knowing that the customer surely would be unable to repay (even if it was legal to do so)?

In 2010, the U.S. Congress passed the Dodd‐Frank Financial Regulation Legislation—an attempt to rein in the most egregious practices in the financial industry. Financial institution lobbyists continue trying to water down the effects of this bill as regulators work to implement its complex regulations. Several European countries might be ahead of the U.S. when it comes to com­ prehensive financial regulation reform.8 Although many experts felt that Dodd‐Frank was a failure in the years immediately following the crisis, the view is more nuanced now, going on ten years after the crisis. While more than a few banks remain “too big to fail,” bank profits are down, capitalization is up, and some experts theorize that the banks are indeed shrinking as a result of the regulation.9

What’s increasingly clear is that corruption exists among the world’s leading financial institutions and that sometimes they collude in that corruption. If you think that is an exaggeration, please read about the LIBOR scandal that broke during the summer of 2012. LIBOR, which stands for the London Interbank Offered Rate, is the interest rate by which banks can borrow from one another. LIBOR is important because so many of the loans around the world—mortgage

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rates, car loans, corporate debt, etc., are pegged to those LIBOR rates. Experts estimate that hundreds of trillions of dollars’ worth of financial contracts and derivatives are tied to LIBOR.

Regulators in several countries have accused a number of global financial institutions with cooperating with one another to rig LIBOR rates to make themselves appear healthier in the wake of the financial collapse of 2008– 2009. Several of the large banks have received huge fines: Deutsche Bank (Germany) paid $2.5 billion in fines, USB (Switzerland) paid $1.5 billion, and Rabobank (Netherlands) paid $1 billion. Other banks including Citi­ group, JPMorgan Chase, Royal Bank of Scotland, and Barclays Bank have paid hundreds of millions of dollars in fines stemming from the scandals and individual traders have been criminally convicted of manipulating the LIBOR and will be serving jail sentences.10 This crisis was particularly shocking because the UBS settlement not only charges that UBS manipulated rates to make itself look healthier, but also that it colluded with other global banks to make money from the manipulated rates. This is the equivalent of the big players admitting that the game is fixed. One Wall Street veteran described the scandal this way: “It’s like finding out that the whole world is on quicksand.”11

Let’s delve into the cynicism that this and previous scandals have created and then try to move beyond it so that you can do things differently in the future.

Moving Beyond Cynicism

After multiple waves of business scandals, some cynicism (a general distrust) about business and its role in society is probably healthy. However, cynicism about business has truly become an epidemic in the United States. To be fair, we should note that although the financial industry screwed up royally, at the same time most other mainstream American companies were “running their companies with strong balance sheets and sensible business models.”12 Most companies were responsible, profitable, and prudent. Because they had serious cash reserves, many of them have actually managed to weather the recent crises reasonably well. But the attention has not been on these responsi­ ble companies. It’s been on the financial sector and its irresponsibility.

How bad is the cynicism? According to the 2016 Edelman Trust Barometer13—a survey of almost 30,000 college‐educated people around the world—it’s bad almost everywhere around the globe. (Edelman is the world’s largest independ­ ent public relations firm with 53 offices around the world. Its business is helping companies build and maintain reputations.) Edelman’s study shows that only 49 percent of consumers trust institutions in general. As for business, globally about half of the general public and about 60 percent of the informed public trust companies.

The Edelman study also highlights the importance of consumer trust—the degree to which consumers trust organizations has a direct impact on their buy­ ing patterns and much more. Over a one‐year period, 91 percent of consumers

Moving Beyond Cynicism 11

stated that they purchased a product of service from a company they trust, and 77 percent of consumers refused to purchase a product or service from a com­ pany that they mistrusted. These figures suggest that corporate reputations affect consumer buying patterns, and companies risk harming their bottom line when they do not act to protect their good name.

However, consistent with our idea that business ethics is not a fad, neither is public cynicism about business ethics new. We have written about it in every edi­ tion of our book (since 1995). Surely, the factor that has contributed the most to cynicism in recent years is the highly visible behavior of some of the nation’s leading corporations and executives, whose activities have garnered so much space in the business press and on the evening news. How do you watch hour after hour of such reporting and not walk away jaded? In the last few years, all you had to do was read about or watch the news to feel cynical, and business school students are no exception. We also note that business is not alone in its scandalous behavior. In recent years, we’ve learned about government employ­ ees who stole or misused funds, academics who falsified their research results, ministers who stole from their congregations, priests who abused children, and athletes who took bribes or used performance‐enhancing drugs. It seems that no societal sector is immune.

Many of our readers are business school students, the current or future managers of business enterprises. Surveys suggest that many business stu­ dents are themselves surprisingly cynical about business (given that they’ve chosen it as their future profession). They might believe that they’ll be expected to check their ethics at the corporate door or that they will be pres­ sured to compromise their own ethical standards in order to succeed. Con­ sider this scenario that took place at a large university: A professor asked his class to name management behaviors that are morally repugnant. His class struggled to name one! In another of his classes, the professor asked if the students would dump carcinogens in a river. This time the class agreed that they would do so because if they didn’t, someone else would. When the pro­ fessor asked if they really wanted to live in such a cynical environment, the class insisted that they already did. The dismayed professor believed that the attitudes of his students were formed long before they landed in his class­ room. He agreed with other observers that the problem goes way beyond business and business schools and that our society, with its emphasis on money and material success, is rearing young people who strive for achieve­ ment at any cost. One symptom: cheating is pervasive in many high schools and colleges.14

This scenario is enough to make anyone wonder about today’s business stu­ dents. But at the same time, we know that students at many colleges and univer­ sities, including business schools, are encouraging their own faculty and administrators to establish newly invigorated academic integrity policies and honor codes. In an honor code community, students take responsibility for implementing the academic integrity policy and for holding each other account­ able to it. They manage study‐run judiciaries that mete out serious discipline to their fellow students who tarnish the community by cheating. These efforts,

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which are gaining real traction at many schools, suggest that at least some stu­ dents have had enough and are willing to turn from cynicism toward a proactive approach to change things.

A 2008 Aspen Institute study of nearly 2,000 MBA students from 15 leading international business schools provides some insight into MBA students’ atti­ tudes, which appear to be moving in a less cynical direction. Similar to the find­ ings they obtained in a 2002 survey, the results of Aspen’s 2008 survey of MBA students indicate that the students anticipate facing difficult conflicts regarding values in their jobs, and they suggest some cynicism about ethics in the work­ place. However, about 40 percent of these students believe that their business education is preparing them to manage values conflicts “a lot,” and another 50 percent believe that they’re being prepared “somewhat.” Also, more than a quarter of the respondents said they are interested in finding a job that gives them the opportunity to contribute to society (compared to only 15 percent in 2002). More than half believe that safe, high‐quality products and responsible governance and transparent business practices are very important in a potential employer. In addition, more than half said they would advocate alternative val­ ues or approaches in response to values conflicts at work (many more than in 2002).15

The media might be largely responsible for students’ cynical attitudes. Think about the depiction of business and its leaders in movies and on television. The Media Research Center conducted a survey of 863 network TV sitcoms, dramas, and movies in the mid‐1990s. Nearly 30 percent of the criminal characters in these programs were business owners or corporate executives. Entrepreneurs were represented as drug dealers, kidnappers, or sellers of defective gear to the military.16 Fortune magazine called this “the rise of corporate villainy in prime time.”17 Movies have abounded with negative messages about corporate Amer­ ica. Think The Big Short, The Wolf of Wall Street, Arbitrage, Avatar, Inside Job, Up in the Air, The Constant Gardner, Gasland, Wall Street, Boiler Room, Civil Action, Glen­ garry Glen Ross, The Insider, Erin Brockovich, Supersize Me, The Corporation, Enron: The Smartest Guys in the Room, Michael Clayton, The International, Quiz Show, The Insider, and Bowling for Columbine. And there are more such movies every year; we’re sure you can add to the list. A much tougher exercise is to generate a list of movies and television shows that actually create a positive ethical impression of business. Can you think of any? The consistent negative representation of business in the media has its effects. Academic research suggests that cynicism toward American business increased after study participants viewed the film Roger & Me, which depicted ruthless plant closings and layoffs at General Motors.18 Imagine the cumulative, daunting effect of viewing countless movies and television programs that portray business as corrupt and business leaders as ruthless and unethical.

To counter that media‐fueled cynicism at least somewhat, we encourage you to think about your own life and the hundreds of reliable products and services you trust and depend on every day as well as the people and businesses that produce them. These good folks are businesspeople too, but it isn’t nearly as

Moving Beyond Cynicism 13

exciting or sexy for the media to portray businesspeople who do the right thing every day. We also encourage you to talk with businesspeople you know, perhaps people in your own family who work for businesses. Do they feel pressured to compromise their ethical standards, or do they see their employer in a more positive light?

Interestingly, the Ethics & Compliance Initiative’s 2013 National Business Ethics Survey (see ethics.org) found that only 9 percent of employees of for‐ profit enterprises report feeling pressured to compromise their ethical stand­ ards. That means that more than 91 percent say that they’re not feeling such pressure. Also, two‐thirds of these employees said that their own company has a strong or strong‐leaning ethical culture. What do these numbers mean? To us, it means that most Americans who work in business think that their own com­ pany and coworkers are pretty ethical. Still, they read the same media accounts and see the same movies and TV programs as everyone else, and these offerings influence cynicism about American business in general.19

Finally, we won’t leave a discussion of cynicism without talking about the events of September 11, 2001. While the business scandals of 2001–02 left many cynical, the events of September 11, 2001, showed us some of the best in many individuals and businesses. We have read about the care, compassion, and assistance that countless American firms gave to those who were harmed by the terrorist attacks. Few firms were hit as hard as Sandler O’Neill & Part­ ners, a small but profitable Wall Street investment bank that lost 66 of its 171 employees—including two of the firm’s leading partners—on September 11. The firm’s offices were on the 104th floor of the World Trade Center. Despite its dire financial straits, the firm sent every deceased employee’s family a check in the amount of the employee’s salary through the end of the year and extended health‐care benefits for five years. Bank of America quickly donated office space for the firm to use. Competitors sent commissions their way and freely gave the company essential information that was lost with the traders who had died. Larger Wall Street firms took it upon themselves to include Sandler in their deals. The goal was simply to help Sandler earn some money and get back on its feet.20 This is only one of the many stories that point to the good that exists in the heart of American business. In this book, we offer a number of positive stories to counterbalance the mostly negative stories por­ trayed in the media.

The bottom line is this. We’re as frustrated as you are about the media por­ trayal of business and the very real, unethical behavior that regularly occurs in the business community. But we also know that the business landscape is a varied one that is actually dominated by good, solid businesses and people who are even heroic and extraordinarily giving at times. So, for our cynical readers, we want to help by doing two things in this book: (1) empowering managers with the tools they need to address ethical problems and manage for ethical behavior, and (2) providing positive examples of people and organ­ izations who are “doing things right” to offset some of the media‐fueled negativity.

14 Chapter 1 Straight Talk about Managing Business Ethics

In May 2009, something notable and quite positive happened. A group of 20 second‐year students at Harvard Business School created The MBA Oath in an attempt to articulate the values they felt their MBA degree ought to stand for:

This focus on positive values among business students and business in gen­ eral received significant publicity and turned into something of a movement. More than 400 graduates of Harvard Business School signed the oath, and they were joined by more than 6,000 business students from 300 other colleges and universities globally. For more information, go to www.mbaoath.org.

Can Business Ethics Be Taught?

Given all that has happened, you might be wondering whether business ethics can be taught. Perhaps all of the bad behavior we outlined earlier results from a relatively few “bad apples” who never learned ethics from their families, clergy, previous schools, or employers.21 If this were so, ethics education would be a

THE MBA OATH

As a business leader I recognize my role in society.

• My purpose is to lead people and manage resources to create value that no single individual can create alone.

• My decisions affect the well‐being of individuals inside and outside my enterprise, today and tomorrow.

Therefore I promise:

• I will manage my enterprise with loyalty and care, and will not advance my personal interests at the expense of my enterprise or society.

• I will understand and uphold, in let­ ter and spirit, the laws and contracts governing my conduct and that of my enterprise.

• I will refrain from corruption, unfair competition, or business practices harmful to society.

• I will protect the human rights and dignity of all people affected by my

enterprise, and I will oppose dis­ crimination and exploitation.

• I will protect the right of future generations to advance their stand­ ard of living and enjoy a healthy planet.

• I will report the performance and risks of my enterprise accurately and honestly.

• I will invest in developing myself and others, helping the management profession continue to advance and create sustainable and inclusive prosperity.

In exercising my professional duties according to these principles, I recognize that my behavior must set an example of integrity, eliciting trust and esteem from those I serve. I will remain accountable to my peers and to society for my actions and for upholding these standards.

This oath I make freely, and upon my honor.

Can Business Ethics Be Taught? 15

waste of time and money, and resources should be devoted to identifying and discarding bad apples, not trying to educate them. We strongly disagree, and the evidence is on our side.

Aren’t Bad Apples the Cause of Ethical Problems in Organizations?

According to the bad apple theory, people are good or bad and organizations are powerless to change these folks. This bad apple idea22 is appealing in part because unethical behavior can then be blamed on a few individuals with poor character. Although it’s unpleasant to fire people, it’s relatively easier for organ­ izations to search for and discard a few bad apples than to search for some organizational problem that caused the apple to rot.

Despite the appeal of the bad apple idea, “character” is a poorly defined concept, and when people talk about it, they rarely define what they mean. They’re probably referring to a complex combination of traits that are thought to guide individual behavior in ethical dilemmas. If character guides ethical conduct, training shouldn’t make much difference because character is thought to be relatively stable: it’s difficult to change, persists over time, and guides behavior across different contexts. Character develops slowly as a result of upbringing and the accumulation of values that are transmitted by schools, families, friends, and religious organizations. Therefore, people come to educa­ tional institutions or work organizations with an already defined good or poor character. Good apples will be good and bad apples will be bad.

In fact, people do have predispositions to behave ethically or unethically (we talk about this in Chapter 3). And sociopaths can certainly slip into organiza­ tions with the sole intent of helping themselves to the organization’s resources, cheating customers, and feathering their own nests at the expense of others. Famous scoundrels like Bernie Madoff definitely come to mind. Such individu­ als have little interest in “doing the right thing,” and when this type of individ­ ual shows up in your organization, the best thing to do is discard the bad apple and make an example of the incident to those who remain.

But discarding bad apples generally won’t solve an organization’s problem with unethical behavior. The organization must scrutinize itself to determine whether something rotten inside the organization is spoiling the apples. For example, Enron encouraged a kind of devil‐may‐care, unethical culture that is captured in the film Enron: The Smartest Guys in the Room. Arthur Andersen’s culture morphed from a focus on the integrity of audits to a consulting culture that focused almost exclusively on feeding the bottom line (you’ll read more about that in Chapter 5). In this book you’ll learn that most people are not guided by a strict internal moral compass. Rather, they look outside themselves— to their environment—for cues about how to think and behave. This was cer­ tainly true in the financial crisis when the mantra became “everyone is doing it” (and making a lot of money besides). At work, managers and the organizational culture transmit many cues about how employees should think and act. For example, reward systems play a huge role by rewarding short‐term thinking and profits, as they did in the recent financial crisis. In this book, you’ll learn about

16 Chapter 1 Straight Talk about Managing Business Ethics

the importance of these organizational influences and how to harness them to support ethical behavior and avoid unethical behavior.

So apples often turn bad because they’re spoiled by “bad barrels”—bad work environments that not only condone, but might even expect unethical behav­ ior. Most employees are not bad to begin with, but their behavior can easily turn bad if they believe that their boss or their organization expects them to behave unethically or if everyone else appears to be engaging in a particular practice. In this view, an organization that’s serious about supporting ethical behavior and preventing misconduct must delve deeply into its own management systems and cultural norms and practices to search for systemic causes of unethical behavior. Management must take responsibility for the messages it sends or fails to send about what’s expected. If ethics problems are rooted in the organiza­ tion’s culture, discarding a few bad apples without changing that culture isn’t going to solve the problem. An effective and lasting solution will rely on man­ agement’s systematic attention to all aspects of the organization’s culture and what it is explicitly or implicitly “teaching” organizational members (see Chapter 5).

This question about the source of ethical and unethical behavior reflects the broader “nature/nurture” debate in psychology. Are we more the result of our genes (nature) or our environment (nurture)? Most studies find that behavior results from both nature and nurture. So when it comes to ethical conduct, the answer is not either/or, but and. Individuals do come to work with predisposi­ tions that influence their behavior, and they should take responsibility for their own actions—but the work environment can also have a large impact. In this book, you’ll learn a lot about how that work environment can be managed to produce ethical rather than unethical conduct.

Shouldn’t Employees Already Know the Difference between Right and Wrong?

A belief associated with the good/bad apple idea is that any individual of good character should already know right from wrong and can be ethical without special training—that a lifetime of socialization from parents, school, and reli­ gious institutions should prepare people to be ethical at work. You probably think of yourself as an individual of good character, but does your life experi­ ence to date prepare you to make a complex business ethics decision? Did your parents, coaches, and other influential people in your life ever discuss situations like the one that follows? Think about this real dilemma.

You’re the VP of a medium‐sized organization that uses chemicals in its pro­ duction processes. In good faith, you’ve hired a highly competent scientist to ensure that your company complies with all environmental laws and safety regu­ lations. This individual informs you that a chemical the company now uses in some quantity is not yet on the approved Environmental Protection Agency (EPA) list. However, it has been found to be safe and is scheduled to be placed on the list in about three months. You can’t produce your product without this chemical, yet regulations say that you’re not supposed to use the chemical until it’s officially approved. Waiting for approval would require shutting down the

Can Business Ethics Be Taught? 17

plant for three months, putting hundreds of people out of work, and threaten­ ing the company’s very survival. What should you do?

The solution isn’t clear, and good character isn’t enough to guide decision making in this case. As with all ethical dilemmas, values are in conflict here— obeying the letter of the law versus keeping the plant open and saving jobs. The decision is complicated because the chemical has been found to be safe and is expected to be approved in a matter of months. As in many of today’s business decisions, this complex issue requires the development of occupation‐specific skills and abilities. For example, some knowledge in the area of chemistry, worker safety, and environmental laws and regulations would be essential. Basic good intentions and a good upbringing aren’t enough.

James Rest, a scholar in the areas of professional ethics and ethics education, argued convincingly that “to assume that any 20‐year‐old of good general char­ acter can function ethically in professional situations is no more warranted than assuming that any logical 20‐year‐old can function as a lawyer without special education.”23 Good general character (whatever that means) doesn’t prepare an individual to deal with the special ethical problems that are likely to arise in a career. Individuals must be trained to recognize and solve the unique ethical problems of their particular occupation. That’s why many professional schools (business, law, medicine, and others) have added ethics courses to their curric­ ula, and it’s why most large business organizations now conduct ethics training for their employees.

So although individual characteristics are a factor in determining ethical behavior, good character alone simply doesn’t prepare people for the special ethical problems they’re likely to face in their jobs or professions. Special train­ ing can prepare them to anticipate these problems, recognize ethical dilemmas when they see them, and provide them with frameworks for thinking about ethical issues in the context of their unique jobs and organizations.

Aren’t Adults’ Ethics Fully Formed and Unchangeable?

Another false assumption guiding the view that business ethics can’t be taught is the belief that one’s ethics are fully formed and unchangeable by the time one is old enough to enter college or a job. However, this is definitely not the case. Research has found that through a complex process of social interaction with peers, parents, and other significant persons, children and young adults develop in their ability to make ethical judgments. This development continues at least through young adulthood. In fact, young adults in their twenties and thirties who attend moral development educational programs have been found to advance in moral reasoning even more than younger individuals do.24 Given that most people enter professional education programs and corporations as young adults, the opportunity to influence their moral reasoning clearly exists.

Business school students might need ethics training more than most because research has shown they have ranked lower in moral reasoning than students in philosophy, political science, law, medicine, and dentistry.25 Also, undergradu­ ate business students and those aiming for a business career were found to be more likely to engage in academic cheating (test cheating, plagiarism, etc.)

18 Chapter 1 Straight Talk about Managing Business Ethics

than were students in other majors or those headed toward other careers.26 At a minimum, professional ethics education can direct attention to the ambiguities and ethical gray areas that are easily overlooked without it. Consider this com­ ment from a 27‐year‐old Harvard student after a required nine‐session module in decision making and ethical values at the beginning of the Harvard MBA program.

Before, [when] I looked at a problem in the business world, I never consciously examined the ethical issues in play. It was always sub‐conscious and I hope that I somewhat got it. But that [ethics] was never even a consideration. But now, when I look at a problem, I have to look at the impact. I’m going to put in this new ten‐ million‐dollar project. What’s going to be the impact on the people that live in the area and the environment. . . . It’s opened my mind up on those things. It’s also made me more aware of situations where I might be walking down the wrong path and getting in deeper and deeper, to where I can’t pull back.27

In 2004, Harvard’s MBA class of 1979 met for its 25‐year reunion. The alumni gave the dean a standing ovation when he stated that a new required course on values and leadership was his highest priority and then pledged to “live my life and lead the school in a way that will earn your trust.”28

It should be clear from the above arguments that ethics can indeed be taught. Ethical behavior relies on more than good character. Although a good upbring­ ing might provide a kind of moral compass that can help the individual deter­ mine the right direction and then follow through on a decision to do the right thing, it’s certainly not the only factor determining ethical conduct. In today’s highly complex organizations, individuals need additional guidance. They can be trained to recognize the ethical dilemmas that are likely to arise in their jobs; the rules, laws, and norms that apply in that context; reasoning strategies that can be used to arrive at the best ethical decision; and the complexities of organ­ izational life that can conflict with one’s desire to do the right thing. For exam­ ple, businesses that do defense‐related work are expected to comply with a multitude of laws and regulations that go far beyond what the average person can be expected to know.

The question of whether ethics should be taught remains. Many still believe that ethics is a personal issue best left to individuals. They believe that much like proselytizing about religion, teaching ethics involves inappropriate efforts to impose certain values and control behavior. But we believe that employers have a real responsibility to teach employees what they need to know to recognize and deal with ethical issues they are likely to face at work. Failing to help employ­ ees recognize the risks in their jobs is like failing to teach a machinist how to operate a machine safely. Both situations can result in harm, and that’s just poor management. Similarly, we believe that, as business educators, we have a respon­ sibility to prepare you for the complex ethical issues you’re going to face and to help you think about what you can do to lead others in an ethical direction.

Defining ethics Some of the controversy about whether ethics can or should be taught might stem from disagreements about what we mean by ethics. Ethics can be defined as “a set of moral principles or values”—a definition that

Can Business Ethics Be Taught? 19

portrays ethics as highly personal and relative. I have my moral principles, you have yours, and neither of us should try to impose our ethics on the other. But our definition of ethics—“the principles, norms, and standards of conduct gov­ erning an individual or group”—focuses on conduct. We expect employers to establish guidelines for work‐related conduct, including such basic matters as what time to arrive and leave the workplace, whether smoking is allowed on the premises, how customers are to be treated, and how quickly work should be done. Guidelines about ethical conduct aren’t much different. Many employers spend a lot of time and money developing policies for employee activities that range from how to fill out expense reports to what kinds of client gifts are acceptable to what constitutes a conflict of interest or bribe. If we focus on con­ duct, ethics becomes an extension of good management. Leaders identify appropriate and inappropriate conduct, and they communicate their expecta­ tions to employees through ethics codes, training programs, and other commu­ nication channels.

In most cases, individual employees agree with their company’s expectations and policies. For example, who would disagree that it’s wrong to steal company property, lie to customers, dump cancerous chemicals in the local stream, or not comply with regulations on defense contracts? At times, however, an employee might find the organization’s standards inconsistent with his or her own moral values or principles. For example, a highly religious employee of a health maintenance organization might object to offering abortion as an alter­ native when providing genetic counseling to pregnant women. Or a highly devoted environmentalist might believe that his or her organization should go beyond the minimum standards of environmental law when making decisions about how much to spend on new technology or on environmental cleanup efforts. These individuals might be able to influence their employers’ policies. Otherwise, the person’s only recourse might be to leave the organization for one that is a better values match.

Good control or bad control? Whether or not we like to admit it, our ethical conduct is influenced (and to a large degree controlled) by our environment.

In work settings, leaders, managers, and the entire cultural context are an important source of this influence and guidance. If, as managers, we allow employees to drift along without our guidance, we’re unintentionally allowing them to be “controlled” by others. If this happens, we’re contributing to the creation of “loose cannons” who can put the entire organization at risk. Guid­ ance regarding ethical conduct is an important aspect of controlling employee behavior. It can provide essential information about organizational rules and policies, and it can provide explanations and examples of behavior that is con­ sidered appropriate or inappropriate in a variety of situations.

But should organizations be “controlling” their employees in this way? B. F. Skinner,29 the renowned psychologist, argued that it’s all right, even prefer­ able, to intentionally control behavior. He believed that all behavior is con­ trolled, either intentionally or unintentionally. Therefore, what was needed was more intentional control, not less. Similarly, ethical and unethical behavior in organizations is already being controlled explicitly or implicitly by the existing

20 Chapter 1 Straight Talk about Managing Business Ethics

organizational culture (see Chapter 5). Thus, organizations that neglect to teach their members “ethical” behavior might be tacitly encouraging “unethical behavior” through benign neglect. It’s management’s responsibility to provide explicit guidance through direct management and through the organization’s culture. The supervisor who attempts to influence the ethical behavior of sub­ ordinates should be viewed not as a meddler but as a part of the natural man­ agement process.

To summarize, we believe that educational institutions and work organiza­ tions should teach people about ethics and guide them in an ethical direction. Adults are open to, and generally welcome, this type of guidance. Ethical prob­ lems are not caused entirely by bad apples. They’re also the product of bad barrels—work environments that either encourage unethical behavior or merely allow it to occur. Making ethical decisions in today’s complex organiza­ tions isn’t easy. Good intentions and a good upbringing aren’t enough. The special knowledge and skill required to make good ethical decisions in a par­ ticular job and organizational setting might be different from what’s needed to resolve personal ethical dilemmas, and this knowledge and skill must be taught and cultivated.

This Book is About Managing Ethics in Business

This book offers a somewhat unique approach to teaching business ethics. Instead of the traditional philosophical or legalistic approach, we take a mana­ gerial approach. Between us, we have many years of experience in manage­ ment, in consulting, and in management teaching and research. Based on this experience, we begin with the assumption that business ethics is essentially about human behavior. We believe that by understanding human behavior in an organizational context, we can better understand and manage our own and others’ ethical conduct. Kent Druyvesteyn was vice president for ethics at Gen­ eral Dynamics from 1985 to 1993 and one of the first “ethics officers” in an American company. He made a clear distinction between philosophy and man­ agement in his many talks with students and executives over the years. As he put it, “I am not a philosopher and I am not here to talk about philosophy. Ethics is about conduct.”30

We agree. After years of study and experience, we’re convinced that a management approach to organizational ethics is needed. As with any other management problem, managers need to understand why people behave the way they do so that they can influence this behavior. Most managers want the people they work with to be productive, to produce high‐quality products, to treat customers well, and to do all of this in a highly ethical manner. They also want and need help accomplishing these goals.