Constructing a Matrix for Integrating Economics, Law, and Ethics: A Rethinking of
the Model for Teaching Corporate Governance
Rebecca Luzadis1
Daniel Herron2
I. Introduction
The thesis of this paper is that there is essentially a dichotomous model for business
decision-making: one based on investors’ or shareholders’ interest; the other based on
multiple stakeholders’ interest. As such, this paper argues for the latter.
This is not a new debate but it is one that has been raging for twenty-plus years.
Supporting the former, Milton Friedman and others argue that two principles must guide
business decision-making: obeying the law and maximizing investor (or owner) wealth.3
Supporting the latter, ethicists Tom Donaldson, Kenneth Goodpaster and others argue
that all stakeholders affected by business decision-making must have their interests
incorporated into the decision-making process.4 As Donaldson and Dunfee note “The
concept of corporate obligations to stakeholders has been a major theme in Western
business ethics for several decades….the nature and scope of corporate obligations to
stakeholders is one of the most important and extensive components of the modern
literature on business ethics.”5
Most of the debate between these two approaches has been centered in two venues: the
economic one or the ethical one. The arguments are laid out rather simplistically like
this:
Economic argument:
Investor theory: since market efficiency is a desired outcome, the focus
of business decision-making should be on maximizing return on
investment; other constituent concerns may be considered by the
government, the legal system or some other advocate, but not by the
business decision-maker. In other words, business does business,
government does government, social welfare groups do social welfare
1
Associate Professor, Department of Management, Miami University, Oxford OH.
Professor of Business Legal Studies, Department of Finance, Miami University, Oxford OH.
3
See, for example, Friedman M. 1962. Capitalism and Freedom Chicago: University of Chicago Press;
1970 The Social Responsibility of Business is to Increase its Profits, New York Times Magazine September
13; Coelho, McClure. Spry. 2003. The Social Responsibility of Corporate Management: A Classical
Critique 18:1 Mid-American Journal of Business 15-24
4
See, for example, Freeman, M, 1970. Strategic Management: A Stakeholder Approach. Boston: Pitman;
Donaldson and Preston. 1995. The Stakeholder Theory of the Corporation: Concepts, Evidence, and
Implications. Academy of Management Review 20:65-91.
5
Cite to Donaldson and Dunfee social contract book p. 235; also Timothy L. Fort, ETHICS AND
GOVERNANCE: BUSINESS AS MEDIATING INSTITUTION (2001) (“No approach has been more prominent in
contemporary business ethics than stakeholder theory. Lead by the work of Ed Freeman, the theory
successfully played off the typical focus on corporate duties to “shareholders” to identify duties toward
employees, suppliers, community, and perhaps many others besides”). p. 119
2
activities, etc and with everyone doing what they are supposed to do, the
system not only works but is efficient.
Stakeholder theory: accepting the notion that market efficiency is a
desired outcome, this theory argues that the most efficient approach is to
take into account all stakeholder interests since that approach will
incorporate all aspects of the decision-making process; proponents of this
approach tend to point to the financial success of companies with
articulated corporate social responsibility credos that incorporate multiple
stakeholders.6
Ethical argument:
Investor theory: business decision-makers have a fiduciary, and hence
ethical, obligation to owners/investors to safeguard and prudently manage
the “money” entrusted to them. No other constituency or stakeholder has
the comparable degree of fiduciary obligation owed to them by the
decision-makers.
Stakeholder theory: the business decision-makers affect, via their
decisions, a variety of stakeholders, including, but clearly not limited to
the investor/owners; as such, some degree of duty, generally characterized
as an ethically based-one (rather than an economically-based one), is owed
to these stakeholders.
While economics and ethics command the focus of the ongoing arguments, ironically the
legal aspect is fairly well-settled and it runs parallel with the investor/ethical argument.
The paramount relationship is that of investor/owner and those who manage that
investment (via decision-making).7 The decision-maker has a fiduciary obligation to
manage that owners’ money according to the wishes and expectations of the investors.
This legal maxim has only been questioned in light of evolving reliance theories which
will be introduced below in part II.
The paper will examine the following issues:
1) the underlying moral and ethical foundations giving rise to the concept of
obligation;
2) the underlying economic foundations that compliment or contradict these
underpinnings;
3) the decision-making model itself and how it may be operationalized.
6
See, for example, Medtronic, Inc., at http://www.medtronic.com/corporate/codeofconduct.html
See the classic book which lays out traditional corporate/legal theory Berle, A and Means, G., 1932. The
Modern Corporation and Private Property. New York: MacMillan
7
II. Moral Obligation
Fundamental Western philosophy holds that all individuals have some degree of
autonomy. We have free will.8 Even with the advent of nineteenth century Darwinist
and Freudian determinism, we base our lives and societies on the concept that human
beings can make decisions.9 Our social institutions rely on this belief. Freedom to marry,
work, worship…all the daily decisions we make are premised upon this one concept of
autonomy and operationalized with the function of free will. Our legal and political
systems could not survive without such a foundation of “free choice.” The determination
of legal liability would be a hollow exercise and democracy would be a silly activity.
However, if autonomy or free will is the very first foundational stone and an obvious one
at that, the second stone is far more difficult to identify and understand. If indeed
“choice” is the first characteristic of decision-making functions, what are the products
and ramifications of such “choice”?
We know the following by experiential data:
Choice or decision  a result
We also know by experiential data that the following may and usually does occur:
Choice or decision  a result  affect on others
The question which is created, which is fundamental to understanding the nature of
“obligation,” is: what is, if any, the relationship between the decision-maker and those
who are affected by that decision. Does some kind of obligation spring into being as a
result of this relationship?
Common law addresses this issue but only after adding two variables.10 If the affected
person “relied” on the decision-maker’s choice to the affected person’s detriment AND
the decision-maker knew or should have known that such reliance was occurring, then
obligation from the decision-maker to the affected person is created.11 This has been
morally encapsulated by John Stuart Mill in 1859:
When a person, either by express promise or by conduct, has encouraged another
to rely upon is continuing to act in a certain way—to build expectations and
8
See Uyl, Douglas, Autonomous Autonomy: Spinoza on Autonomy, Perfectionism, and Politics in Paul,
Miller, Paul, eds., Autonomy Cambridge Univ.Press: 2003), pp.30-69.
9
Id., p. 30, citing to Robert Paul Wolff, In Defense of Anarchism, “The fundamental assumption or moral
philosophy is that men are responsible for their actions. From this assumption it necessarily follows…that
men are metaphysically free.”
10
There is no statutory reference to reliance theories. Reliance theories have evolved exclusively from
judicial interpretation in case law.
11
See McIntosh v.Murphy, 52 Hawaii 29, 469 P.2d 177 (1970) in which the court held that though the
formal contract between the two was technically unenforceable due to the statute of frauds and neither
enforcement of the agreement nor money damages were available, the enforcement of the agreement under
a reliance argument was justified since “…injustice can only be avoided by the enforcement of the contract
and the granting of money damages…”
calculations, and stake any part of his plan of life upon that supposition—a new
series of moral obligations arises on his part towards that person, which may
possibly be overruled, but cannot be ignored…a person is bound to take all of
these circumstances into account, before resolving on a step which may affect
such important interests of theirs; and if he does not allow proper weight to those
interests, he is morally responsible for the wrong.12
Reliance theories essentially permit the substitution of detrimental reliance for
consideration in contract formation and enforcement.13 For example, a person clearly
promises her niece that in exchange for her niece’s many years of devotion and care to
her, she is leaving the niece her home, a valuable piece of property, upon her death. The
aunt invites the niece to move in now while the aunt is still alive. The niece relies on this
information, sells her current home, and moves in with her aunt. Her aunt passes away a
few months later but she neglected to change her will and her will does not mention the
bequest to the niece. Under classic contract law or under the laws of descent, the niece
has very little legal leg to stand on. The niece has not given good consideration for the
transaction (the “years of devotion” were in the past and not good current consideration;
this was essentially a gift that was not executed and thus not enforceable).
However, this is where reliance theory may come into play. Because there was a clear
promise upon which the niece relied and upon which the niece acted to her detriment
(i.e., selling her home and moving in with the aunt), the promise will be enforced as if it
were an enforceable contract.14
However, the law is equally settled that the affected party’s reliance must be based on
good faith and cannot be created if the party knows or should know that such reliance is
misplaced.15 It is not a leap to understand that since the law only requires a fiduciary
obligation between the business decision-maker and the investor/owner, then any attempt
to create a relationship between the business decision-maker and other stakeholders
would be misplaced.16
To capsulate this issue in the context of this paper: must business decision-maker take
into account constituencies, i.e., stakeholders, other than owners, if it can be shown that
1) by express or implied behavior (action or words) the business decision-maker created
12
Mill, John Stuart On Liberty (1859: Cambridge: Cambridge University Press, 1989) p. 103f as cited in
Stakeholder Theory, ed. Zakhem, Palmer, Daniel E., Stoll, Mary Lyn (2008: Prometheus Books, NY)
13
Habibi, Don A.and Herron, Daniel J., Law, Ethics, and the Dilemma of Modern Liberalism, 13 Midwest
Law Review 14, 1-19 (1995).
14
See Farber and Matheson, Beyond Promissory Estoppel: Contract Law and the “Invisible Handshake”,
52 U. Chicago Law Review 903, 903-947 (1985); Metzger and Phillips, The Emergence of Promissory
Estoppel as an Ind ependent Theory of Recovery, 35 Rutgers Law Rev. 472, 472-557 (1983).
15
See Metzger and Phillips, “Promissory Estoppel and the Evolution of Contract Law,” 18 American
Business Law journal 160 (1980)
16
Of course, the long-held judicially-created “business judgment rule” does permit fiduciaries to act in
discretionary ways in the furtherance of the business activity even if the “return on investment” is not fully
and unequivocally maximized. This, for example, would apply to the area of business philanthropy.
reliance in those stakeholders; and, 2) the business decision-making will have a
detrimental effect on those very stakeholders in whom reliance was created.
Yet, from a moral perspective, the question still remains, regardless of the law’s
modification of the question, “does the mere affecting of another by a decision-makercreate some obligatory relationship flowing from the decision-maker to the affected
party?” The resolution of this question goes to the very heart of whether stakeholder
theory has legitimacy as an ethical theory rather than as an economic one based on
competing efficiency approaches or legalistic ones based on reliance theories.
III. The Economic Rationale for Stakeholder Theories
Milton Friedman has argued that the “essence of a competitive market is its impersonal
character,”17 where “no individual can by himself have more than a negligible
influence”18 on the outcomes of competition. “Monopoly exists when a specific
individual or enterprise has sufficient control over a particular product or service to
determine significantly the terms on which other individuals shall have access to it.”19
Friedman went on to say that “the existence of monopoly raises the issue of ‘social
responsibility,’ as it has come to be called, of the monopolist.”20
One rationale for preferring stakeholder theory over investor theory is that Friedman’s
argument against this so-called social responsibility is essentially a political, rather than
an economic, argument. Friedman said: “The monopolist is visible and has power. It is
easy to argue that he should discharge his power not solely to further his own interests
but to further socially desirable ends. Yet the widespread application of such a doctrine
would destroy a free society.”21 Here, Friedman’s primary concern is the protection of
individual freedom and, perhaps one could argue, in particular the protection of
individual freedom of those with that visible power to which he refers. Protection of such
individual freedom, even if one wishes to argue its political or ethical desirability, is not
shown to be necessary for economic success.
This brings up two questions: 1) What is necessary for economic success? And, 2) What
is the definition of economic success?
In his Essays in the History of Economics, George Stigler describes the concept of
perfect competition as being “as pervasive and fundamental as any in the whole structure
of classical and neoclassical economic theory.”22 This is essentially the same concept of
competition as used by Adam Smith, where competition is seen as a rivalry (“a race to
get limited supplies”23). According to Stigler, Smith had 5 conditions of competition24:
17
Milton Friedman, Capitalism and Freedom. University of Chicago Press, 1962, p. 119.
Ibid, p. 120.
19
Ibid.
20
Ibid.
21
Ibid.
22
George J. Stigler. Essays in the History of Economics. University of Chicago Press, 1965, p. 234.
23
Ibid, p. 235.
18
 Rivals must act independently, not collusively,
 There must be a sufficient number of rivals,
 Rivals must have a ‘tolerable’ knowledge of market opportunities,
 Rivals must have the freedom to act on this knowledge, and
 There must be sufficient time for resources to change hands as desired.
According to Stigler, one could reasonably infer that the first two conditions were based
on Smith’s observations of how economic transactions actually occurred.25 The other
conditions, however, appear to be “the necessary conditions for the validity of a
proposition which was to be associated with competition: the equalization of returns in
various directions open to an entrepreneur or investor or laborer.”26
With respect to the question of the viability of stakeholder theory versus investor theory,
let us look at the third and fourth conditions required by Smith: possession of ‘tolerable’
knowledge of market opportunities and the freedom to act on that relevant knowledge. In
1939, N.W. Senior wrote, “It is obvious that these suppositions have no resemblance to
the truth.”27 Despite the clarity of his observation, Senior was the exception; as Stigler
notes, no significant challenge was made to the dominance of the theory.28 Critics tended
to denigrate the entire logic (not to mention ethics) underlying capitalism, rather than
seeking to improve the realism of Adam Smith’s theory. In the early twentieth century,
the mathematical school of economics came into prominence and, in the main, this
approach has continued to dominate economic theory ever since.
Stigler observed, “The vitality of the competitive concept in its normative role has been
remarkable. One might have expected that, as economic analysis became more precise
and as the range of problems to which it was applied widened, a growing list of
disparities …would develop. Yet to date there have been only two major criticisms of the
norm. The first is that the competitive individual [as described by theory] ignores
external economies and diseconomies, which – rightly or wrongly – most economists are
still content to treat as an exception to be dealt with in individual cases [i.e. outside the
theoretical model]. …The time may well come when the competitive concept suitable to
positive analysis is not suitable to normative analysis…’’29
Perhaps that time has come. The reliance on mathematics and the consequent focus on
positive analysis has been a shield behind which modern economics has hidden for too
long. Far too many critical aspects of economic policy and outcomes have been ignored
in favor of a neat, if not very useful, theoretical model. Unlike their historical
predecessors, too many modern-day economists are locked in the limited world of
positivism. Many claim to favor positivism over the more complicated realm of
24
Ibid, p. 237.
Ibid, p. 237. This assumption may also be found to be unrealistic in much of modern day business,
where strategic partnerships are formed.
26
Ibid, p. 238.
27
N.W. Senior. Political Economy, New York, 1939, as cited in Stigler, 1965, p. 239.
28
Stigler, p. 238.
29
Ibid, p. 266.
25
normative economics, arguing that there is no place in the ‘science’ of economics for
normative judgments.
Modern economic modes of thinking … depart from what was
labeled “political economy” by attempting to isolate economics
from a traditional context of moral activities, and to establish
it as a set of activities that could be judged purely in instrumental terms.30
In this way of thinking, individuals are thought of as independent beings who act in the
pursuit of their own self-interest. The law serves to establish rules that govern relations
between individuals, and are based on protecting individual liberties and private
property.31 According to Adam Smith, “The drive for economic self-interest did not, or at
least not necessarily, undermine the important moral values of society.”32
Establishing economics firmly as a science enabled the distinction between positive
analysis and normative judgment.33 In 1890, John Neville Keynes (father of the more
well- know John Maynard Keynes) “distinguished the positive, scientific study of
economics from the ethical value standards required for policy recommendations.”34
Pareto argued that economics must be a science, with its principles rooted in experience
and observation, and that it could “assume no dogmas, ethical principles, or political
exhortations.”35 In 1932 Lionel Robbins said: “Economics deals with the choice of
means to achieve given ends. It is ‘neutral’ with regard to the ends themselves, which are
value judgments that cannot be scientifically evaluated.”36
This position of the ethical neutrality of economics is, of course, subject to obvious
challenge. So-called positive propositions may (and indeed do!) have normative
implications. What’s more, “those implicit value judgments may be more insidious when
advanced as scientific conclusions.”37 “The unstated conclusion is still a sermon to the
effect that the competitive system is best, and this conclusion is no more valid than any
other value judgment.”38 For example, Lester Thurow argues:
In a market economy the income distribution plays a central role
in the allocation of goods and services. Individual preferences determine
market demands, but preferences are weighted by income before they are
communicated to the market. If an individual has no income, his potential
demand for goods and services has no effect on the market. He must have
Daniel Bell, “Models and Reality in Economic Discourse,” in D. Bell and I. Kristol, eds. The Crisis in
Economic Theory. New York: Basic Books, 1981, p. 47.
31
Ibid.
32
Adam Smith. The Theory of Moral Sentiments, as quoted in Everett J. Burtt. Social Perspectives in the
History of Economic Theory. (New York: St. Martin’s Press, 1972), p. 45.
33
Burtt. p. 4.
34
Burtt, p. 6.
35
Ibid.
36
Lionel Robbins. The Nature and Significance of Economic Science. 1932, as quoted in Burtt, pp. 6-7.
37
Burtt, p. 7.
38
Ibid.
30
income with which to make his preferences felt.
…The achievement of efficiency in a market system depends on the prior
achievement of an optimum distribution of income. …If income is not
distributed in accordance with society’s preferences, the market adjusts
to an inequitable set of demands. Market signals to not express society’s
desires and the market system does not result in an acceptable distribution
of goods and services. There is nothing in the system that automatically
achieves the desired income distribution.39
Of course, for centuries economists have known they were on thin ice if they tried to
argue the justness of the existing income distribution, whether it be in 21st century United
States, or hundreds of years before. In the 1800s, John Stuart Mill struggled with what he
saw as competition among individuals for wealth. Mill wrote:
I confess I am not charged with the ideal of life held out by those who
think that the normal state of human beings is that of struggling to
get on; that the trampling, crushing, elbowing and treading on each
others’ heels, which forms the existing type of social life, are the most
desirable lot of mankind.40
Alfred Marshall had “firm faith in the benevolence of the … free enterprise system.”41
However, Marshall noted that “there were evils in the process of economic development,
evils that it was important to identify. For example, the early ‘capitalist employer … was
tempted to subordinate the well-being of his workpeople to his own desire for gain.’”42
“Improvement of the moral climate was important. Marshall urged that businesses adopt
fairer and more benevolent attitudes toward their employees and others. This
philanthropic approach, which emphasized the personal relationships between employers
and their workers and businessmen and the public, he called ‘economic chivalry’”.43
Lest this is not persuasive enough, Adam Smith himself had his doubts about whether the
free-enterprise system was indeed capable of producing the most desired results in terms
of income distribution. Smith thought:
Merchants and businessmen were the ‘enterprisers.’ This class, he said,
was distinguished by its ‘acuteness of understanding’, whereas the landlords,
‘whose revenue costs them neither labour nor care’ were ‘too often, not
only ignorant, but incapable of that application of mind’ needed to foresee
and understand the consequences of public regulations. As for the workers,
their economic condition and lack of education impaired their judgments.44
39
Lester Thurow. Poverty and Discrimination. (Washington, DC: The Brookings Institution, 1969), p.
Burtt, p. 112.
41
Burtt, p. 206.
42
Burtt, p. 207.
43
Burtt, p. 210.
44
Burtt, p. 47.
40
But, Smith wasn’t comfortable leaving capitalists completely on their own. However
valuable they were to society in promoting economic growth, “their self-interest tended
to produce undesirable social ends….Because they have an interest that is ‘never exactly
the same with that of the public … they have generally an interest to deceive and even to
oppress the public, and … have, upon many occasions, both deceived and oppressed
it.’”45
So, clearly many if not most of the most prominent scholars in economics over the
centuries, excluding the latter half of the twentieth century, were well aware of the
shortcomings of classical and neoclassical economic theory. This is not to say that the
theory is of no use. It is to say, however, that neoclassical economic theory should be
limited to areas in which the underlying assumptions are moderately tenable.
Consider, for example, some arguments by Michael Jensen. As Jensen himself explains
stakeholder theory, “managers should make decisions so as to take account of the
interests of all stakeholders.”46 This rule may become troublesome when interests of
some stakeholder(s) conflict with those of stockholders. In setting up his argument,
Jensen explicitly acknowledges that his theory works “under the assumption there are no
externalities or monopolies,” by which he means “the situation in which the full social
cost of an action is not borne by the firm or individual that takes the action.”47 It is
precisely in this reality that stakeholder theory is relevant.
Further, Jensen contradicts himself by arguing first “To the extent that stakeholder theory
argues that firms should pay attention to all their constituencies, the argument is
unassailable. Taken this far stakeholder theory is completely consistent with value
maximization…”48 He then he goes on to say “Any theory of action must tell the actor,
in this case managers and boards of directors, how to choose among multiple competing
and inconsistent interests of those constituencies. …Stakeholder theory as stated by
Freeman and others contains no conceptual specification of how to make the tradeoffs
among stakeholders that must be made. This makes the theory damaging to firms and to
social welfare…”49 How does it necessarily follow that the theory is damaging? Less
than fully useful, perhaps, but damaging? More damaging than a theory that presumes a
just income distribution, full information, and complete mobility?
Unlike what Jensen and others claim, management is not fundamentally worse off
considering input from stakeholders. In many cases, decisions managers must make in
the course of doing business do not have the benefit of full information and incorporation
of stakeholders could actually increase access to and reliability of information that is vital
to making effective business decisions. Claims that consideration of additional
45
Adam Smith. The Wealth of Nations, as quoted in Burtt, pp. 47-48.
See, for example, Michael C. Jensen, “Value Maximization and the Corporate Objective Function,” in
Breaking the Code of Change, M. Beer and N. Norhia, eds., Harvard Business School Press, 2000.
47
Ibid, p, 7.
48
Ibid, p.8.
49
Ibid, p.9.
46
stakeholders in some way necessarily will result in less-than-optimum decisions are
unjustified.
IV. The Stakeholder Decision-Making Model
In order to fully develop the stakeholder model, there is an imperative for “managers to
act as follows:
1) Identify the full range of stakeholders for a given firm and decision;
2) Identify the stakes at issue in the decision;
3) Assess the legitimacy of the stakes;
4) Allocate priority among conflicting stakeholder claims;
5) Identify strategic options for responding to the legitimate stakes having priority;
6) Assess the viability of the options within the framework of corporate governance,
including any special considerations to be given to the interests of the
stakeholders;
7) Make a final decision.”50
From a structural perspective, the model appears to be a classic matrix illustrated
something like this:
Stakeholders→ Owners
Perspectives
↓
Customers
Employees
(incl
vendors,
creditors, et
al.—i.e.,
external
contractual
relationships)
Market
Society
Financial
aka the bottom
line, profit
Legal
aka
compliance
Ethical
The empty cells represent the implications on each stakeholder from each of three
perspectives.
50
Donaldson and Dunfee op. cit. p. 236
With this model presented, the natural questions must be: Why these stakeholders? Why
these perspectives?
THE S TAKEHOLDERS
One of the criticisms of stakeholder theory is the unwieldiness of ascertaining the actual
stakeholders themselves.51 This model answers that criticism by incorporating the entire
universe of potential stakeholders into five manageable categories.
Owners and Employees
Internal to any business functionality are two discrete, though arguably similar, interests:
those who monetarily invest in the venture (and their managerial agents) and those who
non-monetarily invest by virtue of employment commitment; in other words, owners and
employees. In the literature, few if any, dispute the validity of listing owners and
employees on the list of traditional stakeholders. However, the model above does
collapse an often-cited stakeholder into the owner category, and that is “management.”
Management represents the interests of the business organization itself and as such, at
least when squaring that with the legal model of fiduciary obligation, means that
management represents the interests of the owners.
If managers or collectively “management” acts in a way to protect their own jobs, they
fall the into the “employee” stakeholder group and their employment becomes the
primary variable in decision-making activities. As a discrete group, management
represents either owners in an agency relationship or represents a facet of employee
interests, i. e.. their own.
Customers
It is this category of stakeholder that the greatest latitude is taken by this paper for the
sake of model efficiency. “Customers” include all external constituencies (vis owners
and employees as “internal”) that have a contractual relationship with the business and
whose relationship, at least legally, is controlled by that contract. This would naturally
include a whole host of discrete entities: any buyer, suppliers, vendors, or creditors.
The consideration here by the business decision-maker is the long-term business
relationship that both parties are likely anticipating and which they likely were cognizant
of when forming the initial contractual relationship. Much like employees, “customers”,
as defined here, invested not money but the anticipation of a continued business
relationship. The investment goes beyond whatever contract is at hand and looks to the
future relationship as well.
Society
51
See, for example, Coelho, McClure, Spry, The Social Responsibility of Corporate Management: A
Classical Critique, 18 Mid-American Journal of Business, 15, pp. -19 (2003).
Society is the stakeholder that has the most tenuous relationship back to the business
decision-maker. While an external constituent, it has no legally contractual connection.
Yet, when defined contextually as the “local” society, links become apparent. The
previously-identified three stakeholders—owners, employees, customers—are members
of society. The business in question is a member of this society. It does not take any
stretch of logic or imagination to argue that the local community may well be affected by
the business decision-making process. In light of current debate regarding social
responsibility theories, there is strong argument for inclusion of society in the panoply of
identifiable stakeholders.52
Market
Many stakeholder-theory proponents include “competitors” as a stakeholder group.53 This
seems a bit disingenuous in light of our underlying acceptance of a capitalistic market. If
the paradigm of business decision-making is to give some degree of consideration to
those constituencies which have a “stake” in the business, the disenginuity of giving
consider to one’s competitors is even more obvious. However, what proponents of
“competitor as stakeholder” are really articulating is the obligation that business decisionmaking owes to the competitive environment.
In other words, participants in business decision-making must be cognizant and nurturing
of the dynamic that makes the entire activity possible: the relatively free and competitive
market. The “market” is the dynamic or glue that holds the process together. As such, it
forms the fifth and final constituency or stakeholder that needs to be considered in
the matrix.
THE PERSPECTIVES
The classic constraints on business decision-making have traditionally manifested
themselves in two forms: investor expectation and statutory limitations. A third one is
the ethical component which is espoused by this paper and supported by stakeholder
theory.
Financial
The traditional view here is simply return on investment or bottom-line ramification. It is
Friedmanesque in nature and simply espouses the capitalistic view that business decisionmaking must “take care of the bottom line.” Clearly, the contrasts to such a view can be
found in neo-Marxist economic theories and some theories of the not-for-profit firm.
None the less, the U.S. society is premised upon a for-profit and capitalistic model and as
such, profit or the “financial” constraint is a viable perspective.
52
See, for example, Goodpaster and Matthews, Can a Corporation Have a Conscience?, Harvard Business
Review 132-141 (Jan-Feb 1982)
53
See, for example, Kaler, J. Morality and Strategy in Stakeholder Identification, Journal of Business
Ethics 39:91-99 (2002).
Legal
As with the financial constraint, the legal constraint is one that both stakeholder and
shareholder proponents may agree. The legal perspective is reflected by governmental
statutory regulation at both the federal and state level. This perspective is characterized
as a compliance matter. In other words, this perspective is manifested in Friedman’s
admonition to “maximize owners’ wealth and obey the law.”54 Other than for anarchists,
this constraint, just as the financial constraint dictates, is also a constant variable that
must be considered in business decision-making.
Ethical
The ethical perspective provides the point of departure for the stakeholder proponents and
the shareholder proponents. Friedman’s dual variable model is reflected by consideration
of the financial and legal perspectives. The sum of those two results in the Friedman
“ethic.”
This paper has argued an ethical position that espouses not only the consideration of
stakeholder interests but a consideration of an ethical perspective in addition to the
financial and legal perspectives. This paper has argued the validity of such a perspective.
However, it has not proposed from what sources such a perspective may originate.
Express manifestation of business or corporate positions serve as a starting point: mission
statements, value statements, corporate credos, personnel handbooks, even advertising
campaigns serve as express statements of values which can serve as the touchstone for
business decision-making ethical perspective.55 Board of director directives can also fall
into this category.
Balancing Stakeholder Interests
To operationalize the Donaldson and Dunfee model as illustrated above,56 the practical
model or flowchart would be as follows:
1) framing or identifying the question, problem or issue posed that requires a decision or
course of action;
2) brainstorming for all possible solutions to the issue posed;
3) identifying the affected stakeholder(s) in light of the proposed solutions;
4) evaluating each effect on each stakeholder from first the financial, then legal, then
ethical perspectives;
54
Friedman, op. cit.
See, for example, Pearce, J.A. and David, F., “Corporate Mission Statements: the Bottom Line,”
Academy of Management Executive, Vol. 1, #2, pp. 109-16 (1987); Krohe, James, “Do We Really Need a
Mission Statement?” Across the Board, July-August 1995, pp.16-22; David, F., “How do Companies
Define Their Mission,” Long Range Planning, Vol. 2 #1, pp. 90-97 (1989); 55 Bart, C.K., “The Impact of
Mission on Firm Innovativeness,” International Journal of Technology Management, Vol. 11, pp. 479-93
(1996)
56
See footnote 50 above.
55
5) identifying complimentary and competing interests and beginning the balancing
process.
There is nothing inherent in this model that compels the decision-maker from weighting
anyone stakeholder more than another. The model does not compel the decision-maker to
place owners’ at a disadvantage vis a vis other stakeholders. What the model minimally
does is forces the decision-maker to consider all constituent interests in the decisionmaking dynamic.
However, the crux of the matter rests in the evaluation process. What weight is given
each of the stakeholder considerations? How are the effects of proposed solutions to
posed issues considered in relation with each other?
A number of models have been proposed. The “win-win” matrix of four cells
representing two “competing” stakeholder interests as win-win, win-lose, lose-win, loselose. The goal of the business decision-maker is to find the solution that is encapsulated
in the win-win cell.57 Other models include prioritization of competing stakeholder
interests58 and majoritarian determination among the identified stakeholders.59
V. Corporate Governance Issues
Perhaps the most efficient manner to accomplish this prioritization or balancing the
stakeholder interests lies not in the weighing of those interests per se but in the process
for the weighing of those interests, i.e. ensuring that those competing interests are
represented in the decision-making process. One option would be to include
representatives from the various stakeholders into the management structure and/or even
the board of directors of the firm. Such a change in corporate governance could be
voluntary, through a change in the current corporate culture or through governmental
mandate via regulations. As is often the case when the market fails to respond to societal
concerns, “government might be called in to fill the gap between society and business,
which could result in additional governmental regulations.” 60
Much like the evolving literature on corporate governance in areas of shareholder rights
vis a vis stakeholder rights61 or much like negotiated contractual rights between labor and
57
See Windsor, Duane, Can Stakeholder Interests Be Balanced? Unpublished paper delivered at the
International Association for Business and Society annual conference (Paris: June 1999) citing to Drucker,
P.F. Management Challenges for the 21st Century (New York: HarperBusiness 1999)
58
Ibid. p.5.
59
Ibid.
60
Abbass F. Alkhafaji, A STAKEHOLDER APPROACH TO CORPORATE GOVERNANCE: MANAGING IN A
DYNAMIC ENVIRONMENT (1989) at 108.
61
See, for example:
Craig Ehrlich, Dae-Seob Kang ,U.S. Style Corporate Governance in Koreas’s Largest Companies, 18
UCLA PAC. BASIN L.J. 1 (2000);OECD Principles of Corporate Governance,
http://www.oecd.org/daf/governance/principles.htm (May 1999);Galai, Dan, Wiener, Zvi, Stakeholders and
the composition of the voting rights of the board of directors J OURNAL OF C ORPORATE F INANCE pp. 107117, April 2008.
management,62 corporate board composition may be legally mandated to include
stakeholder representation. However, as one commentator notes that if such
governmental regulation occurs occurs, “the organization will have to oblige and conform
to the rules…[h]owever, by recognizing the various stakeholders present, the
organization can eliminate the excess cost of regulations and benefit from a higher rating
by society, perhaps in the form of profits.”63
Freeman argues, though, that the legislatively-imposed board composition requirements
could be detrimental to the board functioning and advocates for voluntary recognition of
stakeholder interests. He argues for a board-level management process in which
“directors and managers can achieve the goals of the reformers voluntarily while keeping
a substantial amount of control over their own future.” 64 He adds that, “to conceive of
board structure in other than these process terms, is to run the risk of legislating
‘mechanical structures’ which will do far more harm than good in terms of ensuring the
responsiveness of the corporation to its stakeholders.” 65
To this end, we return then to the pedagogical emphasis of this paper: the teaching of
stakeholder theory to future managers and, thus, decision-makers, with a goal to changing
the corporate decision-making culture.66
VI. Pedagogical Model for Business Education
Nearly every school of business has what is called a “professional core.” The primary
collegiate accrediting body, the Association of Collegiate School of Business
International (AACSB), requires that specific learning objectives be met.67 The
traditional manner in which such learning objectives are met is with discrete courses.
Endemic to nearly all business professional cores are courses such as:
Principles of—finance, management, marketing, supply chain plus the foundational
courses of micro and macro economics, business law, and the “tools” courses in
accounting, statistics, and management information systems.68
5 USCS § 7101
Abbass F. Alkhafaji, OP CIT..
64
R. Edward Freeman, STRATEGIC MANAGEMENT (1984) p. 112
65
Id.
66
The debate here, which is clearly being begged, is that the common law development in agency theory of
the “fiduciary” obligation of agent to principal interferes, to a great degree, with the altering of the
shareholder exclusivity rule. Under the common law (and reinforced in countless legal precedent) is the
requirement that the agent owes his/her principal exclusive duty (read: corporate board of directors as the
agent of the shareholders). However, the question being begged here is whether that exclusivity can
accommodate primacy. So long as the agent (i.e., business decision-maker) only incorporates other
stakeholders into the decision-making matrix and does not exclude the shareholder, will this fiduciary duty
be satisfied. Another way to look at this would be that shareholders retain primacy in the pantheon of
stakeholder but do not retain exclusivity.
67
pg 3-8, http://www.aacsb.edu/accreditation/BUSINESS-STANDARDS-2009-Final.pdf
68
Ibid, footnote on pg 8 which reads: For the purpose of determining inclusion in AACSB accreditation,
the following will be considered “traditional business subjects”: Accounting, Business Law, Decision
Sciences, Finance (including Insurance, Real Estate, and Banking), Human Resources, Management,
Management Information Systems, Management Science, Marketing, Operations Management,
62
63
It is interesting to note that stand-alone ethics courses and even courses that would focus
on decision-making are absent. Though, many business professional cores include a
capstone strategy course to “tie-up” the curriculum.69 Introducing such concepts at that
stage of collegiate education is much like the adage of closing the barn door once the
horse has escaped!
This paper advocates the creation and implementation of a first-year course taken prior to
any business course in the curriculum. Such a course would not have the complexity of a
traditional capstone course, taken by students after three or four years of collegiate
business education. Instead it would focus on the prefatory material in understanding
how business decisions are made, or, more pointedly, how they should be made.
The course would have three foci:
1) Identifying and characterizing the various business stakeholders, generally
identified as : owners or investors, customers, employees, the supply-chain (and
creditors), society, the market;
2) Exploring how these stakeholders interrelate with each other;
3) Exploring how these stakeholders’ various interests impact decision-making.70
The primary teaching tool would be a combination of real and hypothetical cases to
provide a context for each of these foci. An example of such a case is below.
Identify the key stakeholders below and briefly describe each stakeholder’s interest.
The Province of St. Joseph Capuchin, a small Catholic religious order based in
Milwaukee, placed a resolution on the 2000 shareholder ballot of Merk (a huge
pharmaceutical company), calling on the company to price their drugs “at reasonable
levels” to ease the burden on the elderly and the uninsured. The company opposed the
proposal, citing the high cost and risk of research and development for new medicines.
Organizational Behavior, Organizational Development, Strategic Management, Supply Chain Management
(including Transportation and Logistics), and Technology Management. This list is not intended to be
exhaustive. Normally, extensions of the “traditional business subjects”, including interdisciplinary,
integrated courses, majors, programs, concentrations, or areas of emphasis, will be included in the scope of
AACSB accreditation reviews consistent with Eligibility Criterion D…..
69
Walker, Kenton B., and Black, Ervin L. Reengineering the undergraduate business core curriculum:
aligning business schools with business for improved performance 6 B USINESS PROCESS M ANAGEMENT
J OURNAL 3, pp. 194-213 (2000)… “Finally, the process management approach provides the opportunity
for business managers, faculty, and students to understand the variables that impact on organizational and
individual performance. A lack of perspective on what factors impact performance is a significant gap in
business education and on the management of business schools. Most business education programs
include a capstone policy course intended to provide an integrative view of the functions within a
business. However, this is frequently a case of too little, too late. For business faculty, a reward system
based on student evaluations of teaching and publication output ignores the basic responsibilities of
business schools to their student and employer customers. The process perspective needs to be introduced
early in the business curriculum and within the business faculty to ensure that process is indeed paramount
to function in business education as it is in business.” (emphasis added)
70
See Section IV of this paper above.
Despite support from 15 other institutional investors, the Catholic brothers’ proposal
received less than 10 per cent of the vote. But the company agreed to advocate
prescription drug coverage for recipients of Medicare, Medicaid, and other public health
insurance programs.
An example of a syllabus for such a first year course is attached as appendix A.
APPENDIX A – Sample Generic Syllabus
Ethics in Business Decision Making
Students are encouraged to stop in during office hours to talk about any problems or
suggestions you may have concerning the course. If you find the office hours
inconvenient, feel free to schedule an appointment at a more convenient time or contact
the professor by e-mail.
Individuals who have any disability, either permanent or temporary, that might affect
ability to perform in this class, are encouraged to inform the professor at the start of the
semester. Adaptation of methods, materials or evaluation may be made as required to
provide for equitable participation and grading.
Equitable participation in this class also requires the use of inclusive language, methods
and materials. Students are expected to use inclusive language in written and oral work,
and to respect diversity in viewpoints expressed by others. Students are also encouraged
to identify and bring to the instructors’ attention any ways in which the classroom climate
is not inclusive.
Books:
Linda Trevino and Katherine Nelson. Managing Business Ethics, 3rd edition, Wiley,
2004.
James E. Post, Anne T. Lawrence, and James Weber. Business and Society: Corporate
Strategy, Public Policy, Ethics, 11th edition. McGraw-Hill/Irwin, 2003.
Course Description:
This course introduces students to the integral role that ethical considerations play in
business decision making. Historical as well as current events mandate the importance of
ethical decision making in the marketplace. This course is one of two sections being
offered in the School of Business Honors Program and also will satisfy a requirement for
the University Honors Program. In that this is a first-year course, students are not
presumed to be particularly familiar with any of the functional areas or academic
disciplines within business.
Course Objectives:
The primary goal of the course is to develop students’ abilities to recognize that ethics is
an integral part of business decision making and to develop a framework for
incorporating ethical considerations. In order to accomplish this objective, the course is
structured to include three substantive components:
* exploring the integration of business and ethical theories, including learning to
recognize major groups of stakeholders having an interest in the problems at hand
(including employees, shareholders, society, among others);
* developing a model for business decision making that incorporates ethical
considerations;
* applying the model to a wide variety of business cases.
Another equally important objective of this course is to allow students an opportunity to
improve analytical reasoning skills. We will cover all aspects of critical thinking, from
first gathering enough relevant and reliable information, to careful analysis of the
information, to developing an informed position on the subject. Careful analysis requires
one to pay special attention to information and perspectives that contradict their
preconceived ideas on a subject. We should not assume a conclusion to be a "good" one
just because it conforms to our personal prior views. This class will give students ample
opportunity to practice general analytical skills as well as to increase their comfort level
in dealing with complex issues and problems.
Students will be called upon to communicate their own carefully considered ideas on
topics related to ethics and business decision making. Thinking carefully about
constructive criticism offered by classmates (as well as by the instructor) is often a good
way to hone our reasoning skills in general along with our ideas on particular subjects.
Students will be expected to be thinking about the assigned material throughout the
semester.
Course Requirements:
This class is a seminar and, as such, will rely heavily on student participation. Along
with a portfolio of regular written preparation assignments, participation will factor
heavily into the final grade for the course. There will be two exams, a midterm and a
final, and students will complete an individual project
Attendance is necessary but is not a sufficient condition for meeting the
participation requirement. (In other words, just being there will not be enough.) Before
most classes, students will be given an assignment for the next class. Students are
expected to come to class having completed the assigned reading as well as the class
preparation assignment each day. Students should write out answers to class prep
assignments; high quality answers will demonstrate substantial thought (i.e. preparation)
and will best position the student to participate appropriately in class. The written
answers may or may not be collected in class. Students should always be prepared for
assignments to be collected.
Frequently, the instructor will call on students to begin and/or contribute to class
discussion. Quality of contribution is more important than quantity. Most beneficial
contributions will offer insight into assigned readings and/or preparation assignments, or
connections between the two. When called upon to participate, students will be allowed
to pass occasionally if unprepared; students should realize that passing too often is likely
to reflect negatively on class preparedness as well as participation.
Students who are well prepared and make a valuable contribution to class will get an “A”
for this component of the class. The ultimate determination of a grade for this component
of the class will involve multiple factors. Throughout the semester, students’ preparation
and participation will be evaluated. Students are always welcome to discuss this aspect of
the class with the instructors via an individual appointment. In the end, evidence of
written work done in preparation for class will comprise an individual portfolio of
writing. This, as well as quality of contributions to class, will factor into the grade.
Both the midterm and the final exams will involve significant writing. Both will be inclass.
Several preliminary deadlines relating to the project are listed on the course outline and
schedule. Students will each identify an issue for study, in consultation with the
professor and will be expected to meet several times with the professor outside of class as
the projects are proceeding.
Grades will be earned in this course as follows:
Preparation portfolio and class participation
Midterm exam
Final exam
Research Project
25%
25%
25%
25%
If you have any questions or concerns, or if you are not sure or clear about the course
requirements, please see the professor immediately for clarification. Naturally,
individual problems and circumstances can arise which might interfere with your
academic responsibilities. You are encouraged to become familiar with Part V of the
Student Handbook. Please note that we take issues of academic misconduct very
seriously and will pursue severe penalties against those guilty of such acts. If you are not
sure what the University and the professors consider to be academic misconduct, please
ask so you don’t find out the hard way. All sources (including internet sources) used in
the preparation of any written work for this course must be fully cited. This is true
whether direct passages are used or if you are just paraphrasing. Claiming credit for
words or thoughts that are not your own is one type of academic dishonesty.
Tentative Class Schedule
B&S=Business and Society textbook
MBE=Managing Business Ethics
**Possible joint classes or part-of-time joint classes
Date
Topic
**August 24
Introduction to
course
“Getting the whole
picture”
**26
Homework
assignment(s)
Film on PharMor
Readings
B&S chapter 1;
31
Intro to Stakeholder
theory
Journal articles by Post et
al
MBE 5-45
September 2
Owners
Corporate Model:
B&S chapter 15
who are the owners?
September 7 is
exchange day
September 9
Owners
B&S 286-288,
“Napster”
14
Market
B&S 206-207,
Oracle”
B&S chapter 10
16
21
Consumers
B7S 328-329,
“Big Fat Liability””
B&S chapter 16
23
28
Employees
B&S 60-61, “Malden B&S chapters 18 and 19
Mills”
30
October 5
Society
B&S 246-247, “
Intel”
B&S chapters 12 and 17
7
Perspectives: Legal,
Financial, Ethical
**12
Legal
Hoebel et al. pieces
**14
Financial
Milton Friedman piece
**19
Ethical
B&S chapters 3 and 4
21 –THURSDAY
MIDTERM
26
Review Midterm
**28
Decision-Making
Model
**Nov 2
Research topic
Review: Post et al pieces
identified; outline
format, annotated bib
format, and paper
format reviewed
Application of model How the model
B&S 408, “Enron”
works:
--Frame the issues
--Id the stakeholders
--Examine the
perspectives
--formulate
conclusions
4
Meet with Professor Outline due
to turn in and review
outline
9
Application of model
11
16
Application of model Annotated
bibliography due
Application of model
18
Application of model Pinto Case
23
25th –no class
THANKSGIVING
**30
Intro to Peachtree
case
Dec 2
Research paper due
**7
Role-play Peachtree
Analyze Peachtree
using model
B&S 421, “Odwalla,
Inc., and the E.Coli
Outbreak”
B&S 454, “Microsoft”
B&S 464,
“GlaxoSmithKline and
AIDS Drugs for Africa”
MBE pages and roles to
be assigned
9
Class Wind-up
FINAL EXAM WILL
BE IN-CLASS DURING
FINALS WEEK
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