Week 2 - Doing what is right
Introduction
• Doing what is right - Not only caring for ourselves but
promoting the welfare of others and promoting what is
considered valuable e.g. education, health.
• In business we should think about our career, company
and social welfare.
• These can be in conflict so it’s not easy.
Framework
• A framework with principles can help guide decision
making.
Neoclassical framework
• Neoclassical economics principles
1. People have rational preferences between outcomes that
can be identified and associated with values.
2. Individuals maximize utility and firms maximize profits.
3. People act independently on the basis of full and relevant
information.
Neoclassical framework
• A narrow framework but has had great influence on
management theory and practice
• It suggests that by maximizing profits for shareholders they
can do the best for themselves their company and promote
overall welfare.
Stakeholder orientated framework
• Wider and better for promoting ethical- organizational
integrity.
Neoclassical account
• CSR activists in 60s and 70s – business persons should look
beyond their economic interests to support and drive social
causes like poverty or environmental issues.
• Milton Friedman – “ There is one and only one social
responsibility of business – to use its resources and engage
in activities designed to increase it profits so long as it stays
within the rules of the game, which is to say, engages in
open and free competition without deception or fraud.”
• Group Question - What do you think?
How to link profits and social welfare?
• Individual preferences define the advantage for the
individual and the collective advantage is the sum of the
individual advantages. People will only engage in
transactions that they see as in their own interest and so
individual preferences will be maximized.
• Pareto efficiency happens when one persons happiness
cannot be increased without the other person being
lowered.
How to link profits and social welfare?
• Managers should try to efficiently get products and services
to those who are willing to pay the most for them. This
satisfies consumer preferences.
• Shareholders get a return on investment.
• Successful companies attract capital to provide jobs and
taxes contributing to social welfare.
• Consequently collective preference satisfaction is
maximized.
Neoclassical Model - Friedman
• Managers are the wrong people to help solve societies
problems like crime or poverty – managers have no
training or expertise in that area - managers would not
allocate resources efficiently due to favoritism.
Criticisms
• Freidman does not explain what moral rules companies are
bound by (except to avoid fraud and deception) or why
they would be bound by those rules.
• Freidman's idea on preferences has had philosophical
criticism.
• Profitability for shareholders as an objective tends to
reduce a managers attention to short term gains.
• Managers have shown that they can be effective at helping
with societal problems.
Focusing on short term success
• Is not forward looking enough to consider longer term
opportunities and risks.
• These days is considered poor management.
• Balanced score card is one suggested alternative
• Given as a reason for the recent financial crisis.
• Even if financial success if the main objective this model
doesn’t work well.
Ford Pinto example
• A new subcompact car to compete with foreign automakers
• Accelerated production – product development and tooling
happened at the same time.
• Crash tests revealed a serious flaw in the gas tank
• Ford made a cost benefit analysis – it would cost
$45million to pay compensation and $137 million to fix the
flaw.
• So they made an unethical decision not to fix the flaw.
Long term outlook
• Johnson and Johnson “ customers come fist and
shareholders last, when customer satisfaction is at the top
of the list, shareholders do just fine.”
• Empirical data supports a positive link between a
companies commitment to ethics and social responsibility
and financial performance.
Managers are bad at social issues?
• May not be experts but are not necessarily bad especially
when working with other stakeholders together.
• Ford currently “have never lost sight of the social and
environmental goals that are key elements of the business.”
• Ford global week of caring, Ford dreams, Automotive
Industry Action Group.
• US financial institutions and non-profit group consumer
action have launched Moneywise – free financial education.
Questions
• What narrow measurement does the neoclassical model
suggest that managers should focus on?
• How can we link profits and social welfare?
• What are some criticisms of the neoclassical theory?
Another approach – Stakeholder Management
• Stakeholder management formalized in 1980s by RE
Freeman – How managers should identify and align the
interests of a wide range of individuals and groups.
• Has endured some criticisms
– Ant capitalistic
– Doesn’t provide an objective corporate function
– Could be some favoritism behavior from the manager.
Other options
• Triple bottom line – financial, environmental and social
performance are measured.
http://www.economist.com/node/14301663
• Balanced scorecard approach.
• http://www.economist.com/node/12677043
• Long term wealth production (Economic value added,
Market value added, Shareholder value creation)
Stakeholder management
• Nowadays effective stakeholder management is seen as
essential for long term company value production and
success.
• William George “ Serving all your stakeholders is the best
way to produce long-term results and create a growing
prosperous company… there is no conflict between
servicing all your stakeholders and providing excellent
returns for shareholders. In the long term it is impossible to
have one without the other.”
Step 1
• General guiding stakeholder management strategies to be
fitted to a specific industry.
• Properly identifying company stakeholders.
• Stakeholder = Any individual or group whose claim on a
firms activities could promote or inhibit company value
creation and ultimately company success.
Step 1
• Within each category in Figure 1.1 managers must identify
the specific stakeholders with which they are related. E.g
short term vs long term shareholders.
• Each different group makes a different kind of “claim” on
the company.
– Employees claim wages
– Shareholders a financial return on their investment.
– Activist groups may complain about environmental degradation
or global warming
Step 1
• Fill in the specific stakeholder groups and identify the claims each
group is making.
• In principle meeting the stakeholders claims adds value and
processes should be established to do so. E.g. Failing to pay
suppliers on time could lead to poor quality.
• It adds social capital “a capability that arises from the prevalence of
trust in a society or in certain parts of it… if people who work
together in an enterprise trust one another because they are all
operating according to a set of ethical norms, doing business costs
less.”
Step 1
• Sometimes even if the stakeholders don’t make a claim we
could do what’s best for them and in turn our company. E.g.
improving workplace health and safety or educating
employees can boost company performance.
Step 2
• Improving on what a stakeholder can achieve (e.g. through
education) in order to generate valuable outcomes and
mutually drive company success.
• Mutual stakeholders – have a shared or joint interest in
company success so developing their capabilities helps
drive company success
– Shareholders
– Employees
– Suppliers
Step 2
• Ford actively works with suppliers and industry partners to
encourage the development and implementation of
environmental management systems, life-cycle product
and tooling analysis, environmental modeling and other
sustainability management tools.
• Capital one – financial literacy of consumers
• Deutsche bank – community arts, music and educational
programs.
Two steps
• Help all stakeholders by understanding
1
and meeting their claims
• Help mutual stakeholders by developing
2
their capabilities.
Competing stakeholder demands
1. Don’t ignore any group and take some action for 1 or 2.
Don’t make “either - or” situations “Either we meet our
shareholder claims or our employee claims”
2. Prioritize claims with regard to the potential for short and
long term value production and competitive advantage.
3. Think creatively about how to best meet claims and
develop capabilities. Also use benchmarking.
4. Establish processes to ensure continual improvement.
Response to Criticisms
1. It’s not an easily measurable corporate objective function so
managerial favoritism can happen.
Counter argument - it can be tied to various performance metrics (we
will see later).
2. All stakeholders must be treated equally.
Counter argument - no stakeholder group ignored but managers can
attend to stakeholder claims which better drive sustainable company
success.
3. Stakeholder management requires democratic forms of corporate
governance.
Counter argument – all types of governance are ok.
Summary
• Managers should do what is right for their company and
social welfare.
• In the neoclassical model managers do what is right by
optimizing profits for shareholders.
• However this model is too narrow, doesn't consider long term
value creation and is risky.
• The stakeholder management model is a far better model
which includes meeting stakeholders claims, developing
capabilities and being socially and environmentally
responsible.
Questions
• Who is a stakeholder of a company?
• What are the 2 steps of efficient stakeholder management?
• Give an example of how mutual stakeholders capabilities
can be improved?
• What steps should a manager follow if there is a conflict
between stakeholders claims?