Chapter
Eleven
Corporate
Performance,
Governance,
and Business
Ethics
“There are worse things than
war; and all of them come with
defeat.”
Ernest
Hemingway
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Stakeholders
and Corporate Performance
Stakeholders are individuals or groups with an
interest, claim, or stake in the company, what it
does, and how well it performs.
Stakeholders are in an exchange
relationship with the company
• Contributions: they supply the
organization with important resources
• Inducements: in exchange they
expect their interests to by satisfied
Companies should pursue strategies that
maximize long-run shareholder value and
must also behave in an ethical and
socially responsible manner.
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Stakeholders and Corporate
Performance
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Stakeholders and the Enterprise
Figure 11.1
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Stakeholder Impact Analysis
 Identify stakeholders most critical to survival:
• Identify which stakeholders
• The stakeholders’ interests and concerns
• Claims stakeholders are likely to make
on the organization
• Stakeholders who are most important
to the organization’s perspective
• Identify the resulting strategic challenges
 Usually the most important:
• Customers
• Employees
• Stockholders
Companies must identify the most important
stakeholders and give highest priority to
pursuing strategies that satisfy their needs.
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The Unique Role of Stockholders
Stockholders are a company’s legal owners
and the provider of risk capital, a major
source of capital to operate a business.
Risk capital –
No guarantee to the stockholders that:
• They will recoup their investment
• Or earn a decent return
ESOPs – Employee Stock Option Plans
Employees may also be shareholders
Maximizing long-run profitability & profit growth is
the route to maximizing returns to shareholders, as
well as satisfying the claims of most other stakeholder
groups.
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Profitability, Profit Growth
Stakeholder Claims
and
To grow profits, companies must be doing one
or more of the following:
1.
2.
3.
4.
Participating in a market that is growing
Taking market share away from competitors
Consolidating the industry via horizontal integration
Developing new markets through:
• Diversification • Vertical Integration • International Expansion
Stockholders receive their returns as:


Dividend payments
Capital appreciation in market value of shares
ROIC is an excellent measure of profitability.
A company generating positive ROIC is adding to
shareholders’ equity and increasing shareholder value.
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Agency Theory
Agency relationships arise whenever one party
delegates decision-making authority or control
over resources to another.
Principal-agent relationships
• Principal: person delegating authority
• Agent: person to whom authority is delegated
The agency problem:
• Agents and principals may have different goals.
• Agents may pursue goals that are not in the best
interests of their principals.
• Agents may take advantage of information asymmetries
to maximize their interests at the expense of principals.
• It is difficult for principals to measure performance.
• Trust • On-the-job consumption
• Empire building
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The Tradeoff Between Profitability
and Revenue Growth Rates
Need to maximize long-run shareholder returns
by seeking the right balance between company
growth . . . and profitability and profit growth.
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Figure 11.2
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The Challenge for Principals
Confronted with agency problems,
the challenge for principals is to:
1. Shape the behavior of agents so that they
act in accordance with goals set by
principals
2. Reduce information asymmetry between
agents and principals
3. Develop mechanisms for removing agents
who do not act in accordance with goals and
principals
Principals try to deal with these challenges
through a series of governance mechanisms.
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Governance Mechanisms
Governance mechanisms serve to limit the agency
problem by aligning incentives between agents and
principals and by monitoring and controlling agents.
 The Board of Directors
• Elected by stockholders
• Legally accountable
• Monitors corporate
strategy decisions
• Authority to hire, fire,
and compensate
• Ensures accuracy of
audited financial
statements
• Inside directors
• Outside directors
 Stock-Based Compensation
• Pay-for-performance
• Stock options:
The right to buy company shares
at a predetermined price at some
point in the future
 Financial Statements
• Auditors
• SEC
• GAAP
 The Takeover Constraint
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• Limits strategies that ignore
shareholder interests
• Corporate raiders
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How Options Skew
the Bottom Line
Table 11.1
Source: D. Henry and M. Conlin, “Too Much of a Good Incentive?” Business Week,
March 4, 2002, pp. 38–39.
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Governance Mechanisms
Inside a Company
Important agency relationships also exist between
levels of management within a company. Internal
agency problems can be reduced by:
 Strategic control systems
• To establish standards against which performance can be
measured
• To create systems for measuring and monitoring performance
• To compare actual performance against targets
• To evaluate results and take corrective actions
 Balanced Scorecard model approach is used to drive
future performance
 Employee incentives
• Employee stock options and stock ownership plans
• Compensation tied to attainment of superior efficiency,
quality, innovation, and responsiveness to customers
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A Balanced Scorecard Approach
Figure 11.3
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“It isn’t that they can’t see the
solution. It is that they can’t
see the problem.”
- G. K. Chesterton
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Ethics and Strategy
Business ethics are the accepted principles of right
or wrong governing the conduct of businesspeople.
 Ethical dilemmas occur when:
• There is no agreement over what the accepted principles are
• None of the available alternatives seem ethically acceptable
 Many accepted principles are codified into laws:
•
•
•
•
•
Tort laws – governing product liability
Contract law – contracts and breaches of contracts
Intellectual property law – protection of intellectual property
Antitrust law – governing competitive behavior
Securities law - issuing and selling securities
 Behaving ethically goes beyond staying within the law
An ethical strategy is one that does not
violate the accepted principles.
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Ethical Issues in Strategy
Ethical issues are due to a potential conflict between the
goals of the enterprise, or the goals of the individual
managers, and the rights of important stakeholders:
 Self-dealing
Managers feather their nest with corporate monies
 Information manipulation
Distort or hide information to enhance competitive or personal situation
 Anticompetitive behavior
Actions aimed at harming actual or potential competitors
 Opportunistic exploitation
Of other players in the value chain in which the firm is embedded
 Substandard working conditions
Underinvest in working conditions or pay below market wages
 Environmental degradation
Directly or indirectly take actions that result in environmental harm
 Corruption
Companies pay bribes to gain access to lucrative business contracts.
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The Roots of Unethical Behavior
Why do some managers behave unethically?
No simple answers, but some generalizations:
1. Personal ethics code: will have a profound
influence on behavior as a businessperson
2. Do not realize they are behaving unethically:
by failing to ask the right questions
3. Organization’s culture: de-emphasizes ethics
and considers primarily economic consequences
4. Unrealistic performance goals: encouraging
and legitimizing unethical behavior
5. Unethical leadership: that encourages and
tolerates behavior that is ethically suspect
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Philosophical Approaches
to Ethics
Philosophical underpinnings of business ethics that can
provide managers with a moral compass to help
navigate through difficult ethical issues:
 The Friedman Doctrine
Milton Friedman’s basic position is that the only social responsibility of
business is to increase profits, as long as the company stays within the
law and the rules of the game without deception or fraud.
 Utilitarian and Kantian Ethics
The moral worth of actions is determined by its consequences – leading
to the best possible balance of good versus bad consequences.
Committed to the maximization of good and the minimization of harm.
 Rights Theories
Recognizes that human beings have fundamental rights and privileges.
Rights establish a minimum level of morally acceptable behavior.
 Justice Theories
Focus on the attainment of a just distribution of economic goods and
services that is considered to be fair and equitable.
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Behaving Ethically
To make sure that ethical issues are considered
in business decisions, managers should:
1.
2.
3.
4.
5.
6.
7.
Favor hiring and promoting people with a
well-grounded sense of personal ethics.
Build an organizational culture that
places a high value on ethical behavior.
Make sure that leaders not only articulate but also
act in an ethical manner.
Put decision-making processes in place that require
people to consider the ethical dimension of business
decisions.
Use ethics officers.
Put strong corporate governance processes in place.
Act with moral courage and encourage others to
do the same.
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“Conscience is the inner voice
that warns us somebody may
be looking.”
- H. L. Mencker
- William Adams
“A company’s ethical conduct is
something like a big flywheel. It
might have a lot of momentum,
but it will eventually slow down
and stop unless you add energy.”
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