MUST HAVE 2 SCHOLARLY REFERENCES FROM THE BETHEL LIBRARY. Everything must be in own words. There will be two different attach

The Organization

Chapter Outline 5-1 Organizational Direction: Mission, Goals, and Objectives

5-1a Global Infl uences on Mission

5-1b Goals and Stakeholders

5-2 Social Responsibility

5-3 Managerial Ethics

5-4 The Agency Problem

5-4a Management Serves Its Own Interests

5-4b Management and Stockholders Share the Same Interests

5-5 Corporate Governance and Goals of Boards of Directors

5-6 Takeovers

5-7 Summary

Key Terms

Review Questions and Exercises

Practice Quiz

Notes

Reading 5-1

5

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W hereas previous chapters discussed the external analysis phase of the strategic management process, this chapter begins to consider internal factors. This shift from the industry level to the organiza- tional level refl ects a change in focus from similarities, or factors

that tend to affect all of an industry’s organizations in a like manner, to differ- ences, or issues specifi c to a particular fi rm in an industry. This shift also relates to theoretical perspectives discussed in Chapter 1, marking a movement from an industrial organization (IO) perspective to a resource-based view of the fi rm.

Crafting a strategy for an organization whose purpose and resources are not well understood by its members is a diffi cult task, however. This chapter discusses the role that an organization’s unique mission and resources, as well as social responsibility and ethics, play in the strategic management process.

5-1 Organizational Direction: Mission, Goals, and Objectives

Several terms are commonly used to delineate the direction of the organiza- tion. The mission is the reason for the fi rm’s existence and is the broadest of these terms. The organization’s goals represent the desired general ends toward which efforts are directed. Objectives are specifi c and often quantifi ed versions of goals. Unlike goals, objectives are verifi able and specifi c, and are developed so that management can measure performance. Without verifi ability and specifi city, objectives will not provide a clear direction for strategy.

For example, the mission of an Internet Service Provider (ISP) might be “to provide high-quality, reliable Internet access to the southeastern United States at a profi t.” Management may establish a goal “to expand the size of the fi rm through acquisition of small ISPs.” From this goal, specifi c objectives may be derived, such as “to increase access numbers by 20 percent each year for the next fi ve years.” As another example, management’s goal may be “to be known as the innovative leader in the industry.” On the basis of this goal, one of the specifi c objectives may be “to have 30 percent of sales each year come from new products developed during the preceding three years.”

5-1a Global Infl uences on Mission An organization’s mission may be closely intertwined with international opera- tions in several ways. A fi rm may need inputs from abroad or sell a large percent- age of its products to global customers. Consider, for example, that virtually all of Japan’s industries would grind to a halt if imports of raw materials from other nations ceased, because Japan is a small island nation and its natural resources are quite limited.

Organizational mission and international involvement are also connected through the economic concept of comparative advantage, the idea that certain products may be produced more cheaply or at a higher quality in particular countries due to advantages in labor costs or technology. Chinese manufactur- ers, for example, have enjoyed some of the lowest global labor rates for unskilled or semiskilled production in recent years. As skills rise in the rapidly emerging nation, some companies have succeeded in extending this comparative advan- tage to technical skill areas as well. The annual salary for successful engineers in China rose to around $15,000 in 2007, a level well below their comparably skilled counterparts in other parts of the world.1

Comparative Advantage

The idea that certain products may be pro-

duced more cheaply or at a higher quality

in particular countries, due to advantages

in labor costs or technology

Goals

Desired general ends toward which efforts are

directed.

Mission

The reason for an organization’s existence.

The mission statement is a broadly defi ned but

enduring statement of purpose that identifi es

the scope of an organi- zation’s operations and its offerings to the vari-

ous stakeholders.

Objectives

Specifi c, verifi able, and often quantifi ed versions

of a goal.

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Global involvement may also provide advantages to the fi rm not directly related to costs. For political reasons, a fi rm often needs to establish operations in other countries, especially if a substantial proportion of sales is derived abroad. Doing so can also provide managers with a critical understanding of local markets. For example, Ford operates plants in western Europe, where manufacturing has helped Ford’s engineers design windshield wipers for cars engaged in high-speed driving on the German autobahns.2

5-1b Goals and Stakeholders At fi rst glance, establishing a mission, goals, and objectives for a fi rm appears to be fairly simple; however, because stakeholders have different perspectives on the purpose of the fi rm, this task can become quite complex. Stakeholders are individuals or groups who are affected by or can infl uence an organiza- tion’s operations. Firm stakeholders include such groups as shareholders, members of the board of directors, managers, employees, suppliers, creditors, and customers (see Table 5-1). As owners, shareholders traditionally represent the dominant group of stakeholders. Top managers, too, should be concerned not only with the shareholders’ primary objective of profi ts, but also with those of other stakeholders.3 Ideally, the mission, goals, and objectives should emphasize goals of the shareholders, and balance the pressures from other stakeholders.4

It is not diffi cult to see how stakeholder goals can confl ict with one another. For example, shareholders are generally interested in maximum profi tability, whereas creditors are more concerned with long-term survival so that their loans will be repaid. Meanwhile, customers desire the lowest possible prices, even if offering them would result in losses for the fi rm. Hence, top management faces the diffi cult task of attempting to reconcile these differences while pursuing its own set of goals, which typically includes quality of work life and career advancement.

Source: Ablestock.com

Stakeholders

Individuals or groups who are affected by or can infl uence an organi- zation’s operations.

Stakeholders Goals Customers The company should provide high-quality products and serv-

ices at the most reasonable prices possible.

General public The company should provide goods and services with mini- mum environmental costs, increase employment opportuni- ties, and contribute to social and charitable causes.

Suppliers The company should establish long-term relationships with suppliers and purchase from them at prices that allow the suppliers to remain profi table.

Employees The company should provide good working conditions, equi- table compensation, and opportunities for advancement.

Creditors The company should maintain a healthy fi nancial posture and a policy of on-time payment of debt.

Shareholders The company should produce a higher-than-average return on equity.

Board of directors Current directors should be retained and shielded from a legal liability.

Managers The company should allow managers to benefi t fi nancially from the growth and success of the company.

TA B L E S u g g e s t e d G o a l s o f S t a k e h o l d e r s5-1

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This balancing act is evident when one considers the clash that can occur when top management goals are pitted against those of the board of directors. Although both groups are primarily accountable to the owners of the corpora- tion, top management is responsible for generating fi nancial returns and the board of directors is charged with oversight of the fi rm’s management. Some have argued, however, that this traditional shareholder-driven perspective is too narrow, and that fi nancial returns are actually maximized when a customer-driven perspec- tive is adopted, a view that is consistent with the marketing concept.5 Consumer advocate and 2000 U.S. presidential candidate Ralph Nader has argued for more than thirty years that large corporations must be more responsive to customers’ needs.6

Firms create value for various parties, including employees through wages and salaries, shareholders through profi ts, customers through value derived from goods and services, and even governments through taxes. Firms that seek to maximize the value delivered to any single stakeholder at the expense of those of other groups can jeopardize their long-term survival and profi tability.7 For example, a fi rm that emphasizes the fi nancial interests of shareholders over the monetary needs of employees can alienate employees, threatening shareholder returns in the long run. Likewise, establishing long-term relationships with suppliers may restrict the fi rm’s ability to remain fl exible and offer innovative products to customers. Top management is charged with the task of resolving opposing stakeholder demands, recognizing that the fi rm must be managed to balance the demands of various stakeholder groups for the long-term benefi t of the corporation as a whole.8

5-2 Social Responsibility An organization’s direction is governed in part by its value system. An organiza- tion’s values can be seen through its stance on service to society, as well as its sup- port for high ethical standards among its managers. These factors are discussed in this section.

Social responsibility refers to the expectation that business fi rms should serve both society and the fi nancial interests of the shareholders. A fi rm’s stance on social responsibility can be a critical factor in making strategic decisions. If social responsibility is not considered, decisions may be aimed only at profi t or other narrow objectives without concern for balancing social objectives that the fi rm might embody. The degree to which social responsibility is relevant in strategic decision making is widely debated, however.

From an economic perspective, businesses have always been expected to provide employment for individuals and meet consumer needs within legal constraints. Today, however, society also expects fi rms to help preserve the environment, to sell safe products, to treat their employees equitably, and to be truthful with their customers.9 In some cases, fi rms are even expected to provide training to unemployed workers, contribute to education and the arts, and help revitalize urban areas. Firms such as Home Depot, Coca-Cola, UPS, and Johnson & Johnson recently earned high marks for social responsibility, whereas Bridgestone and Philip Morris were at the bottom of the list.10 Figure 5-1 illustrates the approach to social responsibility at Johnson & Johnson, a fi rm whose corpo- rate reputation ranked number one in 2002 and 2003 in the Harris Interactive survey.11

Many economists, including such notables as Adam Smith and Milton Friedman, have argued that social responsibility should not be part of management’s

Social Responsibility

The expectation that business fi rms should

serve both society and the fi nancial interests of

shareholders.

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decision-making process. Friedman has maintained that business functions best when it concentrates on maximizing returns by producing goods and services within society’s legal restrictions. According to Friedman, corporations should be concerned only with the legal pursuit of profi t, while shareholders are free to pursue other worthy goals as they individually see fi t. Even if one accepts Friedman’s argument, fi rms should act in a socially responsible manner for two primary reasons.

F I G U R E J o h n s o n & J o h n s o n C re d o5-1

Source: Reprinted by permission of Johnson & Johnson

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First, acting responsibly can reduce the likelihood of more costly government regulation. Historically, regulations over business operations often were enacted because certain fi rms refused to act responsibly. Had some organizations not damaged the environment, sold unsafe products, or engaged in discrimination or misleading advertising, legislation in these areas would not have been nec- essary. Government regulation is always possible when companies operate in a manner contrary to society’s interests, even if doing so is clearly within the legal jurisdiction of the fi rm.

Second, stakeholders affected by a fi rm’s social responsibility stance—most notably customers—are also those who must choose whether to transact business with the fi rm. Prospective customers have become more interested in learning about a company’s social and philanthropic activities before making purchase decisions. Those who believe a fi rm is not socially responsible may take their busi- ness elsewhere. The social responsibility debate aside, many executives—espe- cially those in large fi rms—have concluded that their organizations must at the minimum appear to be socially responsible or face the wrath of angry consumers. As such, they are greatly concerned about both the actual behavior of the fi rm and how it is perceived. Evidence suggests that consumers want the fi rms that produce the products and services they buy not only to support public initiatives, but also to uphold the same values in terms of the day-to-day decisions of running the company.12 By defi nition, a fi rm that is socially responsible is one that is able to generate both profi ts and societal benefi ts; but exactly what is good for society is not always clear.13 For example, society’s demands for high employment and the production of desired goods and services must be balanced against the pol- lution and industrial wastes that may be generated by manufacturing operations. The decisions made to balance these concerns, however, can be quite diffi cult to make (see Strategy at Work 5-1).

Social responsibility is a prominent issue in some industries. Pharmaceutical manufacturers, for example, spend billions of dollars to develop drugs for treating a wide range of ailments. The costs of the drugs, however, can determine the extent to which patients will benefi t from them. In the United Kingdom, government offi – cials called on physicians to stop prescribing various drugs for Alzheimer’s disease, acknowledging their benefi ts but arguing that they do not justify the cost.14 The same

S T R A T E G Y A T W O R K 5 – 1

GMAbility: Social Responsibility in Action

The public emphasis that General Motors places on social responsibility is quite noteworthy. The company’s “GMAbility” initiative (www.gm.com/company/gmabil- ity) highlights a number of GM activities. For exam- ple, according to its 2001 sustainability report, GM has taken action to reduce emissions and water and energy consumption, while increasing its community support and number of partnerships. GM is also active in a variety of recycling, education, hazardous waste collection, and pollution prevention programs.

GM has partnered with The Nature Conservancy, an international environmental organization. GM spends $1 million annually to assist in the preservation of land

and water systems in North America, Latin America, the Caribbean, and the Asia/Pacifi c region.

GM also participates in a variety of philanthropic activities, such as violence reduction programs in schools, Special Olympics, and community development. For example, GM partnered with Sun Microsystems and EDS to contribute more than $211 million in com- puter-aided design, manufacturing, and engineering (CAD/CAM/CAE) software, hardware, and training to Virginia Tech.

Sources: R. Alsop, “Perils of Corporate Philanthropy,” Wall Street Journal, 16 January 2002, B1, B4; General Motors, www.gm.com/ company/gmability, accessed March 14, 2002.

Source: Ablestock.com

Source: Ablestock.com

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realities can be true for medical procedures, especially in emerging economies. The pay-as-you-go system for medical treatment in China ultimately can deny costly life- saving treatment for the majority of its citizens who lack health insurance.15

In some instances, society’s expectations of an organization may increase as the fi rm grows. For example, various constituencies have charged Wal-Mart with socially irresponsible behavior in recent years. Critics allege that the mega-retailer often competes unfairly, does not always follow fair hiring and promotion prac- tices, and even contributes to local economic problems by abandoning strip-mall locations when larger stores are constructed. In 2004, CEO Lee Scott signaled a more assertive approach to countering such claims. As Scott put it, “When we’re wrong, we change, so our detractors don’t have a foothold in attacking us. Where we are right, we will fi ght and take each issue to the wall.”16

A broader notion of social responsibility, sustainable strategic management (SSM), has received increased attention in recent years. SSM refers to the strate- gies and related activities that promote superior performance from both market and environmental perspectives. Hence, an ideal strategy should seek market sustainability by meeting buyer demands and environmental sustainability by proactively managing fi nite resources. Organizations able to meet this challenge are more likely to perform well and benefi t society over the long term.

5-3 Managerial Ethics Although social responsibility and managerial ethics are often grouped together in the popular business press, the terms are not synonymous. Whereas social responsibility considers the fi rm’s ability to address issues beyond the fi nancial concerns of the shareholders, managerial ethics refers to an individual’s respon- sibility to make business decisions that are legal, honest, moral, and fair. Strategic decisions should not require managers or other employees to perform activities inconsistent with their ethical convictions concerning the role that they may be expected to play in fi rm activities (see Strategy at Work 5-2). The ethics test in Figure 5-2 provides an assessment of employees’ ethics.

Managerial Ethics

An individual’s respon- sibility to make business decisions that are legal, honest, moral, and fair.

Sustainable Strategic Management (SSM)

Strategies and related activities that promote superior perform- ance from both market and environmental perspectives.

S T R A T E G Y A T W O R K 5 – 2

Good Neighbor or Good Business?

After creating considerable destruction in the Caribbean, Hurricane Ivan hammered the Gulf Coast of the United States in September 2004. Because meteorologists had forecast the magnitude of the storm several days prior, many Americans soon to be affected turned to rivals Lowe’s and Home Depot for plywood to board up their homes, for power generators, and for other sup- plies. Both retailers stepped into high gear to meet con- sumer needs.

Neither chain raised prices amidst the storm prepa- ration and most stores made valiant attempts to remain open as long as possible. In one respect, Home Depot and Lowe’s went the extra mile to assist customers in a crisis. In reality, however, remaining open extra hours was simply good business and helped to minimize local

inventories that could be damaged if the stores were devastated by the storm.

Indeed, the two rivals were well aware of possible long-term effects that could stem from their ability to help customers prepare for the storm. As Home Depot’s eastern division president, Tom Taylor, put it, “They’ll remember who got them stuff. They’ll remem- ber who stayed open. The better job we can do during a hurricane, [the more] we can gain market share [after the storm].”

Could the Lowe’s and Home Depot actions be described as good neighbor or good business? The answer is probably both.

Sources: D. Morse, “Competing in a Crisis,” Wall Street Journal, 16 September 2004, B4, B5.

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F I G U R E E m p l o y e e E t h i c s Te s t5-2

The line between social responsibility and managerial ethics can be diffi – cult to draw, as what may be considered by some to be socially irresponsible fi rm behavior may be a direct result of unethical managerial decision making. Nonetheless, while the debate over social responsibility continues, few would argue that managers should not behave ethically. When executives shun clear ethical principles, corporate scandal or even demise can follow (see Strategy at Work 5-3).

What is morally right or wrong continues to be a topic of debate, especially when fi rms operate across borders where ethical standards can vary considerably.

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S T R A T E G Y A T W O R K 5 – 3

Ethical Concerns and the Corporate Scandals of 2001 and 2002

The period from mid-2001 to mid-2002 witnessed an unprecedented number of ethical allegations and cor- porate misdoings that jolted Americans’ confi dence in corporate America. In August 2002, Forbes published “The Corporate Scandal Sheet” in an effort to keep track of the dearth of ethical violations and allegations ram- pant at that time. The Wall Street Journal also followed in January 2003 with an extensive chronicle of events for 2002. In November 2001, Enron, once one of the world’s largest electricity and natural gas traders, admit- ted overstating its earnings by $567 million between 1997 and 2001 and fi led for Chapter 11 bankruptcy protection the following month. In another case, the astute craft and décor authority Martha Stewart sold a large number of her ImClone Systems shares one day before the company released damaging news about an experimental cancer drug, raising the specter of insider information and thus resulting in a conviction.

Although the deluge of news surrounding such scandals began to slowly subside in late 2002, public fervor concerning a perceived lack of corporate

accountability and widespread corporate legerdemain has not. This fervor has been sparked further by press reports of executive prosecutions associated with these scandals several years later. U.S. governmental agen- cies have responded with new policies and procedures designed to foster a more complete disclosure of cor- porate fi nancial doings and make it more diffi cult for executives to mislead investors about the performance of their fi rms. These actions notwithstanding, however, it is clear that a key part of the solution to this problem lies in a willingness of managers at all levels to commit to a sense of fair play and uphold ethical standards at a personal level.

Sources: R. Alsop, “Corporate Scandals Hit Home,” Wall Street Journal, 19 February 2004, B1, B2; P. Patsuris, “The Corporate Scandal Sheet,” Forbes,www.forbes.com/2002/07/25/account- ingtracker.html, accessed August 26, 2002; L. S. Egodigwe, J. C. Long, and N. Warfi eld, “A Year of Scandals and Sorrow,” Wall Street Journal Interactive Edition, 2 January 2003; P. Behr, “Ailing Enron Files for Chapter 11 Bankruptcy Protection,” Washington Post, 3 December 2001, A7; C. Gasparino and S. Craig, “Merrill Worker Casts Doubt on Stewart’s Stop-Loss Pact,” Wall Street Journal Interactive Edition, 24 June 2002.

In the United States, for example, bribes to government offi cials to secure favor- able treatment would be considered unethical. In other countries—especially those with developing economies—small “cash tips” are an accepted means of transacting business and may even be considered an integral part of an under- paid government offi cial’s compensation.

Ethics is a key consideration, especially at top management levels. Selecting the right individual to serve as CEO can be a perilous task, especially when a leader departs abruptly. Although evaluating a person’s professional qualifications is still important, personal characteristics are gaining promi- nence. Consider that Boeing’s CEO Harry Stonecipher was dismissed in March 2005 after directors became aware of explicit e-mails to a female employee with whom he was having an affair. Events such as these have prompted directors to search for personal behavior that might disqualify them as leaders, including sexual harassment, drinking problems, or failing to file income taxes properly.17

Wal-Mart’s Thomas Coughlin ended his twenty-seven-year stint with the fi rm in 2005. Originally appointed as director of loss prevention in 1978, Coughlin was promoted to director of human resources in 1983 and president of the Wal- Mart Stores division in 1999. In 2003, Coughlin was elected to Wal-Mart’s board. He retired as an executive in January 2005 due to health reasons, but was forced to resign from the board two months later when a pattern of expense account abuses was uncovered. The investigation that uncovered the abuses began when

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Coughlin asked a fi rm lieutenant to approve $2,000 in expense payments without providing any receipts.18

Ethical decisions are not always resolved easily and can even be observed differently at different times. In 1991, for example, the U.S. Food and Drug Administration (FDA) banned silicone breast implants in most instances, a deci- sion that fueled the demise of many of its original marketers who lost billions of dollars in lawsuits alleging product fl aws, breast cancer, and other serious health concerns. Dow Corning lost $3.2 billion in settlements and remained in bank- ruptcy protection from 1995 to 2004. Since that time, however, several major studies found no link between silicone implants and major diseases. In 2006, the FDA reapproved the sale of silicone implants. Hence, what was originally termed as “unethical” behavior by Dow Corning is once again being touted as an accept- able product.19

What constitutes ethical behavior can be viewed in a number of ways, six of which are discussed here. The utilitarian view of ethics suggests that anticipated outcomes and consequences should be the only considerations when evaluating an ethical dilemma. The primary shortcoming associated with this approach, however, is that a decision may have multiple consequences, some of which may be positive, others negative, and still others undetermined. For example, a deci- sion to layoff 10 percent of an organization’s workforce will harm those who lose their jobs but may help shareholders by increasing the projected returns on their …