Module 8 Critical Thinking Exercise In my opinion, Chap
Module 8 Critical Thinking Exercise
In my opinion, Chapter 12 is the most important chapter in the entire textbook. The chapter begins with a company called Theranos and the founder, Elizabeth Holmes. There are many videos on YouTube about Elizabeth Holmes and her company, Theranos. One of note is "Theranos, Elizabeth Holmes, and the Cult of Silicon Valley". Another worth watching is a 60 Minutes report, "The Theranos Whistleblower". ABC News has also completed a four part series called, "The Dropout" that you can find on YouTube or on the ABC site 20/20.
https://abc.com/shows/2020/episode-guide/2019-03/15-the-dropout
Elizabeth Holmes was convicted January 2022.Rothaermel states, "an important implication for the strategic leader is the recognition that effective corporate governance and solid business ethics are critical … governance and ethics are closely intertwined" (p. 451).
Given the Theranos case (this company is by far not the only one) what lessons can be learned? Obviously, not falsifying records is a good start but what else?
Chapter 12
Corporate Governance and Business Ethics
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No reproduction or further distribution permitted without the prior written consent of McGraw Hill.
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Learning Objectives
Describe the shared value creation framework and its relationship to competitive advantage.
Explain the role of corporate governance.
Apply agency theory to explain why and how companies use governance mechanisms to align interests of principals and agents.
Evaluate the board of directors as the central governance mechanism for public stock companies.
Evaluate other governance mechanisms.
Explain the relationship between strategy and business ethics.
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The Shared Value Creation Framework
Provides guidance to managers.
Helps reconcile gaining and sustaining competitive advantage with corporate social responsibility.
Creates a larger “pie” to benefit shareholders and stakeholders.
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Public Stock Company: Four Benefits
Limited liability for investors.
Transferability of investor ownership through stock.
Legal personality, with rights and obligations.
Separation of legal ownership and management control.
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The public stock company enjoys these four characteristics that make it an attractive corporate form.
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The Public Stock Company
Exhibit 12.1
Access the text alternate for slide image.
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Milton Friedman’s Philosophy
“The social responsibility of business is to increase its profits.”
A survey was created:
For the (degreed) top 25% of income earners.
To assess various countries.
To inquire whether they agree with Milton Friedman.
The results…
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Global Survey of Attitudes Toward Business Responsibility
Exhibit 12.2
Source: Depiction of data from Edelman’s, Trust Barometer, 2011 as included in “Milton Friedman goes on tour,” The Economist, (2011, Jan. 27).
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Creating Shared Value
Executives shouldn’t concentrate only on increasing firm profits.
Rather, they should focus on creating shared value.
Economic value (for shareholders).
Social value (address society’s needs and challenges).
Societal progress is important.
Capitalism helps shape society.
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GE, for example, has strengthened its competitiveness by creating a profitable business with its “green” Ecomagination initiative. Ecomagination is GE’s strategic initiative to provide cleaner and more efficient sources of energy, provide abundant sources of clean water anywhere in the world, and reduce emissions. Jeffrey Immelt, GE’s former CEO, would often say, “Green is green,” meaning that addressing ecological needs offers the potential of gaining and sustaining a competitive advantage for GE. Through applying strategic innovation, GE is providing solutions for some tough environmental challenges, while driving company growth at the same time. Ecomagination solutions and products allow GE to increase the perceived value it creates for its customers while lowering costs to produce and deliver the “green” products and services. Ecomagination allows GE to solve the trade-off between increasing value creation and lowering costs. This in turn enhances GE’s economic value creation and its competitive advantage.
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Reconnecting Economic and Societal Needs
Expand the customer base to bring in nonconsumers.
Expand traditional internal firm value chains to include non-traditional partners.
Focus on creating new regional clusters (such as Silicon Valley).
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Porter argues that these strategic actions will lead to a larger pie of revenues and profits that can be distributed among a company’s stakeholders.
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Corporate Governance
The mechanisms to:
Direct and control an enterprise.
Ensure that it pursues strategic goals successfully and legally.
Offers checks and balances.
Attempts to address the principal-agent problem.
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The Principal-Agent Problem
Exhibit 12.3
Access the text alternate for slide image.
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Agency Theory
A theory that views the firm as a nexus of legal contracts.
Conflicts that arise should be resolved legally.
The firm needs to design work tasks, incentives, and employment contracts…
To minimize opportunism by agents.
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© McGraw Hill
Senior executives, such as the CEO, face agency problems when they delegate authority. Employees who perform the actual operational labor are agents who work on behalf of the managers. Such frontline employees often enjoy an informational advantage over management. They may tell their supervisor that it took longer to complete a project or serve a customer than it actually did, for example. Some employees may be tempted to use such informational advantage for their own self-interest (e.g., spending time on Facebook during work hours, watching YouTube videos, or using the company’s computer and internet connection for personal business).
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Adverse Selection and Moral Hazard
Both caused by information asymmetry.
Adverse Selection
An increased likelihood of selecting inferior alternatives.
Moral Hazard
When one party is incentivized to take undue risks or shirk responsibilities,
The costs are incurred to the other party.
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The Board of Directors
Centerpiece of corporate governance.
Represent the interests of shareholders.
Tasked with providing oversight.
Consist of inside and outside directors.
Inside directors: usually consist of CEO, COO, CFO.
Outside directors: senior execs from other firms.
Are elected by the shareholders.
Shareholders vote to determine who is elected.
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Responsibilities of the Board of Directors
Strategic oversight and guidance.
CEO selection, evaluation, compensation, succession.
Guide executive compensation.
Review, monitor, evaluate, and approve strategic initiatives.
Risk assessment and mitigation.
Ensuring financial statements are accurate.
Ensuring compliance with laws and regulations.
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The practice of CEO/chairperson duality—holding both the role of CEO and chairperson of the board—has been declining somewhat in recent years. Among the largest 500 publicly traded companies in the United States, about 70 percent of firms had the dual CEO-chair arrangement in 2005 (before the global financial crisis), but this number had declined to some 50 percent of companies in 2018 (post global financial crisis). High-profile examples of the same person serving as CEO and chair of the board include Jeff Bezos (Amazon), Mark Zuckerberg (Facebook), Robert Iger (Disney), Mary Barra (GM), and Virginia Rometty (IBM).
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Other Governance Mechanisms
Used to align incentives between principals and agents.
Include:
Executive compensation.
The market for corporate control.
Financial statement auditors, government regulators, and industry analysts.
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1. Executive Compensation
Stock options are often part of compensation.
The average ratio of CEO to employee pay is 300:1.
About 2/3 of CEO pay is linked to firm performance.
Incentives can negatively affect performance.
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Based on a survey of CEOs in the S&P 500 by The Wall Street Journal, the median annual compensation was about $11 million. The five highest paid CEOs were Thomas Rutledge of Charter Communications ($98.5 million), Fabrizio Freda of Estée Lauder ($48.4 million), Mark Parker of Nike ($47.6 million), Alex Molinaroli of Johnson Controls ($46.4 million), and Robert Iger of Disney ($43.9 million). Noteworthy are also the two lowest paid CEOs in the S&P 500: Warren Buffett of Berkshire Hathaway ($470,000) and Larry Page of Alphabet ($1, the minimum payment required).
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2. The Market for Corporate Control
An external corporate-governance mechanism.
Activist investors who:
Seek to gain control of an underperforming corporation.
Buy shares of its stock in the open market through buy-outs.
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© McGraw Hill
In a leveraged buyout (LBO), a single investor or group of investors buys, with the help of borrowed money (leveraged against the company’s assets), the outstanding shares of a publicly traded company in order to take it private. In short, an LBO changes the ownership structure of a company from public to private. The expectation is often that the private owners will restructure the company and eventually take it public again through an initial public offering (IPO).
To avoid being taken over against their consent, some firms put in place a poison pill. These are defensive provisions that kick in should a buyer reach a certain level of share ownership without top management approval.
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3. Auditors, Regulators and Industry Analysts
External-governance mechanisms.
To avoid misrepresentation of financial results:
Public financial statements must follow GAAP:
Generally accepted accounting principles.
Financial statements must be audited.
Industry analysts often base their buy, hold, or sell recommendations on:
Financial statements filed with the SEC.
Business news (WSJ, Forbes, CNBC, etc.)
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Corporate-governance mechanisms play an important part in aligning the interests of principals and agents. They enable closer monitoring and controlling, as well as provide incentives to align interests of principals and agents. An industry has sprung up around assessing the effectiveness of corporate governance in individual firms. Research outfits, such as GMI Ratings, provide independent corporate governance ratings. The ratings from these external watchdog organizations inform a wide range of stakeholders, including investors, insurers, auditors, regulators, and others.
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Business Ethics
An agreed-upon code of conduct in business
Provides training for:
Behavior that is consistent with the principles, norms, and standards of business practice that have been agreed upon by society.
Can differ in various cultures around the globe.
Universal norms include fairness, honesty, and reciprocity.
© McGraw Hill
Law and ethics, however, are not synonymous. This distinction is important and not always understood by the general public. Staying within the law is a minimum acceptable standard. A note of caution is therefore in order: A manager’s actions can be completely legal, but ethically questionable.
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When Facing an Ethical Dilemma
Is the action within acceptable norms of professional behavior?
As outlined in the organization’s code of conduct.
As defined by the profession at large.
Would you feel comfortable explaining and defending the decision in public?
How would the media react?
How would the company’s stakeholders feel about it?
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Bad Apples vs. Bad Barrels
Bad Apples.
Individuals who act opportunistically.
Bad Barrels.
An unethical organizational climate.
To set the ethical tone, leaders must:
Set clear ethical expectations.
Put structure, culture and control systems in place.
Formal and informal culture must be aligned.
Executive behavior must adhere to the company vision and values.
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The MBA Oath
| As a business leader I recognize my role in society. |
| My purpose is to lead people and manage resources to create value that no single individual can create alone. |
| My decisions affect the well-being of individuals inside and outside my enterprise, today and tomorrow. |
| Therefore, I promise that: |
| I will manage my enterprise with loyalty and care, and will not advance my personal interests at the expense of my enterprise or society. |
| I will understand and uphold, in letter and spirit, the laws and contracts governing my conduct and that of my enterprise. |
| I will refrain from corruption, unfair competition, or business practices harmful to society. |
| I will protect the human rights and dignity of all people affected by my enterprise, and I will oppose discrimination and exploitation. |
| I will protect the right of future generations to advance their standard of living and enjoy a healthy planet. |
| I will report the performance and risks of my enterprise accurately and honestly. |
| I will invest in developing myself and others, helping the management profession continue to advance and create sustainable and inclusive prosperity. |
| In exercising my professional duties according to these principles, I recognize that my behavior must set an example of integrity, eliciting trust and esteem from those I serve. I will remain accountable to my peers and to society for my actions and for upholding these standards. |
| This oath I make freely, and upon my honor. |
Exhibit 12.4
Developed by Harvard Business School students:
Helps anchor future managers to professional values.
A guideline for integrity in business.
Source: MBA Oath and Max Anderson.
© McGraw Hill
The MBA Oath
As a business leader I recognize my role in society. My purpose is to lead people and manage resources to create value that no single individual can create alone.
My decisions affect the well-being of individuals inside and outside my enterprise, today and tomorrow.
Therefore, I promise that: I will manage my enterprise with loyalty and care, and will not advance my personal interests at the expense of my enterprise or society.
I will understand and uphold, in letter and spirit, the laws and contracts governing my conduct and that of my enterprise.
I will refrain from corruption, unfair competition, or business practices harmful to society.
I will protect the human rights and dignity of all people affected by my enterprise, and I will oppose discrimination and exploitation.
I will protect the right of future generations to advance their standard of living and enjoy a healthy planet.
I will report the performance and risks of my enterprise accurately and honestly.
I will invest in developing myself and others, helping the management profession continue to advance and create sustainable and inclusive prosperity.
In exercising my professional duties according to these principles, I recognize that my behavior must set an example of integrity, eliciting trust and esteem from those I serve. I will remain accountable to my peers and to society for my actions and for upholding these standards.
This oath I make freely, and upon my honor.
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End of Main Content
© 2019 McGraw Hill. All rights reserved. Authorized only for instructor use in the classroom.
No reproduction or further distribution permitted without the prior written consent of McGraw Hill.
Because learning changes everything.®
www.mheducation.com
Accessibility Content: Text Alternatives for Images
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© McGraw Hill
The Public Stock Company Text Alternate
This image shows a series of boxes, starting at the top: State Charter, then Shareholders, then Board of Directors, then Management, then Employees.
The state or society grants a charter of incorporation to the company’s shareholders—its owners, who legally own stock in the company. The shareholders appoint a board of directors to govern and oversee the firm’s management. The managers hire, supervise, and coordinate employees to manufacture products and provide services.
© McGraw Hill
Global Survey of Attitudes Toward Business Responsibility Text Alternate
The survey asked the top 25 percent of income earners holding a university degree in each country surveyed whether they agree with Milton Friedman’s philosophy that “the social responsibility of business is to increase its profits.” The results, as displayed in this graph, revealed some intriguing national differences.
United Arab Emirates: about 82 percent.
Japan: 70 percent.
India: a little less than 70 percent.
South Korea: 66 percent.
Singapore: 66 percent.
United States: 55 percent.
China: a little less than 40 percent, 38 percent.
Brazil: about 37 percent.
Germany: 35 percent.
Italy: 34 percent.
Spain: 33 percent.
(approximate totals)
© McGraw Hill
The Principal Agent Problem Text Alternate
This image shows two circles titled Principal and Agent with arrows pointing to each other. The arrow pointing from Principal to Agent says "hires, monitors and compensates," and the arrow pointing from agent to principal says "performs work, provides time and talents." In the middle of these circles are the words "information asymmetry."
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