Business Ethics Every Company Has Corporate Governance Case Study

Excerpt from Case Study :

Business Ethics

Every company has corporate governance initiatives in place. Consider that corporate governance simply refers to how the company is run and controlled. The current usage of the buzzword derives from the issues that a few companies had where executives or managers were not subject to appropriate levels of governance. Thus, the guidelines issued recently by the OECD, the ASX, the Combined Code and in Sarbanes-Oxley serve to institutionalize stronger corporate governance policies in order to strengthen public confidence in capital markets. Most companies would already be following these guidelines.

For example, the first category covered by the Combined Code is about the Board of Governors. Boards of Governors have always been responsible for corporate governance -- for our company not to have any governance policy would imply that it does not have a Board. What is recommended is that the Board has specific features and structures. One recommendation is that the Board should be primarily comprised of outsiders (board balance and independence). This is because there may be conflicts of interest with too many insiders on the Board. Outsiders have much less personal financial interest in the company, so they are more likely to work in the best interests of the stakeholders. In most cases, the company should only have one or two insiders, one of which would be the CEO, to represent the company's interests. One of the things that came out of Sarbanes-Oxley is the idea that the Board should have one or two financial professionals on it. This allows the Board to better understand complex financial arrangements, and better identify financial fraud when it occurs. There were some instances where the Board was simply unable to determine fraud that was occurring, and this led to an erosion of shareholder value. The company should also establish term limits for Board members to keep Board turnover at a level so as to bring perspectives to the management of the firm.

The OECD discusses shareholder rights as part of its governance code. Ultimately, both the Board and the executive exist to serve the shareholders, to generate the outputs that the shareholders want (usually profit). Thus, the company should ensure that the shareholders have strong rights. Shareholders of course should have voting rights (they already will) but they should also be protected from poison pills that serve to protect management from accountability (and compromise the ability of shareholders to gain for their investments) and all shareholders should have the right to communicate with each other and establish strategy.

One of the more interesting areas of governance policy blends shareholders, the Board and the executive, and that is the area of executive compensation. The company has a number of options -- a common one being a sub-committee on the Board to set executive compensation -- but whatever option is chosen the company should include a balance of fair compensation and mechanisms to control executive compensation from damaging shareholder wealthy unduly. Of particular concern is the issue of using millions of dollars in options to "align" executive interest with the interest of the shareholders. The company should closely consider whether they have hired the right person if they feel that the person is not going to work in the interests of the shareholders without millions of dollars to convince him/her that this is a good idea. The company should also weigh the merits of short-term vs. long-term alignment. Whatever decisions are made, policies should set in accordance with the Board and the shareholders' wishes.

Lastly, the company needs to ensure that there is independent internal auditing department. This is a critical control mechanism for any company. The Combined Code refers to this is "internal control," SOX prescribes a "mandatory audit committee" and the OECD leaves responsibility for the auditing function in the Board's hands rather than management's. Auditing needs to be independent so it is recommended that this function be under control of the Board, and that there be strict rules governing management interactions with the internal auditing department and strict punishments for transgressions.

Question 2. The good thing about corporate social responsibility is that it can be whatever you want it to be. This fine buzzword loosely encapsulates the idea that corporations should focus on outputs that affect all of their stakeholders. This stands in contrast to the shareholder theory of management which holds that managers are agents of the shareholders and, as Friedman wrote in 1970, the only social responsibility of business is to earn profit. If the company has no CSR policies in place, this means that it is essentially taking the Friedman view and any positive outcomes for other stakeholders are either incidental or serve to increase shareholder wealth in some way. Should the company so desire, it is not unreasonable that is use wealth maximization as its guiding CSR principle. It sort of depends on the mission of the company and the desires of shareholders.

Adhering to the shareholder wealth maximization philosophy does not imply at the company is going to be irresponsible. There is a high level of awareness of social and environmental issues today -- ideas that were revolutionary in Friedman's time are mainstream today. This means that there are financial considerations to be taken into account. Individual consumers and advocacy groups often pressure corporations into action, and the negative financial consequences of questionable ethical practices often dictate that a company has a fairly high degree of corporate social responsibility. The most damage comes from major scandals, so I would implement policies that work to prevent those and let the market dictate whatever else we do.

Our CSR policies should focus on eliminating major scandal. Examples include insider trading, unethical practices in the supply chain (i.e. child labor at suppliers, union-busting, discrimination), corruption and fraud and catastrophic environmental outcomes. The company should therefore begin with a written code of ethics and regular ethics training. This provides the baseline for employees, and the training should be given both to new and current employees. In addition, each operating unit should have an ethics committee that meets to discuss ethical issues and disseminate information about ethics around the organization. There should be a code of conduct for suppliers. The company should also have policies about waste and other environmental issues that go considerably beyond EPA guidelines, because those guidelines are usually pretty weak and scandal can occur even when operating within EPA guidelines. With written policies and an improved ethical culture to support market-based approaches to CSR, the company can improve its corporate social responsibility performance. There should also be an annual CSR report, which provides greater transparency and accountability. Lastly, the company should conduct a stakeholder analysis and set concrete objectives for things it wants to achieve with its CSR program.

Part 2. Question 3.

ASX Principle 2 outlines some of the potential causes of unethical activity among Board members. The first is a lack of independence. Board members that are internal to the company have an inherent conflict of interest and should be avoided. However, other Board members can lack independence as well, for example those who work for suppliers or other companies that have a close working relationship with the company will also lack independence. Former executives who are now technically outsiders are also likely to have less independence. The principle also makes the point that even outside Board members who are technically independent need to maintain an independent mindset.

Another contributor to unethical Board behavior can be when the CEO is also the Chairman of the Board. While the CEO should be on the Board, the Chairman is a critical role that demands a degree of independence. The CEO is not in a position to do this, so the ASX makes it clear that the CEO should not be the Chairman of the Board as this creates too much conflict of interest within the function of the Board.

In this principle, the ASX also recommends that the Board should have a nomination committee. This creates a body with designated rights and responsibilities to create the Board. By giving responsibilities with respect to Board selection, the Board establishes set policies and procedures, and Board members outside of the committee will see a reduced level of influence is selecting potential board members for nomination.

The ASX also notes that unethical behavior can derive from a lack of controls and methods for evaluating Board performance. While the Board serves to evaluate the CEO and the CEO the other managers, there are not always adequate mechanisms available to shareholders to hold the Board accountable for its decisions. While it is more a competency issue than an ethics issue, the ASX also recommends that the Board have members who are familiar with the industry, the company and accounting procedures. This allows the Board to provide better oversight into the company's activities.

Question 4.

Companies are motivated to embrace social responsibility for two reasons. The first is purely financial. If the company has a rational motive to behave ethically,…

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