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CHAPTER 2 STAKEHOLDERS, MANAGERS, AND ETHICS

TEACHING OBJECTIVES 1. To discuss an organization’s stakeholder groups, including shareholders, employees, local

communities, and unions. (2.1) 2. To examine difficulties in meeting stakeholders’ goals: competing goals, allocating rewards, and

long-term effectiveness. (2.2) 3. To review and examine how top management is structured, and the role of authority in making

decisions (2.3). 4. To understand agency theory, and how it explains the relationship between top management and the

board of directors (2.3). 5. To understand the role that ethics plays in top management (2.4). 6. To examine how to create an ethical organization (2.4).

CHAPTER SUMMARY

This chapter examines the role that managers and stakeholders play in the organization. Every company has two main groups of stakeholders: (1) inside stakeholders—shareholders, managers, and the workforce; and (2) outside stakeholders—customers, suppliers, the government, trade unions, local communities, and the general public. Although stakeholders have competing interests, an organization must minimally satisfy them all. Satisfying stakeholders creates problems due to competing goals, allocating rewards, and choosing a time frame to measure effectiveness. Difficulties arise in measuring organizational effectiveness even if stakeholders have shared goals. An organization must select the best way to achieve goals. Agency theory explains the relationship between top management and the board of directors. Ethics and ethical behavior is discussed, including the sources of ethics, moral hazard, and how to create an ethical organization.

CHAPTER OUTLINE 2.1 Organizational Stakeholders Organizations create value for stakeholders—those with an interest, claim, or stake in the organization. Stakeholders are motivated to participate in an organization if they receive inducements or rewards that exceed their contributions. Organizational stakeholders include inside and outside stakeholders. (Table 2.1) Inside stakeholders are closest to an organization and have a direct claim on organizational resources. Q: Name some inside stakeholder groups.

A. Inside stakeholders include shareholders, managers, and employees. Shareholders are company owners who buy stock to earn dividends and stock appreciation. They can withdraw support if inducements fall below contributions.

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Notes________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

Organizational Insight 2.1: The Increasing Power of Institutional Investors Large institutional investors have increased the power of shareholders in dealing with management. The California Public Employees Retirement System (Calpers), the largest American public sector pension fund, manages $65 billion for over 1,000,000 members. Q. How do large investors monitor managers? A. Calpers watches managers and boards to guard against the pursuit of personal interests at shareholders’ expense. They block provisions that prevent shareholder benefits and decision making and control managers’ escalating salaries and bonuses. Managers coordinate resources to meet organizational goals and strive to invest shareholder money profitably. Top managers are indirectly appointed by shareholders through a board of directors. Managers contribute skills to receive compensation and satisfaction. Managers often leave an organization if contributions exceed inducements. The workforce includes nonmanagerial employees who contribute through the performance of assigned duties. Motivation is related to the rewards and punishments that influence performance. Employees decrease performance or leave if contributions exceed inducements. Notes________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

Outside stakeholders neither own nor work for the company but have an interest in it. Q. Who are outside stakeholders? A. Outside stakeholders include customers, suppliers, the government, trade unions, local communities, and the general public. Customers are the largest outside stakeholder group. The money paid for a product is a customer’s contribution to the organization. Unless they get value, customers withdraw monetary support, and the company loses a stakeholder.

Organizational Insight 2.2: Southwest Airlines Satisfies Its Customers Q. How does Southwest satisfy stakeholders? A. Southwest focuses on customer satisfaction. It sends birthday cards to frequent fliers, answers letters, and gets feedback from customers on service. Southwest treats employees well; they own 13 percent of the stock. If employees (one stakeholder group) are treated well, they feel motivated to treat customers (another stakeholder group) well.

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Notes________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________ Suppliers provide raw materials and parts and directly affect company efficiency. Suppliers indirectly attract customers because high-quality inputs lead to high-quality products. U.S. automakers are imitating the Japanese, whose cars have high-quality parts, by creating strong ties with suppliers to improve quality. The government wants companies to compete fairly and comply with laws pertaining to employee pay, safety, discrimination, and other issues. The government contributes to organizations by standardizing rules. Trade unions directly impact a company’s productivity and effectiveness, but union demands can conflict with shareholder demands. Local communities: The economics of a community, including real estate and employment, depend on local businesses. The general public: The wealth of a nation is tied to the success of its businesses. The public wants corporations to behave in a socially responsible way. The public was upset in 1992 when the president of United Way misused funds. Notes________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

• Refer to discussion question 1 here to highlight the potential controversy between shareholders and

managers. _________________________________________________________________________________

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2.2 Organizational Effectiveness: Satisfying Stakeholder’s Goals and Interests

Organizations are coalitions of stakeholders who bargain to balance inducements with contributions. An organization must minimally satisfy the interests of all stakeholders who often have conflicting goals. To win stakeholder approval, the organization faces the problems of competing goals, allocating resources, and balancing short- and long-term goals.

Competing Goals

Shareholders own the company, thus managers should maximize shareholder wealth. Yet ownership and control are separated because managers control the company and can pursue personal interest. They may focus on short-term profits instead of long-term growth or avoid risk taking because they control their own salaries.

Allocating Rewards

Reward allocation is important because it motivates stakeholders, yet it is difficult to determine the distribution of excess rewards. Which criteria should measure effectiveness, short-term profit, growth, or

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long-term wealth maximization? Should employees receive short-term bonuses or lifetime employment? Should shareholders receive dividends or have profits reinvested?

Organizational Insight 2.3: Should Doctors Own Stock In Hospitals? There is a trend for medical doctors to become stockholders in the hospitals in which they work.

Q. Is this a conflict of interest between doctors and patients? A. As owners, doctors might have the incentive to give patients minimum standards of care to cut costs or overcharge patients to increase hospital profits. There are potentially competing goals for doctors as shareholders and caregivers. Still, doctors see themselves as professionals and feel there is no reason to assume they lack integrity. Notes________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

Managing Stakeholder Interests

Satisfying stakeholders such as customers, employees, and the government reaches the ultimate goal of satisfying managers and shareholders.

2.3 Top Managers and Organizational Authority Shareholders are the legal owners of the corporation, and they are represented by a board of directors, who act as trustees. The board has the legal authority to hire, fire, and discipline top management. However, the responsibility of using organizational resources to create value is delegated to managers. Authority is the power to hold people accountable for what they do. Figure 2.1 shows the reporting relationships of a large company.

The Chief Executive Officer

The CEO is at the top of the hierarchy and can influence organizational effectiveness and the decision making process in the following five ways: 1. The CEO is responsible for setting an organization’s goals and designing its structure. 2. The CEO chooses key executives to fill top-level positions in the hierarchy. 3. The CEO determines top management’s rewards and incentives. 4. The CEO controls the allocation of scarce resources among an organization’s functions and divisions. 5. The CEO’s actions and reputation influence inside and outside stakeholders opinions of the

organization and impact the organizations ability to attract resources from its environment.

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The Top-Management Team

The president is the person who has a position directly below the CEO and generally is called the chief

operating officer (COO). In most companies the president takes responsibility for managing the organization’s internal operations, and the CEO takes responsibility for managing the organization’s relationship with external stakeholders and for formulating a long-range business plan. Executive vice presidents are directly below the president. They oversee a company’s most important line and staff functions. Q. What is the difference between a line role and a staff role?

A manager who has a line role is directly responsible for the production of goods and services, such as a

production manager. A manager who has a staff role has no direct responsibility for production and is in an advisory role. R&D and sales managers have staff roles. The president and executive vice president constitute a company’s top-management team and are part of corporate management. The top-management team is a critical part of an organization, because they make many important decisions, such as what strategy the organization should pursue.

Other Managers

Other corporate managers include senior vice presidents and vice presidents. Vice presidents report to senior vice presidents, who report to executive vice presidents.

Companies may also have general managers or divisional managers. These managers are present only in companies that are organized into separate business divisions. For example, a person could be in

charge of the Frito-Lay Division of Pepsi-Cola. These managers are divisional management and not corporate management and they determine policies for the divisions that they run instead of objectives for the organization as a whole. Divisional managers generally report to a member of the top-management team.

Managers at the next level are called functional managers; these managers are in charge of a certain function, like marketing or finance. Functional managers are responsible for developing capabilities in their area that lead to core competences.

An Agency Theory Perspective

Agency theory is useful for understanding the relationships between various levels of management. A relationship exists when one party (the principle) delegates decision making authority or control to another (the agent). The agency problem is that of accountability, both because one party may have more information than the other, but also the parties may have different goals. Moral hazard occurs when the agent has more information than the principle and the agent has an incentive to pursue his or her own self-interests.

To solve the agency problem, governance mechanisms must be put in place, which are some forms of control which align the interests of the principles and agents. Q. How does the agency problem make managing difficult?

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The theory is typically used to describe relationships that could exist when managers don’t have a clear picture of or understanding of the job at hand. Consider a job such as a delivery driver. They are basically on the road with little supervision, so they have more information than their managers do regarding the day-to-day requirements of the job. If that is combined with incentive to pursue self-interests, the situation is such that bad things are possible. For example, a delivery driver may decide to spend company time running personal errands, because it is in his best interests, and management will not find out.

Notes________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

2.4 Top Managers and Organizational Ethics Ethics are the moral principles or beliefs about what is right or wrong. These principles help guide managers when the best course of action is not clear, or when different stakeholders have different needs. Because management decisions are often difficult, it is useful to understand the frameworks that individuals use in making ethical decisions. Table 2.2 discusses three models that are relevant for management, the utilitarian model, the moral rights model, and the justice model.

Organizational Insight 2.4: The Use of Animals in Cosmetic Testing Gillette believes that the only safe way to test its products is to use animals, and it defends its position by responding to every letter of protest, and even telephoning children at home to explain. Q. Is using animals ethical? A. Answers will vary dramatically. Instead of letting the students “argue” about the merits of each position, try to frame their answers into the utilitarian, moral rights, and justice perspectives so that they get a feel for why people can come to different conclusions.

Sources of Organizational Ethics Ethics come from three sources, society, group or professional, and individual.

Societal Ethics These include such things as the legal system, customs in a society or culture, and in the norms and values that people use to interact with each other.

Organizational Insight 2.5: Is it Right to Use Child Labor? Many low-cost foreign suppliers employ young children to produce their products. Q. Is it ethical for U.S. companies to purchase products from these companies? A. Again, answers will vary, and the two positions are detailed in the case, but try and frame the discussion around the thought processes that managers might use in making this decision.

Professional Ethics

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These are the moral values and rules that a specific group relies on, such as doctors or lawyers. A good example is athletics. In football or basketball, it is acceptable and not considered cheating to try and sneak something by an official. Players don’t call penalties on themselves. However, in golf, the ethical standards are such that players are expected to call infractions on themselves.

Individual Ethics These are the personal and moral standards that individuals use to structure their interactions with people.

Why do ethical rules develop?

Because individuals when left to their own devices tend to pursue their own goals at the expense of the common good. The “Tragedy of the Commons” example illustrates this well. Ethical rules and laws emerge to control this type of behavior.

Why Does Unethical Behavior Occur?

Unethical behavior occurs due to lapses in personal ethics, self-interest, and outside pressure.

Lapses in Personal Ethics

Individuals may believe that any help to the organization is acceptable, even if it harms others.

Self-Interest

Individuals face ethical issues when they weigh personal interests against the impact of their actions on others. Research suggests that individuals with high stakes are more likely to behave unethically. Companies with financial problems are more likely to commit unethical and illegal acts (price fixing).

Outside Pressure

The probability of unethical behavior increases when outsiders pressure individuals to perform. Notes________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

2.5 Creating an Ethical Organization Ethical people create an ethical organization. An employee decision is ethical if it falls within acceptable standards in the organization’s environment, is communicated to all affected parties and is approved by those with whom the decision maker has significant personal relationships. An unethical decision hurts stakeholders in a manner that is unacceptable in the organization’s environment.

Top managers influence a company’s ethical culture. As a figurehead, a manager models the company position on ethics and promotes ethical behavior through employee incentives. A manager informs customers and stakeholders about values and allocates resources to social causes.

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Designing an Ethical Structure and Control System

Structure and culture can be designed to encourage ethical behavior. Authority relationships and rules can be designed to foster ethical behavior. The mission statement can direct employees towards ethical decisions. If employees feel helpless to prevent an unethical act or are afraid to discuss ethical concerns, they may

confide in an outside person or agency. These are whistle-blowers. An organization can take the following actions to make whistle-blowing acceptable: 1. Allow subordinates to discuss ethical concerns with upper-level managers. 2. Create an ethics officer to investigate claims and inform employees about ethics. 3. Create an ethics committee to make formal ethical judgments.

Creating an Ethical Culture

Ethics are part of an organization’s culture, and top management impacts ethics. Ethical top managers foster an ethical culture, but unethical top managers make an ethical culture difficult to establish.

Supporting the Interests of Stakeholder Groups

Although shareholders want high profits, they don’t want increased profits through unethical behavior. Unethical behavior makes a company a riskier investment, hurts a company’s reputation, and lowers its stock price. Outside stakeholders such as the government can create rules to promote ethical behavior. Outside regulation can help establish societal ethics. Notes________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

DISCUSSION QUESTIONS AND ANSWERS 1. Give some examples of how the interests of different stakeholder groups may conflict.

A good way to illustrate this is to have the students imagine that an organization has much more profit at the end of the year than originally forecasted. What would each stakeholder group want to do with the profits. For example, employees would want a bonus, shareholders would want a dividend, customers would like to see reduced prices, etc. This is a good way to illustrate how different groups will view the same issue.

2. What is the role of the top management team?

Make sure that students understand that top management has specific duties. Too often, we expect top management to know everything that goes on in their organization, when their job may involve staffing, budgeting, or designing the strategic mission. You might also compare what a top management team does in a small company versus a large company.

3. What is the agency problem? What steps can be taken to solve it?

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The main focus of this is to understand the problems that can occur when individuals that need to

work together have different goals, and have the opportunity and motivation to pursue their own self interests. The solution is to make sure systems are in place that keep everyone focused on the same goals.

4. Why is it important for managers and organizations to behave ethically?

Because society is better off, and the organization is better off in the long-term. Look at the long-term benefits of Johnson & Johnson’s decision as compared to Dow Corning. Look at Arthur Andersen. The point is, there are financial reasons to behave ethically as opposed to it just “being the right thing to do.”

5. Ask a manager to describe an instance of ethical behavior that she or he observed and an instance

of unethical behavior. What caused these behaviors, and what were the outcomes?

Make sure the focus is on the long-term outcomes, so that students can see the real value of ethical

behavior.

6. Search business magazines such as Fortune or Business Week for an example of ethical or

unethical behavior, and use the material in the chapter to analyze it.

.

This is easy to do, because most management decisions have an ethical component.

ORGANIZATIONAL THEORY IN ACTION

Practicing Organizational Theory Small groups of students are designing a code of ethics for a large supermarket chain. First they need to discuss what ethical dilemmas employees will face, and then design a code of conduct that is most appropriate. Use the 3 questions on page 38 as a guide for the students to assess the code. Also, you might discuss which stakeholders are affected most by the code of conduct.

The Ethical Dimension

This one asks the student to think about the last time they either were treated unethically or saw someone else being treated unethically. Make sure they understand the difference between ethics and “bad behavior.” It is easy to think that everything wrong in society is an ethical dilemma, but in management, it means something different.

Making the Connection Students are looking for managers that have pursued their own self-interest at the expense of other stakeholders. This is a good exercise for illustrating agency theory and moral hazard, and how this applies to organizations.

ANALYZING THE ORGANIZATION

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This module focuses on having students identify the stakeholders of their chosen organization, identify its top management structure, and try to look at what their ethical stances are.

CASE FOR ANALYSIS

Kinko’s New Operating Structure

Kinko’s Inc. was the largest retailer of copying stores, but it had to change its operating structure in response to competitive pressures from Quick Copy and OfficeMax. Kinko’s had an informal management process and difficulty managing growth. The founder, Orfalea, used franchising to launch growth, but this approach did not assist Kinko’s in controlling costs or improving customer service. Consultants recommended centralized control and a set of internal authority relationships.

1. Why did the managers at the two organizations have different ethical stances towards their

customers? (Hint go to J&J’s website and look at its Code of Ethics).

It is clear from looking at J&J’s credo that they really focus on stakeholders and making ethical decisions. The credo can be viewed at http://www.jnj.com/our_company/our_credo/index.htm. It might be worthwhile to either print this out or bring up the website during class. In contrasting the stance, you might discuss how at Dow Corning, the management behavior seemed “out of character.” What this shows is that organizations must put forth effort to manage ethically, it does not just come naturally to so called “good managers.” Johnson and Johnson does this, and this is illustrated quite well by their credo.

2. Outline a series of steps Dow Corning’s directors and managers should have taken to have

prevented this problem.

The point is that they should have had some sort of ethical system in place to help guide them in making decisions. Had they had a system like J&J, this would have never happened.

TEACHING SUGGESTIONS 1. In small groups, have the students identify all of the stakeholders of a well known organization, such

as their local gas station, church, or electric company. Have them make a list of all of the stakeholders, and discuss what their interest or “claim” in the organization is. This helps them to relate the theory to actual practice.

2. A role play can be used to encourage a discussion on ethics. The setting will be a government warehouse. One student will be a warehouse worker who overhears the supervisor, another volunteer, make a deal with a distributor, a third volunteer. The distributor comes to the warehouse, which contains cleaning supplies, and says to the supervisor: “This warehouse has thousands of items. If you will bypass procurement procedures, I can sell you brooms at a lower price and give you a 5% commission on the deal.” The supervisor states that he or she is tired of paperwork and that will be fine. The supervisor does not know that the worker overheard the conversation.

Discuss what the worker should do. Use the utilitarian, moral rights, and justice models to compare solutions from different perspectives.

3. In light of the recent corporate scandals, make sure the students really understand the value of behaving ethically. Point out that huge companies like Arthur Andersen really can’t afford to have a

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bad image. The global economy is too competitive, and consumers have too many choices. Point out that a few bad decisions at Arthur Andersen effectively shut the company down.

4. Visit the Johnson & Johnson website and look at their credo. Discuss with the class how simple, yet profoundly effective this philosophy is.

5. The organizational insights in this chapter are very useful for classroom discussion. For example, using Insight 2.4, split the class into two groups based upon their initial opinion of using animals in cosmetic testing. You can then have a mini-debate in class on the issues, remembering to keep the focus on how managers must make decisions.