watch the video and answer questions
- Watch the movie “The Corporation” https://www.youtube.com/watch?v=xHrhqtY2khc
Respond to at least 3 of the guide questions AND
You must cite at least 2 scholarly articles and/or your required textbooks (Boatright and Smith and/or Comer and Vega) in your discussionGuide Questions (respond to at least 3 questions):
- In the movie, the corporation is described as a kind of person. What kind of person is the corporation according to experts in teh movie? Do you agree or disagree? Please explain.
- Who bears the moral responsibility for the “corporation’s” actions? Please explain your rationale.
- Is it possible to be a large corporation that is socially responsible AND make major profits? Please explain your rationale.
- If a product cannot be made sustainable should it be made at all? Please explain your rationale.
Ethics and the Conduct of Business
Eighth Edition
John R. Boatright
Loyola University Chicago
Jeffery D. Smith
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Library of Congress Cataloging-in-Publication Data
Names: Boatright, John Raymond, 1941– author. | Smith, Jeffery David, 1971– author. Title: Ethics and the conduct of business / John R. Boatright, Loyola
University Chicago, Jeffery D. Smith, Seattle University. Description: Eighth edition. | Boston: Pearson, [2017] Identifiers: LCCN 2015050453| ISBN 9780134167657 | ISBN 0134167651 Subjects: LCSH: Business ethics. | Social responsibility of business. Classification: LCC HF5387 .B6 2017 | DDC 174/.4—dc23 LC record available at
http://lccn.loc.gov/2015050453
10 9 8 7 6 5 4 3 2 1
ISBN-10: 0-13-416765-1 ISBN-13: 978-0-13-416765-7
Brief Contents
1 Ethics in the World of Business 2 Ethical Decision Making 3 Ethical Theories 4 Whistle-Blowing 5 Business Information and Conflict
of Interest
6 Privacy 7 Discrimination and Affirmative
Action
8 Employment Rights
1 9 Health and Safety
21 10 Marketing and Advertising 46 11 Ethics in Finance 65 12 Corporate Social Responsibility
13 Governance, Accountability,
and Compliance 106 14 International Business Ethics
References
82
133 Credits 156 Index Index
182
208
239
268
297
325
357 380 387
iii
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Contents
Preface About the Authors
1 Ethics in the World of Business
Case: Merck and the Marketing of Vioxx
1.1: Business Decision Making
1.1.1: Nature of Business 1.1.2: Levels of Decision Making
1.2: Ethics, Economics, and Law
1.2.1: Ethics and Economics 1.2.2: Ethics and Law
1.3: Ethics and Management
1.3.1: Ethical Management and Management
of Ethics
1.3.2: Ethics and the Manager’s Role 1.4: Ethics in Organizations
1.4.1: Individual Decision Making 1.4.2: Organizational Decision Making
Conclusion: Ethics in the World of Business
Case: A Sticky Situation Case: Beech-Nut’s Bogus Apple Juice Case: Ethical Uncertainty at Bath Iron Works Case: A Faked Résumé at Yahoo
2 Ethical Decision Making
Case: HP and the Smart Chip
2.1: Market Ethics
2.1.1: The Market System 2.1.2: Ethics in Markets 2.1.3: Breaches and Fraud 2.1.4: Wrongful Harm 2.1.5: Market Failure 2.1.6: Summary of Market Ethics
2.2: Roles, Relationships, and Firms
2.2.1: Agents and Principals 2.2.2: Fiduciaries and Professionals 2.2.3: Firms 2.2.4: Summary of Roles, Relationships,
and Firms 2.3: Ethical Reasoning
2.3.1: Philosophical Accounts 2.3.2: Psychological Accounts 2.3.3: Framework for Reasoning
Conclusion: Ethical Decision Making
Case: Lavish Pay at Harvard Case: Broken Trust at Bankers Trust Case: KPMG’s Tax Shelter Business
ix xi
3 Ethical Theories
Case: Big Brother at Procter & Gamble
1 3.1:
1
4 5 6 7 7 9 11
11 12 13 14 15
16
21
21
22 22 24 25 26 27 30 30 31 31 32
35 35 36 37 38
41
3.1: Utilitarianism
3.1.1: Principle of Utility 3.1.2: Cost–Benefit Analysis
3.2: Kantian Ethics
3.2.1: Universalizability 3.2.2: Respect for Persons
3.3: Virtue Ethics
3.3.1: What Is Virtue? 3.3.2: Defending the Virtues 3.3.3: Virtue in Business
3.4: Rights Rights
3.4.1: Meaning of Rights 3.4.2: Kinds of Rights
3.5: Justice
3.5.1: Nature and Value of Justice 3.5.2: Aristotle on Distributive Justice 3.5.3: Rawls’s Egalitarian Theory 3.5.4: Nozick’s Entitlement Theory
Conclusion: Ethical Theories
Case: Exporting Pollution Case: Clean Hands in a Dirty Business Case: Conflict of an Insurance Broker Case: An Auditor’s Dilemma
4 Whistle-Blowing
Case: Time’s Persons of the Year
4.1: What Is Whistle-Blowing? 4.2: Justification of Whistle-Blowing
4.2.1: Loyal Agent Argument 4.2.2: Meaning of Loyalty 4.2.3: Conditions for Justification
4.3: Right to Blow the Whistle
4.3.1: Existing Legal Protection 4.3.2: Arguments against Protection 4.3.3: Arguments for Protection
4.4: Developing a Policy
4.4.1: Benefits and Dangers 4.4.2: Components of a Policy
Conclusion: Whistle-Blowing
Case: A Whistle-Blower Accepts a “Deal” Case: A Whistle-Blower’s Quandary Case: Who’s a Whistle-Blower?
46
46
48 48 50 52 52 53 53 54 54 55 55 55 56 57 57 58 59 59
60
65
65
67 69 69 71 71 73 73 75 75 76 76 76
77
v
5 Business Information and Conflict
of Interest
Case: Barbie vs. the Bratz Girls
5.1: Confidential Information
5.1.1: Duty of Confidentiality 5.1.2: Competitive Employment 5.1.3: Impact of Restrictions
5.2: Proprietary Information
5.2.1: Intellectual Property 5.2.2: Defining Trade Secrets 5.2.3: Property Rights Argument 5.2.4: Fair Competition Argument 5.2.5: Competitor Intelligence
5.3: Conflict of Interest
5.3.1: Defining Conflict of Interest 5.3.2: Some Relevant Distinctions 5.3.3: Kinds of Conflict of Interest 5.3.4: Managing Conflict of Interest
Conclusion: Business Information and Conflict of Interest
Case: The Aggressive Ad Agency Case: Procter & Gamble Goes Dumpster Diving Case: A Conflict-Laden Deal
6 Privacy
Case: Psychological Testing at Dayton Hudson
6.1: Challenges to Privacy
6.1.1: Privacy in the Workplace 6.1.2: Privacy in the Marketplace
6.2: Meaning and Value of Privacy
6.2.1: History of the Concept 6.2.2: Defining Privacy 6.2.3: Utilitarian Arguments 6.2.4: Kantian Arguments
6.3: Privacy Away from Work
6.3.1: Justifying Monitoring 6.3.2: Limits to Monitoring 6.4: Privacy of Employee Records
6.4.1: Ethical Issues with Records 6.4.2: Justifying a Purpose 6.4.3: Disclosure to Outsiders 6.4.4: Gathering Information 6.4.5: Accuracy, Completeness, and Access
6.5: Big Data Analytics
6.5.1: Data Collection 6.5.2: Ethical Issues with Big Data
6.6: Using the Internet
6.6.1: Information Collection 6.6.2: Ethical Issues with Internet Use 6.6.3: Protecting Privacy
Conclusion: Privacy
82
82
84 85 86 87 88 88 89 90 91 92 93 95 95 96 98
102
106
106
108 108 109 110 111 111 112 113 114 114 115 116 117 117 118 119 120 120 121 122 123 123 124 125
128
Case: Privacy of Text Messages Case: Plugging Leaks at HP Case: Information Handling at ChoicePoint
7 Discrimination and
Affirmative Action
Case: Race Discrimination at Texaco
7.1: What Is Discrimination?
7.1.1: Civil Rights Act of 1964 7.1.2: Disparate Treatment/Impact 7.1.3: Forms of Discrimination
7.2: Sexual Harassment
7.2.1: Defining Sexual Harassment 7.2.2: Forms of Sexual Harassment 7.2.3: Further Issues 7.3: Objections to Discrimination 7.4: Preventing Discrimination
133
133
135 135 136 137 138 138 139 140 140 142
7.4.1: Analysis, Recruitment, and Assessment 142 7.4.2: Objective Tests 142 7.4.3: Subjective Evaluations 143 7.4.4: Sexual Harassment Programs 144
7.5: Affirmative Action
7.5.1: Affirmative Action Plans 7.5.2: Court Actions on Plans 7.5.3: Compensation Argument 7.5.4: Equality Arguments 7.5.5: Utilitarian Arguments 7.5.6: Problems with Affirmative Action
Conclusion: Discrimination and Affirmative Action
Case: Jacksonville Shipyards Case: Sex Discrimination at Walmart
8 Employment Rights
Case: The Firing of Robert Greeley
8.1: Employment at Will
8.1.1: Property Rights Argument 8.1.2: Freedom of Contract Argument 8.1.3: Efficiency Argument 8.1.4: Exceptions
8.2: Right to Due Process
8.2.1: Support for Due Process 8.2.2: Law of Due Process
8.3: Freedom of Expression
8.3.1: Defining Freedom of Expression 8.3.2: Legal Protection for Expression 8.3.3: Arguments over Expression
8.4: Workplace Democracy
8.4.1: Participation and Democracy 8.4.2: Arguments for Democracy
8.5: Worker Compensation
8.5.1: Setting Wages
145 146 146 147 149 150 151
152
156
156
157 158 159 160 161 162 163 163 164 165 165 166 167 167 168 169 170
8.5.2: Market Outcomes 8.5.3: Minimum Wage
8.6: Executive Compensation
8.6.1: Criticism of CEO Pay 8.6.2: Justifying CEO Pay 8.6.3: Problems with Justification
Conclusion: Employment Rights
Case: Fired for Blogging at Google Case: Worker Participation at Saturn Case: Health Benefits at Walmart
9 Health and Safety
Case: The Ford–Firestone Brawl
9.1: Rights in the Workplace
9.1.1: Meaning of Health and Safety 9.1.2: Protecting Health and Safety
9.2: Hazardous Work
9.2.1: Justifying a Right to Refuse 9.2.2: Justifying a Right to Know
9.3: Reproductive Hazards
9.3.1: Scientific Background 9.3.2: Fetal Protection Policies 9.3.3: Charge of Discrimination 9.3.4: Defending against the Charge 9.3.5: Remaining Issues
9.4: Product Safety
9.4.1: Due Care Theory 9.4.2: Contractual Theory 9.4.3: Strict Liability Theory
Conclusion: Health and Safety
Case: Genetic Testing at Burlington Northern Case: Johnson Controls, Inc. Case: The Collapsing Crib
10 Marketing and Advertising
Case: Selling Hope
10.1: Marketing Ethics Framework 10.2: Sales Practices and Labeling
10.2.1: Deception and Manipulation 10.2.2: Information Disclosure 10.2.3: Labeling
10.3: Pricing and Distribution
10.3.1: Anticompetitive Pricing 10.3.2: Unfair Pricing 10.3.3: Distribution
10.4: Development and Research
10.4.1: Product Development 10.4.2: Marketing Research
10.5: Deceptive Advertising
10.5.1: Defining Deceptive Advertising 10.5.2: Applying the Definition
10.6: Irrational Persuasion 170 10.6:
172 173
10.6.1: Threats to Free Choice 10.6.2: Dependence Effect
10.7: Impact of Advertising 174 10.7:
174 175
10.7.1: Impact on Persons 10.7.2: Impact on Society
10.8: Internet Advertising 176 10.8:
10.8.1: Online Placement 10.8.2: Ethics of Placement
10.9: Social Advertising
Conclusion: Marketing and Advertising
182
182
184
Case: McCormick’s Pricing Strategy Case: Capital One’s Online Profiles Case: Herbalife: A Pyramid Scheme?
184 11 Ethics in Finance
185
Contents vii
224 225 225 226 226 228 229 229 230 232
233
239
Case: Goldman Sachs and the Abacus Deal 239
188 11.1: Financial Services 189 11.1.1: Deception 191
192 193 193 11.2: Financial Markets
11.1.2: Churning 11.1.3: Suitability
194 195 195 11.3: Insider Trading 196
196 198
11.2.1: Fairness in Markets 11.2.2: Derivatives and HFT
11.3.1: Theories of Insider Trading 11.3.2: Evaluation of the Two Theories 11.3.3: Recent Insider Trading Cases
200 11.4: Hostile Takeovers
203
208
208
210
11.4.1: Market for Corporate Control 11.4.2: Takeover Tactics 11.4.3: Role of Directors
Conclusion: Ethics in Finance
Case: SCM Mutual Funds Case: Merrill Lynch and the Nigerian Barge Deal Case: Martha Stewart: Inside Trader? Case: Oracle’s Hostile Bid for PeopleSoft
212 212 12 Corporate Social Responsibility
213
Case: Competing Visions at Malden Mills
214 12.1: The CSR Debate 215
215 217 218 219 12.2: Normative Case for CSR
12.1.1: Meaning of CSR 12.1.2: Examples of CSR 12.1.3: Related Concepts
219 220 222 12.3: Business Case for CSR
222 224
12.2.1: Classical View 12.2.2: Friedman on CSR
12.3.1: The Market for Virtue 12.3.2: Competitive Advantage
241 242 243 244 245 246 248 251 252 253 254 255 256 257 260
261
268
268
270 271 272 273 274 274 276 278 278 280
12.4: Implementing CSR
12.4.1: Program Selection and Design 12.4.2: Reporting and Accountability
12.5: Business with a Mission
12.5.1: Social Enterprise 12.5.2: Competing Successfully 12.5.3: Mission and Trust
Conclusion: Corporate Social Responsibility
Case: Starbucks and Fair Trade Coffee Case: Timberland and Community Service Case: Coca-Cola’s Water Use in India
13 Governance, Accountability,
and Compliance
Case: Fraud at WorldCom
13.1: Corporate Governance
13.1.1: Shareholder Control 13.1.2: The Shareholders’ Contract 13.1.3: Shareholders and Stakeholders
13.2: Corporate Accountability
13.2.1: Financial Reporting 13.2.2: Executives and Directors 13.2.3: Criminal Prosecution
13.3: Corporate Compliance
13.3.1: Program Components 13.3.2: Program Benefits 13.3.3: Federal Sentencing Guidelines 13.3.4: Codes of Ethics
Conclusion: Governance, Accountability, and Compliance
Case: Sears Auto Centers Case: Shareholder Rights at Cracker Barrel Case: The Sale of Trans Union
281 14 International Business Ethics
281 283 285 14.1: Different Standards
286 287 289
290
Case: Mattel’s Toy Woes
14.1.1: Relevant Differences 14.1.2: Variety of Outlooks 14.1.3: Right to Decide 14.1.4: Business Necessity
14.2: Guidelines for Multinationals
14.2.1: Rights 14.2.2: Welfare 14.2.3: Justice 14.2.4: International Codes
14.3: Wages and Working Conditions 297 14.3:
297
299
14.3.1: Setting Wages 14.3.2: Working Conditions
14.4: Foreign Bribery 300 14.4:
303 305 307
14.4.1: What Is Bribery? 14.4.2: What’s Wrong with Bribery? 14.4.3: Combating Bribery
14.5: Human Rights Abuses 307 14.5:
310 312 313 314 314 315
14.5.1: Constructive Engagement 14.5.2: Liability for Abuses
Conclusion: International Business Ethics
Case: H. B. Fuller in Honduras Case: Walmart in Mexico Case: Google in China
317 References
319
Credits Index
325
325
328 329 329 330 331 331 332 333 333 335 336 337 339 340 341 342 343 346 347 348
349
357 380 387
Preface
Thfnieerss est iahgchahstih er veeeadmcihteieondnt, twowfh oEic tshhi igicssn oiafbnicvdai otnhute s m Ctooil neadnsutyocontn eoefs r.B eTuahsdie- ing these words, is the transition to digital media. Through Pearson’s online platform REVEL, this text offers not only a new mobile reading experience—on computers, tablets, and even smartphones—but also a new approach to learn ing, with many interactive features, videos, quizzes, and other educational tools. REVEL creates a new frontier in education for both students and instructors. It is exciting for us, as authors, to be pioneer participants in this promis ing and innovative endeavor. Users of previous editions will also note the appear ance of a coauthor, Jeffery D. Smith. His collaboration in the eighth edition not only brings a fresh perspective to what is now a joint venture but also prepares for the future of this classic text, which first appeared more than 20 years ago. Under Jeffery’s guidance, Ethics and the Conduct of Business will hopefully continue to remain current and rel evant through many new editions. The eight editions of Ethics and the Conduct of Business have followed the development of the field of business ethics, which has grown in recent decades into an interdis ciplinary area of study that has found a secure niche in both liberal arts and business education. Credit for this development belongs to many individuals—both philoso phers and business scholars—who have succeeded in relating ethical theory to the various problems of ethics that arise in business. They have shown not only that busi ness is a fruitful subject for philosophical exploration but also that future managers in the world of business can ben efit from the results. Ethics and the Conduct of Business, eighth edition, is a comprehensive and up-to-date discussion of the most prominent issues in the field of business ethics and the major positions and arguments on these issues. It is intended to be used as a text in business ethics courses on either the undergraduate or M.B.A. level. The substantial number of cases included provides ample opportunity for a case-study approach or a combined lecture–discussion format. There has been no attempt to develop a distinctive ethical system or to argue for specific conclusions. The field of business ethics is marked by reasonable disagree ment that should be reflected in any good text for a course. The focus of Ethics and the Conduct of Business is pri marily on ethical issues that corporate decision makers face in developing policies about employees, customers, investors, and the general public. The positions on these
issues and the arguments for them are taken from a wide variety of sources, including economics and the law. The study of ethical issues in business is not confined to a sin gle academic discipline or even to the academic world. The issues selected for discussion are widely debated by legis lators, judges, government regulators, business leaders, journalists, and, indeed, virtually everyone with an inter est in business.
An underlying assumption of this course is that ethi cal theory is essential for a full understanding of the posi tions and arguments offered on the main issues in business ethics. Fortunately, the amount of theory needed is rela tively small, and much of the discussion of these issues can be understood apart from the theoretical foundation provided here. The text also contains a substantial amount of legal material, not only because the law addresses many ethical issues but also because management deci sion making must take account of the relevant law. Many examples are used throughout the text in order to explain points and show the relevance of the discussion to real-life business practice.
New to the Edition
Preparation of the eighth edition of Ethics and the Conduct of Business has provided an opportunity to incorporate new developments and to increase its value in the class room. The major changes from the previous edition are as follows:
Chapter 5 on business information has been expanded to provide greater coverage on confidential information and the duty of confidentiality.
Chapter 6 on privacy has been expanded to include more on the protection of both employee and consumer privacy against intrusions, especially from advances in technology.
The section on product safety has been moved from Chapter 10 on marketing and advertising to the cover- age of worker health and safety in Chapter 9. This change has allowed expanded treatment in Chapter 10
f emerging issues in marketing and advertising, espe- cially those related to the use of social media and data analysis, which have been facilitated by the Internet.
Chapter 12 on corporate social responsibility includes a new section on the recent development of for-profit businesses, known as social enterprises, which operate with a mission to deliver vital social services.
ix
x Preface
The Chapter 13 section on corporate governance has been completely rewritten for greater clarity and coherence.
The eighth edition contains 58 short cases, including 12 new ones on such subjects as a falsified résumé at Yahoo, conflict of interest at Goldman Sachs, a firing at Google for blogging, profiling of Internet visitors by a major bank, variable pricing strategies in grocery stores, Herbalife’s unusual multilevel marketing scheme, Coca-Cola’s water use in India, and bribery by Walmart executives in Mexico.
Acknowledgments
I, John Boatright, am grateful for the support of Loyola University Chicago and especially the Quinlan School of Business. I have benefited from the resources of the Raymond C. Baumhart, S.J., Chair in Business Ethics, which was created to honor a former president of Loyola University Chicago, who was also a pioneer in the field of business ethics. To Ray Baumhart I owe a special debt of gratitude. I am grateful as well to Jeffery Smith for graciously accept ing my offer to become a coauthor of this edition and my ultimate successor in the preparation of future editions. Finally, my deepest expression of appreciation goes to my wife, Claudia, whose affection, patience, and support have been essential for the preparation of the eighth edition, as they were for the ones previous. It goes without saying that I, Jeffery Smith, am excited to work with John Boatright on this important project and appreciate his generous offer to continue our collaboration on future editions. I hope to maintain the clarity, depth, and even-handedness that have made earlier editions so valuable to students and instructors. For over a decade, I
have benefited from the support of the Banta Center for Business, Ethics and Society and my colleagues at the Uni versity of Redlands. For everyone there I am grateful. My thanks also go to DePauw University’s Prindle Institute for Ethics for hosting me as the Nancy Schaenen Visiting Scholar while portions of the eighth edition were written. And I also owe so much to my lovely wife, Rita, who pro vides support when I need it most and continues to keep me grounded.
John R. Boatright Jeffery D. Smith
I, John Boatright, would like to express my gratitude for permission to use material from the following sources:
John R. Boatright, Ethics in Finance, 2nd ed. (Malden, MA: Blackwell Publishers, 2008), copyright © 1999, 2008 by John R. Boatright; Ethics in Finance, 3rd ed. (Malden, MA: Wiley Blackwell, 2014), copyright © 2014 by John Wiley & Sons, by permission of the publisher.
John R. Boatright, “Financial Services,” in Michael Davis and Andrew Stark, eds., Conflict of Interest in the Professions (New York: Oxford University Press, 1999), copyright © 1999 by John R. Boatright.
John R. Boatright, “Corporate Governance,” Ency clopedia of Applied Ethics, 2nd ed., Ruth Chadwick, ed. (Amsterdam: Elsevier, 2011), by permission of the publisher.
John R. Boatright, “The Shareholder Model of Corporate Governance,” in Robert W. Kolb, ed., Ency clopedia of Business Ethics and Society (Thousand Oaks, CA: Sage Publications, 2008), by permission of the publisher.
About the Authors
John R. Boatright is the Raymond C. Baumhart, S.J., Pro fessor of Business Ethics in the Quinlan School of Business at Loyola University Chicago. He has served as the Execu tive Director of the Society for Business Ethics, and is a past president of the Society. He was recognized by the Society in 2012 for a “Career of Outstanding Service to the Field of Business Ethics.” He is the author of the book Eth
ics in Finance, and has edited Finance Ethics: Critical Issues in Theory and Practice. He serves on the editorial boards of Business Ethics Quarterly, Journal of Business Ethics, and Business and Society Review. He received his Ph.D. in phi losophy from the University of Chicago.
Jeffery D. Smith is the Boeing Frank Shrontz Chair of Pro fessional Ethics and Professor of Management in the Albers School of Business and Economics at Seattle Uni versity, teaching ethics to management, accounting and finance students. He currently serves on the executive board of the Society for Business Ethics and the editorial board of the international journal of the Society, Business Ethics Quarterly. He is the editor of Normative Theory and Business Ethics (2008) and has published in a variety of business and philosophy journals. He received his Ph.D. from the University of Minnesota.
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Chapter 1
Ethics in the World of Business
1.1 Identify ethical issues created by diverse
business situations and relationships and the level of decision making required to address them
1.2 Recognize the role of ethics in the conduct of business, with respect to economic principles and the law
1.3 Distinguish between ethical management
and the management of ethics, and each of the three main roles of a manager
1.4 Analyze how ethical business conduct is
challenged by decision making on individual and organizational levels
Case: Merck and the Marketing of Vioxx
On September 30, 2004, Merck & Co. announced the with drawal of Vioxx, its highly profitable pain reliever for arthritis sufferers, from the market.1 This announcement came only seven days after company researchers found in a clinical trial that subjects who used Vioxx more than 18 months had a sub stantially higher incidence of heart attacks. Merck chairman and CEO Raymond V. Gilmartin described the action as “the responsible thing to do.” He explained, “It’s built into the prin ciples of the company to think in this fashion. That’s why the management team came to such an easy conclusion.”2 In the lawsuits that followed, however, damaging documents emerged casting doubt on Merck’s claim that it had acted responsibly by taking appropriate precautions in the develop ment and marketing of the drug.
Development of Vioxx
Competitive Environment
For decades, Merck’s stellar reputation rested on the company’s emphasis on science-driven research and development. Merck employed some of the world’s most talented and best-paid researchers and led other pharmaceutical firms in the publica tion of scientific articles and the discovery of new medicines for the treatment of serious conditions that lacked satisfactory ther apies. For seven consecutive years in the 1980s, Merck was ranked by Fortune magazine as America’s most respected com pany. Merck received widespread accolades in particular for the decision, made in 1978, to proceed with research on a drug for preventing river blindness (onchocerciasis), which is a debilitat
ing parasite infection that afflicts many in Africa, even though the drug was unlikely to pay for itself. Eventually, Merck decided to give away the drug, called Mectizan, for as long as necessary at a cost of tens of millions of dollars per year. This kind of princi pled decision making was inspired by the words of George W. Merck, the son of the company’s founder: “We try never to forget that medicine is for the people. It is not for the profits. The profits follow, and if we have remembered that, they have never failed to appear. The better we have remembered it, the larger they have been.” Vioxx is an example of Merck’s innovative research. Devel oped as a treatment for the pain of arthritis, the drug acts as an anti-inflammant by suppressing an enzyme responsible for ar thritis pain. Other drugs in the class of nonsteroidal anti-inflam matory drugs (NSAIDs) inhibit the production of two enzymes COX-1 and COX-2. However, COX-1 is important for protecting the stomach lining, and so ulcers and stomach bleeding are potential side effects of these drugs. The distinctive benefit of Vioxx over other NSAID pain relievers, such as ibuprofen (Advil) and naproxen (Aleve), is that it inhibits the production of only the COX-2 enzyme, and not COX-1. After approval by the Food and Drug Administration (FDA) in May 1999, Vioxx quickly became a popular best seller. More than 20 million people took Vioxx between 1999 and 2004, and at the time of the withdrawal, with 2 million users, Merck was earning $2.5 billion annually or 11 per cent of the company’s total revenues from the sale of the drug.
The success of Vioxx came at a critical time for Merck. Not only were the patents on several profitable drugs due to expire, open ing the way for generic competition, but also the competitive
1
environment of the entire pharmaceutical industry was undergoing rapid change. Competition from generic drugs increased dramatically due to federal legislation and also due to the rise of large, powerful managed care organizations, which sought to cut the cost of drug treatments through the use of formularies that restricted the drugs doctors could prescribe. The development of new drugs was increasingly shifting to small entrepreneurial research companies focused on specific technologies, which reduced the competitive advantage of the traditional large pharmaceutical firms. Mer ck’s competitors responded to changes in the competitive environment by acquiring small companies, developing new products that duplicated ones already on the market (so called “me-too” drugs), entering the generics market, seek ing extensions of patents after making only slight improvements, and engaging in aggressive marketing, including the use of controversial direct-to-consumer (DTC) advertising. The first four strategies—growth by acquisition, the de velopment of “me-too” drugs, the production of generics, and making improvements merely to extend patents— conflicted with Merck’s culture and values. However, under the previous CEO, Roy Vagelos (who guided Merck through the develop ment of Mectizan for river blindness), the company greatly increased its emphasis on marketing. This increase in em phasis was considered necessary given the short time avail able to sell a drug before the patent expired. In particular, evidence was needed not only to prove a product’s safety and effectiveness in order to gain FDA approval but also to persuade physicians to prescribe it instead of the competi tors’ medications. Since much of the information that could persuade doctors was part of a drug’s label, marketers need ed to be involved in the development of a product from the earliest research stages in order to prepare a persuasive la bel. The label could be improved further by conducting tests, which were not scientifically necessary but which generated clinically proven results that could be useful in persuading physicians. Under Gilmartin, the company’s formally stated strategy became: “Turning cutting-edge science into novel medicines that are true advances in patient care with proven clinical outcomes.”
Decision to Withdraw
In announcing the withdrawal of Vioxx, Gilmartin described the evidence of increased risk of heart attacks as “unex pected.” In the first lawsuits against Merck that came to trial, evidence was presented to show that company scientists had considered the potential heart problems with Vioxx as early as 1997. The first hint of trouble came in that year as Merck scientists noticed that Vioxx appeared to suppress the pro duction of a substance in the body that acted naturally to reduce the incidence of heart attacks. Although the signifi cance of this discovery was recognized, no follow-up investi gations were undertaken.
More significant evidence that Vioxx might contribute to heart attacks was produced by a study concluded in 2000 that was designed to compare the gastrointestinal effects of Vioxx and naproxen in order to improve the label of the Merck product by proving that Vioxx was less harmful to the stomach lining. Although the study, called VIGOR (for Vioxx Gastrointestinal Outcomes Research), showed that Vioxx users had heart attacks at a rate four to five times that of the naproxen group, researchers were uncertain whether the difference was due to an adverse effect of Vioxx in causing heart attacks or a beneficial effect of naproxen in preventing them. The heart attacks in the trial occurred mainly in the Vioxx subjects who were already at greatest risk of heart attacks, and all subjects were prohibited from taking aspirin (which is known to prevent heart attacks) in order to gain reliable results from the study since aspirin affects the stomach. When the results of the VIGOR study were published in the November 2000 issue of the prestigious New England Journal of Medicine, the beneficial effects of naproxen were emphasized in a way that implied that Vioxx was safe for people without the risk factors for heart attacks. After initially resisting pressure by the FDA to include a warning on the Vioxx label, Merck finally agreed in April 2002 to add the evi dence of an increased incidence of heart attacks. However, the language on the label emphasized, again, the uncertainty of the cause and recommended that people at risk of heart attacks con tinue to use an anti-inflammant for protection. In the meantime, Merck continued its aggressive market ing campaign. Between 1999 and 2004, Merck spent more than $500 million on DTC television and print advertising. This expenditure was intended to keep pace with the heavy spend ing by Pfizer for its competing COX-2 inhibiter Celebrex. Merck also maintained a 3,000-person sales force to meet with doc tors for face-to-face conversations about Vioxx. To support this effort, Merck developed materials that provided salespeople with responses to questions from skeptical physicians.3 One document, called an “obstacle handling guide,” advised that questions about the risk of heart attacks be answered with the evasive explanations that Vioxx “would not be expected to demonstrate reductions” in heart attacks and was “not a substi tute for aspirin.” Another document titled “Dodge Ball Vioxx” concluded with four pages that were blank except for the word “DODGE!” in capital letters on each page. Company docu ments also describe an effort to “neutralize” skeptical doctors by enlisting their support or at least defusing their opposition by offers of research support or engagements as consultants.4 The timeline below outlines key events in the development, approval, and marketing of Vioxx and the outcome for Merck.
The History of Vioxx
The Food and Drug Administration (FDA) has a multi-phase approval process to evaluate the testing, safety, and labeling of all new prescription drugs to be sold in the United States. The FDA also monitors the “post-marketing” safety of approved drugs, to ensure that the public is informed of any new health risks that are revealed by widespread use and additional studies.
Timeline
December 1994
1997
November 1998
January 1999
May 1999
October 1999 – December 1999
November 2000
2001
April 2002
September 2004
January 2005
November 2007
December 2011
April 2012
Merck seeks FDA approval to begin Vioxx clinical trials (on human subjects), based on the success of animal testing.
Merck scientists discover the first signs that Vioxx may cause cardiovascular problems.
Merck applies for FDA approval to market Vioxx for the treatment of acute pain, dysmenorrhea (menstrual cramps), and osteoarthritis. The application includes the results of about 60 studies, none of which points to potential cardiovascular risks.
Merck begins the Vioxx Gastrointestinal Outcomes Research study (VIGOR) to determine whether Vioxx is safer for the digestive system than naproxen, an older painkiller. This later becomes a key selling point for the drug.
After a six-month review, the FDA approves Vioxx for the three uses Merck speci fied in its application.
The data and safety monitoring board for Merck’s VIGOR study meets several times to discuss its findings. Although Vioxx appears to increase the risk of heart problems in test subjects, the board votes to continue the study and keep market ing Vioxx to the public.
Merck’s VIGOR study is published in the New England Journal of Medicine, but Merck does not include all observed instances of heart attacks and downplays the cardiovascular risks.
The FDA publishes the full VIGOR study results and additional studies conducted by independent parties also indicate that there is a real risk of cardiovascular problems. In September, the FDA warns Merck that the Vioxx marketing cam paign and label do not adequately represent its health risks.
Merck changes the drug’s label to better reflect the dangers and necessary precau tions for prescribing doctors and users, based on the VIGOR study. The FDA also approves Vioxx for an additional use: the treatment of rheumatoid arthritis.
Merck’s APPROVe (Adenomatous Polyp Prevention on Vioxx) study conclusively shows that Vioxx increases the risk of heart attacks and strokes after 18 months of treatment. Merck then voluntarily stops the sale of Vioxx. A British medical journal publishes a study that estimates Vioxx caused heart at tacks in 88,000–140,000 Americans and fatal heart attacks in 38,000. Study author David Graham is an FDA scientist who also affirmed the correlation between Vioxx and heart attacks in his earlier testimony to Congress. After facing multiple lawsuits, Merck agrees to pay $4.85 billion to settle about 47,000 personal injury claims from former Vioxx users. Merck pleads guilty to promoting Vioxx as a treatment for rheumatoid arthritis before it received FDA approval for this use in 2002. The company agrees to pay a fine of $628 million in the civil settlement. A U.S. district court orders Merck to pay an additional $322 million as a criminal penalty for its misleading promotion and marketing of Vioxx.
Additional sources: “Sequence of Events with VIOXX, Since Opening of IND,” U.S. FDA Advisory Committees Briefing, 9 April 2005; Snigdha Prakash and Vikki Valentine, “Timeline: The Rise and Fall of Vioxx,” National Public Radio, 10 November 2007; “U.S. Pharma ceutical Company Merck Sharp & Dohme Sentenced in Connection with Unlawful Promotion of Vioxx,” U.S. Department of Justice Press Release, 19 April 2012.
The study that conclusively established that Vioxx increased the risk of heart attacks was called APPROVe (Adenomatous Polyp Prevention on Vioxx), which, according to critics, had only a marketing and not a legitimate scientific purpose.5 Although the company could have delayed the withdrawal until ordered to do so by the FDA, Merck acted voluntarily. Gilmartin said that the company “was really putting patient safety first.”6 However, one critic replied, “If Merck were truly acting in the interest of the public, of course, they should have done more studies on Vioxx’s safety when doubts about it first surfaced.”7 Another critic observed that such studies could have been conducted for a fraction of the cost of the $500 million spent on advertising.8
Criticisms and Defenses
Points to Consider…
An editorial in the New York Times declared that “companies must jump at the first hint of risk and warn patients and doctors of any dangers as clearly and quickly as possible. They should not be stonewalling regulators, soft-pedaling risk to doctors or promoting drugs to millions of people who don’t need them.”9 A 179-page report commissioned by the Merck board concluded, by contrast, that executives and researchers acted with integrity in addressing incomplete and conflicting evidence and that “their conclusions were reached in good faith and were reason able under the circumstances.”10 The report closed with the observation that the quick response after the APPROVe study “is not consistent with the view that Merck’s corporate culture put profits over patient safety.”11
These ethical issues are often only part of a complex set of challenges facing the whole of society.
The Vioxx crisis was an unusually difficult and damaging experience for Merck, which has both a history of responsi ble conduct and a commitment to the highest standards of ethics. Although Merck’s culture is built on strong values, these were not enough to prevent a series of decisions that, right or wrong, seriously damaged the company’s care fully built reputation. Merck executives appear to have considered carefully the possible health risk posed by Vioxx, and yet the push for profits may have led them to conclude too easily that Vioxx was not the cause of the heart attacks suffered by test subjects and that further stud ies were not necessary. The increased role of marketing, including heavy consumer advertising, in a traditionally science-driven culture was probably a factor in whatever mistakes were made, as was the change in strategy to seek evidence of the products’ superiority as part of a market ing campaign to influence physicians. However, Merck’s Making strategy could not have avoided some adjustment given the changed competitive environment that was created by
forces outside the company’s control.
All business organizations face the daunting challenge of adhering to the highest standards of ethics while, at the same time, remaining competitive and providing the prod ucts and services that the public demands. The task of managers in these organizations is to make sound business decisions that enable a company to achieve its mission. Some of these decisions involve complex ethical issues that may not be readily apparent, and success in making sound business decisions may depend on understanding these ethical issues and resolving them effectively. Ethical issues are considered by managers in the ordinary course of their work, but they are also matters that are discussed in the pages of the business press, debated in the halls of Con gress, and scrutinized by the courts. This public concern arises because ethical issues in business are closely tied to important matters of public policy and to the legislative, administrative, and judicial processes of government.
WRITING PROMPT
Decisions by Multiple Parties
After Vioxx was taken off the market, Congress began investigating the effectiveness and integrity of the FDA’s drug approval process along with Merck’s own actions. What are the costs and benefits of approving new drugs for sale as quickly as possible? Why might the FDA be reluctant to acknowledge a problem with, or recall, a drug that it had previously approved?
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Submit
1.1: Business Decision
1.1 Identify ethical issues created by diverse business situations and relationships and the level of decision making required to address them
Although ethical issues in business are very diverse, the following examples provide a useful starting point.
The Sales Rep A sales representative for a struggling computer sup- ply firm has a chance to close a multimillion-dollar deal for an office system to be installed over a two-year period. The machines for the first delivery are in the company’s warehouse, but the remainder would have to be ordered from the manufacturer. Because the man- ufacturer is having difficulty meeting the heavy demand for the popular model, the sales representa- tive is not sure that subsequent deliveries can be made
n time. Any delay in converting to the new system would be costly to the customer; however, the blame could be placed on the manufacturer.
Ethical Issue: Should the sales representative close the deal without advising the customer of the deliv ery problem?
2. The Research Director The director of research in a large aerospace firm recently promoted a woman to head an engineering team charged with designing a critical component for a new plane. She was tapped for the job because of her superior knowledge of the engineering aspects of the project, but the men under her direction have been expressing resentment at working for a woman by sub tly sabotaging the work of the team. The director believes that it is unfair to deprive the woman of advancement merely because of the prejudice of her male colleagues, but quick completion of the designs and the building of a prototype are vital to the success of the company. Ethical Issue: Should the director remove the woman as head of the engineering team? 3. The Marketing Director The vice president of marketing for a major brewing company is aware that college students account for a large proportion of beer sales and that people in this age group form lifelong loyalties to particular brands of beer. The executive is personally uncomfortable with the tasteless gimmicks used by her competitors in the industry to encourage drinking on campuses, including beach parties and beer-drinking contests. She worries about the company’s contribution to underage drinking and alcohol abuse among college students. Ethical Issue: Should the marketing director follow the competition’s troubling practices? 4. The CEO The CEO of a midsize producer of a popular line of kitchen appliances is approached about merging with a larger company. The terms offered by the suitor are very advantageous to the CEO, who would receive a large severance package. The shareholders of the firm would also benefit because the offer for their stock is substantially above the current market price. The CEO learns, however, that plans call for closing a plant that is the major employer in a small town. The firm has always taken its social responsibility seriously, but the CEO is now unsure of how to balance the welfare of the employees who would be thrown out of work and the community where the plant is located against the interests of the shareholders. He is also not sure how much to take his own interests into account. Ethical Issue: Should the CEO support a merger that harms the community but benefits the shareholders and himself?
These four examples give some idea of the ethical issues that arise at all levels of business. The individuals in these cases are faced with questions about ethics in their relations with customers, employees, and members of the larger society. Frequently, the ethically correct course of action is clear, and people in business act accordingly. Exceptions occur, however, when there is uncertainty about ethical obligations in particular situations or when considerations of ethics come into conflict with the practi cal demands of business. The sales representative might not be sure, for example, about the extent to which he is obligated to provide information about possible delays in delivery. And the director of research, although convinced that discrimination is wrong, might still feel that he has no choice but to remove the woman as head of the team in order to get the job done.
Judgment Calls on the Job
Describe a situation where you needed to make a decision in which the “right” choice had negative consequences for others or yourself personally. Explain your decision and the reasoning for it.
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1.1.1: Nature of Business
In deciding on an ethical course of action, we can rely to some extent on the rules of right conduct that we employ in everyday life. Deception is wrong, for example, whether we deceive a friend or a customer. And corporations no less than persons have an obligation not to discriminate or cause harm. However, business activity also has some fea tures that limit the applicability of our ordinary ethical views. In business settings, we encounter situations that are significantly different from those of everyday life, and business roles place their own obligations on us. For exam ple, CEOs, by virtue of their position, have responsibilities to several different constituencies, and they face ethical challenges in finding the proper balance among these pos sibly conflicting responsibilities.
One distinguishing feature of business is its economic
character. In the world of business, we interact with each other not as family members, friends, or neighbors, but as buyers and sellers, employers and employees, and the like. Trading, for example, is often accompanied by hard bar gaining, in which both sides conceal their full hand and perhaps engage in some bluffing. And a skilled salesper son is well versed in the art of arousing a customer’s atten tion (sometimes by a bit of puffery) to clinch the sale. Still,
there is an “ethics of trading” that prohibits the use of false or deceptive claims and tricks such as “bait-and-switch” advertising. Employment is also recognized as a special relation ship, with its own standards of right and wrong. Employ ers are generally entitled to hire and promote whomever they wish and to lay off or terminate workers without regard for the impact on the people affected. (This right is being increasingly challenged, however, by those who hold that employers ought to fire only for cause and to follow rules of due process in termination decisions.) Employees also have some protections, such as a right not to be discriminated against or to be exposed to workplace hazards. There are many controversies about the employ ment relationship, such as the rights of employers and employees with regard to privacy and freedom of speech, for example. The ethics of business, then, is at least in part the ethics of economic or market activity, such as the conduct of buy ers and sellers in a market and of employers and employ ees in the workplace. So we need to ask, what are the ethical rules or standards that ought to govern these kinds of activities? And how do these rules and standards differ from those that apply in other spheres of life?
A second distinguishing feature of business is that it typically takes place in organizations. An organization,
according to organizational theory, is a hierarchical system of functionally defined positions designed to achieve some goal or a set of goals. Consequently, the members of a busi ness organization, in assuming a particular position, take on new obligations to pursue the goals of a firm. Because business involves economic transactions and relationships that take place in markets and also in organizations, it raises ethical issues for which the ethics of everyday life has not prepared us. Although the familiar ethical rules about honesty, fairness, promise keeping, and the like are applicable to business, it is necessary in many cases to rethink how they apply in business situations. This is not to say that the ethics of business is different from ethics in everyday life, but only that business is a different context, and it presents us with new situations that require us to think through the ethical issues.
A Business Mindset
What do people usually mean when they defend a business decision by saying, “Business is business”? By what standards should busi ness decisions be evaluated, and how do these compare to the standards in your personal life?
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1.1.2: Levels of Decision Making
Decision making in business occurs on three distinct levels:
• the level of the individual • the level of the organization • the level of the business system
Situations that confront individuals in the workplace and require them to make a decision about their own response are on the level of individual decision making. An employee with an unreasonably demanding boss, for example, or with a boss who is discovered padding his expense account faces the question: “What do I do?” Whether to live with the difficult boss or to blow the whis tle on the padding is a question to be answered by the indi vidual and acted on accordingly.
Many ethical problems occur at the level of the organ ization in the sense that the individual decision maker is acting on behalf of the organization in bringing about some organizational change. Sexual harassment, for example, is an individual matter for the person suffering the abuse, but a manager in an office where sexual harass ment is happening must take steps not only to rectify the situation but also to ensure that it does not occur again. The decision in this case may be a disciplinary action, which involves a manager acting within his or her organi zational role. The manager may also institute training to prevent sexual harassment and possibly develop a sexual harassment policy, which not only prohibits certain behavior but also creates procedures for handling com plaints. Responding to harassment as a manager, as opposed to dealing with harassment as a victim, involves decisions on the organizational level rather than the indi vidual level. The question here is, “What do we as an organization do?”
Problems that result from accepted business practices or from features of the economic system cannot be effec tively addressed by any single organization, much less a lone individual. Sales practices within an industry, for example, are difficult for one company to change single handedly because the company is constrained by competi tion with possibly less-ethical competitors. The most effective solution is likely to be an industry-wide code of ethics, agreed to by all. Similarly, the lower pay for women work results from structural features of the labor market, which no one company or even industry can alter. A single employer cannot adopt a policy of comparable worth, for example, because the problem of lower pay for women is systemic, and consequently any substantial change must be on the level of the system. Systemic problems are best solved by some form of regulation or economic reform. On the systemic level, the relevant question is, “What do we as a society do?”
Use Table 1.1 to review these concepts.
Table 1.1 Levels of Decision Making in Business
Review the type of problem that should be resolved at each level of decision making and the relevant question for each. Then hide the cells in the table to quiz your understanding of these situations.
The Individual
The problem confronts an individual and requires that person to make a decision do? about his or her own response.
What do I
The Individual The problem
confronts an
individual and
What do I
requires that about his or
person to make her own response.
a decision
do?
The problem The
requires that
the individ-
What do we
Organization ual decision organization
maker act on to resolve the
behalf of the situation
as an organi- zation do?
and possibly zational
bring about change.
some organi-
The Business The problem
results from
accepted
What do we
System business the economic
practices or from system which
features of cannot be
as a society do?
effectively individual or
addressed by any organization.
single
Identification of the appropriate level for a decision is important because an ethical problem may have no solution on the level at which it is approached. The beer marketer described earlier may have little choice but to follow the competition in using tasteless gimmicks because the prob lem has no real solution on the individual or organizational level. An effective response requires that she place the prob lem on the systemic level and seek a solution appropriate to that level. Richard T. DeGeorge has described such a move as “ethical displacement,” which consists of addressing a problem on a level other than the one on which the problem appears.12 The fact that some problems can be solved only by displacing them to a higher level is a source of great dis tress for individuals in difficult situations because they still must find some less-than-perfect response on a lower level.
The Authority to Decide
An angry customer is speaking on the phone with a customer ser vice representative. The customer demands a full refund for the defective item she purchased online, although it is past the 30-day period allowed for returns. Describe a possible solution that could be offered at each level of decision making, and explain which level is required to resolve the problem to the customer’s satisfaction.
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1.2: Ethics, Economics, and Law
1.2 Recognize the role of ethics in the conduct of business, with respect to economic principles and the law
Businesses are economic organizations that operate within a framework of law and regulation. They are organized
primarily to provide goods and services, as well as jobs, and their success depends on operating efficiently and com petitively. In a capitalist system, firms operate in an open market by providing goods and services that customers want and by doing so at a low price. This is possible only when the desired goods and services are produced by mul tiple firms competing to attract customers. Thus, profit is not the end or purpose of business, as is commonly asserted, but is merely the return on the investment in a business that is possible only when the business is competitive. Business has often been described as a game, in which the aim is to make as much profit as possible while staying within the rules of the game, which are set mainly by government through laws and regulations.13 On the view of business as a game, profit is a measure and the reward of success, but it cannot be gained without also aiming to be competitive. Moreover, it is necessary, in pursuing profits, to observe cer tain ethical standards, as well as laws and regulation, as a means to the end of profit making.
Both economics and law are critical to business deci sion making, but the view that they are the only relevant considerations and that ethics does not apply is plainly false. Even hard-fought games like football have a code of sportsmanship in addition to a rule book, and business, too, is governed by more than the legal rules. In addition, a competitive business system, in which everyone pursues his or her self-interest, depends for its existence on ethical behavior and is itself justified on ethical grounds. How ever, the relationships of business ethics to economics and the law are very complicated and not easily summarized. The following discussion is intended to clarify these rela tionships.
1.2.1: Ethics and Economics
According to economic theory, firms in a free market uti lize scarce resources or factors of production (labor, raw materials, and capital) in order to produce an output (goods and services). The demand for this output is deter mined by the preferences of individual consumers who select from among the available goods and services so as to maximize the satisfaction of their preferences, which is called “utility.” Firms also seek to maximize their prefer ences or utility by increasing their output up to the point where the amount received from the sale of goods and ser vices equals the amount spent for labor, raw materials, and capital—that is, where marginal revenues equal marginal costs. Under fully competitive conditions, the result is eco nomic efficiency, which means the production of the maxi mum output for the least amount of input.
Economics thus provides an explanatory account of the choices of economic actors, whether they be individu als or firms. By this account, the sole reason for any choice is to maximize utility. However, ethics considers many
ther kinds of reasons, including rights and justice and
ther noneconomic values. To make a choice on the basis
f ethics—that is, to use ethical reasons in making a deci- sion—appears at first glance to be incompatible with eco- nomic choice. To make decisions on economic grounds and on ethical grounds is to employ two different kinds of reasoning. This apparent incompatibility dissolves on closer inspection. If the economists’ account of economic reasoning is intended to be merely an explanation, then it tells us how we do reason in making economic choices but not how we ought to reason. Economics as a science need do no more than offer explanations, but economists gen- erally hold that economic reasoning is also justified. That
economic actors ought to make utility-maximizing choices, which is an ethical, and not merely an economic, judgment.
The argument for this position, that economic actors ought to make util ity-maximizing choices, is the classical defense of the mar ket system. In The Wealth of Nations, Adam Smith, the “father” of modern economics, justified the pursuit of self interest in exchange on the grounds that by making trades for our own advantage, we promote the interests of others. The justification for a free-market capitalist system is, in part, that by pursuing profit, business firms promote the welfare of the whole society. Commentators on Adam Smith have observed that this argument assumes a well ordered civil society with a high level of honesty and trust and an abundance of other moral virtues. Smith’s argu ment would not apply well to a chaotic society marked by pervasive corruption and mistrust. Furthermore, in his defense of the free market in The Wealth of Nations, Smith was speaking about exchange, whereas economics also includes production and distribution.14 The distribution of goods, for example, is heavily influenced by different ini tial endowments, access to natural resources, and the vagaries of fortune, among other factors. Whether the vast disparities in wealth in the world are justified is a question of distribution, not exchange, and is not addressed by Smith’s argument. Moreover, certain conditions must be satisfied in order for business activity to benefit the society. These include the observance of minimal moral restraints to prevent theft, fraud, and the like. Markets must be fully competitive, with easy entry and exit, and everyone must possess all relevant information. In addition, all costs of production should be reflected in the prices that firms and consumers pay. For example, unintended conse quences of business activity, such as job-related accidents, injuries from defective products, and pollution, are costs of production that are often not covered or internalized by the manufacturer but passed to others as spillover effects or externalities. Many business ethics problems
JuStIfICAtION Of MARkEt SyStEM
arise when these conditions for the operation of a free market are not satisfied.
A common view is that ensuring the conditions for free markets and correct ing for their absence are jobs for government. It is govern ment’s role, in other words, to create the rules of the game that allow managers to make decisions solely on economic grounds. However, the task of maintaining the market place cannot be handled by government alone, and the fail ure of government to do its job may create an obligation for business to help. Although government does enact and enforce laws against theft and fraud, including such spe cialized forms as the theft of trade secrets and fraud in securities transactions, there are many gray areas in which self-regulation and restraint should be exercised in order to preserve a well-functioning marketplace.
An example of a gray area in law is the “hardball” tac tics employed by Toys “R” Us.15
CONDItIONS fOR fREE MARkEtS
Case: Toys “R” Us
Toys “R” Us employees allegedly bought inventory off the shelves of a competitor, Child World, during a promotion in which customers received $25 gift certificates for buying merchandise worth $100. The employees of Toys “R” Us were accused of selecting products that Child World sold close to cost, such as diapers, baby food, and infant for mula. These items could be resold by Toys “R” Us at a profit because the purchase price at Child World was barely above what a wholesaler would charge, and then Toys “R” Us could redeem the certificates for additional free merchandise, which could be resold at an even higher profit. Child World claimed that its competitor bought up to $1.5 million worth of merchandise in this undercover manner and received as much as $375,000 worth of gift certificates. Hardball tactics like those allegedly employed by Toys “R” Us are apparently legal, although Child World stated that the promotion excluded dealers, wholesalers, and retailers. Executives at Toys “R” Us did not deny the accu sation and contended that the practice is common in the industry. Child World may have left itself open to such a hardball tactic by slashing prices and offering the certifi cates in an effort to increase market share against its larger rival. Still, many companies would consider such deliberate sabotage of a competitor to be an unacceptable business practice that is incompatible with the market system— especially when it is their competitors who play hard ball.
Recent work in econom ics has revealed the influence of ethics on people’s eco nomic behavior. Economists have shown how a reputation for honesty and trustworthiness, for example, attracts cus tomers and potential business partners, thus creating eco nomic opportunities that would not be available otherwise. Similarly, people and firms with an unsavory reputation
fAIRNESS IN fREE MARkEtS
are punished in the market. People are also motivated in their market behavior by considerations of fairness. This is illustrated by the “ultimatum bargaining game,” in which two people are given a certain amount of money (say $10) on the condition that one person proposes how the money is to be divided (e.g., $5 to each) and the second person accepts or rejects the proposed division. The first person can make only one proposal, and if the proposal is rejected by the second person, the money is taken away and each person receives nothing. Economic theory suggests that the second person would accept any proposal, no matter how small the share, if the alternative is no money at all. Hence, the first person could offer to share as little as $1 or less. But many people who play the game will refuse a pro posal in which they receive a share that is considered too small and hence unfair.16 They would rather have nothing than be treated unfairly. Another example of the importance of fairness in busi ness is the action taken by Home Depot in response to a devastating hurricane.
Case: Home Depot
When weather forecasters predicted that Hurricane Andrew would strike the Miami area with full force, customers rushed to stock up on plywood and other building materials.17 That weekend the 19 Home Depot stores in southern Florida sold more 4-foot-by-8-foot sheets of exterior plywood than they usually sell in two weeks. On August 24, 1992, the hurricane struck, destroying or damaging more than 75,000 homes, and in the wake of the devastation, individual price gougers were able to sell basics like water and food as well as build ing materials at wildly inflated prices. But not Home Depot. The chain’s stores initially kept prices on plywood at pre-hur ricane levels, and when wholesale prices rose on average 28 percent, the company announced that it would sell plywood, roofing materials, and plastic sheeting at cost and take no profit on the sales. It did limit quantities, however, to prevent price gougers from reselling the goods at higher prices. In addition, Home Depot successfully negotiated with its sup pliers of plywood to roll back prices to pre-hurricane levels. Although prices increased early in anticipation of Hurricane Andrew, Home Depot was still able, with the cooperation of suppliers, to sell half-inch plywood sheets for $10.15 after the hurricane, compared with a price of $8.65 before, thereby limiting the increase to less than 18 percent. Home Depot executives explained their decision as an act of good ethics by not profiting from human misery. However, economists explain the behavior of companies like Home Depot and its suppliers by the fact that consid erations of fairness force firms to limit profit-seeking behav ior. Consumers remember price gouging and other practices that they consider unfair and will punish the wrongdoers by ceasing to do business with them or even by engaging in boycotts. One study found that people do
not believe that scarcity is an acceptable reason for raising prices (despite what economists teach about supply and demand),18 and so Home Depot and its suppliers, which are there for the long haul, have more to lose than gain by taking advantage of a natural disaster. Evidence also indi cates that people in a natural disaster feel that everyone ought to make some sacrifice, so that profit seeking by a few is perceived as shirking a fair share of the burden.19 Although Home Depot’s actions can be lauded as a dis play of good ethics, the company also made a shrewd business decision.
Finally, when economics is used in practice to support matters of public policy, it must be guided by noneco nomic values. Economic analysis can be applied to the market for cocaine as easily as to the soybean market, but it cannot tell us whether we should allow both markets. That is a decision for public policy makers on the basis of other considerations. A tax system, for example, depends on sound economic analysis, but the U.S. tax code attempts to achieve many aims simultaneously and to be accepted as fair. In drafting a new tax code, a demonstration that a particular system is the most efficient from a purely eco nomic perspective would not necessarily be persuasive to a legislator who may also be concerned about considera tions of fairness.
Toys “R” Us and Home Depot
Consider the actions of Toys “R” Us and Home Depot and contrast their demonstrated views of what is “fair” in business. How might the considerations of fairness in either case contribute to a well functioning marketplace?
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1.2.2: Ethics and Law
Business activity takes place within an extensive framework of law, and some people hold that law is the only set of rules that applies to business activity. Law, not ethics, these peo ple believe, is the only relevant guide. The reasons that lead people to hold this view are varied, but two predominate.20
tWO SChOOlS Of thOught
One school of thought is that law and ethics govern two different realms. Law pre
vails in public life, whereas ethics is a private matter. The law is a clearly defined set of enforceable rules that applies to everyone, whereas ethics is a matter of personal opinion that reflects how we choose to lead our own lives. Conse quently, it would be a mistake to apply ethical rules in busi ness, just as it would be a mistake to apply the rules of poker to tennis. A variant of this position is that the law represents
a minimal level of expected conduct that everyone should observe. Ethics, on the other hand, is a higher, optional level. It is “nice” to be ethical, but our conduct has to be legal. Both versions of this school of thought are mistaken. Although ethics does guide us in our private lives, it is also applicable to matters in the public realm. We can identify business practices as ethical or unethical, as, for example, when we say that discrimination or consumer fraud is wrong. Moral judgments are also made about economic systems. Thus, most people believe that capitalism is morally justified, although it has many critics who raise moral objections.
the other school of thought is that the law embodies the ethics of business. There are ethical rules that apply to business, according to this position, and they have been enacted by legislators into laws, which are enforceable by judges in a court. As a form of social control, law has many advantages over ethics. Law provides more precise and detailed rules than ethics, and the courts not only enforce these rules with state power but also are available to inter pret them when the wording is unclear. A common set of rules known to all also provides a level playing field. Imag ine the chaos if competing teams each decided for them selves what the rules of a game ought to be. For these reasons, some people hold that it is morally sufficient in business merely to observe the law. Their motto is, “If it’s legal, then it’s morally okay.”21 In countries with well-developed legal systems, the law is a relatively complete guide for business conduct. In the United States, much of what is unethical is also illegal. However, many other countries of the world have unde veloped legal systems so that ethics, not law, provides the main source of guidance. The relative lack of international law leaves ethics as an important guide for global business. Moreover, no legal system can embrace the whole of moral ity. Ethics is needed not only to address situations not cov ered by law but also to guide the creation of new law. The 1964 Civil Rights Act, for example, was passed by Congress in response to the recognition that discrimination, which was legally practiced at the time, is morally wrong.
Despite their differences, these two schools of thought have the same practical impli cation: Managers need to consider only the law in making decisions. This implication is not only false but also highly dangerous. Regardless of the view that a practicing man ager takes on the relationship of law and ethics, reliance on the law alone is a prescription for disaster, as many indi viduals and firms have discovered. Approval from a com pany’s legal department does not always assure a successful legal resolution, and companies have prevailed in court only to suffer adverse consequences in the marketplace. As a practical matter, then, managers need to consider both the ethical and legal aspects of a situation in making a decision for many reasons, including the following.
Why lAW IS NOt ENOugh
first, the law is inappropriate for regulating certain aspects of business activity. Not everything that is
immoral is illegal. Some ethical issues in business concern interpersonal relations at work or relations between com petitors, which would be difficult to regulate by law. Tak ing credit for someone else’s work, making unreasonable demands on subordinates, and unjustly reprimanding an employee are all ethically objectionable practices, but they are best left outside the law. Some hardball tactics against competitors may also be legal but ethically objectionable. Whether the effort of Toys “R” Us to sabotage a promotion by its competitor is acceptable behavior (as discussed in the “Conditions for Free Markets” section) is open to dis pute, but not every legal competitive maneuver is ethical. Generally, legislatures and the courts are reluctant to inter vene in ordinary business decisions unless significant rights or interests are at stake. They rightly feel that outsid ers should not second-guess the business judgment of peo ple closer to a problem and impose broad rules for problems that require a more flexible approach. Compa nies also prefer to handle many problems without outside interference. Still, just because it is not illegal to do certain things does not mean that they are morally okay.
Second, the law is often slow to develop in new areas
of concern. Christopher D. Stone points out that the law is primarily reactive, responding to problems that people in the business world can anticipate and deal with long before they come to public attention.22 The legislative and judicial processes themselves take a long time, and meanwhile much damage can be done. This is true not only for newly emergent problems but also for long-recognized problems where the law has lagged behind public awareness. For example, sexual harassment was not recognized as a legal wrong by the courts until 1977, and it took successive court decisions over two more decades for the legal prohibition on sexual harassment to fully develop. At the present time, legal protections for employees who blow the whistle and those who are unjustly dismissed are just beginning to develop. Employers should not wait until they are forced by law to act on such matters of growing concern.
third, the law itself often employs moral concepts that are not precisely defined. As a result, it is impossible in some instances to understand the law without consider ing matters of morality. The requirement of good faith, for example, is ubiquitous in law. The National Labor Rela tions Act requires employers and the representatives of employees to bargain “in good faith.” One defense against a charge of price discrimination is that a lower price was offered in a good-faith attempt to meet the price of a com petitor. Yet the notion of good faith is not precisely defined in either instance. Abiding by the law, therefore, requires decision makers to have an understanding of this key moral concept. Other imprecisely defined legal concepts are “fair dealing,” “best effort,” and “due care.”
A fourth argument, closely related to the preceding one, is that the law itself is often unsettled, so that whether some course of action is legal must be decided by the
courts. And in making a decision, the courts are often guided by moral considerations. Many people have thought that their actions, although perhaps immoral, were still legal, only to discover otherwise. The courts often refuse to interpret the law literally when doing so gives legal sanc tion to blatant immorality. Judges have some leeway or dis cretion in making decisions. In exercising this discretion, judges are not necessarily substituting morality for law but rather expressing a morality that is embodied in the law. Where there is doubt about what the law is, morality is a good predictor of how the courts will decide.
fifth, a pragmatic argument is that the law is a rather inefficient instrument, and an exclusive reliance on law alone invites legislation and litigation where they are not
necessary. Many landmark enactments, such as the Civil Rights Act of 1964, the National Environment Policy Act of 1969, the Occupational Safety and Health Act of 1970, and the Consumer Protection Act of 1972, were passed by Congress in response to public outrage over the well documented failure of American businesses to act responsi bly. Although business leaders lament the explosion of product liability suits by consumers injured by defective products, for example, consumers are left with little choice but to use the legal system when manufacturers themselves hide behind “If it’s legal, it’s morally okay.” Adopting this motto, then, is often shortsighted, and businesses may often advance their self-interest more effectively by engaging in greater self-regulation that observes ethical standards. Use Table 1.2 to review these points and consider their implications for business decisions.
Table 1.2 Acting Ethically and Legally
Why should managers consider the ethical—and not merely the legal—aspects of a situation when making decisions? Review the arguments in favor of considering both ethics and law in business and the corresponding implication of each argument. Then hide the cells to quiz yourself.
T he law cannot regulate all aspects of business activity.
T he law is often slow to develop in new areas of concern.
T he law often employs moral concepts that are not pre- cisely defined.
Not everything that is legal is moral. Not everything that is immoral is illegal.
5. A n exclusive reliance on law alone and failure to act responsibly can result in legis lation and litigation.
Self-regulation and observing ethical standards can prevent unnecessary lawsuits and new laws that may inter fere with business.
1.3: Ethics and Management
1.3 Distinguish between ethical management and the management of ethics, and each of the three main roles of a manager
Most managers think of themselves as ethical persons, but some still question whether ethics is relevant to their role as a manager. It is important for people in business to be ethical, they might say, but being ethical in business is no different than being ethical in private life. The implication is that a manager need only be an ethical person. There is no need, in other words, to have specialized knowledge or skills in ethics.
Nothing could be further from the truth. Although there is no separate ethics of business, situations arise in business that are not easily addressed by ordinary ethical rules. We have already observed that the obligation to tell the truth is difficult to apply to the dilemma faced by the sales rep. In addition, the manager of a sales force might face the task of determining the rules of acceptable sales practices for the whole organization and ensuring that the rules are followed. More broadly, high-level managers have a responsibility for creating and maintaining an ethi cal corporate climate that protects the organization against unethical and illegal conduct by its members. Furthermore, a well-defined value system serves to guide organizations in uncertain situations and to gain acceptance of painful but necessary change.
1.3.1: Ethical Management and Management of Ethics
A useful distinction can be made between ethical manage ment and the management of ethics. Business ethics is often conceived as acting ethically as a manager by doing the right thing. This is ethical management. Acting ethically is important for both individual success and organizational effectiveness. Ethical misconduct has ended more than a few promising careers, and some business firms have been severely harmed and even destroyed by the actions of a few individuals. Major scandals in the news attract our atten tion, but people in business face less momentous ethical dilemmas in the ordinary course of their work. These dilem mas sometimes result from misconduct by others, as when a subordinate is ordered to commit an unethical or illegal act, but they are also inherent in typical business situations.
The management of ethics is acting effectively in situa tions that have an ethical aspect. These situations occur in both the internal and external environments of a business firm. Internally, organizations bind members together through myriad rules, procedures, policies, and values that must be carefully managed. Some of these, such as a policy
on conflict of interest or the values expressed by a compa ny’s mission statement, explicitly involve ethics. Effective organizational functioning also depends on gaining the acceptance of the rules, policies, and other guides, and this acceptance requires a perception of fairness and commit ment. For example, an organization that does not “walk the talk” when it professes to value diversity is unlikely to gain the full cooperation of its employees. With respect to the external environment, corporations must successfully manage the demands for ethical conduct from groups con cerned with racial justice, human rights, the environment, and other matters. In order to practice both ethical management and the management of ethics, it is necessary for managers to pos sess some specialized knowledge. Many ethical issues have a factual background that must be understood. In dealing with a whistle-blower or developing a whistle-blowing policy, for example, the managers of a company should be aware of the motivation of whistle-blowers, the measures that other companies have found effective, and, not least, the relevant law. In addition, many ethical issues involve competing theoretical perspectives that need to be under stood by a manager. Whether it is ethical to use confiden tial information about a competitor or personal information about an employee depends on theories about intellectual property rights and the right to privacy that are debated by philosophers and legal theorists. Although a manager need not be equipped to participate in these debates, some familiarity with the theoretical considerations is helpful in dealing with practical situations. To make sound ethical decisions and to implement them in a corporate environment are skills that come with experience and training. Some managers make mistakes because they fail to see the ethical dimensions of a situa tion. Other managers are unable to give proper weight to competing ethical factors or to see other people’s perspec tives. Thus, a manager may settle a controversial question to his or her satisfaction, only to discover that others still disagree. Moral imagination is often needed to arrive at creative solutions to problems. Finally, the resolution of a problem usually involves persuading others of the right ness of a position, and so the ability to explain one’s rea soning is a valuable skill. The need for specialized knowledge and skills is espe cially acute when business is conducted abroad.23 In global business, there is a lack of consensus on acceptable standards of conduct, and practices that work well at home may fare badly elsewhere. This is especially true in less developed countries with lower standards and weak insti tutions. How should a manager proceed, for example, in a country with exploitive labor conditions, lax environmen tal regulations, and pervasive corruption? Even the most ethical manager must rethink his or her beliefs about how business ought to be conducted in other parts of the world.
1.3.2: Ethics and the Manager’s Role
Every person in business occupies a role. A role is a struc tured set of relationships with accompanying rights and obligations. Thus, to be a purchasing agent or a personnel director or an internal auditor is to occupy a role. In occu pying a role, a person assumes certain rights that are not held by everyone as well as certain role-specific obliga tions. Thus, a purchasing agent is empowered to make purchases on behalf of an organization and has a responsi bility to make purchasing decisions that are best for the organization. To be a “good” purchasing agent is to do the job of a purchasing agent well.
The obligations of a particular role are sometimes added to those of ordinary morality. That is, a person who occupies a role generally assumes obligations over and above those of everyday life. Sometimes, however, role obligations come into conflict with our other obligations. In selecting people for promotion, a personnel director, for example, is obligated to set aside any considerations of friendship and to be wholly impartial. A person in this position may also be forced to terminate an employee for the good of the organization, without regard for the impact on the employee’s life. A personnel director may even be required to implement a decision that he or she believes to be morally wrong, such as terminating an employee for inadequate cause. In such situations, the obligations of a role appear to be in conflict with the obligations of ordi nary morality.
Various justifications have been offered for role obliga tions. One justification is simply that people in certain positions have responsibilities to many different groups and hence must consider a wide range of interests. The decisions of a personnel director have an impact on every one connected with a business organization, and so deny ing a promotion to a friend or terminating an employee may be the right thing to do, all things considered. A more sophisticated justification is that roles are created in order to serve society better as a whole. A well-designed system of roles, with accompanying rights and obligations, ena bles a society to achieve more and thereby benefits every one. A system of roles thus constitutes a kind of division of labor. As in Adam Smith’s pin factory, in which workers who perform specific operations can be more productive than individuals working alone, so, too, a business organi zation with a multiplicity of roles can be more productive and better serve society.
We cannot understand the role obligations of manag ers without knowing more about their specific role. Man agers serve at all levels of an organization—top, middle, and lower—and fulfill a variety of roles. Usually, these are defined by a job description, such as the role of a purchas ing agent or a personnel director. Uncertainty arises mainly
when we ask about the role of top managers, that is, high-level corporate executives who make key decisions about policy and strategy. The higher one goes in a business organiza tion, the more roles one occupies. Many of the ethical dilemmas for top managers are due to conflicts between three main roles.
1. Managers as Economic Actors.
Figure 1.1
One inescapable requirement of the manager’s role is to make sound economic or business de cisions that enable a firm to succeed in a com petitive market. As economic actors, managers are expected to consider primarily economic factors in making decisions, and the main meas ure of success is profitability. This is the goal of managers who serve as economic actors even if they oper ate a sole proprietorship, a partnership, or any other kind of business enterprise. However, as previously noted, ethical issues are intertwined with business considerations in deci sion making, and the soundness of business decisions often depends on the recognition of these ethical issues and their appropriate resolution.
2. Managers as Company Leaders.
Roles of a Manager
Economic Actors
Every manager is expected to base decisions primarily on economic factors so the
organization can be competitive and profitable. This requires the ability to solve ethical problems that arise in the course of
everyday business.
As leaders of business organizations, managers are en trusted with enormous assets and given a charge to manage these assets prudently. Employees, suppliers, customers, in vestors, and other so-called stakeholders have a stake in the success of a firm, and managers are expected to meet all of their legitimate expectations and to balance any conflicting interests. Corporations are also human communities in which individuals find not only the means to support themselves but also personal satisfaction and meaning. Top managers, in particular, serve these roles by building and maintaining a company’s culture, developing a shared purpose and stra tegic vision, and, most importantly, meeting challenges and creating a strong, enduring organization.
3. Managers as Community Leaders.
Top managers of companies exert enormous power both in side and outside their organizations. Although they are not elected in a democratic process, they nevertheless have many attributes of government officials, such as the power to make decisions that profoundly impact society. The CEO or chairman of a large corporation also serves as an ambas sador, representing the company in its relations with its myr iad constituencies. In any political system, such great power must be legitimized by showing how it serves some generally accepted societal goals, and managerial power is no excep tion. So, top managers are expected to demonstrate corpo rate leadership that serves the interests of society as a whole.
Use Figure 1.1 to review the multiple roles a manager may hold in an organization.
Many of the ethical dilemmas facing managers involve not merely a conflict between one’s personal morality and the morality of a role but also a conflict between the moral demands of different roles. For example, a manager may have to balance fairness to employees or a benefit to the community against an obligation to act in the best interest of the company. Or a CEO may find that he or she cannot easily serve both as a company leader and as a community leader when a decision must be made about a merger that would close a local plant. Some of the hardest dilemmas in business ethics result from such role conflicts.
Ethical Standards for Different Managers
Explain the ethical responsibility of a CEO of a large multinational corporation and that of a proprietor of a small business. What differ ences, if any, in ethical standards do these leaders face?
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1.4: Ethics in Organizations
1.4 Analyze how ethical business conduct is
challenged by decision making on individual and organizational levels
The manager who seeks to act ethically and to ensure the ethical conduct of others—to achieve “ethical manage ment” and “the management of ethics,” respectively— must have the ability not only to understand ethical issues and resolve them effectively, but also to appreciate the challenges of ethical decision making and ethical conduct in an organizational setting. The fact that much business
activity takes place in organizations has profound conse quences for the manager’s role responsibilities for several reasons.
• First, much decision making in business is a collabora tive endeavor in which each individual may play only a small role. Many organizational decisions get made without any one person coming to a decision or being responsible for it. • Second, this collaborative decision-making process is subject to dynamic forces that may not be recognized or understood by any of the participants. As a result, decisions get made that have consequences no one intended or expected. • Third, many organizational acts are not the result of any one person’s actions but are collective actions that result from a multiplicity of individual actions. Many corporate acts are thus “deeds without doers.”24 • Fourth, organizations themselves create an environ ment that may lead otherwise ethical people to engage in unethical conduct. Organizational life, according to sociologist Robert Jackall, poses a series of “moral mazes” that people must navigate at their own peril.25 Consequently, the typical case of wrongdoing in organizations involves missteps that are due more to inadequate thought than to deliberate malice, where people get “lost” in a moral maze. The following two sections discuss the findings, mainly of psychologists and sociologists, about how ethi cal mistakes result from flaws in individual decision mak ing and from organizational forces. 1.4.1: Individual Decision Making Wrongdoing is often attributed to the proverbial “bad apple,” the individual who knows that an action is wrong but deliberately does it anyway. Such persons can be con demned for having a bad character, and the lesson for oth ers is to develop a good character. This common misunderstanding is misleading both as an analysis of the causes of bad conduct and as a prescription for ensuring good conduct. Of course, there are bad apples, and they should not be hired or, if hired, should be let go once their rottenness is known. This “bad apples” explanation is not very convincing, however, when wrongdoing is commit ted by people we would identify as good employees or managers. Moreover, when misconduct is widespread in an organization, as is often the case in major scandals, it is not plausible to believe that dozens if not hundreds of peo ple are all “bad apples.” Some other explanations are needed, and fortunately psychologists and sociologists have offered many. first, many individuals work in environments in which they lack strong guidance and receive conflicting
signals.26 Often there is strong pressure to follow orders and get the job done. Barbara Toffler, who wrote a book about the last days of Arthur Andersen, relates the tale of an under graduate who interned at a major accounting firm where he was ordered to make an accounting entry that appeared to be irregular. When he told his superior, “This doesn’t look right to me. Why am I doing it?” the reply was, “You’re doing it because I told you to do it.”27 Employees who are told “Just do it!” without more explicit instructions and without ade quate resources may perceive these words as an implicit order to do whatever it takes to get a job done. Employees are also urged to be “team players” and go along with what ever is being done. Senior managers, in giving orders, often prefer not to give detailed guidance, in part to avoid opera tional responsibility (“Just do it, and don’t tell me how you got it done”). They also sometimes lack an appreciation of the operational difficulties of a job and thus leave to subordi nates the task of solving problems their own ways.
Second, individuals are prone to rationalization and can often effectively persuade themselves that a course of action is morally right or, at least, is not wrong under the circumstances. Saul Gellerman, in the article “Why ‘Good’
Managers Make Bad Ethical Choices,” identifies four dan gerous rationalizations.28
A belief that the activity is within reasonable ethical and legal limits—that is, that it is not “really” illegal or immoral.
A belief that the activity is in the individual’s or the corporation’s best interest—that the individual would somehow be expected to undertake the activity.
A belief that the activity is “safe” because it will never be found out or publicized; the classic crime-and-pun- ishment issue of discovery.
A belief that because the activity helps the company, the company will condone it and even protect the per- son who engages in it.
What are some other rationalizations?
Examples
A particularly common rationalization in business is “every body’s doing it.” This retort may even justify some actions when refraining would put a company at a competitive disad vantage (when competitors engage in deceptive advertising, for example) or when business cannot be conducted without so acting (e.g., engaging in foreign bribery).29 Other rationali zations include:
“No real harm is done” or “No harm no foul”
“I deserve this” or “They owe this to me” (sometimes used to justify pilfering)
“It’s for a good cause” (the ends justify the means)
“If I don’t do this, someone else will” (restraint is futile; the consequences will happen anyway)
Sociologists who have studied crime, including the kind of white-collar crime that occurs in business, have described a process of rationalization they call “neutraliza tion” that enables lawbreakers to deny the criminality of their behavior.30 Among the techniques of neutralization are the following claims:
one is not really responsible (“I was out of my mind”)
no real harm was done (“No one will miss that amount of money”)
the victim deserved the harm (“I was only paying him back”)
one’s accusers are being unfair (“I’m being singled out for blame”)
one was following some higher duty or loyalty (“I had to protect my friends”) All the rationalizations detailed here show the immense
capacity of people to engage in self-deception.
third, psychologists have identified a number of fea tures of human decision making that produce errors of
• In the anchoring and adjustment heuristic, people tend to form an initial choice (“anchor”) early in the decision making process and then adjust the choice in response to additional information (“adjustment”). Thus, the final decision is heavily influenced by the initial choice, espe cially given that people often fail to make adequate adjustments.
judgment.31 Two of these researchers contend that “unethi cal business practices may stem not from the traditionally assumed trade-off between ethics and profits or from a cal lous disregard of other people’s interest or welfare, but from psychological tendencies that foster poor decision making, Making both from an ethical and a rational perspective.”32 Some of
these “psychological tendencies” are biases that shift our decisions in one direction or another, while others are heuris tics or rule-of-thumb methods that we employ in reasoning.
What are some examples? Examples
Among the biases and heuristics discovered by psycholo gists are the following:
People weigh losses more heavily than gains and thus take greater risks to avoid losing something they have than to gain something that they do not have (loss aver- sion bias).
People pay more attention to information that confirms existing attitudes and beliefs instead of focusing on information that poses challenges to their attitudes and beliefs (confirmation bias).
People tend to persist in a course of action already underway, even in the face of information that should lead them to reconsider their initial decision (commit- ment or sunk cost bias).
People are often overconfident about their own pros- pects for success and about the predictability and the controllability of outcomes, and they make poor judg- ments about risk, overestimating some risks and dis- counting others, often ignoring low-probability events and favoring certain over uncertain outcomes.
Psychologists have also noted that biases and heuris tics prevent us from foreseeing disasters that we should have seen coming33 and lead us to overlook the unethical conduct of others.34 Instances of defective products, accounting fraud, and industrial accidents have been closely studied to reveal the psychological factors that explain how such bad decisions could have been made by decent, diligent, and competent individuals.
These biases and heuristics were developed long ago in the process of evolution to enable human beings to decide and act quickly, especially in dangerous situations with too much information to process fully. Generally, they have served the human race well in pre-historic times but can lead to mistakes in the modern world. Some of the blame for faulty decision making belongs to evolution.
1.4.2: Organizational Decision
When a company produces a defective product (for exam ple, Merck’s Vioxx or Toyota’s accelerator mechanism) or collapses from massive accounting fraud (as did Enron and WorldCom) or experiences a major industrial accident (such as the Bhopal disaster), the fault generally lies with a series of decisions that can be understood only by examin ing organizational factors. With the benefit of hindsight, some mistaken decisions can often be found, but some times all of the decisions involved seemed reasonable at the time. In such cases, the causes of major scandals and disasters must be sought in the decision-making processes.
Decision making in organizations is marked by four features that contribute to mistakes, big and small. • First, major decisions are not made all at once with all
their consequences and ramifications understood; rather, they are made over time in a series of small steps, no one of which may raise any particular concerns. • Second, as they are made over time, these multiple decisions develop a commitment to a course of action that is usually difficult to stop.
Once a project is underway, there may be considerable sunk costs that cannot be recovered, and anyone who pro poses a halt to a project bears a burden of proof to justify it, whereas little justification is needed to proceed with a pro ject underway. Stopping a project also means that mistakes were made, which it may be difficult for managers to admit since someone must bear the blame. With commitment to a
course of action also comes a psychological tendency to interpret evidence in ways that support one’s beliefs and interests. This factor probably goes far toward explaining why, in the development of Vioxx, Merck executives misin terpreted the results of the VIGOR study and concluded that they were due to the heart-protection benefit of nap roxen and not to any harmful effect from Vioxx. The third and fourth factors are the most important: namely,
the diffusion of information and
the fragmentation of responsibility that occurs in
rganizational decision making.35 The information that would show that a product has a
defect, for example, may exist within an organization in an unassembled form in which different facts are known to different individuals. However, unless this information is assembled and made known to at least one person, there may be no reason for anyone in the organization to con- clude that a product is defective. Furthermore, when infor- mation is distributed in organizations on a need-to-know basis, each decision maker may have sufficient information for the decisions that that person makes but lack the neces- sary information for recognizing a defect.
With diffusion of information comes fragmentation of
responsibility. Each decision in a series may be made by different individuals or groups, all of whom are discharg- ing their specific responsibility and doing so well, based on
the information available to them. Thus, a researcher test ing a drug for its efficacy in treating a certain condition may assume that other researchers have already proven its safety, so safety is not that researcher’s responsibility. And the salespeople who pitch the drug to doctors assume that the researchers have done their job to test its safety and efficacy; that is not their responsibility. In the end, when a drug is recalled, it may be that no one is responsible since no one has failed in discharging his or her responsibility. It is often said that “the buck stops at the top,” that the CEO or some other senior executive has a responsibility to ensure, in this example, that a drug is safe, but that person is hostage to a host of decisions made by others that he or she cannot fully assess. In such cases, only the organization as a whole can be blamed or held responsible, and the only remedy to prevent a recurrence is to improve the decision making process within the organization.
Organizational Decisions
Describe an instance when a group of which you were a member made a mistake or poor decision. List which factor(s) of organiza tional decision making contributed to this mistake.
The response entered here will appear in the performance dashboard and can be viewed by your instructor.
Conclusion: Ethics in the World of Business
Business ethics, as presented in this course, is concerned with identifying and understanding the ethical issues that arise in business and with developing the knowledge and skills needed by a practicing manager to address these issues and to make sound business decisions—that is, deci sions that are sound from both an ethical and a business perspective. Ethical issues are an inevitable element of business decision making and are deeply intertwined with managerial practice and economic activity generally. In fact, the success of individual managers, business organi zations, and, indeed, the whole economic system depends upon ethical decisions and practices. Both economics and law are important guides for busi ness decision making, but, as this chapter has shown, they are not complete. Nor can business ethics be understood merely as the treatment of ethical issues from a philosophi cal perspective. As the work of psychologists and sociolo gists on organizational misconduct shows, it is not enough merely to determine a right course of action. Misconduct in
rganizations is also the result of flaws in individual and
rganizational decision making that can be corrected only by changes in decision-making processes. Although this course deals mainly with the treatment of ethical issues in business, practicing managers must also address the larger challenge of preventing misconduct within organizations.
End-of-Chapter Case Studies
This chapter concludes with four case studies.
Unethical decisions can end promising business careers with alarming speed and finality. Each of the following four case studies involves a seemingly “good” person who makes a bad business decision without giving the situation adequate ethical consideration. In “A Sticky Situation,” a young sales representa tive makes a series of seemingly inconsequential half-true state ments that lead him, in the end, to seriously mislead an important
client. In the other three cases, top executives (a president and two CEOs) lose their jobs for serious lapses of ethical judgment in covering up the adulteration and misbranding of a product (Beech-Nut Apple Juice), violating government bidding require ments (Bath Iron Works), and falsifying a résumé (Yahoo).
Case: A Sticky Situation
Kent Graham is still on the telephone, receiving the good news that he has just secured his largest order as an account manager for Dura-Stick Label Products.36 His joy is tinged with uncertainty, however. Dura-Stick is a leader in label converting for the dura ble-products marketplace. Label converting consists of converting log rolls of various substrates (paper, polyester, vinyl) into die-cut, printed labels. The company specializes in high-performance labels for the automotive, lawn and garden, and appliance industries. Dura-Stick has a well deserved reputation for quality, technical knowledge, and service that enables the company to command a premium price for its products in a very competitive market. Kent Graham has been with Dura-Stick for two years. Because he came to the company with 10 years of experience in the label industry, he was able to negotiate a very good salary and compensation plan, but his accomplishments since joining Dura-Stick have been mediocre at best. Kent fears that his time with Dura-Stick might be limited unless he starts closing some big accounts. Furthermore, with a wife and two children to support, losing his job would be disastrous. Kent was on a mission to land a big account. Kent called on Jack Olson at Spray-On Inc., a manufac turer of industrial spraying systems for the automotive painting industry. Dura-Stick has been providing Spray On with various warning and instructional labels for about 20 years. Jack has been very pleased with Dura-Stick’s per formance, especially the quality of its manufacturing department under the direction of Tim Davis. After giving Kent another excellent vendor evaluation report, Jack began to describe a new project at Spray-On, a paint sprayer for household consumer use that needs a seven-color label with very precise graphics. This label is different from the industrial two-color labels that Dura-Stick currently sup plies to Spray-On. Jack explained that this was the biggest project that Spray-On has undertaken in recent years and that it would generate a very large order for some label company. Jack then asked Kent, “Does Dura-Stick produce these multi color, consumer-type labels?” Kent thought for a moment. He knew that a “yes” would give him a better shot at the business, and Dura-Stick might be able to handle the job, even though the company’s experience to date was only with two-color labels. Almost without thinking, he replied, “Sure we can handle it, Jack, that’s right up our alley!”
“That’s great news,” Jack shot back. “Now take this sample and give me your proposal by Monday. Oh, and by the way, I hope your proposal looks good, because I would really feel confident if this important project were in the hands of your production people!”
Kent gave the sample to Marty Klein, who is responsi ble for coordinating the costs and price quotes for new opportunities. Marty took one look at the sample and said emphatically, “We’ll have to farm this one out.” Kent’s heart sank down to his shoes. He knew that Jack would want to work with Dura-Stick only if the labels were pro duced at Dura-Stick’s facility. Yet, he still allowed Marty to put the numbers together for the proposal. Kent presented the proposal to Jack at Spray-On. “Gee, Kent, these prices are pretty high, about 20 percent higher than your competi tion. That’s pretty hard to swallow.”
Kent knew that the price would be high because it included the cost of another company producing the labels plus Dura-Stick’s usual profit margin, but he countered cheerily, “You know the quality that we provide and how important this project is to your company. Isn’t it worth the extra 20 percent for the peace of mind that you will have?” “Let me think about it,” Jack replied. The next day, Kent got a phone call from Jack. “Congratulations, Kent, Dura-Stick has been awarded the business. It was a tough sell to my people, but I con vinced them that the extra money would be well spent because of the excellent production department that you have. If it wasn’t for the fact that Tim Davis will personally oversee production, you guys probably would not have gotten this business.”
Kent had to bite his tongue. He knew that Tim would not be involved because the labels would be produced in Kansas City by Labeltec, which would then send the finished labels to Dura-Stick for shipment to Spray-On’s facility. Kent also knew that Jack would be completely satisfied with the quality of the labels. Besides, this order was crucial to his job security, not to mention the well-being of his company.
While Jack continued to explain Spray-On’s decision, Kent pondered how he should close this conversation.
ShaRed WRITING: a STIcky SITuaTION
Decide if Kent’s statements were within accepted business prac tice. Was Kent telling the truth or lying to his client? Review and comment on at least two classmates’ responses, including one that opposes your own.
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Case: Beech-Nut’s Bogus Apple Juice
When Lars Hoyvald joined Beech-Nut in 1981 as a newly arrived president, the company was in financial trouble.37
In the competitive baby food industry, the company was a distant second behind Gerber, with 15 percent of the mar ket. After faltering under a succession of owners, Beech-Nut was bought in 1979 by Nestlé, the Swiss food giant, which hoped to restore the luster of the brand name. Although he was new to Beech-Nut, Hoyvald had wide experience in the food industry, and his aim, as stated on his résumé, was “aggressively marketing top quality products.” In June 1982, Hoyvald was faced with strong evidence that Beech-Nut apple juice for babies was made from con centrate that included no apples. Since 1977, the company had been purchasing low-cost apple concentrate from a Bronx-based supplier, Universal Juice Company. The price alone should have raised questions, and John Lavery, the vice president in charge of operations, brushed aside tests that showed the presence of corn syrup. Two employees who investigated Universal’s “blending facility” found merely a warehouse. Their report was also dismissed by Lavery. A turning point occurred when a private investiga tor working for the Processed Apple Institute discovered that the Universal plant was producing only sugared water. After following a truck to the Beech-Nut facility, the inves tigator informed Lavery and other executives of his find ings and invited Beech-Nut to join a suit against Universal. Although some executives urged Hoyvald to switch suppliers and recall all apple juice on the market, the presi dent was hesitant. Even if the juice was bogus, there was no evidence that it was harmful. It tasted like apple juice, and it surely provided some nutrition. Besides, he had prom ised his Nestlé superior that he would return a profit of $7 million for the year. Switching suppliers would mean pay ing about $750,000 more each year for juice and admitting that the company had sold an adulterated product. A recall would cost about $3.5 million. Asked later why he had not acted more decisively, Hoyvald said, “I could have called up Switzerland and told them I had just closed the com pany down. Because that is what would have been the result of it.” Fearful that state and federal investigators might seize stocks of Beech-Nut apple juice, Hoyvald launched an aggressive foreign sales campaign. On September 1, the company unloaded thousands of cases on its distributors in Puerto Rico. Another 23,000 cases were shipped to the Dominican Republic to be sold at half price. By the time that state and federal authorities had forced a recall, the plan was largely complete. In November, Hoyvald reported to his superior at Nestlé, “The recall has now been com pleted, and due to our many delays, we were only faced
with having to destroy approximately 20,000 cases.” Beech Nut continued to sell bogus apple juice until March 1983.
ShaRed WRITING: Beech-NuT’S BOGuS aPPle JuIce
Suppose you were a Beech-Nut customer. Would you feel wronged by the misbranded product? The lack of a recall? The dumping overseas? Explain your response. Review and comment on at least two classmates’ responses, including one that opposes your own.
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Case: Ethical Uncertainty at Bath Iron Works
On May 17, 1991, a quick decision by CEO William E. Hag gett almost destroyed Bath Iron Works (BIW), the largest private employer in Maine.38 Founded in 1884, BIW is a major shipbuilder for the U.S. Navy with 10,400 employ ees. As one of two companies with the capability to build Aegis naval destroyers worth $250 million each, BIW was competing fiercely for contracts with its rival, Ingalls Ship building in Mississippi. At 5:30 that morning, a janitor found a 67-page document stamped “Business Sensitive” in a conference room that had been used the previous day for a meeting with navy officials. Two vice presidents who examined the document realized that it contained a detailed comparison of BIW’s and Ingalls’s costs for building the Aegis destroyer. They delivered the document to Mr. Hag gett at 9:00 a.m. The CEO, who was leaving the office to deliver a luncheon speech, examined it for 15 minutes before making a decision. He ordered the two vice presi dents to copy the document, return the original to the con ference room, and meet with him late in the afternoon to discuss how they should handle the situation.
During the next few hours, the two executives ana lyzed the information and did some computer modeling based on it. At 2:15 they decided to notify the president of BIW, Duane D. “Buzz” Fitzgerald, who had a reputation for impeccable integrity. Mr. Fitzgerald immediately recog nized that the federal Procurement Integrity Act requires defense contractors to certify that they have not been in unauthorized possession of any proprietary information. In addition, BIW is a signatory to the Defense Industry Ini tiative on Business Ethics and Conduct (DII), which was formed in 1986 in response to revelations by the Packard Commission of irregularities in defense industry contract ing. The six principles of the DII require not only that
signatories adopt a written code of ethics, engage in ethics training, and provide mechanisms for internal reporting of
possible misconduct, but also that they take responsibility Yahoo for any violation of law. Principle 4 states, “Each company
has the obligation to self-govern by monitoring compliance with federal procurement laws and adopting procedures for voluntary disclosure of violations of federal procure ment laws and corrective actions taken.” Mr. Fitzgerald ordered that all copies be shredded and all data erased from the computer. Upon his return, Mr. Haggett agreed with the action taken and admitted that he had made an “inappropriate business-ethics decision.” The CEO person ally delivered the original document to Navy officials on site. However, Mr. Haggett decided not to reveal that copies had been made but to admit only that “no copies existed.” The Navy launched its own investigation and con cluded that the bidding process had not been compro mised. An adverse decision could have resulted in suspension or debarment as a government contractor, which would have jeopardized the survival of the firm with devastating consequences for its employees and the surrounding community. As part of the settlement with the Navy, BIW agreed to establish an ethics program headed by an ethics officer, expand ethics training, create a board committee for ensuring compliance, and report to the Navy for three years on the implementation of this agreement. BIW was still competing for contracts to build at least two new Aegis destroyers, and many at the company feared that lingering suspicion about the use of a competitor’s information would be an impediment. To allay this concern, the two vice presidents who first handled the discovery of the document were asked to leave the company, and Wil liam Haggett resigned as CEO. He later severed all connec tions with BIW, thus ending a 28-year career with a company where his father had worked as a pipe fitter. He lamented that 15 minutes of ethical uncertainty had cost him his job. Buzz Fitzgerald became the new CEO and immediately declared that BIW “must meet the highest ethical standards and avoid even the appearance of impropriety.”
ShaRed WRITING: eThIcal uNceRTaINTy aT BaTh IRON WORkS
Consider an organization that you work for or have worked for in the past, as a part-time employee, club member, volunteer, or any other capacity. Briefly outline what an ethics program would look like for that organization. Review and comment on at least two classmates’ responses.
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Case: A Faked Résumé at
At the beginning of 2012, Scott Thompson took the reins as the third CEO in five years at the embattled Internet com pany Yahoo. An early leader in the field, Yahoo was losing its once dominant place to newer rivals, such as Google and Facebook. Repeated failed attempts to turn around the troubled company had produced great turmoil in the exec utive ranks and discontent among its large workforce. An activist hedge fund, Third Point led by investor Daniel Loeb, had been using its 5.8 percent stake in Yahoo to agi tate for greater representation on the board in order to change the company’s direction. With an extensive back ground in digital technology, including a stint as president at PayPal, an eBay subsidiary, Mr. Thompson brought strong credentials to the top post at Yahoo.
On May 3, Mr. Loeb dropped a bombshell on the Yahoo board of directors. The official biography of Scott Thomp son in company documents listed an undergraduate degree from Stonehill College, outside Boston, with majors in accounting and computer science. The only problem with this claim was that the school did not offer a computer sci ence major at the time; Mr. Thompson had apparently obtained only a degree in accounting. Ironically, the hedge fund had discovered the discrepancy through a simple Google search.39 The challenge for the board, in responding to this revelation, was to decide whether the false claim was an inconsequential innocent mistake that could be eas ily rectified or an indicator of a more serious matter that might require swift, decisive action.
Mr. Thompson might have put the matter to rest with an immediate full admission and a sincere apology. Instead, he lashed out at Mr. Loeb for using this discovery as a weapon in his fight with the board, and he began to build support among board members and fellow executives. He also blamed the mistake of introducing the false informa tion into his biography on the search firm that had placed him in the presidency of PayPal, a charge the firm indig nantly denied in a statement to the board. Furthermore, a radio interview was discovered by the board in which Mr. Thompson not only did not correct an interviewer’s mis taken reference to the computer science major but also added, “That’s really the background I have, and it started back in my college days, and I think that’s really the won derful part of being an engineer is you think that way.”40
In making a decision, the board needed to consider the well-being of the company. An abrupt change in leadership at this time might continue the downward direction of the company’s fortunes and prevent the recovery that Mr. Thompson had been hired to achieve. The clumsy firing of the previous CEO, Carol Bartz, after a contentious two-year tenure, had unsettled the company and prevented a smooth
succession. (She was fired in a telephone call while trave ling.) The assault by Third Point reflected the vulnerability of the company to a takeover by disgruntled investors. Employees, too, had become disenchanted with Mr. Thompson’s leadership because of the layoff of 2,000 work ers (14% of the workforce), which he implemented in an effort to turn around the company. Moreover, the false claim of a computer science degree was perhaps perceived as a more serious matter by workers in Silicon Valley who took great pride in their own technical education. Firing Mr. Thompson might have been popular with investors and employees with their own interests, even if it were harmful to the company. The top job at Yahoo certainly required a strong techni cal background, and although his experience at PayPal attested to this expertise, the false claim of a degree in com puter science was bound to create uncertainty. Besides technical competence, however, a high leadership position requires confidence in a person’s integrity. A statement by Third Point argued that the false claim “undermines his credibility as technology expert and reflects poorly on the character of a CEO who has been tasked with leading Yahoo at this critical juncture.”41 Although a company biography might be considered to be a minor matter, the false information had been conveyed while Mr. Thompson was president of PayPal and was also contained in Yahoo’s filings with regulators, which he, as CEO, was legally required to certify for accuracy. Mr. Thompson was not the first CEO to falsify a résumé. A head of RadioShack who claimed to be a college graduate was discovered in 2006 to have left school after only two semesters; he was fired. Ronald Zarella, the CEO of Bausch & Lomb from 2001 to 2006, claimed to have an MBA that he never earned; he was kept on the job, although the board rescinded a $1.1 million bonus. An option for the Yahoo board was to terminate Mr. Thompson “for cause,”
which would deny him stock grants worth $16 million. During the board’s deliberations, Mr. Thompson revealed that he had undergone surgery several weeks earlier, which might have impacted his performance, although he did not disclose at that time that it had been for thyroid cancer.
On Sunday, May 13, Mr. Thompson resigned his posi tion, and the board settled the same day with Third Point to allow it three seats on the 12-member board. The new chairman declared, “The board is pleased to announce these changes, and the settlement with Third Point, and is confident that they will serve the best interests of our share holders and further accelerate the substantial advances the company has made operationally and organizationally.”42
ShaRed WRITING: a Faked RéSuMé aT yahOO
In your opinion, what is the strongest argument for Thompson’s resignation? Select one of the alternative endings to Thompson’s story below. List the scenario and explain how this controversy might have played out differently. Review your classmates’ responses. Comment on at least two additional alternative endings.
Thompson’s falsification was discovered when Yahoo held a stronger market position and was less vulnerable.
Thompson held a management position lower than CEO.
Thompson had assumed responsibility immediately instead
f attempting to shift blame.
Silicon Valley culture esteemed practical education and self- taught skills above technical degrees.
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Chapter 1 Quiz: Ethics in the World of Business
Chapter 2
Ethical Decision Making
2.1 Recognize the features of the market
system, the ethics of market transactions, and the problems created by imperfect market conditions
2.2 Identify the duties and obligations
associated with fundamental business roles and relationships in markets and firms
2.3 Describe the philosophical and
psychological approaches to ethical reasoning and the principles that constitute a moral framework for business conduct
Case: HP and the Smart Chip
As a leading innovator in the highly competitive computer printer business, Hewlett-Packard (HP) has promoted its “SureSupply” campaign, which tracks and manages users’ toner and ink levels, provides alerts when the cartridge needs to be replaced, and directs users to the HP online store.1 HP literature boasts, “With a couple of clicks of a button, custom ers can access cartridge information, pricing and purchasing options that best meet their needs from the reseller of their choice.” The key to SureSupply is a “smart chip,” which is embedded in a cartridge and communicates with the com puter to provide information and send messages and alerts. Originally used only with more expensive, high-end printers, HP subsequently extended its smart chip technology across its line of products. Despite HP’s claim to be providing a “free user-friendly tool,” some customers took a different view of the smart chip. Users of HP ink-jet printers complained that the smart chip was programmed to send a premature low-on-ink (LOI) message, while substantial ink remained in the cartridge. They also contended that the smart chip would render a car tridge inoperable after a predetermined shutdown date that is not disclosed to users. This date was usually the earlier of 30 months after the initial installation or 30 months after the “install-by” date. In some instances, a cartridge could shut down even before it had been installed. Although HP cartridges carry a warranty, the warranty does not apply, among other conditions, for “products receiving a printer generated expiration message.” The smart chip also guides
users to HP’s own web store, where they may order a new cartridge. Once the smart chip had shut down a cartridge, it could not easily be refilled, thus requiring replacement with a new one. (The European Union has prohibited manufac turers from installing smart chips in cartridges in an effort to promote recycling. Indeed, the European Parliament uses only recycled cartridges.) The HP promotional materials, users’ manuals, and pack aging reveal little about the features of the smart chip. The box containing a cartridge generally lists the date of the warranty expiration but not any shutdown date. In an issue unrelated to the smart chip, some users were disconcerted to learn that certain color ink-jet printers used colored ink when printing in black and white in a process known as “underprinting” or “un der color addition,” which resulted in more rapid depletion of colored ink. This feature, too, was not commonly disclosed. When several separate suits were filed between 2005 and 2008 (the courts denied requests for class-action status), HP vigorously defended its practices, denying that it had done anything wrong or improper. The company contended that, over all, the smart chip provided a helpful service to users and ensured a better printing experience. The smart chip was necessary, the company explained, to enable users to monitor ink levels and be prepared when a replacement was needed. In any event, the monetary loss to customers was minor compared with the con venience. The smart chip was also beneficial to HP since replace ment cartridges provided approximately half of the revenues of the Imaging and Printing Group, and “consumables” of all kinds generated approximately 10 percent of HP’s total revenue. Typi cally, printers, like razor holders, are sold at very low cost since the profits lie mainly in the products that go with them. The profit
21
How was HP affected by these lawsuits? Expert Analysis
Despite the denials of any wrong or improper conduct, HP agreed in 2010 to settle the suits, which were consolidated into one. In the settlement, HP agreed to state in all on-screen messages, manuals, and other information that the ink-level information is an estimate only, that actual ink levels may vary, and that the
margin on HP’s ink and toner cartridges ranged between 50 and 60 percent.
Points to Consider…
Did HP do anything wrong? The company and its custom ers have different interests that may lead them to different answers. Taking the moral point of view, which is explained in this chapter, requires us to be impartial and to seek out the best reasons. These reasons may not be easy to identify, however, or to apply. As a business, HP may rightly seek to develop its products and market them with a view to prof its within certain limits. The smart chip, in the company’s view, serves not only to sell more cartridges but also to benefit its customers, which is a win-win situation. Cus tomers may complain not only that they pay more than is necessary for products but that they have been misled or deceived. Yet, how much information is HP obligated to provide? Perhaps we should not consider only a business and its customers since others are affected, as well. A potential business in recycled cartridges is thwarted by the smart chip, and the social problem of waste is exacerbated, as demonstrated by the European Union’s prohibition of the chips. Should these matters also be taken into account in our ethical reasoning? In order to identify what makes acts right and wrong and to determine what we ought to do or what our duties and responsibilities are in particular cases, it is necessary to understand the elements of ethical decision making.
What rules or principles apply to business practice? This chapter answers this question by dividing busi
ness ethics into two parts.
• The first part considers the ethics of the marketplace in which two parties, a buyer and a seller, come togeth er to trade or make an exchange. Although simple in concept, such market transactions are governed by a host of rules or principles that constitute a market eth ics. As prominent as market transactions are to busi ness, much business activity also involves roles and relationships, such as the role of an employee and the employer–employee relationship, which are more than mere market transactions.
customers need not replace a cartridge until the print quality is no longer acceptable. HP also agreed to explain on its website and in manuals the use of expiration dates and underprinting and also to explain how underprinting may be minimized or eliminated. Final ly, HP agreed to set aside $5 million to provide e-credits to cus tomers who had purchased certain printers and cartridges. These e-credits, which ranged in amounts from $2 to $6 depending on the printer in question, could be applied only in the HP online store. The settlement did not address the use of the smart chip, and it continues to be used by HP and many other manufacturers.
• The second part of business ethics involves roles and relationships in business, including firms, which are governed by yet other rules and principles. Finally, this chapter offers a framework for ethical decision making that consists of seven basic principles that are widely accepted in business practice.
2.1: Market Ethics
2.1 Recognize the features of the market system, the
ethics of market transactions, and the problems created by imperfect market conditions
The ethics of business is, in large part, the ethics of conduct in a market. In a market, individuals and business firms engage in economic exchanges or transactions in which they relate to each other mainly or entirely as buyers and sellers. Each market participant offers up something in trade in return for something that is valued more, and, in theory, each party leaves the market better off than before, or at least no worse off. Of course, business is more than buyer–seller exchanges, but a useful place to start an exam ination of ethical decision making in business is with an understanding of the ethics of market transactions.
What duties or obligations do market participants have to each other in making trades or exchanges? Do mar ket actors have any rights that can be violated in market transactions? Are any market transactions unfair or unjust or otherwise morally objectionable? These questions can be addressed in the context of simple market exchanges with out introducing the complications that come from consid ering business as conducted in firms, which is discussed after the ethics of markets transactions.
2.1.1: The Market System
In a capitalist economy, major decisions about what goods and services to produce, in what volume to produce them, how to manufacture and market them, and so on are made primarily through a market. Decisions in a market are made
n the basis of prices, which in turn result largely from sup- ply and demand. The principal aim of business firms in a market system is to maximize the return on investment or, in other words, to make a profit. Individuals, as well, are assumed in economic theory to be market actors who trade with each other or else buy products from or sell their labor
r other goods to a firm. Like firms, individuals make deci- sions in a market on the basis of prices and seek to maxi- mize their own welfare to the limits of their assets. Individuals make a “profit” for themselves to the extent that what they gain in trade exceeds what they give up.
FeatuRes oF the system
The market system is char
acterized by three main features: 1. private ownership of resources and the goods and ser
vices produced in an economy;
voluntary exchange, in which individuals and firms are free to enter into mutually advantageous trades; and
the profit motive, whereby economic actors engage in trading solely to advance their own interests or well- being. Private ownership in the form of property rights is necessary for a market system because this is what is trans- ferred in market exchanges. In the sale of a house, for example, the seller who owns it transfers the right to that property to the buyer who becomes the new owner. A sale differs from theft or confiscation, moreover, by being vol- untary. Whenever a trade takes place voluntarily, we can be sure that both parties believe themselves to be better off
at least, no worse off) because, by assumption, no one willingly consents to being made worse off. Finally, it is assumed that each market participant trades solely with a view to his or her own advantage. If two people want the same thing, then a trade might not be possible. But if each person has what the other wants more, then a trade is to the advantage of both. Therefore, trading in a market is an instance of mutually advantageous cooperation.
The main justification
JustiFication oF the system
f a market system over other forms of economic organiza- tion is its promotion of efficiency and hence welfare.2 The simplest definition of efficiency is obtaining the greatest
utput for the least input. That is, given any volume of our limited resources—which include raw materials, labor, land, and capital—we want to achieve the greatest volume
f goods and services possible. Efficiency is generally con- sidered to be desirable because these goods and services increase our overall welfare, and the more of them that we can get, the greater our level of welfare.
example: If Alice sells a book to Bart for $10, she appar- ently values having $10 more than possessing the book, hence her willingness to sell; and similarly Bart would apparently rather have the book than the $10 he currently
possesses, hence his willingness to buy. Before the transac tion, there was an opportunity to increase the overall level of welfare, and the exchange that takes place turns this opportunity into a reality. Every economic exchange can thus be seen as a welfare-increasing event, and the more trades that take place, the greater the level of welfare.
Similarly, when firms engage in production, they see an opportunity to purchase inputs, such as raw materials, machinery, and labor, which can be combined to yield a product that can be sold to consumers. Like Alice, the sell ers of the raw materials, machinery, and labor would rather have the money they receive for selling their various assets, and, like Bart, the consumers would rather have the prod uct than the money they give up in payment. In the end, everyone is better off.
What is true of individual market actors, whether peo ple or firms, is also true of an economy as a whole. In an economy built on markets, laborers, in search of the high est possible wages, put their efforts and skill to the most productive use. Buyers seeking to purchase needed goods and services at the lowest possible price force sellers to compete with one another by making the most efficient use of the available resources and keeping prices at the lowest possible level. The resulting benefit to society as a whole is due not to any concern with the well-being of others, but solely to the pursuit of self-interest. By seeking only per sonal gain, each individual is, according to a famous pas sage in Adam Smith’s The Wealth of Nations, “led by an invisible hand to promote an end which was no part of his intention.” Smith continued, “Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”
In addition to welfare enhancement, the market sys tem is morally desirable because it promotes freedom or liberty. The opportunity to make trades is an exercise of lib erty by which individuals are able to advance their inter ests in society, thus promoting democracy. A market is an instance of what Friedrich von Hayek called a spontaneous order, which contrasts with the planned order of a state owned, socialist economy, in which a central authority sets goals and organizes people’s activities to achieve them.3 In a spontaneous order, the only goals are those that individ uals set for themselves, and the only coordination is that provided by the rules for people’s interaction, which per mit them to enlist the cooperation of others, each in the pursuit of his or her own goals. The advantages of sponta neous order are, first, that it protects and expands the basic rights to liberty and property. Second, a spontaneous order will generate a much greater complexity than could be pro duced by deliberate design. A planned order is limited by the vision and skill of a few people, but a spontaneous order allows everyone to participate in an economy and make a contribution.
A stronger argument for the market system, and per haps the decisive reason for the failure of socialism, is the ability of markets to utilize information. A central planner faces the formidable task of gathering all available infor mation about such matters as people’s preferences for products, the supply of raw materials, the capacity and condition of machines and workers, the state of distribu tion facilities, and many other factors. Not only is the amount of information required for economic decision making immense, but also the details are constantly chang ing. Put simply, the information-gathering and processing requirements of central planning outstrip the capabilities of any one person or group of people. Markets solve this problem by enabling individuals to utilize the information that they possess in ways that can be known by others. This is done mainly through the price system. The prices of all manner of goods and services reflect the available infor mation, and these prices may fluctuate as new information becomes available. Thus, the market system may be justi fied on the multiple grounds of enhancing welfare, secur ing rights and liberty, and utilizing all available information.
Although markets operate, in theory, to make each participant better off and thereby to increase the welfare of all, they also result in distributions of income and wealth that may be criticized on moral grounds. In particular, market transactions function as a means for distributing goods and services, and in so doing, they may produce much greater gains for some parties than for others, so as to increase inequality in society. Thus, a skillful trader, such as Warren Buffett, may parlay a string of successful trades into great wealth, while another trader, through misjudgment or misfortune, may lose everything. How people fare in markets may depend not only on skill or luck but also their inborn abilities and circum stances of birth, over which they have no control. Market returns are also a function of the amount of risk taken. Thus, an entrepreneur like Bill Gates who bets everything on a single idea stands to reap a fortune or endure failure. Some moral philosophers, such as Robert Nozick, argue that market outcomes are just, no matter how unequal they may be, merely because they result from voluntary trans actions. Others, such as John Rawls, hold that market out comes may need to be altered when they lead to unjust levels of inequality. In any event, the moral justification of markets must address the question of the justness of mar ket outcomes.
maRket outcomes
2.1.2: Ethics in Markets
If a market transaction is wholly voluntary, then how can one market actor wrong another? In a free market, every participant seeks his or her own benefit and has no obli gation to protect or promote or otherwise consider the
interest of the other party. Exclusive self-interest is an accepted and justified motive for trading. However, in a market people are able to get what they want only with the cooperation and voluntary consent of others; acquisi tion without consent is a kind of theft. Consequently, eve ryone’s gains in a market are by mutual agreement or consent, in which case no moral wrongs are possible. Indeed, the philosopher David Gauthier has character ized perfectly competitive markets as morally free zones, where there is no place for moral evaluation.4 A world where all activity took place in a perfectly competitive market would have no need of morality.
The idea that a market is a morally free zone such that no wrong can occur from each participant pursuing his or her own advantage with the voluntary consent of others presupposes, as Gauthier makes explicit, the ideal of a per fectly competitive, properly functioning market. In such a market, the following points are assumed.
First, everyone completes an exchange by fulfilling the terms of all agreements. Every market transaction can be viewed as a kind of contract, and the market system requires that participants honor all contracts made. In law, a failure to do this would be called a breach of con- tract, which is a legal and moral wrong.
Second, a voluntary exchange precludes force or fraud. Any transfer by force is not a market transaction but an instance of theft or expropriation, which is an obvi-
us legal and moral wrong. By contrast, fraud is a more subtle wrong that is not an uncommon occur- rence in market transactions and that, like force, is also prohibited by law. Indeed, fraud, which is discussed in the next section, is a major concern in business ethics.
Third, market transactions can result in harm to per- sons that constitute a wrongful harm when the harm results from some wrongful act. For example, the harm done to the buyer of a defective product is a wrongful harm if the seller has a duty to ensure the safety of the product when properly used. Similarly, an employer has a duty not to discriminate, and so the refusal to hire or promote a person on the basis of race or sex is also an instance of a wrongful harm. Such wrongful harms are the subject of the law of torts, which is often the basis of suits for injury or loss of some kind.
Fourth, perfect markets require a number of condi- tions, and when these are not satisfied, the personal and social benefits that result from mutually advanta- geous cooperation, as described in Adam Smith’s invisible hand argument, may not occur. The absence
f these conditions leads to a number of commonly recognized situations known as market failures, which are discussed later in this chapter. Consequently, wrongs can occur in actual markets, as
pposed to ideal or perfect markets, and market ethics may
be characterized as the ethical rules that apply in imperfect market exchanges or transactions to address recognized market failures. Because market failures are also addressed by much government regulation, there is an extensive overlap between business ethics and the moral rationale or justification for this regulation. Market ethics—the ethics that applies when the condi tions for perfect markets do not exist—can be categorized under these four headings: 1. observing agreements or contracts, 2. avoiding force and fraud, 3. not inflicting wrongful harms, and 4. acting responsibly in cases of market failures. Since much of business ethics consists of this market ethics, a further examination of the failure to adhere to these four principles follows.
2.1.3: Breaches and Fraud
Breach of contract and fraud, which are two wrongs that can occur in market transactions, are not only major con cerns of law but also of common morality. Indeed, they are violations of two basic moral values: promise keeping and honesty. Every market trade or exchange is a kind of prom ise, and so a failure to honor what is agreed to in a transac tion is the breaking of a promise. And inasmuch as fraud necessarily involves a knowing or intentional falsehood, it is a form of dishonesty.
Much of business ethics can be reduced to two rules: Keep your promises and be honest!
A market actor who fails to perform—by not delivering promised goods or refusing to pay, for example—is obviously breaching an agreement or contract, and such cases of nonperformance are obviously wrong and require little explanation. However, actual con tracts are often vague, ambiguous, incomplete, or other wise problematic, causing reasonable people to be uncertain or disagree about whether a contract’s terms have been fulfilled. Disputes of this kind, which are not uncommon, are often taken to court. In actual business practice, three main ethical problems with contracts arise. 1. They are implicit. Many contracts in business are not explicitly formulated but are left implicit because of a desire or a need to avoid excessive legalism and to keep some flexibility. Business is sometimes better con ducted with a handshake than a written contract. Thus, employee contracts may contain explicit terms about pay and job description, but leave implicit any prom ises of specific job responsibilities, advancement op portunities, or guarantees of job security. Such matters may be better left to the unstated understandings of implicit contracts rather than to the legally enforceable
BReach oF contRact
language of explicit contracts. However, implicit con tracts are subject to disagreements, and since they are generally not legally enforceable, they may be violated with impunity.
example: A laid-off employee may believe that he had been guaranteed greater job security than was the case, or a company may change its policy to of fer less job security, which may be legally permis sible in the absence of an explicit contract.
They are incomplete. A perfect contract in which every detail and contingency are addressed may be impos- sible to formulate because the transaction is too com- plex and uncertain to plan fully. Even if a fully explicit contract is sought, it may be impossible to draft it in complete detail.
example: In hiring a chief executive officer (CEO), neither the CEO nor the board of a company can anticipate all the situations that might arise and agree upon detailed instructions for acting in each
ne. Indeed, the CEO is being hired precisely for an ability to manage complexity and to handle un- anticipated events successfully. The best that can be done is typically to require the CEO to exert his
r her best effort, to set and reward certain goals, and to impose a fiduciary duty to act in the share- holders’ interest. The CEO’s contract with a firm is necessarily an incomplete contract.
They lack remedies. The contracts that occur in market exchanges often consider only the duties or obligations
f each party to the other and fail to specify the reme- dies in cases of breach. What ought to be done in cases where one party is unable or unwilling to fulfill a con- tract? Such situations are often the subject of ethical and legal disputes. While remedies for breaches can usually be made explicit, there is evidence that firms
ften prefer to leave this matter implicit, in which case courts are called upon to determine a just outcome.5 One problematic area of justice in breaches occurs when a party does not observe a contract in which the cost of observance would exceed the penalty for breach.
example: A question of ethics arises when home-
wners who owe more on a mortgage than a house is worth walk away and return the house to the bank. On the one hand, the homeowner has signed a loan agreement to repay the full amount of the loan, and, on the other, the contract signed provides only for repossession as the penalty for nonpayment.
These three features of contracts—being implicit and
incomplete and lacking remedies—give rise to many situa- tions in which the ethical course of action is unclear and disputable. One possible guide in such cases is to try to
determine what more explicit and complete contracts the parties might have agreed to before the situation arose. To use this guide is to ask what the fairest resolution is for both parties.
Contracts and Trust
Given the discussed advantages and disadvantages of contracts, describe the kinds of situations in which a contract is important and the kinds of situations in which some other means of agreement would be more appropriate.
The response entered here will appear in the performance dashboard and can be viewed by your instructor.
Fraud is one of the most common violations of business ethics, and the many fraud statutes on the books provide a powerful arsenal of legal tools to prosecute people for a wide variety of misdeeds. Consequently, it is essential for business people to under stand what actions constitute fraud. A few incautious remarks have led to costly legal judgments and fines and even to years of imprisonment for not a few executives, and some companies have been seriously damaged and even bankrupted by fraudulent schemes. Fraud is commonly defined as a material misrepresenta
FRaud and manipulation
tion that is made with an intent to deceive and that causes harm to a party who reasonably relies on it. This definition contains
five elements:
the making of a false statement or the misrepresentation
f some fact;
materiality, which means that the fact in question has some important bearing on the business decision at hand;
an intent to deceive, which is a state of mind in which the speaker knows that the statement is false and de- sires that the hearer believe it and act accordingly;
reliance, by which the hearer believes the statement and relies on it in making a decision; and
harm, which is to say that the decision made by the hearer on the basis of the misrepresentation leads to some loss for that person. The first three conditions bear on whether the speaker has acted wrongly, while the last two are relevant to whether the hearer has been wronged and deserves some compensation. The simplicity of this definition is deceptive because each of the five elements hides a host of subtle pit- falls for the unwary. For starters, a misrepresentation need not be spoken or written but may be implied by word or deed, as when, for example, a used car dealer resets an
dometer, which is a clear case of consumer fraud.
Partial statements and omissions may constitute fraud when they are misleading within the context provided. Thus, the used car dealer who fails to disclose certain faults or presents them in a way that minimizes their seriousness may be guilty of fraud. Saying nothing, which avoids the risk that a partial statement is misleading, may still consti tute fraud if one has a duty to disclose certain information. Such a duty may be the result of one’s position or the nature of the facts. Thus, a real estate agent has a duty, as an agent, to inform a buyer of certain facts about a home sale, and the seller generally has a duty to disclose certain hidden faults, such as termite damage.
Generally, opinions, predictions, and negotiating posi tions do not constitute facts that can be misrepresented. It is not usually considered material, or significant, in nego tiation to conceal or even lie about the amount one is will ing to accept or pay, which is known as one’s “reservation price.” Certain amounts of bluffing and exaggeration in negotiation are usually permissible, also on the grounds that the harm is not material. However, one’s intentions— such as making a promise that might not be kept—are commonly regarded as facts about a speaker’s state of mind, so the misrepresentation of such matters may consti tute fraud.
Although intent, being a mental state, is difficult to ascertain, the fact that a person knows the true state of affairs is usually sufficient to establish it. More difficult are cases of willful ignorance where a seller of a house, for example, declines to engage a termite inspector to check suspicious deposits of sawdust in the basement, so he can truthfully tell a buyer, “I don’t know,” when asked about any termites. Finally, it is often difficult to know whether a party to a transaction actually relied on a misrepresenta tion in making a decision or did so reasonably. Thus, a seller’s deceptive claim to be ignorant of termite damage may have played no role in the buyer’s decision. And even if it did, should the buyer have engaged his or her own termite inspector instead of relying (perhaps unreasona bly) on the seller’s vague denial? Generally, in negotia tion, it is unwise to act solely on the other party’s words, and market participants have some obligation to deter mine the facts themselves.
2.1.4: Wrongful Harm
Although buyers and sellers in market exchanges have no duty to consider the other party’s interest, they still have the obligations of basic morality toward each other and deserve compensation when they suffer some loss when the other party acts in violation of some obligation. For example, a manufacturer has an obligation beyond any warranty extended (which is a kind of contract) to exercise due care and avoid negligence in producing goods, so that a buyer of the product who is injured has some claim for
compensation. In law, this claim is based not on contract law but on tort law, which is the law of wrongful harms. Although wrongful harms can occur in the course of a mar ket transaction—buying the product, in this case—they occur in many instances that do not involve markets at all. Thus, a company might be sued for a defective product not only by the injured buyer but also by anyone who suffers an injury from a defective product. The ethics involved in wrongful harms overlaps with but is much more extensive than merely market ethics. Market participants give their voluntary consent to a transaction, and in general, consent is an excusing condi tion when harm is inflicted. That is, the buyer of a stock that declines in value may lose in a transaction, but he or she believed at the time of the purchase that the stock was a good value and was aware of the possibility of loss. Such a person has only himself or herself to blame for the loss. The seller can say, “I am not to blame; it’s your own fault.” On the other hand, the buyer of a defective product con sents to the purchase but not to the possibility of injury. Similarly, the victims of a stock fraud, such as the Ponzi scheme perpetrated by Bernard Madoff, cannot be said to have consented to their losses. The ethical transgressions in both cases do not lie in the market transactions themselves but in the wrongs that accompany them, namely, the negli gence of the manufacturer and the fraud of Mr. Madoff. The wrongs in wrongful harms are many and varied and constitute much of business ethics and the whole of tort law. On the side of the violators, these wrongs involve a fail ure to fulfill a duty, often the duty of due care, or involve its opposite, the commission of negligence. That is, manufactur ers have a duty to exercise due care and not be negligent in the products they market to consumers, in the working con ditions they provide for employees, in their environmental impacts they have on communities, and so on. Generally, due care and negligence apply to unintentional harms, but companies also have a duty to avoid intentional harms that result not from negligence but from deliberate or purpose ful actions. On the side of victims, wrongful harms typically involve a violation of rights. Thus, consumers have a right to safe products; employees have a right to a safe and healthy workplace; and everyone has privacy rights, property rights, a right not to be discriminated against, and so on. The violations of these rights—whether they are due to neg ligence or intentional actions, or are committed in markets transactions or not—are wrongful harms.
2.1.5: Market Failure
The virtues of the market system, including its efficiency and Adam Smith’s “invisible hand” argument, occur only under certain ideal conditions and not necessarily in the real world where people live. Some departures from these ideal conditions are serious enough to be described by economists
as market failures. Indeed, much of business ethics involves questions about how to respond to such failures.6 Markets fail for four main kinds of reasons, which may be grouped under the headings of imperfect conditions (especially a lack of perfect competition and perfect rationality), exter nalities, public goods, and collective choice.
conditions The argument that free markets are effi cient presupposes certain conditions. The first of these con ditions is perfect competition. This condition is satisfied when there are many buyers and sellers who are free to enter or leave the market at will and a large supply of rela tively homogeneous products that buyers will readily sub stitute one for another. In addition, each buyer and seller must have full knowledge of the goods and services avail able, including prices. In a market with these features, no firm is able to charge more than its competitors because customers will purchase the competitors’ products instead. Also, in the long run, the profit in one industry can be no higher than that in any other because newcomers will enter the field and offer products at lower prices until the rate of profit is reduced to a common level.
Competition in actual markets is always imperfect to some degree. One reason is the existence of monopolies and oligopolies, in which one or a few firms dominate a market and exert an undue influence on prices. Competition is also reduced when there are barriers to market entry (as in phar maceuticals that require costly research), when products are strongly differentiated (think of the iPhone, which many people strongly prefer despite similar alternatives), when some firms have information that others lack (about new manufacturing processes, for example), and when consum ers lack important information. Competition is also reduced by transaction costs, that is, the expense required for buyers and sellers to find each other and come to an agreement.
The argument that free markets are also efficient makes certain assumptions about human behavior. It assumes, in particular, that the individuals who engage in economic activity are fully rational and act to maximize their own welfare or utility.7 This construct, commonly called Homo economicus or economic man, is faulty for at least two rea sons. One is that people often lack the ability to gather and process the necessary information to act effectively in their own interests. Economic actors have what is described as bounded rationality. The other reason is that human motiva tion is much more complex than the simple view of eco nomic theory. People often give money to the poor or return a lost wallet, for example, with no expectation of gain. Altruism and moral commitment play a prominent role in our economic life, along with self-interest, and yet economic theory gives them scant regard.8
In addition, firms do not always act in the ways pre dicted by economic theory. To compensate for people’s bounded rationality, business organizations develop rules
and procedures for decision making that substitute for the direct pursuit of profit. For example, it would be impossi ble to set wages with a view solely to profitability, yet the wage-setting process in companies, which involves many factors, has profit making as an ultimate goal. Firms also do not necessarily seek optimal outcomes, as economists assume, but, in the view of some organizational theorists, they settle for merely adequate solutions to pressing prob lems through a process known as satisficing. The immedi ate aim of firms, according to these theorists, is to achieve an internal efficiency—the well-being of the firm—rather than external efficiency in the marketplace.9
exteRnalities The efficiency argument assumes that there are no spillover effects or externalities, which is to say that all costs and benefits associated with the production of goods and services are reflected in the prices that are paid in the market.
a negative externality is present when prices fail to record a cost of production. This cost is consequently not borne by either the buyer or the seller but is imposed on third parties, often without their knowledge or consent. These additional costs associated with a particular good or service are said to be externalized by the producer. When the manufacturer of a product is permitted to pollute a stream, for example, there are health and environmental costs that the manufacturer avoids and passes on to other businesses or communities downstream. Other examples of externalities in present-day markets include: • inefficient use of natural resources (automobile drivers do not pay the full cost of the gasoline they use and hence overconsume it), • occupational injuries (which may result when employ ers underinvest in safety when not they but their employees bear the cost), and • accidents from defective products (in which consumers, like injured employees, bear the preponderance of the cost). The presence of negative externalities creates ineffi ciency in the market because the ability of producers to transfer the costs of production to other parties creates an incentive within the market to overproduce certain harm ful goods and services.
a positive externality exists when prices fail to reflect a benefit for which some party does not have to pay.
Common examples of positive externalities include: • goods related to public health, such as vaccines (when individuals who do not receive a vaccine still derive the benefit from others’ vaccination); • creative goods, such as music or film (when individu als can easily download digital copies without paying); and
• goods shared by a community, such as home values (when the value of one person’s home appreciates when neighbors make improvements).
The presence of positive externalities also creates inef ficiency in the market because certain beneficial goods and services are underproduced when individuals can receive benefits without paying for them and thus have the oppor tunity of becoming “free riders.”
The task of dealing with externalities falls mainly to governments, which have many means at their disposal.10 In the case of negative externalities, polluters can be forced to internalize the costs of production, by regulations that prohibit certain polluting activities (the use of soft coal, for example) or set standards for pollution emissions. Alterna tively, government can create incentives that achieve the same end, such as tax benefits for installing pollution con trol devices.
Free-market theorists have proposed solutions to the problem of negative externalities that make use of market mechanisms. Under a California law known as the Global Warming Solutions Act, manufacturing companies must have a sufficient number of emission “credits” to match the amount of greenhouse gas pollutants that they emit in their operations. Firms that employ new technologies to reduce greenhouse gas emissions below their allowable credits can trade their surplus credits to firms that emit more than their credits allow.11 Other proposals allow firms that pol lute less than allowed to “sell” their “right to pollute” to other firms. In the case of positive externalities, free- market approaches include the offer of benefits to producers that would otherwise be unobtainable. For example, patent laws assure that inventors of new technologies are paid for their socially beneficial contribution, so that members of society are prevented from becoming “free riders.”
Most goods that are traded in markets
puBlic Goods
are private in the sense that they can be owned and con sumed by single individuals. Toothpaste, for example, is sold in tubes, and people buy tubes for personal use and commonly do not share them. A public good, by contrast, is a commodity that other people cannot be excluded from using. Automobiles are examples of private goods, while roads are a public good in that their use by one person does not exclude their use by others. Once built, roads are acces sible by everyone.
A market economy has a well-known bias in favor of private over public consumption. That is, markets produce in abundance goods that can be owned and used by one person. However, goods for the enjoyment of all are gener ally not available in markets but are provided, usually, by governments. As a result of this bias in favor of private consumption, people spend large sums on their own cars but little to build and maintain a system of roads. Public parks, free education, public health programs, and police
and fire protection are all examples of public goods that are relatively underfunded in an otherwise affluent society.12
The reason for this bias is simple: There is little profit in public goods. Because they cannot be packaged and sold like toothpaste, there is no easy way to charge for them. And although some people are willing to pay for the pleasure of a public park, for example, others, who cannot be excluded from enjoying the park as well, will be free riders; that is, they will take advantage of the opportunity to use public goods without paying for them. Indeed, if we assume a world of rational economic agents who always act in their own inter est, then everyone would be a free rider, given the chance. To act otherwise would be irrational.13 Consequently, public goods are ignored by the market and are typically left for governments to provide, if they are provided at all.
A further objection to the effi ciency argument concerns the problem of collective choice.14
collective choice
In a market system, choices that must be made for a whole society—a transportation policy, for example—are made by aggregating a large number of individual choices. Instead of leaving a decision about whether to build more roads or more airports to a central planner, we allow individuals to decide for themselves whether to drive a car or to take an airplane to their destination, and through a multitude of such individual decisions, we arrive at a collective choice. The underlying assumption is that if each individual makes rational choices—that is, choices that maximize his or her own welfare—then the collective choice that results will also be rational and maximize the welfare of society as a whole. The assumption that rational individual choices always result in rational collective choices is brought into question by the prisoner’s dilemma.15 Suppose that two guilty suspects have been apprehended by the police and placed in sepa rate cells where they cannot communicate. Unfortunately, the police have only enough evidence to convict them both on a minor charge. If neither one confesses, therefore, they will receive a light prison sentence of one year each. The police offer each prisoner the opportunity of going free if he confesses and the other does not. The evidence provided by the suspect who confesses will then enable the police to convict the other suspect of a charge carrying a sentence of 20 years. If they both confess, however, they will each receive a sentence of five years. A matrix of the four possi ble outcomes is represented in Figure 2.1.
Figure 2.1
Prisoner’s Dilemma
Prisoner B
Prisoner A
Confess
Not Confess
Confess
Not Confess
A: 5 B: 5
Years Years
A: 0 B: 20
Years Years
A: 20 B: 0
Years Years
A: 1 B: 1
Year Year
Obviously, the best possible outcome—one year for each prisoner—is obtained when both do not confess. Nei ther one can afford to seek this outcome by not confessing, however, because one faces a 20-year sentence if the other does not act in the same way. Confessing, with the prospect of five years in prison or going scot-free, is clearly the pref erable alternative. The rational choice for both prisoners, therefore, is to confess. But by doing so, they end up with the second-best outcome and are unable to reach the opti mal solution to their problem.
The dilemma in this case would not be solved merely by allowing the prisoners to communicate, because the rational strategy for each prisoner in that case would be to agree not to confess and then turn around and break the agreement by confessing. The prisoner’s dilemma is thus like the free-rider problem discussed earlier. If each prisoner has the opportunity to take advantage of the other’s cooperation without paying a price, then it is rational to do so.16 The true lesson of the prisoner’s dilemma is that to reach the best possible outcome, each must be assured of the other’s cooperation. The prison er’s dilemma is thus an assurance problem.17 It shows that a rational collective choice can be made under cer tain circumstances only if each person in a system of cooperative behavior can be convinced that others will act in the same way.
The prisoner’s dilemma is not an idle intellectual puzzle. Many real-life situations involve elements of this problem.18 example: The factories located around a lake are pollut ing the water at such a rate that within a few years none of them will be able to use the water, and they will all be forced to shut down or relocate. The optimal solution would be for each factory to install a water-purification system or take other steps to reduce the amount of pol lution. It would not be rational for any one factory or even a few to make the investment required, however, because the improvement in the quality of the water would be minimal and their investment wasted. With out assurance that all will bear the expense of limiting the amount of pollution, each factory will continue to pollute the lake and everyone will lose in the end. The most rational decision for each factory individually will thus result in a disastrous collective decision.
Solving prisoner’s dilemma cases
The usual solution to prisoner’s dilemma cases—along with those involving externalities and public goods—is govern ment action. By ordering all the factories around the lake to reduce the amount of pollution and backing up that order with force, a government can assure each factory owner that the others will bear their share of the burden. As a result, they could achieve an end that they all desire but could not seek without this assurance. Regulation of this kind is not neces sarily incompatible with the operation of a free market.
Thomas C. Schelling points out that voluntarism versus coer cion is a false dichotomy because coercion also can enable firms to do what they want to do but could not do voluntar ily.19 Firms are not always averse to internalizing costs and providing public goods, Schelling observes, as long as they are not penalized more than their competitors.20 This condi tion can also be secured by government regulation. Another solution for prisoner’s dilemma cases is the availability of trustworthy partners and an ability to identify them. If the prisoners in the dilemma situation were trust worthy and their trustworthiness known to each other, then they could confidently not confess and reach the optimal solution. Similarly, the factory owners around the lake could dispense with government regulation if they were all known for their trustworthy character.
2.1.6: Summary of Market Ethics
This section shows that much of business ethics is market ethics. This is true not only because much of business is conducted in markets but also because of the importance of imperfect markets and market outcomes for business ethics. In perfect markets there is little if any need for ethics or morality; we would conduct our affairs harmoniously by voluntary, mutually advantageous cooperation. Much of ethics in business is necessary, therefore, to address problems in imperfect markets. These problems include instances of not abiding by agreements (breaches), making false statements (fraud), failures to observe duties and violations of rights (torts), market failures, and market outcomes. In law, the prob lems of breach of contract, fraud, and torts are addressed by contract law and the law of fraud and torts, respectively, and market failures and market outcomes are appropriate subjects for government regulation and legislation, includ ing antitrust law, consumer law, employment law, securi ties law, environmental law, taxation, and the like. Use Table 2.1 below to review some of the ethical prob lems in imperfect markets and the manner in which they can be addressed.
2.2: Roles, Relationships, and Firms
2.2 identify the duties and obligations associated with
fundamental business roles and relationships in markets and firms
Insofar as business activity takes place in a market, it involves mainly discrete transactions, in which each person pursues his or her own self-interest and is bound only by the ethics of the marketplace. However, business is more than market activity or transactions; it also consists of roles that people assume and relationships that they build. These roles and relationships evolve out of markets in that people agree in market transactions to assume certain roles and enter into certain relationships. Once these roles and rela tionships are created, though, they give rise to certain moral duties or obligations and to certain rights that are also a part of business ethics. Like the transactions of mar ket ethics, roles and relationships of are voluntarily entered into for mutual advantage, but many of these roles and relationships preclude us from acting solely in our own interest. Indeed, many of them explicitly commit us to act ing in the interests of others, thereby forgoing or subordi nating our own interests.
The moral importance of roles and relationships is well recognized in the professional ethics of, say, physi cians and attorneys. Before assuming these roles, they are bound only by market ethics and the common morality of our society; in particular, they have no duty or obligation to serve other people’s interests. Once they assume these roles and build relationships, though, by accepting others as patients or clients, they are pledged to forgo their self interest and act solely in the interest of these other persons. They enter into these roles and relationships voluntarily, of course, and they are compensated for doing so. However, they now occupy a different moral space: Their actions are now bound by the professional ethics of physicians and attorneys, respectively.
Table 2.1 Ethics in Markets
Review the ethical problems in imperfect markets that have been discussed in this section, along with their elements and available solutions. Hide the cells in the table to quiz yourself.
Violation of agreements (breaches of contract)
Breaches of contract often result from agreements that are implicit, incomplete, and lack immediate remedy.
Misrepresentation of information (fraud)
Wrongful harm of others (torts)
Fraud involves not only misrepresentation of information but also materiality, intent to deceive, reliance, and harm.
Torts are the intentional or negligent violation of rights in such matters as health, safety, privacy, property, and discrimination.
Contract law
Principles for promise keeping
Anti-fraud law
Principles for honesty
Tort law
Principles for due care
Market failures (inefficiency)
Market failures result in inefficiency due to low competi tion, externalities, public goods, and collective choice problems.
Government regulation and legislation like antitrust law, consumer
law, employment law, securities law, environmental law, taxation
Special use of market mechanisms
Trustworthy behavior
Some business people are also professionals—these include accountants, engineers, and others with specialized training—and they, too, are committed to the ethics of their professions. The two most important roles and relation ships in business, however, are those of agent and fiduciary. Like professional roles and relationships, these are entered into voluntarily in market transactions, but by agreeing to become an agent or a fiduciary, a person takes himself or herself out of a market and enters a new moral space in which one is pledged to serve the interests of others and to be bound by the ethics of that role or relationship.
2.2.1: Agents and Principals
An agent is a party who has been engaged to act on behalf of another, called the principal, and the relationship between the two is called an agency relationship. Agency relationships are ubiquitous in business and everyday life because of the need to engage other people’s skills and knowledge and to allow them to exercise judgment and discretion on our behalf. To illustrate: In some instances, such as plumbing repairs, we simply hire a worker to perform a specified job, just as a firm engages contractors or suppliers in a market. In other situations, though, it is necessary for a service pro vider to employ skills and knowledge and to exercise judg ment and discretion in acting on our behalf. We cannot ask a physician or an attorney, for example, to perform a par ticular job at our direction like a plumber; we must ask them to use their skills and knowledge on our behalf with out close direction and to act as we would ourselves if only we had their expertise. Another example of an agency rela tionship occurs in real estate where selling a house requires considerable knowledge and skill, as well as time. Conse quently, a seller may engage a real estate agent to act on the seller’s behalf, doing what the seller (who is now a princi pal) would do if that person had the real estate agent’s knowledge and skills. An agent thus becomes an extension of the principal, acting in the principal’s place, with a duty to use his or her abilities and expertise solely for the princi pal’s benefit. Business firms have need of many specialized services and thus engage numerous outside service providers as agents. Among such agents are law and accounting firms, banks and investment advisers, insurance agencies, adver tising and public relations agencies, management consult ing firms, human resource and compensation specialists, safety experts, and the like. The employees of these outside firms have agency duties to their clients. Inside a firm, employees are a major group of agents, especially those employees whose job is not merely to perform a specific task, like assembly line workers, but to exercise judgment and discretion over matters where they know, perhaps b etter than their employer-principal, how a job is to be
performed. Employees are also agents in matters where they can legally bind their employer or can expose the employer to legal liability. Thus, a purchasing agent who can sign a contract that legally commits a company to a purchase, or a truck driver whose accidents can lead to lawsuits for injuries, is considered an agent of the employer.
The main duties of agents are as follows: • to work as directed, • to perform tasks with competence and care, and • to act in all matters within the sphere of their role in
the interest of the principal. More specifically, an agent has a duty to act only within the scope of his or her authority and not to exceed it, to avoid conflicts of interest that interfere with an ability to act in the principal’s interest, and to preserve the confi dentiality of information.
The Agency Relationship
Given the duties of agents, what corresponding duties (if any) do principals have to their agents? Develop an example of one general duty of principals in a principal—agent relationship.
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2.2.2: Fiduciaries and Professionals
In law, all agents are fiduciaries, though not all fiduciaries are agents who are pledged to serve the interest of a princi pal and empowered to act on that party’s behalf. The defin ing characteristics of a fiduciary are thus different from those of an agent. Although agency relations in business are ubiquitous, nonagent fiduciaries are less common but still very important roles. Being a professional is also a carefully defined role that applies to only a few but impor tant business occupations.
FiduciaRies A fiduciary is a person who has been entrusted with the care of another’s property or assets and who has a responsibility to exercise discretionary judg ment in this capacity solely in this other person’s interest. Common examples of fiduciaries are trustees, guardians, executors, and, in business, officers and directors of corpo rations, who have a fiduciary duty to the corporation and its shareholders. Partners in a business venture are fiduci aries for each other, and banks and investment firms are fiduciaries for their depositors and clients. Fiduciaries pro vide a valuable service for individuals who are unable for some reason to manage their own property or assets. A
fiduciary is one part of a fiduciary relationship, in which the other party is the beneficiary of the fiduciary’s service. A fiduciary duty may be defined as the duty of a person in a position of trust to act solely in the interest of the ben eficiary, without gaining any material benefit except with the knowledge and consent of this person.
A fiduciary relationship has two elements: trust and confi
dence.
Something is entrusted to the care of a person with the confidence that proper care will be taken. Broadly, the duty of a fiduciary is to act in the interest of the beneficiary. This duty, which requires the subordination of self-interest, con trasts with market conduct, in which everyone is assumed to act out of self-interest. As Justice Benjamin Cardozo famously observed, “Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is the standard of behavior.”21 The main elements of fiduciary duty—candor, care, and loyalty—are explained in Figure 2.2.
pRoFessionals The conduct of physicians, lawyers, engineers, and other professionals is governed by special professional ethics. Which occupations are professions is subject to dispute, but there are three commonly accepted defining features of a profession.
Figure 2.2 Main Elements of Fiduciary Duty
A specialized body of knowledge. Professionals do not merely have valuable skills, like those of a plumber, but possess a highly developed, technical body of knowledge that requires years of training to acquire.
A high degree of organization and self-regulation. Pro- fessionals have considerable control over their own work, and, largely through professional organizations, they are able to set standards for practice and to disci- pline members who violate them.
A commitment to public service. The knowledge pos- sessed by professionals serves some important social need, and professionals are committed to using their knowledge for the benefit of all. These three features are closely related and mutually reinforcing. It is because professionals possess a specialized body of knowledge that they are given a high degree of con- trol over their work. For the same reason, we leave it to pro-
fessionals to determine what persons need to know to enter a profession and whether
Loyalty
A duty of loyalty requires a fiduciary to do two things: • Act in the interest of the
beneficiary, by acting as the beneficiary would if he or she had the
knowledge and skills of the fiduciary.
• Avoid taking any personal advantage of the relationship. Taking personal advantage is deriving any benefit from the relationship without the knowledge and consent of the
beneficiary.
The Duty to Act in Another’s Interest
A business hires an interior designer to redecorate its offices and gives the designer an agreed-upon amount to spend on everything that is needed. Would you consider the designer a fiduciary or an agent of the company? What duties would such a person have in this relationship, and what would be the basis for these duties?
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they know it. There is a danger in giving so much independence and power to profes sionals, but we have little choice if we are to enjoy the benefit of their valuable special ized knowledge. Consequently, profession als enter into an implicit agreement with society: In return for being granted a high degree of control over their work and the opportunity to organize as a profession, they pledge that they will use their knowl edge for the benefit of all. Without this guarantee, society would not long tolerate a group with such independent power.
The standards of a profession include both technical standards of competence and ethical standards. Ethical standards are generally presented in a code of professional ethics, which is not only a mechanism for the self-regulation of a profession but also a visible sign of the profession’s com mitment to public service. A code of ethics is not an option for a professional but something that is required by the nature of professionalism itself. Developing a code of eth ics is often the first step taken by an occupational group that is seeking recognition as a profession.
2.2.3: Firms
Business is conducted not only in markets but also in firms: business organizations or corporations. Thus, markets and
firms are two basic spheres of business activity to which ethics applies. The focus of this chapter so far has been on markets, although firms have also been considered as mar ket actors. The question arises, therefore, whether firms should be understood merely as market actors for which market ethics is sufficient or whether there is also an ethics for firms and their activities. What attention must business ethics give to the fact that much business activity takes place in firms, as well as in markets? Standard economic theory has tradi
economic view
tionally viewed the firm as a market actor like an individ ual, making decisions with a view to seeking maximum profits. The firm itself has generally been considered to be a “black box,” whose internal workings are irrelevant to economics. The result has been a neglect of any moral issues that arise from the existence of firms as distinct enti ties. Individuals may act rightly or wrongly, virtuously or not, but the firm itself is merely a market actor who raises no ethical issues beyond those of individuals acting in a market. This view has been replaced in recent decades, however, with an understanding of the firm as a combina tion of markets and relationships. The starting point of this new economic view is a 1937 article by the Nobel Prize–winning economist Ronald Coase, “The Nature of the Firm,” in which he asked why all economic activity does not take place in a market.22 That is, why do firms exist at all? His answer was that some economic activity is more efficiently organized in hierarchical relationships rather than in transactional mar kets. Thus, according to Coase, there are two fundamental ways of organizing economic production: in markets and in firms, using transactions and relationships, respectively. In a market, all activity is conducted by voluntary, mutu ally advantageous transactions. In a hierarchical firm, peo ple submit to authority relationships and agree to work in cooperation with or at the direction of others. Much of the activity of a firm with outside parties— both individuals and other firms—is conducted in arm’s length market transactions, which fall in the domain of market ethics. These other parties include suppliers in commodities markets, consumers in products markets, workers in labor markets, investors in financial markets, and so on. Indeed, much of a firm’s activities consist of market transactions or contracts, and the inside of a firm has many elements of a market system. For example, employees may be aware of their other employment opportunities and may leave if another employer offers higher pay. However, employees also become agents of the employer and assume the duties of an agent while they are employed. Some members of a firm, including the chief officers and board directors, are also fiduciaries with the standard fiduciary duties. To the extent that employees or
other individuals or groups enter into these relationships, they take themselves out of a market and become organ ized in systems of roles and relationships.
The outcome of the economic view of the firm, then, is that business ethics consists of both the ethics of transac tions in a market and the ethics of roles and relationships in a firm. And these two ethics apply to both individuals and firms. Like individuals, firms in markets have the market ethics obligations to observe all agreements or contracts, avoid force and fraud, not inflict wrongful harms, and act responsibly in cases of market failures. Business firms can also be agents and fiduciaries; and in these roles and rela tionships, they, too, have duties similar to individuals.
In the language of the law, a firm is a corpo ration. This legal entity, the corporation, was described by Chief Justice John Marshall in his famous 1819 Dartmouth College v. Woodward decision as “an artificial being, invisi ble, intangible, and existing only in contemplation of law.” As a legal person which is distinct from the individuals or natural persons who compose it, a corporation can own property, make contracts, sue and be sued, and otherwise conduct business in its own name. The founders of a corpo ration invest their own private property in a joint venture, but the corporation, once founded, is legally separate from any individuals and is the property of no one. A corpora tion owns itself in the same way that natural persons belong to no one else. The property that the founders have invested in the corporation is given up in exchange for some set of rights, which include, usually, the right to control the busi ness and a right to receive its profits. A corporation can also survive the death of its founders, and thus it enjoys the con venient benefit of unlimited life or immortality.
The recognition of a corporation as a legal person gives rise to many difficult legal and ethical questions, such as the following:
leGal view
Do corporations have the rights that the law confers on natural persons, such as the right to engage in free speech and the right to make political contributions?
If a corporation is a collective entity that is composed
f individuals and yet is distinct from them, how should we view corporate wrongdoing?
Can a corporation be blamed for misconduct, or should wrongful acts be ascribed only to particular individuals?
And if corporations can be blamed for wrongdoing apart from the acts of individual members, then can they be held criminally liable and be subjected to crim- inal penalties?
If business corporations are founded to enable individ- uals to conduct business in the corporate form, usually with the aim to make a profit for the founders, should they also be expected to exercise social responsibility?
Debate has long raged over the justification for allow ing the creation of corporations as legal persons. One justi fication, which may be called the property rights theory, holds that the right to incorporate is an extension of the property rights and the right of contract that belong to all persons.23 Just as individuals are entitled to conduct busi ness with their own assets, so, too, have they a right to con tract with others for the same purpose. This theory receives support from the fact that the original form of the corpora tion was the joint stock company, in which a small group of wealthy individuals pooled their money for some under taking that they could not finance alone. In a pure expression of the property rights theory, the Michigan State Supreme Court declared in Dodge v. Ford Motor Co. (1919),
“A business corporation is organized and carried on pri marily for the profit of the stockholders.”24
The idea that corporations are the property of the shareholders, to be operated for their benefit, had greater validity before the separation of ownership and control noted by Adolph A. Berle and Gardiner C. Means in their
1932 book The Modern Corporation and Private Property.25
Berle and Means contended that shareholders ceased to be owners in any meaningful sense once effective control of corporations was assumed by professional managers. Another justification—let us call it the social institution theory—holds that the right to incorporate is a privilege granted by the state for some social good and that corpo rate property thus has an inherent public aspect.26 The social institution theory emphasizes that a corporation is not merely a private association created for the purpose of personal enrichment but also a public enterprise that is intended to serve some larger social good. Support for this theory is provided by the fact that the earliest joint stock companies were special grants that kings bestowed on favored subjects for specific purposes. In contrast to the Dodge v. Ford Motor Co. decision, E. Merrick Dodd argued the following point in a famous 1932 debate with Adolph A. Berle: The corporation is “an economic institution which has a social service as well as a profit-making function.”27 Dodd also argued that corporate managers have a right, even a duty, to consider the interests of all those who deal with the corporation.28 With the rise of the idea that corporations have a social responsibility, Berle conceded that public opinion and the law had accepted Dodd’s con tention that corporate powers ought to be held in trust for the whole of society.29 Whereas economists speak of
socioloGical view
firms and legal theorists of corporations, sociologists pre fer the term “organization” as the unit of analysis. This term stresses the similarity of business corporations with
other, nonbusiness organizations in which human beings associate for some end.
All organizations are characterized by a common purpose or goal, a structure of roles and relationships, and some decision-making processes.
Viewed as an organization, the firm is a kind of com munity with all the needs for morality that arise in such organized human groups.
This expanded view of the business firm incorporates most of the economic view and adds other elements.
1. Organizational Ethical Climates. Chief among these elements is the existence of distinctive organizational ethical climates, which embody certain values, beliefs, assumptions, perceptions, and expectations.30 The ethical climate of an organization can profoundly in fluence how members identify moral issues, make moral judgments, arrive at decisions, and ultimately act. Organizations with a good ethical climate can foster exemplary moral conduct, while organizations that lack one can socialize otherwise good people into wrongdoers.31 A task for the leaders of organizations is to determine the desired ethical climate and to cre ate and sustain it. Members of an organization must understand the organizational ethical climates they en counter, including the climates’ positive and possibly negative impacts.
2. Organizational Justice. A second element introduced by the sociological view is organizational justice. In or ganizations, decisions are made that impact individu als and groups in different ways, benefiting some and harming others, and it is critical for smooth organiza tional functioning that these decisions be accepted as just.32 People in organizations have a strong sense of fair treatment, of “how things should be,” and they re act quickly when they believe they are being treated unfairly. Much of the concern with organizational jus tice revolves around the rules and policies of organi zation, both written and unwritten. Managers must ensure, therefore, that an organization’s rules and poli cies are perceived as just, in both their formulation and implementation.
3. Organizational Harms. Organizational harms consti tute a third element that raises ethical issues on the sociological view. Many of the wrongs that are com mitted by business are attributable to the whole organ ization rather than the actions of a few identifiable individuals. They often result from a sequence of deci sions that may be made without a full understanding of their consequences. Indeed, it is often difficult to identify any specific individuals who caused a com pany to produce, say, a defective product or an indus trial accident. As one writer observes, “[T]he harm
may seem to be an organizational product that bears no clear stamp of any individual actor.”33 It is not suf
ficient, therefore, for individuals in organizations to attend only to their own ethics and strive to be ethical themselves; it is necessary, as well, to appreciate the powerful forces that cause individuals to participate in organizational wrongdoing and to develop procedures and systems for preventing organizational harms.
2.2.4: Summary of Roles, Relationships, and Firms
Business ethics, understood as the ethical rules and princi ples that apply to business conduct, may be divided into two ethics: the ethics of the market and the ethics of roles and relationships. In the absence of any roles or relationships, including those in firms, individuals and firms relate to each other as market actors who are bound only by the eth ics governing market transactions. Although this market ethics is extensive, it does not include a requirement that market actors consider any interests but their own. The jus tification for this market ethics is due primarily to the fact that the two parties in a market transaction reach a mutu ally beneficial agreement and give their consent to it. Much of the need for ethics in markets, as well as for regulation, occurs when markets are imperfect because of market fail ures or when market outcomes are unfair. Although market actors typically have no obligation to consider the interests of others, such an obligation may nevertheless arise through the market itself when individ uals and firms agree to assume certain roles or to enter into certain relationships. Such roles and relationships are ubiq uitous in business, and the obligations that attend these roles and relationships, including activity conducted in firms, constitute much of business ethics. The exact content of these role and relationship obligations is determined by the agreements or contracts that create them. example: Employers and employees are free to con tract on various terms, so the obligations that each has toward the other depend, in part, on the specifics of the contracts themselves (although some obligations in the employer–employee relationship, such as to provide a safe and healthy workplace, are due to mar ket ethics). Thus, an employer may have no obligation to offer a pension plan; but when one is offered, the employer (voluntarily) assumes, by contract, the obli gations of a fiduciary. The justification for these role and relationship obligations and their specific terms derives, like the justification of market transactions, from the voluntary consent that creates them. Finally, business firms are constituted by myriad roles and relationships, which involve a complex set of obliga tions. Many of these obligations are those of market ethics,
while others arise from specific roles and relationships. Because firms are community-like organizations to which people devote much of their life and on which their liveli hood depends, managers must attend to the organizational ethical climate, to justice within the organization, and to the possible organizational harms that could be produced.
2.3: Ethical Reasoning
2.3 describe the philosophical and psychological
approaches to ethical reasoning and the principles that constitute a moral framework for business conduct
Understanding business ethics as the ethics of market trans actions and the ethics of roles and relationships provides some useful guidance for decision makers. For starters, anyone in business should begin by asking whether one is dealing with other parties purely as market actors or whether one is in a particular role or relationship. Many of the rules and principles of market ethics and of the ethics of roles and relationships are clearly defined: One should keep all agreements and avoid fraud, for example, and employ ees should be loyal agents for their employer. In many situ ations, however, the precise contours of one’s duties or obligations are far from clear and require moral reflection. For example, one may be uncertain whether the failure to disclose certain information constitutes fraud or whether a certain disclosure is a violation of an agent’s duty. The duty of an agent to preserve confidentiality might have an excep tion for whistle-blowing to protect others, or this duty might be outweighed by a more stringent duty to blow the whistle. Such moral uncertainty requires business people to engage in ethical reasoning to determine what ought to be done or what is the right thing to do.
Ethical reasoning varies in level from the ordinary moral deliberation that everyone engages in before acting to the very sophisticated moral arguments that draw heav ily on ethical theory. Complex moral controversies over such ethical issues as privacy, discrimination, worker health and safety, and international labor standards require a deep understanding of the relevant facts in addition to the relevant ethical principles. Examples of ethical reason ing are provided by the extensive studies that governmen tal and nongovernmental bodies engage in before making recommendations on important matters. Any recommen dations made by such bodies are only as strong as the arguments supporting them. Some of the most difficult moral controversies are those in which competing or con flicting ethical considerations are involved.
examples:
Affirmative action designed to correct past discrim- ination is alleged by its opponents to be itself a form
f discrimination.
• Foreign sweatshops may involve exploitation of workers but are, at the same time, a significant resource for development. • And finally, ethical reasoning must be reconciled with powerful business imperatives. If the ethical course of action involves significant costs that reduce profits, for example, then the arguments for it need to be very compelling. Ethical reasoning can be understood both as an intel lectual procedure for justifying ethical judgments and as a psychological process whereby people actually form ethi cal judgments. For an account of the former concept of ethical reasoning, we need to turn to philosophy; for the latter, psychology provides an explanation.
2.3.1: Philosophical Accounts
What does it mean for a person to engage in ethical reason ing? One philosophical account is that engaging in ethical reasoning means taking the moral point of view. The moral point of view is a standpoint from which ethical decisions are made that structures how ethical decisions should be made and what considerations are relevant in making a sound ethical decision. In this respect, the moral point of view is an ideal perspective that may or may not actually be adopted by all individuals in all circumstances.
the moral point of view has two important fea tures.34 the first is a willingness to seek out and act on
reasons. The best action, according to one writer, is “the course of action which is supported by the best reasons.”35
It indicates a commitment to
use reason in deliberating about what to do and to construct persuasive arguments that consider impor- tant facts,
effectively weigh consequences and alternatives,
express clear goals or objectives, and
avoid inferences that are hasty or impulsive.36 An important first step in finding the “best reasons” to
support a particular ethical decision or course of action, therefore, begins with principles that express general values that others can understand as important and worthy of respect. Examples include the requirements to protect indi- vidual rights, promote welfare, treat others fairly, and remain honest. These principles are justified not simply because they are preferred or are accepted as part of a pre- vailing social convention; rather, they are grounded in the most general and comprehensive values recognized by everyone, regardless of specific social circumstances.
A commitment to find the best reasons also involves
the consistent application of ethical principles. An indi- vidual’s previous decisions set a precedent for future deci- sions. This is one of the marks of remaining rational in
one’s decisions. For example, if someone maintained that breaking a promise should be avoided because it violates the principle to be honest, then a consistent application of the principle requires the same judgment in other cases involving promises. Ethical principles cannot be selec tively applied without regard for how they relate to all similar situations.
Astute observers will quickly reply that different cases always exhibit subtle variations and that what a principle entails in one situation may vary from its implications in others. Suppose, for example, that a promise that was obtained through coercive means is actually harmful to the person who made the promise. Does the principle to remain honest require that this person honor a promise made under these circumstances? In such a case, unique facts may justify a decision to break the promise even if breaking promises should generally be avoided because of the high value we place on honesty. The presence of coer cion provides a special reason that weighs against keeping a promise for reasons of honesty. The important point, however, is that this decision-making process still remains focused on finding the best possible reasons for justifying departures from the otherwise consistent application of a principle. Finding the best reasons to justify an ethical deci sion involves a careful consideration of the particular facts of a case, in light of the general ethical values expressed in principles. Sound ethical decisions recognize the general importance of principles, while also acknowledging that there are novel situations in which particular facts justify modifying what a principle ordinarily requires.37 a second important feature of the moral point of view is that it requires us to be impartial. We must regard the interests of everyone, including ourselves, as equally worthy of consideration. This does not entail that every one’s interests always deserve equal weight but only that everyone’s interests deserve consideration in making sound ethical decisions. This feature of the moral point of view allows one’s own self-interest to be part of an overall assessment about what course of action should be taken, but it precludes the point of view that one’s self-interest is the only relevant consideration in making a sound ethical decision.
Notice that this feature of impartiality is captured in the content of the ethical principles previously discussed. The principles to respect individual rights, enhance wel fare, treat others fairly, and be honest are examples of how sound ethical decisions advance others’ interests, for their own sake. These principles also underscore how the moral point of view is, by its very nature, a public point of view in the sense that it involves a shared set of principles that can be accepted and observed by everyone.38 A good test of the moral point of view is whether our colleagues, friends, and family understand and accept the decisions we make. A decision made from the moral point of view can
withstand and even invites this kind of openness and scru tiny because it is expected that ethical decisions impartially balance the interests of everyone.
The Moral Point of View
How is adopting a “moral point of view” different from what is com monly considered “being reasonable”? What are some challenges to ethical reasoning?
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2.3.2: Psychological Accounts
Psychologists, who are concerned to describe how we actu ally reason in matters of ethics as opposed to what consti tutes sound ethical reasoning, generally consider this subject as part of a larger process of decision making that results in behavior. What psychologists have concluded from experimental observations is that our decisions and consequent behavior are based far less on reasoning than is
commonly thought. Many of our judgments about right conduct are attributed by psychologist Daniel Kahneman to quick and largely subconscious intuitive reactions, which he calls System 1 thinking.39 The kind of ethical rea soning that consists of the conscious consideration of good reasons and the logical evaluation of arguments—which philosophers idealize—occurs only infrequently and with great difficulty in System 2 thinking, which is utilized typi cally only when intuitions fail. Decisions made in System 2 seldom run counter to intuitive reactions and, indeed, often may serve merely to rationalize them.
Another perspective on the psychology of ethical deci sion making and ethical behavior is that of Lawrence Kohlberg, who proposed the theory that people develop the cognitive ability to engage in ethical reasoning through a series of three levels, each divided into two stages, in a process that takes place from infancy to adulthood (see Figure 2.3).40
A disturbing discovery of psychologists is that higher levels of ethical reasoning—Kahneman’s System 2 or Kohlberg’s Level 3—do not necessarily produce more eth ical behavior. These higher levels may involve greater intellectual engagement (Kahneman) or cognitive devel opment (Kohlberg), and they may also enable individuals
Figure 2.3 Kohlberg’s Six Stages of Moral Development
Level 3 Post-Conventional Morality
Stage 6: Universal Principle Orientation
Motivation: To live in a just society of free and equal persons.
Perspective: Respects all people as free and equal, and recognizes abstract, general moral principles (such as rights and justice) as binding on all people.
Stage 5: Social Contract and Individual Rights Orientation
Motivation: To satisfy self-interest by cooperating with others.
Perspective: Recognizes that people have di erent interests that can be reconciled by mutually advantageous cooperation.
Level 2 Conventional Morality
Stage 4: Authority and Social Order Orientation
Motivation: Conformity to requirements of living in society.
Perspective: Recognizes importance of system for social order.
Stage 3: Good Interpersonal Relations
Motivation: Conformity to the expectations of others.
Perspective: Respects the interests of others.
Level 1 Pre-Conventional Morality
Stage 2: Self-Interest Orientation
Motivation: What’s in it for me?
Perspective: Sees that others have interests that can be manipulated for own benefit.
Stage 1: Obedience and Punishment Orientation
Motivation: What’s going to happen to me?
Perspective: Recognizes only self and own interests.
Table 2.2
Moral Development According to Kohlberg
Try to identify the stages associated with each level of moral development, as well as how these levels correspond to an increasing capacity for ethical reasoning. Hide the cells in the table to check your understanding.
1. Pre-Conventional Morality
1. Obedience and Punishment Orientation 2. Self-Interest Orientation
People are focused on themselves and incapable of other-oriented ethical reasoning or behavior.
3. Post-Conventional Morality
5. Social Contract and Individual Rights Orientation 6. Universal Principle Orientation
People* can engage in mutually advantageous cooperation, understand the value of abstract moral principles, and practice sophisticated ethical reasoning.
*Fewer than 20% of adults
to make sounder judgments about right conduct; but they may not actually lead individuals to act more ethically— or to be as ethical as they think they are.41 Research has shown that people’s predictions about how ethical they would be in hypothetical situations often conflict with their actual behavior.42 The same disconnect applies to the philosopher’s other central concept of character or virtue: A strong moral character may prove to be a weak bulwark against involvement in unethical conduct.43 Both the deci sions we make and the behavior that follows are subject to many psychological quirks that are embedded deeply in the human brain. Moreover, character turns out to be a highly malleable and fluctuating factor in our decision making and behavior. One factor identified by psychologists as a counter to the roles of reasoning and character in decision making and behavior is context. Context matters, they say. In par ticular, human beings have strong tendencies to submit to authority and to conform to those around them. Thus, the presence of an authority figure or an outspoken peer may influence people unawares. Such environmental factors as whether others are watching or time is short have been shown to affect people’s degrees of honesty, generosity, and the like. Individuals with a fixed character may thus act differently under different environmental conditions. A possible explanation for people’s faulty predictions about how ethical they would be is that decisions about hypo thetical future situations focus attention on general princi ples of right conduct, while decisions made at the time of an action are influenced more by practical considerations. For example, a test subject who is certain that she would give to a worthy cause at some future date may fail to do so when the time arrives if she is concerned about having enough money for lunch.44 A second important factor cited by psychologists that counters reasoning and character is rationalization, which is to say people’s ability to find justifications for what they want to do. This ability to rationalize conduct in ourselves that we might quickly fault in others is facilitated by many means, including partial and distorted perceptions and
fabricated and conveniently suppressed memories. Research has found that people cheat more than they care to admit, but that they also want to maintain a positive image of themselves as basically ethical.45 The psycholo gist Dan Ariely explains this discrepancy: “Essentially, we cheat up to the level that allows us to retain our self-image as reasonably honest individuals.”46 In sum, ethical rea soning as described by psychologists is far less a matter of an ethereal mind, as in the philosophers’ idealized view, and more rooted in the corporeal brain of social animals.47
Use Table 2.2 to review Lawrence Kohlberg’s stages of moral development and their significance.
2.3.3: Framework for Reasoning
No framework can be comprehensive enough to capture the full complexity and diversity of ethical reasoning. However, it is possible to formulate a few basic ethical principles that are commonly recognized by business peo ple and are expressed in corporate codes of conduct.
Of course, a framework is of no use unless a person recognizes that a situation presents an ethical issue that requires some moral reflection. So an awareness of the ethical dimensions of a situation is a nec essary precondition for the application of any framework. One factor that might make one aware of an ethical issue is a consideration of any harm that is done. What makes moral wrongdoing of any significance is that someone is usually made worse off. Not every action that harms another is wrong, but any harm should be investigated for possible wrongdoing. That is, anytime a person is harmed, we should stop to consider whether a moral wrong has occurred. Hence, a careful consideration of the conse quences of any action helps increase moral awareness.
For example, illegal copying of software might seem like a victimless crime, but a thorough search for conse quences would reveal the harm done to software develop ers and legitimate users. The whole of society would be worse off without respect for intellectual property rights. Another factor that increases moral awareness is the
awaReness oF issues
language used to describe actions. Thus, to speak of steal ing software or of software piracy makes us aware of the moral issues at stake.
Personal Awareness of Issues
List several ethical issues in business that you are personally con cerned about or that you think create serious problems in society. Why do you characterize these issues as ethical issues? What ethi cal values or principles underlie each?
The response entered here will appear in the performance dashboard and can be viewed by your instructor.
Once we are aware that there may be a moral issue in a situation, the next task is to iden tify that issue. This task is facilitated by gathering and understanding all the relevant facts, including the full range of consequences. Following this step, the major task of ethical reasoning is to identify the relevant ethical prin ciples and subsequently to determine how to honor best the values expressed in them. These principles may be grouped under seven headings as part of a framework for ethical reasoning (see Figure 2.4 below).
identiFyinG issues
Figure 2.4 Framework for Ethical Reasoning
1. Welfare. We often use the overall impact on people’s welfare—“The greatest good for the greatest num ber”—as a justification for making social improve ments, and we consider the alleviation of suffering (after a natural disaster, for example) to be a moral imperative. Although the promotion of welfare is a good, a person may have no duty or obligation to promote it in any given instance, and some harm may result without anyone being responsible for it. In
general, inflicting harm becomes a moral matter only when some wrong is committed, which was described previously as a wrongful harm. Still, welfare is an im portant value in ethical reasoning: Welfare should be promoted, and any infliction of harm requires some moral justification.
In business, the welfare principle requires that a manager take into account the impacts that personnel decisions and policies have on employees, that prod ucts and services have on consumers, and that corpo rate activities have on communities. Although layoffs, for example, are sometimes unavoidable, they should be done in ways that minimize the human cost and enable employees to seek other employment. Manu facturers have an obligation to ensure that their prod ucts are reasonably free of defects that can cause serious injury or death. When companies engage in activities that harm communities—as when banks were charged with refusing loans in poor areas, a now illegal practice known as “redlining”—they commit a moral wrong.
2. Duty. A duty or an obligation (the two concepts are used here interchangeably) is a moral requirement to act in a certain way, something that we ought to do. Such a requirement may be one imposed on all per sons, such as a duty to tell the truth or to keep prom ises. Many duties in business arise from agreements or contracts, which are kinds of promises, and from the assumption of specific roles and relationships, as is done by agents and fiduciaries (who have an agency and a fiduciary duty, respectively). Duties are espe cially associated with professionalism since profes sionals explicitly assume certain responsibilities that they have a duty to fulfill. A person who has a duty is expected to fulfill it without regard for his or her own interest, which means that a person with a duty, say a fiduciary, is expected to be diligent, to exercise care and loyalty, to not engage in self-dealing, and to avoid conflicts of interest that would interfere with the per formance of a duty.
3. Rights. A right is an entitlement whereby a person is due certain treatment from others. Rights are of ten said to be correlated with duties such that if one person has a right, then another person has a duty to treat others in a certain way. In business, certain rights are generally recognized for employees, including the right to privacy, a right not to be discriminated against, and a right to a safe and healthy workplace. Other rights are commonly accorded to consumers (con sumer rights) and investors (the rights of bondholders and shareholders). One of the most important rights in business is property rights, which are basic to markets (since a transaction is a transfer of property rights) and
important for profitability (without patent rights, for example, innovation would be discouraged). Rights are also closely related to the welfare principle inas much as many wrongful harms are wrong precisely because they involve the violation of some right. For example, a person may be harmed when refused a job, but a refusal to hire itself may not be a wrongful harm unless it involves a violation of a right, such as the right not to be discriminated against.
4. Fairness. Fairness or justice—which means, very roughly, equal treatment or different treatment ac cording to some justified differences—is applied to a wide range of activities and practices in business. We speak of fairness in market exchanges (with regard to committing fraud, for example, taking unfair advan tage of another or setting a fair price), of fair compe tition (which rules out monopolies, anticompetitive sales practices, and price-fixing), of fair labor practices (treating employees fairly in hiring and promotion, of fering fair wages, allowing collective bargaining), of the fair sharing of burdens (not being a freeloader or a free-rider), and of fairness to creditors and investors (treating them fairly in bankruptcy, for example, or in matters of corporate governance). Fairness or justice is also closely related to rights inasmuch as unfair or unjust treatment often involves violating someone’s rights. Thus, discrimination is unfair, but it is also a violation of rights. In this case, applications of the con cepts of fairness and rights may be merely different ways of describing the same moral wrong. 5. Honesty. Although honesty may be regarded as a du ty—a duty to tell the truth—it is important enough in business to be considered a basic ethical principle. As previously noted, markets require a certain amount of information, and fraud, which involves the mis representation of a material fact, is a prominent vi olation of market ethics. Furthermore, the business system requires an abundance of accurate and relia ble information. This is especially true of financial in formation, which companies are required to disclose and which is subject to certified audits. Accounting fraud is a particularly serious breach of honesty that causes a great deal of harm. Honesty is a value that is lost when bribes are paid to public officials since such corrupting payments deprive countries of the honest services of their officials. Honesty is also an important element in developing the kind of trust, with employees, customers, and the public, that suc cess in business requires. It is integral to a company’s reputation. 6. Dignity. The concept of dignity expresses the funda mental ethical principle that all people deserve respect as human beings. All moral systems regard persons as
autonomous moral agents who should be free to make their own decisions and pursue their aims in life. This view is expressed in Immanuel Kant’s idea that every one should be treated as ends in themselves and not as a means to be used solely for the benefit of others. Human dignity is denied when people are subject to violence, coercion, manipulation, degradation, or the risk of serious injury or death. Often, people’s dignity is denied when their rights—especially fundamental human rights—are violated. The principle of dignity is most commonly employed in business in operations in less-developed countries where standards of accept able business conduct may be lower or ineffectively enforced. In particular, environmental damage from mining and oil production and working conditions in garment factories have been criticized as violating a principle of dignity or respect for persons. 7. Integrity. Integrity is an elastic term that denotes a person of character or virtue who holds the right val ues and has the courage of his or her convictions.48 According to Robert Solomon, “Integrity is not so much a virtue itself as it is a complex of virtues, the virtues working together to form a coherent charac ter, an identifiable and trustworthy personality.”49 The concept is also widely adopted in business codes of conduct not only to describe an ideal for employ ees but also to characterize the company itself. Motorola, for example, has adopted the slogan “Uncompromising Integrity” as its guide for conduct worldwide. Lynn Paine also uses the term “integrity strategy” to describe a value-based form of internal control, which she calls “moral self-governance.”50 A person or an organization with integrity would be one that adheres to the other six ethical principles described here.
These seven principles of accepted business conduct express virtually the whole of business ethics. Their usefulness as a guide, though, is limited by the problem of interpretation or application. How one uses this framework in practice to resolve issues is critical. The main value of these principles lies in posing a set of ques tions that a person should ask when making a decision in a situation that raises ethical issues:
ResolvinG issues
Who is affected by any proposed course of action? Is anyone harmed, and if so, can the harm be justified?
What is my duty in this situation? In particular, are there any special duties that belong to any role or rela- tionship that I am in?
Are anyone’s rights being violated, and if so, can the violation be justified?
Is any proposed course of action fair to all affected parties?
Am I being entirely honest in my decision?
Am I showing respect for all persons involved?
Finally, is the decision one that would be made by a person of integrity? In addition to these questions, there are others that can
guide one in making the right decision by testing whether
ne has applied the seven principles correctly. Having applied these principles, a decision maker should also develop a sound rationale that supports the correctness of the application. Since the results of ethical reasoning must be defensible to others and not merely acceptable to one- self, a person might consider how the decision would appear to other parties, especially any ones adversely affected. How decisions appear to others be tested in a number of ways, as shown in the box at right.
Tests of Ethical Decisions
the “sunshine test” How confident one feels that any decision could be defended in a public forum
the “newspaper test” How willing one would be for a full account of
ne’s actions to appear in a newspaper
the “mirror test” How one feels looking in a mirror
the “legacy test” How one would like to be remembered
the “tombstone test” What one would want engraved on a tombstone
Conclusion: Ethical Decision Making
Ethical decision making in business is often difficult and complex. Some situations are easily handled because what one ought to do or what is right and wrong is evident. Those situations that give us pause or produce moral anguish require careful thought and ultimately an ability to engage in ethical reasoning. This chapter contributes to an understanding of ethical decision making by offering a division of business ethics into two parts: an ethics of the market and an ethics of roles and relationships, including firms. In business, we deal with some parties purely as mar ket actors who are on the other side of a market transaction or exchange. For such market activity, certain moral rules or standards apply. Much of business, however, involves roles and relationships and takes place in firms or organizations. These roles, relationships, and firms arise in a market, but, by mutual agreement in a market, we take ourselves out of the market and govern our actions by a different “ethics,” the ethics of these roles and relationships. When we attempt to think through the ethical issues that arise in business, we are engaging in ethical reasoning, which may be conducted on different levels. Ethical theo ries, which are presented in the next chapter, can guide ethi cal reasoning on the highest level by providing the most comprehensive and fundamental grounds for our moral beliefs and judgments. Fortunately, substantial moral argu ments can be constructed that do not require an understand ing of these theories. Most of our everyday ethical reasoning employs familiar ethical concepts and principles that can be readily understood and applied. Accordingly, this chapter provides a framework of seven basic ethical principles that are sufficient for most business decision making.
End-of-Chapter Case Studies
This chapter concludes with three case studies.
Each case provides opportunities to explore different aspects of two important themes presented in this chapter: the ethics of the market and the ethics of roles and relation ships. At the Harvard endowment fund, managers were paid for performance, which was spectacular, but the reaction from alumni, faculty, and students brought into question the fair ness or justice of the market as a mechanism for determining appropriate compensation. The Bankers Trust case illustrates a common quandary for service providers: Are they merely market actors, bound only by the ethics of the market, or are they in a relationship that requires them to consider the best interests of a client? The decision of a few partners at the tax and consulting firm KPMG, despite reservations by others, to pursue a legally questionable line of business reflects a dis missive attitude toward legal compliance.
Case: Lavish Pay at Harvard
In 2004, Jack R. Meyer, the head of Harvard University’s $20-billion endowment fund, was under pressure to change the compensation plan for the fund’s top investment man agers. The previous year, the top five managers of Harvard Management Company, who were university employees, received a total of $107.5 million. The two most successful
managers earned more than $34 million each, while Mr. Meyer’s own paycheck was $6.9 million.51
A few Harvard alumni protested. Seven members of the class of 1969 wrote a letter to the university president calling the bonuses “unwarranted, inappropriate and con trary to the values of the university.” One signer of the let ter explained, “Our collective concern is that we think the amounts of money being paid to these folks are by almost any measure obscene.”52 They added, “Harvard should use its endowment for the benefit of students, not for the benefit of people who manage the endowment.”53 The alumni suggested that the millions of dollars paid to fund managers should be used instead to reduce tuition. Angry threats were made to withhold gifts to the university unless the compensation was reduced. The letter said, “Unless the University limits payments to financial managers to appro priate levels … we see no reason why alumni should be asked for gifts.”54 The compensation of the endowment fund managers far exceeded the salaries of Harvard faculty members and administrators, including the president, who made around half a million dollars. The 5-percent hike in tuition for Har vard students in 2004 was equal to the $70 million paid to the two highest earners. One critic noted, “The managers of the endowment took home enough money last year to send more than 4,000 students to Harvard for a year.”55 Although Harvard has the largest university endow ment, the salaries and bonuses paid to the managers greatly exceeded the compensation paid at any other school. The head of Yale’s third-place endowment was paid slightly over $1 million in 2003.56 However, Yale, like most univer sities, does not manage its investment fund in-house. When management of an endowment is outsourced, the manag ers are not university employees, and the fees paid to them, which may be as high as or even higher than those at Har vard, do not need to be reported. Mr. Meyer and his team of managers have produced consistently superior returns for the Harvard endowment. Over a period of 14 years, he increased the endowment from $4.7 billion to $22.6 billion. Over the previous 10 years, the Harvard fund had an average return of 16.1 per cent, which is far above the 12.5 percent return of the 25 largest endowments.57 If the fund had produced average returns during this period, the endowment would have been one-half of what it was in 2004, which is a difference of almost $9 billion. One person observed, “With results like that the alumni should be raising dough to put a statue of Jack Meyer in Harvard Yard, not taking potshots at him.”58 Mr. Meyer observed, “The letter [from members of the class of 1969] fails to recognize that there is a direct con nection between bonuses and value added to Harvard. If you don’t pay the $17.5 million bonus, you don’t get the approximately $175 million in value added—so their math is a little perverse.”59 Moreover, the school’s large
endowment is used in ways that benefit students. Endow ment income covers 72 percent of undergraduate financial aid,60 and the university charges no tuition to students from families earning less than $60,000.61 Harvard’s immense endowment also enables the school to increase the faculty in growing areas and to expand its facilities.
In the end, Harvard decided to cap the compensation of fund managers. The result was that Jack Meyer and his team of managers left to start their own investment com panies, at which many could earn 10 times their Harvard salary. Harvard Management Company also placed large amounts of endowment assets with these new firms. In so doing, it reduced the percentage of assets managed in-house and incurred the higher fees of outside manag ers, though they did not have to be reported. The univer sity administration declined to defend its previous pay policy, which produced such stellar returns but drew considerable moral outrage. Business writer Michael Lewis speculates that Harvard’s leaders were afraid to say what they thought. He observes, “We have arrived at a point in the money-management game where the going rate for the people who play it well is indefensible even to the people who understand it. No one wants to be seen thinking it is normal for someone to make US$25-million a year.”62
ShaRed WRITING: LavISh Pay aT haRdWaRd
Explain whether or not Harvard made the right choice in placing a limit on how much the fund managers could earn in-house. Con sider whether the limits placed on compensation at Harvard also apply to the corporate world, and explain any differences that you see between the two situations. Review and comment on at least two classmates’ responses.
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Case: Broken Trust at Bankers Trust
Bankers Trust (now part of Deutsche Bank) was a leading seller of complex derivatives, which include futures, options, swaps, and other financial instruments whose value is based on (or derived from, hence the name “derivatives”) other securities.63 One Bankers Trust client was the consumer products giant Procter & Gamble (P&G), which used derivatives extensively. One type of derivative frequently used by P&G is an interest rate swap, in which the holder of, say, fixed interest bonds can
exchange the payment of a fixed rate of interest with another party and pay, in effect, a variable rate. The other party pays the fixed rate to the bondholder and accepts from the swapholder a variable rate. Such an agreement is beneficial to a company with bond obligations that carry a high fixed interest rate if it believes that interest rates will remain low or even fall, because it will pay less interest at a variable rate. However, the other side of the swap is bet ting that interest rates will rise, because, otherwise, it would lose money by paying a fixed rate in return for accepting a variable rate. An interest rate swap is a pure bet on the direction of interest rates. In 1993, which was a time of low interest rates, P&G had a debt load of approximately $5 billion. Of that debt, $200 million of fixed interest bonds had been covered with an interest rate swap that was expiring, and P&G asked Bankers Trust for help in creating a new swap. After some negotiation, P&G accepted an offer from the bank to enter into a complicated swap in which the variable interest rate that P&G would pay would set in six months according to a complex formula (which Bankers Trust refused to reveal, claiming that it was proprietary) based on the difference or “spread” between 5-year and 30-year treasury bonds.64 The formula “leveraged” the bet on interest rates since each percentage point rise in interest rates would result in a disproportionately large increase in the amount of vari able interest paid by P&G. In two transactions, one on November 2, 1993, and the other on February 14, 2004, P&G entered into the swaps with Bankers Trust (see Figure 2.5 below).
Figure 2.5 P&G’s “5–30” Swap Agreement with Bankers Trust
What if interest rates rise?
P&G pays a variable interest rate that is linked to the value
What if interest rates stay low or fall?
P&G would result in a bonanza for Bankers Trust. Unlike several other Bankers Trust clients who claimed that they had been misled about the risks they were taking, P&G admitted that it knowingly took a great risk in betting that interest rates would not rise. Edwin L. Artz, the chairman of P&G, said, “The issue here is Bankers Trust’s selling practices.” He continued, “There’s a notion that end users of derivatives must be held accountable for what they buy. We agree completely, but only if the terms and risks are fully and accurately disclosed.”65 Specifically, P&G felt it had been misled by assurances from Bankers Trust that it could get out of the swaps with little loss before the varia ble rate set in six months. Bankers Trust maintained that it had assured P&G that it would buy back the company’s swap position only at the current market rate as calculated by the bank. Every derivative has a current market value, and as a dealer in derivatives Bankers Trust stood ready to buy back any derivative it sold—but at the current market price, which might involve a considerable loss to the sell ing party. The bank denied that it had ever promised that it could limit P&G’s losses, which in any event would be impossible since the extent of any losses cannot be known in advance. Anyone dealing in options knows that no such assurance could be given. In the end, P&G was able to get out of the swaps but at a price of paying an interest rate of nearly 20 percent for four years.
The position of Bankers Trust was that it was merely a seller of a product that P&G wanted and that all appro priate disclosures had been made. In particular, the bank insisted that it was not a fiduciary with any obligation to protect P&G’s interest. P&G was a sophisticated investor that could understand the risks it was taking and determine its risk tolerance. Bankers Trust was not a trusted adviser in this instance but merely a trader. This position was compro mised, however, by audio tapes that recorded conversations of Bankers Trust employees involved in the P&G transactions. (Most banks routinely record conversations in order to settle disputes over trades.) In discussing the swaps
of 5- and 30-year treasury bonds. After 6 months, the current rate is fixed for the remaining period.
Trouble developed almost immediately when the Fed eral Reserve began raising interest rates. Although the six month lock-in of interest rates had not yet occurred, the cost to P&G of getting out of the swaps had soared so that P&G’s borrowing costs would be increasing to more than 14 percent over the standard interest rate, costing the com pany approximately $130 million in additional interest. In a swap option, any loss to one party is a gain in the same amount to the other side of the bet. So a large loss at
sold to P&G, one employee was recorded as say ing, “They would never know. They would never know how much money was taken out of that.” To this, a colleague who agreed replied, “That’s the beauty of Bankers Trust.” Other com ments include these: “This could be a massive huge future gravy train,” and “It’s like Russian roulette, and I keep putting another bullet in the revolver every time I do one of these.” A video of a training session recorded an instructor saying, “[W]hat Bankers Trust can do for [cli ents] is get in the middle and rip them off—take a little money.” It was alleged that employees at Bankers Trust used the acronym ROF for “rip-off factor” in their conver sations and messages.
Bankers Trust denied that these taped conversations were representative of the culture at the bank, and a spokes person said that “these stupid and crude comments . . . were the basis of disciplinary actions against these individ uals last year.”
ShaRed WRITING: BROkeN TRuST aT BaNkeRS TRuST
Consider the relationship between Bankers Trust and Procter & Gamble (P&G). Did Bankers Trust have a duty to inform P&G of how it would be calculating rates to protect the company from losses, even though that would reduce its own profits? Or was P&G being a sore loser, having agreed to the terms of the swap deal despite the risks? Explain your reasoning. Review and comment on at least two classmates’ responses, including one that opposes your own.
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Case: KPMG’s Tax Shelter Business
In the 1990s, KPMG, one of the “big four” accounting firms, began offering tax shelters to corporations and wealthy investors. In addition to standard audit and consulting ser vices, KPMG aggressively developed and marketed a num ber of innovative ways for clients to avoid taxes. Not only did individuals and businesses reduce taxes on billions of dollars of gains, but also KPMG partners pocketed many millions for their assistance. Acting like any business developing a new product, KPMG established a “Tax Innovation Center” to generate ideas and to research the accounting, financial, and legal issues.66 Previously, tax shelters had been individualized for particular clients, but the new ones were intended to be generic, mass-marketed products. Once a strategy was approved, it was energetically promoted to likely clients by the firm’s sales force. KPMG tax professionals were turned into salespeople. They were given revenue targets and urged to use telemarketing and the firm’s own confi dential records to locate clients. The strategies—which bore such acronyms as OPIS, BLIPS, FLIP, and SOS—gen erally involved complicated investments with cooperat ing foreign and offshore banks that generated phantom losses that could be used to offset capital gains or income from other investments. The shelters were accompanied by opinion letters from law firms that assessed their legal ity. The gain to KPMG and its clients and the loss to the
U.S. Treasury were significant. The four main tax shelters marketed by the firm generated over $11 billion in tax deductions for clients, which yielded at least $115 million in fees for KPMG and cost the government $2.5 billion in lost tax revenue.67
During the period in which the KPMG tax shelters were sold, no court or Internal Revenue Service (IRS) rul ing had declared them illegal. However, KPMG had failed to register the shelters with the IRS as required by law. Reg istration alerts the tax authorities to the use of the shelters and permits them to investigate their legality. One KPMG partner attributed this failure to a lack of specific guidance by the IRS on the rules for registration and the agency’s lack of interest in enforcing the registration requirement.68 Furthermore, this partner calculated that for OPIS, the firm would pay a penalty of only $31,000 if the failure to register were discovered. This amount was more than outweighed by the fees of $360,000 for each shelter sold.69
Until a court or Congress explicitly outlaws a tax shel ter, the line between legal and illegal tax strategies is often difficult to draw. The IRS typically employs the “economic substance” test:
Do the transactions involved in a tax shelter serve a legiti mate investment objective or is their only effect to reduce taxes?
A tax shelter that offers no return beyond a tax saving is abusive in the view of the IRS. However, an IRS ruling is not legally binding until it is upheld by the courts, and the courts have occasionally held some shelters to be legal even if they do not involve any risk or potential return. One rea son for such decisions is that tax shelters typically involve legitimate transactions combined in unusual ways. As one observer notes, “Most abusive shelters are based on legal tax-planning techniques—but carried to extremes. That makes it hard to draw sharp lines between legitimate tax planning and illicit shelters.”70 Even when a shelter like those sold by KPMG is found to be legal, a tax savings is almost always the only outcome. According to an IRS com missioner, “The only purpose of these abusive deals was to further enrich the already wealthy and to line the pockets of KPMG partners.”71
When a tax shelter is found by the court to be abusive, the usual outcome is simply a loss of the tax advantage so that the client pays what would be owed otherwise plus any penalties. The issuer is seldom sanctioned. KPMG and other marketers of tax shelters generally protect them selves, first, by having the client sign a statement affirming that he or she understands the structure of the transaction and believes that it serves a legitimate business purpose. This makes it more difficult for the client to sue the firm. KPMG also sent all related documents to its lawyers in order to protect them from disclosure by claiming lawyer– client privilege.
Although some partners at KPMG thought that the tax shelters were illegal and raised objections, others argued for their legality—and, in any event, their shelters were an immensely profitable part of the firm’s business. Aside from the huge fees, the motivation to market the shelters came from the KPMG culture, which New York Times business reporter Floyd Norris characterized as that of a “proud old lion.” He writes, “Of all the major accounting firms, it was the one with the strongest sense that it alone should determine . . . the rules it would fol low. Proud and confident, it brooked no criticism from regulators.”72
Which of the seven ethical principles discussed in this chapter was KPMG most guilty of violating? Explain the reasons for your response. Review and comment on at least two classmates’ responses.
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chapter 2 Quiz: ethical decision making
Chapter 3
Ethical Theories
3.1 Describe the four theses of classical
utilitarianism, the utilitarian approach to decision making, and the main criticisms of the cost–benefit analysis method
3.2 Summarize the two intuitive principles of
Kantian ethics and their implications for moral reasoning
3.3 Define virtue and explain how virtues and
principles of virtue ethics are relevant to business
3.4 Identify the meaning and importance of
rights and the types of rights that apply in different situations
3.5 Explain the role of justice in business ethics,
the three kinds of justice outlined by Aristotle, and the contemporary principles of justice offered by Rawls and Nozick
Case: Big Brother at Procter & Gamble
In early August 1991, a former employee of Procter & Gamble telephoned Wall Street Journal reporter Alecia Swasy at her Pittsburgh office to report some disturbing news.1 “The cops want to know what I told you about P&G,” he said. This 20-year veteran of the company had just been grilled for an hour by an investigator for the Cincinnati fraud squad. The investigator Gary Armstrong, who also happened to work part-time as a security officer for P&G, had records of the ex manager’s recent long-distance calls, including some to Swasy. Alecia Swasy had apparently angered CEO Edward Artz with two news stories about troubles at P&G that the company was not ready to reveal. An article in the Wall Street Journal on Monday, June 10, 1991, reported that B. Jurgen Hintz, executive vice president and heir apparent as CEO, had been forced to resign over difficulties in the food and beverage division. The next day, on Tuesday, June 11, a long article on the division’s woes quoted “current and former P&G managers” as saying that the company might sell certain product lines, including Citrus Hill orange juice, Crisco shortening, and Fisher nuts. Swasy believed that Artz had deliberately lied to her when she tried to confirm the story of Hintz’s departure in a telephone conversation
46
on Saturday, and that he tried to sabotage the Journal by allowing the news to be released to the rival New York Times and the Cincinnati newspapers in time for the Sun day editions while the public relations department contin ued to deny the story to Swasy. Immediately after the two articles appeared in the Wall Street Journal, Artz ordered a search of P&G’s own phone re cords to determine the source of the leaks to the press. When this investigation failed to uncover any culprits, the company filed a complaint with the Hamilton County prosecutor’s office, which promptly opened a grand jury investigation. The grand jury then issued several subpoenas calling for Cincinnati Bell to search its records for all calls in the 513 and 606 area codes, which cover southern Ohio and northern Kentucky, and to identify all telephone calls to Alecia Swasy’s home or office and all fax transmissions to the newspaper’s Pittsburgh office be tween March 1 and June 15. The search combed the records of 803,849 home and business telephone lines from which users had placed more than 40 million long-distance calls. P&G contended that it filed the complaint because of “sig nificant and ongoing leaks of confidential business data, plans and strategies,” which included not only leaks to the news media but also leaks to competitors as well. The legal basis for the grand jury probe was provided by a 1967 Ohio law that makes it a crime to give away “articles representing trade secrets” and by a 1974 Ohio law that prohibits employees from disclosing “confidential information” without the permission of the employer. However,
How do you think the public responded to P&G’s actions?
Compare Your Thoughts
The response to P&G’s role in the investigation was quick and angry. The Cincinnati chapter of the Society of Professional Journalists wrote, in a letter to CEO Artz, “The misguided
reporters are generally protected by the First Amendment right of freedom of the press, and Ohio, Pennsylvania, and 24 other states have so-called “shield laws” that protect the identities of reporters’ confidential sources. Information about an executive’s forced departure is scarcely a trade secret on a par with the formula for Crest toothpaste, and the use of the phrase “articles represent ing trade secrets” has been interpreted in the Ohio courts to mean documents such as photographs and blueprints, not word-of-mouth news. Any law that limits First Amendment rights must define the kind of speech prohibited and demon strate a compelling need, but the 1974 law does not specify what constitutes confidential information or the conditions under which it is protected. Thus, some legal experts doubt the law’s constitutionality. P&G denied that any reporter’s First Amendment rights were being violated: “No news media outlet is being asked to turn over any names or any informa tion. The investigation is focused on individuals who may be violating the law.”
Points to Consider…
Procter & Gamble’s heavy-handed investigation was undeni ably a violation of several accepted business ethics principles. However, the critics of P&G did not cite any harmful conse quences of the investigation beyond the chilling effect it might have had on employees and members of the press. They com plained instead about the abuse of power and invasion of pri vacy. In particular, P&G was charged with violating certain rights—the right of reporters to search out newsworthy infor mation and the right of ordinary citizens not to have their tel ephone records searched. Less certain is whether an employee has the right to disclose information to a reporter. Consequences aside, however, there is something objec tionable about a company snooping on its own employees and using law enforcement officials for company purposes. Although P&G’s conduct appears questionable, it is not easy to specify exactly the moral wrongs. Moreover, reasonable people might disagree about what is wrong in this case and on the more general issues involved. Our ordinary moral beliefs and the simple rules and principles of morality cannot settle all controversies that might arise from this and other cases. When reasonable persons disagree about cases like these, we need to go beyond our conflicting positions and seek common ground in ethical theory. Put simply, the really
action Procter & Gamble is taking threatens to trample the First Amendment and obviously reflects more concern in identifying a possible leak within the company rather than protecting any trade secrets. . . . Your complaint has prompted a prosecutorial and police fishing expedition that amounts to censorship before the fact and could lead to further abuse of the First Amendment by other companies also disgruntled by news media coverage.” An editorial in the Wall Street Journal asked, “What possessed P&G?” and questioned the legality by saying, “We understand that P&G swings a big stick in Cincinnati, of course, and maybe the local law can, like Pampers, be stretched to cover the leak. It is not funny, though, to the folks being hassled by the cops.” The sharpest criticism came from William Safire, the New York Times columnist, who objected to Edward Artz’s contention that P&G’s mistakes are not “an issue of ethics.” Safire concluded a column entitled “At P&G: It Sinks” with the words, “It’s not enough to say, ‘our leak hunt backfired, so excuse us’; the maker of Tide and Ivory can only come clean by showing its publics, and tomor row’s business leaders, that it understands that abuse of power and invasion of privacy are no mere errors of judgment—regrettably inappropriate—but are unethical, bad, improper, wrong.” In the end, no charges were filed against any individual, and the company continued to deny any wrongdoing. A spokesperson for P&G stated, “[The press] has the right to pur sue information, but we have the right to protect proprietary information.” Fraud squad investigator Gary Armstrong later went to work for P&G full-time.
hard questions of ethics require that we think deeply and search out the best reasons available. For a fuller, more ade quate understanding of ethical reasoning than that provided by the previously presented ethical framework, we may need the resources of the ethical theories that have been developed over the centuries by major moral philosophers.
It is customary initially to divide ethical theories into two types, usually called teleological and deontological. The most prominent historical examples of a teleological and a deontological theory are utilitarianism and the ethical theory of Immanuel Kant, respectively.
Teleological theories hold that the rightness of actions is determined solely by the amount of good consequences they produce. (The word “teleological” is derived from the Greek word “telos,” which means an end.) Actions are jus tified on teleological theories by virtue of the end they achieve, rather than some feature of the actions themselves.
Deontological theories, by contrast, deny that conse quences are primary in determining what we ought to do. Deontologists typically hold that we have a duty to per form certain acts not because of some benefit to ourselves or others, but because of the nature of these actions or the inherent value of the principles from which they follow. (The word “deontological” is derived from “deon,” the Greek word for duty.) Thus, what makes lying wrong, a
deontologist would say, is the very nature of lying, not the consequences of lying. Other examples of nonconsequential ist reasoning in ethics include arguments based on principles such as the Golden Rule and those that appeal to basic notions of rights, human dignity, and respect for other persons. The features of these two kinds of ethical theories are shown in Figure 3.1.
Figure 3.1 What Actions Are Morally “Right”?
A third type of ethical theory identifies virtue as the key element and focuses less on right conduct and more on good character. Morality on this view is mainly about acquiring and practicing the character traits that conduce to a good life. Virtue ethics does not attempt to answer the central question of teleological and deontological theories about what makes actions right; rather, it asks how we can live a life of right action. These theories are not only a valuable resource for ena bling us to think through ethical issues in business but also the foundation for the ethics of business. The arguments that are presented in subsequent chapters about a wide range of business ethics issues all draw upon these various ethical theories. Some familiarity with these theories, then, will greatly improve the moral compass that we use to nav igate the treacherous ethical terrain of the business world.
Teleological, Deontological, and Virtue Ethics
Explain whether these three schools of thought seem equally valid. Which perspective do you adopt most often in your own life, and why?
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3.1: Utilitarianism
3.1 Describe the four theses of classical utilitarianism,
the utilitarian approach to decision making, and the main criticisms of the cost–benefit analysis method
Different parts of the utilitarian doctrine were advanced by philosophers as far back as the ancient Greeks, but it remained for two English reformers in the nineteenth cen tury to fashion them into a single coherent whole. The crea tors of classical utilitarianism were Jeremy Bentham (1748–1832) and John Stuart Mill (1806–1873), who lived in a turbulent era when England experienced some of the worst conditions of the Industrial Revolution. These were the con ditions that moved Karl Marx to write The Communist Mani festo, and they were indelibly described by the poet William Blake as “these dark Satanic Mills.” In the hands of Bentham and Mill, utilitarianism was not an ivory-tower philosophy but a powerful instrument for social, political, economic, and legal change. Bentham and Mill used the principle of utility as a practical guide in the English reform movement.
3.1.1: Principle of Utility
Classical utilitarianism can be stated formally as follows:
An action is right if and only if it produces the greatest balance of pleasure over pain for everyone.
So stated, the utilitarian principle involves four distinct theses: 1. Consequentialism. The principle holds that the right ness of actions is determined solely by their conse quences. It is by virtue of this thesis that utilitarianism is a teleological theory. 2. Hedonism. Utility in this statement of the theory is identified with pleasure and the absence of pain. Hedonism is the thesis that pleasure and only pleasure is ultimately good. 3. Maximalism. A right action is one that has not merely some good consequences but also the greatest amount of good consequences possible when the bad conse quences are also taken into consideration. 4. Universalism. The consequences to be considered are
those of everyone. Consequentialism requires that the results or conse quences of an act be measured in some way so that the good and bad consequences for different individuals can be com puted and the results of different courses of action compared.
According to hedonism, the good and bad conse quences to be considered are the pleasure and pain pro duced by an act. Virtually every act produces both pleasure and pain, and the principle of utility does not require that only pleasure and no pain result from a right action. An action may produce a great amount of pain and still be
right on the utilitarian view as long as the amount of pleas ure produced is, on balance, greater than the amount of pleasure produced by any other action. Utilitarianism assumes that the amount of pain produced by an action can be subtracted from the amount of pleasure to yield the net amount of pleasure—in the same way that an account ant subtracts debts from assets to determine net worth. The thesis of universalism requires us to consider the pleasure and pain of everyone alike. Thus, we are not fol lowing the principle of utility by considering the conse quences only for ourselves, for our family and friends, or for an organization of which we are a part. Utilitarianism does not require us to ignore our own interest, but we are permitted to place it no higher and no lower than the interest of anyone else. The utilitarian principle does not insist that the interest of everyone be promoted, though. In deciding whether to close a polluting plant, for example, we need to consider the impact on everyone. No matter what decision is made, the interests of some people will be harmed. Utilitarian reasoning obligates us only to include the interests of everyone in our calculations, not to act in a way that advances every individual interest. Use Figure 3.2 to review these four theses of utilitarianism.
Figure 3.2 Four Distinct Theses of the Utilitarian Principle
The pleasure and pain of everyone must be given equal consideration.
The Meaning of Utilitarianism
What problems might someone have with the four elements of utili tarianism? How might any one of these theses be modified to create a different form of utilitarianism?
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ACt- AnD Rule-utilitARiAnism
In classical utilitari anism, an action is judged to be right by virtue of the con sequences of performing that action. As a result, telling a lie or breaking a promise is right if it has better consequences
than any alternative course of action. Utilitarian morality thus seems to place no value on observing rules, such as “Tell the truth” or “Keep your promises,” except perhaps as “rules of thumb,” that is, as distillations of past experi ence about the tendencies of actions that eliminate the need to calculate consequences in every case.
This result can be avoided if we consider the conse quences of performing not just particular actions but also actions of a certain kind. Although some instances of lying have consequences that are better than telling the truth, lying as a general practice does not. As a kind of action, then, truth-telling is right by virtue of the consequences of performing actions of that kind, and any instance of truth telling is right because actions of that kind are right.
This suggestion leads to a distinction between two ver sions of utilitarianism, one in which we calculate the con sequences of each act and another in which we consider the consequences of following the relevant rule. These two versions are called act-utilitarianism and rule-utilitarianism, respectively. They may now be expressed formally in the following way:
An action is right if and only if
it produces the greatest balance of pleasure over pain for everyone. (Act-Utilitarianism)
it conforms to a set of rules the general acceptance of which would produce the greatest balance of pleasure
ver pain for everyone.2 (Rule-Utilitarianism)
Both act-utilitarianism and rule-utilitarianism have their merits, and there is no consensus among philosophers about which is correct.3 Act-utilitarianism is a simpler the ory and provides an easily understood decision procedure. Rule-utilitarianism seems to give firmer ground, however, to the rules of morality, which are problems for all teleolog ical theories.
There is little difficulty in cal culating that some actions produce more pleasure for us than others. A decision to spend an evening at a concert is usually the result of a judgment that listening to music will give us more pleasure at that time than any available alternative. Confronted with a range of alternatives, we can usually rank them in order from the most pleasant to the least pleasant. A problem arises, however, when we attempt to determine exactly how much pleasure each course of action will produce, because pleasure cannot be measured precisely in terms of quantity, much less qual ity. Moreover, utilitarianism requires that we calculate utility not only for ourselves but also for all persons affected by an action.
Some critics contend that this requirement imposes an information burden on utilitarian decision makers that is difficult to meet. In order to buy a gift for a friend that will produce the greatest amount of pleasure, for example, we
CAlCulAting utility
need to know something about that person’s desires and tastes. Consider, for example, the task faced by a utilitarian legislator who must decide whether to permit logging in a public park. This person must identify all the people affected, determine the amount of pleasure and pain for each one, and then compare the pleasure that hiking brings to nature lovers versus the pain that would be caused to loggers if they lost their jobs. The abilities of ordinary human beings are inadequate, critics complain, to acquire and process the vast amount of relevant information in such a case. The response of utilitarians to these problems is that we manage in practice to make educated guesses by relying on past experience and limiting our attention to a few salient aspects of a situation. Comparing the pleasure and pain of different people raises a further problem about the interpersonal comparison of utility. Imagine two people who each insists after attending a concert that he or she enjoyed it more. There seems to be no way in principle to settle this dispute. Some philosophers and economists consider this problem to be insoluble and a reason for rejecting utilitarianism both as an ethical theory and as a basis for economics.4 Others argue for the possibil ity of interpersonal comparisons on the basis that regardless of whether we can make such comparisons precisely, we do make them in everyday life with reasonable confidence.5 We may give away an extra ticket to a concert, for example, to the friend we believe will enjoy it the most based on past experience. The problem of the interpersonal comparison of utility is not insuperable, therefore, as long as rough com parisons are sufficient for utilitarian calculations.
Utilitarianism in Action
What are the problems with trying to objectively compare, or quan tify, pleasure and pain? Think of the number scale doctors ask patients to use to describe the level of physical pain they are feeling. On this scale, 0 represents no pain and 10 represents pain so intense it causes the patient to lose consciousness. Why couldn’t a similar system be used to quantify the consequences of an act for both pleasure and pain?
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3.1.2: Cost–Benefit Analysis
The utilitarian ideal of a precise quantitative method for decision making is most fully realized in cost–benefit analy sis. This method differs from classical utilitarianism, with its measure of pleasure and pain, primarily in the use of monetary units to express the consequences of various alternatives. Any project in which the dollar amount of the benefits exceeds the dollar amount of the costs is worth
pursuing, according to cost–benefit analysis, and from among different projects, the one that promises the greatest net benefit, as measured in dollars, ought to be chosen.6
The chief advantage of cost–benefit analysis is that the prices of many goods are set by the market, so that the need to have knowledge of people’s pleasures or preferences is largely eliminated. The value of different goods is easily totaled to produce a figure that reflects the costs and benefits of different courses of action for all concerned. Money also provides a common denominator for allocating resources among projects that cannot easily be compared otherwise. Would scarce resources be better spent on preschool educa tion, for example, or on the development of new sources of energy? In cost–benefit analysis, decision makers have an analytic framework that enables them to decide among such disparate projects in a rational, objective manner.
evAluAtion of Cost–Benefit AnAlysis Cost–
benefit analysis is criticized for problems with assigning monetary values to costs and benefits. first, not all costs
and benefits have an easily determined monetary value.
The value of the jobs that are provided by logging on public land can be expressed precisely in dollars, as can the value of the lumber produced. But because the opportunity for hikers to enjoy unspoiled vistas and fresh-smelling air is not something that is commonly bought and sold, it has no established market price. Experts in cost–benefit analysis attempt to overcome the problem of assigning a dollar fig ure to nonmarket goods with a technique known as shadow pricing. This consists of determining the value reflected by people’s market and nonmarket behavior. For example, by comparing the prices of houses near airports, busy high ways, and the like with the prices of similar houses in less noisy areas, it is possible to infer the value that people place on peace and quiet. The value of life and limb can be simi larly estimated by considering the amount of extra pay that is needed to get workers to accept risky jobs.
There are some pitfalls in using the technique of shadow pricing, especially when human life is involved. Many peo ple buy houses in noisy areas or accept risky jobs because they are unable to afford decent housing anywhere else or to secure safer employment. Some home buyers and job seek ers may not fully consider or appreciate the risks they face, especially when the hazards are hidden or speculative. Also, the people who buy homes near airports or accept work as steeplejacks are possibly less concerned with noise or dan ger than is the general population. We certainly do not want to assume, however, that workplace safety is of little value simply because a few people are so heedless of danger that they accept jobs that more cautious people avoid.7
A second criticism of cost–benefit analysis is that some applications require that a value be placed on human
life. Although this may seem heartless, it is necessary if cost–benefit analysis is to be used to determine how much to
spend on prenatal care to improve the rate of infant mortal ity, for example, or on reducing the amount of cancer-caus ing emissions from factories. Reducing infant mortality or the death rate from cancer justifies the expenditure of some funds, but how much? Would further investment be justi fied if it reduced the amount available for education or the arts? No matter where the line is drawn, some trade-off must be made between saving lives and securing other goods. The purpose of assigning a monetary value to life in a cost– benefit analysis is not to indicate how much a life is actually worth but to enable us to compare alternatives where life is at stake. Several methods exist, in fact, for calculating the value of human life for purposes of cost–benefit analysis.8 Among these are the discounted value of a person’s future earnings over a normal lifetime, the value that existing social and political arrangements place on the life of individuals, and the value that is revealed by the amount that individuals are willing to pay to avoid the risk of injury and death. When people choose through their elected representatives or by their own consumer behavior not to spend additional amounts to improve automobile safety, for example, they implicitly indicate the value of the lives that would otherwise be saved. Using such indicators, economists calculate that middle-income Americans value their lives between $3 mil lion and $5 million.9 Experts in risk assessment calculate that the “break-even” point where the amount expended to save a life is worth the cost is about $10 million.10
Third, people’s individual and collective decisions are not always rational. People who drive without seat belts are probably aware of their benefit for other people but are con vinced that nothing will happen to them because they are such good drivers.11 As a result, they (irrationally) expose them selves to risks that do not accurately reflect the value they place on their own lives. Mark Sagoff observes that the choices we make as consumers do not always correspond to those we make as citizens. He cites as examples the fact that he buys beverages in disposable containers but urges his state legisla tors to require returnable bottles and that he has a car with an “Ecology Now” sticker that leaks oil everywhere it is parked.12
Assigning MoneTAry VAlues
A further criticism of cost–benefit analysis is that even if all the other problems
with assigning monetary values could be solved, there are still good reasons for not assigning a monetary value to some things. Steven Kelman argues that placing a dollar value on some goods reduces their perceived value because they are valued precisely because they cannot be bought and sold in a market. Friendship and love are obvious examples. “Imagine the reaction,” Kelman observes, “if a practitioner of cost– benefit analysis computed the benefits of sex based on the price of prostitute service.”13 In The Gift Relationship: From Human Blood to Social Policy, Richard M. Titmuss compares the American system of blood collection with that of the Brit ish. In the United States, about half of all blood is purchased from donors and sold to people who need transfusions.14 The British system, by contrast, is purely voluntary. No one is paid for donating blood, and it is provided without charge to anyone in need. As a result, the giving of blood and the receipt of blood have an entirely different significance. If blood has a price, then giving blood merely saves someone else an expense, but blood that cannot be bought and sold becomes a special gift that we make to others.15
Although some things are cheapened in people’s eyes if they are made into commodities and traded in a market, this does not happen if goods are assigned a value merely for purposes of comparison. It is the actual buying and sell ing of blood that changes its perceived value, not perform ing a cost–benefit analysis. Moreover, Titmuss himself argues in favor of the British system on the grounds that the system in the United States is
highly wasteful of blood, resulting in chronic acute shortages;
administratively inefficient because of the large b ureaucracy that it requires;
more expensive (the price of blood is 5 to 15 times higher); and
more dangerous because there is a greater risk of dis- ease and death from contaminated blood.16 In short, a cost–benefit analysis shows that it is better not to have a market for blood. Use Table 3.1 to review the pros and cons of cost–benefit analysis as a quantitative method for decision making.
Table 3.1 Pros and Cons of Cost–Benefit Analysis
Review the main pros and cons for each point given in the left column. Then hide the cells to quiz yourself.
Consequences measured by monetary value in a market
The market price or value of goods and services can be used to compare outcomes.
Not all costs and benefits have a discernible mar ket value or can be objectively valued.
Consequences in a market
measured
by monetary
value
The market can be used
price or value to compare
of goods outcomes.
and services
Not all costs and ket value or can be
benefits have a objectively
discernible mar- valued.
Shadow pricing
of nonmarket
goods
Market value relative worth behavior.
can be of choices
estimated by suggested
analyzing the by actual
Not all people are accordance with rational decisions.
able to act or their preferences,
choose in or make
Placing a value experiences
on human
life and
Can apply human health
cost–benefit and safety
analysis to
issues such as
Seems cold-hearted piness, etc. cannot ened by assigned
and reductive; be bought and values
life, love, hap- are cheap-
Conducting a Cost—Benefit Analysis
Your city council is considering a law to raise the local minimum wage paid to all employees. Many local businesses are concerned that such a measure would significantly increase the costs of doing business. How could your city council use cost—benefit analysis to decide whether to raise the minimum wage law and, if so, by how much?
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3.2: Kantian Ethics
3.2 summarize the two intuitive principles of Kantian
ethics and their implications for moral reasoning
Immanuel Kant (1724–1804) wrote his famous ethical trea tise Foundations of the Metaphysics of Morals (1785) before the rise of English utilitarianism, but he was well acquainted with the idea of founding morality on the feel ings of pleasure and pain, rather than on reason. Accord ingly, Kant set out, in the spirit of the Enlightenment, to restore reason to what he regarded as its rightful place in our moral life. Specifically, he attempted to show that there are some things that we ought to do and others that we ought not to do merely by virtue of being rational. Moral obligation thus is not based on maximizing consequences, in Kant’s view, but arises solely from a moral law that is binding on all rational beings. Although Kant’s own expression of his theory is difficult to understand, the main thrust can be formulated in two intuitive principles: uni versalizability and respect for persons.
3.2.1: Universalizability
The universalizability principle can be illustrated by one of Kant’s own examples:
[A] man finds himself forced by need to borrow money. He well knows that he will not be able to repay it, but he also sees that nothing will be loaned him if he does not firmly promise to repay it at a certain time. He desires to make such a promise, but he has enough conscience to ask himself whether it is not improper and opposed to duty to relieve his distress in such a way.
What (morally) ought this man to do? A teleological theory would have us answer this question by determining the consequences of each alternative course of action, but Kant regarded all such appeals to consequences as morally irrelevant. As a deontologist, he held that the duty to tell the truth when making promises arises from a rule that ought to be followed without regard for consequences. Even if the man could do more good by borrowing money
under false pretenses—by using it to pay for an operation that would save a person’s life, for example—the action would still be wrong. (See What Actions Are Morally “Right”? to review the difference between teleological and deontological perspectives.)
Kant addressed the problem of making a lying prom ise with a principle that he called the categorical imperative. His own cryptic statement of the categorical imperative is as follows:
Act only according to that maxim by which you can at the same time will that it should become a universal law.
Rendered into more comprehensible English, Kant’s principle is, act only on rules (or maxims) that you would be willing to have everyone follow. The categorical impera tive suggests a rather remarkable “thought experiment” to be performed whenever we deliberate about what to do. Suppose, for example, that every time we accept a rule for our own conduct, that very same rule would be imposed, by some miracle, on everyone. We would become, in other words, a universal rule maker. Under such conditions, are there some rules that we, as rational beings, simply could not accept (that is, will to become universal law)?
Applying this thought experiment to Kant’s example, if the man were to obtain the loan under false pretenses, the rule on which he would be acting might be formulated as: Whenever you need a loan, make a promise to repay the money, even if you know that you cannot do so. Although one person could easily act on such a rule, the effect of its being made a rule for everyone universally would be, in Kant’s view, self-defeating. No one would believe anyone else, and the result would be that the phrase “I promise to do such-and-such” would lose its meaning. To Kant’s own way of thinking, the objection to the rule just stated is not that everyone’s following it would lead to undesirable consequences—that would be utilitarianism—but that everyone’s following it describes a logically impossible state of affairs. Willing that everyone act on this rule is analogous to a person making plans to vacation in two places, say Acapulco and Aspen, at the same time. A person could will to go to either place, but willing the logical impossibility of being in two places at once is not some thing that a rational person could will to do.
Regardless of whether Kant is successful in his attempt to show that immoral conduct is somehow irrational, many philosophers still find a kernel of truth in Kant’s principle of the categorical imperative, which they express as the claim that all moral judgments must be universalizable. That is, if we say that an act is right for one person, then we are committed to saying, as a matter of logical consistency, that it is right for all other relevantly similar persons in rele vantly similar circumstances. By the same token, if an act is wrong for other people, then it is wrong for any one person unless there is some difference that justifies making an
exception. This principle of universalizability expresses the simple point that, as a matter of logic, we must be consist ent in the judgments we make. The principle of universalizability has immense impli cations for moral reasoning.
1. first, it counters the natural temptation to make ex ceptions for ourselves or to apply a double standard.
example: Consider a job applicant who exaggerates a bit on a résumé but is incensed to discover, after being hired, that the company misrepresented the opportunity for advancement. The person is being inconsistent to hold that it is all right for him to lie to others but wrong for anyone else to lie to him. An effective move in a moral argument is to challenge people who hold such positions to cite some morally relevant difference. Why is lying right in the one case and wrong in the other? If they can offer no answer, then they are forced by the laws of logic to give up one of the inconsistent judgments. The principle of universalizability counters the natural temptation to make exceptions for ourselves or to apply a double standard.
2. the universalizability principle can be viewed as underlying the common question, “What if everyone did that?”
example: The consequences of a few people cheat ing on their taxes are negligible. If everyone were to cheat, however, the results would be disastrous. The force of “What if everyone did that?” is to get people to see that because it would be undesirable for everyone to cheat, no one ought to do so. This pattern of ethical reasoning involves an appeal to consequences, but it differs from standard forms of utilitarianism in that the consequences are hypothet ical rather than actual. That is, whether anyone else actually cheats is irrelevant to the question, “What if everyone did that?” The fact that the results would be disastrous if everyone did is sufficient to entail the conclusion that cheating is wrong because an indi vidual cannot rationally accept those results.
3.2.2: Respect for Persons
Kant offered a second formulation of the categorical imper ative, which he expressed as follows:
Act so that you treat humanity, whether in your own per son or that of another, always as an end and never as a means only.
These words are usually interpreted to mean that we should respect other people (and ourselves!) as human beings. The kind of respect that Kant had in mind is compat ible with achieving our ends by enlisting the aid of other peo ple. We use shop clerks and taxi drivers, for example, as a means for achieving our ends, and the owners of a business
use employees as a means for achieving their ends. What is ruled out by Kant’s principle, however, is treating people only as a means, so that they are no different, in our view, from mere “things.”
In Kant’s view, what is distinctive about human beings, which makes them different from “things” or inanimate objects, is the possession of reason, and by rea son Kant means the ability to posit ends and to act pur posefully to achieve them. In acting to achieve ends, human beings also have free will that enables them to cre ate rules to govern their own conduct. This idea of acting on self-devised rules is conveyed by the term autonomy, which is derived from two Greek words meaning “self” and “law.” To be autonomous is quite literally to be a law giver to oneself, or self-governing. A rational being, there fore, is a being who is autonomous. To respect other people, then, is to fully respect their capacity for acting freely, that is, their autonomy. When individuals are deceived, seriously harmed, or treated unfairly their autonomy is disrespected.
Kant’s ethical theory thus yields at least two important results: the principles of universalizability and respect for persons, which are important elements of ethical reasoning that serve as alternatives to, or perhaps as valuable addi tions to, the utilitarian approach.
A Kantian Thought Experiment
Describe a few examples of unethical behavior in business that you have witnessed or experienced. How do these examples fail to meet Kant’s universalizability principle? How do they fail to demonstrate respect for human beings?
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3.3: Virtue Ethics
3.3 Define virtue and explain how virtues and
principles of virtue ethics are relevant to business
Despite their differences, utilitarianism and Kantian ethics both address the question, “What actions are right?” Virtue ethics asks instead, “What kind of person should we be?” Moral character rather than right action is fundamen tal in this ethical tradition, which originated with the ancient Greeks and received its fullest expression in Aris totle’s Nicomachean Ethics. The role of ethics according to Aristotle is to enable us to lead successful, rewarding lives—the kinds of lives that we would call “the good life.” The good life in Aristotle’s sense is possible only for
virtuous persons—that is, persons who develop the traits of character that we call “the virtues.” Aristotle not only made the case for the necessity of virtue for good living but also described particular virtues in illuminating detail.
3.3.1: What Is Virtue?
Defining virtue has proven to be difficult, and philoso phers are by no means in agreement.18
• Aristotle described virtue as a character trait that man ifests itself in habitual action. Honesty, for example, cannot consist in telling the truth once; it is rather the trait of a person who tells the truth as a general prac tice. Only after observing people over a period of time can we determine whether they are honest. Mere feel ings like hunger are not virtues, according to Aristotle, in part because virtues are acquired traits. A person must become honest through proper upbringing. • A virtue is also something that we actually practice. Honesty is not simply a matter of knowing how to tell the truth but involves habitually telling the truth and possessing the attitudes that unconditionally support honest behavior. For these reasons, Aristotle classified virtue as a state of character, which is different from a feeling or a skill. • Finally, a virtue is something that we admire in a per son; a virtue is an excellence of some kind that is worth having for its own sake. A skill like carpentry is useful for building a house, for example, but everyone need not be a carpenter. Honesty, by contrast, is a trait that everyone needs for a good life. A complete definition of virtue must be even more encompassing because a compassionate person, for exam ple, must have certain kinds of feelings at the distress of others and also the capacity for sound, reasoned judgments in coming to their aid. Virtue, for Aristotle, is integrally related to what he calls practical wisdom, which may be described roughly as the whole of what a person needs in order to live well. Being wise about how to live involves more than having certain character traits, but being practi cally wise and exhibiting virtue are ultimately inseparable. Although the problems of defining virtue are important in a complete theory of virtue ethics, the idea of virtue as a trait of character that is essential for leading a successful life is sufficient for our purposes. Most lists of the virtues contain few surprises. Such traits as benevolence, compassion, courage, courtesy, dependability, friendliness, honesty, loyalty, moderation, self-control, and toleration are most often mentioned. Aristotle also considered both pride and shame to be vir tues on the grounds that we should be proud of our genu ine accomplishments (but not arrogant) and properly shamed by our failings. More significantly, Aristotle lists
justice among the virtues. A virtuous person not only has a sense of fair treatment but can also determine what con stitutes fairness.
3.3.2: Defending the Virtues
Defending any list of the virtues requires consideration of the contribution that each character trait makes to a good life. In particular, the virtues are those traits that everyone needs for the good life irrespective of his or her specific situation. Thus, courage is a good thing for any one to have because perseverance in the face of dangers will improve our chances of getting whatever it is we want. Similarly, Aristotle’s defense of moderation as a virtue hinges on the insight that a person given to excess will be incapable of effective action toward any end. Honesty, too, is a trait that serves everyone well because it creates trust, without which we could not work coop eratively with others.
What is the good life, the end for which the virtues are needed?
In defending a list of virtues, we cannot consider merely their contribution to some end, however; we must also inquire into the end itself. If our conception of a suc cessful life is amassing great power and wealth, for exam ple, then would not ruthlessness be a virtue? A successful life of crime or lechery requires the character of a Fagin or a Don Juan, but we scarcely consider their traits to be vir tues—or Fagin and Don Juan to be virtuous characters. The “end” of life—that at which we all aim, according to Aristotle—is happiness, and Aristotle would claim that no despot or criminal or lecher can be happy, no matter how successful such a person may be in these (disreputable) pursuits. Defending any list of virtues requires, therefore, that some content be given to the idea of a good life.
The virtues, moreover, are not merely means to happi ness but are themselves constituents of it. That is, happi ness does not consist solely of what we get in life but also includes who we are. A mother or a father, for example, cannot get the joy that comes from being a parent without actually having the traits that make one a good parent. Similarly, Aristotle would agree with Plato that anyone who became the kind of person who could be a successful despot, for example, would thereby become incapable of being happy because that person’s personality would be disordered in the process.
To summarize, defending a list of the virtues requires both that we determine the character traits that are essen tial to a good life and that we give some content to the idea of a good life itself. Virtue ethics necessarily presupposes a view about human nature and the purpose of life. This point is worth stressing because the possibility of applying virtue ethics to business depends on a context that includes some conception of the nature and purpose of business.
3.3.3: Virtue in Business
Virtue ethics could be applied to business directly by hold ing that the virtues of a good businessperson are the same as those of a good person (period). Insofar as business is a part of life, why should the virtues of successful living not apply to this realm as well? However, businesspeople face situa tions that are peculiar to business, and so they may need certain business-related character traits. Some virtues of eve ryday life, moreover, are not wholly applicable to business.
What virtues have limited application in business?
Two examples are compassion and honesty.
Any manager should be caring, for example, but a concern for employee welfare can go only so far when a layoff is una voidable. Honesty, too, is a virtue in business, but a certain amount of bluffing or concealment is accepted and perhaps required in negotiations.
Regardless of whether the ethics of business is differ ent from that of everyday life, we need to show that virtue ethics is relevant to business by determining the character traits that make for a good businessperson. Applying virtue ethics to business would require us, first, to determine the end at which business activity aims. If the pur pose of business is merely to create as much wealth as possible, then we get one set of virtues. Robert C. Solomon, who devel ops a virtue ethics–based view of business in his book Ethics and Excellence, argues that mere wealth creation is not the pur pose of business. Rather, a virtue approach, according to Solo mon, considers business as an essential part of the good life.19 Solomon contends that individuals are embedded in communities and that business is essentially a communal activity, in which people work together for a common good. For individuals, this means achieving a good life that includes rewarding and fulfilling work, and excellence for a corpora tion consists of making the good life possible for everyone in society. Whether any given character trait is a virtue in busi ness, then, is to be determined by the purpose of business and by the extent to which that trait contributes to that purpose. Virtues and vices in business also depend on the character traits that enable or hinder a person in the performance of specific jobs, as illustrated in Table 3.2.
Table 3.2 Virtues and Vices in Business
For each job listed in the table, what character trait(s) might be considered a virtue? In contrast, what trait might be a vice, or a trait that might hinder the job holder’s ability to do the job well?
Hide the cells to come up with your own suggestions. Then click each cell to see the provided examples.
Virtues as Job Requirements
Suppose that those who are happy with their jobs also perform well in them because they are personally suited for the role. Now think of a career you have considered for yourself. What character traits would a person need to excel in that job or field?
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3.4: Rights
3.4 Identify the meaning and importance of rights and the types of rights that apply in different situations
Rights play an important role in business ethics and, indeed, in many ethical issues in society. Both employers and employees are commonly regarded as having certain rights. Employers have the right to conduct business as they see fit, to make decisions about hiring and promotion, and to be protected against unfair forms of competition. Employees have the right to organize and engage in collective bargain ing and to be protected against discrimination and hazard ous working conditions. Consumers and the general public also have rights in such matters as marketing and advertis ing, product safety, and the protection of the environment. Some American manufacturers have been accused of violat ing the rights of workers in developing countries by offering low wages and substandard working conditions.
3.4.1: Meaning of Rights
The introduction of rights into the discussion of ethical issues is often confusing.
First, the term rights is used in many different ways, so that the concept of a right and the various kinds of rights must be carefully distinguished.
Second, many rights come into conflict. The right of an employee to leave his or her employer and join a com- petitor conflicts with the legitimate right of employers to protect trade secrets, for example, so that some bal- ancing is required.
Third, because of the moral significance that we attach to rights, there is a tendency to stretch the concept in ways that dilute its meaning. For example, the rights to receive adequate food, clothing, and medical care, mentioned in the Universal Declaration of Human Rights, are perhaps better described as political goals rather than moral rights.
Fourth, there can be disagreement over the very exist- ence of a right. Whether employees have a right to due process in discharge decisions, for example, is a sub- ject of dispute.
For all these reasons, the claim of a right is frequently the beginning of an ethical debate rather than the end. The concept of a right can be explained by imagining a company that treats employees fairly but does not recog nize due process as a right.20 In this company, employees are dismissed only for good reasons after a thorough and impartial hearing, but there is no contract, statute, or other provision establishing a right of due process for all employ ees. Something is still missing, because the fair treatment that the employees enjoy results solely from the company’s voluntary acceptance of certain personnel policies. If the company were ever to change these policies, then employ ees dismissed without due process would have no recourse. We can contrast this with a company in which due process is established as a right. Employees in this company have something that was lacking in the previous company. They have an independent basis for challenging a decision by the company to dismiss them. They have something to stand on, namely, their rights. Rights can be understood, therefore, as entitlements.21 To have rights is to be entitled to act on our own or to be treated by others in certain ways without asking permis sion of anyone or being dependent on other people’s good will. Rights entitle us to make claims on other people either to refrain from interfering in what we do or to contribute actively to our well-being—not as beggars, who can only entreat others to be generous, but as creditors, who can demand what is owed to them. This explanation of rights in terms of entitlements runs the risk of circularity (after all, what is an entitlement but something we have a right to?), but it is sufficiently illuminating to serve as a begin ning of our examination.
3.4.2: Kinds of Rights
Several kinds of rights have been distinguished. 1. Legal and Moral Rights. Legal rights are rights that are recognized and enforced as part of a legal system. In the United States, these consist primarily of the rights set forth in the Constitution, including the Bill of Rights, and those created by acts of Congress and state legislatures. Moral rights, by contrast, are rights that do not depend on the existence of a legal sys tem. They are rights that we (morally) ought to have, regardless of whether they are explicitly recognized by law. Moral rights derive their force not from being part of a legal system but from more general ethical rules and principles. 2. Specific and General Rights. Some rights are specific in that they involve identifiable individuals. A major source of specific rights is contracts because these ubiquitous in struments create a set of mutual rights as well as duties for the individuals who are parties to them. Other rights are general rights because they involve claims against
everyone, or humanity in general. Thus, the right to free speech belongs to everyone, and the obligation to en force this right rests with the whole community.
3. Negative and Positive Rights. Generally, negative
rights are correlated with obligations on the part of others to refrain from acting in certain ways that in terfere with our own freedom of action. Positive rights, by contrast, impose obligations on other people to pro vide us with some good or service and thereby to act positively on our behalf.22 The right to property, for example, is largely a negative right because no one else is obligated to provide us with property, but everyone has an obligation not to use or take our property with out permission. The right to adequate health care, for example, is a positive right insofar as its implementa tion requires others to provide the necessary resources. 4. Natural Rights. Among the moral rights that are com monly recognized, one particular kind that is promi nent in historical documents is natural rights, which are thought to belong to all persons purely by virtue of their being human.23 Natural rights are characterized by two main features: universality and unconditionality. Universality means that they are possessed by all per sons, without regard for race, sex, nationality, or any specific circumstances of birth or present condition. Unconditionality means that natural or human rights do not depend on any particular practices or institu tions in society. The unconditionality of rights also means that there is nothing we can do to relinquish them or to deprive ourselves or others of them. This feature of natural, or human, rights is what is usually meant by the phrase inalienable rights, which is used in the American Declaration of Independence.24 The most prominent natural rights theory is that pre sented by John Locke (1633–1704) in his famous Second Treatise of Government (1690).25 Locke began with the sup position of a state of nature, which is the condition of human beings in the absence of any government. The idea is to imagine what life would be like if there were no gov ernment and then to justify the establishment of a political state to remedy the defects of the state of nature. Locke held that human beings have rights, even in the state of nature, and that the justification for uniting into a state is to protect these rights. The most important natural right for Locke is the right to property. In his view, although the bounty of the earth is provided by God for the benefit of all, no one can make use of it without taking some portion as one’s own. This is done by means of labor, which is also a form of property. “Every man has property in his own person,” according to Locke, and so “[t]he labor of his body and the work of his hands . . . are properly his.”
Use Figure 3.3 to review key points about the different kinds of rights discussed.
Figure 3.3 Different Kinds of Rights
Rights in Business
What right do you think is most often neglected or violated in the employment relationship? Give an example, identify what type of right it is, and explain what entitlement it grants to employers or employees.
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3.5: Justice
3.5 explain the role of justice in business ethics, the
three kinds of justice outlined by Aristotle, and the contemporary principles of justice offered by Rawls and nozick
Justice, like rights, is an important moral concept with a wide range of applications. We use it to evaluate not only the actions of individuals but also social, legal, political, and economic practices and institutions. Questions of jus tice or fairness (the two terms are used here interchangea bly) often arise when there is something to distribute. If there is a shortage of organ donors, for example, we ask, what is a just or fair way of deciding who gets a trans plant? If there is a burden, such as taxes, we want to make sure that everyone bears a fair share. Justice is also con cerned with the righting of wrongs. It requires, for exam ple, that a criminal be punished for a crime and that the punishment fit the crime by being neither too lenient nor too severe. To treat people justly is to give them what they deserve, which is sometimes the opposite of generosity and compassion. Indeed, we often speak of tempering justice with mercy.
The concept of justice is relevant to business ethics pri marily in the distribution of benefits and burdens. Economic transformations often involve an overall improvement of welfare that is unevenly distributed, so that some groups pay a price while others reap the rewards. Is the resulting distribution just, and if not, is there anything that is owed to the losers? Justice also requires that something be done to compensate the victims of discrimination or defective prod ucts or industrial accidents. Because justice is also an impor tant concept in evaluating various forms of social organization, we can also ask about the justice of the eco nomic system in which business activity takes place.
3.5.1: Nature and Value of Justice
The ancient Greek philosopher Aristotle distinguished three kinds of justice.
Distributive justice, which deals with the distribution of benefits and burdens.
Compensatory justice, which is a matter of compensat- ing persons for wrongs done to them.
Retributive justice, which involves the punishment of wrongdoers. Both compensatory and retributive justice are con- cerned with correcting wrongs. Generally, compensating the victims is the just way of correcting wrongs in private dealings, such as losses resulting from accidents and the failure to fulfill contracts, whereas retribution—that is, punishment—is the just response to criminal acts, such as assault or theft.26 Questions about distributive justice arise mostly in the evaluation of our social, political, and economic institu- tions, where the benefits and burdens of engaging in coop- erative activities must be spread over a group. In some
instances, a just distribution is one in which each person shares equally, but in others, unequal sharing is just if the inequality is in accord with some principle of distribution. Thus, in a graduated income tax system, ability to pay and not equal shares is the principle for distributing the bur den. Generally, distributive justice is comparative, in that it considers not the absolute amount of benefits and burdens of each person but each person’s amount relative to that of others.27 Whether income is justly distributed, for example, cannot be determined by looking only at the income of one person but requires us, in addition, to compare the income of all people in a society. The rationale of compensatory justice is that an acci dent caused by negligence, for example, upsets an initial moral equilibrium by making a person worse off in some way. By paying compensation, however, the condition of the victim can be returned to what it was before the acci dent, thereby restoring the moral equilibrium. Similarly, a person who commits a crime upsets a moral equilib rium by making someone else worse off. The restoration of the moral equilibrium in cases of this kind is achieved by a punishment that “fits the crime.” Both compensa tory justice and retributive justice are noncomparative. The amount of compensation owed to the victim of an accident or the punishment due to a criminal is deter mined by the features of each case and not by a compari son with other cases. A useful distinction not discussed by Aristotle is that between just procedures and just outcomes.28 In cases of dis tributive justice, we can distinguish between the proce dures used to distribute goods and the outcome of those procedures, that is, the actual distribution achieved. A sim ilar distinction can be made between the procedures for conducting trials, for example, and the outcomes of trials. If we know what outcomes are just in certain kinds of situ ations, then just procedures are those that produce or are likely to produce just outcomes. Thus, an effective method for dividing a cake among a group consists of allowing one person to cut it into the appropriate number of slices with the stipulation that that person take the last piece. Assum ing that an equal division of the cake is just, a just distribu tion will be achieved, because cutting the cake into equal slices is the only way the person with the knife is assured of getting at least as much cake as anyone else. Similarly, just outcomes in criminal trials are those in which the guilty are convicted and the innocent are set free. The com plex rules and procedures for trials are those that generally serve to produce those results.
3.5.2: Aristotle on Distributive Justice
Aristotle described justice as a kind of equality, but this is not very helpful since equality is subject to varying inter pretations.29 The extreme egalitarian position that everyone
should be treated exactly alike has found few advocates, and most who call themselves egalitarians are concerned only to deny that certain differences ought to be taken into account. A more moderate egalitarianism contends that we ought to treat like cases alike. That is, any difference in the treatment of like cases requires a moral justification.
Aristotle expressed the idea of treating like cases alike in an arithmetical equation that represents justice as an equality of ratios.30 Let us suppose that two people, A and B, each receive some share of a good, P. Any difference in their relative shares must be justified by some relevant dif ference, Q. Thus, a difference in pay, P, is justified if there is a difference in some other factor, Q, that justifies the differ ence in P—such as the fact that one person worked more hours or was more productive. Aristotle added the further condition that the difference in each person’s share of the good must be proportional to the difference in his or her share of the relevant difference. If one person worked twice as many hours as another, and the amount of time worked is the only relevant factor, then the pay should be exactly twice as much—no more and no less. Aristotle’s principle of distributive justice can be stated in the follow ing manner.31
A’s share of
A’s B’s share share of of P P =B’s share of Q Q
This account of Aristotle’s principle of distributive jus tice is obviously not complete until the contents of both P and Q are fully specified. What are the goods in question? What features justify different shares of these goods? Among the goods distributed in any society are material goods, such as food, clothing, housing, income, and wealth, which enable people to purchase material goods. There are many nonmaterial goods, including economic power, par ticipation in the political process, and access to the courts, which are also distributed in some manner. Finally, Aristo tle counted honor as a good, thereby recognizing that soci ety distributes status and other intangibles.
Among the many different justifying features that have been proposed are ability, effort, accomplishment, contribution, and need.32
Example: Possible Justifications for Unequal Pay
In setting wages, for example, an employer might award higher pay to workers who:
have greater training and experience or greater talent (ability);
apply themselves more diligently, perhaps overcoming
bstacles or making great sacrifices (effort);
have produced more or performed notable feats (accomplishment) or who provide more valued services (contribution); or,
have large families to support or who, for other reasons, have greater need.
The Concept of Distributive Justice
A manager is passed over for a lucrative promotion because her team regularly fails to meet project deadlines and goes over budget. The promotion is given instead to a manager who has been with the com pany for a shorter period of time, but whose team makes their dead lines and manages to stay within budget. Develop a case that explains why this promotion is fair. Develop a case that explains why it is not.
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3.5.3: Rawls’s Egalitarian Theory
In A Theory of Justice (1971), the contemporary American phi losopher John Rawls (1921–2002) offered two principles that he thought express our considered views about justice. Rawls began by asking us to imagine a situation in which rational, free, and equal persons, concerned to advance their own interests, attempt to arrive at unanimous agreement on prin ciples that will serve as the basis for constructing the major institutions of society. Rawls stipulated further that these individuals are asked to agree on the principles of justice behind a veil of ignorance, which prevents them from knowing many facts about themselves and their situation. Behind this veil, the bargainers are forced to be impartial and to view pro posed principles from the perspective of all persons at once. Without any knowledge of their race or sex, for example, they are unlikely to advocate or support discriminatory principles because they could be among the victims of discrimination. Now, what principles would rational, self-interested persons freely agree to in a position of equality behind a veil of ignorance? Rawls proposed two principles, which he stated as follows:
1. each person is to have an equal right to the most extensive total system of basic liberties compatible with a similar system of liberty for all.
Rationale: The reasoning behind the first principle is that rational individuals under a veil of ignorance will choose an equal share of basic liberties (such as freedom of expression, association and political par ticipation) because these liberties are essential to eve ryone, no matter their position in life.
social and economic inequalities are to be arranged so that they are both,
to the greatest benefit of the least advantaged, and
attached to offices and positions open to all under conditions of fair equality of opportunity.33
Rationale: The second principle recognizes that there are two conditions under which rational, self-interested persons would make an exception to the first principle and accept less than an equal share of some goods.
Like the person who cuts the cake knowing that he will get the last piece, persons in the original position would generally opt for equal shares. However, according to principle 2a, called the difference principle, an unequal distribution is justified if everyone would be better off with the inequality than without it. If it is possible to increase the total amount of income, for example, but not possible to distribute it equally, then the resulting distribution is still just, according to Rawls, as long as the extra income is distributed in such a way that everyone benefits from the inequality.
Principle 2b, the principle of equal opportunity, is sim
ilar to the view that careers should be open to all on the basis of talent. Whether a person gets a certain job, for example, ought to be determined by compe tence in that line of work and not by skin color, family connections, or any other irrelevant characteristic.
3.5.4: Nozick’s Entitlement Theory
Robert Nozick (1938–2002) offered a theory of justice, called the entitlement theory, which stands alongside Rawls’s egalitarianism as a major contemporary account of justice. The principles of justice in Nozick’s theory differ from Rawls’s theory in two major respects.
1. First, they are historical principles as opposed to non historical or end-state principles.34 Historical princi
ples, Nozick explains, take into account the process by which a distribution came about, whereas end-state principles evaluate a distribution with regard to cer tain structural features at a given time. 2. Second, the principles of justice in both Aristotle’s and
Rawls’s theories are patterned.35 A principle is pat terned if it specifies some feature in a particular distri bution and evaluates the distribution according to the presence or absence of that feature. Any principle of the form “Distribute according to _______,” such as “Distribute according to IQ scores,” is a patterned prin ciple, as is the socialist formula, “From each according to his abilities, to each according to his needs.” Nozick thought that any acceptable principle of justice must be nonpatterned because any particular pattern of distribution can be achieved and maintained only by vio lating the right to liberty. Upholding the right to liberty, in turn, upsets any particular pattern of justice. He argued for this point by asking us to consider a case in which there is a perfectly just distribution, as judged by some desired pat tern, and also perfect freedom.
example: Suppose that a famous athlete—Nozick sug gested Wilt Chamberlain—will play only if he is paid an additional 25 cents for each ticket sold and that many people are so excited to see Wilt Chamberlain play that they will cheerfully pay the extra 25 cents for the privilege.
What distribution of income will result from this arrangement?
Both Wilt Chamberlain and the fans are within their rights to act as they do; but at the end of the season, if 1 million peo ple pay to see him play, then Wilt Chamberlain will have an additional income of $250,000, which is presumably more than he would be entitled to on a patterned principle of jus tice (such as a performance-based salary or a fair percent age of regular ticket sales). By exercising their right to liberty, though, Wilt Chamberlain and the fans have upset the just distribution that formerly prevailed.
Could the resulting distribution be altered in a just manner?
In order to maintain the patterned distribution, it would be necessary to restrict the freedom of Wilt Chamberlain or the fans in some way, such as prohibiting the extra payment or taxing away the excess. However, such a restriction of free dom might itself be considered unjust.
The entitlement theory can be stated very simply.
A distribution is just, Nozick said, “if everyone is entitled to the holdings they possess.”36
Whether we are entitled to certain holdings is deter mined by tracing their history. Most of what we possess comes from others through transfers, such as purchases and gifts. Thus, we might own a piece of land because we bought it from someone, who in turn bought it from someone else, and so on. Proceeding backward in this fashion, we ulti mately reach the original settler who did not acquire it through a transfer but by clearing the land and tilling it. As long as each transfer was just and the original acquisition was just, our present holding is just. “Whatever arises from a just situation by just steps is itself just,” Nozick wrote.37 In his theory, then, particular distributions are just not because they conform to some pattern (equality or social utility, for example) but solely because of antecedent events. Nozick’s theory thus requires at least two principles: a
principle of just transfer and a principle of just original
acquisition. Because holdings can be unjustly appropri ated by force or fraud, a third principle, a principle of rectification, is also necessary in order to correct injustices by restoring holdings to the rightful owners. If we right fully possess some holding—a piece of land, for example, by either transfer or original acquisition—then we are free to use or dispose of it as we wish. We have a right, in other words, to sell it to whomever we please at whatever price that person is willing to pay, or we can choose to give it away. As long as the exchange is purely voluntary, with no force or fraud, the resulting redistribution is just. Any attempt to prevent people from engaging in voluntary exchanges in order to secure a particular distribution is a violation of liberty, according to the entitlement theory.
A world consisting only of just acquisitions and just transfers would be just, according to Nozick, no matter what pattern of distribution results. Some people, through hard work, shrewd trades, or plain good luck, would most likely amass great wealth, whereas others, through indolence, mis judgment, or bad luck, would probably end up in poverty. However, the rich in such a world would have no obligation to aid the poor,38 nor would it be just to coerce them into doing so. Each person’s share would be determined largely through his or her choices and those of others. Nozick sug gested that the entitlement theory can be expressed simply as “From each as they choose, to each as they are chosen.”
The entitlement theory supports a market system with only the absolute minimum of government intervention, as long as the principles of just acquisition and just transfer are satisfied. The reason is that a system in which we have com plete freedom to acquire property and engage in mutually advantageous trades (without violating the rights of another person, of course) is one in which our own rights are most fully protected. To critics who fear that unregu lated markets would lead to great disparities between the rich and the poor and a lowering of the overall welfare of society, Nozick had a reply. The point of justice is not to pro mote human well-being or to achieve a state of equality; it is to protect our rights. Because a market system does this bet ter than any other form of economic organization, it is just.
Conclusion: Ethical Theories
This chapter presents the main concepts and theories of ethics that have been developed over centuries by major moral philosophers. The value of any theory for busi ness ethics is its usefulness in evaluating business prac tices, institutional arrangements, and economic systems. In general, all of these theories justify most prevailing
business practices, the institution of the modern corpo ration, and capitalism or the market system, but they also provide the basis for some criticism and improve ment. In the subsequent chapters, this theoretical foun dation is used to explore a wide range of practical business ethics topics.
End-of-Chapter Case Studies
This chapter concludes with four case studies.
These cases illustrate long-recognized tensions between the major ethical theories. The memo in “Exporting Pollution” employs seemingly valid utilitarian reasoning in the form of cost–benefit analysis, but the conclusions may strike some readers as ethically unacceptable. The classic “dirty hands” problem, which dates back to Machiavelli (i.e., Should a great leader be willing to commit immoral acts in achieving great ends?) is displayed in “Clean Hands in a Dirty Business,” as one friend attempts to persuade another that what appears to be unethical conduct (Kant) might have overall beneficial conse quences (Bentham and Mill). “Conflict of an Insurance Broker” shows that it is not always clear what it means for an agent to act in the interest of the client, especially when agency duties are complicated, as they are in this case, by conflict of interest. Important lessons in “An Auditor’s Dilemma” are that the utilitar ian search for consequences must probe deeply to find less obvious harms and that the Kantian question (What would hap pen if everyone acted in the same way?) can be usefully com bined with utilitarianism to produce a more complete analysis.
Case: Exporting Pollution
As an assistant to the vice president of environmental affairs at Americhem, Rebecca Wright relished the oppor tunity to apply her training in public policy analysis to the complex and emotion-laden issues that her company faces.39 Rebecca was convinced that cost–benefit analysis, her specialty, provides a rational decision-making tool that cuts through personal feelings and lays bare the hard eco nomic realities. Still, she was startled by the draft of a memo that her boss, Jim Donnelly, shared with her. The logic of Jim’s argument seemed impeccable, but the conclu sions were troubling—and Rebecca was sure that the docu ment would create a furor if it were ever made public. Jim was preparing the memo for an upcoming decision on the location for a new chemical plant. The main problem was that atmospheric pollutants from the plant, although mostly harmless, would produce a persistent haze, and one of the particles that would be released into the atmosphere is also known to cause liver cancer in a very small portion of the people exposed. Sitting down at her desk to write a response, Rebecca read again the section of the memo that she had circled with her pen.
From an environmental point of view, the case for locating the new plant in a Third World country is overwhelming. These reasons are especially compelling in my estimation:
1. The harm of pollution, and hence its cost, increases in proportion to the amount of already existing
pollution. Adding pollutants to a highly polluted environment does more harm than the same amount
added to a relatively unpolluted environment. For this reason, much of the Third World is not effi ciently utilized as a depository of industrial wastes, and only the high cost of transporting wastes pre vents a more efficient utilization of this resource.
The cost of health-impairing pollution is a function
f the forgone earnings of those who are disabled or who die as a result. The cost of pollution will be least, therefore, in the country with the lowest wages. Any transfer of pollution from a high-wage, First World country to a low-wage, Third World country will pro- duce a net benefit.
The risk of liver cancer from this plant’s emissions has been estimated at one-in-a-million in the United States, and the resulting cancer deaths would occur mostly among the elderly. The risk posed by the new plant will
bviously be much less in a country where people die young from other causes and where few will live long enough to incur liver cancer from any source. Overall, the people of any Third World country might prefer the jobs that our plant will provide if the only drawback is a form of cancer that they are very unlikely to incur.
The cost of visibility-impairing pollution will be greater in a country where people are willing to spend more for good visibility. The demand for clear skies— which affects the aesthetics of the environment and not people’s health—has very high-income elasticity, and so the wealthy will pay more than the poor to live away from factory smoke, for example. Because the cost of anything is determined by how much people are willing to pay in a market, the cost of visibility- impairing pollution in a First World country will be higher than the same amount of pollution in a Third World country. Thus, people in the United States might prefer clear skies over the benefits of our plant, but people elsewhere might choose differently.
ShaRed WRITING: exPORTING POlluTION
This case is based on an actual memo that aroused a storm of criticism. What points in the memo might critics consider to be morally objectionable? Should moral criticism be directed only to this particular application of cost—benefit analysis or to the method of cost—benefit itself?
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Case: Clean Hands in a Dirty Business
Even with her newly-minted MBA degree, Janet Moore was having no luck finding that dream job in the marketing department of a spirited, on-the-move company. Now,
almost any job looked attractive, but so far no one had called her back for a second interview. Employers were all looking for people with experience, but that requires getting a job first. Just as she began to lose hope, Janet bumped into Karen, who had been two years ahead of her in college. Karen, too, was looking for a job, but in the meantime she was employed by a firm that was planning to add another market ing specialist. Janet was familiar with Karen’s employer from a case study that she had researched for an MBA marketing course, but what she had learned appalled her. The company, Union Tobacco, Inc., is the major U.S. manufacturer of snuff, and her case study examined how this once staid company had managed to attract new cus tomers to a product that had long ago saturated its tradi tional market.40 Before 1970, almost all users of snuff—a form of tobacco that is sucked rather than chewed—were older men. The usual form of snuff is unattractive to non users because of the rough tobacco taste, the unpleasant feel of loose tobacco particles in the mouth, and the high nicotine content, which makes many first-time users ill. Snuff, to put it mildly, is a hard sell. The company devised a product development and mar keting campaign that a federal government report labeled a “graduation strategy.” Two new lines were developed—a low-nicotine snuff in a tea-bag-like pouch with a mint flavor that had proved to be popular with young boys and a step up product with slightly more nicotine, a cherry flavor, and a coarse cut that avoids the unpleasantness of tobacco float ing in the mouth. Both products are advertised heavily in youth-oriented magazines with the slogan “Easy to use, anywhere, anytime,” and free samples are liberally distrib uted at fairs, rodeos, and car races around the country. Broker
The strategy had worked to perfection. Youngsters who started on the low-nicotine mint- and cherry-flavored products soon graduated to the company’s two stronger, best-selling brands. Within two decades, the market for snuff tripled to about 7 million users, of which 1 million to 2 million are between the ages of 12 and 17. The average age of first use was now estimated to be 9½ years old. Janet also reported in her case study that snuff users were more than 4 times more likely to develop cancers of the mouth generally and 50 times more likely to develop specific can cers of the gum and inner-cheek lining. Several suits had been filed by the parents of teenagers who had developed mouth cancers, and tooth loss and gum lesions have also been widely reported, even in relatively new users. Karen admitted that she was aware of all this but encouraged Janet to join her anyway. “You wouldn’t believe some of the truly awful marketing ploys that I have been able to scuttle,” she said. “Unless people like you and me get involved, these products will be marketed by peo ple who don’t care one bit about the little kids who are get ting hooked on snuff. Believe me, it’s disgusting work. I don’t like to tell people what I do, and I sometimes look at
myself in the mirror and ask what has become of the ideal ism I had starting out. But there will always be someone to do this job, and I feel that I have made a difference. If you join me, the two of us together can slow things down and avoid the worst excesses, and maybe we’ll even save a few lives. Plus, you can get some experience and be in a better position to move on.”
Janet admitted to herself that Karen had a strong argu ment. Maybe she was being too squeamish and self centered, just trying to keep her own hands clean. Maybe she could do others some good and help herself at the same time by taking the job. But then again. . . .
ShaRed WRITING: CleaN haNdS IN a dIRTy BuSINeSS
On what grounds can Karen’s work at the tobacco company be considered ethical or unethical? Explain whether or not you believe that Karen has made a morally significant difference and done more good than harm, as she states. Would you advise Janet to take the job or hold out for something else?
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Case: Conflict of an Insurance
I work for an insurance brokerage firm, Ashton & Ashton (A&A), which is hired by clients to obtain the best insurance coverage for their needs.41 To do this, we evaluate a client’s situation, keep informed about insurance providers, negoti ate on the client’s behalf, and present a proposal to the client for approval. Our compensation comes primarily from a commission that is paid by the client as part of the premium. The commission is a percentage of the premium amount, and the industry average for commissions is between 10 percent and 15 percent. A secondary source of compensa tion is a contingency payment that is made annually by insurance providers; the amount of this payment is based on the volume of business during the past year.
One of our clients, a world-class museum in a major American city, has been served for years by Haverford Insurance Company. Haverford is a financially sound insurer that has provided the museum with reliable cov erage at reasonable prices and has gone out of its way on many occasions to be accommodating. Haverford has also built good relations with A&A by allowing a 17 per cent commission—a fact that is not generally known by the clients. When the museum’s liability insurance policy
came up for renewal, A&A was asked to obtain competi tive proposals from likely insurers. We obtained quota tions from four comparable insurance companies with annual premiums that ranged between $90,000 and $110,000. A fifth, unsolicited proposal was sent by a small, financially shaky insurance company named Reliable. The annual premium quoted by Reliable was $60,000. There is no question that the museum is best served by continuing with Haverford, and our responsibility as an insurance broker is to place clients with financially sound insurers that will be able to honor all claims. The museum has a very tight operating budget, however, and funding from public and private sources is always unpredictable. As a result, the museum is forced to be extremely frugal in its spending and has always chosen the lowest bid for any service without regard for quality. The dilemma I faced, then, was: Should I present the Reliable bid to the museum? If I present Reliable’s bid, the museum will almost certainly accept it given its priority of saving money. Because the market indicates that the value of the needed policy is around $100,000, the Reliable proposal is definitely an attempt to “low-ball” the competition, and the company would probably raise the premium in future years. Is this honest competition? And if not, should A&A go along with it? Allowing a client to accept a low-ball bid might also jeopardize our relations with the reputable insurers that submitted honest proposals in good faith. If relations with Reliable are not successful, the museum is apt to blame us for not doing our job, which is not merely to pass along proposals but to evaluate them for suitability. On the other hand, A&A will receive a higher commis sion and a larger contingency payment at the end of the year if the museum is presented with only the four solicited proposals and never learns of the Reliable bid. Because of our financial stake in the outcome, however, do we face a conflict of interest? Could we be accused of choosing a course of action that benefits us, even though in reality the client is also better served?
Explain whether or not A&A would be acting responsibly in its role as a broker by allowing the museum to make a poor choice. How can the broker act responsibly toward the museum while still pre senting the inferior insurance bid?
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Case: An Auditor’s Dilemma
Sorting through a stack of invoices, Alison Lloyd’s atten tion was drawn to one from Ace Glass Company. Her responsibility as the new internal auditor for Gem Pack ing was to verify all expenditures, and she knew that Ace had already been paid for the June delivery of the jars that are used for Gem’s jams and jellies. On closer inspection, she noticed that the invoice was for deliveries in July and August that had not yet been made. Today was only June 10. Alison recalled approving several other invoices lately that seemed to be misdated, but the amounts were small compared with $130,000 that Gem spends each month for glass jars. “I had better check this out with purchasing,” she thought.
Over lunch, Greg Berg, the head of purchasing, explained the system to her. The jam and jelly division operates under an incentive plan whereby the division manager and the heads of the four main units—sales, pro duction, distribution, and purchasing—receive substantial bonuses for meeting their quota in pretax profits for the fiscal year, which ends on June 30. The bonuses are about one-half of annual salary and constitute one-third of the managers’ total compensation. In addition, meeting quota is weighted heavily in evaluations, and missing even once is considered to be a deathblow to the career of an aspiring executive at Gem. So the pressure on these managers is intense. On the other hand, there is nothing to be gained from exceeding a quota. An exceptionally good year is likely to be rewarded with an even higher quota the next year because quotas are generally set at corporate head quarters by adding 5 percent to the previous year’s results.
Greg continued to explain that several years ago, after the quota had been safely met, the jam and jelly division began prepaying as many expenses as possible—not only for glass jars but also for advertising costs, trucking charges, and some commodities such as sugar. The prac tice has continued to grow, and sales also helps out by delaying orders until the next fiscal year or by falsifying delivery dates when a shipment has already gone out. “Regular suppliers like Ace Glass know how we work,” Greg said, “and they sent the invoices for July and August at my request.” He predicted that Alison will begin seeing more irregular invoices as the fiscal year winds down. “Making quota gets easier each year,” Greg observed, “because the division gets an ever-increasing head start, but the problem of finding ways to avoid going too far over quota has become a real nightmare.” Greg is not sure, but he thinks that other divisions are doing the same thing. “I don’t think corporate has caught on yet,” he said, “but they created the system, and they’ve been happy with the results so far. If they’re too dumb to figure out how we’re achieving them, that’s their problem.”
Alison recalled that upon becoming a member of the Institute of Internal Auditors (IIA), she agreed to abide by the IIA code of ethics. This code requires members to exer cise “honesty, objectivity, and diligence” in the perfor mance of their duties but also to be loyal to the employer. However, loyalty does not include being a party to any “illegal or improper activity.” As an internal auditor, she is also responsible for evaluating the adequacy and effec tiveness of the company’s system of financial control. “But what is the harm of shuffling a little paper around? Nobody is getting hurt, and it all works out in the end,” she thinks to herself.
ShaRed WRITING: aN audITOR’S dIleMMa
What, if anything, is really wrong with the practice that Greg has explained? How could someone criticize Alison’s assessment that “nobody is getting hurt, and it all works out in the end”?
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Chapter 3 Quiz: ethical theories
Chapter 4
Whistle-Blowing
4.1 Define the significance of whistle-blowing
and the act itself according to seven criteria
4.2 Assess situations where whistle-blowing
may or may not be justified, given the duties and obligations of all parties and the potential consequences of the act
4.3 Describe the characteristics and importance of laws designed to protect whistle-blowers and key points in the debate over the moral justification of these laws
4.4 Identify the importance of developing an
effective whistle-blowing policy for an organization and the key components of such a policy
Case: Time’s Persons of the Year
Similarities and Differences
In a year of momentous events, Time magazine honored three whistle-blowers as “persons of the year” for 2002.1 With the collapse of Enron and WorldCom and the aftermath of 9/11 still reverberating, this annual cover story brought recognition to three women who played important roles in these calamities. Sherron Watkins wrote a lengthy memo to Ken Lay, her top boss at Enron, warning of the financial time bomb hidden in the company’s questionable off-balance-sheet partnerships.2 “I am incredibly nervous,” she wrote, “that we will implode in a wave of accounting scandals.” Cynthia Cooper, the head of internal auditing at WorldCom, unraveled the accounting irregularities that en abled CEO Bernie Ebbers and CFO Scott Sullivan to hide almost $4 billion in losses (a figure that eventually totaled more than $9 billion).3 And Coleen Rowley, a career FBI agent in Minneapolis, sent a confidential 13-page memo to the agency’s direc tor, Robert Mueller, contradicting his claim that there was no evidence that terrorists were planning the 9/11 attacks.4 She complained that the head office in Washington, DC, had ignored pleas from the Minneapolis branch to inves tigate Zacarias Moussaoui, the alleged missing twentieth highjacker, who had been eager to learn how to fly a Boe ing 747, and had also overlooked reports from an agent in Phoenix about Middle-Eastern students seeking to enroll in flying schools there.
In each case, these “persons of the year,” all women who occupied relatively high positions, had exhibited extraordinary courage and determination to establish the truth and make it known to those in charge. None of them sought public acclaim or even thought of themselves as whistle-blowers. They sub mitted their memos confidentially to the appropriate parties. Watkins responded to an open invitation by Lay, the chairman of the board, for Enron employees to air their concerns after the sudden departure of CEO Jeffrey Skilling. She explained to Lay that Skilling probably saw the coming collapse and wanted to avoid involvement. Cooper reported her findings to the audit committee of WorldCom’s board because Ebbers and Sullivan, her superiors, were deeply implicated. Only Rowley went outside the usual chain of command by writing directly to the FBI director. Their memos became public when they were leaked during preparations for congressional hearings. Wat kins and Rowley were eventually called to testify before Con gress, but Cooper was excused to avoid interfering with a Justice Department investigation of WorldCom. Their motivation, in each case, was to save the organiza tion and, for Watkins and Rowley, the top leaders from serious mistakes. Watkins apparently thought that Lay was unaware of the danger facing the company and that, once informed, he would take corrective action. (She would discover later that Lay’s immediate response was to seek an opinion from a company lawyer on whether she could be terminated.) Row ley sought to apprise FBI director Mueller of the truth so that he could correct his public statements and avoid the politi cal damage that might result from any revelations about the
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Were they really whistle-blowers? Compare Your Thoughts
bungled Moussaoui investigation. She also urged Mueller to undertake reforms that she thought would strengthen the agency. Only Cooper seemed to be aware that her revela tions could cause great problems for her superiors, Ebbers and Sullivan, in this case, but she recognized that the board of directors rightly controls the corporation and has ultimate responsibility for protecting it. She no doubt thought that the audit committee of the board, which has the task of ensuring proper accounting, would take appropriate action, as indeed it did. A further similarity is that each whistle-blower did not voice vague, unfounded concerns but assembled a carefully documented list of possible wrongdoings. The charges in their memos were made more credible by the women’s ex pertise and insider’s knowledge. Watkins obtained a mas ter’s degree in accounting and had risen in the ranks at Arthur Andersen, where she worked on the Enron account before being recruited by the company in 1993. At Enron, she held four high-level finance positions in seven years, eventually becoming vice president of corporate develop ment. In her memo, she explained in detail the problems with two off-the-books partnerships, the Condor and the Raptor deals, and urged that they be reviewed by independent law and accounting firms. Cooper and her staff worked many weeks, often after hours, untangling WorldCom’s irregular accounting practices, and in a meeting with the audit com mittee in Washington, DC, she was able to explain how CFO Sullivan and the company’s controller had systematically recorded expenses as capital investments, a clear violation of accounting rules. In keeping with Rowley’s sole purpose “to provide the facts within my purview so that an accurate assessment can be obtained,” she provided an exhaustive account with footnotes of the Minneapolis agents’ investi gation of Moussaoui and the obstacles thrown up by the Washington head office.5 Much has been made of the fact that all three of these whistle-blowers are women, a feature they share with two other prominent whistle-blowers whose stories were made into popular movies, namely, Karen Silkwood and Erin Brockovich.6 However, research suggests that women are less likely than men to blow the whistle.7 Several other com mon factors, though, may explain why these women became whistle-blowers. They had benefited from the breaks in the glass ceiling that allowed them to assume high positions, which in turn enabled them to witness wrongdoing and to have credibility reporting it. At the same time, they were still outsiders in a clubby male culture and did not share the values of their male colleagues or their sense of belonging. Anita Hill, who herself gained national attention by raising charges of sexual harassment in the confirmation process for Supreme Court justice Clarence Thomas, calls these women “insiders with outsider values.”8 Hill suggests that women’s sensitivity to their own mistreatment in the workplace may
make them more sensitive to other kinds of wrongdoing and more willing to speak out against them. As one journalist ob served, these whistle-blowers prove that “there are women talented enough to break through the glass ceiling who are even more willing to break more glass to make the climb to the top worth it.”9
Questions have also been raised about whether these wom en were even whistle-blowers. Although each wrote an ex plosive memo, it was sent confidentially to a person at the top of the organization with the aim of protecting the organi zation. No one went outside the chain of command. Only Coleen Rowley’s memo to the audit committee of the board produced decisive, corrective action. After Watkins met personally with Lay, he turned the memo over to the same law firm that had approved many Enron transactions, and, unsurprisingly, this firm found no substance to the charges she raised. The memos by Watkins and Rowley provided top leaders with an opportunity to protect themselves before any bad news reached the public. And all three memos came to light only because of congressional hearings. Watkins’s action, in particular, has been criticized. Her memo advises Lay to develop a “clean up plan” that consists in the best case to clean up “quietly if possible,” and in the worst case to develop public relations, investor relations, and customer assurance plans, legal actions, dismissals, and disclosure. By assuming that Lay was uninformed about Enron’s financial problems, some charge that Watkins bol stered his legal defense strategy of ignorance. One expert on whistle-blowing said, “She spoke up, but I don’t see any evi dence that she resisted or went beyond in some way to demand a remedy.”10 Dan Ackman of Forbes magazine was more critical: A whistle-blower, literally speaking, is someone who spots a criminal robbing a bank and blows the whistle alerting police. That’s not Sherron Watkins. What the Enron vice president did was write a memo to the bank robber, suggesting he stop robbing the bank and offering ways to avoid getting caught. Then she met with the rob ber, who said he didn’t believe he was robbing the bank, but said he’d investigate to find out for sure. Then, for all we know, Watkins did nothing, and her memo was not made public until congressional investigators released it six weeks after Enron filed for bankruptcy.11 Whether Watkins, Cooper, and Rowley are whistle-blow ers in a precise sense, most people would probably agree with Time magazine that “They were people who did right just by doing their jobs rightly—which means ferociously, with eyes wide open and with the bravery the rest of us always hope we have and may never know if we do.”
Points to Consider…
There have always been informers, or snitches, who reveal information to enrich themselves or to get back at others. However, whistle-blowers like Time magazine’s “persons of the year” are generally conscientious people who expose some wrongdoing, often at great personal risk. The term “whistle-blower” was first applied to government employ ees who “go public” with complaints of corruption or mis management in federal agencies.12 It is also now used in connection with similar activities in the private sector, as well as with the conduct of government contractors. Opin ion differs, for example, on whether Edward Snowden, an employee of a contractor, was a whistle-blower when he released classified documents exposing domestic surveil lance by the National Security Agency.13
Whistle-blowers often pay a high price for their acts of dissent.
Watkins, Cooper, and Rowley emerged from their experience relatively unscathed, but most whistle-blowers are not so fortunate. Retaliation is common and can take many forms—from poor evaluations and demotion to out right dismissal. Some employers seek to blacklist whistle blowers so that they cannot obtain jobs in the same industry. Many whistle-blowers suffer career disruption and financial hardship resulting from the job dislocation and legal expenses, and there is severe emotional strain on them and their families as coworkers, friends, and neigh bors turn against them. Given the high price that whistle-blowers sometimes pay, should people really be encouraged to blow the whis tle? Is the exposure of corruption and mismanagement in government and industry the best way to correct these faults? Or are there more effective ways to deal with them without requiring individuals to make heroic personal sac rifices? Should whistle-blowers be protected, and if so, how can this best be done? In addition to these practical questions, there are more philosophical issues about the ethical justification of whistle-blowing.
Do employees have a right to blow the whistle? Although they usually act with the laudable aim of protecting the public by drawing attention to wrongdoing on the part of their organization, whistle-blowers also run the risk of violating genuine obligations that employees owe to employers. Employees have an obligation to do the work that they are assigned, to be loyal to their employer, and generally to work for the interest of the company, not against it. In addition, employees have an obligation to preserve the confidentiality of information acquired in the course of their work, and whistle-blowing sometimes involves the release of this kind of information. Cases of
whistle-blowing are so wrenching precisely because they involve very strong conflicting obligations. It is vitally important, therefore, to understand when it is morally per missible to blow the whistle and when whistle-blowing is, perhaps, not justified. Our first task, though, is to develop a definition of whistle-blowing.
Examining Personal Biases
When you hear about whistle-blowers in the news, what is your first reaction? Are whistleblowers typically telling the truth, or are you skeptical of their motives? Explain your opinion.
The response entered here will appear in the performance dashboard and can be viewed by your instructor.
4.1: What Is Whistle Blowing?
4.1 Define the significance of whistle-blowing and the
act itself according to seven criteria
As a first approximation, whistle-blowing can be defined as the release of information by a member or former mem ber of an organization that is evidence of illegal and/or immoral conduct in the organization or conduct in the organization that is not in the public interest. There are sev eral points to observe in this definition.
First, blowing the whistle is something that can be done only by a member of an organization. It is not
whistle-blowing when a witness to a crime notifies the police and testifies in court. It is also not whistle-blowing for a reporter who uncovers some illegal practice in a cor poration to expose it in print. Both the witness and the reporter have incriminating information, but they are under no obligation that prevents them from making it public. The situation is different for employees who become aware of illegal or immoral conduct in their own organization because they have an obligation to their employer that would be violated by public disclosure. Whistle-blowing, therefore, is an action by an individual inside an organiza tion to expose wrongdoing to those outside it.
Second, there must be information. Merely to dissent publicly with an employer is not in itself blowing the whistle; whistle-blowing necessarily involves the release of nonpublic information. According to Sissela Bok, “The whistleblower assumes that his message will alert listen ers to something they do not know, or whose significance they have not grasped because it has been kept secret.”14 A distinction can be made between blowing the whistle and sounding the alarm. Instead of revealing new facts, as
whistle-blowers do, dissenters who take a public stand in opposition to an organization to which they belong can be viewed as trying to arouse public concern, to get people alarmed about facts that are already known rather than to tell them something they do not know.
Third, the information is generally evidence of some significant kind of misconduct on the part of an organiza tion or some of its members. The term “whistle-blowing”
is usually reserved for matters of substantial importance. Certainly, information about the lack of preparedness by the FBI to protect American citizens against terrorist acts like those on 9/11 would justify the memo that Coleen Rowley sent to the director of her agency. Some whistle blowing reveals violations of law, such as the accounting fraud at WorldCom that Cynthia Cooper uncovered, but an employee could also be said to blow the whistle about activities that are legal but contrary to the public interest, such as waste and mismanagement in government pro curement or threats to the environment. Information of this kind could alert the public and possibly lead to new legis lation or regulation. However, merely exposing incompe tent or self-serving management or leaking information to influence the course of events is not commonly counted as whistle-blowing. Lacking in these kinds of cases is a seri ous wrong that could be averted or rectified by whistle blowing.
Fourth, the information must be released outside normal channels of communication. In most organiza
tions, employees are instructed to report instances of ille gal or improper conduct to their immediate superiors, and other means often exist for employees to register their con cerns. Some corporations have an announced policy of encouraging employees to submit any suspicions of mis conduct in writing to the CEO, with an assurance of confi dentiality. Others have a designated official, often called an ombudsman, for handling employee complaints. Whis tle-blowing does not necessarily involve “going public” and revealing information outside the organization. There can be internal as well as external whistle-blowing. How ever, an employee who follows established procedures for reporting wrongdoing is not a whistle-blower. Thus, Watkins, Cooper, and Rowley are probably not whistle blowers in a precise sense, despite the use of this label in the popular press.
Fifth, a definition of whistle-blowing also needs to take into account to whom the whistle is blown. In both
internal and external whistle-blowing, the information must be revealed in ways that can reasonably be expected to bring about a desired change. Merely passing on infor mation about wrongdoing to a higher-up or a third party does not necessarily constitute whistle-blowing. Going to the press is often effective because the information ulti mately reaches the appropriate authorities. Reporting to a credit-rating agency that a person faces bankruptcy, by
contrast, would not usually be an instance of whistle-blow ing but of ordinary snitching because the receiving party in this case is not an appropriate authority.
Sixth, the release of information must be something that is done voluntarily, as opposed to being legally
required. The distinction, however, is not always clear. Watkins and Rowley were called to testify before congres sional committees. Although such testimony may be legally required, the call to testify may come only after wit nesses volunteer that they have incriminating evidence. However, in a state supreme court case, Petermann v. Inter national Brotherhood of Teamsters, a treasurer for a union had no desire to be a whistle-blower, but he refused to perjure himself before a California state legislative body as he had been ordered to do by his employer.15 Although Petermann acted with considerable courage, it is not clear whether he should be called a whistle-blower because he had little choice under the circumstances since his testimony was legally compelled.
A seventh and final point is that whistle-blowing must be undertaken as a moral protest. That is, the motive
must be to correct some wrong and not to seek revenge or personal advancement. This is not to deny that a person with incriminating evidence could conceivably be justified in coming forth, whatever the motive. People “go public” for all sorts of reasons—a common one being fear of their own legal liability—and by doing so, they often benefit society. Still, it is useful to draw a line between the genuine whistle-blower and corporate malcontents and intriguers. Because the motives of whistle-blowers are often misper ceived in the organization, employees considering the act must carefully examine their own motivation.
Putting all these points together, what is a more ade quate definition of whistle-blowing?
A better (but unfortunately long-winded) definition of whistle blowing is as follows:
Whistle-blowing is the voluntary release of nonpublic in formation, as a moral protest, by a member or former member of an organization outside the normal channels of communication to an appropriate audience about il legal and/or immoral conduct in the organization or con duct in the organization that is opposed in some signifi cant way to the public interest.
Whistle-blowing is a unique ethical concern in business because it concerns how, when, and under what circum stances an agent of an organization is morally permitted to reveal otherwise confidential information about his or her employer. Despite the term’s popular usage when describ ing all sorts of controversial acts to expose wrongdoing, the term “whistle-blowing” focuses attention on the challenge of how to best balance the responsibilities of loyalty to one’s organization with the public’s interest.16
Table 4.1 What Constitutes Whistle-Blowing?
Read each question and identify the defining characteristics of whistle-blowing. Show the cells to check your answers.
Who can blow the whistle?
An individual inside an organization exposes wrongdoing.
A witness to a crime or a reporter
What kind of information is involved? What is it reserved for?
Nonpublic information that reveals new facts Calling attention to matters of substantial importance
Facts that are already known to the public Exposing matters of minor importance, such as incompetent management
Who is informed and how?
External: An employee “goes public” to inform individuals or groups outside the organization.
Internal: An employee informs others within the organization by going outside normal channels of communication.
An employee follows established procedures to report wrongdoing through normal channels of communication.
What is the immediate goal?
To correct a wrong by bringing about a desired change
To pass on information about wrongdoing to a supervisor, director, or a third party
Was the person compelled to act? What is the motive?
The release of information is voluntary. To stage a moral protest.
The testimony is legally compelled (by a court of law). To seek revenge or personal advancement
Use Table 4.1 above to review the main considerations for determining whether an act truly constitutes whistle blowing, as just defined.
4.2: Justification of Whistle-Blowing
4.2 Assess situations where whistle-blowing may or
may not be justified, given the duties and obligations of all parties and the potential consequences of the act
The ethical justification of whistle-blowing might seem to be obvious in view of the laudable public service that whistle-blowers provide—often at great personal risk. However, whistle-blowing has the potential to do great harm to both individuals and organizations. The negative case against whistle-blowing is given vigorous expression in a widely cited passage from a 1971 speech by James M. Roche, who was chairman of the board of General Motors Corporation at the time. He writes, “Some critics are now busy eroding another sup port of free enterprise—the loyalty of a management team, with its unifying values of cooperative work. . . . However this is labelled—industrial espionage, whistle blowing, or professional responsibility—it is another tactic for spread ing disunity and creating conflict.”17 In the same vein, Sissela Bok observes that “the whistleblower hopes to stop the game, but since he is neither referee or coach, and since he blows the whistle on his own team, his act is seen as a violation of loyalty.”18 As these remarks indicate, the main stumbling block in justifying whistle-blowing is the duty of loyalty that employees have to the organization of which they are a part. The public service that whistle-blowers provide has
to be weighed against the disruptive effect that the disclo sure of information has on bonds of loyalty.
Does a person in a position to blow the whistle have a greater obligation to the public or to the organization? Where does the greater loyalty lie?
That we have an obligation to the public is relatively unproblematic; it is the obligation to prevent serious harm to others whenever this is within our power. An obligation of loyalty to an organization is more complex, involving, as it does, questions about the basis of such an obligation and the concept of loyalty itself. What does an employee owe an employer, and, more to the point, does the employment rela tion deprive an employee of a right to reveal information about wrongdoing in the organization? In order to answer these questions, let us begin with a commonly used argu ment against the right of an employee to blow the whistle.
Citizen or Employee?
How should a person in a position to blow the whistle determine whether he or she has a greater obligation to the public or to his or her employer? How should competing loyalties be balanced?
The response entered here will appear in the performance dashboard and can be viewed by your instructor.
4.2.1: Loyal Agent Argument
According to one argument, an employee is an agent of an employer.19 An agent is a person who is engaged to act in the interests of another person (called a principal) and is authorized to act on that person’s behalf. This relationship is typical of professionals, such as lawyers and accountants, who are called upon to use their skills in the service of a
client. Employees are also considered to be agents of an employer in that they are hired to work for the benefit of the employer. Specifically, an employee, as an agent, has an obligation to work as directed, to protect confidential infor mation, and, above all, to be loyal. All these are seemingly violated when an employee blows the whistle.
The loyal agent argument receives considerable support from the law, where the con cept of agency and the obligations of agents are well devel oped. Although our concern is with the moral status of employees, the law of agency is a rich source of relevant insights about the employment relation.20 According to one standard book on the subject, “an agent is a person who is authorized to act for a principal and has agreed so to act, and who has power to affect the legal relations of his princi pal with a third party.”21 Agents are employed to carry out tasks that principals are not willing or able to carry out for themselves. Thus, we hire a lawyer to represent us in legal matters where we lack the expertise to do the job properly. The main obligation of an agent is to act in the interest of the principal. We expect a lawyer, for example, to act as we would ourselves, if we had the same ability. This obli gation is expressed in the Second Restatement of Agency as follows: “[A]n agent is subject to a duty to his principal to act solely for the benefit of the principal in all matters con nected with his agency.”22 The ethical basis of the duty of agents is a contractual obligation or an understood agree ment to act in the interests of another person. Lawyers agree for a fee to represent clients, and employees are simi larly hired with the understanding that they will work for the benefit of an employer.
DuTieS oF An AgenT
At first glance, a whistle blower is a disloyal agent who backs out of an agreement that is an essential part of the employer–employee relation ship. A whistle-blowing employee, according to the loyal agent argument, is like a lawyer who sells out a client— clearly a violation of the legal profession’s code of ethics. Closer examination reveals that the argument is not as strong as it appears. Although employees have an obliga tion of loyalty that is not shared by a person outside the organization, the obligation is not without its limits. Whis tle-blowing is not something to be done without adequate justification, but at the same time, it is not something that can never be justified.
LimiTS To Agency DuTieS
First, the law of agency does not impose an absolute obligation on employees to do whatever they are told.
Rather, an agent has an obligation, in the words of the Sec ond Restatement, to obey all reasonable directives of the prin cipal. This is interpreted to exclude illegal or immoral acts; that is, employees are not obligated as agents to do any thing illegal or immoral—even if specifically instructed by a superior to do so. Questions can arise, of course, about the legal and moral status of specific acts. Is an agent free to
disobey an order to do something that is suspect but not clearly illegal or immoral, for example? Borderline cases are unavoidable, but in situations where a crime is being committed or people are exposed to the risk of serious injury and even death, the law of agency is clear: An employee has no obligation to obey.
The law of agency further excludes an obligation to keep confidential any information about the commission of a crime. Section 395 of the Second Restatement of Agency reads in part: “An agent is privileged to reveal information confidentially acquired . . . in the protection of a superior interest of himself or a third person.” The Restatement does not define what is meant by a “superior interest” except to note that there is no duty of confidentiality when the infor mation is about the commission of a crime. “[I]f the confi dential information is to the effect that the principal is committing or is about to commit a crime, the agent is under no duty not to reveal it.”23 Protecting oneself from legal liability can reasonably be held to be a “superior interest,” as can preventing some serious harm to others.
Second, the obligations of an agent are confined to the needs of the relationship. In order for a lawyer to rep resent a client adequately, it is necessary to impose a strong obligation of loyalty, but the obligation of loyalty required for employees to do their job adequately is less stringent. The obligation of agents to follow orders exactly stems, in part, from the fact that they may be binding the principal to a contract or exposing the principal to tort liability. The duty of confidentiality is justified by the legitimate right of an employer to maintain the secrecy of certain vital infor mation. Thus, Coleen Rowley was legally barred, for good reason, from divulging information about an investigation. She could not have “gone public” with her information without violating her duty as an FBI agent.
Employees are hired for limited purposes, however. As Alex Michalos points out, a person who has agreed to sell life insurance policies on commission is committed to performing that activity as a loyal agent. “It would be ludi crous,” he continues, “to assume that the agent has also committed himself to painting houses, washing dogs, or doing anything else that happened to give his principal pleasure.”24 Similarly, a quality control inspector is not hired to overlook defects, falsify records, or do anything else that would permit a danger to exist. Information about irregularities in safety matters is also not the kind that the employer has a right to keep confidential because it is not necessary to the normal operation of a business.
To conclude, the loyal agent argument does not serve to show that whistle-blowing can never be justified. The obligations that employees have as agents of an organiza tion are of great moral importance, but they do have limits. Specifically, the agency relation does not require employ ees to engage in illegal or immoral activities or to give over their whole life to an employer.
4.2.2: Meaning of Loyalty
The concept of loyalty itself raises some questions. One is whether whistle-blowing is always an act of disloyalty or whether it can sometimes be done out of loyalty to the organization. The answer depends, in part, on what we mean by the term “loyalty.” If loyalty means merely fol lowing orders and not “rocking the boat,” then whistle blowers are disloyal employees. But loyalty can also be defined as a commitment to the true interests or goals of the organization, in which case whistle-blowers are often very loyal employees. Thus, whistle-blowing is not neces sarily incompatible with loyalty; and, indeed, in some cir cumstances, loyalty may require employees to blow the whistle on wrongdoing in their own organization. All too often, the mistake of the whistle-blower lies not in being disloyal to the organization as such but in break ing a relation of trust with a few key members of an organ ization or with associates and immediate superiors. Insofar as an employee has a duty of loyalty, though, it cannot be merely to follow orders or to go along with others. Loyalty means serving the interests and goals of an organization, which can sometimes lead to divided loyalties and uncer tainties about what is best for an organization. Some evidence for the claim that whistle-blowers are often loyal—perhaps even too loyal—to the organizations they serve is provided by Myron Glazer, a sociologist who interviewed 55 whistle-blowers in depth. One of his find ings is stated as follows: Virtually all of the ethical resisters . . . had long histories of successful employment. They were not alienated or politically active members of movements advocating major changes in society. On the contrary, they began as firm believers in their organizations, convinced that if they took a grievance to superiors, there would be an appropriate response. This naiveté led them into a series of damaging traps. They found that their earlier service and dedication provided them with little protection against charges of undermining organizational morale and effectiveness.25 The irony of this finding is that whistle-blowers are often loyal employees who take the first steps toward whistle-blowing in the belief that they are doing their job and acting in the best interests of the company. As further evidence that the relationship between whistle-blowing and loyalty is far more complex than it first appears, the economist Albert O. Hirschman argues, in a book entitled Exit, Voice, and Loyalty, that members of organizations and people who deal with organizations, such as customers of a firm, can respond to dissatisfaction either by leaving the organization and having no further dealings with it (exit) or by speaking up and making the dissatisfaction known in the hope of bringing about change (voice). Loyalty is a factor that keeps people from exiting
an organization; but, at the same time, it activates the voice option. According to Hirschman, those who exercise the voice option are often the most loyal and are convinced that by speaking up they can get the organization back on the right track.26
On Hirschman’s analysis, exit is a more extreme form of dissent than voice, but business firms do not usually regard an employee’s departure as a form of disloyalty. In fact, whistle-blowers are often treated in ways designed to get them to leave voluntarily. It may benefit an organiza tion in the short run to get rid of troublemakers, but Hirschman argues that in the long run, encouraging employees to use the exit option will harm the organiza tion by depriving it of those people who can bring about healthy change. As a result of loyalty, these potentially most influential members will stay on longer than they would ordinarily, in the hope or reasoned expectation that improvement or reform can be achieved from within. Thus, loyalty, far from being irrational, can serve the socially useful purpose of preventing deterioration from becoming cumulative, as it so often does when there is no barrier to exit.27
A further complication is the fact that employees typi cally have a number of loyalties, both inside and outside an organization, which can come into conflict. Although employee loyalty is morally required, a company is not a single entity to which the employee owes loyalty but is, rather, a complex of individuals, groups, projects, and missions. Loyalty to one aspect of a company may require disloyalty to another. An employee may not be able to be loyal to an immediate superior whose order conflicts with loyalty to a company’s mission to provide quality service, for example. Employees are also citizens who may have a duty of loyalty to obey the law or pursue some public good. To whom should an employee be loyal when asked, for example, to discharge pollutants into a stream? Merely appealing to a general duty of loyalty does not resolve these kinds of conflicts.28
Even if we limit loyalty to a specific employer, ques tions about what loyalty means still arise. The Code of Ethics for Government Service, for example, contains the following instruction for federal employees: “Put loyalty to the high est moral principles and to country above loyalty to per sons, party, or government department.” This lofty statement is a prescription for confusion when employees of an administration or an agency are called upon to be team players.
4.2.3: Conditions for Justification
Whistle-blowing is not something to be undertaken lightly, especially in view of the serious, often devastating conse quences. In order to be sure that that whistle-blowing is justified, a potential whistle-blower should analyze the
situation carefully and accurately and also formulate an effective course of action.29
The first step for a per son considering whistle-blowing is the decision whether to blow the whistle. More specifically, the following questions require adequate consideration.
AnALyzing The SiTuATion
Is the situation of sufficient moral importance to justify whistle-blowing?
A cover-up of lethal side effects in a newly marketed drug, for example, is an appropriate situation for disclo sure because people’s lives are at stake. But situations are not always this clear. Is whistle-blowing warranted if the side effects are not lethal or debilitating but capable of causing temporary discomfort or pain? What if the drug is the most effective treatment for a serious medical problem, so that the harm of the side effect is outweighed by the benefit of using the drug? In such a case, we need to ask how serious is the potential harm compared with the ben efit of the drug and the trouble that would be caused by blowing the whistle. The less serious the harm, the less appropriate it is to blow the whistle. In addition to the moral importance of the situation, consideration should also be given to the extent to which harm is a direct and predictable result of the activity that the whistle-blower is protesting. For example, a toy that might be hazardous under unusual circumstances war rants whistle-blowing less than one that poses a risk under all conditions. Sissela Bok contends that the harm should also be imminent. According to her, an alarm can be sounded about defects in a rapid-transit system that is already in operation or is about to go into operation, but an alarm should not be sounded about defects in a system that is still on the drawing boards and is far from being operational.30 Do you have all the facts and have you properly under stood their significance? Whistle-blowing usually involves very serious charges that can cause irreparable harm if they turn out to be unfounded or misinterpreted. A potential whistle-blower, therefore, has a strong obligation to the people who are charged with wrongdoing to make sure that the charges are well founded. The whistle-blower should also have as much documentation and other corroboration as possible. A whistle-blower’s case is stronger when the evidence con sists of verifiable facts and not merely hunches or rumors. Because whistle-blowing cases often end up in court, the proof should also be strong enough to stand up under scrutiny. The support for the charges need not be over whelming, but it should meet the ordinary legal standard of a preponderance of the evidence. Employees often have access to only some of the facts of a case and are liable, as a
result, to form false or misleading impressions. Would-be whistle-blowers must be careful, therefore, not to jump to conclusions about matters that higher-level managers, with a fuller knowledge of the situation, are in a better position to judge. Typically, employees have only one kind of expertise, so they are not able to make an accurate judg ment when different kinds of knowledge are needed.
Have all internal channels and steps short of whistle blowing been exhausted?
Whistle-blowing should be the last rather than the first resort. It is justified only when there are no morally prefer able alternatives. The alternatives available to employees depend to a great extent on the provisions an organization makes for dissent, but virtually every organization requires employees to take up any matter of concern with an imme diate superior before proceeding further—unless that per son is part of the problem. Courts will generally not consider a complaint unless all possible appeals within an organization have been exhausted. Some progressive cor porations have recognized the value of dissent in bringing problems to light and have set up procedures that allow employees to express their concern through internal chan nels. Steps of this kind reduce the need for whistle-blowing and the risks that external whistle-blowers take.
It is possible to justify not using internal channels, however, when the whole organization is so mired in the wrongdoing that there is little chance that using them would succeed. Another justification for “going public” before exhausting internal channels is the need for a quick response when internal whistle-blowing would be too slow and uncertain. Two engineers at Morton Thiokol expressed concern to their superiors about the effects of low temperature on the O-rings on the booster rockets for the Challenger spacecraft, but their warning never reached the officials at NASA who were responsible for making the decision to go ahead with the launch. The engineers spoke out after the Challenger explosion—for which they were disciplined by Morton Thiokol—but their whistle-blowing was too late to avert the disaster. To be effective, they would have had to blow the whistle before the decision was made to launch the spacecraft. This would have required them to go outside the company and contact the officials at NASA directly.
TAking AcTion
Once an organization member has decided that a situation justifies whistle-blowing—that is, the “whether” question has been answered—attention must turn to the critical matter of the most effective course of action, which is the “how” question.
What is the best way to blow the whistle? Determining the most effective course of action for a determined whistle-blower requires the adequate
consideration of many factors, beginning with the fol lowing questions:
• To whom should the information be revealed? • How much information should be revealed? • Should the information be revealed anonymously or accompanied by the identity of the whistle-blower? Often an anonymous complaint to a regulatory body, such as the Environmental Protection Agency or the Securi ties and Exchange Commission, is sufficient to spark an investigation. The situation might also be handled by con tacting the FBI or a local prosecuting attorney or by leaking information to the local press. The less information that is revealed, the less likely an employee is to violate any duty of confidentiality. Employees can also reduce conflicts by waiting until they leave an organization to blow the whistle. Whistle-blowing is also more likely to be effective when an employee presents the charge in an objective and responsi ble manner. It is especially important that a whistle-blower stick to the important issues and refrain from conducting crusades or making personal attacks on the persons involved. Organizations often seek to discredit whistle blowers by picturing them as disgruntled misfits or crazy radicals; intemperate, wide-ranging attacks undermine the whistle-blower’s own credibility. Many whistle-blowers recommend developing a clear plan of action. Do not blow the whistle impulsively, they advise, but think out each step and anticipate the possible consequences.31 What is my responsibility in view of my role in the organization? The justification for blowing the whistle depends not only on the wrongdoing of others but also on the particular role that a whistle-blower occupies in an organization. Thus, an employee is more justified in blowing the whistle—and may even have an obligation to do so—when the wrongdo ing concerns matters over which the employee has direct responsibility. When an employee is a professional, the question of whether to blow the whistle must be considered in the context of professional ethics. Professionals, such as lawyers, accountants, and engineers, have a greater obliga tion to blow the whistle under some circumstances and are restricted or prohibited from whistle-blowing under others. What are the chances for success? Insofar as whistle-blowing is justified because of some good to the public, it is important to blow the whistle only when there is a reasonable chance of achieving that good. Whistle-blowing may be unsuccessful for many reasons. Sometimes the fault lies with the whistle-blower who fails to make a case that attracts widespread concern or to devise an effective plan of action; other times it is simply that the organization is too powerful or the public not suf ficiently responsive.
Being Heard and Being Known
Why would someone presume that an anonymous whistleblower’s claims are taken less seriously than those of a whistleblower who is willing to publicly expose wrongdoing? Construct a scenario where a whistleblower might act anonymously out of loyalty to the organiza tion, rather than from a fear of reprisal or unwanted media attention.
The response entered here will appear in the performance dashboard and can be viewed by your instructor.
4.3: Right to Blow the Whistle
4.3 Describe the characteristics and importance of laws designed to protect whistle-blowers and key points in the debate over the moral justification of these laws
Even though whistle-blowing can be justified in some sit uations, the sad fact remains that courageous employees who perform a valuable public service are often subjected to harsh retaliation. Our reaction when this occurs is, “There ought to be a law!” and, indeed, many have been proposed in Congress and various state legislatures.32 Few have passed, however, and there are some strong arguments against providing legal protection for whistle blowers. In this section, we will examine the debate over the moral justification of laws to protect whistle-blowers against retaliation. It will be useful, first, to survey the existing legal protection.
4.3.1: Existing Legal Protection
Legal protection for whistle-blowing is provided by an extremely complex patchwork of state and federal laws, supplemented by precedents from case law and private agreements, such as labor contracts and company person nel policies. Existing laws are very narrowly drafted with regard to the protected employee activities and the permis sible employer actions. Most laws prohibit retaliatory action against employees for certain specified activities, along with a prescribed remedy for wrongful retaliation, usually reinstatement with some compensation.
Public employees of federal and state governments receive much greater protection than private sector work ers, although the increasing use of outside contractors by governments, most notably the Department of Defense, has extended federal protection into the private sphere. Increasingly, whistle-blower protection is being used, especially by the federal government, to encourage the disclosure of fraud by allowing whistle-blowers to share
in the amounts recovered from legal settlements with wrongdoers.
Despite the very large number of relevant laws, the legal protection for whistle-blowers can be fairly described as limited and uncertain.
Retaliation against federal employees who report instances of waste and corruption in government is prohib ited by the Civil Service Reform Act of 1978, which also set up the Merit System Protection Board (MSPB) to receive and act on complaints of retaliation.33 The provisions of this legislation were strengthened by the Whistleblower Protection Act of 1989, which allows the Office of Special Counsel to represent federal employees before the MSPB and provides numerous procedural safeguards. The 2012 Whistleblower Protection Enhancement Act addressed many problematic issues, including the scope of protected activities, the available remedies, the ease and effectiveness of enforcement, and the education of employees about their rights. Some protection for whistle-blowers in both the public and private sectors exists in the antiretaliation provisions of various pieces of federal legislation. The National Labor Relations Act of 1935 (NLRA) forbids employers to retali ate against any employee who files a charge with the National Labor Relations Board (NLRB). Title VII of the 1964 Civil Rights Act protects employees who file a charge of discrimination, participate in an investigation or pro ceeding connected with a charge, or oppose an activity of a company that the employee believes is discriminatory. The Occupational Safety and Health Act of 1970 also prohibits retaliation against any employee who files a complaint with the Occupational Safety and Health Administration or testifies in a proceeding.
What other federal acts have antiretaliatory provisions?
Other federal acts with antiretaliatory provisions include the following:
Surface Mining Act
Railway Safety Act
Surface Transportation Safety Act
Safe Drinking Water Act
Toxic Substance Control Act
Clean Air Act
Water Pollution Control Act
Energy Reorganization Act
Solid Waste Disposal Act The Sarbanes-Oxley Act of 2002 (SOX) also created
federal whistle-blower protection for private sector employees.34 Passed by Congress in response to massive
fraud at Enron, WorldCom, and other companies, the act offers multiple forms of protection.
What protections does Sarbanes-Oxley offer?
Sarbanes-Oxley prohibits retaliation against any employee “for providing to a law enforcement officer any truthful infor mation relating to the commission or possible commission of any Federal offense.” In addition to requiring that every publicly traded com pany establish an independent audit committee of the board with responsibility for detecting fraud, the act sup ports internal whistle-blowing by mandating that all compa nies, whether publicly traded or not, have procedures for employees to make confidential allegations about sus pected fraudulent activity. Employees who avail themselves of SOX protection are entitled to be made whole by such means as reinstatement, back pay, and reimbursement for legal expenses, and also to receive “special damages” for such noneconomic losses as emotional distress. Under SOX, an employer who retaliates against a whis tle-blower may be subject to a fine or imprisonment or both.
Perhaps the most effective federal statute for protect ing whistle-blowers is the once-moribund federal False Claims Act of 1863 (amended 1986). This Act was origi nally passed by Congress to curb fraud during the post– Civil War reconstruction period by allowing private citizens who blow the whistle on fraud against the govern ment in federal procurement (e.g., defense contracting) or federal benefits programs (e.g., Social Security and Medi care) to share in the financial recovery.
What protections does the False Claims Act offer?
The False Claims Act has been updated to encourage indi viduals to report any fraud against the government that they observe by entitling whistle-blowers to receive between 10 percent and 30 percent of the funds recovered in any suit.35 In many instances, the government will investigate and prosecute on the basis of the evidence provided by the whistle-blower, but if the government declines to prosecute, the whistle-blower can pursue legal action alone, acting on behalf of the government in a so-called qui tam action. If suc cessful in the qui tam suit, the individual may be entitled not only to an award but also to the recovery of legal expenses. The largest award to date was made to a former quality assurance manager for GlaxoSmithKline, Cheryl Eckard. She received approximately $96 million from the $750 mil lion in penalties that the company paid to the government for selling substandard drugs to Medicare and Medicaid, and she is entitled to millions more from states that had been defrauded.36
What protections does the 2010 Wall Street Reform and Consumer Protection Act offer?
The 2010 Wall Street Reform and Consumer Protection Act (the so-called “Dodd-Frank Bill”) strengthens existing whistle blower antiretaliation protection in other federal legislation
and introduces some new provisions for the securities mar kets and other areas not covered by prior legislation. Dodd Frank includes provisions for awards to whistle-blowers similar to the federal False Claims Act and protection for employees who make disclosures to the newly created Con sumer Financial Protection Bureau. In addition, it directs the Securities and Exchange Commission to create a special whistle-blower office to oversee enforcement of the whistle blower provisions of the act.
More than two-thirds of the states have passed laws designed to protect whistle-blowers. Most of these apply only to government employees, but a few—Michigan’s Whistle Blowers Protection Act, for example—extend more widely. Most of these state statutes specify the procedures that a whistle-blower must follow to receive protection and place requirements on the persons to whom the informa tion is disclosed and on the kind of information that the whistle-blower discloses. Another source of protection for whistle-blowers is state court decisions limiting the tradi tional right of employers to fire at will. These decisions protect workers against retaliation for many reasons besides whistle-blowing, but they also leave some whistle blowers unprotected. Use Table 4.2 to review the main whistle-blower protec tions and antiretaliation provisions in federal and state law.
Table 4.2 Legal Protections for Whistle-Blowers
The Sarbanes-Oxley Act of 2002
Prohibits retaliation against whistle-blowers who are private sector employees, and entitles them to compensation for retaliation
Requires all companies to have confidential reporting procedures
The False Claims Act
Entitles whistle-blowers to file a qui tam action against a company and receive 10–30% of the funds recovered in any suit, plus compensation for legal expenses
State laws
Most protect only state employees Most specify whistle-blowing procedures and other requirements for protection
4.3.2: Arguments against Protection
There are many problems with drafting legislation for pro tecting whistle-blowers.
First, a law recognizing whistle-blowing as a right is
pen to abuse. Whistle-blowing might be used by
disgruntled employees to protest company decisions or to get back at their employers. Employees might also find an excuse to blow the whistle in order to cover up their own incompetence or inadequate per formance. Alan F. Westin notes, “Forbidding an employer to dismiss or discipline an employee who protests against illegal or improper conduct by man agement invites employees to take out ‘antidismissal insurance’ by lodging a whistle-blowing complaint.”37
• Second, legislation to protect whistle-blowers would
encroach on the traditional right of employers to con duct business as they see fit. It would also add another layer of regulation to the existing legal restraints on business, thereby making it more difficult for manag ers to run a company efficiently. The courts would be called upon to review and possibly reverse a great many personnel decisions. The likely increase in employee litigation could also, according to Westin, “create an informer ethos at work that would threaten the spirit of cooperation and trust on which sound working relationships depend.”38
• Third, if whistle-blowing were protected by law, what should be the legal remedy for employees who are unjustly dismissed? Reinstatement in the work place, which is the usual remedy in union contract grievance procedures, may not be feasible in the case of employees who are perceived as being disloyal. As an alternative to reinstatement, though, whistle blowers could be offered a monetary settlement to compensate them for the losses suffered by being wrongly dismissed. An award could be arrived at by negotiation or arbitration, or it could result by allow ing dismissed employees to sue for wrongful injury.
4.3.3: Arguments for Protection
The main argument in defense of a law to protect whistle blowers is a utilitarian one that rests on the contribution whistle-blowers make to society. There is a direct benefit
in having instances of illegal corporate conduct, gross waste and mismanagement, and dangers to the public brought to light. This benefit can be achieved, the argument goes, only if whistle-blowers are encouraged to come forward and make their information known. Ralph Nader makes the fur ther point that because employees are often the first to know about hazards, allowing them greater freedom to speak out makes it easier to enforce existing laws and to bring about desirable changes in corporate behavior.39
These benefits must be balanced against the undenia ble harm that a greater incidence of whistle-blowing would have on business firms. Insofar as companies might become less efficient—because of either the greater regula tion or the loss of loyalty within organizations—a right to blow the whistle is not justified on utilitarian grounds.
A second argument for providing legal protection for whistle-blowers appeals to the First Amendment right of freedom of speech. A distinction needs to be made, though,
between the appeal to freedom of speech as a legal argu ment and as a moral argument. Our rights under the Con stitution protect us for the most part only against acts of government and not against those of private employers. Consequently, the freedom of speech that we have as a matter of legal right does not necessarily prevent corpora tions from retaliating against whistle-blowers, although it does confer some protection on government employees who speak out as citizens. Although the First Amendment right of free speech cannot be used as a legal argument for holding that whis tle-blowing is a protected activity in the private sector, it can still be maintained that there is a moral right to freedom of speech and that (morally) there ought to be a law extend ing this right to whistle-blowers.40 At least one legal scholar has urged that we recognize a right that is broader than merely freedom of speech, namely, a right to follow one’s own conscience. Whistle-blowers are often led to speak out not by a desire to serve the public good but to do what they feel is morally required of them. “Thus,” this writer con cludes, “the interests that weigh in favor of providing legal protection to the external whistleblower are not those embodied in an employee’s obligation to society, but rather those embodied in his interest as an individual to act in accordance with the dictates of conscience.”41
4.4: Developing a Policy
4.4 identify the importance of developing an effective
whistle-blowing policy for an organization and the key components of such a policy
Companies have many incentives to develop a whistle blowing policy.42 No company is immune from wrongdo
ing, and an effective policy on whistle-blowing enables a company to deal with misconduct internally, thereby pre venting embarrassing public disclosure. For a policy to be effective, however, employees must be assured that their reports will be taken seriously—which means that an investigation will be conducted and appropriate action taken. More importantly, employees must feel confident that they will not suffer any retaliation.
4.4.1: Benefits and Dangers
Although companies might prefer to ignore some wrong doing and to continue profitable but questionable prac tices, they can also benefit from learning about problems early and taking corrective action before the problems become public. The lack of a policy will not prevent whistle-blowing by a company’s employees, and the
increasing public acceptance of whistle-blowing combined with expanded legal protection makes whistle-blowing all the more likely. The aftermath of a whistle-blowing inci dent also creates problems that are best avoided. In par ticular, dismissing whistle-blowers with legitimate complaints sends the wrong signal to other employees, and yet allowing whistle-blowers to remain in the work place may cause tension and strife. These equally undesira ble alternatives can be avoided by eliminating the need for any employee to go outside of the normal channels of com munication. An effective whistle-blowing policy can have the added benefit of affirming a company’s commitment to good ethics and creating an ethical corporate climate.
Whistle-blowing policies also benefit employees by providing them with a channel of communication for responding to perceived wrongdoing in the organization. Employees are likely to welcome an opportunity to express their legitimate concerns without the risk of going public with damaging information. Whistle-blowing policies involve some dangers, however. Encouraging employees to report on each other can create an environment of mis trust and intimidation, especially if people feel vulnerable to the possibility of false accusations.
4.4.2: Components of a Policy
A well-designed whistle-blowing policy should include the following components.
1. An Effectively Communicated Statement of Responsibility
Employees should understand that they have a responsibility to report all concerns about serious unethical or illegal con duct through the appropriate internal channels.
2. A Clearly Defined Procedure for Reporting
A procedure should be established that allows employees to report their concerns in a confidential manner. The procedure should specify the persons to whom reports are to be made and the proper form, and employees should be made aware of the procedure. Some companies use an ethics “hot line” that allows employees to make a report by calling an 800 number; other companies insist that reports be made to a person’s immediate superior unless that person is involved in the suspected wrongdoing. Multiple means of reporting con cerns and the choice of anonymous reporting are available in some companies with whistle-blowing policies.
Well-Trained Personnel to Receive and Investigate Reports The success of a whistle-blowing policy depends heavily
n the skill of the personnel who receive and investigate the reports from employees. Especially critical is the ability to maintain confidentiality and to conduct a fair and thorough investigation. For these reasons, the personnel should be
well-trained and have sufficient authority within the organiza tion, and the program should be evaluated periodically for effectiveness.
4. A Commitment to Take Appropriate Action
Employees must be assured that their reports of suspected wrongdoing will not be ignored or misused. Not only should the purposes of a whistle-blowing policy be effectively com municated to all employees, but the company must also assure employees by both word and deed that their reports will be used only for these purposes. The best policies also stipulate that reporting employees will be informed about the outcome of an investigation and the action taken.
5. A Guarantee against Retaliation
By far, the most critical component in any whistle-blowing policy is the assurance that employees will not suffer retalia tion for making reports in good faith. Retaliation can be pre vented, however, only if the importance of the policy is ef fectively communicated to everyone in the organization and there is a credible commitment to the policy’s success by top management. Companies must be on guard, of course, for employees who might abuse an ethics hot line or oth er reporting mechanisms for personal ends, but a fair and
thorough investigation should reveal the facts of the case apart from the reporting employee’s motives.
A whistle-blowing policy by itself will neither protect an organization from wrongdoing nor prevent whistle blowing outside of prescribed channels. A poorly designed or implemented policy also runs the risk of doing more harm than good. Still, a policy with regard to whistle blowing is worth considering by any company that is com mitted to ethical conduct.
Encouraging Internal Whistle-Blowing
Suppose your company has just created an official whistle-blowing policy. How can employees be encouraged to use it for the good of the company, its clients, customers, or others that may be affected by wrongdoing? Why might it be necessary to have a pre-existing ethical culture at the company for the policy to succeed?
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Conclusion: Whistle-Blowing
Whether or not to blow the whistle on misconduct in an organization is the most difficult decision that some people ever have to make. The decision is wrenching personally because the stakes are so high. Yet many whistle-blowers say that they could not have lived with themselves if they had stayed silent. The decision is also difficult ethically because whistle-blowing involves a conflict between two competing duties: to protect the public and to be loyal to an organization. Although loyalty is not always overrid ing, as the loyal agent argument holds, neither is it incon sequential. Deciding between these duties often requires that an employee exercise very careful judgment. The one certain conclusion of this chapter is that whis tle-blowing is ethically permissible under certain carefully specified conditions. (Whether it can ever be ethically required is a different question that seldom arises. Every one has an obligation not to be a part of illegal and immoral activity, but exposing it at great risk to oneself is usually regarded as beyond what duty requires.) Blowing the whistle is only one response that an employee can make to corporate misconduct, however, and the act of whistle blowing itself can take many different forms. So in addi tion to whether to become a whistle-blower, employees are
faced with the further question of how to blow the whistle in a justified manner.
Finally, it is evident that employees who are justified in blowing the whistle ought not to suffer retaliation. What ought to be done to protect whistle-blowers from this fate is less clear. A plausible case can be made for legislation in this area, but the difficulty is drafting laws that achieve the desired result without interfering unduly in the legitimate conduct of business.
End-of-Chapter Case Studies
This chapter concludes with three case studies.
Beyond the initial questions of whether to blow the whis tle and how to do so lies the equally important matter of whether the whistle-blower’s objectives have been achieved. The courageous whistle-blower in “A Whistle-Blower accepts a ‘Deal’” must decide whether the “deal” offered is a satisfac tory resolution. The other two cases explore different aspects of the rules for qualifying as a whistle-blower under the federal False Claims Act: Must the whistle-blower be the “original”
source of the information with “direct and independent knowl edge” (“A Whistle-Blower’s Quandary”), and must the whistle blower report the information directly to the government or is reporting to one’s own employer sufficient to qualify (“Who’s a Whistle-Blower?”)?
Case: A Whistle-Blower Accepts a “Deal”
As the head of corporate audit for a major pharmaceutical company, I was involved in the lengthy approval process that the Food and Drug Administration (FDA) requires before a new drug can be brought to market.43 The reviewer for the FDA was asking some tough questions about the data supporting our application to market a new drug. Although I managed to answer the reviewer’s questions to his apparent satisfaction, doubts were beginning to form in my own mind about the reliability of the data I was defend ing, so I instructed my staff to get photocopies of the origi nal research reports for me as soon as possible. The photocopies provided evidence of “double books.” The raw data in the original reports were entirely different from the data in our FDA application and showed the new drug failing every required test. I had heard rumors of other questionable conduct by the project director, and I suspected that he was implicated in the falsification of the data, although I had no proof for any accusations. I rejected the idea of blowing the whistle on the company by telling everything to the FDA and decided instead to follow the procedure outlined in the company’s own whistle-blowing policy. Accordingly, I prepared a report stating only the facts that I could document, and I sent it to the next highest level above the person involved, which in this situation was the legal department of the corporation. My internal whistle-blowing prompted a quick response. I was summoned to meet with the board of direc tors, which had a team of lawyers from an outside firm pre sent. The original research reports had apparently been destroyed, but there was no question about the authentic ity of the photocopies that I still retained because the raw data were accompanied by the researchers’ signatures and the dates of entry. After friendly but close questioning, the board of directors offered me a “deal.” They would give me all of the resources that I needed to get the drug approved by the FDA, but they promised that the drug would never be marketed. The board intended to correct the problems within the company (and the project director soon resigned), but it wanted to avoid the embarrassment of public exposure. The board’s plan was to request that approval of the drug be withdrawn afterward by telling the FDA that mistakes had been made in the marketing projec tions. I accepted the deal and succeeded in getting the drug
approved. The board kept its word, and 10 years later the drug is still not on the market.
After my “deal” with the board, other changes were made. Corporate policy was revised so that I no longer had ready access to company records. The FDA has the author ity to conduct “surprise” audits at any time, and the policy had been to allow my office to mimic FDA audits, so that the company would always be “FDA-ready.” Under the new policy, audits must be prearranged with the depart ment involved, and the department can stop an audit and reschedule it at any point. Finally, the department is allowed to review the audit report before it is submitted. To my knowledge, there has been no repetition of the events of 10 years ago, but my ability to uncover such misconduct has been severely limited. Oftentimes I wonder whether I should have accepted that “deal.”
What is your interpretation of the company’s changes to its internal auditing procedure? Is this an attempt to shut down further inquiries from the whistle-blower, or is there reasonable justification for the company’s actions? What would you advise the whistle-blower to do in order to satisfy his or her concerns at this point? Review and comment on at least two classmates’ responses.
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Case: A Whistle-Blower’s Quandary
As a vice president for Pharmacia (which was acquired by Pfizer in 2003), Dr. Peter Rost was in charge of worldwide marketing for the drug Genotropin, which is a synthetic human growth hormone that is used to treat a limited range of hormonal deficiencies in children and the elderly.44 Beginning in 1997 and continuing until 2003, Pharmacia aggressively promoted Genotropin for conditions beyond those for which the drug had received approval from the FDA. Physicians may legally prescribe an FDA-approved drug for such “off-label” use, but pharmaceutical compa nies are strictly prohibited from any promotional activities designed to encourage physicians to prescribe a drug for any but approved uses. However, Pharmacia attempted to persuade physicians to prescribe Genotropin for short chil dren without any hormonal deficiency as well as for elderly patients as an antiaging therapy. Among the means used to
increase prescriptions were kickbacks to physicians in the form of all-expense-paid company-sponsored conferences, paid participation in drug studies, and lucrative consulting positions. These efforts produced results. During the period from 1997 to 2003, approximately 25 percent of all prescrip tions for children and 60 percent of prescriptions for adults were for off-label use. Dr. Rost became aware of the illegal promotional activ ities in his role as head of marketing for Genotropin, and he immediately protested to his superiors. After an investiga tion by Pharmacia, the off-label promotion activities, including the kickbacks to physicians, were curtailed but not eliminated. Soon after Pfizer’s acquisition of Pharma cia, which occurred on April 16, 2003, Dr. Rost presented evidence to his new superiors of the illegal off-label mar keting of Genotropin. Without Dr. Rost’s knowledge, Pfizer conducted its own investigation, and exactly one month after the acquisition, on May 16, 2003, Pfizer voluntarily notified the FDA and the other relevant government agen cies of the illegal off-label promotion activities and within a few days provided them with extensive documentation of the kickbacks, as well as information about the corrective actions that were being taken. Unaware of his employer’s disclosures to the federal government, Dr. Rost decided to file a complaint under the federal False Claims Act (FCA), which he did on June 5. The FCA allows private individuals to aid the federal gov ernment in investigating and prosecuting fraud in federal procurement and benefit programs, including Medicare and Medicaid. In return for the service that such whistle blowers provide in combating fraud—which the federal government cannot practically do on its own—a complain ant can receive a percentage of the amount recovered. This percentage varies greatly, depending on circumstances, but can range from roughly 10 percent to 30 percent. The FCA requires that any individual receiving an award must pre sent information that he or she possesses from personal experience that has never been publicly disclosed. That is, a complainant must be the “original” source of the infor mation and have “direct and independent” knowledge. These conditions are necessary in order to prevent an opportunistic use of the law to collect an award based on publicly available information. Although the promotion of off-label use of a drug is illegal, it is not itself a violation of the FCA. Separately, Pfizer paid $35 million to settle charges of bribery and improper promotion in connection with Genotropin. In a complaint under the FCA, it is necessary to show that the illegal promotional activity caused the submission of a false insurance claim to the government (for reimburse ment from Medicare/Medicaid). Evidence that a false claim was submitted must be more specific than arguing that the illegal promotional activity was likely to cause the submission of false claims.
Did Dr. Rost have sufficient evidence to support his complaint? Compare Your Thoughts
The evidence provided by Dr. Rost focused mainly on one phy sician, Dr. Pamela Clark, who practiced in Louisville, Kentucky. Dr. Clark, who attended several Pharmacia-sponsored con ferences in exotic locales and received some compensation for various services rendered to Pharmacia, allegedly wrote Genotropin prescriptions for eight Medicaid patients to treat growth hormone deficiency (GHD), for which Genotropin is an FDA-approved use. However, Dr. Rost maintained that this use is permitted “on-label” only if the diagnosis is based on at least two tests for GHD, and Dr. Clark performed only one test for each patient. Dr. Rost presented no evidence to show that Pharmacia had encouraged doctors to perform only one test for a diagnosis of GHD. As further evidence that false claims were submitted, Dr. Rost cited 8 physicians in Indiana who prescribed Genotropin for an off-label treatment of 10 patients for whom Medicaid paid 122 claims, but he could offer no evidence that any of these physicians had ever been targeted by Pharmacia promotional activities. The FCA further requires that a claim submitted to the fed eral government contain some falsehood. The Medicaid claims in question were filed by the pharmacies that processed the physicians’ prescriptions. Federal law requires that any kick back in the prescription of a drug be disclosed, and so any party who does not disclose receiving a kickback is in violation of the anti-kickback law. However, the pharmacies in these cases did not receive a kickback; the physicians did, and the pharmacies in submitting the claims were certifying only that they had not received a kickback. A claim that Medicaid receives for reimbursement for a drug that has been improperly prescribed as the result of a kickback fails to make a required disclosure—and is in that respect false—but the fault lies with the dishonest physicians and not with the pharmacies. Phar macia, by its illegal promotion of off-label use directed toward physicians, did not cause any pharmacy to submit a false claim.
Faced with many questions, Dr. Rost had to decide whether to proceed with filing an FCA complaint. He had acted as a whistle-blower within the organization, and in so doing he had initiated a chain of events that led Pfizer to voluntarily investigate itself and report the findings to the FDA. In the end, Pfizer ceased the illegal off-label promo tional activities and settled with the government at consid erable cost. Although a federal investigation continued, the Department of Justice eventually decided, after two and one-half years of consideration, not to take further action. Dr. Rost had performed a valuable service as a courageous employee, for which he suffered some on-the-job retribu tion45 and was eventually fired.46 For society, the question remains whether, as a matter of justice, he should also be rewarded with millions of dollars as a complainant under the federal False Claims Act.
Dr. Rost was not the “original” source of the information with “direct and independent knowledge” of the wrongdoing commit ted. Develop a case either for or against why he should be rewarded for coming forward or compensated for the loss of his job. What percentage, if any, should he receive of the $35 million collected from Pfizer? Review and comment on at least two classmates’ responses.
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Case: Who’s a Whistle-Blower?
In June of 2010, Khaled Asadi, the head of General Electric Energy’s operations in Iraq, learned from an Iraqi govern ment source that the company had hired a woman who was “closely associated” with the Senior Deputy Minister of Electricity “in order to curry favor with the Minister while negotiating a lucrative Joint Venture Agreement.”47 The source specifically warned that GE was “pimping its way to the agreement” by employing the woman. Asadi’s suspicions had already been aroused by the rumor that a single bid had been received for the project, which was generally not permitted under Iraqi law. Khaled Asadi, who held dual citizenship in the United States and Iraq, was employed in the U.S., but he had accepted a temporary assignment in 2006 to Amman, J ordan, where he served as GE–Iraq Country Executive for General Electric Energy, a wholly owned subsidiary of GE. Mr. Asadi was concerned that the hiring of the woman might upset the delicate negotiations that were being conducted, as well as be a violation of the Foreign Corrupt Practices Act, which might damage the company. He immediately reported the information he had acquired to two superiors in the com pany, and subsequently an ombudsperson for the parent company, GE, contacted and interviewed him. The negotia tions were successful, and a seven-year agreement worth $250 million was signed on December 30, 2010. Shortly after the interview with the ombudsperson, Mr. Asadi reported that he received a “surprisingly nega tive” performance review, which contrasted sharply with his 10 previous favorable evaluations. The review, he claimed, did not list specific faults or offer any steps for improvement. In subsequent months, he was subjected, reportedly, to “constant and aggressive severance negotia tions,” which were followed on June 24, 2011, by an emailed termination notice. The notice indicated that his employment
was being terminated as a U.S. employee in accord with U.S. law.
However, U.S. law, specifically, the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, prohibits retaliation against whistle-blowers and permits a recovery of damages. In addition, the Foreign Corrupt Practices Act of 1977 and 1988 and the 2002 Sarbanes-Oxley Act, passed after the Enron scandal, contain whistle-blower protec tions, which are further enhanced by the federal False Claims Act. Mr. Asadi believed that he was a victim of unlawful retaliation and filed a suit under the Dodd-Frank Act. In reporting his concerns, Mr. Asadi also believed that he had followed company policy. The parent company’s General Electric Company Code of Conduct directed employ ees to report any suspected violations of company policy and assured them that no retaliation would result.
An issue in the lawsuit brought by Mr. Asadi is the definition of a whistle-blower. GE Energy argued that Mr. Asadi did not fit the wording of the Dodd-Frank Act, which prohibits retaliation only against an employee who pro vides information about a violation of securities law to the Securities and Exchange Commission (SEC). Mr. Asadi conceded that he reported the information only internally and not to the SEC. Lawyers for GE argued, “Without any allegation that he reported a securities-law violation to the SEC, Asadi is not a ‘whistleblower’ under Dodd-Frank.” An appeals court agreed with the GE position and dis missed the suit.48 The message sent to whistle-blowers, then, is that antiretaliation protection is available from the courts only if the information is conveyed externally to the proper legal authorities. Blowing the whistle in-house is not sufficient.
Why is this the wrong message to send? Compare Your Thoughts
This ruling by the courts undermines the effectiveness of companies’ own internal compliance programs by poten tially discouraging employees from coming forward with allegations in the early stages of misconduct and allowing companies to police their own employees swiftly. However, during the comment period when the SEC was drafting rules for the implementation of the Dodd-Frank whistle blower provisions, GE joined five other large corporations, including Google, JPMorgan Chase, and Microsoft, in a statement that strongly urged the commission to support their compliance programs by requiring employees seek ing legal protection as whistle-blowers to report internally first.49 The signatories to these comments declared, “[W]e believe that the best way to balance the desires for strong compliance functions and an effective whistleblower pro gram is to require internal reporting to be eligible for an award except in cases where the whistleblower’s company does not maintain an effective compliance program with an acceptable reporting process.” The final SEC rules did not
contain a requirement that employees report internally to be eligible for legal protection.
A mandatory requirement to report internally would not have affected Mr. Asadi, who did just that, nor would it have affected 92 percent of all whistle-blowers who were found in a 2013 study by the Ethics Resource Center to have disclosed information internally first.50 Thus, only 8 percent of whistle-blowers disclosed information solely to external parties. The same study reports that only 20 per cent of whistle-blowers ever go public with their informa tion and that a mere 9 percent reported problems to the government and thus gained any legal protection from the Dodd-Frank Act. The ineffectiveness of internal reporting at some companies is evidenced by the findings that of those reporting externally, 29 percent said that the com pany did not act on the disclosure, and 36 percent were not satisfied with their company’s action. Lawyers for Khaled Asadi decided not to file an appeal to the U.S. Supreme Court, which would have provided the top court with an opportunity to issue a definitive ruling
on whether a whistle-blower has the protection of law only if information is reported externally to the proper legal authorities.51 An answer to this question awaits future developments.
ShaRed WRITING: WhO’S a WhISTle-BlOWeR?
Why should the Dodd-Frank Act be modified to protect internal whistleblowers like Khaled Asadi? Why does it only seem to pro tect those who report wrongdoing to the SEC? What does this suggest about the perceived value or effectiveness of compa nies’ internal programs for handling financial wrongdoing? Review and comment on at least two classmates’ responses.
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chapter 4 Quiz: Whistle-Blowing
Chapter 5
Business Information and Conflict of Interest
5.1 Identify the competing rights and
considerations of fairness for employers and employees seeking to protect or use confidential information
5.2 Explain the concepts of intellectual property
and trade secrets; the arguments surrounding questions of the ownership, protection, and
collection of proprietary information; and how these issues affect the employer– employee relationship
5.3 Describe the meaning of conflict of interest,
the different types of conflict of interest, and ways by which business firms can manage these situations
Case: Barbie vs. the Bratz Girls
For more than 40 years, since her launch in 1959, Barbie dom inated the fashion-doll market. As the most popular doll ever produced, Barbie contributed greatly to the profitability of its developer, Mattel. In 2001, challengers emerged in the form of pouty, sultry dolls with large lips and eyes and indeterminate but exotic ethnicity. Promoted as dolls with “a passion for fashion” and “some serious attitude,” these Bratz girls capti vated the imagination of the Barbie market demographic, the 6-to-12-year-old age group, known in the industry as “tweens.” Executives at Mattel were alarmed by more than the unwelcome competition: The creator of the Bratz girls was a former employee who had approached a competitor, MGA Entertainment, with a few drawings and a crude model that he had developed while working at Mattel.1
Mattel’s Charges
The employee, Carter Bryant, had worked two stints at Mattel, between September 1995 and April 1998 and then again from January 1999 until October 2000. He was employed in the “Barbie Collectibles” department to design clothing and hairstyles for specialty dolls that were aimed at collectors rather than youngsters. In August of 2000, Mr. Bryant approached MGA, a small toy manufacturer located near Mattel in the Los Angeles area, and pitched the idea for the Bratz line of dolls. He signed a consulting agreement
with MGA on October 4, 2000, gave Mattel two weeks’ notice the same day, and left for new employment on Octo ber 19. During this two-week period, he worked with MGA on the new doll line, including the creation of a clay model that was made by a sculptor under Mr. Bryant’s direction. Upon rejoining Mattel in 1999, Mr. Bryant signed an em ployment agreement, which included the provisions: “I agree to communicate to the Company . . . all inventions (as defined below) conceived or reduced to practice by me (alone or jointly with others) at any time during my employment by the Company. I hereby assign to the Company . . . all my right, title and inter est in such inventions.” The contract further specifies that “the term ‘inventions’ includes, but is not limited to, all discoveries, improvements, processes, development, designs, know-how, data computer programs and formulae, whether patentable or unpatentable.” About six months after Mr. Bryant’s departure from Mattel, in May 2001, MGA launched the four original dolls in the Bratz line, named Cloe, Yasmin, Sasha, and Jade. By the end of 2005, MGA had sold 125 million Bratz dolls worldwide and captured about 40 percent of the fashion-doll market, leaving Barbie a 60 percent share.2 Mattel attempted to counter MGA’s Bratz line in 2002 with a redesign of Barbie in the “My Scene” series, in which this once-demure doll now had platform shoes, low-rise jeans, heavier makeup, and an exposed navel.3 In 2003, Mattel intro duced the urban, hip-hop Flavas line, which Newsweek magazine described as “ghetto-fabulous.”4 At some point, Mattel became aware of Carter Bryant’s role in MGA’s development of the Bratz
82
Developer’s Defense
Mr. Bryant defended his right to the drawings by claiming that he developed the idea and made the original drawings in the summer of 1998 while living with his parents in Missouri between the two stints at Mattel. The inspiration for the characters, he said, came from, among other sources, shoe ads in Seventeen magazine and the cover of a Dixie Chicks album. The drawings he showed to MGA, he argued, were simply transfers from these original drawings. All the work on the idea of a Bratz line was done, he claimed, on his own time and not while performing his assigned tasks at Mattel. Furthermore, these tasks did not include generating new ideas for doll lines, so work on the Bratz dolls occurred outside the scope of his employment. Also, the phrase in the employment contract, “at any time during my employment by the Company,” was ambiguous, he claimed, and could mean only during working hours and not apply to time spent away. More crucially, the employment contract is phrased in terms of inventions, which it defines in some detail. No part of the definition would seem to apply to ideas for a new doll line. Inventions are generally regarded as concrete creations that can be implemented, while ideas are more ephemeral, exist ing initially only in the mind of a conceiver. For example, the idea of a machine to remove seeds from cotton fiber is different from the invention of the cotton gin. Moreover, the drawings themselves were sketchy and far removed from the eventual design of the Bratz dolls. What was original in Mr. Bryant’s idea
Even if Mattel owned the drawings and the model that Mr. Bryant had created, would the four original Bratz dolls constitute a violation of Mattel’s property rights?
Compare Your Thoughts
dolls5 and charged him with violation of his employment contract. Specifically, Mattel claimed that his drawings and the model be longed to the company and that he had also wrongfully appro priated the name “Bratz.” The drawings and model should have been turned over to his employer and certainly not shown to a competitor. Mattel further alleged that it had considered using the name “Brats” in connection with the Diva Starz doll, launched in 2000, so Mr. Bryant’s use of the similar sounding “Bratz” was also in violation of his employment contract.
Points to Consider…
It is understandable that companies such as Mattel seek to protect sensitive business information. Information is a valu able corporate asset, which companies have a right, as well as a strong interest, to protect, and which employees and others may have a duty not to disclose or otherwise misap propriate. It is also important in business to manage conflict of interest, which is a situation in which a personal interest interferes with the ability of an individual to fulfill some obligation or duty to act in the interest of others. This chap ter explores the two topics of business information and con flict of interest, with particular concerns for understanding
was not the actual appearance of the dolls themselves—which were not yet fully developed in the drawings—but the element of edginess or transgressive behavior in a doll. As one writer explains: “What Bratz dolls are both contributing to and feed ing on is a culture in which girls play at being ‘sassy’—the toy industry’s favorite euphemism for sexy.”6
The same question could also be raised about the other Bratz dolls developed by MGA, including Bratz Boyz, Bratz Kidz, and Baby Bratz, as well as many other Bratz characters in MGA television shows and movies. If Mattel owned the drawings, it would presumably have a right to a specific, unique expression of an idea, such that the production of any dolls by a competi tor that looked virtually identical to the drawings would be a violation of their property rights, but the idea of bratty dolls itself would not seem to be protectable as a form of property. For example, the writer of a vampire novel can rightfully protect a specific character or plot (an expression) but could not pre vent others from writing a novel about vampires (an idea). Even if an expression of an idea is substantially similar with out being virtually identical (which would be a kind of theft), much more contributes to success than the mere appearance of a doll. Many competitors sought to emulate Mattel’s success with the Barbie doll but failed due to the difficulties of marketing such a product, and Mattel tried but failed with dolls similar to the Bratz girls, such as Diva Starz and the Flavas line, and even with the Barbie “My Scene” series. In these failures, Mattel was attempting to use the idea, though not the expression, employed by a com petitor. As for the charge of wrongfully appropriating the name “Bratz” from Mattel’s development of the Diva Starz, MGA denies that Mr. Bryant was aware of any discussions. The name was first used in 1994 for a line of children’s clothing that is sold exclusively at Costco, and it was assigned by the owner to MGA in 2002.7
the ethical issues involved and the management of these issues in business practice.
In considering business information, it is useful to make a distinction between confidential information and pro prietary information. These two kinds of information are conceptually distinct, but they overlap in practice. Confi dential information is internal information, which a com pany tries to keep secret, or “in house,” because disclosure to competitors or the public might be harmful. Generally, confidential information is known only by company insid ers in the course of their employment. Proprietary infor mation, which may or may not be confidential, is distinguished by a claim of ownership: It is information
Figure 5.1 Business Information
What exactly is “business information”? What is the difference between “confi dential” and “proprietary” information, and how do these two categories overlap?
Some information may be both confidential because a company would want to keep it from competitors and also proprietary because it may represent an investment in developing a valuable resource.
that a company can be said to own as a form of property by virtue of creating or discovering it. Examples of confiden tial information are sales figures, product plans, and future advertising campaigns. Propriety information, some of which is also called “intellectual property,” includes trade secrets, patents, trademarks, and copyrights. Information such as a customer list may be both confidential because a company would want to keep it from competitors and also proprietary because it may represent an investment in developing a valuable resource. Use Figure 5.1 to review the distinguishing features of different types of business information. The protection of both confidential information and proprietary information is of concern not only to business but also to society, since economic development depends crucially on the handling of all kinds of business informa tion. Knowledge and innovation are the drivers of increased productivity in the economy, and the incentives to develop and utilize these critical factors would be damp ened if they were not protected to some extent. These two kinds of business information are associ ated with two different means of protection. Confidential information is protected mainly by the imposition of a duty of confidentiality on employees and others to maintain secrecy and refrain from disclosure or misappropriation. By contrast, the means for protecting proprietary informa tion that is regarded as the property of a company is the enforcement of property rights, so that the taking of such information—whether it is widely known or not—is a kind
f theft. Companies make investments in informa- tion in many ways, including the development of novel ideas, the collection of useful data, and the building of strong brands. These creations, which may seem ephemeral, nevertheless constitute kinds
f property that can properly be said to belong to their originators as a return on investment.
Product Concept versus Execution
A jury found MGA guilty of interfering with the employment contract between Bryant and Mattel, but not guilty of copy right infringement. Mattel neither owned the copyright to the Bratz doll concept and drawings, nor any Bratz trademarked properties, and therefore was not awarded any share of the resulting profits.8
Give some examples of the different types of business
information involved in developing, manufacturing, advertis ing, and selling a new and innovative product on the mar ket, such as the Bratz dolls. Then explain whether the success of the product can be largely attributed to the initial concept and design, another single piece of confidential or proprietary information, or all of the information is equally essential.
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5.1: Confidential Information
5.1 Identify the competing rights and considerations of fairness for employers and employees seeking to protect or use confidential information
Confidentiality may be breached not merely by disclosing information to others but also by using information that belongs to a current or former employer for one’s own ben efit, either in the service of another employer or by starting a business of one’s own. In the Mattel case study, if Carter Bryant’s ideas were the property of Mattel—which was a point in dispute—and he had used these ideas to start his own business instead of disclosing them to a competitor, he would still have acted wrongly. The information involved in such a wrongful act may include not only busi ness secrets but also the training that is given to employees at an employer’s expense. This training may involve busi ness secrets—how to perform certain specialized opera tions, for example—but it may also constitute a kind of property that is created merely by an employer’s invest ment of resources.
Both cases—the use of business secrets and the use of employer-provided training—may involve some wrong. However, neither of these uses can be addressed by means
f a confidentiality agreement, which prohibits mainly dis- closure. For this reason, employers attempt to protect con- fidential information not only by imposing a duty of confidentiality—that is, a duty not to disclose—but also by restricting competitive employment through noncompeti- tion agreements. Like confidentiality agreements, though, restrictions on competing with a former employer may impose an unfair burden on workers by foreclosing legiti- mate employment opportunities. Thus, the morality of imposing upon employees either a duty of confidentiality
r a duty not to compete requires a careful balancing of both competing rights and considerations of fairness.
5.1.1: Duty of Confidentiality
A duty of confidentiality arises either from some relation ship, such as employment, or from an explicit agreement or contract. Not only do employees have a general duty of confidentiality as agents of an employer, but they may also sign confidentiality or nondisclosure agreements, as well as noncompetition agreements, which reaffirm and reinforce agency-based duties through legally binding contracts. A duty of confidentiality applies most notably to employees with regard to information that they acquire in the course of their employment, but issues of confidential ity also arise about information that companies possess about employees, customers, and suppliers. Employees’ salaries, consumers’ purchases, and suppliers’ price lists, for example, may all be confidential. In addition, many business deals, such as mergers and acquisitions, require that companies share sensitive information, which, if leaked, could endanger the successful completion of a transaction. Confidentiality is also a critical concern for professionals, such as physicians, attorneys, accountants, and consultants, who are given access to sensitive informa tion in order to provide their services.
Example: The ability of advertising agencies to develop campaigns for new products requires that clients share carefully guarded secrets that must be held in confidence (see Case: The Aggressive Ad Agency).
An employee’s duty of confi dentiality is ethically problematic for many reasons. Com panies have some right to protect valuable business information, especially when an investment or a competi tive advantage is involved, but employees also have the right to change jobs or to start up a business of their own using some of the skills and knowledge they have acquired in their previous employment. This kind of job mobility is critical for workers’ own well-being, and companies also benefit from the right to use their own employees’ skill and knowledge that may have been acquired elsewhere. Fur thermore, the economic development of society is enhanced when information is allowed to flow freely through the
JuStiFying thE Duty
unfettered utilization of workers’ skills and knowledge. The issues surrounding the protection of business informa tion thus involve three parties:
1. businesses, 2. workers, and 3. society as a whole.
In many situations, the duty of confidentiality arises as part of agency and fiduciary relationships, which involve a commitment to act in another party’s interest. For agents and fiduciaries, any disclosures that would inflict harm on this other party are prohibited. Thus, the third Restatement of Agency states, “An agent has a duty . . . not to use or communicate confidential information of the principal for the agent’s own purposes or those of a third party.”9 In other cases, a duty of confidentiality is based on an agreement or contract, which is imposed as a pre condition for the sharing of sensitive information. For example, no company would disclose sensitive informa tion to a consultant or a potential acquirer except under a pledge of confidentiality.
Whether a duty of confidentiality arises from a relation ship or a contract—or both, as the two sources are not mutu ally exclusive—similar problems of interpretation arise.10
First, in determining whether an individual has a duty of confidentiality—or whether such a duty has been breached—it is necessary to establish the existence of the duty. Usually, this is a simple matter of establishing that a person is an agent or a fiduciary or has signed a confidenti ality agreement. However, Carter Bryant claimed that the agreement he admitted signing with Mattel did not apply to ideas he developed during the time he spent between employment stints or while away from the workplace. He recognized that he had a duty of confidentiality when com pleting work directed by his employer but denied that this duty applied to him outside of the scope of his assigned tasks at Mattel.
Second, anyone who is an agent or a fiduciary or who is bound by an agreement must still understand which information may not be rightly disclosed.
What information really is confidential and thus covered by an agreement?
Again, Mr. Bryant claimed that the drawings and models he created were mere ideas, which, aside from being developed on his own time, were too sketchy to con stitute the kind of information covered by the agreement. Other information might be judged as too unimportant or too well known to be truly confidential. Alternatively, the information might have been known prior to the relation ship or agreement from some other source, or it might have subsequently become public through no fault of the person with a duty not to disclose. Would disclosure of such infor mation violate a duty of confidentiality?
These questions about a duty of confidentiality and many others are com monly addressed in the text of confidentiality or nondisclo sure agreements, which are ubiquitous in business. Many employees sign, usually as a condition of employment, a confidentiality agreement, which creates an explicit con tractual obligation that is often more stringent than the obligation of confidentiality that is typically created by an agency or fiduciary relationship. Confidentiality agree ments are almost universally demanded by companies when they deal with consultants and a range of other busi ness partners. Similarly, companies engaged in mergers and acquisition negotiations insist that all parties agree to treat all shared information as confidential. In addition to being more stringent, a duty of confidentiality created by an agreement or contract may also not end with the termi nation of employment but may continue to exist after an employee leaves one job for another. Although confidentiality agreements have some bene fits for both employers and employees, they are subject to one notable ethical objection. Because they are usually required as a condition of employment, employees are effectively coerced into giving up rights to which they would otherwise be entitled. By relying on a legally enforceable duty of confidentiality, companies place a sig nificant restraint on employee mobility and career pros pects. Even if employees sign a confidentiality agreement, the coercive conditions under which they do so bring into question the extent to which their consent is willingly or voluntarily given. Since willing or voluntary consent is necessary for any agreement to have moral, as well as legal, binding force, its lack in confidentiality agreements raises serious ethical concerns. These ethical concerns can be countered by employers’ rights to protect confidential information and by the bene fits gained by workers in signing confidentiality agree ments. The justification for requiring employees to sign such an agreement is strengthened to the extent that confi dential information is important to a company and is, con sequently, common in the industry. Companies in high-tech industries, for example, depend heavily on their ability to protect critical information, while the dependence on secrecy is much less critical in businesses involving basic consumer products. Moreover, employees in high-tech industries are, in general, well-compensated and have ample opportunities to advance their careers without vio lating any confidentiality agreements. The ethical point at issue is whether the harm to employees from the coerced restraint that is created by confidentiality agreements is outweighed by the benefit that employers gain from insisting on the signing of these agreements as a condition of employment. The justification of confidentiality agreements thus involves a careful bal ancing of the rights and interests of both employers and
ConFIDEntIalIty agrEEmEntS
employees, which can be done, perhaps, only on a case-by case basis. In addition, the interest of society as a whole in promoting economic development must also be consid ered in determining the proper balance.
An important factor in justifying confidentiality agree ments is whether the proper balancing of the rights and interests at stake could be achieved by other means that are less objectionable. Michael S. Baram contends that the use of agreements or contracts rarely preserves either the secrecy of company information or the liberty of employ ees, and that both of these ends are better served by means of more sophisticated management.11 Among the policies he suggests are:
improving security procedures in the workplace;
securing the legal protection of patents, copyrights, and trademarks whenever possible;
segmenting information so that fewer people know the full scope of a trade secret;
limiting information to those with a need to know; and
using increased pensions and postemployment con- sulting contracts to keep employees from taking com- petitive employment. In addition, the incentive for employees to leave with
valuable information can be reduced by greater recogni- tion of employees for their contributions. Not infrequently, employees go to a competitor or set up a business of their
wn because of a feeling that they have not been fairly treated. Baram concludes that the key to protecting confi- dential information lies in improved employee relations, in which both employers and employees respect the rights of the other and take their obligations seriously. And a key element in improving employee relations is an ethical cli- mate of fair play. Employers might find that treating employees fairly provides more protection for confidential information than reliance on the law. 5.1.2: Competitive Employment Because of the difficulty of using confidentiality agree- ments to protect sensitive information after workers leave, many companies have chosen instead to require employ- ees to sign a noncompetition agreement, usually at the time of hiring. These agreements typically restrict an employee from working for a competitor in comparable jobs, for a certain period of time, within a given geographi- cal region after leaving a company.
Noncompetition agreements are especially common,
and arguably more justified, for high-level executives and highly creative people who typically possess the most valu- able secrets in an organization. Their departure for compet- itive employment has the potential to seriously damage the company they leave behind. Imposing a duty of confidenti- ality on such employees is often an ineffective safeguard,
since it may be humanly impossible for them, even with the best of intentions, not to utilize, perhaps unconsciously, the skills and knowledge that they carry away. The sale of a business also usually involves a noncompetition agree ment, since much of the value for the buyer lies in the cus tomer base, which would be eroded if the former owner re-opened nearby.
5.1.3: Impact of Restrictions
In many cases, the impact of the restrictions on future employment falls on well-to-do individuals who are amply compensated for any burden that these agreements impose. However, the Huffington Post reported in October 2014 that the sandwich chain Jimmy John’s required its low-wage sandwich makers and delivery drivers to sign an agreement that prohibited them from working at a competing sandwich shop for a period of two years after leaving the company.12 A competitor was defined in the agreement as any business that earned more than 10 per cent of sales from similar-style sandwiches and was located within three miles of any Jimmy John’s shop. Noncompetition agreements have been imposed for such entry-level, often temporary jobs as camp counselor, stu dent intern, and hair stylist.13 The wide imposition of noncompetition agreements has been criticized as employer overreach: gaining a sig nificant competitive advantage simply because they can, without offering workers any benefit in return. With jobs in short supply, desperate workers may simply acquiesce, if indeed they are even aware of the rights they are signing away. Highly compensated workers, by contrast, are in a stronger position to bargain, and they may be willing to accept restrictions on job mobility in return for the benefits of the offered job, especially high pay. If employers are willing to pay for the benefits that they gain from noncom petition agreements, then the loss of job mobility for work ers can be a fair bargain. However, workers who are forced to accept this loss without any compensating benefits are, arguably, the victims of unfair treatment.
Like confidential ity agreements, noncompetition agreements require justifi cation because of their coercive nature and the arguably unfair constraints that they place on workers’ job mobility. Noncompetition agreements are almost entirely for the benefit of employers and impose a burden on employees that may be out of proportion to any gain. The restrictions on job mobility were less of a burden at a time when work ers stayed with one company for the whole of their career or moved only once or twice in a lifetime. Today, move ment between jobs is much more frequent due, in part, to life in a “free agent era,” in which businesses, workers, and society benefit from the opportunity to employ the best tal ent, especially in the technology and media sectors.
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Another drawback to noncompetition agreements is that they typically apply regardless of the conditions under which employment is terminated, and so they may con tinue to be binding even in cases of involuntarily dismissal, which adds insult to injury for fired workers. In addition, an agreement may continue to bind a worker whose com pany is merged or acquired, with the result that a wider range of employment would be considered competitive than at the time of the signing. Finally, if noncompetition agreements are intended merely to limit competition rather than to protect sensitive information, then they undermine the beneficial workings of a competitive marketplace.
A few states (most notably, California) consider non competition agreements to be so unfair that they are pro hibited entirely, while others place restrictions on them.14 Where noncompetition agreements are permitted by law, the courts have generally imposed a number of tests to determine whether they are justified.15 These tests are that the restrictions contained in an agreement
1. must serve to protect legitimate business interests, 2. must not be greater than that which is required for the
protection of these legitimate interests, 3. must not impose an undue hardship on the ability of an employee to secure gainful employment, and 4. must not be injurious to the public.
Legitimate business interests include the protection of proprietary information or customer relations, but the pur pose of an agreement cannot be merely to protect an employer against competition.
In determining whether restrictions are greater than those required to protect the legitimate interests of an employer, three factors are important. These are the time period specified, the geographical area, and the kind of work that is excluded. The value of confidential informa tion is reduced over time, so that a noncompetition agree ment designed to protect important secrets can justifiably restrain an employee only during the time when they have value. Without a time limit on an agreement, an employee could be prevented from working for a competitor even after formerly confidential information becomes common knowledge. Similarly, an employer with a legitimate inter est in protecting the customers it serves in New York City, for example, might be justified in preventing a sales repre sentative from working for a competitor in that area but not elsewhere.
Noncompetition agreements that specify the kind of work too broadly also run the risk of hampering an employee unduly. In one case, a woman in Georgia signed a contract with an employment agency in which she agreed not to work in any capacity for a period of one year for any com petitor within a 25-mile radius. The Supreme Court of Geor gia ruled that the time period and the area were reasonable