Ethics, Governance and Sustainability - Study Guide

Introduction:

The Ethics and Justice topic area looks at basic principles of ethics and justice and then applies them in the business setting.

When we talk of ethics and ethical behaviour, we are referring to the theory of morality covering moral rules and principles of human conduct – what is right and wrong, what is good and bad, and what the underlying motives are, of human behaviour.

Morality has to do with the standards by which people ought to behave and principles which reflect what is ultimately good or desirable.

Justice is concerned with fairness – in the distribution of things in society and in the way we treat others (including how we distribute things between, and treat, other humans within the current and future generations and non-human species).

Video: What is Ethics?: (2 min 25 sec)

Video: Ethics and International Standards of Behaviour: (2 min 27 sec)

Video: Virtue ethics and business: (2 min 18 sec) 

Learning objectives:

1. Understand the different ethical theories and the basis on which ethical decisions are made.
2. Understand the drivers for unethical behaviour in the business setting and how managers might address these issues.

Discussion:

The discussions we have had on the shareholder approach, the stakeholder approach, CSR, and the TBL, plus those we will have later in the course on sustainable business and governance, all try in some way to confront issues about how organizations and the people in them should behave and to whom they hold responsibilities. But as soon as we start talking about should, we start talking about ethical issues that guide us as to what behaviours we should or should not be engaging in, not just what we must do because the law or someone in a position of authority/power says so (although this also has an ethical side - our belief as to what laws or other commands should be obeyed), or what our own self interest might propose.

If we are to behave ethically, on what basis do we make decisions that would meet the ‘ethical’ criteria? Where do the standards come from?

In some sectors of society they come, to varying degrees, from religious texts (the Bible, the Koran, and so on). Outside of this, the history and scope of exploration into the basis of ethical action is substantial and can be quite challenging to digest.

The readings for this topic 3 walk through some of these questions which will help provide a platform to consider some of the ethical issues we will confront as the course progresses. The topic readings are quite comprehensive however, in general terms, there are three key foundations on which ethical decision making is considered namely, a:

• Consequentialist approach
• Deontological approach
• Virtues approach

Consequentialist approach

This approach to ethical decision making is goals/outcomes based where actions are considered to be right or wrong based on their outcomes (Ikeme 2003; O'Neill, Holland & Light 2008; Holbrook 2009). It asks the question "What state of affairs ought I to bring about?" (O'Neill, Holland & Light 2008, p. 47)

In practice, consequentialism translates to setting a desired outcome (say, a public policy goal regarding income distribution) and then putting in place the mechanisms to go about achieving this goal. When there is a conflict between the general good, and group or individual rights, the general good takes priority (Ikeme 2003).

The consequentialist approach has a number of different versions, some of the more common being:

• Actual and expected consequentialism

Actual consequentialism sees actions as right or wrong based on their actual effects. This has its problems, an example being where actions that are malicious or irresponsible accidentally produce good outcomes where, for actual consequentialism, this would not matter (Holbrook 2009).

Expected consequentialism sees actions as right or wrong based on the effects that are reasonably expected to occur – it is a ‘good intentions’ view (Holbrook 2009).

• Utilitarianism

The modern day roots of utilitarianism are mostly attributed to John Stewart Mill and his 'greatest happiness principle'. It is based on the idea that we should promote that which produces the greatest good for the greatest number. In its classical form, utilitarianism seeks the greatest aggregate good through summing the individual welfare outcomes – in effect, if we had a choice of say, two acts, we add up the individual good and harm from both and the one with the greatest net good is the preferred act (Ikeme 2003).

One of the key criticisms of utilitarianism is that it does not rule out inequality in the actual distribution of things within society. Although having a preference for spreading the 'good' around, the ‘greatest good’ objective comes first even if this good is concentrated in the hands of a few. Utilitarianism can also produce outcomes that are oppressive to minorities by placing the interests of the many over those of the few (Bell 2009).

Other versions of utilitarianism include pluralist consequentialism which is an extension of classical utilitarianism that seeks to both maximise welfare and to achieve equity in distribution, and hedonism which seeks the greatest pleasure and least pain at the individual level (Ikeme 2003).

One of the modern-day tools for making utilitarian type decisions in Cost Benefit Analysis, where the costs and benefits of a certain action (say, introducing regulations to discourage smoking, building a road, opening a forest to logging, …. ) are determined and if the benefits outweigh the costs, then the action is an acceptable one to pursue. We look at some of he possible problems with using Cost-Benefit analysis in this way, in the discussion below.

Deontological approach

The deontological term comes from Greek deon, 'that which is obligatory' and is an actions based approach where actions are considered to be right or wrong based on the morality of the actions themselves independently of the outcomes that follow (Ikeme 2003; O'Neill, Holland & Light 2008; Holbrook 2009). It asks the question "What acts am I obliged to perform or not perform?" (O'Neill, Holland & Light 2008, p. 47).

The deontological approach is based on principles of justice, basic rights, duties, obligations, responsibilities, proper conduct and inherent natural rights of others, and is largely ascribed to Immanuel Kant and his 'categorical imperative' to act only on certain rules and principles (Ikeme 2003).

For Kant, an act can be seen as morally right if it can be judged by all reasoning people to be a universal principle of conduct regardless of whether a person is the doer of an act, the receiver, or a mere observer. An example of such a categorical imperative is the ‘golden rule’ – do unto others as you would have done unto yourself (Fisher & Lovell 2009).

Two of Kant’s Categorical Imperatives are:

“Principle of universality – Act Only According To The Maxim By Which You Can At The Same Time Will That It Should Become A Universal Law.

Principle of Humanity – Act So That You Treat Humanity, Whether In Your Own Person Or In That Of Another, Always As An End and never As A Means Only” (Chan & Shenoy 2011, pp 34).

The Principle of Humanity means, in a practical sense, that we shouldn’t see people as simply things to use as a means to some outcome, but we should treat them as having value in themselves. People can of course be both a means to an end and an end in themselves. Think for example of a child. The child can bring happiness and purpose to his/her parents and family unit so in that sense is a means to an end – the child brings about benefits to others that those others desire from the child. But at the same time, the child is (for most parents we might hope) valued for his/her own sake. The parents love and care for the child independently of the benefits the child brings to them – the child is in this sense treated as an end in its own right.
You might like to give some thought to how this notion of treating people as ends , not just means to an end, might apply in the workplace – say, the organisation’s attitude to its employees (are employees simply a ‘resource’ for the firm?), or how stakeholders might be treated (is it right to treat stakeholders as merely a means to maximising shareholder profit?).

Another noted approach that fits under this general deontological category is Rawls’ theory of justice. Rawls’ theory is known as one of ‘Justice and Fairness’ where he proposes that social rules of conduct should be made under a ‘veil of ignorance’. This idea of a veil of ignorance sees people needing to assume what Rawls calls an ‘original position’ where the rules by which society will operate, and hence what is right or wrong in the way our social system works, should be made without anyone knowing what their lot in life might be – not knowing if they will be rich or poor, what race they might be, what their childhood might be like, if they will be tall or short, intelligent or not so, healthy or ill, physically or mentally sound or in some way disabled, and so on.

For Rawls, two key principles of justice can be derived from this ‘original position’ thought experiment:

“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.

Social and economic inequalities are to be arranged so that they are both:

(a)   To the greatest benefit of the least advantaged; and

(b)   Attached to offices and positions open to all under conditions of fair equality of opportunity” (Chan & Shenoy 2011, p 42).

Other formulations of the deontological approach place an emphasis on the notion that all humans have a set of inalienable rights which no one, including the State, is allowed to interfere, irrespective of the consequences. As such, justice demands respect for these rights or remedial action if these rights are violated (Ikeme 2003). Under this view, ends (consequences) are just so long as the decisions that gave rise to the ends are just, regardless of what those ends actually are (Ikeme 2003).

One version of such a rights-based deontological approach that you will see in certain political narratives to varying degrees is libertarianism (Okereke 2006), which holds that people are entitled to their market allocation of goods in society regardless of the degree of poverty or want surrounding the outcome. Robert Nozick’s “Entitlement Theory”, set out in his book “Anarchy, State and Utopia”, is an example of this approach, as is the work by Ayn Rand as discussed in her book “Atlas Shrugged”. Under this view the market is seen as inherently just and capable of distributing costs and benefits in an efficient and appropriate manner. For libertarianism, State interventions are mostly undesirable, unnecessary, and a violation of the individual right to liberty, although the State is seen as having an important role in enforcing private property rights. This approach is consistent with neo-liberalism and is sometimes referred to as neo-liberal justice.

Some critics of the deontological approach suggest that it risks a 'means justify the ends' approach being adopted to decision making, where the ends can tend to fade to insignificance and all that matters is the means by which the ends came about (Ikeme 2003).

Virtues approach

A virtues ethic is based on consideration of what comprises a good human life and the personal qualities/virtues that provide the basis for such a life.

"The basic good of ethical life is the development of a certain character. A right action is the act a virtuous agent would perform; the best state of affairs is one that a good agent would aim to bring about" (O'Neill, Holland & Light 2008, p. 47).

Exactly what these virtues might be is a matter of dispute but might include things such as such as courage, loyalty, compassion, honesty, justice and so on.

The virtues approach then, asks the question "What kind of person should I be?" (O'Neill, Holland & Light 2008, p. 47) with ethical decision making based on living up to these virtues.

This approach is not based on a set of rules but rather a set of personal characteristics that, if practiced, will see a person likely to make sound choices when confronted with ethical matters.

East and West

The discussion so far has looked at different approaches to ethics from a mostly Western perspective.

This Western focus of much of the ethical discourse in the business literature is quite limiting in the globalised world in which we live.

Rather than trying to work through Eastern perspectives in these notes, an optional reading has been added to the readings list for this topic (the Chan article) and you are encouraged to browse though this article to gain some insights into Eastern views.

Another of the optional readings – the one by Fisher & Lovell, goes into the different approaches to ethics, as set out above, in more detail and is also worth looking through.

Issues

The different approaches to ethical decision making are often accepted as separate and incompatible on the assumption "that there is a single basic question and answer in ethical deliberation about the priority of states of affairs, acts and agency (O'Neill, Holland & Light 2008, p. 47).

An alternate approach to reliance on any one form of decision making (consequentialist, deontological, virtues… ) is a pluralist approach (O'Neill, Holland & Light 2008). This approach sees the need for procedural arrangements that support good decision making in the light of complex and often conflicting issues, demands, and ethical implications. It may be unrealistic to expect that rational decision making can resolve all moral conflicts that arise; it may be better to accept that conflicts will arise and that we need to make the best choices we can under the circumstances despite some uncomfortable and painful consequences.

Possible drivers of unethical behaviour in business

A number of factors are identified in the literature that may act as drivers of unethical behaviour in business. Here we touch on a few of these namely:

• How people are remunerated
• The focus on profits
• The use of cost-benefit analysis (CBA) as a decision making tool

In reading through these points, consider whether you agree with what is presented and if you think it has merit, what might be done to address the problems that are identified.

Remuneration:

One of the proposed drivers for unethical behaviour is how people are remunerated. An area of particular focus on this remuneration topic is executive pay and whether this is properly tied to the interests of shareholders (say, by way of share options and/or bonuses based on the extent to which shareholder value is enhanced). Executive pay is also picked up in the governance topic we cover later in this course. With our discussion on shareholder vs stakeholder approaches, this begs the question as to whether tying executive pay to shareholder value alone is the answer – why isn’t it tied to the achievement of goals that take into account the broader set of stakeholder needs and other corporate responsibilities, goals or objectives picked up in say, CSR?. Two member's of KPMG’s Sustainability Advisory Services practice support this view by proposing that "tying pay to sustainable development performance at organizational levels creates a true incentive for innovation and accepting the change to the “business as usual” culture" (Riepenhoff & Radcliffe 2001).

Profit focus

Linked to this question of the incentives people are given in their work environment is the focus of the business itself. Anita Roddick (of The Body Shop fame) sees the unethical behaviour of people in business as driven by the shareholder-profit model. Bakan (2005) describes Roddick's view this way:

"Roddick blames the 'religion of maximizing profits' for business's amorality, for forcing otherwise decent people to do indecent things: 'because it has to maximize profits…everything is legitimate in the pursuit of that goal, everything… so using child labor or sweatshop labor or despoiling the environment…is legitimate in the maximizing of profit.

The managers who do these things are not monsters, Roddick says. They may be kind and caring people, loving parents and friends [but] they compartmentalize their lives. They are allowed, often compelled, by the corporation's culture to disassociate themselves from their own values – the corporation, according to Roddick, 'stops people from having a sense of empathy with the human condition'; it 'separates us from who we are" (pp. 55-56).

What Roddick and Bakan are getting at is that, in their view, the very foundations on which corporations are structured encourages corporate behaviours, and behaviours of people in them, that can lead to the types of outcomes that cases like Enron show in the extreme. In discussing this further, Bakan goes on to say:

"Though the company [Enron] is now notorious for its arrogance and ethically challenged executives, the underlying reasons for its collapse can be traced to characteristics common to all corporations; obsession with profits and share prices, greed, lack of concern for others, and a penchant for breaking legal rules" (p. 58)

Cohan (2002) picks up this theme in a few places – here are a couple of the more direct statements from that article:

"It has been pointed out that people in corporations tend to make decisions that may not be in keeping with their own sense of morality. People working within corporations often have a distinct business persona, different from the one they display within their family relationships or in other roles in society. The idea is that people may act in seemingly altruistic ways outside the corporation, but in the firm there is a business morality that is somehow different from one's personal morality, that "business is business," with the focus being to maximize profit without regard to other considerations." (p. 288)

and

"Many supervisors, consciously or not, do not want to know precisely how their subordinates achieve their results. As long as the bottom line is profitable, there is little incentive to discover how those results were achieved. Focusing on the bottom line also facilitates the denial of either moral or legal complicity should severe problems be uncovered.'' (p. 286)

The last paragraph (from Cohan, p 286) is quite an aggressive statement about things that go in inside business, and we all (including Cohan) would probably hope that this is not the norm – but maybe in some areas it is. An article in the March 2008 issue of Scientific American on the problems with the tuna industry, that gives a clear link between the issue of ethics and sustainability, had this to say:

"Even if lower quotas [on the bluefin tuna catch] were in place, however, the bluefin would still be imperilled. The tuna fishery is rife with illegal, unregulated fleets that ignore quotas, restrictions, boundaries, and any other rules and regulations that might threaten their catch. Furthermore, the Japanese market – which devours about 60,000 tons of bluefin every year, or more than three quarters of the global catch – is only too eager to buy tuna, regardless of where or how it is caught. Japanese fishers have contrived to circumvent even their own country's restrictions, bringing in thousands of tons of illegal tuna every year and then falsifying their records" (Ellis 2008, p. 68).

The point to all of this is that advocates of the 'problem is in the system' view of the corporate world will say that Enron type events cannot be prevented simply by better policing. Bakan, Roddick, and like minded commentators focus more on the underlying system and how this needs to be reformed in order to reduce the Enron type consequences. They would argue that business needs to focus on more than just shareholder value as its purpose in life, hence the themes we find in approaches such as the stakeholder approach, CSR, and sustainable business.

Cost-benefit analysis (CBA)

CBA is a key decision making tool for government and business. It is used in many types of decision making including whether government should build a new road, or put in place some new regulations, or invest more in education and so on. For business it is used for things like whether a new factory should be opened, a new machine purchased… the list goes on. The concept is fairly straight forward although behind the scenes it can be a bit challenging to work through. Basically though, CBA is a process of working out all of the good things (benefits) that come from taking a certain action, working our all of the bad things (costs) that will arise, and so long as the good is greater than the bad, then this can provide a basis on which to go ahead and take the action. Because good and bad things can be both money and non-money items, the CBA process converts everything into money in current day dollar terms, so we end up with a purely money based decision to make. You are probably familiar with CBA from other MBA courses or studies you have done, mostly talked of in terms of net-present-value (NPV) calculations in project analysis. But CBA has its dark side and the following examples touch on some of these that are relevant to the issues covered in this course.

The first example is the Ford Pinto case. The Ford Pinto was a car built by Ford in the 1970's that had a habit of bursting into flames if on the receiving end of a rear-end collision (it had to do with the positioning of the fuel tank). Someone inside Ford worked out that it would cost (all these numbers are in 1970 US dollars) $137m per year to fix the problem based on the per-car additional costs incurred. But, it was also calculated that if a life was valued at $200,000 (remembering that CBA converts all things to money values), then the total cost of lost lives based on an estimated 180 deaths per year would be $36m. So it was financially better – about $100m better – for Ford to not make changes to the car and pay out compensation for deaths caused by the fault in the car. Eventually Ford was forced to fix the problem (Ackermann 2008). What we can see here though, when looking at the case form an ethical standpoint, are some challenging issues including:

(a) People inside Ford thought this CBA outcome (save money by paying compensation rather than fixing the fault) was a rational and sensible argument.
  Do you think it was a rational and sensible argument?
      If yes, why?
      If no, why not?
  What implications does your answer have for the use of CBA in your own professional life?

(b) Lives were converted into dollars.
  Do you think it is right to place a value on lives in this way?
      If yes, why and under what conditions?
      If no, why, and what alternate approach do you think might be useful for decision making?

(c) The ones carrying the costs of the bad design and faulty product were the people in the burning cars, not the company that sold a faulty product – the harm was ‘externalised’ (we will look at externalities in more detail later in the course, however in brief, an externality occurs when the activities of one party (say, a company) provide a cost or benefit to another party, with no compensation occurring. An example is pollution from a coal fired power station where the company and its shareholders gain from the sale of electricity, however communities and the environment suffer from the pollution the plant generates without these harms and related costs being imposed back onto the company and its shareholders).
  What ethical issues do you think might apply here in this externalising of harms approach?

Another more recent case has to do with cigarettes. Around the year 2000, Philip Morris, the cigarette company, commissioned an international consulting firm, Arthur D Little, to report on the public finance implications of smoking in the Czech Republic – the report looked at the numbers for the year 1999. Here is what the first few paragraphs of the report said:

"Based on up-to-date reliable data and consideration of all relevant contributing factors, the effect of smoking on the public finance balance in the Czech Republic in 1999 was positive, estimated at +5,815 mil. CZK.

This report details the findings of a study commissioned by Philip Morris and undertaken by Arthur D. Little to quantify the effects of smoking on the public finance balance in the Czech Republic in 1999. The objective was to determine whether costs imposed on public finance by smokers are offset by tobacco-related tax contributions and external positive effects of smoking”.

To come up with the numbers, the consulting firm did things like work out the 'financial benefits' from things such as the savings due to people dying early from smoking-caused illness (savings in elderly housing, in long-term healthcare, and in old age pensions) and income from cigarette taxes. On the negative were costs such as loss of income tax from people dying sooner and not being able to work, losses from fires (say, from falling to sleep with a cigarette in the hand) and so on. All up though, according to the report, the Czech public finances were much better off due to smoking and so, according to Philip Morris, no action should be taken to try and reduce the extent people smoked.
Looking at this case through ethical eyes, it raises a few issues to think about including:

(a) Similar to the Ford Pinto case, harms to people – illness and shortened lives – were reduced to dollar values where it was not a life lost or a person harmed that was at stake but a question of money in and money out.

(b) Causing harm (the negative impacts to human health from smoking) was, using CBA, transformed into a social financial good.
What do you think of this feature of how CBA works – what ethical issues do you think come in to play?

(c) We can ask questions about the values and ethics (or lack thereof) displayed by both Philip Morris in commissioning and promoting the report, and by Arthur D Little in taking the assignment and placing their name on the report.
Should the consulting firm have accepted such an assignment?
What flow on implications do you think your answer has for how professional advisers to firms (lawyers, accountants, PR consultants etc) should act and what contracts they should be willing to take on?

A copy of the full report is included in the additional readings for this topic.

The last case we will look at is a famous memo written in 1991 by Lawrence Summers, the then World Bank Chief Economist. Here is the full content of the memo (which is readily accessible on the internet – here is one URL access point: http://www.whirledbank.org/ourwords/summers.html).

World Bank Chief Economist, Lawrence Summers 1991 internal memo: 

DATE: December 12, 1991
TO: Distribution
FR: Lawrence H. Summers
Subject: GEP

'Dirty' Industries: Just between you and me, shouldn't the World Bank be encouraging MORE migration of the dirty industries to the LDCs [Less Developed Countries]? I can think of three reasons:

1) The measurements of the costs of health impairing pollution depends on the foregone earnings from increased morbidity and mortality. From this point of view a given amount of health impairing pollution should be done in the country with the lowest cost, which will be the country with the lowest wages. I think the economic logic behind dumping a load of toxic waste in the lowest wage country is impeccable and we should face up to that.

2) The costs of pollution are likely to be non-linear as the initial increments of pollution probably have very low cost. I've always though that under-populated countries in Africa are vastly UNDER-polluted, their air quality is probably vastly inefficiently low compared to Los Angeles or Mexico City. Only the lamentable facts that so much pollution is generated by non-tradable industries (transport, electrical generation) and that the unit transport costs of solid waste are so high prevent world welfare enhancing trade in air pollution and waste.

3) The demand for a clean environment for aesthetic and health reasons is likely to have very high income elasticity. The concern over an agent that causes a one in a million change in the odds of prostrate cancer is obviously going to be much higher in a country where people survive to get prostrate cancer than in a country where under 5 mortality is 200 per thousand. Also, much of the concern over industrial atmosphere discharge is about visibility impairing particulates. These discharges may have very little direct health impact. Clearly trade in goods that embody aesthetic pollution concerns could be welfare enhancing. While production is mobile the consumption of pretty air is a non-tradable.

The problem with the arguments against all of these proposals for more pollution in LDCs (intrinsic rights to certain goods, moral reasons, social concerns, lack of adequate markets, etc.) could be turned around and used more or less effectively against every Bank proposal for liberalization.

The basic ideas that Summers was proposing were that:

(a) Because people in poor countries earn less than people in rich countries, we should dump toxic waste in poor countries as less income will be lost from a poor person dying prematurely than for a rich person.

(b) Poor countries have less pollution than the rich so the rich should transfer their polluting industries to poor countries to 'share the pollution around'.

(c) Because people in poor countries have a shorter life expectancy than those in the rich countries, it is better to put polluting industries in poor countries as if it causes premature death then the poor were going to die sooner anyway so it doesn't matter as much.

There are many issues here that are important for our current purposes, including:

(a) The same issue as in the first two examples where harms are valued in terms of lost money, not for what they are – harms to people.

(b) The idea that harming the poor ‘costs less’. This links to some important issues of justice (which we will explore further in the next topic) where a well documented problem exists in our society (both locally and in the global context) where the rich tend to get the environmental and consumptive ‘goods’ and the poor get the environmental and consumptive ‘bads’. This also has an important connection to business and how businesses go about extending their supply chains and often locating ‘dirty’ industries in less developed countries (say, in Africa, South America, Asia, and Eastern Europe), or employing labour in countries with poor labour standards. Although the logic for these commercial supply chain decisions may not be based on the arguments Summers sets out in his memo, the effect is the same – the poor tend to get more of the ‘bads’, and the rich get the benefit of the consumed goods.

So what has all of this got to do with this Ethics and Justice topic? A lot really. It goes to the core of how our society values things, what we care about and why. Should we really reduce things of value – human health and wellbeing, the existence of an old-growth forest, the continued existence of the orang-utan, the maintaining of traditional cultures, and so on – to dollar values or are some things simply valuable in ways that money just cannot express? This is not to say that some things have an 'infinite' money value, they just cannot have a dollar-value put on them at all and to try to do so is seen by some as offensive and insulting.

Ackerman & Heinzerling (2004), in their book "Priceless: On Knowing the Price of Everything and the Value of Nothing", propose that CBA has a seriously negative impact on our society where we lose our sense of what is of value and what isn't – converting everything to money erodes our value system and blinds us to what really is of importance in the world. On CBA, the authors suggest that where good and bad things are in real hard dollar terms then yes, recognise that but other things – human wellbeing, species at risk, potential loss of forests or wetlands and so on – keep them in the decision making process for exactly what they are.

Ethical decision making and duties to the firm

Ethical decision making and the duties of company decision makers (Directors, management….) raises some interesting questions: this scenario brings one of these into focus: 

A firm’s decision makers (Management, Board) decide to not enter into a transaction that was legal and profitable (and the best deal on the table at the time), because for some reason that transaction had aspects that did not pass the ‘ethical test’. To stretch the scenario, the risks to the firm of some form of harm from the deal were minimal so on a risk basis, doing the deal was fine.

Are the firm’s decision makers right in taking such a decision based on their duties to the firm? Is there an inherent conflict in place where duties to a firm can override an ethical stance?  

This goes to the core of the basis of ethical decision making – that is where decisions are based on questions or right or wrong, not of right and wrong dependent on self-interest outcomes (in this case, the self-interest of the firm, it’s shareholders, and possibly some of its other stakeholders).

The first part of the equation in thinking about this is the legal position:

The duties of directors are owed to the company. However, in law the interests of the company are often regarded as the same as the interests of the shareholders. There have been a few cases where decisions of directors have been overturned because there was no benefit to the company, aka the shareholders, even though directors thought their decision was morally correct. A classic example of this is:

Parke v Daily News [1962] Ch 927 – in this case the company was going to cease operations and instead of giving back the surplus to shareholders the directors decided to make gratuitous payments to employees who at that time were not entitled to redundancy payments. The court found that the directors had acted contrary to the interests of the company: ”Stripped of all its side issues, the essence of the matter is this, that the directors of the defendant company are proposing that a very large part of its funds should be given to its former employees in order to benefit those employees rather than the company, and that is an application of the company funds which the law… will not allow… the proposal to pay compensation is one which a majority of shareholder is not entitled to ratify”

However, many now regard this case as rather old fashioned and have limited it to instances where the interests of a particular stakeholder group ie employees were allowed to trump the interests of the company. It is probably the case that these days the courts allow directors broad discretion to determine what might be in the interests of the company including from the perspective of what is the right thing to do. You may remember that the James Hardies’ directors raised the issue of shareholder interests apropos their initial decision not to fund the Asbestos Compensation Fund more than had previously been determined. Most commentators of the time regarded this as an excuse to try and rationalise what had occurred re: the underfunding rather than an actual legal constraint upon their decision making. Nonetheless the question remains open. England has since changed its law to allow directors to take account of stakeholder interests as part of their decision making (see s 172 Companies Act 2006 which explicitly requires directors to consider the interests of its stakeholders including employees and suppliers). Australia also considered something similar but ultimately rejected it. In Australia the question will turn on whether the directors:

• made the decision in good faith for a proper purpose;
• rationally believed the decision was in the best interests of the company after having made all reasonable inquiries necessary to inform themselves about the subject matter of the decision; and
  • made the decision while having had no personal interest in the matter.

The idea of businesses making decisions concerning whether a transaction will be entered in to, using criteria beyond the legality of the transaction and the returns to a firm, is common practice. An example is in the banking and finance area and the Equator principles to which certain banks have signed up to. When you look at the principles, notice that they talk of social and environmental risks, not financial risks to the lender: http://www.equator-principles.com/index.php/about-ep/about-ep . This doesn’t mean that the lender might not face flow-on financial risk if the principles were not adhered to in entering into a transaction; the point for our purposes is that the focus is on non-financial aspects of the project to which funding is being considered and a willingness to walk away from a transaction if the social and environmental risk criteria are not properly addressed.

The idea of businesses conducting themselves in an ethical way as a key basis for decision making can also be found in policy documents such as those of the ASX. Principle 3 of the ASX Corporate Governance Principles and Recommendations (see topic 10 of the course notes) states:

“Principle 3 – Promote ethical and responsible decision-making: Companies should actively promote ethical and responsible decision-making.”

In day-to-day business life, we also make decisions along the way of who we will work with and who we won’t. It’s not unusual to say “we don’t want to do business with this person/firm – they don’t live up to the standards we live by (or words to the effect)”.

So where does this all lead?

Do we really live in a world where in business, when faced with the cold hard reality of entering, or not entering, into a transaction based on ethical grounds despite the financial attractiveness of the deal, we must do the deal to meet the duties of acting in the interests of the firm? 

Well, no. We are not stuck in this space or, more correctly, we do not need to be stuck in it.

In real life, how often a firm’s decision makers would be confronted with a decision of material consequences where an ethical stance would not benefit the firm in some way (if not financially, then by way of reduced risk, improved social credibility, better employee morale, improved PR….) is probably few and far between, but the acid test of a business ethic is that it will hold up under these ‘no-win and possible cost’ scenarios.

The other point that is important is that any one decision (to not do a transaction due to ethical considerations) should be looked at in terms of the whole – that is, by acknowledging that at times some transactions will be walked away from, the overall effect of a strong ethical stance by the firm is better for all stakeholders – shareholders included.

So what to do?

There are 2 key parts to seeing this all come together nicely in an organisational setting

• First is to make sure the firm has a well drafted code of ethical conduct that puts ethical action at the core of all decision making, and for this to be a public document, embedded in organisational culture, and reinforced at AGMs. This way, all stakeholders (and all shareholders for that matter) are aware of the basis on which the firm operates and if a decision to invest in the firm is made, the rules under which the firm operates are known.
  This type of ethical structure is covered in Topic 3 of the course and is consistent with the idea behind the ASX Principle 3 referred to above.
• Second, where decisions are made that see transactions occur or not occur based on ethical considerations, then the decision making process should be fully documented so that, if at any time, questions were raised, the reasons can be demonstrated. The decision process should tie to the organisation’s code of ethics.

References

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 Riepenhoff, C & Radcliffe, M 2001, 'Maximizing the business value of sustainable development', Green@work - Corporate Sustainability Magazine; online article at http://www.greenatworkmag.com/magazine/corp_acts/01sepoct.html Sept/Oct 2001.