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CHAPTER LEARNING OBJECTIVES,

1
OUTLINES, AND CASE NOTES

Introduction to the Field

SUMMARIZING OUTLINE
Chapter 1 introduces the field and describes how it will be explored. It begins with a story about Exxon
Mobil Corporation illustrating the business-government-society relationships of one company.* After some
discussion of the nature of the field, including definitions of key terms, four models of the businessgovernment-society relationship are presented. Finally, the chapter sets forth certain approaches and
assumptions used in the book.

The introductory story is about ExxonMobil. It raises central questions about the role of business
in society, including when is a corporation socially responsible?

ExxonMobil descends from the Standard Oil trust incorporated in 1882 by John D.
Rockefeller.

* As in the textbook, Exxon Mobil is written as two words when followed by the word Corporation, but as one word
when the word Corporation is not used. This is the companys preferred usage.
2

Standard Oil grew so large and powerful that it was broken apart by the Supreme Court in
a 1911 antitrust case. Exxon and Mobil were two companies in the original trust. A merger
in 1999 reunited them.

ExxonMobils corporate culture still reflects the values of Rockefeller, its founder. It is
fiercely competitive, profit-focused, and efficient.

ExxonMobil faces challenges in its business, government, and social environments.

In the business environment it is challenged by the rise of state-owned oil


companies.

With government, it is restricted by laws and regulations in each country in which


it does business.

In the social environment it is closely monitored by environmental, civil rights,


labor, and consumer groups--some of which are actively hostile.

The story of ExxonMobil raises central questions about the role of business in society.
When, for example, is a corporation socially responsible? What actions are ethical or
unethical?

What is the business-government-society (BGS) field and what is its importance?

The field is explained as the study of interrelationships among its three elements, each of
which is defined. These interrelationships change over time.

Business encompasses a broad range of economic actions, institutions,


and processes the purpose of which is to make a profit by providing
products and services that satisfy human needs.

Government refers to institutions and processes in society that


authoritatively make and apply policies and rules.

Society is a network of human relations including ideas, institutions, and


material things.

Ideas are intangible objects of thought and include the following.

Values, or enduring beliefs about which fundamental life


choices are correct.

Ideologies, or bundles of values that create worldviews.

Institutions are formal patterns of relationships that link people


together to accomplish a goal. A range of institutions is necessary
to support markets.

Material things are the tangible artifacts of a society that shape


and are shaped by ideas and institutions.

The BGS field is important to managers, because to succeed they must respond to forces in
both their economic and noneconomic environments. The history of ExxonMobil illustrates
the powerful impact not only of market forces, but of government and social values.

In 1911 the Supreme Court broke up Standard Oil. The decision reflected social
values favoring open, competitive markets. These values lay behind the Sherman
Antitrust Act and negative public opinion at the time.

In 1989 the Exxon Valdez oil spill created acute legal, political, and image
problems for the firm.

These incidents with ExxonMobil illustrate that business must comply with a social
contract, that is, an imaginary, unwritten agreement between business and society that
defines basic duties and responsibilities of business.

Four basic models of the BGS relationship are set forth.

The market capitalism model depicts the relationship as a set of arrangements in accord
with the assumptions of classical capitalism. It is assumed that social responsibility is
measured primarily as economic performance that enhances social welfare.

The basis for the model is the nature of capitalism. It is explained this way.

People have always traded. Markets are timeless phenomena.

Market economies, or economies in which people produce mainly for trade, not
subsistence, developed in the 1700s.

Adam Smith wrote The Wealth of Nations in 1776. In it, he explained the market
economy, which he called commercial society.

The desire for trade is a human instinct.

A division of labor in society led people to satisfy their self-interests by


specializing their work, then exchanging goods with each other.

The markets pricing mechanism reconciles supply and demand. It works


to make commodities cheaper, better, and more available.

By the late 1800s developed economies had evolved from Smiths depiction of
innumerable small owner-run businesses into systems of managerial capitalism
dominated by smaller numbers of large corporations run by hierarchies of salaried
managers.

Smiths model incorporates important assumptions.

Commercial society coordinates the activities of strangers and, to gain


their selfish advantage, they must fulfill the needs of others.

Government intervention in the economy is limited. This is the economic


philosophy of laissez-faire.

Individuals own private property.

Markets are competitive.

Consumers inform themselves about products and make rational


decisions.

Moral restraint accompanies the self-interested behavior of business.

Capitalism is recurrently attacked. The enduring criticisms are these.

It is energized by greed, envy, avarice, selfishness, and ruthlessness and so


it slights virtues such as love, friendship, and compassion.

It leads to inequalities of wealth and income.

It encourages exploitation of workers.

Capitalist nations engage in imperialism to spread markets.

It places too much emphasis on money and material objects.

It generates conspiracies and monopolies.

It leads to environmental pollution and resource exploitation.

The dominance model represents society as a pyramid. Atop it, business and government
dominate. This is the model of business critics. It suggests that business has too much
unchecked power.

Proponents of the model focus on the defects and inefficiencies of capitalism.

It gained a following in the late 1800s.

Its perspective is fundamental to populism and Marxism.

The countervailing forces model shows flows of power and influence between
environmental factors, the public, government, and corporations. It represents a pluralist
vision in which the power of business is checked and controlled.

It depicts business as deeply integrated into an open society.

It assumes that business is a major force, sometimes dominating but also subject
to defeat or compromise.

It suggests that to maintain broad public support, business must adjust to social,
political, and economic forces it can influence but not control.

It suggests that business-government-society relationships evolve as changes take


place in ideas, institutions, and processes of society.

The stakeholder model puts the corporation in a web of mutual relationships with persons
and groups. It promotes the idea that firms have ethical duties and social responsibilities
toward a wide range of stakeholders due to their impacts on them.

Stakeholders are those whom the corporation benefits or burdens by its


actions and those who benefit or burden the firm with their actions.

Primary stakeholders affect or are affected by the corporation


immediately, continuously, and powerfully.

Secondary stakeholders include a wide range of entities that are less


affected by a firm or have less power to affect it.

The stakeholder model reorders the priorities of management from making


profits to fulfilling ethical duties

Critics of the stakeholder model argue that it unrealistically demotes


stockholders, that ethical duty is an unworkable decision criterion, and
that because stakeholder interests vary and conflict with each other there
is no objective measure of performance.

Finally, the main characteristics of analysis in the book are briefly set forth.

A comprehensive scope allows coverage of many topics.

An interdisciplinary approach includes scholarship from many fields. However, the


central focus is the discipline of management.

Theories are rudimentary in the field, but where they exist they are discussed. Otherwise,
the approach used is description of events and discussion of cases.

A global perspective is adopted.

Historical perspective is added in many chapters to show the action of historical forces,
emphasize change, and deepen understanding of current phenomena.

2
The Dynamic Environment
LEARNING OBJECTIVES

SUMMARIZING OUTLINE
The basic lesson in this chapter is that business exists in a complex, changing environment. It begins with a
story about how Royal Dutch Shell adapts to change by using scenarios. Then nine deep historical forces
that cause change are discussed. Then the environment of business is broken down into seven elements,
called key environments, and recent trends in each are discussed. Finally, the case study on The
American Fur Company invites discussion about how historical forces shape environments and how the
business environment has changed.

The introductory story is about Royal Dutch Shell PLC.

Shell uses a unique method of analyzing its environment. Since the 1970s it has used
scenarios, or plausible projections of the future based on assumptions about current
trends.

In the 1990s Shell planners developed a theory of change in the global business
environment based on three strong forces: liberalization (or relaxation of trade
restrictions), globalization, and technological change.

More recently, they have written two new scenarios, Scramble and Blueprints, about the
future of the global energy system. These scenarios take into consideration the rise of
developing nations, a likely shortfall in supplies of oil and natural gas, and growing stress
from climate warming.

In Scramble, the world fumbles its response to the energy challenge. Human wellbeing is threatened.

In Blueprints the world has a more effective response and catastrophic climate
change is avoided.

Three specific Shell scenarios are discussed in the story. Students can go to Shells Web
site to learn more about these and additional scenarios.

Nine deep historical forces cause change in the business environment.

The Industrial Revolution was an economic metamorphosis in England in the late 1700s.
It initiated a series of changes that created an industrial economy. These changes spread to
other countries and continue to spread.

The size and acceleration of industrial growth are astounding. World GDP between
1950 and 2000 exceeded all that came previously in human history.

Industrial growth remakes societies. It places social institutions under great strain.

Inequality is a timeless motive force in all political systems. Income inequality between
industrialized and less developed nations is pronounced and growing.

Although income inequality is slowly rising, the percentage of people living in


poverty worldwide is declining.

The Human Development Index, a statistical tool used by the United Nations to
measure human progress, shows long-term increases in overall human welfare.

Population growth will remain rapid and is faster in less industrialized, non-Western
nations.

World population, about 6.9 billion in 2011, will peak at 9.2 billion in 2075,
decline for a century, then rise again to about 9 billion in 2300.

For the near future the world population will experience rapid, but slowing,
growth.

Technology is a powerful force for change. Since the late 1700s there have been five
waves of innovation.

New technologies bring productivity gains that sustain long-term economic


progress.

Because technology changes faster than human beliefs and institutions, it strains
society.

Globalization is the creation of networks of economic, political, social, military, scientific,


or environmental interdependence spanning worldwide distances.
9

It is a long-term environmental force going back to prehistoric times.

It exposes transnational corporations to demands of more varied stakeholders,


including anticorporate, antiglobalization activists.

Nation-states are international actors that define many rules and incentives in global
markets.

In the past, nations sought to expand their wealth and power by seizing territory.
Today, many nations instead seek aggrandizement through international trade.

Global market forces limit the power of governments to control their domestic
economies.

Dominant ideologies are a persistent force.

An ideology is a set of reinforcing beliefs and values that creates a worldview.

Ideologies such as constitutional democracy, progress, social Darwinism, and the


Protestant Ethic have reinforced industrial capitalism.

With globalization has come a Darwinian competition in the marketplace for ideas
and the elimination or marginalization of many religions, languages, and cultural
beliefs.

Great leadership is found in all historical eras. Two views about it exist. One is historian
Arnold Toynbees idea that leaders are situated by fortune at the intersection of powerful
social forces. The other is that of essayist Thomas Carlyle, who wrote that great leaders
are masters of their own fate and shape history themselves rather than simply representing
irresistible causes.

Chance is a force that may explain otherwise inexplicable environmental changes.

The six key external environments of business are these.

Economic. It includes forces influencing market operations. It is changing today as output


grows, corporate investment becomes more international, and markets expand.

Technological. Developments in nanotechnology, biotechnology, and digital technology


generate turbulence in the environments of many businesses. New technologies will create
unforeseeable threats and opportunities for managers.

Cultural. Business expansion has many impacts on the shared knowledge, values, norms,
customs, and rituals of societies.

10

Government. Two strong trends today are first, the expansion of government activity
(including more regulation of business), and second, the rise of more democratic regimes.

Legal. Laws and regulations codifying corporate duties and responsibilities are now more
numerous, complex, and global. There are five enduring trends in this environment.

Industrialization encourages the rise of postmaterialist values based on


assumptions of security and affluence that lead to demands for quality-of-life
improvements.
Postmaterialist values support a global tide of morality that elevates expectations
about multinational corporations.

Growth in number and complexity of laws and regulations.

Expanding duties to protect the rights of stakeholders.

Expanding exposure of corporations to international law with globalization,


including soft law, or principles and standards in global codes of conduct that are
based on emerging norms.

A tendency of voluntary measures to become legal duties.

Expanding liability.

Natural. Economic activity changes the natural environment and currently disrupts
ecosystems.

The World Wide Funds Living Planet Index records a decline in biodiversity. Its
Ecological Footprint metric suggests that human activity is unsustainable for the
long run.

Changing public attitudes based on such measures put pressure on managers to


include environmental criteria in decisions.

Beside external environments, corporations also have an internal environment. It consists of four
groups: managers, owners or shareholders, employees, and boards of directors.

Forces in external environments affect the power relationships of these internal groups.

Their duties are defined in laws and regulations.

In sum, corporations exist in a dynamic, often turbulent business environment shaped by both deep
historical forces and more immediate changes in key current environments.

11

Note

Case

THE AMERICAN FUR COMPANY


This case study tells the story of a dominant company in the fur trade. In its era, the fur trade was a global
industry so important that it might be compared with the energy industry today. The American Fur
Company is not a forgotten company that deserves only to be a historical footnote. Rather, it is a company
that arguably did as much or more to shape American history than any other. Important lessons can be
learned from it.
Discussing the case helps students understand that basic ideas about the business-government-society
relationship introduced in Chapters 1 and 2 are applicable in the past as well as the present. Thus, the field
offers dynamic ideas for understanding this relationship that, while falling short of a general theory, are
useful for classifying phenomena, explaining events in disparate settings, and comparing the past with the
present.
Specifically, the case is a springboard for discussion of ideas in Chapters 1 and 2, including models of the
business-government-society relationship, deep historical forces, and major environments of business. In
addition, some issues in the case anticipate ideas in later chapters. In anticipation of Chapter 3, the
American Fur Company story exemplifies how business activity has the power to shape and change society
and how this power reaches limits. In anticipation of Chapters 7 and 8 on business ethics, the case raises
questions about the behavior of John Jacob Astor and other fur traders.

Answers to Case Questions


1. How would you evaluate Astor in terms of his motive, his managerial ability, and his
ethics? What lesson does his career teach about the relationship between virtue and
success?
Astors actions suggest a motive of greed. His actions in the market and with politicians suggest he had a
need for power. His careful planning and attention to detail show a need for control. His abortive effort to
form a new nation in the Oregon territory and be its king implies a touch of megalomania.
12

As a manager he had some admirable qualities. He was hard working, confident, and a good negotiator. He
generated visionary strategies. His tactics were expedient. He let others do the difficult work of pioneering
an area, then muscled them aside using a set of competitive tactics that carried his signature. These
included predatory pricing, plying Indians with whisky, purchases of large quantities of trade goods to
lower cost, horizontal and vertical integration along the chain of activities that comprised the fur trade, and
use of political influence.
He was ruthless and little inclined to niceties. In his behavior there is a mixture of ethical and unethical by
both the standards of his era and the standards of today. For example, decimating a species would be wrong
today, but in Astors era it caused no concern beyond its business implications. But giving whiskey to
Indians was plainly seen as wrong in Astors time, just as it is wrong now.
What is the lesson about the relationship between virtue and success? Is there a moral law in the universe
such that if a merchant imposes sustained wrongs and ruin on others then such behavior eventually breeds
ill fortune

13

in return? If so, Astor seems to have escaped its application, living a life of wealth, seemingly content.
There are four theoretical relationships between ethics and success in business, as illustrated in the table
below. Students may be invited to think of examples in each of the four quadrants. The main reason that
wealth and virtue are not necessarily connected is that the world often yields before a strong will to power
that is unshackled by everyday morality. In addition, luck and the times may influence the fortunes of
people in business.

High

ETHICS
Low
Low

High

SUCCESS

2. How did the environment of the American Fur Company change in the 1830s? What
deep historical forces are implicated in these changes?
In the 1830s the fur trade reached its climactic era. It would soon decline in size and influence. The basic
cause of its demise was depletion of the animals that were its resource base. Worldwide, fur-bearing
animals had been hunted to near-extinction.
As early as 200 B. C. the fur trade made extinct a species of beaver native to northern Greece. By the
sixteenth century, demand for pelts had exhausted the supply of fur-bearing animals in Europe and Russia,
so Europeans turned to the unexploited lands of North America. There, the fur trade began with the French
around 1530 and marched across the continent, depleting one area after another of fur-bearing animals. By
the 1830s, 300 years after the beginning of the North American fur trade, the Rocky Mountains were the
last bastion of the North American beaver.
As the decade of the 1830s progressed, rapid change in the business environment caused the collapse of the
Rocky Mountain fur trade. The beaver population was fast exhausted. Fashion trends shifted and demand
for pelts dropped. Silk from China was substituted for beaver, mink, otter, and other skins. A global cholera
epidemic made consumers afraid of fur pelts. In addition, the cost of trapping in the Rocky Mountains rose
because of encounters with increasingly hostile Indians.

14

The operation of deep historical forces can be observed in the rise and fall of the fur industry.

Although the fur trade was an ancient business, it came to reflect and embody forces
created by the Industrial Revolution. It introduced factory-made products such as trade
goods. It relied on manufactured weapons to dominate more primitively equipped natives.
And it tied Indians and settlers in North America into global markets.

Some ideologies supported and shaped the fur trade, including (1) the idea that humans
dominate nature, which exists to be exploited; (2) the theory of classical capitalism, which
generated in that era attitudes of exploitation; (3) the idea of progress, which saw
economic growth as good; (4) the frontier ethic, or the idea that a wilderness populated by
natives was untamed but became civilized when explored and settled; and (5) race
doctrines depicting Indians as inferior, ignorant, savage, and unchristian.

European-Americans harnessed technology to dominate preindustrial Native Americans.


However, a major technological advance, the steamboat Yellowstone, backfired on its
creators when it carried a smallpox epidemic up the Missouri, killing thousands of Indians.
That epidemic hastened the end of an already moribund fur industry.

The dynamics of nation-states played a defining role in the development of North


American fur trading. National rivalries over fur resources drove continental exploration
and settlement. Competition between British traders and the American Fur Company
hastened the exhaustion of beaver. In some parts of Canada, the British practiced
conservation by rotating trapping areas, but where international rivalry caused a rush to
harvest, such methods were impractical.

In the United States, leadership in the fur trade came from Astor. His actions defined the
competitive environment. The leadership of Thomas Jefferson in making the Louisiana
Purchase and in encouraging the presence of American fur traders as a defense against
British inroads shaped history. Both George Washington and Thomas Jefferson failed to
carry out their visions of government-run trading posts giving fair prices and fair treatment
to Indians. Astors strong-willed expansion pushed aside the half-hearted federal policy.

Inequality is a major historical force when it creates a schism between haves and have
nots. In this sense it was not a major factor shaping the fur trade. However, there was a
significant imbalance of power between the traders and the Indians that defined the
outcome of a clash of cultures and values.

Because of population growth in the United States there was pressure to follow the
trappers and settle in new areas. Between 1790 and 1830 the population grew from 3.9
million to 12.9 million, increasing by more than 30 percent each decade.1

Globalization was a significant force in the fur trade. This was an international industry.
As fur resources were exhausted on one continent, activity moved to another.

U.S. Census Bureau, Statistical Abstract of the United States: 2001 (121st edition) Washington D.C., 2001, table

1.

15

Finally, chance can be read into several events. It was Astors good fortune to meet a fur
trader willing to be his teacher on the long voyage from Europe to America. What if Astor
had become friendly with a banker, shipbuilder, or livestock broker? If Astor had arrived in
the United States twenty years later, would he have encountered a more entrenched
competitor driving a fur company to monopoly? The cholera epidemic of the 1830s
occurred just as the industry was wobbling from its excesses and it hastened the end.
Likewise, the spread of smallpox by the Yellowstone was disastrous misfortune.

3. What were the impacts of the fur trade on society in major dimensions of the business
environment, that is, economic, technological, cultural, governmental, legal, natural, and
internal?
This evaluation parallels the discussion of these dimensions of the business environment in Chapter 2 on
pages 36-45.

In the economic dimension the fur trade created enormous wealth for those such as Astor
who profited from it. Beyond that, it was a global industry that provided a livelihood for
many. It created trails and settlements that stimulated economic expansion across the North
American continent.

In the technological dimension the introduction of first the keel boat and then the
steamboat on the Missouri River was important.

In the cultural dimension the primary stress was on native Indian cultures that came in
contact with European industrial values. Fur traders introduced new artifacts to Indian
societies, including trade goods, alcohol, money, and firearms. New material motives led
Indian traders to seek profits to acquire property.

In the natural dimension the fur traders depopulated the continent of fur-bearing animals
from the beaver to the plains buffalo. Over time, they cut down significant forest acreage
for forts, trading posts, and fuel.

Astors actions in the governmental dimension show how open the young American
political system was to corrupt influence. With gifts, loans, and contributions he
systematically bribed and suborned a range of politicians including at least one president.

The fur trade affected the legal environment because it was a source of international
tensions that led to treaties. Statutes to set up government trading posts and regulate
contacts with Indian tribes were passed to limit the operations of the American Fur
Company and its competitors.

Of course, the internal environment of the American Fur Company was entirely dominated
by Astor. Other fur companies were operated as simple proprietorships or partnerships.
The scope and power of the fur trade brought no change in the structure of these
arrangements.

16

4. Who were the most important stakeholders of the nineteenth-century fur industry? Were
they treated responsibly by the standards of the day? By the standards of today?
Astor, as principal owner of the American Fur Company, compensated himself lavishly. The suppliers and
employees of the company were not treated so nobly. Indian trappers were cheated, robbed, and killed. Free
trappers and traders worked for low pay under hard, dangerous conditions. Customers in markets around
the world were served. Government was manipulated, bypassed, resisted, and used.
Astors abuse of weaker stakeholders was typical of the era. In his History of the Great American
Fortunes, Gustavus Myers compares Astor with other capitalists of the day.
All of the confluent facts of the time show conclusively that every stratum of commercial society
was permeated with fraud, and that this fraud was accepted generally as a routine fixture of the
business of gathering property or profits. Astor, therefore, was not an isolated phenomenon, but a
typically successful representative of his time and of the methods and standards of the trading
class of that time.2

By current standards the American Fur Company would not be considered an ethical enterprise.

5. On balance, is the legacy of the American Fur Company and of the fur trade itself a
positive legacy? Or is the impact of these companies predominantly negative?
This question invites a utilitarian calculation of benefits and costs. Examples of factors to be considered are
listed in the following table.
BENEFITS

Created wealth, employment, tax revenue.


Supplied a product in high demand.
Spurred exploration of the West.
Constituted a United States presence in
unsettled lands.
Trappers and traders became leading
citizens in new settlements.
Brought progress to areas unsettled by
Euro-Americans.

COSTS

Economic benefits were narrowly enjoyed.


Business activity was exploitative.
Destruction of Native American cultures.
Ecological damage.
Spread of smallpox.
Many trappers died in a dangerous
occupation.
Retarded growth of respect for a
government of laws.

The weights assigned to these factors are a matter of opinion. Perspective is important. For the Indians the
industry was a disaster. For Astor, the federal government, and later settlers, the benefits undoubtedly
outweighed the costs.

6. Does the story of the American Fur Company hint at how and why capitalism has
changed and has been changed over the years?

Gustavus Myers, History of the Great American Fortunes (New York: Random House, 1936), pp. 110-11.

17

The operation of the American Fur Company is akin to a laboratory experiment in how an industry would
operate in an environment of pure laissez faire capitalism. All the basic ingredients existed including private
property, competitive markets, the profit motive, social values that supported ruthless exploitation of
resources, and very limited government interference. Regulation was nonexistent. There was no
Environmental Protection Agency, Occupational Safety and Health Administration, Federal Trade
Commission, or Equal Employment Opportunity Commission to restrain Astor. There were no organized
watchdogs such as Public Citizen, Greenpeace, People for the Ethical Treatment of Animals, and the
American Indian Movement.
The external costs of the American Fur Companys operations were borne by weak and unorganized
stakeholders. Companies continued such predatory and exploitative operations until the late 1800s when the
people who suffered from their operations organized powerful reform movements.

7. Do one or more models of the business-government-society relationship discussed in


Chapter 1 apply to the historical era set forth in this case? Which model or models have
explanatory power and why?
Two of the models in Chapter 1 have strong descriptive validity.

The market capitalism model accurately describes business-government-society


relationships of that era. It depicts primacy of economic forces over social and political
forces, the priority of economic performance as a measure of success, laissez faire
markets, a limited role for government, and weak nonmarket forces.

The dominance model is also a useful lens for studying the American Fur Company in its
era. It depicts undemocratic dominance by an elite of wealth and power, feeble government
regulation due to the influence of business on government, and lack of effective pressures
for social responsibility. These assumptions in the model accurately depict the businessgovernment-society interrelationship in Astors day.

The countervailing forces model has far less descriptive power. Nature limited the expansion of the fur
trade, illustrating some validity in the model. Only later, however, would public values and government
regulation come into play. The stakeholder model, which emphasizes duties toward a range of
stakeholders, has little descriptive value. Fur companies were run to maximize the wealth of owners and
stockholders. Other stakeholders had little power and managers like Astor were unenlightened about the
ethical duties implied in the model.

18

3
Business Power
LEARNING OBJECTIVES
SUMMARIZING OUTLINE
This chapter explains the tremendous power of corporations to change society through their actions. It
illustrates this power with stories about the American Tobacco Company, the railroads, J. P. Morgan, and
the Standard Oil Company. Power is defined, then its exercise is described on surface and deep levels in
areas corresponding to the key environments in Chapter 2. Finally, two theories of business power are set
forth--the dominance theory of overbearing power and the pluralistic theory of counterbalanced power.

The introductory story is about the American Tobacco Company.

The company was founded by entrepreneur James B. Duke after the Civil War. Duke
capitalized on the new technology of the Bonsack machine to increase output of cigarettes
and used clever marketing to sell his brands worldwide.

Dukes company eventually had a monopoly on tobacco. The Supreme Court used the
Sherman Antitrust Act to break it up in 1911.

The story shows how a powerful company can shape society. Dukes monopoly spread
smoking, revived the postwar southern economy, introduced new kinds of marketing, and
created the modern tobacco industry.

Power is the force or strength to act. It has many sources. Business power is the force behind an
act by a company, industry, or sector. Its primary source is a grant of authority from society,
stemming from the social contract, to convert resources efficiently into needed goods and services.
It is legitimate when it is exercised rightfully, or in keeping with the social contract.

Corporate power has an impact on society at two levels.

On the surface level it is the direct cause of visible, immediate changes.

On the deep level it shapes society over time through the aggregate, indirect, and
unforeseen changes caused by industrial activity.

On both the surface and deep levels corporate power is exercised in seven spheres corresponding
closely to the key business environments described in Chapter 2 (here power over individuals is
included in place of the internal environment).

Economic power comes from the use of property and resources to influence events and
people.

Technological power influences the direction, rate, characteristics, and consequences of


innovations.

Political power is the ability to influence governments.

Legal power is the ability to shape laws and regulations.

Cultural power is influence over values, habits, and institutions.

Environmental power is the impact of a company on nature.

Power over individuals is exercised over employees, managers, stockholders, consumers,


and citizens.

The rise of the railroads in the United States after1850 illustrates how power radiated from an
industry in these seven areas, bringing both surface and deep changes.

Two basic and opposing positions about business power exist.

The dominance theory is that business power is preeminent in American society. It is


excessive. It is inadequately checked.

One branch of the dominance theory finds evidence of excessive corporate power
in asset concentration among a few large firms. However, there is no evidence
that asset concentration is growing. In fact, despite a succession of merger waves
it has fallen. Also, turnover in the Fortune 500 and Dow Jones Industrial Average
companies during the twentieth century shows that technological change causes
the rise and fall of mighty firms.

Another branch of the dominance theory attributes corporate ascendancy to the


power of an economic elite. Evidence is varied.

The founders who created the Constitution were an aristocracy of wealth.

The story of how J. P. Morgan dominated the nations financial system


during the panic of 1907 is told to illustrate the elite thesis.

In the 1950s C. Wright Mills wrote of a small power elite commanding


business, government, and the military.

More recently, scholars G. William Domhoff and Thomas R. Dye have


found evidence of elites in American society and tried to both describe and
quantify them. Dye, for example, identified an institutional elite of 5,778
individuals who occupy top positions in a wide range of institutions.

Another scholar, David Rothkopf, describes the emergence of a global


superclass with a membership of about 6,000 individuals.

The pluralist theory is that in a pluralistic society such as the United States business power is
adequately checked by democratic values, the Constitution, laws, markets, government, labor
unions, advocacy groups, and public opinion. Four boundaries on managerial power exist.

Governments and laws regulate business.

Social interest groups represent broad and diverse interests within society and use many
methods to restrain business, from boycotts to media campaigns.

Social values restrain managers. An example is the pervasive belief in equality in America
that discourages deference to an aristocracy of corporate wealth.

Markets and economic stakeholders discipline corporations to channel their power


within the limits of the social contract. Markets register technological changes that cause
the rise and fall of dominant industries.

In conclusion, if corporate power remains generally accountable to democratic controls, society


will accord it legitimacy.

Note
152.

Case

JOHN D. ROCKEFELLER AND THE STANDARD OIL TRUST

This case study has several elements.


First, it is a narrative of John D. Rockefellers life. Business students enjoy this story and find inspiration in
his personality and his sweeping triumph. They might be asked: Do you admire Rockefeller? Would you
enjoy working for him? What was his leadership style? What made it effective?
Second, it is a historical study of the interaction between industrial growth and societal values in another
era. Reading the case prepares students to discuss how growth of the oil industry altered American life in
such areas as social values, work, leisure, transportation, and government regulation.
Third, it is a story that raises enduring ethical issues.

Answers to Case Questions


1. With reference to the levels and spheres of corporate power discussed in the chapter, how
did the power of Standard Oil change society? Was this power exercised in keeping with the
social contract of Rockefellers era?
This question refers to the section in Chapter 3 entitled Levels and Spheres of Corporate Power on pages
59-61. The actions of Rockefeller and of Standard Oil had many impacts at both the surface level and the
deep level. Among them are these.

Economic power. On the surface Standard Oil built facilities, hired workers, and defined
the structure of a growing industry. At a deeper level it made fuels that spurred growth in
other industries such as the auto industry, shaping the American economy.

Technological power. On the surface, Standard Oil applied, perfected, and spread oil
refining technology. On a deeper level its product fueled the spread of other technologies.

Political power. On the surface, Rockefeller and company officials corrupted politicians
by giving large campaign contributions in return for favors. At a deep level, growth of the
company and its efforts to insulate itself from regulation invited public reaction, leading to
passage of the Sherman Antitrust Act, a legal crowbar that eventually pried open its
monopoly and then remained on the books to break up other trusts and corporations over
many years.

Legal power. Ultimately, Standard Oil did not shape the law to its advantage. It was
reaction to its power that led to change. On the surface, the visible response to its power
came first in the Sherman Act of 1890, followed 21 years later by the Supreme Court
decision that applied this statute to break up the company. Other statutes and federal court
decisions followed. So on a deeper level, the reaction shaped the nations antitrust policy

Cultural power. On the surface, Rockefellers example of cold-blooded ambition inspired


many others to emulation and may have changed American commercial culture. James
Duke, for example, was inspired to copy his tactics in creating the American Tobacco
trust. At a deep level growth of the Standard Oil Trust changed public attitudes toward big
business. It confronted the public with a giant corporation exceeding in its power any that
had gone before. People grew cynical about corporate power and began to fear it. These
feelings persist to this day.

Environmental power. On the surface Standard Oils operations led to widespread air,
water, and land pollution. On a deep level, the burning of kerosene, oil, and gasoline made
by Standard Oil raised levels of carbon dioxide in the earths atmosphere, contributing to
climate change.

Power over individuals. On the surface, Standard Oil affected the daily lives of thousands
of employees, suppliers, competitors, and other stakeholders. On a deep level the fuels
developed by Standard Oil changed how people lived. For instance, with cheap kerosene
for light it was practical for people to stay up late at night to read or work.

At first, the actions of Standard Oil were consistent with the social contract between business and
American society. In the laissez faire atmosphere of its early years the company could focus on profit
maximization and still fulfill social expectations. Later, public expectations changed. Rockefellers
relentless drive exposed the shortcomings of unregulated markets. Fear of his power over consumers altered
the social contract. The questions raised for American society by the success of Standard Oil required
answers, and the answers revised the social contract, creating new rules of fair competition and new
responsibilities of companies to use their power for ends beyond profit maximization.

2. How does the story of Standard Oil illustrate the limits of business power? Does it better
illustrate the dominance theory or the pluralist theory discussed in the chapter?
The limits of business power are discussed in Chapter 3 in the section entitled Pluralist Theory on pages
71-75. Four general boundaries on managerial power are suggested in this section: governments, social
interest groups, social values, and markets and economic stakeholders. Standard Oil dominated its markets
and, at first, was little restrained by other forces. At the zenith of the companys power it suffered attacks
by labor unions, socialists, and progressives, but pressure groups had little impact on the behemoth. Rising
criticism reflected changing social values. Rockefellers business methods offended public attitudes about
fair play and competition. Eventually, government acted when Congress passed the Sherman Act of 1890
and, although it took more than twenty years, the Supreme Court finally used it to break up Standard Oil in
1911.
The dominance theory best explains the power of Standard Oil during the years of its rise. It concentrated
wealth and American institutions did not yet have the ability to check its power. However, when the public
became aroused, sufficient means to blunt and channel the companys power were forged from raw
materials present in Americas constitutional democracy. Thus, the company was brought to heel by forces
in a pluralistic society. So both theories have some validity, but at different points in the story.

3. Did Rockefeller himself ever act unethically? By the standards of his day? By those of
today? How could he simultaneously be a devout Christian and a ruthless monopolist? Is
there any contradiction between his personal and business ethics?
In response to questioners later in life, Rockefeller stated so firmly and frequently his conscience was clear
that believing him seems prudent. He thought he had applied Christian precepts in all his business dealings
and that his riches were a gift of God. God gave me my money, he said in 1905. The Puritan ethic and the
Protestant work ethic held that hard work and diligence were rewarded by riches. These riches were a sign
that God approved of enterprise over idleness, productivity over waste, and progress over decay.
Repeatedly, Rockefeller noted to colleagues that the purpose of the Standard Oil Company was to bring
light to the poor.
He was, beyond question, deeply religious. Devoutness was instilled in him by his mother. He attended
church regularly throughout his life at either the Erie Street Baptist Church in Cleveland or the Fifth
Avenue Baptist Church in New York. He read the Bible daily. The tension between his religiosity and his
remorseless suppression of competition is an enduring puzzle. Students might be asked if being
simultaneously a good Christian and a ruthless manager is possible. Note that Rockefeller was fixated on
making money and making the oil industry grow into his vision. He was not enamored with philosophy, art,
science, or the humanities. His mind did not delight in theories and abstract ideas. Perhaps he gave little
thought to how, in a roundabout way, his business practices undermined certain religious ideals.
Evidence that Rockefeller ever took direct action to break any law is elusive. As a competitor he was tough,
but the record is free of clearly documented lying, lawbreaking, or cheating. He was audacious and would
maneuver around the rules of the game as followed by more ordinary players. But he never went outside the
law or, in his opinion, forsook Christian virtue. To call him ruthless is not sufficient to prove him
unethical. It may be that Rockefeller never appreciated the extent to which low-level employees of lesser
insight, diligence, and religious conviction were pressured to act unethically when carrying out the details
of his vision. It is also arguable that any such ignorance was intentionally maintained.
Against Rockefellers relative purity, a mass of evidence suggests that his company repeatedly violated the
law over many years. In handing down its decision breaking up the trust in 1911, the Supreme Court said
that the record in the case, at that point 12,000 pages, established as fact that the company had fixed
prices, limited production, obtained preferences and rebates from railroads, restrained transportation of oil
in interstate commerce, spied on competitors, and set up bogus companies, all to suppress competition
unfairly and earn artificially high profits, and all to the detriment of the American public. 1 The Trusts fatal
mistake was that it failed to reform its behavior after passage of the Sherman Act in 1890.
Some of Rockefellers and the Trusts actions were legal at first, but became illegal as time went on, for
example, giving large cash payments to Senators (outlawed by the Tillman Act of 1907) or obtaining
rebates and drawbacks from the railroads (outlawed under the Elkins Act of 1903).

Standard Oil Co. of New Jersey v. United States, 221 U.S. 1 (1911).

4. In the utilitarian sense of accomplishing the greatest good for the greatest number in
society, was the Standard Oil Company a net plus or a minus? On balance, did the
company meet its responsibilities to society?
Business historians debate the accomplishments of great entrepreneurs in the post-Civil War era.
Rockefeller is often included in the roll call of robber barons who built huge fortunes using sharp
practices. In this debate the traditional school holds that Rockefeller and others were unscrupulous
buccaneers of the markets who used unfair methods to create monopolies and then enrich themselves at
public expense. The revisionist school argues that Rockefeller and others performed a beneficial function
by creating an industrial infrastructure. Their actions may be ethically questionable today, but in their era
they were simply shrewd realists acting well within the norms of old-time business ethics.
The Standard Oil Company brought many benefits to society, including (1) standardized distillates that
were less likely to explode than early competing brands, (2) stabilization of oil prices in most areas, (3)
development of facilities and production technology, (4) jobs and payrolls, (5) tax revenues for government,
and (6) the financial means for great works of philanthropy. Rockefellers dogged attention to detail also
made the company very efficient, a benefit to consumers. For example, a historian writes this about
Rockefellers battle in the 1880s to dominate the world oil trade.
The Russians, in their plentiful oil fields at Baku, had a richer, more viscous oil that yielded 280
barrels per well per day, compared with 4.5 barrels per day from American wells. Also, Russia
was closer to European countries, many of which slapped high tariffs on U.S. oil. Yet
Rockefellers Standard Oil ran such an innovative, efficient operationfrom making of barrels to
the deploying of ocean tankersthat it could sell oil for an incredible seven cents a gallon... and
thereby outmaneuver the Russians for most of the world oil trade. 2

From a utilitarian perspective, Rockefeller and Standard Oil are a net gain for society. Utilitarianism, as an
ethical principle, was a handmaiden to the Industrial Revolution, and it lends itself to rationalization of
economic development in exchange for some cost in human suffering, environmental pollution, or other
detriment.
Key questions to ask when assessing whether Rockefeller and Standard Oil acted ethically are these: Is
there a relationship between ends and means? Can worthwhile and socially beneficial ends be attained using
compromising means? If some students believe that Rockefeller acted unethically, then they may feel that
his achievements are tainted. Would we honor the work of a burglar who broke into a house, stole a large
sum, and gave it to a worthy charity where it helped many people?
A simple way to assess the social performance of Standard Oil is to comment on each element in Archie
Carrolls four-part definition of corporate social responsibility.3

As to economic responsibilities, the company created a reliable, standardized product;


improved social welfare by spreading illumination; and was the source of significant
employment, tax revenue, and capital formation. There is no indication that innovation and
progress would have occurred more quickly without the domination of Standard Oil or that

Burt Folsom, Entrepreneurs vs. the Textbooks, The Wall Street Journal, July 22, 1987.

3 See Archie B. Carroll and Ann K. Buchholtz, Business and Society: Ethics and Stakeholder Management, 6th ed.
(Mason, OH: Thomson/South-Western Publishing, 2006), pp. 35-41.

capital and resources would have been used more efficiently. The verdict is overwhelmingly
positive here.

As to legal responsibilities, the company meandered around and across bright lines. It was
a generally law-abiding firm but fought some laws and stretched the letter of others and the
spirit of still more. Rockefeller resisted antitrust actions. He often fudged his testimony in
courts and in Congress. His reorganizations of Standard Oil as a corporation and a trust
were designed to keep the company just a step ahead of greater government control. Much
of his resistance to the law was accomplished through political influence tactics that would
be considered corrupt today. The verdict is clearly mixed here.

As to ethical responsibilities, Rockefeller apparently satisfied his own conscience, but


critics could point to his rebate and drawback schemes and his pressure on employees to
drive out the competition as enough evidence to make the verdict mixed.

As to voluntary responsibilities, Rockefellers lifetime of philanthropy is a lasting model


for others. The verdict here is thumbs up.

5. Did strategies of Standard Oil encourage unethical behavior? Could Rockefellers vision
have been fulfilled using nicer tactics?
Rockefeller had a strong drive to dominate and control his environment. As a boy, he fretted when a tree
blocked a panoramic vista from a window in the family farmhouse. He finally cut it down to open the field
of view. As a manager he was obsessed with small economies, domination of his rivals, and rationalizing
the oil industry. Nccol Machavelli searched in vain for a strong prince to unify the fragmented city-states
of the Italian peninsula. He would have admired Rockefellers conquest of the oil industry. Here was a
forceful man who brought unity to a chaotic situation. Rockefellers obsessions may have led him to
rationalize when he used compromising means to achieve ends that he thought noble.
If Rockefeller had never been born, would another person have stepped up to destiny and accomplished
similar feats? Or is Rockefeller so unique as an individual that only the force of his personality was
sufficient to conquer an industry exploding with new importance? Whichever of these questions may be
answered affirmatively, the ripeness of the historical moment when Rockefeller appears is unarguable. Two
of his biographers write about it this way:
The making of the great Standard Oil fortune was an accident. It was as if a door had stood open
for a brief historical moment and Rockefeller, who just happened to be passing by, managed to
squeeze in before it closed. Never before had it been possible for an individual to build the
organization he built; it would never be possible again. It was the random collision of a man with
an opportunity.4

Finally, it is doubtful that Rockefeller would have understood an admonition to be nicer. His business
methods were means to the end of rationalizing an industry and justified by that end.

4
1976), p. 6.

Peter Collier and David Horowitz, The Rockefellers: An American Dynasty (New York: New American Library,

4
Critics of Business

SUMMARIZING OUTLINE
The chapter explains the historical origins and evolution of criticism of business. It begins with a
discussion of how Greek philosophers encoded critical attitudes, then traces the persistence of these
attitudes through the Middle Ages, the Renaissance, the Industrial Revolution, and the history of the United
States. Current criticisms of business and the methods of activist critics are enumerated.

The introductory story is about Mary Mother Jones (1837-1930).

Mary Jones was an Irish immigrant. After her husband and children died she became
involved in the United Mineworkers Union. Eventually, she adopted the persona of
Mother Jones and took on the miners as her boys.

She was a spirited organizer, and briefly a socialist, who used colorful language to attack
corporations and monster capitalism, which she labeled a robber system.

Her invective reflected the radical temper of business criticism in her time and exemplified
timeless and continuing antibusiness attitudes.

Through Mother Jones, students learn that the attitudes behind attacks on business today
are neither new nor novel.

Criticism of business has two underlying sources.

The first is that people in business prioritize profit over noble values such as honesty,
truth, justice, love, devoutness, and respect for nature. This view arose in ancient Greece
and persisted in medieval Church doctrine.

Plato believed that people in trade succumbed to an insatiable appetite for money.
Money, in turn, led to corruption, inequality, envy, and other evils.

Aristotle taught that character virtues were superior to external and material
goods. Pursuit of wealth was base behavior.

The Roman Catholic Church was suspicious of commerce because it diverted


traders from devoutness. It exhorted merchants to charge a just price for a fair
and modest profit as opposed to a market price determined by supply and
demand. It condemned usury, or lending money for interest.

New ideas that arose during the Renaissance served to promote commerce. These
include the Protestant ethic that justified wealth as a sign of Gods approval and
Adam Smiths theory of capitalism.

The second source of criticism is the social strain caused by economic development.
Industrial growth often changes a society more rapidly than values and institutions can
shift to support new ways of life. It causes displacements and injustices for some people,
which become the raw material of business critics.

American history illustrates the strain of development. Growth put pressure on the values,
lifestyles, and institutions of the early nations agrarian society, a society based on the values of
an agricultural economy. The stress led to recurrent waves of reform. Antibusiness values were
weak in the beginning, but grew stronger with time and economic development.

The colonial era was characterized by probusiness attitudes. The first colonists were
backed by corporate investors in England. Trade grew. Farmers prospered. The writings
and maxims of Benjamin Franklin blazed with a capitalist spirit. In the New World, he
said, diligence would bring success and wealth.

In the young nation of the late 1700s Alexander Hamilton, who promoted rapid
industrialization, prevailed over his political and philosophical rival Thomas Jefferson,
who sought to avoid the evils of industrial growth by limiting economic development. Their
conflict cast the dye for the conflict between business and its critics that continues in
America to this day.

Steady industrial growth in the period 1800-1865 aroused critics.

Ralph Waldo Emerson and Henry David Thoreau rejected rising commercial
values because they eclipsed older, more virtuous habits.

Robert Owen set up the first of many socialist utopias in 1825. These were model
communities based on principles of equality, charity, cooperation, and moderation.
These values challenged the prevailing values of capitalism such as unlimited
materialism, competition, individualism, and tireless labor. The allure of the
external world caused the quick failure and disbanding of most utopias.

By the late 1800s, steady industrial growth had created growing strains. It fueled two
movements critical of big business.

The Populist movement, lasting from the 1870s to 1900, was a radical (by
todays standards) protest movement that assailed rising business interests. In it,
farmers and workers blamed the social ills caused by industrialization on the
railroads, financiers, and moguls of the era. It led to creation of the Interstate
Commerce Commission in 1887 and passage of the Sherman Antitrust Act in
1890.

The Progressive movement of 1900-1914 was created by mainstream reformers.


It left a legacy of greater reform than the populists, including more antitrust laws,
regulation of consumer products, prohibition of corporate campaign contributions,
and the corporate income tax.

The Populist and Progressive movements coincided with a strong Socialist movement.

Modern socialist doctrine originated with Francois-Nol Babeuf (1764-97), who


wrote of an egalitarian society and advocated seizing the possessions of the
wealthy during the French Revolution in 1789.

With the publication of The Communist Manifesto in 1848, Karl Marx (1818-83)
gave socialism a more compelling theoretical foundation. Marx also set forth an
explicit indictment of capitalism as dehumanizing, exploitative, material, and
corrupt.

The appeal of American socialism reached its zenith in the early 1900s, but
ebbed because moderate reforms and rising prosperity relieved social ills
and because radical socialist doctrines alienated many people.

Business scandals and high unemployment during the Great Depression brought out
radical reformers such as Huey Long. Long believed the economic elite were too rich. He
wanted to redistribute wealth. Others advocated socialism. President Franklin D.
Roosevelt saved American capitalism by advocating more moderate reforms, including
added regulation of business and the economy.

During the late 1960s and early 1970s opinion polls measuring public support for
business, which had been high following World War II and the prosperous 1950s, showed
plummeting support. The cause was a redefinition of American values in an increasingly
affluent society.

Business was attacked for causing pollution, employment discrimination,


consumer fraud, and other problems. A marked increase in regulation of business
followed.

Business groups organized to lobby against further regulation. They achieved


much success and succeeded in frustrating liberal reformers, who sought to use
government to control business.

Out of this liberal defeat rose a left-wing, new progressive movement that sought
to control business by both government regulation and direct action. This is the
movement that has generated recent activist attacks on corporations.

The antibusiness attitudes of the new progressives come from three basic beliefs.

First, corporations have too much power and too little accountability in its
use.

Second, corporations have excessive legal rights. These rights should be


restricted.

Third, corporations are inherently immoral.

The new progressive movement has no single leader, but a prominent figure is
Ralph Nader, a longtime activist who has twice run losing presidential campaigns
to challenge corporate dominance of American politics.

Growing corporate power in the world economy is opposed by forces in an emerging global civic
culture.

One force is the rapid proliferation of non-governmental organizations (NGOs), or


voluntary, nonprofit organizations that are not affiliated with governments.

Another is the recent emergence of a global civil society, a zone of ideas, discourse, and
action dominated by progressive values. It is composed of NGOs, intellectuals,
movements, and institutions.

A global justice movement has evolved within civil society. Its motive is to resist a global
economy directed by and for markets and corporations.

In the 1990s an antiglobalist movement coalesced around resistance to a global economy


directed by corporate interests.

The antiglobalists agenda opposes neoliberalism, or the ideology of using


markets to organize society and a set of policies to free markets from government
intrusion.

To the antiglobalists, neoliberalism is a rebirth of an enlightenment philosophy.

Its roots go back to liberalism, a social philosophy that arose in Europe in


the 1500s to promote an open society in which government does not
interfere with individual rights.

One natural extension of liberalism was a philosophy of economic


liberalism, or the idea that social progress comes when individuals freely
pursue their self-interests in unregulated markets.

In the progressive view, economic liberalism opened the door to rapacious


capitalism that, free of state restraint, exploited humanity and nature.

This exploitative ideology prevailed until the 1930s, when the Great
Depression led governments to adopt Keynesianism, or the belief that
active government intervention in markets was needed to promote
economic and social welfare.

Although Keynesianism became the dominant economic philosophy of


Western governments, the old ideas of economic liberalism were preserved
and nurtured by a small group of conservative intellectuals.

This group saw free markets as counterbalancing government


authority and essential to efficient allocation of resources. Its
members opposed the regulation and other forms of government
intervention promoted by Keynesianism.

The term Chicago School came to be applied to its members,


including most famously Milton Friedman, and to its ideas.

In the 1970s and 1980s its ideas were embraced by governments,


first in Chile, then in England and the United States.

By the 1990s the Chicago School philosophy was a dominant


ideological force in economic globalization. It was simultaneously
labeled neoliberalism, a rebirth of the old economic liberalism.
Global activists use a range of tactics to pressure corporations, including the
following.

Consumer boycotts that pressure companies in the marketplace.

Shareholder attacks in which progressive groups sponsor socially


responsible shareholder resolutions at corporate annual meetings.

Harassment, ridicule, and shaming by picketing, lawsuits, sarcastic


awards, and other disruptive actions.

Corporate campaigns, or broad, sustained attacks, usually by a coalition


of groups, involving a range of tactics. An example is a campaign by
ForestEthics to stop Victorias Secret from using pulp from virgin forests
in its catalogs.

In conclusion, there is endless debate between critics and defenders of capitalism. Each group
believes its approach best promotes human progress.

Economic liberals defend free markets as consistent with natural law.

Progressives believe that society should be managed according to a human plan furthered
by government intervention.

Note

153.

Case

A CAMPAIGN AGAINST KFC CORPORATION


This case is the story of an activist campaign against a corporation. There are several focal points for
discussion.

First, as in many corporate campaigns, there is a gulf between the values of the activists and the values of
the corporation. People for the Ethical Treatment of Animals (PETA) believes that chickens have rights that
should be given equal consideration with the interests of humans and priority over the interests of
corporations. The group believes KFC Corporation unfairly exploits chickens, which are treated cruelly in
the production process. KFC, on the other hand, has adopted principles of animal welfare and claims to
treat chickens humanely. What are the merits of each set of values? Which values are most compelling?
Second, PETA uses a wide range of tactics. Both the effectiveness and the ethics of these tactics can be
discussed. Do PETAs ends justify the use of certain outlandish means?
Third, unlike some of its competitors, KFC Corporation has resisted PETAs demands, holding firm for
more than five years. Why has it been able to do what other companies could not?

Answers to Case Questions


1. Do you support KFC Corporation or People for the Ethical Treatment of Animals in this
controversy? Why?
This is a matter of opinion based on values about food animals. And values are polarized. Those who
support KFC believe it is ethical to raise animals for food. In direct opposition is PETAs belief that
animals are not ours to eat.
Although PETA opposes raising animals for food, it has temporized by challenging KFC only on the issue
of humane treatment. Therefore, students could support PETA if they simply believe that KFC is not doing
enough to treat chickens humanely. It is not necessary to believe that eating chickens is always wrong.

2. What are the basic criticisms that PETA makes of KFC? Are they convincing? Are its
criticisms similar to timeless criticisms of business mentioned in the chapter?
PETAs basic criticism is that KFC is violating the rights of living, sentient creatures by raising them for
human consumption. Its campaign, however, is based on more specific criticisms about the treatment of
chickens.
According to PETA, KFC permits inhumane treatment in a variety of ways because, overall, its animal
welfare standards are lower than those of its competitors. It uses deficient electrical stunning instead of gas
killing, it has not installed cameras to monitor workers in growing and slaughter facilities, it does not use
mechanized catching, it uses strains of chickens with bodies ill-suited to rapid weight gain in forced-growth
regimens, it fails to provide sufficient room, and it does not facilitate the expression of instinctive chicken
behaviors. KFCs animal welfare standards are inadequate.
These criticisms are convincing to those who share PETAs values.

PETAs charges reflect the basic, timeless criticism that business is pursuing profit at the expense of other,
higher values. Here it is the welfare of animals being sacrificed. Just as Mother Jones believed that big
mining corporations were profiting on the suffering of unorganized miners, so PETA believes that KFC is
profiting on the pain of chickens. Its rhetoric is as sharp as that of Mother Jones.

3. What methods and arguments has KFC used to support its actions? Is it conducting the
best defense?
KFC maintains a low profile. On occasions noted in the case it has been provoked into calling PETAs
actions terrorism or saying it has been abused. But it has been generally restrained, perhaps feeling
that publicity would only educate more consumers about PETAs charges.
Also, it would be a losing battle to prove that chickens are treated humanely. The imperatives of factory
farming prevent their being cosseted like pets. Instances of pain, suffering, and thwarted instinct would be
impossible to eliminate. As noted in the case, the public is largely indifferent to food animal welfare issues.
PETAs ethical position on animals is compelling in theory. In practice, it has little value for the vast
majority who eat meat. Its acceptance would call a durable, strongly-held dietary preference into question.
A 2004 Gallup poll found that 85 percent of Americans actively try to include chicken in their diets. 1
However, added publicity for PETA could lead to more debate and more converts.
KFC has worked to strengthen its animal welfare policies. It created a first set of animal welfare principles
in 2000. Then in 2004 it adopted more comprehensive poultry guidelines to be implemented in grower
contracts. It started making unannounced audits of grower slaughterhouses. It convened an Animal Welfare
Council of experts, including four members suggested by PETA. In 2005 three members of this panel
issued a set of recommendations to improve chicken welfare that met with PETAs approval. When KFC
rejected them, two of the three resigned. KFC also works with industry trade associations that are
developing new poultry welfare guidelines. KFC claims to have adequate policies to insure the humane
treatment of chickens.

1 Gallup Poll, USGALLUP.04JLY8, R35C, July 8, 2004.

Company executives have met and corresponded with PETA representatives. Such meetings have not
resulted in concessions by either side. Over time, the two sides seem to have grown more distrustful. PETA
claims that KFC is unresponsive and takes inadequate steps.
Is KFC conducting the best defense? Whether it is the best or not, it has enabled the company to defy
PETA, unlike many of its competitors, who compromised with the activists.

4. Is the range of PETAs actions acceptable? Why does the group use controversial tactics?
What are its sources of power in corporate campaigns?
PETA uses a wide range of actions. Some, such as letter writing, lawsuits, endorsement of the cause by
celebrities, picketing and leafleting, informational Web sites, and shareholder resolutions are very ordinary.
Others are considered outrageous by some. Street theater, bold caricature, and ridicule fall into this
category. Such actions grant no respect to the target. PETAs use of open sexuality offends those who
believe it is degrading women to further its cause. Its most extreme actions have included the assault of
CEO David Novak by blood and feather throwing protestors and activist forays into the neighborhoods and
churches of executives. These actions cross a line dividing civility from lawlessness and personal offense.
KFC executives doubtless would like to keep the issue out of their personal lives. But to activists the end
justifies the means. Their assaults are a necessary resort in the fight against a major evil.
Animal rights issues have low salience with the public. PETA uses controversial tactics to attract attention.
The group can educate only those who focus on the conflict. Some who are attracted to the spectacle will
become converts. PETA cannot win without the power to damage KFCs brand image. Without publicity
for its cause it has little power.
One source of the groups power is animal rights philosophy. In this philosophy unenlightened humans
exhibit an evil prejudice toward animals. Animals have the right to equal consideration with humans.
Adherents believe that they have a just cause. A related source of power is PETAs claim that it represents
the interests of animals much the same way that Mother Jones and other union organizers claimed to
represent miners.

5. Is it proper for PETA to pressure KFC for change when the company is following the law
and public custom? Does PETA represent so compelling a truth or enough people to justify
attacks on, and perhaps damage to, major corporations supported by and supporting
millions of customers, employees, and stockholders?
These questions invite students to comment on the charge that progressive activists challenge traditional
notions of democracy. KFC is following the law. Rather than approach Congress trying to have its animal
welfare philosophy made into public policy, PETA is trying to build moral outrage against KFC. It lacks
the power to change KFCs behavior by changing the law because few Americans agree with its extreme
positions on the rights of animals in factory farms. So it is trying to gain power over KFC by affecting its

sales. In other words, it is attempting to bypass traditional democratic channels for instituting change and
impose its will without new laws or regulations.

PETA claims to have more than 2 million members and supporters worldwide. There is no way of
knowing how precise is this designation. In its 2010 financial report PETA reported contributions of
$32,218,815, an average of $16.10 per member and supporter. 2 Its total contributions are just six tenths
of 1 percent of the $5.3 billion revenues from the 16,844 KFC stores in 110 countries in the same year. 3 Of
course, only the dead flesh of the chickens has monetary value; their rights are unpriced by markets.
PETA is unwilling to accept as responsible corporate behavior guided by laws and markets. It has the First
Amendment right to speak out for animal welfare issues without restriction by government. Is it a favorable
development that it can also gain enough power in markets to exert political control over large
corporations?

6. Do animals have rights? If so, what are they? What duties do human beings have toward
animals? Does KFC protect animal welfare at an acceptable level?
Some accept that animals have rights. These may include the right to be free of exploitation, the right to
equal consideration with human interests, the right to exercise instinctive behaviors, the right to have basic
needs satisfied, and the right to be free of human-imposed cruelty. Such rights, if they exist, create
corresponding duties on humans and corporations.
The original, groundbreaking discussion of animal rights is Peter Singers book, Animal Liberation.4
Students can be assigned to review its arguments.

2 People for the Ethical Treatment of Animals, PETA 2010 30th Anniversary Annual Review, p. 2, at
www.mediapeta.com/peta/pdf/USAnnualReview2010-72webonly.pdf.
3 See Yum! Brands! Inc., Form 10-K, February 15, 2011, p. 4, and Yum Brands! at
www.yum.com/company/ourbrands.asp, statement of Roger Eaton, chief executive officer, KFC, U.S., June 3, 2011.
4 Peter Singer, Animal Liberation: A New Ethics For Our Treatment of Animals (New York: Avon Books, 1975). A
New Revised Edition was published in 1990.

5
Corporate Social Responsibility
LEARNING OBJECTIVES
How ideas about corporate responsibility in the chapter apply to General Electric Company during the
years when Jack Welch was CEO.

SUMMARIZING OUTLINE
This chapter introduces the idea of social responsibility in business and follows its evolution from colonial
America to its present expansion into the global economy. The opposition of critics and managers who defy
the idea in practice is explained. General principles of corporate social responsibility are set forth. The
relationship between social and financial performance is discussed. A section is devoted to the rise of a
global system of civil regulation to prompt CSR in multinational corporations. Eight major elements of this
system are discussed.

The introductory story is about Merck & Co., Inc.

Merck spent more than $200 million developing a drug treatment for river blindness, a
disease endemic in underdeveloped nations, although neither patients nor international
organizations could or would pay for it.

Since 1987 Merck has given away more than 2.5 billion doses of ivermectin, mostly in
Africa, at a cost of $3.9 billion. The medicine has saved hundreds of thousands of people
from blindness and strengthened local economies in some equatorial nations.

The story is an outstanding example of how some corporations accept the idea of corporate
social responsibility and go beyond normal market operations, acting to improve society in
some way.

Corporate social responsibility, or CSR, is the duty of a corporation to create wealth in ways that
avoid harm to, protect, or enhance societal assets. The idea has expanded in meaning over time.

Advocates of CSR justify it with three arguments.

It is an ethical duty to promote social justice.

It has concrete benefits such as creating loyal customers.

It is necessary to force full responsibility on corporations, particularly those


operating in global arenas where government regulation is weak.

CSR is opposed at opposite ends of a political spectrum.

On the far left, progressives believe it is an insufficient substitute for tougher laws
and regulations.

Conservatives on the far right believe it violates free market economic doctrines.

It imposes costs that make corporations less efficient, thus subtracting


from overall social welfare. It distracts managers from profit-making
duties.
It is unfair to shareholders because managers divert dividends to social
projects.

It thwarts natural market dynamics by diverting investment to social


programs based on managers opinions rather than market incentives.

It obliges business to meet social goals, which should be primarily the


job of government.

The meaning of corporate social responsibility has evolved.

In classical economic theory a business was socially responsible if it maximized profits


while operating within the law.

In colonial America merchants were thrifty, but charity was a coexisting virtue and
business owners gave to churches, orphanages, and poorhouses.

In the early 1800s wealthy entrepreneurs such as Steven Girard began to give large gifts
and bequests to schools and other worthy causes.

They were followed by entrepreneurs who made fortunes during the economic growth of
the late 1800s. John D. Rockefeller and Andrew Carnegie are examples of industrialists
who turned into great philanthropists.

The rise of social Darwinism in the last half of the nineteenth century braked expansion of
the social responsibility idea. Popularized by Herbert Spencer, social Darwinism held
that charity, which supported weaker and less successful individuals, ran contrary to the
harsh reality of evolution. And it was evolution, not soft-headed benevolence that brought
progress. Social Darwinism justified predatory competition ahead of any social goal.

Early in the twentieth century three interrelated ideas emerged to justify broader corporate
responsibility.

Managers were trustees, or agents of corporate power whose positions implied a


duty to protect stakeholders.

Managers had an obligation to balance the multiple interests of stakeholders.

The service principle was a near-spiritual belief that individual managers served
society by building successful businesses. The prosperity they created would
eradicate broad social ills such as poverty.

Not everyone subscribed to these expansions of the social responsibility doctrine.


Henry Ford, for example, ruthlessly maximized profits at the expense of workers.
But others such as General Robert E. Wood of Sears, Roebuck accepted
expanding duties toward society.
An early, influential statement of the contemporary idea of social responsibility
was Howard R. Bowens book, Social Responsibilities of the Businessman, in
1953.

Soon conservative economists such as Milton Friedman emerged with a set of arguments
against business responsibility. Friedmans basic views, as follows, are still heard today.

The one and only responsibility of business is to make a profit because business
institutions work best responding to markets. Governments should run social
programs, not companies.

In the free enterprise system managers are responsible only to stockholders.


Spending money on social projects wrongly appropriates money that belongs to
them. It also robs consumers, who must pay higher prices for products. This is
taxation without representation.

Social responsibility threatens political freedom because it requires that


companies perform political functions, gives executives political power, and opens
business to evaluation by political criteria.

Despite Friedmans arguments the business community has largely accepted the idea of
corporate social responsibility. Debate and resistance ebbed after two prominent business
groups formally embraced it.

In 1971 the Committee for Economic Development published a report calling for
expansive social responsibility. The report set forth three concentric circles of
responsibility.

An inner circle of responsibility for economic performance.

An intermediate circle requiring exercise of the economic function with


sensitivity to social values and priorities.

An outer circle of emerging responsibilities for business to improve the


social environment broadly in ways not directly related to its economic
function.

In 1981 the Business Roundtable issued a Statement on Corporate


Responsibility saying that corporations had both economic and social duties and
that there was no necessary conflict between them.

Acceptance of the doctrine of corporate social responsibility by the business elite protected
the legitimacy of large corporations. Still, many managers retain an inner conviction that
Friedman is correct and they resist expansive CSR.

There are three basic elements of social responsibility.

Market actions are competitive responses to forces in markets. They dominate corporate
decisions. When a corporation responds to markets, it fulfills its first and most important
social responsibility. It creates jobs, pays taxes, and meets consumer needs. This is its
major impact on society.

Mandated actions are programs required by government regulation or by agreements


negotiated with stakeholders such as unions. The importance of mandated actions grew in
the twentieth century.

Voluntary actions are those that go beyond legal, regulatory, or negotiated mandates. A
wide range of social programs and charitable activities fall in this category.

Eight widely accepted general principles of corporate social responsibility exist to guide
managers.

First, corporations are economic institutions run for profit and should not be expected
to meet major social objectives without financial incentives.

Second, all firms must follow multiple bodies of law including (1) corporation laws and
chartering provisions, (2) the civil and criminal laws of nations, (3) legislated regulations,
and (4) international laws.

Third, managers must act ethically.

Fourth, corporations have a duty to correct the adverse social impacts they cause.
They should internalize external costs, or costs of production borne by society.

Fifth, social responsibility varies with company characteristics such as size and
location.

Sixth, managers should try to meet legitimate needs of multiple stakeholders.

Seventh, corporate behavior must comply with norms in an underlying social contract.

Eighth, corporations should be transparent and accountable and publicly report on their
social performance.

Are social and financial performance related? Research suggests that more responsible companies
are at least as profitable, and often more so, than companies rated as less responsible. However,
methodological questions create enough doubt to warrant reservations.

Today the idea of CSR has taken on a global dimension.

While there is no consensus on its precise meaning and practice it is widely accepted in
industrialized nations.

Early development was strongest in the United States.

In the 1990s leadership passed to Europe.

CSR also has strong roots in Japan, Australia, and India.

It is now defined mainly by the progressive ideology of Western civil society.

With economic globalization CSR has taken on new, novel international dimensions
because corporations are seen as eluding proper controls in their cross-border activities.

International law is weak in addressing the social impacts of business.

Less developed nations sometimes have weaker regulations.

Strategies of joint venture, outsourcing, and supply chain extension distance large
corporations in developed nations from direct accountability for social harms.

Much more government regulation of transnational firms is unlikely.

New norms of responsibility were incubated by the United Nations in a series of 1990s
conferences.

The conferences generated a series of declarations, resolutions, statements,


guidelines, and frameworks shaping international norms for corporate conduct.

These comprise a body of soft law, or statements of philosophy and principle in


nonbinding international conventions that, over time, gain legitimacy as guidelines
for interpreting the hard law in legally binding agreements.

A new system of global CSR is evolving. It is based on an evolving, solidifying, maturing


patchwork of ideas, codes, voluntary corporate actions, and multistakeholder initiatives
involving corporations, nongovernmental organizations, and governments working together
to promote a part of the CSR agenda. There are eight major elements in this new global
CSR system.

New norms and principles to direct CSR have emerged. Many are found in
declarations and codes emanating from United Nations.

Codes of conduct, or formal statements of aspirations, principles, and guidelines


for corporate behavior, have proliferated. Large multinational corporations are
signatories of multiple codes.

Reporting and verification standards encourage firms to reveal information


about their CSR performance through, for example, sustainability reports, or
publications explaining economic, social, and environmental performance.

Certification and labeling schemes set rules for social and environmental
responsibility in the production process, then use labels or certifications on the
resulting products to show consumers that companies have complied.

Management standards provide models of methods a corporation can use to


achieve social responsibility goals.

The United Nations and progressive investors have developed social investment
and lending criteria. They require corporations to meet social, human rights, and
environmental standards as a condition of borrowing and attracting investment.

Some government actions advance the CSR agenda. These include participation
in code or labeling initiatives with corporations and NGOs and adoption of laws
that require CSR-like actions.

Civil society vigilance enforces corporate compliance with emerging CSR norms
as groups threaten brand attacks and harassment against deviant corporations.

The new system of global CSR is one of civil regulation, or regulation by nonstate actors
based on social norms or standards enforced by social or market sanctions.

Growth of civil regulation means that NGOs and civil society increasingly favor
constructive engagement with corporations rather than hostile attacks.

In the emerging system the multinational corporation is increasingly defined as a


stakeholder entity with broad responsibilities.

Civil regulation is a pragmatic solution to the shortage of cross-border regulation


of corporate conduct.

Critics point out that the new regime stands outside governments and is, therefore,
subject to the charge of being undemocratic.

In conclusion, for more than two centuries doctrines of business responsibility have expanded to
require more concern for stakeholders and society. This expansion will continue

Note

154.

Case

JACK WELCH AT GENERAL ELECTRIC


Jack Welch ran one of Americas largest companies for twenty years. He became a celebrity CEO, admired
for his innovative management methods and for achieving great financial success. His star still burns so

brightly it distracts almost everyone from the comments of cynics and critics. However, questions about the
social and ethical performance of GE during his tenure persist.
Chapter 5 discusses many ideas about the nature of corporate social responsibility. It also lists criteria for
judging the performance of companies. This case study gives students a chance to apply these concepts to a
specific instance, the operations of GE during the Welch years.

Answers to Case Questions


1. Corporate social responsibility is defined in Chapter 5 as the corporate duty to create
wealth by using means that avoid harm to, protect, or enhance societal assets. Did GE in
the Welch era fulfill this duty? Could it have done better?
There is no question that GE created wealth. An investor who put $100 into GE in 1980 would have had
$6,749 when Welch retired, compared with only $2,229 for investing in the Dow Jones Industrial Average
and $1,839 for the Standard and Poors 500.
Was this wealth created in ways that avoided harm to, protected, and enhanced societal assets? It is a
matter of opinion. On the one hand, GE harnessed the efforts of tens of thousands in an efficient
organization that used their skills to make products and services benefitting millions. GE medical
equipment promoted human health. Its jet engines facilitated safe travel. Its locomotives moved food, fuel,
and merchandise to where it was needed.
On the other hand, the company polluted the Hudson River, hurt communities with layoffs and factory
closings, has been accused of anticompetitive actions, used an evaluation system that some thought unfair,
and was unable to achieve diversity in top management.1
Could it have done better? This also is a matter of opinion. The very strategic actions and management
methods it is criticized for were critical to the companys financial success. Cleaning up pollution of the
Hudson River was never made a priority. Rightly or wrongly, the company was reactive, resisting
mitigation until pushed by regulators. Eventually, Welchs successor Jeffrey Immelt chose to cooperate with
the Environmental Protection Agency. This story is told at the beginning of Chapter 13. Arguably, it should
have acted sooner. Failure to achieve diversity may stem from lack of focus. Had a dynamic leader such as
Welch chosen to emphasize diversity at the top it would have been evident in GEs officer corps.

2. Does GE under Welch illustrate a narrower view of corporate social responsibility closer
to Friedmans view that the only social responsibility is to increase profits while obeying the
law?
Milton Friedman argues that the only social responsibility is to maximize profits
while staying within the law. This seems to characterize the attitude of Jack Welch.
He concentrated on playing the competitive game, building dominant businesses,
and making money. Although GE had a philanthropic arm, Welch was never one of

1
sec. 3, p. 1.

Mary Williams Walsh, Where G.E. Falls Short: Diversity At the Top, The New York Times, September 3, 2000,

those executives who emphasized service to causes or focused the company on a


progressive agenda.
Welch agreed with Friedmans view that managers should give primacy to the
interests of shareholders.
Friedman also argued that corporations should not take on political and social
projects outside their sphere of economic expertise. Welch likely agreed with this.

3. How well did GE comply with the General Principles of Corporate Social
Responsibility set forth in the section of that title in the chapter?
The general principles of CSR are set forth on pages 133 and 134.

Providing economic benefits is the greatest responsibility. Judged by this criterion, GE


excelled during the Welch years.

Corporations have a duty to follow the law. GE had a lengthy record of violations during
the Welch years. Employees in large corporations may violate laws and regulations without
encouragement by top executives and this undoubtedly explains some misdeeds. Are some
GE transgressions the result of heavy performance pressure emanating from Welch? Was
criminality at GE greater than at similarly sized companies? The answers to these
questions are not known, though Welch has given responses. He says he told GE
employees that he would not wink at misbehavior created by profit pressure. He is quoted
as saying: It is better that profits be lost than corners cut or rules bent. 2 With respect to
criminality, Welch likes to compare GE with a city having a population of about the same
size as the companys workforce, such as Newark or St. Paul. Newark, for example, has a
police force of 1,000 to combat a steady stream of murders, rapes, assaults, and thefts. 3
The implication is that GEs workforce, though not perfect, is a more law abiding
population. This is correct, however, the analogy is not compelling.

Managers must act ethically, conforming their behavior to ethical principles. Welch was
never flagrantly unethical. He never suborned fraud. As GEs top manager he emphasized
compliance. He spoke about the need for ethical behavior in meetings. Every training
program at GE was required to have a component on ethical issues related to its subject.

Corporations have a duty to alleviate adverse effects on society, that is, to internalize
external costs. PCB pollution of the Hudson River weighs against the company here,
although a mass of scientific and technical detail and disagreements about the nature of the
environmental damage make a clear assessment of GEs culpability elusive.

Social responsibility varies with company characteristics such as size, industry, strategies,
marketing techniques, locations, internal cultures, stakeholder demands, and managers
values. Students can be invited to comment on the specific duties GE might have in each of
these areas. For example, Welchs early strategy emphasized layoffs in restructuring to
meet global competition. Did this create a special duty to mitigate negative effects on
workers?

2 Quoted in Noel M. Tichy and Stratford Sherman, Control Your Destiny or Someone Else Will (New York:
Currency/Doubleday, 1993), p. 116.
3

Ibid., p. 114.

Managers should try to meet legitimate needs of stakeholders. Welch prioritized


stockholders and emphasized responsiveness to customers. Directors, executives, and highperforming managers became wealthy. The bottom layer of managers was subject to
annual rounds of firings. Hourly workers found their jobs in constant jeopardy, their wages
and benefits under pressure. Although pensioners were given some increased benefits,
pension fund appreciation was not shared proportionately with them.

Corporate behavior must comply with norms in an underlying social contract. GE led the
way in the restructuring of American corporations to make them competitive in global
markets. Welch helped to define the social contract of the 1980s and 1990s.

4. What are the pros and cons of ranking shareholders over employees and other
stakeholders? Is it wrong to see employees as costs of production? Should GE have
rebalanced its priorities?
Shareholders are ranked first in classical economic theory, where managers are solely responsible to the
interests of owners. Only when investors get a favorable return will they risk their capital. A shareholdercentered model insures the primacy of that incentive.
Marjorie Kelly argues that the shareholder centered view of corporations is wrong.
When we say that a corporation did well, we mean its shareholders did well. The companys
local community might be devastated by plant closings, its groundwater contaminated with
pollutants. Employees might be shouldering a crushing workload, doing without raises for years
on end. Still we will say, The corporation did well. 4

In Kellys view, employees do the fundamental work that makes a corporation go. Yet rewarding them is
considered an expense to be reduced. Stockholders who have done none of the hard labor get the rewards.
In other words, says Kelly, one group gets what another earns.5
Should GE have rebalanced its priorities? This is a matter of opinion, but it is certain that had the company
reoriented itself to emphasize gains in worker income and benefits it would never have achieved such
remarkable equity appreciation. That appreciation enriched many ordinary people including GE common
shareholders, GE employees at all levels, mutual fund investors, and pension fund beneficiaries.

4 Marjorie Kelly, Is Maximizing Returns to Shareholders a Legitimate Mandate? The Divine Right of Capital: Part
One, Beyond the Bottom Line (San Francisco, CA: Berrett-Koehler, 1999), p. 5. See also Kelleys book, The Divine Right of
Capital: Dethroning the Corporate Aristocracy (San Francisco, CA: Barrett-Koehler, 2001).
5

Ibid., p. 6.

5. Was GE a more socially responsible corporation in the Welch era of the Immelt
aftermath? In which era did it most benefit society? What lesson(s) can be learned from the
differences?
After Welchs 2001 exit the company moved in a more progressive direction. It was more cooperative with
regulators with respect to, for example, the Hudson River cleanup. It pursued a major new sustainability
strategy. The ecomagination initiative is both a business strategy and a social responsibility strategy.
When Jeffrey Immelt, the new CEO, joined the board of Catalyst, he made a symbolic move to affirm the
importance of diversity.
However, corporate responsibility has multiple dimensions. GE has not been as profitable under the new
Immelt regime. Stockholders have received modest, unexciting returns.
A reasonable argument can be made that GE was more responsible under Welch because of its greater
creation of surplus wealth for society. Welchs management methods and his strategic philosophy of
downsizing and outsourcing were reviled by labor, but they inspired GE and other American companies to
shed lazy ways and become more competitive in world markets.
One lesson here is that social responsibility depends on your definition. Is it primarily the social dividend
from economic success? Or is it primarily fulfilling ethical duties to the range of stakeholders beyond
shareholders. Of course, full responsibility is both. But in this case neither Welch nor his successor did it
all.

6
Implementing Corporate Social
Responsibility
SUMMARIZING OUTLINE
While the previous chapter explained the idea of corporate social responsibility and its expansion over time,
this chapter focuses on what managers do to implement social programs. Beginning on page 158, the text
sets forth and discusses a model process of CSR implementation. A second part of the chapter discusses
corporate philanthropy.

The introductory story is about the Bill & Melinda Gates Foundation.

Using his Microsoft fortune, billionaire Bill Gates and his wife Melinda set up a
foundation. It is currently the worlds largest, with an endowment of $37 billion.

The foundation is based on two simple values. The first is that all lives are of equal
worth. The second is that persons with great wealth have great obligations.

The foundation focuses on neglected diseases of the poor and on improving education.

Corporations face pressures for CSR from many quarters, including all major stakeholder groups.
The chapter explains how they can organize management processes to respond.

Key elements of managing the corporate social response are these.

Leadership sets the tone.

Business models govern a wide range of organizational responses. Companies may be


divided into three types based on their business models and the values of their founders.

First, a few companies, such as The Body Shop and Ben & Jerrys, are founded on
a progressive business model, or one that defines a strategy that meets market
needs and, in the process, mitigates social problems or improves society.

Second, some companies have traditional business models supplemented by


cultures that emphasize social responsibility. Bertelsmann and Johnson &
Johnson are examples.

Third, most large transnational corporations have traditional business models


and no special culture of social responsibility. Their social performance is based
on management responses to external pressures.

A model process with a sequence of steps for CSR implementation is set forth.

The first step is CSR review, in which the corporation assesses its current situation. There
are two key activities in this step.

First, the company should discover its core values by reviewing documents such
as mission and values statements and examining the attitudes of its founders and
leaders.

Second, it should evaluate laws, regulatory requirements, its supply chain, and
stakeholder demands to discover the expectations of society about its behavior.

A stakeholder map, or a diagram showing multiple stakeholders and their


relationship to each other and the firm, helps to identify sources of
expectations.

Many companies then engage stakeholders in dialogue to identify gaps


between social performance and expectations.

The second step is to develop an overall CSR strategy, or a basic approach, method, or
plan for achieving a social objective.

The company can examine many alternative actions, then set a few priorities.

It can seek to focus on either generic social issues that have little impact on the
companys business or it can try to find competitive social issues related to
factors that affect its business. By focusing on the latter, it may create shared
value, that is, benefits for both itself and society.

The third step is implementation of CSR strategy.

The company should create a formal organization structure for CSR decisionsmaking. This might include committees, managers, and departments.

It should develop action plans setting forth tasks such as creating policies,
budgeting resources, and assigning work.

Performance goals and timelines should be set.

Incentives such as links between pay and social performance can be created.
Then, to establish accountability, individuals and business units can be rewarded
or punished based on sustainable performance.

Corporate culture must be aligned with social strategy, for example, by


connecting career advancement with support for social policies.

The fourth step is reporting and verification.

Companies can assess and report information about their social performance.

Social reporting creates transparency, or a state in which company social


strategies, structures, and processes are visible to external observers.

The Global Reporting Initiative (GRI) is developing uniform standards for


sustainability reporting, which is documentation and disclosure of how closely
corporate performance conforms to the goal of sustainable development, or the
ideal of economic growth that does not compromise the social and environmental
welfare of future generations.

GRI guidelines ask companies to report a triple bottom line, that is, a
calculation of corporate economic, social, and environmental
performance.

The GRI has developed performance indicators and reporting formats to


allow comparison of the sustainability performance of corporations.

The GRI guidelines suggest that companies provide assurance, or an


independent verification by audit that information in sustainability reports
is reliable.

A recent survey found that a majority, nearly three-fourths, of 500 multinational


corporations have done sustainability reports. But progressives still question the
sincerity of their commitment.

Philanthropy is charitable giving of money, property, or work for the welfare of society. Corporate
philanthropy has a long history.

Until the 1950s, few companies gave much to charity because they feared suits
accusing them of exceeding the powers in corporate charters and giving away
funds that rightfully belonged to stockholders.

Then, in 1953, the A. P. Smith decision held that corporate charters permitted
charitable contributions. Companies started giving more and they set up
foundations that gave to a broad range of worthy causes.

Most philanthropy, about three-quarters of the annual total, comes from


individuals. Corporate philanthropy was $14.1 billion in 2009 and has risen over
the past decade.

Four basic philanthropic strategies are discussed.

Checkbook philanthropy is giving to multiple worthy causes without any link to


business strategy.

Strategic philanthropy, which aligns a corporations business mission with its


charitable mission, arose in the 1980s. Money is not given out of purely altruistic
motives. Rather, it is given at least partially in support of commercial objectives.

Cause marketing is a form of strategic philanthropy in which charitable


contributions are based on purchases of a product. Company ads connect a brand
with a social cause. When consumers buy the product they feel they are also
helping society.

Philanthrocapitalism relies on market forces to achieve results. It takes a variety


of forms ranging from using return-on-capital measures to allocate charitable
funds to starting for-profit companies that try to solve social problems.

In conclusion, good intentions must be translated into action. It is necessary to use basic
management tools in implementing social strategies and to use them with discipline.

Note

Case

MARC KASKY VERSUS NIKE


Nike was complacent for many years as foreign factories in its supply chain violated international labor
norms. Eventually, it was attacked by labor groups and other NGOs. The attacks threatened to damage its
brand. Nikes first efforts to implement a CSR program were defensive and insufficient. It went through a
learning process and now has a state-of-the art implementation process. Students researching the case can
be referred to the semi-annual social responsibility reports posted on its Web site. They explain at length the
substance and process of its CSR implementation. Students can be asked to compare and contrast what
Nike does with the model process of CSR implementation shown in Figure 6-3 and discussed at length in
Chapter 6.
A unique element of the case is a California law that allowed a social activist, Marc Kasky, to sue Nike for
defending its labor practices in the media. His lawsuit led to a California Supreme Court decision that still
stands and has the potential to chill corporate speech.

Answers to Case Questions


1. What responsibility does Nike have for conditions of workers at foreign factories making
its products?
As the source of work in contract factories that sometimes violate international labor norms Nike cannot
escape some responsibility for problems. In the eyes of the global public it will be seen as responsible. This
is new in civilization and a result of modern economic globalization. Before the 1980s, absent a criminal

motive, no multinational company was held responsible for the local social costs of operations in foreign
contract factories. Ethical complicity was always present, but global norms were weaker and company
actions far less transparent.
Some labor violations can be traced directly to Nike, for example, its planners have now and then
miscalculated the production capacity of factories, pressuring local managers who then abuse workers if
that will meet deadlines. Nike has a duty to correct its own actions that trigger deviations.
Other causes of violations, such as local economic climates that condone weak labor laws, are not Nikes
doing. It may have a duty to influence countries to improve their standards, but it lacks power to force
change. It could relocate to countries with strong labor protections. However, abandoning hundreds of
thousands of low-skilled workers and raising prices is irresponsible and impractical. So the situation is a
classic example of ethical proportionality, where good and evil are inextricably interlinked.
So Nike has some, but not full, responsibility for poor labor conditions.

2. Could Nike have better anticipated and more effectively handled the sweatshop issue?
What did it do right? What was ineffective or counterproductive?
Over the years, Nike has moved from the left to the right of the response spectrum in Figure 6.2. It should
have done more and done it earlier. Early actions were weak and allowed the sweatshop issue to fester. The
initial Nike response was very defensive. Then-CEO Philip Knight defended its standards in the press. It
hired Andrew Young to make a quick tour of some Asian plants and pronounce them acceptable. It invested
in a public relations campaign. These actions failed to satisfy critics. Like many corporations, it had to
learn under pressure.
Although Nike moved slowly, it always moved in the right direction.
In the early going Nike often undermined its own efforts. All the while that it tried to fight sweatshop
abuses with codes and inspections, its own business processes and culture, inadvertently to be sure, pushed
abuses along. Its buyers kept up with fashion trends by pressuring for quick production. Its low-inventory
policy led to last-minute production that tempted factory managers to squeeze employees. Such tendencies
were reinforced by an aggressive corporate culture. So Nikes corporate culture was not well-aligned with
its social strategy. It had much to learn.

3. Has Nike created and implemented an effective approach to social responsibility? Does it
address root causes of problems in Nikes supply chain? Should it now do more or do
something different?
It is fair to answer yes to the first question. However, critics in the labor movement remain unconvinced.
Their negativity is also fair because many problems remain in Nikes contract factories. Still, Nike has a
consistent record of trying to improve worker welfare and its efforts have grown much more sophisticated.
In the early going, Nike wrote two codes of conduct. Over time it stiffened code requirements, increased
staffing in its compliance department, set up a department of corporate responsibility headed by a vice
president, conducted more discerning factory audits, allowed independent factory audits, and eliminated the
use of chlorine compounds in shoe making.
When compliance problems persisted, then-CEO Philip Knight put together a senior management team led
by the vice president of corporate responsibility and asked it to figure out why compliance problems defied
elimination. The team concluded that policies on labor standards were not aligned with long-standing
incentives and business processes. For example, procurement teams got bonuses for meeting price, quality,
and delivery criteria, so they sometimes ignored labor code guidelines to hit targets. Nikes policy of
minimal inventory sometimes led to shortages of hot-selling items and in their rush to replenish stock the
teams encouraged practices such as excessive overtime that were contrary to code requirements. 1 The teams
responded to rapidly shifting style trends in the market by using tight schedules. This also encouraged
overtime.

1 Simon Zedak, The Path to Corporate Responsibility, Harvard Business Review, December 2004, p. 129.

Nike was learning that enforcement audits measured and corrected symptoms but did not fix root problems.
So it began to look for the root problems. Here are several some examples of such problems from its most
recent Corporate Responsibility Report.2

Excessive overtime is a persistent code violation. One root cause is asking contract factories to
produce too many styles. Changing from one style to another takes time. If there are too many
changes factory managers may be tempted to violate overtime rules to meet schedules. Knowing
this, Nike has reexamined its product creation process. It found many problems. Business plans
called for abundant styles. Long waits for approvals and last minute changes in colors and fabrics
pushed orders to factories too close to production deadlines. Another root cause of multiple styles
is pressure in global markets. Fashion trends change quickly. Consumers want many styles and
value variety. Competition is fierce. Nike has tried to reduce the number of styles starting in its
planning process. It believes that by lessening production changes and reducing time pressure it can
reduce overtime violations in factories more effectively than by simply auditing to catch violations.

Wage violations persist. Nike believes there are two root causes. First, the global economic
downturn has put pressure on wages everywhere, especially the wages of low-skilled garment
workers. Second, the conflicting interests of stakeholders put downward pressure on wages. While
workers want higher wages, stockholders want higher profits, governments want to attract foreign
investment, factory managers want to maintain profit margins, and consumers want attractive
prices. So workers are the only stakeholders putting a priority on wages and they are, perhaps, the
least powerful.

Organizing activity is often repressed. Collective bargaining is an effective way to protect workers.
In many factories the employee-management dialogue called for in international labor norms is
nonexistent. The root causes are legal and political constraints in nations where Nike contracts its
production. Nike cannot change this environment. However, it has a training program for factory
managers that includes discussion of international labor norms and best practices.

Over the last several years Nike has also been consolidating its supply chain, reducing the number of
contract factories by 10 percent. It wants to concentrate production in factories that are relatively more
committed to its labor principles.
It also works through collaboratives such as the Global Alliance for Workers and Communities, the
International Labour Organizations Better Work program, and the Sustainable Apparel and Footwear
Initiative to improve practice across the entire industry. It even works with competitors. It believes that
another root problem is diverging audit standards among multiple brands. Some factories are audited as
many as 40 to 50 times a year and must comply with many different, sometimes conflicting, rules. This
reduces efficiency and leads to labor abuses. Overwhelmed managers coach employees, hide information,
and lie to auditors. With some success, Nike has worked with other companies to combine audits and
standardize measures.

2 Nike, Inc., Corporate Responsibility Report FY 07-09, see Chapter 3, Workers and Factories.

Nike has also developed an overall CSR strategy, which is to bring people, planet and profits into balance
for lasting success.3 Its social responsibility actions, then, emphasize not only improving the lives of
factory workers but reducing its environmental impact as well.
Overall, the company conducts a relatively young, but very refined, advanced CSR implementation effort.
However, this effort is insufficient to overcome many root causes of labor violations in its factories. Too
much lies outside its power. Some activists argue that voluntary CSR efforts such as Nikes avoid real
reform. If real reform requires more power than corporations have, then this observation is correct.

4. Did the California Supreme Court correctly decide the Kasky case? Why or why not?
This is a matter of opinion. A central issue is the novel test devised by the four-member majority to define
commercial speech. Under it, speech is commercial if it (1) comes from a business, (2) is intended for an
audience of consumers, and (3) makes representations about the companys products. This test of
commercial speech sweeps in virtually any statement about a companys actions made by a manager that
consumers can hear.
Three dissenting justices who opposed the test felt it was overly broad. It would remove First Amendment
protection for comments by managers in public debate. California courts would become arbiters of truth
and falsehood for broad statements previously judged by society in the open marketplace of ideas. The line
between advertising and public debate would vanish. The test would chill public debate and mute the voice
of organizations (corporations) that have a constitutional right to speak out.

5. How should the line between commercial and noncommercial speech be drawn?
The Supreme Court has held that speech proposing a commercial transaction is entitled to First Amendment
protection against government restriction, provided it is truthful. There has never been any protection for
false advertising. The Court has held that there is a strong public interest in promoting truth in the
marketplace. This basic doctrine of commercial speech has usually been applied to traditional advertising
formats that present a product and propose a commercial transaction between buyer and seller.
In the Kasky case, the speech at issue was at least partly, and perhaps primarily, speech about a public
issue. It did not propose a commercial transaction. It was presented in public forums, not in a traditional
advertising format. It concerned a matter of high public interest.
As Justice Anthony Kennedy wrote in dissenting from the Supreme Courts decision to dismiss Kasky, in
the past the Court has repeatedly held that speech on matters of public concern needs breathing space to
survive, even if that means allowing some false or misleading speech.4
The issue could be resolved in several ways.

3 Ibid., p. 22.
4 Nike v. Kasky, 539 U.S. 654 (2003).

First, the California Supreme Courts definition could be upheld by the Supreme Court. This would greatly
expand the type of speech defined as commercial speech and subject it to more regulation based on its truth
or falsehood.
Second, the California Supreme Courts definition could be struck down. This would mean that Nikes
statements about the sweatshop issue would be regarded as noncommercial speech and given broad First
Amendment protection unless they appeared in a traditional advertising format and accompanied a proposal
to buy Nike shoes.
Third, courts could try to separate statements intended to influence purchasing decisions from statements
intended as part of the debate on issues of public importance. They would not have to assume that all the
Nike speech in question was either commercial or noncommercial. Instead, they could classify some speech
in either category. Such a classification scheme would require a narrowing of the California Supreme
Courts three-pronged commercial speech test.
The litigation concerning the California Supreme Courts commercial speech test ended in 2003 when the
U. S. Supreme Court declined to rule on it. Thus, the test still stands and has a broad reach. In theory it
could be applied to any corporation that sells products in California. This gives it significant potential to
chill corporate speech in the future.

7
Business Ethics
SUMMARIZING OUTLINE
The first part of the chapter is a theoretical discussion of business ethics. It focuses on explaining the idea
of ethics, sets forth theories about how ethics apply to business, explains the origins of ethical values, and
explains how and why business ethics differ around the world. There is extended discussion of how the law
sanctions corporate and management misbehavior. The remainder of the chapter focuses on practical
aspects of ethics in organizations. Organizational elements that influence levels of ethics are discussed. And
steps that corporations take when they set up ethics programs are set forth with examples of practice.

The introductory story is about the trial and sentencing of Bernard J. Ebbers, the former CEO of
WorldCom.

Ebbers received the longest sentence of any defendant in the turn-of-the-century corporate
fraud scandals.

In 2005, at the age of 65, he drove himself to a federal prison in Louisiana to begin serving
a 25-year federal sentence.

Ebbers was accused of manipulating financial information to disguise problems at


WorldCom from investors. He was convicted on nine counts of criminal conspiracy,
securities fraud, and filing false documents with the SEC.

His sentence was longer than that of some major Mafia figures who led lifetimes of crime,
including a self-confessed hit-man guilty of 19 murders. It is longer than the average

sentence of first-degree murderers in California. The story raises the question of whether
Ebbers 25 year sentence is appropriate for a white collar crime.

Ethics is the study of what is good and evil, right and wrong, and just and unjust.
Business ethics is the study of good and evil in business.

Two basic views exist about whether ethics in business are more permissive than general societal
and personal ethics.

The theory of amorality is that business may be conducted without reference to the full
range of ethical standards, restraints, and ideals in society.

The theory of moral unity requires that business actions be judged by the general ethical
standards of society, not by a special set of more permissive standards.

There are four main sources of ethical values in business.

In all great religions a divine will reveals the nature of right and wrong.

Over 2,000 years philosophy has produced a stream of principles for judging right and
wrong.

Cultural experience shapes ethical values transmitted across generations. Two


perspectives apply to cross-cultural differences in ethical values.

First, ethical universalism holds that human nature is the same everywhere;
therefore, ethical rules are transcultural.

Second, ethical relativism holds that although human nature is the same, varying
cultural experience creates and justifies diverging ethical values.

Donaldson and Dunfee believe that a deep social contract underlies all human
societies and it generates hypernorms, or a limited set of principles at the root of
all human ethics. However, these hypernorms are broad enough to permit a variety
of ethical practices in moral free space, where inconsistent norms are permitted if
they do not violate any hypernorms.

The law codifies, or formalizes, ethical expectations. Legal expectations are enforced
through damages, criminal prosecution of managers and corporations, sentencing, and
fines.

Compensatory damages are payments awarded to redress actual, concrete losses


suffered by injured parties.

Punitive damages are payments in excess of a wronged partys actual losses to


deter similar actions and punish a corporation exhibiting reprehensible conduct.

Crimes are offenses against the public prosecuted by governments. Both individual
managers and corporations are prosecuted for crimes.

Under the doctrine of respondeat superior corporations are liable for the
actions of employees who commit a crime in the course of their
employment when their act is for the benefit of the company.

Corporations are reluctant to go to trial because a criminal trial and


possible guilty verdict can impose enormous reputational damage.

To avoid criminal prosecution companies enter into deferred and


nonprosecution agreements. In these agreements they agree to
cooperate with the government and take remedial actions,
including hiring monitors to oversee compliance programs.

Executives are more often prosecuted than corporations, though harder to convict
because they have more legal rights and are less inclined to cooperate with
prosecutors.

Recently the nation has gone through a cycle of corporate crime prosecutions. Two
task forces were created to prosecute executive fraud. The Enron Task Force had
20 convictions. The Corporate Fraud Task Force has brought in more than 1,300
convictions.

Sentences and fines for managers and corporations are usually based on guidelines
set forth by the U.S. Sentencing Commission.

Four prominent forces shape ethical conduct in corporations.

Leaders set the ethical tone. Managers should not show by their actions that a difference
exists between ethical policies and everyday practice.

Managers must create ethical strategies and realistic performance goals. Otherwise,
employees may feel pressured to engage in unethical behavior.

Each companys culture has an ethical dimension. A corporate culture is a set of values,
norms, rituals, formal rules, and physical artifacts.

When behavior of employees does not live up to espoused rules and codes, it can
be a reflection of silent assumptions deep in the culture that conflict with formal
policies.

Stories of events at Fannie Mae and Consolidated Edison illustrate the power of
these tacit underlying assumptions to frustrate ethical policies. It is very difficult
to change such long-standing cultural values.

Behavior is also motivated by individual characteristics.

Research suggests that ethical behavior is associated with demographic traits such
as education, religious belief, age, and work experience.

Personality traits are less studied, but Machiavellianism, or the tendency of an


individual to use self-centered, immoral, manipulative behavior in a group, is
correlated with unethical behavior.

Evidence suggests that individuals are heavily influenced to be more or less ethical
by situations. The psychological processes involved are illustrated by the story of
a couple who defrauded a corporation.

Many corporations have an ethics and compliance program, or a system of structures, policies,
procedures, and controls used to promote ethical behavior and ensure compliance with laws and
regulations.

Several developments have encouraged ethics and compliance programs.

Billing scandals of the 1980s in the defense industry led defense companies to
pioneer such programs. Health care corporations adopted them after Medicare
billing frauds in the 1990s.

In 1996 the Caremark decision suggested that corporate directors might be


responsible to stockholders for monetary damages if they failed to set up
procedures guarding against misbehavior that resulted in fines and penalties.

In 1991 the U. S. Sentencing Commission issued sentencing guidelines for


organizations that reduce penalties if programs for preventing criminal behavior
exist.

The Sarbanes-Oxley Act of 2002 and related stock exchange listing standards
introduced new ethics standards for corporations.

Because of these developments, most corporations now have at least some program
elements in place. There are two distinct approaches.

A compliance approach teaches employees to meet legal and regulatory


requirements and emphasizes following rules.

An ethics approach teaches values such as integrity, truth, and fairness, preparing
workers to separate right from wrong in moral spheres of work life.

Most companies focus on compliance, but many combine the two approaches.

The federal sentencing guidelines suggest seven steps for an adequate compliance
program.

Establish standards and procedures to prevent and detect criminal conduct.


Many companies have responded by adopting conduct codes.

Give oversight of the program to the board of directors and assign responsibility
to a company executive who, in turn, will assign day-to-day responsibility to a
high-level manager.

Exclude individuals with a history of illegal or unethical conduct from


positions of substantial authority.

Communicate standards to all employees. Training is a key method for meeting


this requirement.

Monitor and audit the organization. Set up an anonymous hotline for reporting
criminal and ethics violations.

Enforce standards. Use incentives for ethical behavior. Discipline violators.

Assess areas of risk for criminal behavior. Modify programs accordingly. Take
steps to prevent repeat violations.

Most large companies now satisfy these requirements. The main incentive is fear of
criminal prosecution.

Note

Case

THE TRIAL OF MARTHA STEWART

This case study is a narrative that tells the story of the Martha Stewart trial. It describes the stock trade and
investigation that led to criminal charges against her, her trial, and her sentencing. It raises questions about
whether she was fairly indicted, fairly tried, fairly convicted, and fairly sentenced.

Answers to Case Questions


1. Did Martha Stewart commit the crime of insider trading when she sold her ImClone
shares on December 27, 2001?
Investigations of Martha Stewart by the Department of Justice and the Securities and Exchange
Commission (SEC) originated in the suspicion that she had engaged in illegal insider trading. However, she
was never charged with this crime. Yet the suspicion of insider trading hung over the trial.

Eight counts against Stewart charged her with conspiracy, obstruction of justice, and making false
statements to investigators. (The ninth count, that she engaged in securities fraud by lying to the public for
the purpose of propping up the shares of her company, was dismissed.) To establish a motive for her
actions, the government tried to show that she had sold her ImClone shares based on inside information
from its CEO, Sam Waksal, and her broker, Peter Bacanovic.
Insider trading occurs when corporate directors, officers, and employees buy and sell stock in their
company. These trades must be reported to the SEC. They are legal unless the insiders possess material,
nonpublic information about developments. Trades based on such information are illegal under Section 16
of the Securities Exchange Act of 1934 and elaborating rules the agency has issued. 1 Insiders are also
prohibited from tipping off others outside the firm, who then trade on the information. The SEC
summarizes the law this way.
Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty
or other relationship of trust and confidence, while in possession of material, nonpublic
information about the security. Insider trading violations may also include tipping such
information, securities trading by the person tipped, and securities trading by those who
misappropriated such information. 2

Did Martha Stewart break the law? She did not if she sold her ImClone shares based on a preexisting
agreement with Bacanovic to sell at $60 a share. The existence of any prior contract, written plan, or
instruction to an agent is an affirmative defense against the charge of trading on material nonpublic
information. It is set forth in paragraph (c)(1)(i)(A) of the SECs Rule 10b5-1. However, if that agreement
did not exist before the trade the issue is whether she received an illegal tip.
If Sam Waksal had called her and told her about the Food and Drug Administrations impending rejection of
its cancer drug that would have been illegal tipping. This did not occur. She seems only to have known that
Waksal and his daughter sold the shares in their Merrill Lynch accounts. Was this material information?
The significance of this information to Martha Stewart is unclear. Did she know that the Waksals held a
large number of shares through Merrill Lynch? Did she know what percentage of the shares the Waksals
owned were at Merrill Lynch? Did she assume any motive for their selling? They could have been selling to
raise cash, to diversify their holdings, or because they were trading illegally to avoid an imminent decline.
When she placed a call to Waksal after her conversation with the broker, she may have been trying to
satisfy her curiosity about their reasons for selling. The Waksal trades were a brazen violation of securities
law for which Sam Waksal went to prison. If Stewart had no other knowledge aside from the fact that they
were selling, would she have concluded that they were exercising such terrible judgment?

1 See Rule 10b5-1, Trading on the Basis of Material Nonpublic Information in Insider Trading Cases, and Rule
10b5-2, Duties of Trust or Confidence in Misappropriation Insider Trading Cases, at www.sec.gov.
2 Securities and Exchange Commission, Insider Trading, modified April 19, 2001, at
www.sec.gov/answers/insider.htm.

Stewart traded either based on a prior sell agreement or based on information that the Waksals were selling.
In the former situation she is innocent of wrongdoing. In the second situation she traded on nonpublic
information that the Waksals were selling, but absent any contact with the Waksals its meaning was
ambiguous. Would a jury have found this information material, that is, important enough to convict
Stewart of a crime? We can only speculate. However, it is not obvious that the information is particularly
damning.

2. Did the U.S. Attorneys and the Securities and Exchange Commission use good judgment
in indicting Martha Stewart? Do you believe that her indictment was based on evidence of
a serious crime, or do you believe that prosecutors consciously or unconsciously had
additional motives for pursuing the case?
One element of their judgment was a decision not to charge her with insider trading. This may be an
indication that they did not consider her guilty or that they believed that convincing a jury would be difficult
based on the evidence.
She was charged with eight criminal counts for conspiring with Bacanovic, obstructing the government in
its investigation, and perjuring herself in interviews with agents. The evidence here was sufficient to
convince a grand jury that indictment was warranted. At trial, it convinced a jury to convict on some

counts. Lying to federal agents is a serious crime. If she was innocent of illegal trading, she exercised bad
judgment in conspiring with Bacanovic and dissembling to investigators.
The decision to charge her with securities fraud because she spoke in public declaring her innocence seems
in retrospect to have been an error. Martha Stewart is a public figure. Convincing a jury that she had no
right to defend her reputation would have been difficult. Government suppression of speech is questionable
under the expansive constitutional doctrine of free speech. This ninth count was dismissed before it went to
the jury.
Whether prosecutors had motives beyond enforcing the law is unknown. The two devious motives most
discussed in the press are that Stewart was prosecuted because she was a successful woman and that she
was prosecuted because in a period of many corporate scandals the government needed to show its ability
to punish business leaders. Both are speculation.

3. Do you agree with the jury that she was guilty beyond a reasonable doubt of the
conspiracy and obstruction of justice charges?
This is a matter of opinion. The question should create a discussion.

4. Was her punishment, including both imprisonment and fines, appropriate? Were the
punishments of Peter Bacanovic and Douglas Faneuil appropriate?
Judge Miriam Cedarbaum sentenced Martha Stewart to five months in prison, five months of home
confinement, and a fine of $30,000. Judge Cedarbaum based the sentence on federal sentencing guidelines,
which set a base offense level of 12 for the crimes of obstruction of justice and perjury. 3 Using a table in the
Guidelines Manual, the judge determined the appropriate sentencing range for this offense level was 10 to
16 months.4 She chose the minimum sentence. For that offense level, the guidelines required her to impose
at least one-half the minimum confinement sentence in the form of prison confinement, the remainder to be
served on supervised release with a condition of community confinement or home detention.5 This is how
Stewart wound up in prison for five months and in home detention for five months.
Peter Bacanovic was sentenced to five months in prison, five months of home confinement, and a fine of
$4,000. His sentence was calculated in the same way.
Because Douglas Faneuil cooperated with prosecutors, they did not seek a prison sentence. He was fined
$2,000.
Before her sentencing, Martha Stewart argued that the sentencing guidelines were unconstitutional and did
not apply to her. In Blakely v. Washington the Supreme Court invalidated sentencing guidelines used in that
states courts because they gave judges too much discretion.6 It held that key factors in sentencing should be
decided by juries, not be left to the discretion of judges. Stewart believed that Blakely called Judge
Cedarbaums use of the federal guidelines into question. Judge Cedarbaum rejected this argument.

3 United States Sentencing Commission, Guidelines Manual, 2J1.2 and 2J1.3 (Nov. 2002).
4 Ibid., Sentencing Table, 5A.
5 Ibid., 1A4(e).
6 124 S. Ct. 2531 (2004).

While Stewart was serving incarcerated, the Supreme Court decided another case, United States v. Booker,
holding that the federal sentencing guidelines are no longer mandatory.7 Federal judges such as Cedarbaum
could consider them advisory. It did not find the guidelines unconstitutional. Stewart again appealed,
seeking to have her period of home confinement reduced. But Judge Cedarbaum again declined to change
her sentence.8
During her home confinement, in 2005, Stewart petitioned Judge Cedarbaum to be allowed to remove her
ankle bracelet and to be away from her home for 80 hours a week instead of the 48 hours a week allowed.
Her petition was denied.

7 125 S. Ct. 738 (2005).


8 U.S. v. Stewart and Bacanovic, 03 Cr. 717 (MGC) (S.D.N.Y., 2005).

In 2004 Stewart and Bacanovic filed an appeal seeking a new trial. 9 They presented multiple grounds for
findings of error at their trial.

Prosecutors should have permitted her to respond to allegations that she had engaged in
insider trading.

The government improperly introduced statements made during investigation interviews by


both Stewart and Bacanovic. It then used statements by one defendant to convict the other.
This was improper because neither defendant had a chance to cross-examine the other. 10
Since statements of each were used to prove facts that led to conviction of the other, this
violated their Sixth Amendment right to cross-examine accusers.

She should have been granted a new trial after it was discovered that the government ink
expert had given false testimony.

Judge Cedarbaum erred in not holding a hearing to explore the significance of juror
misconduct when a juror lied about his past.

The federal sentencing guidelines were improperly applied.

In early 2006 a federal appeals court rejected these arguments (although it allowed Bacanovic again to
appeal his sentence to Judge Cedarbaum).11
In sum, although Stewart and Bacanovic repeatedly appealed their conviction and sentencing presenting
multiple grounds, they never got a favorable ruling. If fairness is procedurally correct treatment under the
law, they seem to have received fair treatment and punishment.
As noted in the case study, Stewart and Bacanovic both settled civil proceedings with the Securities and
Exchange Commission in 2006. Stewart agreed to a fine of $195,081 and Bacanovic to a fine of $75,645.
Stewart was barred from serving as an officer or director of any company for five years, until 2011. As of
June 2011 she had not chosen to be an officer or director of her company. Her title remains that of
Founder/Chief Editorial, Media and Content Officer. Her 2010 compensation was $5.9 million, more than
twice the $2.7 million of the companys CEO. 12 Bacanovic was permanently barred from working as a
securities broker. The two are no longer friends. Recently they ran into each other at the Monkey Bar, a
Midtown Manhattan restaurant. According to the New York Post they were polite, did not make eye
contact and did not speak.13

9 Brief for Defendant-Appellant Martha Stewart in United States v. Stewart and Bacanovic, 04-cr-3953(L), filed
October 20, 2004.
010 This claim raises a procedural technicality grounded in the Sixth Amendments confrontation clause.
11 U. S. v. Stewart and Bacanovic, 433 F.3d 273 (2006).
212 Martha Stewart Living Omnimedia, Inc., Notice of 2011 Annual Meeting of Stockholders and Proxy Statement,
April 5, 2011, p. 27.
313 Marthas Night Out, New York Post, February 22, 2010, p. 10.

Samuel Waksal served five years in federal prison and was released in 2009. He is barred by the SEC from
being an officer or director of a publicly traded company but is now chairman and CEO of Kadmon
Pharmaceuticals, a privately-held biopharmaceutical company he started. The company has raised more
than $200 million from investors who are not put off by Waksals past misdeeds. 14 Despite fines and
imprisonment he retains his multimillion dollar art collection.
Students can debate the fairness of punishments handed out in this case using ethical rather than legal
guidelines. Instructors can guide such a debate by introducing the simple maxims in the sphere of
retributive justice set forth in Chapter 8. These are that (1) blame should be fairly imposed and (2)
punishment should be proportionate to the crime.

414 Andrew Pollack, ImClone Ex-Chief Embarks on a New Biotech Venture, The New York Times, November 1,
2010, p. B1.

8
Making Ethical Decisions in Business
SUMMARIZING OUTLINE
Chapter 8 explains a range of ethical principles, setting them forth in alphabetical order, discussing how
they can be applied in business, and weighing their usefulness. Short incidents at the end of the chapter give
students an opportunity to apply them. In addition, the chapter explains new research about the brain that
reveals much about how we make ethical decisions. It gives readers practical suggestions for making them.
It concludes with some thoughts about why ethical decisions are or seem difficult.

The introductory story is about the coming of age and early career of entertainment mogul David
Geffen. It tells how he used compromised ethics at critical junctures, yet was ultimately and
spectacularly successful. It illustrates a basic distinction in ethical philosophy. Geffens career
defies any final, absolute ethical judgment.

Deontological ethics is the idea that actions are right and wrong in themselves
independently of consequences. When Geffen lied, for example, to get and keep an early
job, his actions did not conform to this standard.

Consequentialism is the idea that actions are right or wrong, in part or whole, based on
their consequences. When Geffens overall contributions to society are weighed using this
standard, his earlier compromises diminish in importance.

Students may be asked whether Geffens career allows any final, absolute ethical judgment.

Fourteen principles of ethical conduct are set forth.

Immanuel Kants categorical imperative is to act so that your action could become a
universal law. It embodies the quick test of universalizability.

The conventionalist ethic is that in business it is all right to take an action if it does not
violate the law.

The disclosure rule requires thought about how it would feel to explain an ethical decision
to a wide audience, such as television viewers or newspaper readers.

Aristotles doctrine of the mean calls for virtue through moderation. Avoid behavior that
is excessive or deficient.

The ends-means ethic is that worthwhile ends justify the use of means that would
otherwise be considered compromising. It is associated with Machiavelli.

The Golden Rule is Do unto others as you would have them do unto you. A related
principle is Kants practical imperative requiring that others be treated as ends in
themselves not as means to selfish goals. Both embody the idea of a test of reversibility in
which a person places himself or herself in the shoes of the person affected by a decision.

The intuition ethic is that we intuitively know right and wrong, therefore, we can allow
ourselves to be guided by emotional reactions as well as logic.

The timeless might-equals-right ethic rationalizes that what is right is what a person has
the strength and power to accomplish.

The organization ethic is be loyal to the organization.

Herbert Spencers principle of equal freedom is that each person may exercise liberties
until the point where they infringe on the liberties of others.

The proportionality ethic is inherited from medieval Catholic theology and applies to
situations in which a decision leads to both good and evil effects. Two formulations are set
forth.

The type of good and evil involved.

The urgency of the situation.

The probability of both good and evil effects.

The intensity of influence over effects.

The existence of alternatives.

The principle of double effect is a simpler formulation of proportionality. Actions


are ethical if three conditions exist.

The good effects outweigh the evil.

The managers intention is to achieve the good effects.

There is no better alternative.

The rights ethic protects important liberties that people have. Because of their human
nature, people have natural rights. In societies they have also received legal rights. An
important aspect of rights is that they imply duties.

The theory of justice defines what individuals must do for the common good of society.

Thomas M. Garretts principle of proportionality requires managers to weigh


five factors in their decisions.

John Rawls has developed a set of principles of justice that would be chosen by
rational persons acting behind a hypothetical veil of ignorance.

Distributive justice requires that benefits and burdens be distributed using


impartial criteria.

Retributive justice requires punishment to be evenhanded and proportionate to


transgressions.

Compensatory justice requires fair compensation to victims.

The utilitarian ethic advocates the greatest good for the greatest number.

A separate virtue ethic denotes a source of ethical behavior separate from principled reasoning.
Aristotle wrote that moral virtue is a result of habit. He suggested building an ethical character by
habitually making right choices. Plato set forth four cardinal virtues as the most basic traits of an
ethical character. These are justice, temperance, courage, and wisdom.

Ethical decisions have a neural basis. A fast, unconscious, and automatic process in neural circuits
causes ethical judgments to appear in our awareness. Both emotional circuits and rational circuits
are activated by ethical decisions, but emotional circuits tend to dominate.

Researchers use functional magnetic resonance imaging, or fMRI to map neural


processes in the brain.

When fMRI is used on subjects considering ethical dilemmas, it shows how they engage
different brain regions depending on the nature of the dilemma. Impersonal dilemmas
engage conscious reasoning, while more personal dilemmas engage social emotions. In
these latter dilemmas, individuals with brain damage to regions of social emotion made
more calculating, some would say less ethical, decisions.

It is theorized that emotions have evolved to play a central role in ethical thought because
of their adaptive value in promoting social cooperation in human society.

Neuroscience suggests the existence of a moral intuition based on rapid activation of


neural circuits that process social emotions. This process creates quick mental awareness
of an ethical choice without any logical reasoning process.

Evidence suggests that the sensitivity of neural pathways is altered by social experience
and learning. This indicates that character development is important to ethical decisions.

Practical suggestions for making ethical decisions are set forth.

Learn to pay attention to your ethical intuition.

Consider using simple decision methods such as devils advocacy, a balance sheet, or the
critical questions approach of answering a prepared list of questions.

Sort out ethical priorities before dilemmas arise. Publicly commit on ethical issues, making
it harder to compromise your position later.

Set an example for others.

Have the courage to translate your principles into action.

Cultivate sympathy and charity toward others.

Note
155.

Case

SHORT INCIDENTS FOR ETHICAL REASONING


The ten incidents raise many ethical issues. They can be used for class discussions or assigned for written
evaluation. Either way, students can practice principled ethical reasoning. In evaluating the incidents, the
fourteen ethical principles set forth in Chapter 8 are useful. Ideas from Chapter 7 on Ethics in the
Business System are also applicable. Comments on each incident follow.

A Clouded Promotion
The president of the accounting firm must decide whether to promote, retain, or dismiss the vice chairman
who falsely claimed an M.B.A. from the University of Michigan. Four considerations predominate.
First, what is the presidents attitude toward lying on an employment application? Claiming an unearned
degree was a premeditated, aggressive, manipulative lie. It deprived the firm of making a fully informed
decision among qualified applicants. It likely deprived another individual of the job the vice chairman now
holds. Most people condemn lies on resumes. Yet some employers are charitable when the person
subsequently does the job well. Different responses come from variations in ethical values about truth
telling.
Second, the past performance of the vice chairman has been excellent. How should this be weighed? A
maxim of retributive justice is that punishment should be proportionate to the crime. Only then is it
deserved. For years the vice chairman has done an outstanding job, and this performance may be a
mitigating factor.
Third, what is company policy about false statements on resumes? If lower-level employees or applicants
have been fired and rejected for falsehoods, then retaining the vice chairman suggests a double standard.
Keeping this person would cause widespread cynicism.
Finally, this is an accounting firm. Accountants follow a code of professional ethics. It is crucial that clients
perceive the firm as having integrity. If it becomes known that the company excuses questionable behavior
in senior managers, clients might worry about the conduct of audits or other sensitive matters. This is an

overriding consideration. The story is based on an incident at the Los Angeles office of an international
accounting firm, where the vice chairman was fired after discovery of a falsified application form.
False degree claims periodically surface in the press. Examples that led to firings are mentioned in Chapter
7 on page 225. Sometimes the executive survives. In 2002 the story got out that Ronald Zarella, CEO of
Bausch & Lomb, falsely claimed an MBA from New York University. He offered to resign, but the
companys directors retained him though they took away a $1.1 million bonus.15

515

Philip Walzer, Reasons Not To Pad Your Resume, The Virginian-Pilot, May 4, 2007, p. D1.

The Admiral and the Thieves


In his primer on the use of power, The Prince, Nccol Machiavelli wrote: A prince should care nothing
for the accusation of cruelty so long as he keeps his subjects united and loyal, and argued that by making
a very few examples he can be more truly merciful than those who through too much tender-heartedness
allow disorders to arise.16
When the admiral fired the three workers for a theft of materials worth $25, he acted in accord with
Machiavellis philosophy. The ethical principle that important ends sometimes justify harsh means could be
applied. The admirals aim was to achieve an important community good. The means he chose broadcast
the determination with which he intended to pursue the no-theft policy. However, they involve manipulation
of the three workers. This action might conflict with the idea in Kants practical imperative, which requires
that individuals be treated as ends in themselves, not as means to other ends.
Disciplinary actions raise ethical questions. The maxim of retributive justice, that punishment should be
proportionate to the crime, is applicable. Students may feel that losing thirty years of work toward a
pension is too great a penalty for aiding in a minor theft. They could be asked what alternatives existed and
if they would have worked as well to deter future theft. Some alternatives are these.

Point penalties under a point system.

Verbal or written reprimand.

Leave without pay for one or more days. A variant is an unpaid, one-day decision-making
leave, after which the employees would return and say whether they intended to be honest
as a condition of continued employment.

Reduction in rank for the petty officers.

A combination of these measures.

The admiral displayed an authoritarian management style and believed that the workers under his command
could be motivated by fear. As Machiavelli noted, it is much safer to be feared than to be loved, if one
must choose.17

Sam, Sally, and Hector


The three layoff victims have different personalities. Sam and Hector are less aggressive than Sally and do
not get the extra benefits she negotiates. Although all three workers are in the same situation, one is treated
more generously.

616

T. G. Bergin, ed., New York: Appleton-Century-Crofts, 1947, pp. 47-48. Written in 1513.

717

Ibid., p. 48.

The maxim of distributive justice requires that rules apply equally to workers in identical situations and
that benefits or burdens be distributed equally unless a job-relevant difference justifies differential
treatment.
Sally received preferential treatment owing to force of personality, ability to express threatening behavior,
negotiating skill, or obstinate demands. Are these relevant criteria for distributing benefits? If there was a
specific company policy about layoff compensation and an exception was made, then the maxim of
distributive justice is violated unless something in the situation exists to justify the exception. Here it can be
argued that Sally has traits that are valuable in business situations. She created a negotiation, asserted her
interests, and deserved the extra reward she got because she acted whereas others passively accepted the
situation.

A Personality Test
The questions on the psychological profile test are designed to reveal personality traits in job applicants,
including abnormalities. For example, the questions about difficulty sleeping, worrying about sexual
matters, and work stress are designed to detect anxiety. The questions about disjointed hands and strange
odors are aimed at schizophrenics. The question about enjoying dancing in junior high school suggests
masculine or feminine attitudes. And the question about friends not liking you could reveal paranoid
feelings. Naturally, these questions reveal personality only when combined with many others in a validated
test.
Psychological tests such as this may create conflicts of rights, or entitlements that people have. Employers
have the right to protect their assets and to raise efficiency by hiring the best applicants. Applicants, on the
other hand, have the right to privacy of thoughts and emotions. Ordinarily, there is a great power imbalance
in the test-taking situation. Applicants refusing tests are likely to go no further. Lying and deception are a
common reaction to unfair, overbearing power. A job applicant lies on a test that he or she feels is intrusive
but must be taken to get the job. Is this justified?
The ends-means ethic and the conventionalist ethic can be used to rationalize faking answers to give the
appearance of a normal personality or show traits that the employer seeks. The important thing, it can be
reasoned, is to get the job, and to do so, expedient means are justified. The goal of getting the job justifies
some dissembling.
Lying, or the intentional misstatement of fact, is not ethical. It violates principles such as the categorical
imperative. Still, many people believe that puffery is acceptable in the application process. They may be
cheating themselves if subsequently they do not fit into the job. A question that could be discussed,
however, is this. Would deceit be justified under limited circumstances, such as if a person were
unemployed and his or her family struggling?

Al
Al the sales representative exemplifies the phenomenon of the highly successful corner-cutter. Such people
exist in every organization. Several problems surface in the performance review.

First, by giving friendship and small gifts to loading dock workers in exchange for preferential treatment,
he undermines both company policy and the formal authority of the loading dock supervisor. Other sales
reps will see this as favoritism. The supervisor will be angry. Many are watching to see how Al is handled.
If he continues to get away with this, employees will become cynical about how things really work around
here and will believe that other policies are made to be broken.
Second, by giving unauthorized discounts, Al has again violated policy and this time undermined the
authority of sales management. If discounts are necessary, he should request in advance an exception or a
policy change. By not doing so, he has opened himself and other sales reps to pressure from customers for
future concessions.
Third, Al has asked one customer to participate in a lie that works to his personal benefit. Delay of payment
for one week is not a great departure from normal procedure, but people at the other company may feel
uncomfortable being recruited into Als self-dealing and wonder when Als propensity will turn to their
disadvantage.
Als story raises the question of whether the ends justify the means. Al is productive. Do the benefits to the
company justify his tactics? This age-old philosophical issue is worth discussing. But for a practicing
manager the answer should be no. Als actions are a challenge to the seriousness of any ethics statement set
forth by management. Not even the utilitarian ethic rationalizes well what Al is doing. Benefits from Als
high sales may be great, but is the alternative of letting him work unchecked worth the cost in organization
morale? A key consideration is that his questionable actions are probably not necessary. He could excel
without them. Over time the destructive achiever diminishes organizational performance. Unless Al is
disciplined, his actions will spread cynicism, encouraging others to cut corners and demotivating coworkers
who follow the rules but do not get Als star status.
The CEO was wrong, therefore, not to take action on Als performance review.

A Trip to Sea World


The buyer from the retail chain asks for a favor that is financially insignificant compared with the possible
sale. According to utilitarian reasoning, there are compelling benefits to paying for the requested $500 trip
to San Diego. The company will make a $3.6 million gross profit. The buyers commission will be $50,000.
Major stakeholders of the company will benefit.
What costs must be weighed against these benefits? The most important one is the precedent of permitting
such a manipulation. What will the buyer want next year? Will word get around that the manufacturer can
be rolled? Paying for the trip introduces a tolerance for extortion into the business environment. The
specific ethical problem is that the buyer is using his power as a representative of his company to intimidate
the manufacturers sales representative and get a personal benefit for himself and for his wife. This is abuse
of authority.
How should the sales representative handle this? He stands to make $50,000 from the sale and could pay
for the San Diego trip using his personal bank account. The ethical drawback to this, however, is that the
rep is then open to future extortionate demands in matters in which the manufacturer, his employer, has a
critical interest. Therefore, a private bribe is wrong because it confuses authority of the company with
personal gain in a way that is analogous to the way the buyer is confusing his authority with self-gain. He
should inform the sales manager at the manufacturing company and seek advice.

The sales manager must decide what to do. To approve the trip validates an ethical compromise. Refusing it
might kill the order, but it might not. A third option is to inform managers at the retail chain about the
buyers behavior.
This story is inspired by a similar situation occurring in a large corporation. In the real-life version the
sales manager elected to inform the buyers superior. The buyer was fired and the purchase went through.

Mary and Tom


Was Tom fair to Mary? Justice requires acting equitably toward others. In this situation that means
shouldering an equal share of the burden with Mary in their joint project. Tom skimped on his share,
allowing ambition and self-interest to divert his efforts.
Toms promotion over Mary was inevitable. Both worked on the critical radar project, but Toms resume
had an additional line for the privacy task force, a project not as important to the company but one with
high visibility. Tom showed political awareness when he joined the task force, something that is a legitimate
consideration in promoting a manager. Mary showed only competence as a technician; she did not showcase
ambition and political ability as did Tom.
This kind of promotion, which appears to reward the less competent, arouses cynicism in workers who
want to see the company (and the world) as a fair place. It shows how things really work around here and
teaches by example. Was the promotion fair to Mary? No, if merit alone is considered. Was the company
wrong to promote Tom? Not necessarily, if both merit and political skills are important.
Although the incident invites a focus on distributive justice, other ethical principles are useful. Toms
actions fail the categorical imperatives lofty standard, since slacking off cannot be made a universal rule.
They fail the quick test of reversibility; if Tom put himself in Marys position, the injustice to her would
jump out. They violate the organizational ethic in which people subordinate their interests to the overall
good.
On the other hand, Toms actions are rationalized by ethical principles from the realist school. These are
based on worldliness, not ideals. When Tom cut corners on the radar project to get time for the privacy
meetings he followed the conventionalist ethic, which encourages self-promotion if it does not break a law
or rule. Following the ends-means ethic, he made himself a more attractive promotion candidate at Marys
expense.

The Honda Auction


Dennis Josleyn, zone sales manager for the West Coast, is asking Dave Conant, co-owner of a Honda
dealership, for a kickback. Josleyn has arranged for Conant to get 64 cars for $128,000 less than their
market value. He wants half that, or $64,000, returned to him, with the money laundered through a
business he owns.
This violates the categorical imperative. It would never withstand disclosure. It is a means only to a selfish
end. It contradicts the Golden Rule. The intuition of any ethical person would reject it. It violates the
organization ethic because it steals from Honda. It cannot be justified by any weighing of proportionality. It
is against the law and bends corporate policy unfairly, contravening maxims of justice. It could be justified
by utilitarianism using only the most expedient calculus. Josleyn lacks cardinal virtues.

If Conant acts on principle, refusing the deal, he rejects a $64,000 windfall. Worse, he declares that he is
not a player. New Hondas will flow to dealers willing to pay these kickbacks. Conants dealership, his
livelihood, will wither. Since the corporation will not act against rogue managers such as Josleyn, reporting
the circumstances over his head is an ineffective option.
Is there any ethical rationale for making the payoff? Aristotles theory of responsibility is that an actor is
responsible for his or her choices unless excused by ignorance or incapacity. Conant is not ignorant of
unsavory consequences from this payment. However, an argument that he is incapacitated exists. He is
forced to make the payment, so the reasoning goes, because if he does not he will lose his business. He is in
the same position as a corporation in a foreign land that cannot stay in business unless it descends into
bribery. Yet this argument is flawed. The kickback is wrong and the choice not to make it exists. The cost of
standing on principle may be loss of the dealership, a very high cost. But saying that the dealer is forced to
make the bribe is incorrect. He can refuse.
A second rationalization for making the payment is in the theory of amorality, discussed in Chapter 7,
which is that a separate, lower set of ethics is applicable in business. Therefore, pursuing commerce with
clean hands is impossible. Our protagonist has no choice but the kickback. Without it he leaves the game.
This result validates the theory of amorality. But it also rationalizes unethical behavior, an end some are
unwilling to accept. They accept the theory of moral unity, holding that there is only one, high set of ethics
to use in all areas of life. The dealer should stick to these standards even if it requires starting the game
over.
In the end, when Conant paid the $64,000 it was a decision wrong in principle. We can empathize. Yet it
was wrong.
This incident was part of a much wider fraud conspiracy among managers at American Honda Motor
Company, a subsidiary of Honda Motor Company of Japan. A corrupt hierarchy formed within the sales
division. Dealers bribed district sales managers for a better mix of cars. They bribed zone sales managers
to get more car shipments and paid off regional sales managers for new dealer franchises.
Like the dealers, people in the sales division had an ethical decision to make. Quickly they learned that
careers stalled for those who did not join the club. A few managers remained outside the conspiracy. Their
careers stagnated and they had nowhere to turn, since the highest-ranking sales executives openly socialized
new participants into the scheme. Top Japanese officials at American Honda were warned repeatedly about
the corruption, but remained aloof and secretive. Their silence protected the gang of Americans.
After fifteen years of rampant dishonesty, from the late 1970s to the early 1990s, American Honda finally
began to root out the crooked managers when some dealers sued. In 1995, the Department of Justice
brought fraud charges against top sales division managers, including Dennis Josleyn.18 Josleyn, who
admitted receiving $1.2 million in payoffs and kickbacks, was convicted of racketeering, conspiracy, and
fraud and sentenced to 6 years in prison. His appeal was unsuccessful. 19 Honda Motor Co. has paid more
than $400 million to Honda dealers because of their lawsuits.20

The Tokyo Bay Steamship Company


818

United States v. John W. Billmyer, Dennis R. Josleyn, Criminal Nos. 94-029-01, 94-029-04-JD (USCD, New
Hampshire), September 26, 1995.

919

United States v. Dennis R. Josleyn, 206 F.3d 144 (2000).

020

In re: American Honda Motor Company, Inc., Dealerships Relations Litigation, 162 F.Supp. 2d 387 (2001).

The Tokyo Bay Steamship Company is taking advantage of the sanguinary interest of the Japanese public
in suicides to expand business. The conventionalist ethic can be used to justify the companys operations. It
is making money in the marketplace without violating any laws. But, of course, a business does not always
benefit individuals and society simply by meeting market demand. Meeting demand for refrigerators,
automobiles, and hamburgers is beneficial. Meeting demand for cheap handguns, video game violence, and
obscene lyrics creates a mixture of good and bad and is controversial. Meeting demand for heroin, contract
murders, and machine guns subtracts from individual and societal well-being and is wrong (and illegal).
Note that if someone has ethical values that uphold suicide as a personal decision in which society has no
interest, then the behavior of the company is rationalized.
Several ethical principles lend themselves to condemnation of the companys actions.

Aristotles theory of responsibility is that a person or a company is responsible for


permitting harm or evil unless ignorance or incapacity prevent action. Although the
Japanese culture views suicide more charitably than American culture, the Japanese still
try to prevent it. If suicide is an evil, then it is the obligation of the company to stop it, not
facilitate it. The company cannot claim ignorance or incapacity. Therefore, it is culpable.

The principle of proportionality invites reasoning that also leads to condemnation of the
volcano tours. Suicide is a major evil involving the loss of life without proportionate,
compensating social benefit. The harm to persons here outweighs the benefits for curious
tourists and stockholders. There is no evidence that the company would fail if it declined
suicide-related business. It is certain that evil effects will accompany the island business
(in part because efforts to stop the suicides are only partly effective). And the company has
influence over these evil effects because it provides transportation for the suicides.

The practical imperative can also be applied. It admonishes that people be treated as ends
in themselves, not as objects of manipulation for the selfish ends of others. The Tokyo Bay
Steamship Company is using suicidal individuals to build its revenues. They could be
carried as goodwill on its balance sheet. The practical imperative, however, teaches that
the company should be working to help individuals, not to assist self-destruction.

Tiger Woods
Tiger Woods displayed lack of integrity toward his family. The resulting global scandal reduced, but did not
eliminate his value for endorsing products. His main sponsors are corporations with formal codes of
conduct. None of these codes directly mention the conduct of celebrity endorsers.
Students can research the conduct codes of the companies mentioned in the short incident and examine
closely the wording to see if it does or should apply to Tiger Woods. Almost every code has a general
statement about integrity. None of these company codes try to regulate or penalize off-work behavior (with
the exception of criminal activity). Some codes, such as Nikes, expect employees to avoid seemingly any
behavior that tarnishes the companys reputation. Nikes code applied to every employee. The company
may have rationalized that Tiger Woods was not technically an employee.

Should these companies have extended the rules for their employees to cover Tiger Woods? It seems
reasonable to argue yes. A corporation with a double standard for employees and product endorsers is open
to criticism. There are, however, other arguments. One is that profits should have priority over ethics.
Another is that the codes do not literally apply to the personal lives of people connected to, but not
employed by, the corporation.

Note

Case

TANGLED WEBS
Two stories are woven together in this case study. Both raise ethical issues.
One story is of Ashley Madison, a social networking Web site for married men and women seeking to have
affairs. Is it an ethical business? What is its responsibility for the deceptions that go along with the
networking it promotes? Do the rationalizations of its founder meet the test of ethical principles studied in
the chapter?
A second story is of a man and a woman who meet through the site. They have an affair, then add another
layer of deception when one of them trades stock options based on nonpublic information from the other.
The story is useful for studying the nature of lies, secrets, and deception. When, if ever, are they justified?
What are their functions? Who do they harm and how?

Answers to Case Questions


1. What lies are present in the tangled webs considered here? How were they used? How
were they justified by those who executed them? Who was harmed by them? Which lies
were most harmful?
James E. Gansman, as a senior partner and an attorney in the New York office of Ernst & Young, engaged
in various forms of deception. When he gave information to Donna Murdoch about pending mergers, he
violated his employers written policy against revealing confidential information and kept this a secret. He
signed annual statements of compliance with a second Ernst & Young policy prohibiting trading on nonpublic information. Doing no trading himself, he was literally entitled to sign. However, he knew Murdoch
was trading on confidential information he gave her. By withholding this knowledge from Ernst & Young he

failed to tell the full truth. Finally, after his indictment, Gansman said he did not know of Murdochs trades.
Murdoch said he did know and their 7,000 phone calls and text messages undermined the credibility of his
claim, making it likely he was lying.
Murdoch also engaged in multiple deceptions. She had secrets. She likely concealed full disclosure of her
actions from her husband. She concealed her relationship with Gansman from her supervisor and second
Ashley Madison confederate. She deceived the Securities and Exchange Commission about her trading
activity, tried to avoid revealing the truth by having her hard drive erased, and lied to the FBI.

Both Gansman and Murdoch were bundles of secrets, deceptions, and lies. By keeping his actions secret
Gansman manipulated his employer into inaction. In return he enjoyed continued employment and rewards
from a relationship with Gansman. We can only guess how he justified his actions. In the end he tarnished
his employers reputation and contributed to loss of public confidence in markets. If trading activity by
Murdoch and her co-conspirators influenced the market price of target company shares, it may have raised
the cost of mergers for Ernst & Young clients. Murdoch used Gansmans deceits for financial gain.
In the end Gansman and Murdoch lost the most. Gansman received a prison sentence. Murdoch gave up her
gains and has yet to be sentenced. Her sentencing is delayed while she continues to cooperate with the
government. Those she tipped have given up their gains and paid fines. In February 2011 her other
paramour and supervisor, Richard Hansen, pleaded guilty to conspiracy and securities fraud. He will pay
back $60,000 in trading gains and faces a 16 month prison term.1

2. Were the punishments for James Gansman, Donna Murdoch, and Gerald Brodsky fair?
Gansman was sentenced to a year and a day in a federal prison and six months of supervised release. He
was disbarred and can no longer practice law in New York. He was fined $250,000 by the Securities and
Exchange Commission to disgorge part of the profits made by Murdoch. Students can debate whether this
was fair.
Murdoch, who initially pleaded not guilty, changed her plea and agreed to testify against Gansman. She
agreed to pay $404,054, but this sum was waived because she was unable to pay. The waiver may have
been partly due to her cooperation with federal prosecutors. She has yet to be sentenced. She may receive a
prison sentence. However, she will not be financially indebted to the government.

3. Is Ashley Madison based on an ethical business model?


Ashley Madison is based on a business model that enables adultery. Adultery has harmful effects. It
undermines the family institution. It leads to forms of deception including insincere promises, guilty secrets,
and lying. In this way the business imposes the external costs of dishonesty on innocent individuals
(noncustomers) and society. Like other businesses that impose external costs such as pollution and noise,
the company does not pay the full cost of its operations. As Ashley Madison grows it might achieve a scale
sufficient to diminish the marriage institution.
It is a legal business model. However, an ethical business model should better safeguard the honesty and
integrity of its stakeholders.

4. How does Noel Biderman, the founder of Ashley Madison, explain and justify the
business? Does he fulfill his ethical duties to all those affected by his actions?
Noel Biderman offers various rationalizations. They are listed here with possible rebuttals.

1 Bruce Golding, Sex and Stocks Guilty Plea Deal, New York Post, February 11, 2011, p. 13.

Monogamy is biologically unnatural, so men and women are genetically predisposed to seek
multiple partners. But cultural values are human inventions designed to promote monogamy. In that
sense they are natural to the race and deserve support.

Ashley Madison does not persuade anyone to abandon a happy marriage. But, the presence and
convenience of the service enhances the opportunity to stray.

The business cannot control, affect, or influence individual decisions to deceive their partners. But,
by making cheating more convenient, broadening the population of potential adulterous partners,
and offering an entertaining, game-like Web site Ashley Madison may incite adultery.

The site offers tips for safe encounters and an extramarital dating arena apart from work where
those already committed to an adulterous affair are relatively more protected from harms such as
sexually transmitted disease, sexual assault, and job loss. But, by removing risks more men and
women may be attracted to stray.

Ashley Madison has the right to advertise just as any legal business. But, to protect vulnerable
individuals and cultural values, society prohibits and restricts ads by other legal businesses.
Arguably, ads for adultery should be restricted.

5. What do the events in this story teach us about business ethics? About capitalism?
An ethical lesson is that otherwise good people fall victim to ethical traps in the business landscape. One
trap is a morally questionable but highly profitable business. Another trap is opportunity to profit from
unethical behavior. A further lesson in this case is that unethical behavior invites retribution or, worded
otherwise, crime does not pay.
A lesson about capitalism is that markets are amoral. Where there is demand for services, whether based on
virtue or vice, supply will emerge.

9
Business in Politics

SUMMARIZING OUTLINE
This chapter gives an overview of business in American politics. It begins by describing how the formal
structure of government affects the ability of business to exercise influence. Then a section traces the
history of business influence in government from the colonial era to the present, making the point that
business has always been a dominant interest. The rest of the chapter focuses on business lobbying and
business influence exercised through campaign contributions. It concludes with a section discussing the
nature of corporate political influence.

The introductory story is about Paul Magliocchetti, a former legislative aide whose lobbying firm
specialized in earmarks for defense companies. An earmark is a sum added to an appropriation bill
by a member of Congress.

Magliocchettis firm grew to 35 lobbyists. It lobbied for large and small defense
contractors. Its success was based on his knowledge of the appropriations process and on
campaign contributions he orchestrated for members of an appropriations subcommittee.

When Magliocchetti was indicted for illegal campaign contributions, his firm collapsed.

Then the House of Representatives investigated seven members for ethical lapses, trying to
learn if they traded earmarks for campaign contributions in violation of bribery laws. All
were cleared, but the investigation revealed questionable actions by Rep. Peter Visclosky
(D-Indiana). His fundraising methods are set forth in the story and students can discuss
what they imply about how corporations work to influence Congress.

The structure of American government, as shaped by the Constitution, affects business. Most
important, it is extraordinarily open to influence.

The federal system divides powers between a central (federal) government and subdivision (state)
governments. It creates many points of access for business influence. Within this system, the
supremacy clause in the Constitution allows federal law to preempt state law.

The system of separation of powers divides powers among the executive, legislative, and
judicial branches of the federal government. This also creates multiple points of access.
The constitutional system of checks and balances among the branches lends itself to delay.
If business can influence one branch, it may block action by the other two.

Judicial review is the power of judges to review actions of government officials and strike
down laws that are unconstitutional. In the past, courts have blocked actions and
invalidated laws opposed by business.

The First Amendment protects the right of business to influence government. It gives
business the right to lobby officials and to express ideas expansively.

The preeminence of business in politics is an enduring fact in America.

An economic elite wrote and ratified the Constitution. Its arrangements open the
government to business influence.

In George Washingtons administration the groundwork for business dominance was laid
when Alexander Hamilton set up policies of industrialization. As the nations economy
expanded so did business political power.

After the Civil War, commercial interests lacked strong opposition and grew exceptionally
powerful. Politics in the late nineteenth century was defined by the corruption this led to.

The 1930s depression brought major reforms to control excessive powers of business in
the U. S. economy. The overbearing power of business was curtailed for a time during
Franklin D. Roosevelts administration.

In the prosperous 1950s business again surged to dominance.

Then, with the rise of social movements in the 1960s, business faced hostile reform groups
that succeeded in getting new regulations. Reforms in Congress that diffused power also
reduced business influence. However, this era of effective opposition to business interests
was short-lived. By the late 1970s business interests were resurgent. Since then, they have
dominated liberal, progressive, and pro-regulation interests.

The organizations that represent business are classified this way.

Peak associations represent many companies in different industries. The U.S. Chamber of
Commerce is an example.

Approximately 6,000 trade associations represent companies grouped by industry. Large


companies are often members of many trade associations.

Many companies have Washington offices to house their own lobbying staffs.

Business interests form coalitions to broaden support. Coalitions come and go in


Washington. Many alliances are ephemeral.

There are two broad areas of business involvement in politics.

Lobbying is advocating a viewpoint to government.

Lobbyists give lawmakers technical information and inform them about how
special interests stand on issues. They gain power from having access to
government officials.

Lobbyists use many methods. They do research, talk to legislators, host receptions,
and cultivate public support for issues in a practice known as grassroots
lobbying.

Lobbyists are little regulated because the First Amendment protects their activities.
However, the Lobbying Disclosure Act of 1995 requires them to register and both
the House and the Senate have adopted rules to prevent impropriety. Many
loopholes weaken these laws and rules.

Lobbyists are also subject to bribery statutes making it illegal for lawmakers to
exchange official acts for anything of value given with corrupt intent. Legal
campaign contributions are not considered bribes.

Lobbyists and lawmakers must also avoid the crime of illegal gratuity or the
exchange of a gratuity for an official action in the past or future when that action
might have been or might be taken even without the gift.

Business also engages in electoral activity to get friendly politicians elected. There is a
long history of efforts to reduce corporate influence in elections.

Progressive reformers passed the Tillman Act of 1907, prohibiting corporate


contributions to federal candidates. The law was quickly bypassed by, for instance,
large individual contributions from business executives.

The Federal Election Campaign Act (FECA), as amended in 1974, set up a


regulatory framework intended to limit contributions and expenditures. It failed to
limit campaign spending, mainly for the following reasons.

In Buckley v. Valeo the Supreme Court invalidated the statutes


expenditure limits. Its contribution limits continued in force.

The proliferation of interest groups, including business groups, led to


growth in campaign contributions.

Business discovered methods of avoiding the laws limits and prohibitions


on corporate giving. These include the following.

Political action committees, or PACs, set up by companies and


funded by employee contributions. PACs can legally give to
federal candidates, whereas their sponsoring companies cannot.

Soft money contributions unregulated under the FECA. Federal


Election Commission rulings permitted corporations to give
unlimited amounts of soft money to party committees. This money
was then used to influence federal elections, primarily by funding
issue ads that promoted federal candidates but avoided specific
wording about election or defeat of those candidates.

The Bipartisan Campaign Reform Act (BCRA) of 2002 was passed to close the
soft money loophole.

It prohibited corporations from giving soft money to national political


party committees.

It prohibited corporations from funding issue ads if they ran on broadcast


media 30 days before primaries and 60 days before general elections.

It raised contribution limits for individuals and allowed adjustments for


inflation.

In 2010, in Citizens United v. Federal Election Commission, the Supreme Court


struck down the BCRAs prohibition against corporate funding of issue ads and
the Federal Election Campaign Acts prohibition against corporations making
independent expenditures for the election or defeat of candidates. It held that these
prohibitions violated the First Amendments free speech protections.

Today corporations have a variety of legal options for injecting money into
elections. They include the following.

Political action committees that raise money from employees.

Individual contributions by executives.

Bundling by executives who solicit contributions for a candidate from


friends, then bundle them together and pass them on to the candidate.

Contributions to 501(c) groups, or tax-exempt groups organized to


represent business interests. These groups include trade associations,
which can use corporate dues to make lobbying and electioneering
expenditures.

Contributions by 527 groups, or committees organized under the tax


codes to engage in political activity.
Independent expenditures for political advertising when those
expenditures are not coordinated in any way with candidates.

Giving in state and local elections. Approximately half the states allow
direct corporate contributions to state and local candidates.

The chapter concludes with an observation that restraints on corporate political activity are
limited by the First Amendment. Nevertheless, corporate influence today seems less
corrupting than in the past.

Note

Case

CITIZENS UNITED v. FEDERAL ELECTION COMMISSION


This case study is the story of a Supreme Court decision. Citizens United is an important decision. It
removes a major barrier to corporate political activity. Before it, corporations could not spend money
independently to pay for political advertising or to instruct their employees how to vote. After it, there is no
limit on these independent expenditures so long as they are not coordinated with candidates. Corporations
are still prohibited from making direct campaign contributions.
Critics of the decision said it would unleash a flood of corporate money into elections, threatening their
integrity. This has not yet happened. Spending on elections has continued to rise. In the midterm elections of
2010, the first following the courts decision, spending was about $4 billion as compared with $3 billion in
the elections of 2006. This is a large increase, but expected and not due to independent contributions from
corporations. As explained in Chapter 9, corporate money finds many channels into elections and the
history of American elections is one of continuously rising expenditures. Even without the new channel
opened by Citizens United more business money would have found its way in.
To research the case students can read the decision. It is a long one, at 48,686 words the ninth longest ever.
Although parts of it may be difficult reading, reflecting the complexity of election law, other parts are lively
argumentation, doubtless reflecting the passions of the justices.

Answers to Case Questions


1. Was Hillary: The Movie a disguised campaign ad or a journalistic documentary? Should
the Court have created an exception in the law to permit its broadcast? What could it have
done?
Hillary: The Movie was made to influence voting. It was screened at theaters in various states at
times coinciding with their presidential primaries. It was produced by Citizens United, a nonprofit,
conservative political group with a history of disparaging Bill and Hillary Clinton. Hillary was
similar to an issue ad (or electioneering communication in the jargon of election law) in having a

partisan message but avoiding words such as vote for and vote against. It was partly funded
by corporate contributions. So, yes, it could be called a campaign ad disguised as journalism, a
documentary, or a feature film.
However, Hillary also meets the definition of a documentary film, commonly understood to be an
extended portrayal, interpretation, or exploration of a person, event, or subject. Documentary
films are not necessarily balanced or unbiased. They have the perspective of the film maker. So
Hillary might also be called a documentary.

Citizens United produced Hillary in response to the success of Michael Moores popular film
Fahrenheit 9/11, which was released during the 2004 presidential campaign and heaped ridicule
on President George W. Bush. Citizens United complained to the Federal Election Commission
(FEC), arguing that Fahrenheit 9/11 was a disguised issue ad, but the FEC ruled that because its
producers charged viewers to watch it was a commercial activity exempt from the reach of
election law. When Citizens United showed Hillary in theaters and sold DVDs on its Web site, it
availed itself of this exemption. But when it tried to show Hillary on a cable network it no longer
had that exemption.
Should the Court have created an exception in the law for Hillary? It could have with an opinion
that Hillary was primarily a commercial venture or clearly a documentary because of its length or
a piece of journalism because of its treatment of a political figure. One problem with such an
exception was that the FEC and federal courts would wind up enforcing one more line between
permitted and prohibited speech. And it would not be a sharp line. For example, would a 10
minute film qualify as a documentary? How much revenue must a film earn before a group
could pay to show it on television before an election? The Citizens United majority believed the
case could not be resolved on such narrow grounds without further expanding an already too
complicated censorship apparatus and, inevitably, further chilling political speech. Therefore, it
chose to examine the constitutionality of the law that prohibited showing Hillary.
2. Should the First Amendment protect corporate political expression? If not, where should
the line be drawn for corporations between freedom and restrictions? Should First
Amendment protections apply only to individual citizens?
Corporate political speech is restricted. Corporations can support candidates and causes through political
action committees and, since Citizens United, with independent expenditures. They cannot contribute to
candidates directly, a major restriction of their speech.
The arguments for restricting corporate speech begin with the charge that corporations have wealth that
could corrupt or strike fear into politicians, undermining the integrity of their decisions. Their speech
could drown out other voices. For more than 100 years Congress has legislated to restrict corporate speech.
Federal courts have generally supported this policy. Corporations are not natural persons. They are not
flesh and blood voters. They have no conscience. Their sole interest is in making profits. Also, the Founders
never intended the First Amendment to protect corporations. They were suspicious of them and greatly
restricted their activities.

The counter argument is that corporate speech is entitled to the fullest First Amendment protection. A
corporation is a voluntary association of individuals and as such should be entitled to political speech just
as a political party or an interest group composed of farmers or workers. The Founders never intended that
the government should balance voices of competing interests. To do so it must be a censor, which is
inappropriate. Indeed, James Madison in the Federalist No. 10 wrote: It is in vain to say that enlightened
statesmen will be able to adjust . . . clashing interests and render them all subservient to the public good.1
For Madison, the remedy for an interest that would trample on the rights of others is a republican
government in which all factions are given free voice. The citizen body is not easily duped. If corporations
spend large amounts of money this will be revealed and voters will take it into consideration.
There is a perennial argument about whether corporations should have the same First Amendment or other
constitutional rights as ordinary citizens. In the 1886 Santa Clara case, the Supreme Court accepted the
theory that corporations were persons under the law entitled to the same Fourteenth Amendment equal
protection rights as natural citizens.2 Since then this conclusion has held, but it is politically charged
because the personhood of the corporation shields it from some government regulation. Leftists, who
believe in more regulation, dislike this shield. Conservatives, who seek more corporate freedom, approve of
it.
Students can debate whether corporate speech is entitled to the same protection as that of a natural person.
If so, more of the restraints put on by Congress over the years will have to be removed. One justice,
Antonin Scalia, has already said he is ready to strike down all limits on corporate electoral participation.3

3. If you were on the Supreme Court would you have voted in the majority or joined the
dissent? Why?
These questions invite students to discuss and defend their opinions.
You would join the majority if, overall, you believe in the rashness of extending rights of personhood to
corporations, the importance of settled law, the wisdom of congressional lawmaking over a century, and the
idea that corporate wealth poses a danger to elections.
You would join the dissenters if, overall, you believe that corporations are persons entitled to full First
Amendment speech protections, that historical evidence of corporations corrupting elections is thin, that
government should not censor political speech, and that the body of campaign finance law has grown too
complex and is in itself a barrier to constitutional free speech.
Students can be asked to defend the various points in each of the arguments.

1 Clinton Rossiter, ed., The Federalist Papers (New York: The New American Library, 1961), p. 80.
2 Santa Clara v. Southern Pacific Railroad Company, 118 U.S. 394 (1886).
3 See his dissent in Austin v. Michigan Chamber of Commerce, 110 S. Ct. 1391 (1990).

4. After Citizens United are the rules for corporate participation in elections still too strict,
about right, or too relaxed? Why?
The answers to these questions are subjective. If you are a conservative, antiregulation, pro-speech, procorporation thinker you will believe that remaining restraints on corporate speech, such as limits on direct
contributions to candidates, should be removed. If you are a liberal or progressive thinker suspicious of
corporate influence, you will decry the loosening of restraint on corporate speech.
In fact, no post-Citizens United gusher of corporate independent expenditures has appeared. An event early
in the 2010 campaign season alarmed corporations. Target Corp., headquartered in Minnesota, gave a
contribution of $150,000 to an independent group supporting Tom Elmer, a gubernatorial candidate. Target
liked Elmers positions on taxes, spending, and Minnesotas business climate. Its money was used to fund
an ad for him. However, Elmer was also against gay marriage. Gay rights organizations started a national
boycott of Target, this despite its long record of progressive corporate policies and support for gay causes.
Whether or not the boycott was significant for lost revenue, it played heavily in the media. The story scared
other corporations, making them reluctant to associate with particular candidates. So most corporate money
continued to flow through nonprofit organizations and trade associations. These entities need not disclose
the names of donors. They effectively mix corporate donations to dissociate individual companies from
specific ads.

5. Should Congress legislate in response to Citizens United? If so, what should it do?
Congress cannot overturn the Citizens United decision. If it tried the current Supreme Court would declare
its action unconstitutional. It could initiate a constitutional amendment, the first to limit freedom of speech,
but it has not.
Instead, Democrats in 2010 proposed the Democracy Is Strengthened by Casting Light on Spending in
Elections Act, or the DISCLOSE Act. The bill, which was a direct response to Citizens United, passed in
the House of Representatives, but failed in the Senate where it drew a filibuster. It was viewed as a partisan
measure and found no Republican support. Corporations lobbied to defeat it. Its main provisions were
these.

New, extensive disclosure requirements would be required to inform voters of the source of
money for both issue ads and express advocacy ads. For example, CEOs of corporations
who funded a TV ad would have to appear on camera saying they had approved the
message.

Companies accepting federal bailout funds would be prohibited from spending to influence
elections.

Companies with more than $50,000 in federal contracts or with 20 percent or more foreign
ownership would be banned from making independent expenditures to support candidates.

10
Regulating Business

SUMMARIZING OUTLINE
This chapter begins with a discussion of the reasons for regulation and its historical rise. It next explains
the regulatory process, including the nature of regulatory statutes, delegation of power to agencies, the
rulemaking process, and how the White House, Congress, and the federal judiciary exercise oversight.
Discussion then turns to the costs and benefits of regulation. Finally, the chapter looks at regulation in
foreign countries.

The introductory story is about how the Federal Aviation Administration (FAA) licenses civilian
rocket launches.

The FAA is an agency in the Department of Transportation. Its Office of Commercial


Space Transportation issues launch licenses.

The main purpose of a launch license is to protect the public from harm by an errant
rocket.

To get a license, a company must submit massive paperwork about its launch vehicle and
its planned flight trajectory. The FAA then uses statistical models to decide how dangerous
the flight is to the public and issues a license only if the risks of public casualties from an
explosion or falling debris are less than 30 in 1 million.

There are two fundamental reasons for government regulation of the private sector.

The first is market flaws, including these.

Natural monopoly, where a firm can supply the entire market for a good or service
more cheaply than any combination of smaller firms.

Destructive competition, in which companies that dominate an industry compete


unfairly by, for example, cutting prices until competitors are forced out.

Externalities, or costs of production such as pollution not borne by an enterprise


that causes them but by society.

Inadequate information that reduces the efficient operation of markets. Where


information is not available government may provide it or have industry do so.

The second is social and political objectives for regulation, including these.

To insure production of socially desirable goods and services such as safe


products.

To encourage socially desirable production methods, for example, by inspections


for workplace safety.

To resolve national and global problems that state and local governments and
individuals cannot manage.

To benefit special interests that have the political strength to pressure lawmakers
for favorable laws and rules.

Regulation in America has grown in a wavelike pattern.

The first wave, from the Colonial era to 1860, was predominantly promotional for
business.

The second wave, from the 1860s through the 1920s, imposed state and federal regulatory
power on railroads and showed a gradually increasing willingness to control business with
regulation.

The third wave, in the 1930s, resulted from the ravages of the great depression and saw
the federal government exercising new and substantial regulatory powers over the
economy.

The fourth wave, in the 1960s and 1970s, came when government enacted major
legislation and set up new agencies protecting the environment, consumers, and workers.

The fifth wave began in 2001 with creation of a massive Department of Homeland
Security to protect against terrorism and further expanded in 2008 when financial
regulators intervened to protect the economy from a liquidity crisis.

The process of regulation is discussed.

All federal regulation originates in an act of Congress.

When a statute is passed, it is assigned to a regulatory agency.

Independent commissions are agencies run by a small group of commissioners


independent of political control.

Executive agencies are regulatory agencies in the executive branch run by a single
administrator.

Statutes are more or less specific. Sometimes they are vague. Often they make broad
grants of authority to agencies to define and carry out their intent.

In a process called rulemaking agencies promulgate rules having the force of law. A rule
is a decree issued by an agency to implement a statute passed by Congress.

Rules are created in a complex, formal process. Some take years to complete.

Executive agencies must submit proposed rules to the Office of Information and
Regulatory Affairs in the White House for approval.

If it is proposing a significant regulatory action, defined as a rule with an annual


effect on the economy of $100 million or more, the agency must prepare a report
explaining its full benefits and costs.

Independent commissions do not submit proposed rules to the White House for
approval and need not prepare benefit-cost studies.

Proposed and final rules of all agencies and commissions are printed in a daily government
publication called the Federal Register. The rising annual total of its pages is a crude
marker for the growth of regulation.

Final rules are codified in the Code of Federal Regulations, which is annually updated.

In addition to formal rules, agencies often use guidance, or informal documents such as
letters and manuals, to clarify official regulations.

Since the days of Theodore Roosevelt presidents have sought, with mixed success, to
exercise control over regulatory agencies.

President Ronald Reagan issued Executive Order 11291 giving the White House
authority to review existing and proposed rules and requiring all new rules to meet
a net benefit criterion.

President Bill Clinton issued Executive Order 12866 to require, inter alia, that
regulations be written in simple, easily understood language.

President George W. Bush appointed political czars in each agency to review


proposed rules and toughened White House review procedures.

Immediately on taking office, President Barack Obama issued Executive Order


13497 to rescind the Bush policies and made no formal effort to reduce the flow of
new regulations.

Congress also tries to exercise control over regulators. Its committees hold oversight
hearings to question them. In 1996 it passed the Congressional Review Act giving itself
the authority to block major new rules from going into effect with a resolution of
disapproval. The resolution must pass by a majority in both the House and Senate and be
signed by the president.

Federal courts have the power to review agency decisions when cases are brought by
regulated parties.

Under the Chevron doctrine courts tend to defer to agency rules that are based on
reasonable interpretations of statutes.

Congress has given federal courts the power to strike down agency actions that are
arbitrary, capricious, unconstitutional, beyond agency jurisdiction, or unsupported
by evidence.

Benefits and costs of regulation are difficult to measure. No precise calculation of its overall net
benefit (or cost) exists.

Costs are heavy. Compliance costs were estimated as high as $1.2 trillion in 2009. Federal
agency budgets totaled $45 billion in 2009. Other costs of regulation such as slowed
innovation are less quantifiable but still high.

Benefits are also great. A review of major regulations for which benefit-cost studies had
been made between 1998 and 2008 showed that benefits exceeded costs by a huge margin.
Unmeasured benefits such as prevention of corruption, disease control, and lessened
workplace discrimination are great.

Annual studies by the World Bank catalog and compare business regulations in 183 nations.

Regulation varies widely around the world.

Poor countries tend to impose heavier regulation on business. Heavier regulation raises
costs, invites corruption, and lowers productivity.

Rich countries regulate business less and engage in ongoing regulatory reform.

Developed countries engage in continuous regulatory reform to improve the business


environment.

Note

Case

GOOD AND EVIL ON THE RAILS


This is a story about how a major rule regulating the railroads came to exist. It illustrates the regulatory
process as depicted in Figure 10.3 and discussed in the chapter.
The case begins with a recounting of the collision between a Metrolink commuter train and a Union Pacific
freight train near Los Angeles. Twenty-four passengers and the engineer of the commuter train were killed.
Soon after, Californias two senators pushed a bill through Congress requiring enormously expensive
equipment to automatically control trains. This equipment increases safety, but its costs far exceed its
benefits. The main question raised by the case is whether the regulation is worth it. According to the
benefit-cost calculations of regulators it is not. The existence of a major rule that imposes a net cost on
society is one lesson about regulation.

Answers to Case Questions


1. What were the causes of the Metrolink accident?
The Metrolink engineer was distracted by texting.

According to the National Transportation Safety Board (NTSB), the probable cause of the collision was
failure of the Metrolink engineer to observe and appropriately respond to the red signal . . . because he
was engaged in prohibited use of a wireless device . . . that distracted him from his duties. The NTSB also
found that lack of a positive train control system was a contributing factor. 1 If such a system had
existed, it would have stopped the train at the red light, allowing the Union Pacific freight train to switch
off on the siding.

2. What could have been done to prevent the accident? Was management deficient? Were
regulators deficient? Should either have been doing anything differently?
As noted above, a positive train control system would have prevented the accident by sensing a track
violation and overriding the engineer to stop the train before it rolled past a red signal.
Two other actions also could have prevented the collision.

Robert Sanchez could have been fired or removed from safety-sensitive duties after
violating cell phone rules. Management did not recognize that these rule violations were the
tip of an iceberg. His cell phone records revealed a pattern of gross negligence. Because
management saw his two cell phone violations in the context of hundreds of other
efficiency tests that he mostly passed, they did not trigger alarms. Management could
have made the safety-protective assumption that if two violations were recorded, many
others went unobserved.

Management could have installed audio or video equipment in locomotive cabs to monitor
engineers. Video equipment would have deterred texting.

It should be noted that both these management actions would have met union opposition.
The Federal Railroad Administration required constant, frequent testing and observation of engineers. It did
not get around to prohibiting engineers and conductors from using personal electronic devices on duty until
several weeks after the Metrolink collision when it issued an emergency order.2 It noted that while most
railroad operators already had cell phone rules they had not prevented accidents. The agency listed at least
five incidents, in addition to the Metrolink collision, in which railroad employees using cell phones had been
hit and killed by trains or trains had collided because one or both engineers were distracted by cell phone
conversations. It was galvanized by the Metrolink fatalities. Had it acted sooner Metrolink might have been
more strict with Sanchez.

1 National Transportation Safety Board, Collision of Metrolink Train 111 With Union Pacific Train LOF-65-12
Chatsworth, California, September 12, 2008: Accident Report (Washington, DC: NTSB, 2010), p. 66.
2 Federal Railroad Administration, Emergency Order to Restrict On-Duty Railroad Operating Employees Use of
Cellular Telephones and Other Distracting Electronic and Electrical Devices, 73 FR 58702, October 7, 2008.

3. Is the cost of positive train control justified by the likely safety gains for passengers?
No. As noted in the case the costs of the positive train control rule outweigh its benefits, which include
$176 million to $269 million for fatalities prevented, by a ratio exceeding 20:1. 3 The rule is also not
justified by prevention of property losses or by efficiency gains in rail traffic.

4. Did the Federal Railroad Administration fairly value a statistical life at $6 million?
The agency based the $6 million figure on a basket of economic studies that measure peoples willingnessto-pay to avoid risk of injury and death. The figure is very close to estimates of other federal agencies.
Methods of calculating the value of a statistical life and their fairness are discussed in Chapter 14 (see
pages 490-491). The agencys calculation can be justified by procedural fairness and accords with
mainstream thinking in the regulatory community about the best method for calculating the value of a life.
It might not be considered a fair figure by those who believe life is a priceless, sacred, or otherwise
precious beyond the comprehension of mortals.

5. Is money spent to regulate railroad safety being spent in the most efficient way to reduce
risks of death and injury in society?
It is not. Many other regulatory programs save lives at lower cost. A national smoking cessation program
would save lives at a much lower cost. Most federal programs have far more favorable benefit-cost ratios.
The positive train control rule is an extreme outlier.

6. Were the railroads justified in opposing legislation to mandate train controls?


Their opposition is certainly understandable. The eventual rule coming from the legislation imposes on
them billions of dollars of capital expenditures over 20 years and massive new paperwork requirements. It
expands the regulatory burden on an industry that has struggled to be profitable. Railroad corporations
naturally opposed these outcomes.

7. Is video recording in locomotive cabs an invasion of privacy? Should unions oppose it?
The Brotherhood of Locomotive Engineers and Trainmen opposes video cameras in cabs, calling them
needlessly invasive. It claims collective bargaining rights under the Railway Labor Act were violated when
Metrolink installed them. It also claims that the privacy rights of engineers under Article 1, Section 1of the
Constitution of the State of California are violated. However, the relevant passage states only a very
general privacy right.
All people are by nature free and independent and have inalienable rights. Among these are
enjoying and defending life and liberty, acquiring, possessing, and protecting property, and
pursuing and obtaining safety, happiness, and privacy.

3 Federal Railroad Administration, Positive Train Control Systems: Final Rule, 75 FR 2685, January 15, 2010.

The union has proposed use of cell phone jamming systems instead of cameras. These systems block
incoming and outgoing communications and send a signal if an engineer attempts to make a call.
Railroad unions also favor positive train controls as the best method for improving train safety.

11
Multinational Corporations

SUMMARIZING OUTLINE
This chapter defines and characterizes the multinational corporation and explains its impact in the global
economy, particularly in less developed nations. Then, the chapter discusses efforts to control the power by
multinationals, including the development of international codes of conduct. Two codes, the OECD
Guidelines for Multinational Enterprises and the United Nations Global Compact, are discussed at more
length as specific examples. Efforts to use the Alien Tort Claims Act as a restraint on multinational
corporations are also explained. Finally, a case study about the Union Carbide Corporation in India allows
discussion of the responsibilities of multinationals.

The introductory story is a sketch of Coca-Cola Company as a multinational corporation.

Although headquartered in the United States, the company gets 75 percent of its sales in
200 foreign countries.

It spreads its operations internationally primarily by licensing bottlers.

It is attacked by progressive and labor activists who accuse it of human rights and
environmental abuses.

To maintain its legitimacy, it undertakes an array of corporate responsibility activities and


aspires to comply with multiple international codes of conduct.

A multinational corporation (MNC) is an entity headquartered in one country that does business
in one or more foreign countries.

MNCs vary greatly in their strategies and structures. Overall, there are five tiers of
internationalization that represent alternative ways to extend business into foreign markets.
These are export sales, licensing, foreign sales offices, foreign direct investment, and
global production.

The United Nations calculates there are today about 82,000 transnational corporations
(defined as parent firms that control the assets of affiliated entities in foreign countries)
and they have 807,000 foreign affiliates.

One method of measuring the multinationality of a corporation is to calculate its


transnationality index, which is the average of three ratios: foreign assets to total assets,
foreign sales to total sales, and foreign employment to total employment.

The story of Weatherford International illustrates how multinational corporations can


loosen the bonds of attachment to their home country by operating through foreign
affiliates.

The best measure of the power and activity of multinationals is foreign direct investment, or
funds invested by an MNC for starting, acquiring, or expanding an enterprise in another nation.

MNCs make foreign direct investments to enter markets, to grow by expanding beyond
small domestic markets, and to lower production costs by creating cross-border value
chains.

Most FDI goes to developed countries, but FDI in less developed countries is significant
because it can have a great impact on local economies. Progressive activists believe that
this impact is often very negative and have sought to limit the power of MNCs.

International codes of conduct are voluntary, aspirational statements of standards for MNC
foreign operations. They are proliferating. One study identified 246.

In 1977 the Rev. Leon Sullivan, an American minister, created a code of conduct requiring
multinational corporations in South Africa to do business in a nondiscriminatory way. This
pioneering effort inspired later codes.

Codes come from corporations, industries, business groups,


organizations, governments, and partnerships of stakeholders.

Two of the most prominent international codes are discussed as examples.

nongovernmental

The first is a set of guidelines from the Organisation for Economic Co-operation and
Development, the OECD Guidelines for Multinational Enterprises.

The Guidelines are recommendations to be taken into account by multinational


corporations headquartered in the 33 OECD nations and 11 other participating
nations.

They consist of 11 general policies supplemented by more detailed guidelines.

There are no sanctions for violating them. However, a formal process exists to resolve complaints
and encourage compliance.

The story of one corporation, Vedanta Resources, is used as a case study of the
strengths and weaknesses of the Guidelines.

Vedanta, an Indian company headquartered in Great Britain, was accused of


violating the human rights of an indigenous people in India where it wanted to
build a mine. An NGO filed a formal complaint that it had violated the
Guidelines. This complaint was upheld, but Vedanta disagreed and could not be
penalized. However, partly as a result of the complaint, the government of India
stopped construction of the mine.

The most conspicuous effort to promote MNC social responsibility is the United Nations
Global Compact.

The Global Compact requires corporations to carry out a set of 10 principles


based on established and emerging global norms. More than 6,500 corporations
had volunteered to join by 2011.

It is supported by six United Nations agencies and administered by an office in the


Secretariat.

Member corporations agree to report each year their progress in carrying out the
Global Compact principles. A sampling of these reports is given.

Critics believe that while the Global Compact has succeeded in enrolling large
numbers of multinational corporations it has not fundamentally elevated global
corporate responsibility. They want more demanding standards that challenge
corporations.

Activists seek to use the Alien Tort Claims Act to apply elevated standards of human rights, labor
rights, and environmental protection to the actions of MNCs in developing nations.

This is a 1789 law permitting foreign citizens to litigate alleged violations of


international law in United States federal district courts.

Most litigation under the Alien Tort Claims Act has failed. The story of the
Drummond Company, sued by widows of murdered union leaders in Colombia, is
told to illustrate a specific case. A jury found the company not guilty of violating
human rights laws.

Despite repeated failures progressive lawyers and labor unions continue to test
various legal theories under which allegations against multinational corporations
might be upheld under the Alien Tort Claims Act.

Note

Case

UNION CARBIDE CORPORATION AND BHOPAL


The case of Union Carbide and the Bhopal gas leak is a classic. Its dramatic elements keep it alive in the
curriculum. Today, we can look back and understand the full scope of the tragedy, the consequences for the
company and the people of India, and the changes in the business environment that followed.

Answers to Case Questions


1. Who is responsible for the Bhopal accident? How should blame be apportioned among
parties involved, including Union Carbide Corporation, UCIL, plant workers, governments
in India, or others?

A range of parties are implicated.

Union Carbide senior management. Immediately following the gas leak CEO Warren
Anderson accepted moral responsibility for it. However, as noted in the case, the plant
was run by Union Carbide India Limited, a subsidiary with considerable autonomy. In an
article analyzing Bhopal as an industrial accident, S. Prakash Sethi criticized Union
Carbides American managers for underestimating the risks of introducing an
inappropriate, complex, dangerous industrial technology into the Indian setting.1 The
abstract principle that managers can delegate authority but not responsibility imposes
ultimate responsibility for the tragedy on top management.

Union Carbide India Limited managers. The subsidiary oversaw of plant operations.
Managers might have been more attentive to the risks posed by lower training standards,
operating economies, staffing cuts, deferred maintenance, and processing shortcuts.
Managers at this level bear some responsibility for complacency. In 2010 an Indian court
convicted seven UCIL managers of causing death by negligence, giving them two-year
sentences. They have appealed.

Workers at the MIC unit. If one worker acted as a saboteur, he or she bears grave
responsibility. If the Indian governments water washing theory is correct sloppy work
contributed to the accident. Plant workers were too low in the company hierarchy to see
flawed management controls. They may have been too poorly trained to appreciate safety
risks. They had little influence over policy. Some of them can be criticized for running
from their stations and appropriating for their getaway buses that could have been used in
evacuating nearby neighborhoods.

Bhopal community officials. The city of Bhopal was lax in enforcing residential codes to
prevent slum dwellers from settling near the plant. Perhaps it was remiss in not requiring
the plant to move away from the dwellings. Homes crowded the plant, violating the codes.
Plant officials were never vocal about risks. Holding the poor responsible in any way for
their ill fortune seems uncharitable.

The state and federal governments. The federal government, through the Foreign
Exchange Regulation Act of 1973, prohibited American managers from running the plant.
Madhya Pradesh, one of the poorest states in India, provided incentives for the plants
construction and later encouraged building the methyl isocyanate production unit that
made the plant more dangerous than when it simply formulated pesticides from shipped-in
ingredients. Environmental and safety agencies were overwhelmed. At the time of the gas
leak they had insufficient staffing and inadequate equipment to inspect industrial facilities.

1
103.

S. Prakash Sethi, Inhuman Errors and Industrial Crises, Columbia Journal of World Business, Spring 1987, p.

2. What principles of corporate social responsibility and business ethics are applicable to
the actions of the parties in question?
Corporate social responsibility is defined in Chapter 5 as the duty a corporation has to create wealth by
using means that avoid harm to, protect, or enhance societal assets. Ultimately, Union Carbide Corporation
and its subsidiary, UCIL, did not live up to this standard.
In Chapter 5 it is noted that responsibility varies with company characteristics, including the kind of
industry and location of facilities. In hindsight, closer monitoring and higher safety standards were
necessary for a dangerous pesticide plant in a less-developed nation.
Union Carbide Corporation was seen as a highly responsible corporation before Bhopal. Worldwide, it had
perhaps the most stringent environmental and safety standards in the industry. After the gas leak, it tried to
help the residents of Bhopal recover, but many of its most constructive efforts were rejected.
Many ethical principles are applicable. One that leads to a revealing ethical analysis is Aristotles theory of
ethical responsibility. According to Aristotle, a person (or a corporation) is responsible for the rightness or
wrongness of their actions. However, two factors--ignorance or incapacity---excuse or diminish
responsibility. Was Union Carbide ignorant of conditions and risks at the Bhopal plant? Having delegated
operation of the plant to UCIL and removed Americans from the facility to comply with Indian law,
American managers probably knew little about its operations. Can this be defined as purposeful ignorance?
Managers at UCIL must have or should have known the details. Should they have reported to Union
Carbide? Was Union Carbide incapacitated in any way from acting to reduce risks? Aristotle allowed that
some factors create incapacity. In this case it might be argued that the Foreign Exchange Regulation Act of
1973 was an external force that prevented the American company from taking more responsibility. It lacked
the power to intervene. If so, its ethical responsibility is eliminated.

3. How well did the legal system work? Do you agree with the decision to try the lawsuits in
India? Were victims fairly compensated? Was Union Carbide sufficiently punished?
Initially, American attorneys were criticized for unseemly haste in their rush to sign up Indian plaintiffs for
cases to be heard in the United States. These attorneys defended their actions as necessary to get justice for
gas victims and to establish the precedent of holding U.S. multinationals accountable in U.S. courts for
actions in host countries. Of course, they stood to gain from contingency fees if the cases went to trial.

The cases filed by American attorneys were consolidated in New York, where a federal district court
dismissed them on the grounds of forum non conveniens.2 This is a legal principle that allows a court to
decline jurisdiction when an alternative trial forum is more convenient. On a practical level, the decision
made sense. Witnesses, records, and evidence were in India. Indian law was probably applicable. Travel
costs would be reduced. This outcome was a great victory for Union Carbide Corporation. In India, court
awards for the value of a life and for injuries were much lower. The Indian government also won, because it
wanted to press the case against Carbide in India to stand tall before the world. The big losers were the
American attorneys, who were barred by the Indian government from representing plaintiffs in India. In his
opinion Judge John F. Keenan commented about these lawyers, remarking that they did little to better the
American image in the Third Worldor anywhere else.3
In 1986 the Indian government brought its case against Union Carbide Corporation in a Bhopal court. The
legal maneuvering between 1986 and 1989 was convoluted. It was probably most trying for Carbide. In
brief, it involved the following events.

The Indian government sued only the U.S. corporation and not the Indian subsidiary, under
a novel legal theory without precedent in international law.

Five supervising Indian judges came and went, a remarkable turnover.

In 1987, the Indian Supreme Court issued a bizarre ruling, handed down by a justice on
the day he retired, that set a legal precedent moving beyond strict liability to a theory of
absolute liability under which Union Carbide Corporation would be held responsible for
the gas leak no matter what had happened.4

One judge held that Union Carbide Corporation must pay $270 million to the gas leak
victims ahead of any finding of liability. This was later overturned by a higher court.

Union Carbide tried to build credibility for the sabotage theory by having a paper on it
presented at an engineering conference.

In re Union Carbide Corporation Gas Plant Disaster at Bhopal, India, 634 F.Supp. 842 (S.D.N.Y., 1986).

Ibid., at 844.

4 M. C. Mehta v. Union of India (1987) 1 SCC 395. The reasoning in the Mehta decision was this. Existing theories
of strict liability for inherently dangerous or hazardous activity, derived in English common law from Rylands v. Fletcher, L.R.
3 H.L. 330 (1868), evolved in the nineteenth century in a different economy in which science and technology were less
sophisticated. Now a new theory of liability was needed. It was all right for an Indian court to depart from internationally
accepted theories of common law because the time had come for India to build a new principle to deal with the unusual
circumstances arising from the operation of dangerous industries.

The eventual $470 million settlement was a victory for Carbide. It capped liability, was affordable, and let
the company emerge from the shadow of uncertainty. Death and injury benefits were not great by American
standards, but exceeded Indian standards.
Union Carbide issued a fact sheet defending the settlement in these words.
The final settlement is many times larger than any damage award in the history of India. It is also
$120 million more than the settlement accepted in a U.S. court by U.S. attorneys for Indian
victims. U.S. attorneys... ultimately told the U.S. court that $350 million was a fair settlement. The
Supreme Court of India ruled that the $470 million settlement was just, equitable, and
reasonable.... The invested settlement will provide major benefits for the victims, whose average
yearly income is less than $300 a person... On May 4, 1989 the Supreme Court of India...
emphasized that the compensation levels provided for in the settlement were well in excess of
those which would ordinarily be payable under Indian law.5

Was the company sufficiently punished? The answer depends on the extent of its responsibility, since a
central guideline of retributive justice is that the punishment be proportional to the crime. Students may
wish to debate this issue. Union Carbides payout was far less than the two other big corporate payouts of
the late 1980s ordered by American courts for wrongful death and injury.

It was $2,105,000,000 less than the $2,575,000,000 paid into a trust fund by Johns
Manville Corporation in 1988 to settle an estimated 100,000 asbestos illness claims (and
the company was also committed to contributions from future profits).

It was $2,005,000 less than the $2,475,000,000 put into a trust fund by A. H. Robins in
1989 to pay approximately 200,000 women injured by the Dalkon Shield.

Since no trial was held, the world cannot know what theory of causation would have been accepted by a
jury once all evidence was presented. A jury verdict would have affixed legal responsibility for the accident.
A shortcoming of the overall legal process was delay in getting compensation to victims, but had the case
gone forward, Indian authorities estimated twenty years to completion of trial and appeals in Indias court
system. This would have meant greater delay.
Ultimately, Bhopal exhausted the company. Repercussions from the gas leak, playing out over many years,
turned it into a smaller, weaker player. It was forced to sell profitable brands and businesses. It no longer
held its own in global competition. In 2001 Dow Chemical absorbed it in a merger.

Bhopal Settlement and Aid to Victims, Danbury, Conn.: Union Carbide Corporation, undated, p. 3.

4. Did Union Carbide handle the crisis well? How would you grade its performance in
facing uniquely difficult circumstances?
The case study details some actions taken by Union Carbide Corporation immediately following the gas
leak. In fact, the company did much more. A company fact sheet in 1985 described many more activities in
four pages of single-spaced entries. Included are long-term relief efforts designed to provide housing, jobs,
medical rehabilitation, and humanitarian relief to the people of Bhopal. Unfortunately, for political reasons,
much of Union Carbides largess was rejected because Indian officials thought it was tainted. But the
company carried through with humanitarian aid programs where permitted.
After the tragedy, Union Carbide adopted new, strict guidelines on safety and environmental protection.6 A
special committee monitored safety codes and practices. Environmental and safety compliance audits were
conducted. A corporate vice president of environmental affairs was appointed. Between $300 and $400
million annually were spent on plant safety in the years following Bhopal.

5. Does Dow Chemical Company have any remaining legal liability, social responsibility, or
ethical duty to address unresolved health and environmental claims of Bhopal victims?
When Dow Chemical absorbed Union Carbide as a subsidiary it took on the risk of any remaining legal
liabilities and, presumably, the obligation of any remaining social and ethical duties.
Organized groups of gas victims are tireless in pressing claims. Dow Chemical is just as tenacious in
denying responsibility of any kind. It makes several arguments. It never owned or operated the Bhopal
plant. No Indian assets were involved in its merger with Union Carbide. All legal claims against Union
Carbide were resolved before the merger. Implicitly, it argues that all responsibility to the Indian
government and the gas victims ended when legal responsibility ended.
Victims try in various ways to reopen legal proceedings. One recent claim is that Dow may have violated
international human rights laws. A report by Amnesty International sets forth the argument. It says that
beyond nations, every individual and every organ of society bears responsibility for protecting and
observing the human rights of all persons.7 These rights are found in the Universal Declaration of Human
Rights, United Nations treaties, treaties between nations, and international law. Specifically, Amnesty
International argues that Dow Chemical is responsible for violating the following rights of Bhopal victims
and under international human rights law it must take responsibility for and correct, where possible, these
violations.

6 Marc S. Reisch, Carbides Kennedy Expresses View on Industrial Safety, Other Issues, Chemical & Engineering
News, May 13, 1991.
7 Amnesty International, Clouds of Injustice: Bhopal Disaster 20 Years On (Oxford, U.K.: Alden Press, 2004), p. 28.

The right to life was violated by the gas leak.

The right to the highest attainable standard of health is violated because medical problems
continue.

The right to a remedy is violated because victims have not received adequate
compensation.

The right to an adequate standard of living is violated because many victims, already poor
at the time of the gas leak, are now less able to earn a living.

The right to freedom from discrimination is violated because women exposed to the gas
have been stigmatized. They have difficulty finding husbands. Men are reluctant suitors
because they fear these women cannot have children, that their future health will be fragile,
and that they will have expensive chronic illnesses.

The right to a safe environment is violated because the plant still contains contamination to
which Bhopal residents are exposed.8

Some students may argue that former CEO Warren Andersen has an obligation to appear in an Indian court
on the culpable homicide charge.
All threads of legal liability leading from India back to Dow Chemical are weak. Still, the question of
responsibility beyond the law hangs in the air. Students can discuss whether any principle or theory of
ethics or any guideline for social responsibility is persuasive. If Dow Chemical wanted to help the victims
as an act of either responsibility or charity, it could easily find an ethical argument to justify action. In the
end, it does not want to allow any crack in the closed case that might expose it to more legal liability.

8 These alleged human rights violations and the sources of the standards or treaties they violate are set forth in Ibid.,
chapter 2.

6. What lessons can other corporations and countries learn from this story?
Some lessons can be learned from Bhopal.

The early and continuing efforts to place blame for the accident on Union Carbide
Corporation underscore the elementary principle that managers may delegate authority, but
cannot delegate responsibility. A large American corporation will be held responsible for
any disaster connected with its operations.

Crisis and evil can befall even the best-intentioned companies. In the early 1980s Union
Carbide was viewed as progressive by environmentalists and had done more than other
large companies. It was making the pesticide Sevin in India rather than the DDT some
competitors made there because Sevin was regarded as less environmentally damaging.

Responsible corporations with operations that pose catastrophic risks cannot be even a
little bit lax about environmental and safety concerns. The Responsible Care program
adopted by the chemical industry after Bhopal reflects learning of this lesson.

Events following the accident illustrate again (as with, for example, A. H. Robins and
Johns Manville) that existing legal mechanisms are inadequate to provide reasonably
prompt compensation when corporate activity injures and kills many people.

Multinational corporations are morally and (probably) legally responsible for


environmental and human rights impacts of foreign facilities they invest in, even if they
have no direct management responsibility. Bhopal was the event that taught this lesson.

1
2
Globalization, Trade, and
Corruption
SUMMARIZING OUTLINE
This chapter covers three broad, interrelated topicsglobalization, trade, and corruption. It begins with a
story about McDonalds Corporation to illustrate how one multinational company both influences and
adapts to national cultures. Then it defines globalization and sets forth main forces that contribute to it. It
explores international trade as the mainspring of globalization. After a brief history of trade since 1800 the
discussion focuses on the creation and evolution of the Bretton Woods institutions and their role in trade
expansion since 1945. Free trade theory is explained. Issues raised by preferential trade agreements and
protectionist forces are discussed. The last section discusses types of corruption, international efforts to
fight it, egregious examples of corporate bribery, and guidelines corporations can use to prevent corrupt
actions.

The introductory story is about McDonalds Corporation.

McDonalds grew from a small hamburger stand in southern California to a transnational


corporation with restaurants in 117 nations and an internationally recognized brand.

The spread of its operations exposes it to cultural differences. It is a lightning rod for
critics who believe in American cultural imperialism.

Though some believe that McDonalds is an agent spreading pernicious American values,
the truth is more complex. The story gives examples such as the following.

Anthropologists document McDonalds impact. It introduced practices that spread


in Asian nations, including clean restrooms and birthday celebrations for children.

Local entrepreneurs with McDonalds franchises in France, China, and Saudi


Arabia have adapted their menus and serving policies to reflect local customs.

Globalization occurs when networks of economic, political, social, military, scientific, or


environmental interdependence grow to span worldwide distances. It is an ancient, enduring
process driven now by a set of interacting forces, among them technologies, international
institutions, economic development, and the rise of a vibrant civil society.

The KOF Globalization Index measures trends in economic, political, and social
dimensions of globalization. This index shows a pronounced rise in globalization since
1970.

Almost uniformly, nations and areas are becoming more globalized, but rates differ. Two
countries at opposite ends of the globalization index, Belgium and Niger, are compared on
multiple measures, revealing a wide gap.
The mainspring of globalization is trade.

Before 1800, the world economy grew very slowly and trade was limited.

The dominant trading nations were the rich nations of Europe that based their economies
on mercantilism, or the policy of increasing national power by creating trade surpluses.
These nations exploited colonial empires.

After the Industrial Revolution England lowered protective trade barriers. Other nations
followed and global trade grew remarkably.

The run of free trade ended with World War I, which inflamed national rivalries and led to
rising tariffs (taxes or duties charged by governments on goods moved across a border)
and, in some cases, policies of autarky (reduction or elimination of trade to promote
national sufficiency and independence).

After World War II the victorious allies, particularly the United States, resolved to set up
institutions that would open nations to trade and bring global economic growth. Their plan
came to fruition at a postwar meeting in Bretton Woods, New Hampshire.

A new World Bank was created to overcome capital shortages.

An International Monetary Fund was created to stabilize exchange rates.

A General Agreement on Tariffs and Trade (GATT) set up a process through


which nations could conduct multilateral trade negotiations, or talks in which
multiple nations seek consensus on an agreement that will apply equally to all. The
GATT was based on two key principles.

The most-favored-nation principle is that if one participant extends any


benefit to another, that participant must extend the same benefit to all.

The national treatment principle is that once inside a domestic market


foreign goods must be given equal treatment with local goods.

Eight rounds of multilateral trade negotiations were completed under the GATT
framework.

More nations entered the process as time went on. Major tariff cuts were
achieved and world trade greatly expanded.

In the last round participating nations created a new international


institution, the World Trade Organization (WTO), to succeed GATT.

The WTO is a framework for trade negotiations. It has 153 member nations. It
provides a stable platform for resolving trade disputes. However, it has been
unable to complete another multilateral trade round known as the Doha Round.
There are many reasons.

Developed countries are unwilling to abandon protective trade barriers for


agricultural products, frustrating less developed countries that hope for
more agricultural exports.

Less developed countries feel rich nations took advantage of them in


previous trade rounds, particularly in imposing expansive requirements
for protecting intellectual property rights.

Membership has expanded, making it more difficult to reach a multilateral


consensus.

With increasing trade from developing nations the United States and its
European allies have lost the power to impose their will on the global
trading system.

In addition to membership in the WTO, nations also enter regional trade


agreements with one or more other nations. In 2011 there were 290 such
agreements.

Many are free trade agreements in which member countries eliminate


import duties and other barriers to trade with each other, but maintain
them for imports from nonmember countries.

Others are customs unions that form a free trade area and impose a
common external tariff on imports from nonmember nations.

Some trade experts believe that regional trade agreements, because they
discriminate against nonmember countries, undermine the goal of a world
trading system based on the most-favored-nation principle.

Free trade and protectionism are discussed.

Free trade is a philosophy that recognizes the law of comparative advantage, which is
that efficiency and the general economic welfare are optimized when each country
produces that for which it enjoys a cost advantage.

Protectionism is the use of trade barriers to shield domestic industries from foreign
competitors. There are four reasons for the practice.

Governments use trade barriers to reduce unhealthy trade deficits.

Trade barriers often accompany industrial policy, or government policies to shape


national economies by promoting certain companies or industry sectors.

Countries use trade barriers to retaliate against other countries that have used
unfair trade tactics.

Tariffs are important sources of revenue for some governments.

Overall, the United States, despite its strong free trade rhetoric, indulges in hundreds of
tariffs, quotas, import prohibitions, and Buy American laws.

Despite the long-term trend toward freer trade, protectionist deviations from free trade
policy are common. Examples are given from Japan, China, South Korea, and other
nations.

Corruption is defined as the debasement of integrity for money, position, privilege, or other selfbenefit. It is a widespread trade barrier.

Corruption raises the costs of doing business and distorts the operation of markets.
According to the World Bank, corrupt expenditures are 5 percent of global GDP.

A spectrum of corruption exists. From one end to the other they include these basic
categories. Examples of each are given.

Facilitating payments are small amounts of money demanded by minor officials


to do their duties.

Subtle bribes are endemic and routine in less developed nations. These usually
discrete bribes shade into open bribery that is less disguised and less modest.

Major and extortionate bribes are requested and paid in some of the worlds
most corrupt nations.

For corruption to exist there must be both demand and supply. Transparency International
country indexes show wide variation in perception of the likelihood of corrupt demands
and the likelihood of payments being provided.

Corruption has grown along with trade volume, but international efforts to reduce
corruption have expanded with globalization.

The Organisation for Economic Co-operation and Development has called on


member nations to pass laws punishing bribery and requiring corporations to keep
better records of financial transactions.

The United Nations, the World Bank, and the International Monetary Fund have
adopted anti-corruption measures.

In the United States the milestone law for fighting corruption is the Foreign
Corrupt Practices Act of 1977. Recently, enforcement has been stepped up. The
basic provisions of this law are set forth.

It is both a civil and criminal offense to bribe an official of a foreign


government or ministry, or a member of a foreign political party or
candidate for office.

Bribery is making or offering to make a payment of money or anything of


value with the corrupt intent to influence any official act or decision in
favor of a companys business.

The law applies to the actions of U.S. executives and corporations


anywhere in the world. Foreign corporations can be prosecuted if they are
listed on U.S. stock exchanges, pay illegal bribes in U.S. territory, or use
U.S. mails or telecommunications in corrupt transactions.

Facilitating payments intended only to expedite routine government


action are permitted under the law.

Bribes paid to managers of one corporation by managers of another are


legal under this law but may be illegal under fraud statutes in most
nations.

Basic actions corporations take to prevent corrupt payments include these.

Establishing policies against bribery.

Setting up ethics and compliance programs.

Training employees to recognize problems and follow policies and laws.

Studying business climates of countries and potential partners or agents before


entering foreign markets.

Note
156.

Case

DAVID AND GOLIATH AT THE WTO

This case relates the story of a trade dispute between the United States and the Carribean nation of Antigua
and Barbuda (hereafter Antigua). The United States signed a multilateral trade agreement, the General
Agreement on Trade in Services (GATS), that the World Trade Organization (WTO) said required it to open
its borders to online gambling enterprises sheltered by the Antigua government. Doing so would make the
United States a huge market for foreign companies offering forms of online betting that American firms
could not legally offer. After four years of fighting, the United States lost its case. Refusing to open its
borders to the online betting parlors, it has opened itself to retaliation.
The case illuminates the WTO procedure for resolving trade disputes. It also invites a debate about online
gambling.

Answers to Case Questions


1. Was Jay Cohens conviction justified?
Jay Cohen was a citizen of the United States charged with violating its laws. He was arrested and tried in
the United States, where the government of Antigua had no jurisdiction. His actions were fairly
straightforward violations of the Wire Wager Act of 1961 that prohibit using wire communications for
betting within the United States or between the United States and a foreign country.
Jurors were not moved by his basic defense, that a foreign government sanctioned what the United States
made criminal. He showed courage in returning from Antigua to U.S. soil so that the clash between
domestic laws and international trade rules could be resolved.

Critics of the WTO complain that, through its auspices, these international trade rules are allowed to
override domestic laws and regulations, particularly environmental regulations. Not in this case. The United
States chose to defy the WTO and adhere to its domestic gambling laws.

2. Do you concur with the decisions of the World Trade Organization in this case? The
panel report? The appellate decision? The arbitration ruling?
The WTO delivered three decisions.

In 2004 a dispute panel held that the United States had violated its obligations under the General
Agreement on Trade in Services. It said the United States had committed itself to opening its
borders to international gambling services. Yet even as the United States allowed certain forms of
gambling it criminalized cross-border Internet gambling. This was an illegal trade restriction. The
decision is correct based on a literal reading of the GATS schedule. In that sense it is effortless to
agree with its logic. On the other hand, conformity to GATS would counter a long-standing body of
domestic American laws that balance polarized views on gambling by allowing it in some forms
and prohibiting it in others. The United States felt it had the sovereign right to uphold laws that
were long-standing and necessary to protect American morality. It appealed.

In 2005 an appellate body again rejected the U.S. argument, although it agreed that gambling laws
might be necessary to protect against immoral behavior. Still, since the United States allowed
domestic betting parlors to take bets on horse races over the wires but not foreign bookmakers it
was clearly in violation of the national treatment principle in GATS (which requires equal
treatment of foreign and domestic services within the each signatory nations markets).

At this point the United States was given a year to comply with the WTO rulings. It could do so in two
ways. It could change its laws to permit cross-border Internet betting. Or it could ban all domestic online
gambling, specifically, horse racing. It did neither. Instead, Congress defied the WTO by passing the
Unlawful Internet Gambling Enforcement Act of 2006 to block bank payments for online bets, with the
exception of horse racing bets. The United States also withdrew its commitment to allow cross-border
betting services under GATS. This is permitted, but when it occurs trading partners can request retaliation
to make up for lost trade revenues. Antigua requested retaliation, leading to a third decision by a WTO
arbitration panel.

In 2007 the arbitration panel issued a ruling allowing Antigua to retaliate against the United States
by copying and selling annually up to $21 million of trademarked and copyrighted music, films,
and software. It was authorizing a rare form of cross retaliation. The argument for this decision is
that the United States, like other nations, should be held to its formal commitments. Otherwise, the
international trading system would break down. The argument against the panel ruling is that
pirating digital products is an international problem and this legitimizes the practice.

3. Should Antigua and Barbuda have the right to retaliate against the United States by
exporting copyrighted entertainment material? Is that a bad precedent?
The WTO seeks to facilitate negotiated agreements between disputants. When mutually acceptable
agreements are not reached, member nations take their disagreements to the formal dispute resolution
process. After a lengthy semi-judicial process WTO bodies issue a ruling. The WTO has no power to
enforce its rulings. It has no police powers and no authority to fine its members. It can, however, give
nations the right to retaliate against other nations that refuse to accept a WTO ruling.
Ordinarily, retaliation takes the form of imposing or raising tariffs on products or services. The nation
harmed by another nations use of prohibited trade barriers can impose concessions equal to the damages it
has suffered or continues to suffer while the other nation refuses to comply.
Antigua sought to impose concessions worth $3.44 billion a year, an amount it said matched the level of
nullification or impairment of benefits accruing to Antigua and Barbuda as compensation for lost internet
gambling revenue.1 This amount was determined in an economic study commissioned by the government
of Antigua. The United States countered that this amount was a figure more than three times the size of
Antiguas entire economy and was patently excessive2
The Antigua figure was based on assumptions that the United States gambling market would have been
completely open and that Antiguas betting businesses would have gained a percentage of that open market
equal to their percentage of the world market. The WTO did not accept these assumptions. It ultimately
ruled that the island nations lost online gambling revenue was only $21 million a year, less than 1 percent
of what Antigua sought.
Ordinarily, a nation authorized to retaliate must seek concessions under the same trade agreement that the
nation retaliated against has violated. Since the United States violated its obligations under the General
Agreement on Trade in Services (GATS), Antigua could raise tariffs or other barriers on imports of
American services. However, since imports of services into the tiny Antiguan economy are so limited, this
would not have raised $21 million in annual revenue.
Therefore, the WTO arbitration panel gave Antigua the right to engage in cross-retaliation, that is, to seek
concessions under another trade agreement. In this case, Antigua was allowed suspend its obligations under
the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS). Specifically, it was
authorized to violate the intellectual property rights of American corporations by duplicating copywritten
films, music, and software. Under WTO rules, neither country can appeal this decision.

1 World Trade Organization, United States: Measures Affecting the Cross-Border Supply of Gambling and Betting
Services, II.A.2.3.
2 Statement on Internet Gambling, Office of the United States Trade Representative, Press Release, December 21,
2007.

The New York Times reported the decision under the headline In Trade Ruling, Antigua Wins a Right to
Piracy.3 Since the ruling the United States and Antigua have been in talks about its implementation. U.S.
trade representatives have argued that trademark and copyright infringement will undermine Antiguas
efforts to market itself as a legitimate base for electronic commerce. Antigua has not yet acted. If it does,
one way the United States can fight is to question the monetary value of any product duplication. For
example, if Antigua claims that a certain number of copies of a Universal Studios film on DVD are worth
$100,000, the United States can challenge that amount, claiming the copies are worth more.
Trademark infringement also violates the Berne Convention for the Protection of Literary and Artistic
Works, an international treaty protecting copyrights. Both the United States and Antigua are signatories.
This treaty exists separately from trade agreements such as GATS and TRIPS. It could complicate matters
if Antigua begins to retaliate with copied or counterfeit products.

4. Should the United States have abrogated its commitment to gambling services under the
General Agreement on Trade in Services (GATS)? Did it have a better alternative?
Withdrawal of a commitment is permitted under Article XXI of the GATS treaty. The United States
probably needed to withdraw its commitment to treat imported gambling services, no less favorably
than domestic gambling services. It could never live up to this commitment. To do so would require revising
the laws of almost every state (or passing a preempting federal law) to either ban all online gambling or
permit it. Since there are strong forces both for and against gambling in domestic politics this is impossible.
To continue the commitment would only have seemed hypocritical and undermined American influence in
the WTO and in the multilateral trading system.

5. How can the dispute between the United States and Antigua and Barbuda be resolved
now?
Negotiations are ongoing between the countries. The United States is under pressure from entertainment
and software companies to prevent Antigua from pirating digital products. News reports indicate it is
seeking to negotiate a mutually agreeable annual sum of payments to Antigua.

6. Do you support the proposed Internet Gambling Regulation, Consumer Protection, and
Enforcement Act? Why or why not?
The answer depends on your views about online gambling. If enacted, the law would legalize online betting.
Online gambling sites would be licensed. They would report customers winnings to the Internal Revenue
Service.
In its favor, it would move online gambling into the open, bring in tax revenue, and free average people
from fear of prosecution for gambling in their living rooms. According to some, it would remove a
government infringement on personal liberty.

3 James Kanter and Gary Rivlin, December 22, 2007,

p. C13.

Those opposed, argue it would encourage compulsive or irresponsible betting by youth, alcoholics, drug
abusers, the mentally disabled, and other vulnerable members of society. It would harm families, breed
money laundering, and otherwise damage the social fabric. Operators of legal card clubs and casinos also
oppose the bill, fearing new online competition.
There are many forms of gambling and the case study discusses online gambling only as a trade issue.
Nevertheless, the following more general questions could lead to a lively discussion. Is gambling immoral?
Is it a socially responsible business? Is it primarily harmless entertainment? Does it ruin lives? Does it
foster crime? Does it elevate the cost of social services? Do its benefits exceed its costs? Is a continuing
ban on Internet gambling practical? While answers are a matter of opinion there are many studies of
gambling from which evidence can be found to support one side or another.

1
3
Industrial Pollution and
Environmental Regulation
SUMMARIZING OUTLINE
This chapter begins by briefly examining the history of pollution problems caused by human and industrial
activity, beginning with a story about the Hudson River. It explores the environmental consequences of
industrialization. Then it turns to the history of ideas about the relationship between commercial activity
and nature to show that while prominent ideologies of the past encouraged exploitation, newer ideas
encourage sustainability. Finally, the chapter surveys environmental regulation of industry in the United
States, discussing laws to protect air, water, and land.

The introductory story is about the contamination of the Hudson River with polychlorinated
biphenyls from General Electric factories.

Once a majestic example of natures efflorescence, the river was heavily polluted by the
rise of commerce and industry. Its history illustrates the course of industrial pollution
described in the chapter.

Under the federal Superfund law GE has spent more than $1 billion cleaning the river.
This is an example of the modern statutory and regulatory approach to environmental
protection explained in the chapter.

Pollution refers to the presence of substances in the environment that inconvenience or endanger
humans.

Pollution endangers human health. Pollution causes 11 percent of the disease burden in
less developed countries in contrast to only 1 percent in developed countries. Nonindustrial
pollution from feces in water and indoor fuel use in homes causes a far greater disease
burden than air and water pollution in industrial societies. As nations industrialize, they
reduce pollution dangers.

Industrial activity harms the biosphere. In particular, it degrades ecosystems, the


animated, interactive realms of plants, animals, and microorganisms that define areas of
the nonliving environment.

Such degradation inhibits ecosystem services, or the productivity of natural


ecosystems in creating food and fiber and in regulating climate, water, soil,
nutrients, and other forms of natural capital.

Economic growth has strained broad ecosystems. If industrial activity that


capitalizes on ecosystems is to continue and expand it must be modified to allow
sustainability.

Sustainable development is nonpolluting economic growth that raises standards of living without
depleting the net resources of the earth.

Newly developing nations do not follow this path, but research suggests that polluting
emissions follow an environmental Kuznets curve, or an inverted U-shaped curve.

Following this curve, pollution rises during early stages of growth, then levels off and falls
as public values about environmental quality change and institutions are better able to
regulate industry. Thus, growth can mitigate pollution damage.

Early in the history of Western civilization ideas emerged that encouraged humans to dominate
nature and consume resources.

The Bible told that God created nature, then man, and instructed man to subdue the earth
and to take dominion over its living creatures. This Judeo-Christian perspective laid the
foundation for the view that humans were separate from and superior to nature.

In the seventeenth century, Ren Descartes set forth a theory of dualism that reinforced
this biblical view. He held that humans were separated from nature by their powers of
reason and because they had souls.

During the early industrial revolution economic expansion was reinforced by popular belief
in progress, or the idea that history was a narrative of improvement.

The theory of capitalism valued nature primarily as a commodity to be used in wealthcreating activity.

The ethic of utilitarianism, or the greatest good for the greatest number, was used to
justify industrial growth as the greatest good, despite obvious costs and harms.

In the last third of the twentieth century new ideas emerged to challenge human dominance of
nature.

Aldo Leopolds land ethic is that humans are members of a broad community of
interdependent parts of nature and have duties toward other entities including the land,
plants, and animals.

The deep ecology of Arne Naess holds that human domination of nature must cease. All
species have equal rights to coexist and flourish. The instrumental value given nature
under capitalism is wrong; nature has intrinsic value.

Peter Singer popularized the idea of speciesism, a prejudice in favor of the human species
and against other species that is akin to racism or sexism.

The dominant approach to industrial pollution control in the United States is application of
regulatory statutes to industrial activity. The Environmental Protection Agency (EPA) is a
massive regulatory agency responsible for most of the nations environmental regulation.

The three media for pollution are air, water, and land. Regulatory activity in each is reviewed.

Air pollution is a set of complex interrelated problems, each requiring different controls.
The Clean Air Act, as amended in 1990, is the primary air pollution control statute.

To control urban air pollution the EPA sets standards to curb emissions of six
substances called criteria pollutants. These are carbon monoxide, nitrogen
dioxide, sulfur dioxide, ozone, particulates, and lead. Over the past thirty years
aggregate emissions of these substances have fallen.

Hazardous air pollutants are chemical emissions that pose a risk of serious
illnesses such as cancer with small inhalation exposures. Regulation has greatly
reduced industry emissions, but the EPAs goal of less than a 1 in 1 million lifetime
risk from exposures is still unmet.

Acid rain, or the deposition of acids in rain or other precipitation, is caused by


releases of sulfur dioxide and nitrogen oxide, primarily by electric utilities. The
Clean Air Act set up an emission allowance trading program to reduce these
releases. Aggregate emissions of both substances have fallen and the program is
considered a great success.

Indoor air pollution is a serious problem. The EPA has little authority to regulate
it.

Pollution by ozone-destroying gases has thinned the ozone layer in the


stratosphere. The Montreal Protocol, a 1987 treaty, phases out the use of these
gases. The treaty is working. Emissions peaked in the mid-1990s and the ozone
layer will be restored sometime between 2050 and 2075.

Greenhouse gas emissions continue to rise, changing the chemistry of earths


atmosphere and raising risks of climate warming. No effective global mechanism
to reduce emissions of greenhouse gases exists. So far, the United States has made
only very limited efforts to reduce emissions.

Water pollution by industry is controlled under the Federal Water Pollution Control Act
Amendments of 1972, known as the Clean Water Act.

Under the authority of the Clean Water Act the EPA sets standards for levels of
pollutants permitted in water bodies, then issues permits to industrial point
sources setting allowable effluent levels. This permit system is called the National
Pollution Discharge Elimination System.

The EPA has had less success controlling effluents from nonpoint sources such as
farmlands and urban areas. Such sources are now the primary cause of impaired
water bodies. The Clean Water Act does not give the EPA proper authority to
control nonpoint pollution.

Land pollution from hazardous waste is regulated mainly by two laws.

The Resource Conservation and Recovery Act of 1976 gives the EPA authority
to manage hazardous waste. It is a strict, complicated law requiring expensive
compliance measures.

The Comprehensive Environmental Response, Compensation, and Liability


Act of 1980, better known as Superfund, established a program to clean up
abandoned toxic waste sites.

The law has brought effective remediation to many of these sites at great
expense. Other sites remain and high levels of spending will continue for
decades.

The story of the American Creosoting Co. site illustrates the nature of
remediation work, its expense, and benefit-cost issues raised by massive
Superfund projects.

Note
157.

Case

A WORLD MELTING AWAY


This case focuses on the fate of one species listed as threatened under the lawthe polar bear. This large
mammal is threatened now and likely to be endangered in the future because of Arctic warming. So the case
invites discussion of global climate change. Some students are skeptics of climate change. The evidence of
recent Arctic warming is presented in the case. The significance of this evidence can be discussed.
Climate change and the bears fate should be put in perspective. The bears plight is one illustration of
broad human impact on natural ecosystems. It has been suggested that we are living in a new epoch within
the Quaternary period. This new unit of geological time is tentatively named the Anthropocene epoch
because it is an age of planetary change effected by humans. 4 Though geologists have not settled on a
beginning date for an Anthropocene epoch, many would date it from the late eighteenth century when James
Watt invented the steam engine. Since then, humans have altered earths natural processes and terrain in
significant ways over a very brief instant in geological time.
Earths climate has changed before. The Quaternary period, which began 2.6 million years ago, has been
characterized by regular ice ages, each lasting 80,000 to 100,000 years. These changes in climate result
from irregularities in the earths orbit around the sun. Between these ice ages are brief interglacial intervals
lasting 10,000 to 15,000 years. We live now in one of these intervals, which has been labeled the Holocene
epoch.
Since the start of the Holocene epoch at the end of the last ice age about 11,000 years ago, Homo sapiens
has flourished in a stable, warm climate. After the Industrial Revolution, beginning only a little more than

4 See Paul J. Crutzen, Geology of Mankind, Nature, January 2002, p. 23 and Jan Zalasiewicz, et al., The New
World of the Anthropocene, Environmental Science & Technology, 44 (2010), 2228.

200 years ago, human activity has altered atmospheric chemistry in ways predicted to cause warming. This
could lead to a mass extinction in which species that are unable to follow a suitable, shifting climate band
become extinct. The polar bear would be one such species.
Can the polar bear be saved from extinction? Since habitat warming is the main cause of its peril, any
significant protective action is also an action that drastically reduces greenhouse gas emissions. Such an
action is improbable today.

Answers to Case Questions


1. Do you believe that polar bears are endangered as a species now or in the future? Why or
why not?
Survival of Ursus maritimus as a species is not currently endangered. In fact, its numbers increased
remarkably over the last 50 years after Arctic nations put strict limits on hunting. In the 1960s there were
only 5,000 to 10,000 of them in circumpolar regions. Now there are as many as 25,000 individuals in 19
somewhat distinct subpopulations, an impressive rebound. But the bear is on the precipice of decline. Of
the 19 subpopulations eight are declining, three are stable, and only one is increasing (the small MClintock
Channel population). Insufficient data is available to report a trend for the remaining seven.
Now climate warming is a growing threat to the polar bear. Since the 1990s its sea ice habitat has been
diminished by warming ocean currents and rising air temperatures. Climate scientists predict Arctic
warming will continue and, about 2050, summer sea ice will disappear. Polar bears have evolved to survive
by hunting seals in summer months on frozen oceans with large expanses of broken ice cover. If the
summer ice disappears their survival as a species will be endangered. They can move about on dry land
eating berries and birds eggs, but these terrestrial food sources do not provide enough energy for long-term
survival and reproduction. Their main food source, the ringed seal, also depends on summer sea ice habitat
and cannot survive on land.
When it listed the polar bear as a threatened species in 2008 the Fish and Wildlife Service said this about
endangerment.
We do not believe that the species is currently endangered, but we believe it is likely that
the species will become endangered during the foreseeable future given current and
projected trends... 5
The agency defined foreseeable future as 45 years, or three polar bear generations. Thus, it was
predicting likely endangerment of the species by 2053, about the time summer sea ice will disappear from
Arctic oceans.

2. What is the value of the polar bear to the United States? To humanity?
The polar bear has little direct, quantifiable economic value. Some tour businesses earn revenue by taking
travelers to see them. They attract visitors to zoos and museums. They have been used in advertising to sell
consumer products, perhaps most famously, Coca Cola. They are important as a source of income for
indigenous peoples in Arctic regions, where some hunting still is permitted. Canada, for example, allows
Inuit hunters to take 500 polar bears each year using a permit lottery. These natives can sell hunting rights
to trophy hunters or take bears for subsistence use. Inuits have average incomes of about $20,000 a year. A
bear hide can bring $2,500. The bones and skull can be turned into tools or saleable craft products. The
meat is edible. So a bear kill provides both income and subsistence to an Inuit family.6

5 U.S. Fish and Wildlife Service, Endangered and Threatened Wildlife and Plants; Determination of Threatened
Status for the Polar Bear (Ursus maritimus) Throughout Its Range, 73 FR 28249, May 15, 2008.
6 George W. Wenzel, Polar Bear Management, Sport Hunting and Inuit Subsistence at Clyde River, Nunavut,
Marine Policy, October 2010, pp. 2-3.

Extinction of the polar bear would, nevertheless, be a loss. Individuals could be kept and bred in zoos, but
the species would depart from the wild and with it an awesome example of natural selection. The Arctic
environment would lose its top mammalian predator, but here its chief prey species, the ringed seal, would
not flourish, having also lost its environmental niche. The disappearance of these species would be only an
immaterial, intellectual loss to most people.

3. Is it important that humanity act to save the polar bear? Why or why not?
It is not important to save the bear to prevent direct economic losses. It is not necessarily important to save
it simply to know it is still there. One argument for saving it is the self-interest of humanity. If the bears
ecological niche so changes that it cannot survive, that ecosystem change might bode ill for human survival.
Another argument is that humanity has a moral or spiritual duty to protect nature, its processes, its terrain,
its living elements, and its metaphysical essence. One student of the polar bear puts the arguments this
way.
[Polar bears] are the envoys from the real world sent to remind us of our obligations as stewards of this
planet and its fragile ecosystems. They stand for the eternal beauty of nature, for wildness,... [and] for
everything that human beings need to protect in order to survive.7

4. Can the bear be saved? What actions are required?


In theory the gathering forces that will endanger the polar bear can be blunted.

Predicted Arctic warming is the most ominous force. Arctic warming is associated with rising air
temperatures and warming sea currents. These, in turn, are associated with human activity
releasing carbon dioxide and other gases that trap more solar energy in the earths atmosphere. If
nations could agree to cut drastically emissions of these gases to preindustrial levels warming
might reverse. This will not happen.

Oil and mineral development in circumpolar regions has the potential to disturb the bears. Some of
the last and largest unexploited oil fields, containing as many as 50 billions barrels in United States
territory alone, now lie near and under Arctic oceans. As ice retreats development becomes more
attractive. Aircraft, ships, drilling sites, and oil spills can disrupt bears. Oil production could be
banned. This is unlikely while national economies are heavily dependent on oil. Besides oil,
geologists believe that ice retreat will uncover big deposits of iron ore and zinc.

As areas of ocean ice shrink new shipping lanes will open in Arctic seas, making them attractive as
trade routes. Shipping will increase. Exploitation of new routes would have to be limited to avoid
intrusion of tankers and cargo ships in bear habitat.

Chemical pollution of the Arctic food chain may be harming bear health. Removing organic
chemicals such as DDT from the Arctic food chain is impractical. But the risks they pose to species
survival are unknown and probably insignificant. No action is necessary or likely here.

7 Richard Ellis, On Thin Ice (New York: Vintage Books, 2009), p. 278.

Carbon particles from combustion are transported in the atmosphere to the Arctic where they fall
on snow or ice, decreasing reflectance and increasing heat retention. Large global reductions in
diesel exhaust are necessary to eliminate this deposition. They will not soon occur.

Tourism in areas populated by the bears is growing. It could be limited to avoid more disturbances.

Encounters between humans and bears will increase as more production workers come to oil fields
and more adventurers hike, ride, camp, and kayak in bear habitat. These encounters are most often
fatal to bears.

Hunting of bears continues. Each year about 2 to 3 percent of the bear population is killed by
hunters or in chance confrontations with humans. Hunting could be prohibited. Some countries
now do so, but in Canada there is strong political pressure to continue the Inuit cultural tradition of
subsistence hunting.
Bears cannot be moved to Antarctica, which is a rocky continent lacking the sea ice habitat they
need to survive. Bears can live and reproduce in zoos, so the species could survive in captivity in
small numbers. Captive breeding is suggested as an insurance policy for threatened species.8
Recently two hybrid bears, the offspring of polar and grizzly bears, were killed by hunters in the
Canadian Arctic.9 Such interbreeding is not a solution. The pizzlies, as they were called, would
not be finely adapted to either Arctic or forest environments and would be at an evolutionary
disadvantage.

5. Should more be done now? If so, what is feasible?


If Ursus maritimus is to be saved, it is prudent to do more now. Yet little is feasible. The action that would
help most, limiting global emissions, is beyond current human resolve. In the United States statutory
authority under the Endangered Species Act is inadequate to force even national emissions reductions. The
Clean Air Act does not mandate sufficient reductions.
As an alternative to regulatory action, plaintiffs emerged attempting to use federal nuisance law to curb
emissions.

The City of Kivalina, a small village in Alaska sued Exxon Mobil and other oil companies claiming
that the companys emissions were responsible for the global warming that was melting sea ice
protecting nearby shores from erosion. It claimed the emissions were a public nuisance and the
companies must pay to move the village. The case was eventually dismissed because the court felt
the issue was a political question not for the courts to decide.10

8 See D. A. Conde, et al., An Emerging Role of Zoos to Conserve Biodiversity, Science, March 18, 2011. Today
zoos and aquariums hold about 15 percent of threatened species worldwide.
9 Hybrid Bears on the Move, National Geographic, June 2011.
010 Native Village of Kivalina v. ExxonMobil, 663 F. Supp. 2d 863 (2009).

Mississippi Gulf coast property owners sued oil and chemical corporations for emitting greenhouse
gases that increased the ferocity of Hurricane Katrina and destroyed their property. A federal court
has given the plaintiffs standing to assert this claim, but it has not yet been tried.11 This case was
doomed by the Supreme Courts decision in the following case.

Eight states and the City of New York sued six electric power companies with power plants in
twenty states, arguing that greenhouse gas emissions from these plants contributed to global
warming that harmed human health and destroyed societal resources. The plaintiffs claimed the
companies should be held liable for damages under federal and state nuisance laws. In 2011 the
Supreme Court rejected the states argument, holding that global warming emissions should be
regulated by the EPA under the Clean Air Act, not by federal judges hearing nuisance claims.12

Such lawsuits have little promise. In the meantime, environmentalists slow oilfield development in Alaska
by litigating over oil exploration permits. They have also tried to shut down the 800-mile Trans-Alaska
Pipeline, arguing it is too old to operate safely. If it no longer operated, it would not be practical to produce
oil in northern oilfields.

6. Would the economic and noneconomic benefits of saving the bear exceed the costs?
The economic costs of saving the bear are both astronomical and incalculable. Poorer nations would have
to slow or halt economic development. China would need to cut its energy use drastically. Consumer prices
would rise in rich nations, threatening their economies with recession. As opposed to this sacrifice, the short
term economic benefits of saving the bear are as insignificant as an ice cube in the Arctic Ocean.
Noneconomic benefits, including moral satisfaction and aesthetic delight in the species are elite diversions
that would escape most of the worlds population.

11 Ned Comer, et al., v. Murphy Oil USA, et al. 585 F.3d 855 (2009).
212 American Electric Power v. Connecticut, No. 10-174 (2011).

1
4
Managing Environmental Quality
SUMMARIZING OUTLINE
The chapter begins with a story about health risks from diesel exhaust for people living near California
railyards. Chapter text begins with an explanation of the Environmental Protection Agencys two-part risk
analysis model. The first part is the four-stage, science-based risk assessment procedure. The second part is
the risk management process in which decisions are based on law, economics, politics, and ethics. Benefitcost analysis and the merits of alternative regulatory approaches are explained. The chapter ends with a
section describing management methods and strategic approaches that companies use to reduce adverse
environmental impacts.

The introductory story is about a complex of four railyards in Commerce, California.

The railyards saturate the air with diesel exhaust, a complex mixture of gases and
particles containing at least 40 chemical carcinogens.

Inhalation of diesel exhaust from the railyards exposes thousands of residents of


Commerce to cancer risks as high as 800 in a million. It exposes 1.3 million nearby
residents of Los Angeles to an elevated cancer risk.

The chapter text begins with a discussion of regulating environmental risk, defined as a
probability existing somewhere between zero and 100 percent that a harm will occur. To analyze
and manage risks, the Environmental Protection Agency uses a two-part model.

One part of this model is a science-based risk assessment process consisting of four steps.
The steps are illustrated mainly as they apply to assessment of cancer-causing substances.

Hazard assessment establishes a link between a substance and human disease.

Animal tests are often used to establish this link. Animals are exposed to
high doses, then dissected to check for tumors. The tests are criticized.
High doses and differences in animal physiology make relevance of test
results to humans questionable.

Epidemiological studies, or statistical surveys designed to show a


relationship between human health effects and environmental exposures,
also identify hazards. Although they measure dangers to humans directly,
they have low statistical power due to latency periods, multiple exposures,
and other problems such as inaccurate death certificates.

Dose-response assessment is a quantitative estimate of how toxic a substance is


to humans or animals at varying exposure levels.

The EPA usually assumes a linear dose response rate between risk and
exposure, meaning that risks rise in proportion to exposure amounts.

For most chemicals, regulators use extrapolation (or the inference of the
value of an unknown state from the value of another state that is known)
from high doses to predict effects on human populations at much lower
doses.

Some carcinogens have a threshold. That is, they do not produce tumors
at low exposures and pose no risk until the threshold exposure amount is
reached.

Exposure assessment is the study of how much of a substance humans absorb


through inhalation, ingestion, or skin absorption.

Risk characterization is an overall conclusion about the dangers of a substance.


It is usually a detailed, written narrative based on the weight of quantitative and
qualitative evidence.

Benzene is used as an example.

EPA policy is to regulate when risk to a human population exceeds 1 in


10,000.

The second part of the EPAs two-part model is risk management, or choosing how to
manage risks once they are characterized.

Control options are alternative methods for reducing risks. These include both
scientific and regulatory options.

Legal considerations include readings of environmental laws to see what actions


are mandated. Some laws allow decisions based on the best control technology.
Some allow moderate or reasonable risks. Others dictate controls to reach no-harm
levels.

Economic and social factors include analysis of costs and benefits and polling to
discover public preferences.

Cost-benefit analysis is the systematic identification, quantification, and


monetization of social costs and social benefits so they can be directly
compared.

It has certain advantages. For example, it forces consideration


and weighing of many factors, invites rational thinking, and
promotes efficiency by revealing marginal abatement costs.

On the other hand, it requires subjective, controversial


assumptions about monetizing the value of human life and
environmental features. Environmentalists believe it invites
unwise trades of environmental quality for economic benefit.

One method used for putting dollar amounts on environmental


goods is contingent valuation, a polling process that asks people
what sum they are willing to pay for untraded goods, such as an
environmental quality or feature. Responses are averaged to
calculate monetary value.

Methods of calculating the value of a statistical life are


controversial. The EPA now calculates it as the amount that
people exposed to pollution are willing to pay to reduce the risk of
premature death.

Regulatory options for controlling pollution risks lie on a


spectrum. At one end is strict control, at the other complete
freedom. The EPA uses the following approaches.

Command-and-control regulation introduces predictable, uniform standards


applied to all companies. It can be inflexible and expensive.

Market incentive regulation gives companies financial motives to reduce


pollution, allowing freedom to create cost-effective abatement methods.

Environmental taxes can be imposed on polluting emissions or products.


Some nations experiment with environmental tax reform, or the
substitution of revenues from taxes on pollution for revenues from taxes
on productive activities such as sales, revenue, or payroll taxes.

Emissions trading programs, sometimes called cap and trade programs,


allow the most efficient companies to cut relatively more pollution and get
the same emissions reductions as command-and-control regulation but at
lower cost. Such programs require the following steps.

Set an overall cap, or limit, on emissions of a pollutant.

Allocate permits (usually annual) to companies equaling the


emissions they are allowed to release.

Fine companies for polluting over their permit limits.

Allow companies to buy and sell permits on an open market.

Gradually lower the cap at scheduled intervals.

Cap-and-trade programs for greenhouse gases allow carbon offsets, or


projects that compensate for a companys greenhouse gas emissions by
eliminating the CO2 equivalent of those emissions from another source.

Such projects include planting trees, paying farmers not to till


their soil, and recovering methane from pig farms.

Environmentalists criticize offsets, comparing them with the sale


of indulgences by the medieval Church.

Information disclosure harnesses market forces by affecting consumer


perceptions and equity prices. An example of its use is the Toxics Release
Inventory, an EPA program that requires industrial facilities to disclose emissions
and spills of hazardous chemicals.

Voluntary regulation is regulation without statutory mandate, compulsion, or


sanctions. An example is Climate Leaders, an EPA program that invites
companies to set goals for reducing greenhouse gas emissions and report on their
progress.

There are many incentives and pressures for corporations to protect the
environment. Corporate environmental responsibility is most often a response to
external forces.

Proactive companies adopt environmental management systems. These systems


orchestrate methods and tools for aligning corporate strategies, policies, and
operations with principles that protect the environment.

ISO 14001 is a set of standards developed by the International Organization for


Standardization to be a model for environmental management systems.

Leading companies take many actions to elevate their environmental performance. These categories
of action are discussed.

Some companies take precautionary actions in keeping with an evolving global norm
known as the precautionary principle, or the idea that risky industrial activities should be
restrained when their dangers are yet unclear. DuPont took its popular Scotchgard fabric
protector off the market when it learned that a chemical it contained was widely present in
human tissue, though danger was unproven.

Many companies have pollution prevention programs to alter industrial processes so that
pollution is not generated. This philosophy stands in contrast to use of end-of-the-pipe
control technologies that remove pollutants after they are generated.

Product analysis detects environmental problems through the product life cycle.

Environmental marketing takes advantage of possibilities for revenue creation in green


products, services, or advertising appeals.

Environmental metrics are used to measure environmental performance and costs of


environmental management. Examples given are a dashboard of indicators used by
Office Depot and quantitative environmental goals set by Dow Chemical.

Note

Case

HARVESTING RISK
This case tells the story of Amvac, a pesticide manufacturer. It raises questions about Amvacs strategy,
which is to buy relatively dangerous pesticide brands and milk them for profits as obsolescence and
regulatory censure close in. It illustrates the idea of risk discussed in the chapter and also the difficulties of
regulating risk. It raises ethical issues regarding the molecular-level dangers that Amvacs pesticides pose to
human health.

Answers to Case Questions


1. Does Amvac have an ethical strategy?
Ethical issues are raised by three elements of Amvacs strategy. First, it buys aging organochlorine and
organophosphate brands from the big agrochemical corporations. These pesticides have been superseded in
major markets by safer products. Second, it seeks new markets for the old brands to extend their life. Some
of these are domestic niche markets. Some are foreign markets where regulations still permit broad
application. Third, it resists regulators who threaten to limit or cancel registrations. Since its pesticides are
registered and marketing is consistent with approved uses, its actions are legal. Legality may set a low bar
for ethical behavior. However, Amvacs actions can be defended as compliant with laws and regulations.
The central ethical issue is that Amvac sells pesticides that pose risks to human health, wildlife, and nature.
Pesticides are inherently dangerous. Their use is justified by utilitarian arguments that the benefits to
society exceed the risks. Amvacs strategy reduces the net benefit in the utilitarian equation because its
brands pose a greater risk than those of other manufacturers. Therefore, Amvac has a narrower margin of
ethical legitimacy than competitors with newer, safer products.
Even if there is a net gain to society in Amvacs brands, its strategy might be ethically questionable because
its actions increase risk unnecessarily.
Amvac is also subject to the basic criticism of business noted in Chapter 4 on Critics of Business. That
is, that it places profit before more worthy values including protection of human health and the natural
environment.

2. Do you believe that Amvac is faithful to its ethics code? Does the code adequately address
the consequences of its operations? What might be added or changed to improve it?
There is no evidence that anyone at Amvac has acted unethically. The companys operations raise certain
broad ethical issues. Its strategies impose a system that may lead individuals to decisions with ethically
questionable consequences for those who apply or have unintended exposures to Amvac products.

The American Vanguard Corporation Code of Conduct and Ethics is posted on the companys Web site
at www.americanvanguard.com/Governance/CodeofConductandEthics/tabid/96/Default.aspx. It begins
with a section that sets its overall tenor. It says that employees should achieve business and personal
ethical standards and comply with laws and regulations. The overall standard is to have high ethical
conduct. Since the Code cannot anticipate every ethical conflict, the company states its intention to rely
on an individuals sense of what is ethical. Employees are also instructed to make decisions that reflect
care for all of our stakeholders.
The bulk of the 2,400-word code is devoted to specific areas of ethical concern, including conflicts of
interest, gifts, confidentiality of information, protecting personnel and accounting records, the companys
rights to intellectual property developed by its employees, accuracy of financial statements, insider trading,
antitrust compliance, discrimination, sexual harassment, and protecting the environment.
The Environment section is short, only six lines. It seems intended to warn employees to be careful when
they dump waste or discharge chemicals into the air or water. It notes the need to comply with regulations.
A final section discusses how the Code is administered. It is distributed to all employees, who must certify
their receipt. Violations are reported to members of the audit committee on the Amvac board of directors or
to any board member.
Nothing in the Code addresses the ethical issues raised in the case study. It does not define the companys
stakeholders, although there is a prohibition against dealing unfairly with customers, suppliers,
competitors and employees. Applicators of pesticides are never mentioned. There is no statement that
makes protection of human health a priority.
Overall, the Code is basic and generic. It could serve virtually any manufacturing company as written. It
does not directly address unique ethical issues raised by Amvacs business model. For example, there is no
section on product safety. The Code is positive, helpful, necessary, and probably inadequate.

3. Should the law prohibit Amvac and others from exporting pesticides barred from use in
the United States?
There are two views. Progressives often want to see the regulatory standards of developed nations become
global standards. Others argue that this is an imposition on the sovereignty of developing nations, which
deserve autonomy in developing their own rules. The scientific expertise necessary to evaluate pesticides
may lag in developing nations. The political will to regulate powerful agricultural interests may not be
present.
Amvacs export sales have grown. In 2010 they were 17 percent of net sales, more than double their 7.3
percent in 2006.1

1 American Vanguard Corporation, Form 10-K, April 10, 2011, p. 6.

4. Is the value to society of pesticides such as dibromochloropropane, mevinphos, and


dichlorvos great enough to warrant the risks they pose?
This is a matter of opinion. It is a utilitarian calculation. Monetized figures allowing comparison of benefits
to costs do not exist. The discussion in the case study about the overall benefits and costs of pesticide use
reports evidence of both great costs and great benefits. The costs decline now as new generations of
pesticides and biological alternatives to pesticides prove less dangerous. Amvac is extending the lives of
older, more risky pesticides.

5. If economic and market conditions remain favorable for Amvacs strategy, would you
buy its stock?
This question invites students to reveal their values. Those who prioritize financial gain will buy the stock.
Those who prioritize prudence will not. Prudence, according to Aristotle, is the ability to deliberate and
choose both good ends and good means.2 A prudent person chooses practical lines of conduct that benefit
both him or herself and others.

2 Aristotle, The Nichomachean Ethics, trans. J. A. K. Thomson, rev. ed. (New York: Penguin Books, 1976), pp. 21216.

1
5
Consumerism

SUMMARIZING OUTLINE
The chapter begins with the story of Harvey W. Wiley, a crusader for pure food laws in the early 1900s.
Consumerism is defined. The rise of consumerism as a powerful ideology of material acquisition is
explained. The attacks on and defenses of the consumer ideology are set forth. Then the actions of
government agencies to protect consumers are reviewed. Finally, basic protections for consumers in product
liability law are discussed. At the end of the chapter, the case study raises questions about alcoholic
beverage advertising.

The introductory story is about Harvey W. Wiley.

Wiley was principled and idealistic. He came to Washington, D.C., to head the Bureau of
Chemistry in 1883. This small agency was charged with detecting adulteration in foods.

Wiley discovered widespread fraud and impurity. He campaigned for laws to regulate food
companies and protect the public.

As part of this campaign he staged a dramatic experiment in which he fed small groups of
volunteers high doses of common chemical preservatives. The volunteers were known
collectively as the poison squad.

The experiments and other pressures moved Congress to pass the Pure Food and Drug
Act in 1904.

Wiley and his agency, which would evolve into the Food and Drug Administration,
enforced the new law. But his strict, vigorous, and uncompromising enforcement alienated
industry leaders, who succeeded in undermining his authority.

Wiley resigned in frustration and defeat. He continued working for consumer causes. He
might be called the nations first consumer advocate.

Consumerism is a word with two meanings.

First, consumerism is a movement to promote the rights and powers of consumers in


relation to sellers of products and services.

Second, consumerism is a powerful ideology, in which the pursuit of material goods


beyond subsistence shapes social conduct.

Consumerism as an ideology first appeared in Western Europe about 300 years ago. Its
appearance is explained by the rise of conditions that gave new importance to the acquisition and
display of material objects. These conditions include the following.

Economic progress.

Expanding trade with colonial empires that brought in new products.

The rise of small shops and innovations in advertising and marketing such as window
displays and print ads.

The decline of religious doctrines that stifled pursuit of material pleasures.

The rise of individualism.

Growth of cities.

The breakdown of traditional status boundaries.

The consumer ideology rose in the United States in the late 1800s, after similar changes prepared
the ground. The changes included these.

An Ascetic Puritan theology relaxed its grip.

Individualism grew stronger.

International trade expanded, the American economy grew, and some became affluent.

Expansion of the railroads created national markets.

A merger wave created large businesses to serve these markets.

New consumer products such as autos, watches, and refrigerators appeared.

People left small towns and moved to growing cities, joining waves of immigrants.

Traditional status distinctions loosened.

Critics of consumerism have fought a losing battle against its spread.

Henry David Thoreau rejected material life, living in the woods and writing clever essays
to puncture the pretenses of people in his era striving for wealth and possessions.

Economist Thorstein Veblen satirized consumers who spent, not to gain ordinary utility
from their purchases, but to create invidious comparison with their neighbors and display
status through conspicuous consumption.

Attempts to create sanctuaries from consumerism, including Sunday closing laws for
stores, known as blue laws, and efforts to keep advertising out of schools and reduce
advertising aimed at children, have failed. Prescriptions for thrift and simple living attract
few converts.

Critics make these arguments, all based on the idea that material values undermine higher
values.

Consumerism leads to commodification of life. People are judged by their possessions.

Consumption for emotional reasons encourages unwise, unproductive uses of money.

Heavy consumption wastes natural resources.

Consuming luxury items evidences the sins of gluttony and greed.

Consumerism distorts values. For example, it converts profligacy into social status.

Consumerism is a pathology of corporate capitalism that leads corporations to manipulate


consumers.

The triumph of consumerism despite persistent criticism is evidence of important virtues. Its
defenders make these points.

Products and services are designed to fulfill consumer needs. Fulfilling both explicit needs
and latent needs awakened by marketers has emotional benefits.

Competition to satisfy consumer needs works to bring consumers lower prices and higher
quality.

Proliferating product and service choices stimulate consumption and, in turn, economic
growth.

Happiness derived from material acquisition is as fulfilling as happiness derived from


nonmaterial pursuits and just as fulfilling.

The rise of consumer ideology is paralleled by a progressive social movement to protect consumers
from fraud, deception, and greed using government power.

In the United States this movement began with the Populists and the Progressives in the
late 1800s and early 1900s.

A new era of activism in the 1960s and 1970s prompted a more recent wave of legislation
to protect consumers.

Consumer critics, including Ralph Nader and Vance Packard, created public
discontent and support for government action.

President Kennedy gave impetus to the movement in a 1962 speech setting forth
basic rights of consumers.

Congress responded by passing more than a dozen consumer protection statutes


and creating four new federal consumer agencies.

Since the mid-1970s, consumer activists have been less successful in getting new
laws. However, spending to enforce existing laws has grown continuously as
consumer agencies mint new rules.

More than fifty federal agencies are active in consumer affairs. Short sketches of four of the most
important ones are given.

The Food and Drug Administration, created in 1906, is the oldest and largest consumer
protection agency. It has 11,500 employees who enforce 42 statutes regulating foods,
drugs, medical devices, cosmetics, tobacco, and radiation-emitting products.

The Federal Trade Commission is another venerable agency. It was created in 1914 with
broad powers to protect the public against unfair competition. It also protects consumers
against deceptive advertising, sales fraud, and lender discrimination.

The Consumer Product Safety Commission was created in 1972 to protect consumers
against injury from consumer products. With fewer than 500 employees to regulate more
than 15,000 products it is an agency overwhelmed by its mission.

The National Highway Traffic Safety Administration was created in 1966 to set safety
standards for autos and trucks. Its regulatory actions are one factor in the decline of
highway fatalities since its creation.

Product liability is a doctrine in the law of torts that covers redress for injuries caused by defective
products. There are three fundamental theories.

Negligence. Manufacturers and sellers have a duty to do what a reasonable, prudent


person exercising ordinary care would do under the same circumstances.

In the late 1800s and early 1900s product liability doctrine was undeveloped and
manufacturers were protected from findings of negligence by two obstacles in the
law.

First, the principle of caveat emptor, a Latin phrase meaning let the
buyer beware, imposed responsibility on consumers to inspect products
they bought. The legal presumption was that if a product had a defect, the
injured consumer should have been wary and spotted it.

Second, the principle of privity held that consumers could sue only the
party that sold them the product. This made it difficult to sue
manufacturers and hold them negligent.

Both principles became outmoded as America grew into a consumer


society and courts broke them down.

One milestone case was MacPherson v. Buick Motor Co., in which the
court held that a consumer could sue Buick, the manufacturer, directly.
Buick was found negligent for a defect in the wheels.

Warranty. A warranty is a contract in which the seller guarantees the nature of the
product. If the product does not conform to the standards in the warranty, the buyer is
entitled to compensation for any consequent loss or injury. Two kinds of warranties are
recognized.

An express warranty is an explicit claim made by the manufacturer to the buyer


that the product will perform in a specified way.

An implied warranty is an unwritten, commonsense warranty arising out of the


buyers reasonable expectations that a product will fulfill its ordinary purpose and
the particular purpose of the buyer.

Strict liability. Under the doctrine of strict liability manufacturers and sellers can
be held liable without a showing of negligence. It applies where the product is
inherently dangerous even if properly manufactured.

A landmark case is Henningsen v. Bloomfield Motors, in which the court


held that limitations on the express warranty for a Plymouth were
overridden by an implied warranty that the car was suited for ordinary
use.

The landmark case is Greenman v. Yuba Power Products, in which a


consumer who was injured using a power tool sued the manufacturer and
won after the court held that, although the company had not been
negligent, the machines design was defective.

Product liability law is intended to compensate victims and to deter future corporate wrongdoing.
A basic trend, through the twentieth century but especially since the 1960s, is expansion of this law
to favor injured plaintiffs.

Product liability lawsuits create both benefits and costs. They are responsible for removing
many dangerous products from the market. On the other hand, they dampen innovation and
impose insurance costs on companies.

In sum, this chapter discusses two perspectives on consumerism. First, consumerism is a powerful
ideology that has swept across America and the world. Second, as a protective movement,
consumerism has led to expansion of government power to regulate business and expansion of legal
doctrines designed to protect consumers from fraud and injury.

Note

Case

ALCOHOL ADVERTISING
Alcoholic beverages pose risks to society. Companies making them face serious, long-term opposition.
About 10 percent of Americans want to ban alcohol. Others are concerned about its consequences for
youthful drinkers, particularly drunken driving accidents.
Much ire is focused on advertising. The nature of the product dictates use of brand image advertising, but
activists find this approach manipulative, misleading, and irresponsible. Image ads inflame the industrys
adversaries and some of them want to dictate the kinds of ads it can use. However, proposals to ban or limit
ads collide with speech protections in the First Amendment.
Students can discuss the advertising used by the industry. This advertising surrounds us. Although the
companies have faith in its efficacy, most students do not believe it affects their consumption. They do not
see themselves as gullible and they are unaware of using alcohol brands to satisfy emotional needs.

Answers to Case Questions


1. Were Spykes and Wide Eye bad products? Do you think they were marketed in
objectionable or misleading ways? Do you think companies should be allowed to market
other caffeinated alcoholic beverages?
Spykes and Wide Eye were innovative products. Spykes was an effort by Anheuser-Busch to compete for
younger drinkers increasingly attracted to novel distilled spirits products. Wide Eye, a caffeinated schnapps
beverage was an example. Both sought to capitalize on market trends including caffeination, sweet and
fruity flavors, and unconventional ingredients such as ginseng, guarana, and ginkgo biloba. Sales of

products in the caffeinated alcoholic beverage category were growing and several dozen brands had
appeared. These were good products in the sense that they fulfilled consumer needs.
The very traits that made Spykes, Wide-Eye, and the others good in the market stigmatized them among
antialcohol crusaders. Features that attracted young drinkers such as inviting flavors, small containers,
large containers, garish container labels, and Web sites with adolescent themes and imagery were red flags.
The use of caffeine was another red flag. Its stimulant action was said to mask impairment for
inexperienced drinkers. In short, anything that made this new alcoholic beverage alluring to its target
audience was damning to antialcohol groups.

Soon caffeinated alcoholic beverages were demonized in the media. Politicians attacked their manufacturers
and passed laws restricting or prohibiting their use. In 2009 the Food and Drug Administration sent letters
to 27 companies asking them to explain why caffeine was a safe ingredient in their products. Then in 2010
the agency sent letters to four manufacturers saying they had failed to show that caffeine was a safe
ingredient and it was recommending that consumers avoid them. The companies were given 15 days to
respond before the agency sought a court order to stop the sale of their caffeinated products. 1 All four
discontinued their products or reformulated them without caffeine.
Reason magazine described the assault on these drinks as a moral panic brought on by the guardians of
public health and morals who were offended by their popularity among young partiers. 2 It pointed out
that mixing caffeine and alcohol is an old custom. Adults drink coffee cocktails and pour whisky or liqueurs
into after-dinner coffee. The only thing offensive about Spykes, Wide-Eye, and Four Loko, it argued, was
their marketing to young adults who were condescendingly taken as especially innocent and reckless.
So were Spykes, Wide-Eye, and the others bad products? Based on their overall market performance the
answer is no. Based on the consequences for their corporate parents the answer is yes. Anheuser-Busch,
Constellation Brands, Phusion Projects, and other companies were subject to considerable criticism
followed by regulatory action and, ultimately, the need to discontinue or reformulate brands. For those who
are critical of youth alcohol consumption they were bad products because their social impact was said to
be negative. Their abuse was associated with rapes, assaults, drunken driving, and fatal accidents.
Should the companies be allowed to market other caffeinated alcoholic beverages? In practice they will not
because the Food and Drug Administration opposes them. However, the main problem is not caffeine in
beverages. It is marketing imaginative products to youthful drinkers. When Phusion Projects removed the
caffeine from Four Loko and remarketed it attacks continued. Four Loko comes in sweet flavors and is sold
in colorful 23.5 ounce cans. Critics call it blackout in a can, cocaine in a can, and even killer in a
can. Its marketing is said to encourage underage drinking. Although it no longer contains caffeine, its days
may be numbered. Similar attacks have been mounted on Blast, a new fruit-flavored malt beverage
from Pabst that contains 12 percent alcohol by volume and comes in a 23.5 ounce
can. It has been derided by attorneys general from several states as a binge in a
can.3 There is a perennial war between product innovation and social standards
enforced by the antialcohol coalition.

1 Food and Drug Administration, Serious Concerns Over Alcoholic Beverages with Added Caffeine, FDA
Consumer Health Information, November 2010.
2 Loco over Four Loko, Reason, March 2011, p. 48.
3 David Kesmodel, Pabsts New Label Faces Heat, The Wall Street Journal, April 22, 2011, p. B8.

2. Do alcoholic beverage companies fulfill their ethical duty to be informative and truthful
in advertising? Do they generally uphold their ethical duty to minimize potential harm to
society from underage drinking?
Industry claims a right to advertise with some voluntary restrictions and minimal regulation by government.
In the law this right is protected by the First Amendment, which is the basis for the Supreme Courts
commercial speech doctrine. In practice, the industry receives broad protection for its advertising claims.
In traditional ethical doctrines, rights and duties are linked. Therefore, advertisers exercising First
Amendment rights have a corresponding duty to make an ethical sales pitch. At a minimum, advertisers
have these general ethical duties.

The duty to tell the truth and make honest claims.

The duty to accept responsibility for the consequences of their ads.

The duty to work for a positive societal impact and to avoid doing harm. Ads should not
undermine societal values.

The duty to respect and preserve the free will of consumers in buying decisions.

Alcoholic beverage companies have an additional duty to avoid appeals to underage


drinkers.

Students can be asked to discuss whether alcohol advertisers are fulfilling these duties.

3. Are some beer, wine, or spirits ads misleading? What examples can you give? What is
misleading in them? Do some ads contain images and themes that go too far in appealing to
an audience under the legal drinking age? Can you give examples?
Two basic kinds of advertising are informational advertising and persuasive advertising. Although all
advertising is intended to persuade, persuasive advertising is characterized by heavy reliance on emotional,
nonlogical appeals. It is often used in oligopolistic consumer products industries where products are
virtually identical and companies have parallel pricing policies. Its purpose is to build brand loyalty and
keep new entrants out of the market unless they can afford the national advertising campaign needed to
launch a brand and give it a distinct image. Alcohol ads typify this approach to advertising. Most do not lay
out straightforward information about product features. Rather, they show lifestyle images and offer
slogans. Partly for this reason, and partly because they fail to acknowledge health risks, critics see them as
misleading.
Unlike information ads that use words to convey facts, words in lifestyle ads have emotional appeal but
often lack clear meaning. What, for example, is the literal meaning of print slogans such as Youve come a
long way, baby (Virginia Slims), Just do it (Nike), No one does it like the bull (Schlitz Malt Liquor),
Bacardi by night (Bacardi), or Works every time (Colt 45)? Some critics say such phrases compound
the misleading character of alcohol ads. The same charge could be leveled against catchphrases in political
speech. What, for example, is the literal meaning of New Deal, New Frontier, or New World Order?

A more comprehensive list of reasons why alcohol ads may be thought misleading follows.

The words in them convey no logical meaning.

Products are associated with and subtly promise youth, vigor, athletic prowess, sex appeal,
success, wealth, and other things consumers desire. Yet they cannot deliver. There is no
connection in life between alcohol use and these attributes, except in the minds of gullible
consumers.

The ads encourage young people to drink at times in their lives when decisions lack
maturity.

Alcohol has health risks, but ad imagery overshadows government-mandated warnings-when warnings appear at all.

The ads appeal to emotionally vulnerable consumers and they seduce the weakest in the
audience to compensate for psychological deprivation by using alcohol.

The cumulative effect of millions of staged scenes spewed out by alcohol companies is that
the average American sees drinking as part of an acceptable, even glamorous, lifestyle.

The ads use subliminal appeals, such as phallic symbols or mysterious pictures drawn in
ice cubes. Critics do not attribute much significance to this occasional practice, but some
students have heard of it and think it is effective and conspiratorial.

Naturally, the alcohol industry does not regard its ads as misleading. Its trade groups claim that critics take
a condescending view of drinkers, portraying them as gullible or irrational. The ads, they say, are
competitive weapons in the struggle for market share.
Emotional appeals are an accepted part of the advertising game and used in many industries. Theodore
Levitt argued in a classic article that puffery in advertising is necessary to express the capacity of a product
to fulfill legitimate emotional needs.4 What a boring place the world would be, declared Levitt, if all ads
were simply dry and informational.

Theodore Levitt, The Morality (?) Of Advertising, Harvard Business Review, July-August 1970.

4. Do you believe there is a need for more restrictions on alcohol advertising? If so, what
limits are needed? Explain how a ban or any restrictions could meet the Central Hudson
guidelines?
The belief in the need to ban or restrict alcohol ads is a matter of opinion.
Some critics want a complete ad ban, but it is unlikely that this extreme measure would survive a court test.
Inspired by the success of attacks on tobacco advertising designed to reduce its influence on children,
advocates of curtailing alcohol ads have similarly sought to protect underage and youthful viewers. Many
of their proposals were combined in a bill introduced in the House of Representatives more than a decade
ago by Rep. Joseph P. Kennedy II (D-Mass.). 5

Alcohol ads would be prohibited in video games or films and on billboards within 1,000
feet of schools and playgrounds.

In publications with 15 percent or more readers under age 21, ads would be restricted to
text and black and white only; no images would be allowed.

No television ads could be broadcast between the hours of 7:00 A.M. and 10:00 P.M.

Hats, T-shirts, coffee mugs, and other promotion items with the brand name of an alcoholic
beverage would be prohibited.

On college campuses, companies would be prohibited from using brochures, giving away
free drinks, and sponsoring concerts, dances, or sports events. Ads in college newspapers
could contain only product names and prices.

The tax deductibility of ads for beer, wine, and spirits under the Internal Revenue Code
would end.

Health warnings would be required on beer, wine, and spirit labels. (In the past, ad
opponents have wanted health warnings in alcohol ads as well.)

In a separate bill, Rep. Kennedy would have required the Federal Communications
Commission to write a voluntary advertising code for limiting childrens exposure to
alcohol ads.

H.R. 1982 (1997).

Kennedys bill was opposed by industry and failed to come to a vote. Yet the ideas in it have not lost favor
among those who want ad restrictions, and they continue to resurface in policy proposals.
How can the constitutionality of bans or restrictions be evaluated? In the Central Hudson case in 1980 the
Supreme Court set up a four-part balancing test for situations where government has imposed bans or
restrictions on commercial speech.6 The four parts of the test, with brief comments, are these.

152.

Commercial speech must concern lawful activity and not be misleading. Alcohol ads
would not be deprived of constitutional protection on either count. Buying alcohol is lawful
for adults and typical lifestyle ads would not violate any legal definition of misleading.
Only advertising aimed at children or containing objectively false statements would fail
here.

153.

The government interest in preventing underage drinking would have to be


substantial enough to warrant speech limits. The government might argue that social
problems caused by teen drinkers, such as drunk driving accidents, impose costs on society
and create a substantial interest in curbing ads. The industry would argue that the
government interest is small and indirect.

154.

Ad limits and restrictions would have to advance the government interest directly.
Government must show that restricting ads in certain media, places, and times would make
substantial inroads into problem drinking. This is a difficult task. Industry lawyers would
retort that the government could not prove a connection between ads and underage
drinking. The government would lose here unless it had studies showing a connection
between various ad practices and, say, drunk driving behavior.

155.

The ad ban must not be more extensive than necessary to advance the government
interest. If there are other ways to curb underage drinking that are less restrictive of
speech, they should be preferred. Counter advertising, public service advertising,
enforcement of point-of-sale restrictions, and increases in excise taxes are several
measures that might have equal or greater impact than ad bans.

Overall, it is unlikely that the Supreme Court would uphold broad restrictions. Recent commercial speech
cases suggest the justices are skeptical of ad restrictions and believe that if the governments purpose is to
solve a social problem, such as excessive drinking, it should exhaust other policy remedies before trying
censorship. It has applied this test in two cases where government restricted alcohol advertising.

Central Hudson Gas & Electric Corp. v. Public Service Commission, 447 U.S. 557.

156.

In Rubins v. Coors Brewing Company the Court struck down a federal statute prohibiting
labels from disclosing the amount of alcohol in a beer bottle and the use of wording such
as extra strength suggestive of high alcohol content.7 The government argued that the
rule was necessary to prevent so-called strength wars in which brewers compete by
raising alcohol content and impose the resulting social costs on the public. The Court held
that although this interest was legitimate, the government failed to prove that censoring
labels would accomplish it.

157.

In 44 Liquormart v. Rhode Island the Court struck down a state law banning price
advertising for alcoholic beverages.8 The state argued that the law was necessary to
promote temperance, but the Court held that there was no evidence it did so.

The Supreme Courts commercial speech test applies only to restrictions imposed by government. Alcohol
advertisers can voluntarily restrict their messages and they do. As discussed in the case study, the trade
associations representing brewers, vintners, and distillers each have voluntary codes that restrict some
forms of advertising. They are a source of moral suasion to control borderline practices that might invite
more criticism and perhaps government regulation. They are loosely enforced. The Beer Institute and the
Distilled Spirits Council of the United States report formal complaints and code enforcement decisions on
their Web sites. Students can be assigned to look at these reports and evaluate the industrys actions in light
of its voluntary code and their own standards.

115 S. Ct. 1585 (1995).

116 S. Ct. 1495 (1996).

16
The Changing Workplace

SUMMARIZING OUTLINE
The main body of this chapter discusses six forces changing the workplace: (1) demographic change, (2)
technological change, (3) structural change, (4) competitive pressures, (5) reorganization of work, and (6)
government intervention. Discussion is centered on the United States, but the chapter includes sections on
Europe and Japan and observations about the global reach of these forces. The thesis that global
environmental forces cause great turbulence in the workplace runs through the chapter.

The introductory story is about Ford Motor Company. It illustrates how Ford workers have been
affected over the years by the forces discussed in the chapter.

Ford was started by the inventor Henry Ford, who introduced an autocratic style and failed
to keep up with technological change in the auto industry. The impact of competition
forced Ford to close assembly plants in 1927 and idle 100,000 workers.

Unions tried to organize Ford workers, but ran into vicious opposition. Despite the
workers dissatisfaction with company management, it was not until government
intervention with legislation and enforcement action that unions were formed.

In the 1980s, Ford underwent reorganization of work for both hourly employees and
salaried managers because of Japanese competition. This was the beginning of a series of
reorganizations running to the present day.

Ford now faces relentless global competition. It is still hampered by a dysfunctional


culture that proves impervious to change. Its workers suffer.

The 2008 financial crisis forced union concessions that lowered production costs and allow
management more labor market flexibility.

Six environmental forces shape the workplace.

Demographic change is altering the United States labor force of 154 million in the
following ways.

It is growing at 1.1 percent a year, but growth has slowed compared with
historical rates.

It is becoming more diverse. Hispanics and Asians are increasing their numbers
faster than whites and blacks. The percentage of women compared with men is
rising, but the rise is now slowing.

It is aging. Because the large baby boom generation is aging, the median age of
workers is rising. Declining fertility contributes to aging in the labor forces of all
developed nations. The American labor force ages more slowly because it takes in
many young immigrants.

Technological change affects working conditions and the number and types of jobs
available.

A compelling example of its impact is the quick conversion of 7.6 percent of the
labor force from agricultural to industrial work after introduction of mechanical
harvesters in the 1850s.

Automation has caused significant job loss in less-skilled manufacturing and


service occupations. Coal miners and telephone operators, for example, have lost
jobs to mechanization.

Structural change refers to any shift in the proportions of agricultural, goods-producing,


and service occupations in an economy.

The agricultural sector has declined to 1.4 percent of the United States labor
force, down from 90 percent in colonial America.

The goods-producing sector that employed 34 percent of workers in 1950


employed only 14.2 percent in 2008. Despite this decline, manufacturing output
has increased by approximately one-third.

The service sector consists of occupations that add value to manufactured goods.
It employed 40 percent of the labor force in the 1950s. This rose to 77 percent in
2008.

Sector trends in the United States, particularly long-term job loss in agriculture
and long-term gains in service jobs, are consistent with trends in other developed
nations.

Long-term employment stagnation in the goods-producing sector has been a


critical factor in the decline of unions, which represented only 7.2 percent of
private sector employees in 2009.

Competitive pressures have intensified.

For businesses this is due to deregulation, growth in foreign trade that puts
domestic firms in competition with foreign rivals, faster new product development,
and customer pressure for better service.

Workers in high-wage, developed nations now compete against rivals in low-wage,


less developed regions. For example, hourly compensation for manufacturing
workers in 2009 was $33.53 in the U.S. compared with $1.17 in India.

Reorganization of work by corporations is an adjustment to environmental


changes, primarily competition. A key driver of change is the altered relationship
with time and space because of faster communications and cheaper transport.

Outsourcing is the transfer of work from within a company to an outside supplier.

Offshoring is the transfer of work from a domestic to a foreign location or to a


foreign supplier.

Offshoring has attracted much attention, but it is a tiny fraction of job loss in the
U.S. labor force. Job gain and job loss is a dynamic and healthy process caused by
companies adapting to competitive forces.

Government intervention in the workplace has grown in the United States.

Historically, a strong laissez-faire current in American economic philosophy made


government reluctant to interfere in the employment contract, or the agreement
by which an employee exchanges his or her labor in return for specific pay and
working conditions.

This laissez-faire thinking was reinforced by the old liberty of contract doctrine,
which was that employers and workers should be free of government intervention
to negotiate all aspects of the employment contract. In the late 1800s and early
1900s courts often struck down laws that interfered with this freedom.

Eventually, due in part to the agitation of a strengthening labor movement, the


public and the courts realized that in employment bargaining there was a huge
imbalance of power between workers and big companies. The liberty of contract
doctrine lost its hold and in the 1930s a wave of federal and state laws were
enacted to protect and encourage unions.

Since the 1930s, almost 225 major statutes protecting the rights of employees have
been enacted. States have enacted many others. These new laws and
accompanying regulations have greatly redressed perceived weaknesses of workers
in the employment contract.

Employment-at-will is a legal theory that an employment contract can be ended


by either the employer or the employee without notice and for any reason.

Until recently, the interpretation of this theory was that employees could be
dismissed for good, bad, or no cause. However, state courts have introduced
several exceptions that limit an employers ability to fire a worker.

The public policy exception is that employees cannot be fired for


complying with laws and public policies.

The implied contract exception prohibits firings where workers have been
promised permanent employment.

The implied covenant of good faith exception is that employers have a


duty to be fair to workers and cannot dismiss a worker for unjust reasons.

American workers enjoy a high level of benefits and protections. Workers in other
developed nations have similar or greater welfare.

In Japan, workers receive steadily rising compensation and lavish benefits in


community firms, or corporations that operate on a model analogous to a family.

These firms promise lifetime employment and a comfortable income. In


return, they expect absolute loyalty and strenuous effort from workers.

Labor unions are not as strong or antagonistic to employers as in the


United States or Europe.

Workers in the industrialized nations of Europe have the worlds highest wages
and extensive benefits.

After World War II, European nations adopted a social welfare model of
industrial relations in which government heavily regulates the labor
market to secure strong rights and high benefits for workers. The model is
designed to ensure full employment.

Germany is an example. Among many generous arrangements, German


workers get six months notice before being fired. During the global
recession in 2008-2009 the German government paid up to two-thirds of
the salary of an underemployed worker so their employer would not have
to lay them off.

Minimum standards for labor market regulation are set forth in international labor
conventions. All nations are called on to comply with four core labor standards.

Eliminate all forced or compulsory labor.

Abolish child labor.

Eliminate employment discrimination.

Guarantee the right of collective bargaining.

There is a tradeoff in labor regulation between protecting worker welfare and allowing
labor market flexibility. Research suggests that growth is slower, unemployment is greater,
and corporate investment is lower in more heavily regulated labor markets.

Labor flexibility is the ability to make quick and smooth shifts of workers into
and out of jobs, companies, or industries as business conditions change.

Countries differ in labor flexibility. The World Bank has constructed a Rigidity of
Employment Index to measure it on a scale of 0 (less rigid) to 100 (more rigid).
The United States scores 0.

Flexibility benefits employers and the economy, but labor activists believe it is a
corporate con that enhances employer power at the expense of workers.

In conclusion, six powerful forces are reshaping the workplace today. Perhaps the most critical
factor in determining the experience of workers is the balance a government strikes between
protecting labor and allowing adjustment to competitive forces.

Note

Case

A TALE OF TWO RAIDS


Employers find it difficult to avoid hiring immigrants not authorized to work in the United States. Some
companies have trouble filling jobs because citizens are unwilling to do the work. The case explores these
and other problems in the stories of two raids. One is an early morning raid on six Swift & Company plants
by uniformed immigration agents. The second is a silent raid in which a document audit by immigration
agents led to mass terminations at an apple grower in Washington. The case also explains the strengths and
weaknesses of current civil rights and immigration regulation.

Answers to Case Questions


1. Is the current employment verification system fair to employers?
The answer is yes and no.
Yes. In many ways the system is fair and helpful to employers. Form I9 requires minimal processing,
training, and investigation. An employer need only look at documents a worker produces to verify that their
appearance is reasonably authentic. E-Verify works quickly and at low cost to employers. If a discrepancy
arises, the burden is on the applicant to resolve it. The error rate is low.
No. Neither screening method is foolproof. Both Form I9 and E-Verify are subject to fraud. Despite goodfaith compliance a company can wind up with unauthorized workers. Then, like Swift or Gebbers Farms, it
may feel the sting of enforcement. In addition, employers can be cut off from the supply of willing
applicants for demanding, monotonous, low-wage work. Is it fair they pay the price for enforcing a policy
that fails to accommodate a national need for people in jobs Americans are unwilling to do?
An additional problem for employers is lawsuits by employees who claim that companies depress their
wages by hiring illegal aliens. In 2010 Mohawk Industries settled a class action suit for $18 million and
tort lawyers have sued other companies.1

1 Williams v. Mohawk Industries, No. 4:04-cv-0003, N. Dist. Ga., 2010.

2. Was Swift & Company socially responsible in its hiring and verification practices? Could
it have done more? Was it treated fairly by ICE?
All indications are that Swift & Company acted as a responsible firm. It treated its workers well, giving
them good wages and benefits. After passage of the Immigration Reform and Control Act in 1986 it began
using I9 forms to screen workers. It was, indeed, overconscientious, giving greater scrutiny to applicants
than the law required. In consequence, it committed civil rights violations and was heavily fined. In 1997 it
was an early

volunteer for E-Verify. It is not clear what more the company could have done. Despite its efforts, it still
had many unauthorized workers on its rolls.
When it learned that Immigration and Customs Enforcement (ICE) was planning a raid, it tried to work
with the agency. ICE rejected its suggestion for conducting plant-by-plant raids. One-at-a-time actions
would have defeated the main purpose of the raids, which is to catch and deport illegal entrants. It talked
the agency into allowing it to do a voluntary I9 audit of its workforce, but undocumented workers caught
on and were disappearing. The agency concluded that this too defeated its purpose and ended Swifts
voluntary workforce review.
Then Swift tried to stop the raids in court by arguing it had constitutionally-guaranteed property rights that
would be violated when ICE disrupted its operations. This was a weak argument. If a federal judge allowed
it to prevail, corporations could claim violation of their property rights whenever regulatory enforcement
interfered with their ongoing way of business. Every enforcement action would have to be weighed against
the property rights of the company. ICE countered Swifts claim by asserting there was no constitutional
right to break a law. The judge ruled for ICE.
Finally, after the raids Swift contributed to charities to help families of workers taken from its six plants.
Overall, this is a record of conscientious, responsible, even exemplary action.

3. Is the work authorization audit a better enforcement tool than the worksite raid? What
are the advantages and disadvantages of each?
Immigration and Customs Enforcement (ICE) emphasized worksite raids during the George W. Bush
administration. They are labor intensive for the agency and expensive to conduct. They can be highly
stressful for workers, employers, and (probably) agents. They result in the detention and deportation of
unauthorized workers who have illegally entered the United States. Nabbing and removing illegal entrants
is their main advantage, although not everyone agrees this is an advantage.
During the Barack Obama administration ICE has emphasized audits. One advantage of audits is lower
cost. They are done in the background by individuals or small teams. It is not necessary to use large
contingents for surrounding worksites, detaining people, bussing them out, and processing them at detention
centers. Another advantage is less trauma for unauthorized workers and their families. Their lives are not
instantly sundered. However, this makes the audit less of a deterrent than a workplace raid. Employers are
still hit with a sudden loss of workers. But the unlawful immigrants remain in the country. Many must shift
from relatively good, high-paying jobs where they pay taxes to lower-paying work or exploitation in the
underground economy.
Any conclusion about which approach is better depends on views about immigration policy. If your views
are conservative and oriented toward strict enforcement then you favor raids. If your views are more liberal
and oriented toward tolerance and amnesty then you favor audits.

4. Is the current verification system fair to job applicants and employees? Does it allow
companies to exploit unauthorized workers?
Overall, the system is fair to applicants and employees. Form I9 requires minimal identification. The rules
protect the persons civil and privacy rights by limiting the employers ability to require more information
and documentation. The rules protect legal immigrants and United States citizens by prohibiting
discrimination based on national origin. The E-Verify system has similar protections and a very small error
rate. A recent study by the Government Accountability Office found significant improvement in error rates
and fraud detection.2 Both systems offer some protection to legal residents and citizens from competition
with undocumented applicants.
Neither system can prevent fraud by an employer conspiring with unauthorized workers. Likewise, neither
can protect workers in the underground economy from forms of exploitation including harassment, belowmarket or minimum wage pay, unpaid overtime, and poor working conditions.

5. Do you believe that unauthorized workers should have the same protections against
discrimination, sexual harassment, and wage and hour violations as authorized workers?
The Immigration Reform and Control Act makes it illegal to employ an unauthorized worker. Nevertheless,
if such a worker is employed, he or she is entitled to the same civil rights and labor protections as a United
States citizen or permanent resident.
Title VII, the Age Discrimination in Employment Act, the Americans with Disabilities Act,
and the Equal Pay Act . . . prohibit discrimination against employees who work in the
United States for covered employers, regardless of citizenship or work authorization.
While federal law prohibits employers from employing individuals lacking work
authorization, employers who nonetheless employ undocumented workers are prohibited
from discriminating against those workers.3
Unauthorized workers are also protected under the Fair Labor Standards Act which requires, for example,
that all covered workers be paid no less than the federal minimum wage. 4 However, farm workers and
domestic workers are excluded from coverage. The National Labor Relations Act, which gives workers the
right to unionize, also excludes farm workers, domestic workers, and taxi drivers. 5 Even though illegal
workers have rights, they are easily exploited by employers who know the illegals fear deportation if they
report violations.

2 Government Accountability Office, Employment Verification: Agencies Have Improved E-Verify, but Significant
Challenges Remain, GAO-11-552T, April 14, 2011.
3 U.S. Equal Employment Opportunity Commission, EEOC Compliance Manual (Washington, DC: EEOC,
December 2, 2002), 13-VI(B).
4 Ibid., 13-VI(A).
5 Harold Meyerson, Worker Loopholes, Los Angeles Times, June 24, 2011, p. A17.

Some students may argue that unauthorized workers are not entitled to such protections. They are not
citizens. They are violating immigration and employment laws themselves. They may be complicit in
document fraud. However, civil rights and labor protections must be enforced uniformly. Until a worker is
found to be unauthorized, he or she must be treated equally with others under the law. When the workers
unauthorized status becomes known, he or she must be dismissed, not abused.

6. Does current enforcement of workplace immigration rules invite disrespect for the law?
Should the government step up enforcement? Should U.S. immigration policy be reformed?
If so, how should it be changed?
Immigration laws and their enforcement have failed to check illegal entry and unauthorized employment.
The presence of low-wage jobs for unskilled workers and a dearth of Americans willing to take them are
huge incentives for entry and for laxity of detection by employers. Immigration rules are widely violated.
Efforts at strict enforcement have driven much immigration underground.
The nations last major statute on immigration was the Immigration Reform and Control Act in 1986. A
subsequent, bipartisan effort at comprehensive reform failed in the mid-2000s. More recently, even narrow
reforms have failed in Congress. The Dream Act of 2010 would have set up a road to citizenship for
children of immigrants who enrolled in college or joined the military. The Secure Border Act of 2011 would
have built more fences and put more agents on borders. Neither was enacted.
The idea of reform is polarized. Liberals and civil rights groups believe immigrants help the economy and
strengthen the nation by working hard and rising in status over generations. They favor some combination
of opening borders and granting amnesty. Conservatives believe immigrants lower wages, burden social
welfare programs, and aggravate social problems such as crime, teen pregnancy, and illiteracy. They want
stricter enforcement, more deportations, and more fences. Some business groups favor creating new guest
worker programs for growers, meat packers, and seasonal industries that need low-cost labor. Business also
favors visa reform to loosen entry requirements for entrepreneurs with funds to start businesses and for
highly educated graduates of foreign universities.
Absent comprehensive reform at the national level states and cities have passed immigration laws. The
Legal Arizona Workers Act of 2007 is the current model for employment-related rules. It requires all
employers within the state to use E-Verify or lose their business licenses. The Chamber of Commerce
challenged this law on the narrow constitutional grounds that immigration law was preempted by federal
policies that make E-Verify voluntary for most companies. However, the Supreme Court found no express
preemption in federal statutes and held it was within the police power of a state to enact such a law.6 Four
other states--Alabama, Georgia, Indiana, and Utah--have similar laws. Some cities, for example, Temecula,
California, also require E-Verify.

6 Chamber of Commerce of the United States v. Whiting, 179 L. Ed. 2d 1031.

1
7
Civil Rights, Women, and
Diversity
SUMMARIZING OUTLINE
The thesis of this chapter is that the American nation was founded on high ideals of justice, but throughout
its history civil rights practice has never lived up to these ideals. Beginning with a discussion of slavery in
the colonial era, the chapter explains the discrepancy. Two historical eras are emphasized. The first is the
post-Civil War period when constitutional amendments and statutes intended to end employment
discrimination were rendered ineffective. The second is the period from passage of the Civil Rights Act of
1964 to the present, during which practice has come much closer to the ideal of equal treatment. Next, the
chapter examines women at work and the kinds of discrimination they face, including sexual harassment. A
final section discusses diversity and explains actions taken by corporations in diversity management
programs.

The introductory story is about the Employment Non-Discrimination Act of 2009, the latest
version of a bill to extend workplace civil rights protections to gays, lesbians, bisexuals, and
transsexuals.

Workers in the United States enjoy a wide range of protections against discrimination at
work. However, gay, lesbian, bisexual, and transsexual workers are still subject to
arbitrary firing in most states because they have no federal statutory protection.

For more than 20 years, advocates in Congress have tried to legislate against such unfair
actions. The Employment Non-Discrimination Act is opposed by conservatives and
religious fundamentalists who see it as promoting a homosexual lifestyle.

Advocates of the bill, including progressives and civil rights groups, argue it is the
constitutional right of every American to have equal workplace protection under the law.

This story is a preview of both the civil rights protections workers have gained over many
years and the continuing presence of gaps in those protections.

Employment discrimination in America has a long history.

The earliest discrimination dates back to 1619, when slave traders first brought African
natives to the nations shores.

In 1776, the Declaration of Independence established an American Creed incorporating


high ideals of equality, justice, human rights, freedom, and opportunity. The promises in
this document were not a reality then or later, but existed as a set of ideals that minorities
looked to and called on the country to live up to.

The Declaration endowed Americans with unalienable rights, or natural rights


to which a person is entitled simply because he or she is human and that cannot be
taken away by government.

Natural rights exist on a higher plane than civil rights, or rights bestowed by
governments on their citizens. Civil rights guarantees must be measured against
the natural rights to which all persons are entitled.

The U.S. Constitution reflected the gap between high American ideals and the reality of
workplace discrimination. While it gave citizens many rights, in five clauses it sanctioned
slavery by protecting the interests of slave owners.

Following the Civil War (1861-1865) Congress passed three constitutional amendments
and other laws to end discrimination against former slaves.

The Thirteenth Amendment (1865) abolished slavery.

The Fourteenth Amendment (1868) prohibited states from passing discriminatory


laws that deprived citizens of their rights.

The Fifteenth Amendment (1870) prohibited race discrimination in voting.

Civil rights measures, including acts prohibiting employment discrimination in


1866 and prohibiting discrimination in transportation and accommodations in
1875, completed a formidable legal mechanism for ensuring the rights of freed
slaves.

The new civil rights structure functioned well for a brief time in the 1870s, but was soon
undermined by three developments. Long years of workplace discrimination followed.

First, when the electoral vote was contested in the presidential race of 1876
between Republican Rutherford B. Hayes and Democrat Samuel J. Tilden,
candidate Hayes agreed to remove federal troops still occupying the South in
return for electoral votes from southern states. When the troops left, the new civil
rights laws were not as well enforced and southern racism reasserted itself.

Second, in the Civil Rights Cases (1883) the Supreme Court held that Congress
lacked the authority to regulate race relations between private citizens. It allowed
the private wrong of race discrimination in transportation and accommodations
to continue by declaring the Civil Rights Act of 1875 unconstitutional.

Third, in Plessy v. Ferguson (1896) the Supreme Court ruled that state
segregation laws were permitted by the Fourteenth Amendment while
accommodations for blacks were equal to those of whites. This entrenched the
separate but equal doctrine that remained in the law until overturned in Brown v.
Board of Education in 1954.

Because of these developments, the American South was rife with Jim Crow laws,
or measures legalizing segregation in public places, transportation, schools, and
business.

During the 1800s American Indians, Hispanics in territories ceded to the United
States, Chinese immigrants, and Japanese immigrants faced prejudice and
employment discrimination institutionalized in law.

Spurred by the civil rights movement of the 1950s and 1960s, Congress passed the
landmark Civil Rights Act of 1964.

In the law was Title VII, a section prohibiting employment discrimination based
on race, color, religion, sex, or national origin. As originally passed, Title VII was
flawed as a legal tool to fight discrimination.

Title VII was intended to level the playing field for all workers by ending
discrimination.

It outlawed disparate treatment, or unequal treatment of employees


based on race, color, religion, sex, or national origin.

It contained no means of fighting disparate impact, or discrimination


caused by policies that apply to everyone and seem neutral but
disadvantage a protected group.

The Supreme Court remedied this deficiency in Griggs v. Duke


Power Company (1971) when it struck down an employers high
school diploma requirement in a geographic area where blacks
had very low graduation rates. After the Griggs decision, Title VII
outlawed disparate impact.

In 1978 the Equal Employment Opportunity Commission defined


illegal disparate impact in the 80 percent rule, as [a] selection
rate for any race, sex, or ethnic group which is less than fourfifths (4/5) or (eighty percent) of the rate for the group with the
highest rate...

As originally passed, Title VII did not require affirmative action, defined
as policies that seek out, encourage, and sometimes give preferential
treatment to employees in the groups it protects (unless a federal court
ordered it). However, two developments soon led to widespread
affirmative action by companies.

In 1965 President Lyndon Johnson issued Executive Order


11246 requiring affirmative action by federal contractors.

In United Steelworkers v. Weber (1979) the Supreme Court held


that Title VII permitted affirmative action plans leading to reverse
discrimination against white workers if the plans were designed to
break down patterns of past discrimination, did not absolutely bar
white advancement, and were both temporary and flexible.
Dissenting justices argued that this violated the plain language of
Title VII.

Since Weber, the Supreme Court has made a series of decisions


on affirmative action, at first expanding it, but in recent years
making it harder to justify.

Basic arguments for and against affirmative action are grounded in three broad
ethical perspectives.

Utilitarianism justifies affirmative action for those who believe it benefits


the nation as a whole though inconveniencing some who do not fall into
protected categories. Opponents of affirmative action say its benefits do
not exceed its costs.

Compensatory justice requires that those wronged by past discrimination


be compensated, and affirmative action helps them. On the other hand,
distributive justice requires that work benefits be distributed based on
equal treatment and merit. Affirmative action seems to violate this.
Conflict between these separate spheres of justice is what makes contrary
views on affirmative action irreconcilable.

Advocates of affirmative action say that it does not violate the rights of
whites because it is benevolent of intent, unlike ill-intended discrimination
based on race prejudice. Opponents argue that affirmative action violates
the more fundamental right of equal treatment under the law.

Women have entered the workplace in large numbers. The trend is worldwide.

Worldwide, 52 percent of women enter labor forces compared with 78 percent of males.

Participation rates are highest in the least developed nations of East Asia and Africa,
lowest in Arab nations.

Women who work face gender-based discrimination.

Men and women are socialized into distinct sex roles such that men are perceived as
aggressive and logical while women are seen as submissive and emotional.

These traditional stereotypes, now eroded but still present, are often carried into the
workplace.

Often, the discrimination created by these stereotypes is subtle.

Women are evaluated based on physical attractiveness, marital status, and


potential for motherhood.

Workplace cultures are based on masculine norms. Advancement requires staying


late at work when women have heavy responsibilities to home and children.

Men misinterpret female linguistic styles as indications of lacking self-confidence,


often interrupting them in meetings.

Many women experience sexual harassment, defined as annoying or persecuting behavior


in the workplace that asserts power over a person because of their sexual identity. Many
behaviors, from joking to physical assault, may be sexual harassment.

Men are motivated to harass by gender distinctions. Harassment is usually


intended to reinforce male power and status in work settings. By frightening and
humiliating women it puts them in the stereotyped role of submissive female.

In 1980 the Equal Employment Opportunity Commission issued guidelines making


sexual harassment a form of sex discrimination under Title VII. The guidelines
defined two situations where harassment is illegal.

One is the quid pro quo, when submission to sexual activity is required to
get or keep a job.

The other is a hostile environment, where sexually offensive conduct is


so pervasive that it makes work unreasonably difficult.

Although quid pro quo situations are usually clear, courts at first
struggled to define the characteristics of a hostile environment.

In Harris v. Forklift Systems (1993) the Supreme Court set guidelines for
what constitutes a hostile environment. No precise test was created, but a
reasonable person would find the environment abusive. Harassing
conduct is to be evaluated based on its frequency, its severity, its
unreasonable interference with work, and its threatening or humiliating
nature.

Women also face occupational segregation in jobs that are lower in status and
pay than typically male jobs.

Women dominate traditionally female occupations such as school teacher,


secretary, and receptionist.

They are underrepresented in traditionally male occupations in


manufacturing, construction, and craft work. In these areas women are
often 5 percent or less of workers in specific occupations.

Women hit a glass ceiling, or an invisible barrier of discrimination


thwarting their advance to top corporate positions. In 2010, they were
only 7.6 percent of top earning executives.

Women receive lower compensation than men for the same work. The Equal Pay
Act of 1963 forbids sex-based pay differences. Since its passage the pay gap has
narrowed from 59 cents for every dollar earned by a man to 81 cents in 2010. The
pay gap between men and women is worldwide. There are several causes for the
persistence of an earnings gap.

First, occupational segregation places women in female-dominated


occupations that tend to be lower-paying.

Second, women pay a heavy earnings penalty for child bearing and child
rearing. Their careers are interrupted.

Third, the earnings gap reflects elements of sex discrimination.

The pay gap between men and women is worldwide, between 10 and 30
percent in most countries according to the International Labour
Organization.

Diversity management refers to programs to recruit from diverse groups, promote tolerance, and
modify cultures to include nonmainstream employees.

Categories of diversity are numerous. They encompass individuals sharing a characteristic


disfavored by the mainstream.

Being in such a category can lead to discrimination, exclusion, and inhibited


opportunity.

The identity of disfavored groups varies among societies.

Workforce diversity creates tensions. Their causes are elusive, but can be
unspoken assumptions in corporate cultures based on mainstream values (usually
white and male values in the United States).

Many companies train employees to recognize and tolerate divergent attitudes.


Other companies have tried the more difficult task of deep culture change.

Diversity programs have many elements.

Leadership from the top.

Changes in the organization structure, such as setting up affinity groups, which


are support networks for employees who personify an attribute associated with
discrimination, stereotyping, or social isolation.

Training programs.

Mentoring.

Data collection.

New policies to adapt to the needs of diverse employees.

Rewards for managers who achieve diversity goals.

Despite decades of effort, tensions caused by diversity remain. There are many reasons.

Problems are complex and prejudices are deeply rooted.

Diversity programs are now institutionalized at big companies and some believe
they have turned into empty rituals.

When employees believe their status is threatened they resist change.

Some diversity practitioners accept the inevitability of strife and friction.

In conclusion, the chapter covers four civil rights eras.

A 244-year era of slavery ending when President Lincoln signed the Emancipation
Proclamation in 1863.

A short post-Civil War era in which freed slaves were protected by new laws and
constitutional amendments extending equal protection to all citizens.

A long era of widespread employment discrimination lasting to passage of the Civil Rights
Act of 1964.

A modern civil rights era since 1964 characterized by lessening workplace and societal
discrimination.

Note

Case

ADARAND v. PEA
The subject of this case study is a landmark legal challenge to affirmative action. Adarand Constructors is a
highway construction firm in Colorado that bid on a guardrail contract. Despite making the low bid it lost
the job to a Hispanic-owned company. Adarand sued, arguing it had been deprived of its constitutional right
to equal treatment under the law. What followed was twelve years of litigation on multiple federal court
cases. The end result was a partial victory for Adarand Constructors. The Supreme Court made affirmative
action harder to justify, but did not rule it unconstitutional.
Students can discuss the strengths and weaknesses of affirmative action in the context of its use in federal
highway construction. Students researching the case or assigned to present it in class can be referred to the
six separate opinions in the 1995 Adarand v. Pea decision. The majority opinion makes the argument for
reducing the use of affirmative action. The two concurring opinions make the case for ending affirmative
action. And the three dissenting opinions argue for retaining affirmative action.

Answers to Case Questions


1. What constitutional issue is raised in the Adarand litigation?
The question before the Supreme Court was whether a federal affirmative action program that favored
some citizens over others based on race, ethnicity, and sex was constitutional. The specific constitutional
issue in Adarand was the precise meaning of the due process clause in the Fifth Amendment that reads:
No person shall... be deprived of life, liberty, or property, without due process of law. The white-owned
contractor argued that these words guarantee each citizen the right to equal treatment under the law and
prohibit racial, ethnic, or sex preferences in contracting. The words in the Fifth Amendment do not literally
state that people have to be treated equally by the federal government, but accumulated precedent from past
Supreme Court decisions creates such a guarantee.
There is a more specific guarantee of equal treatment in Section 1 of the Fourteenth Amendment: No
State shall... deny to any person within its jurisdiction the equal protection of the laws. This guarantee is
binding only on states, not the federal government, but the Supreme Court has held that no lesser duty to
treat citizens equally should be enforced on the national level than on the state level. Therefore, the Fifth
Amendment embodies a guarantee of equal treatment as strong as that in the Fourteenth.

Despite these guarantees of equality, governments are not prohibited from classifying citizens for various
reasons when a legitimate purpose is served. For example, citizens are classified based on their income for
taxation and their age for licensing drivers. However, any classification of citizens must be carefully
scrutinized.

When laws set up racial and ethnic classifications they must meet a stiffer test. How strict a standard
should race-conscious affirmative action programs meet? In the past, a Supreme Court dominated by
liberal justices who believed in the need for affirmative action upheld race-conscious classifications if they
met a standard of intermediate scrutiny. In Adarand the more conservative majority discarded years of
precedent and concluded that this standard was too lenient; henceforth, federal affirmative action had to
meet a standard of strict scrutiny.

2. After the Supreme Courts 1995 decision in Adarand v. Pea what requirements did an
affirmative action program have to meet to be constitutional?
A program had to meet the strict scrutiny standard. In practice, this meant it had to pass two tests.

First, the government must prove a compelling interest. That is, the government has to
prove that discrimination against the favored groups exists and that the affirmative action
plan is designed to end it.

Second, the plan must be narrowly tailored. It must cover only persons who have suffered
discrimination. It cannot give unfair advantage to a wider group that includes persons who
have not suffered discrimination.

Because of the decision the Department of Transportation revised its rules for awarding federal highway
contracts to disadvantaged business enterprises (DBEs).

The 10 percent of highway funding intended for DBEs was defined as an aspirational
goal at the national level. These words moved away from any presumption that there was
a firm quota or set-aside.

To meet DBE goals, Colorado and other states were required to emphasize race-neutral
methods, or methods that encouraged all small businesses, including minority-owned firms.

Race-conscious methods of awarding contracts could only be used if race-neutral methods


failed in the presence of egregious discrimination.

States were required to do studies proving the existence of racism before race-conscious
methods of distributing highway funds could be used.

The definition of economically disadvantaged was changed so wealthy owners of


minority businesses no longer qualified. Specifically, those with a net worth of $750,000 or
more (not including the value of their homes) were excluded.

White males were allowed to apply for socially and economically disadvantaged status,
which they could get by proving they had suffered financial hardship due to discrimination.

These changes were a significant weakening of affirmative action in government contracting. Randy Pech
and his lawyers still believe the program is unconstitutional. Their appeals were unsuccessful. In Adarand
v. Slater (2000) a federal appeals court upheld the modified program as constitutional. In Adarand v.
Mineta (2001) the Supreme Court dismissed Adarands challenge as improperly raised.

3. Was the decision of the Court majority correct? Why or why not?
This question refers to the decision in Adarand v. Pea. Opponents of affirmative action approve of this
decision. They see it as correct on a constitutional plane, believing that affirmative action violates
fundamental guarantees of equality. They may believe that some affirmative action is all right if it can
withstand strict scrutiny. Or they may think that all affirmative action is wrong and approve of Adarand
only as a way station on the road to ending all race-based preferences.
Since Adarand makes it harder to justify affirmative action, people who advocate it disagree with the
decision. They believe that the majoritys principled argument about the need for strict scrutiny hobbles the
most effective laws the nation has to stop ongoing racism and sexism in contracting.

4. In a concurring opinion, Justice Scalia said that race classifications by government were
never legitimate. In dissenting opinions, Justices Stevens, Souter, and Ginsburg argued that
race-conscious remedies were justified. What were their arguments? With whom do you
agree? Why?
Justice Scalia argued that, in principle, government can never have a legitimate reason for classifying
citizens based on race. This is so because (a) the constitution bestows rights on individuals and not groups,
so racial groups cannot have rights (there can be no such thing as either a creditor or a debtor race) and
(2) the Constitution clearly rejects distinctions based on race for any purpose, be it evil or benign. He adds
that race-preference laws also preserve for future mischief the same evil that supported slavery.1
Stevens, Souter, and Ginsburg argued in their separate opinions in favor of so-called benign race
distinctions.

Stevens argued that it was correct for the Court to be wary of race distinctions in law but
that race preferences in set-asides were justified by their morally correct intentions. The
principle of utterly race-blind policy, said Stevens, would disregard the difference between
a No Trespassing sign and a welcome mat.2 He also observed that federal affirmative
action laws reflected the will of the people as expressed by a democratically elected
Congress.

123 L. Ed. 2d 190 (1995).

132 L. Ed. 2d 193 (1995).

Souter wrote that discrimination has existed and continues to exist in the construction
industry and its lingering effects justified the use of affirmative action if programs were
reasonable and temporary.3 He would have required only intermediate scrutiny.

Ginsberg cited recent research showing that discrimination continues. Congress, she wrote,
should not be required to ignore race, but should be allowed to use affirmative action for
achieving the equality promised in the Constitution. Preferences should be carefully
designed and not interfere too harshly with the opportunities of white males.4

Agreement with Scalia or with the dissenters is a matter of opinion. There is a major difference in
perspective. Scalia makes a principled argument in which a color-blind Constitution is inviolate. Using
racial thinking in law merely reflects and perpetuates racism. The three dissenters are pragmatic. Lofty
sentiments and principles will not stop entrenched discrimination. They believe that race preferences, used
well, are important, practical tools against bias.

5. Following Adarand v. Pea, the district court held that the affirmative action program in
federal highway contracts was unconstitutional. Do you agree with this decision? Why or
why not?
In due course, John L. Kane, Jr., a federal judge in Colorado, applied the strict scrutiny standard to the
affirmative action plan objected to by Adarand Constructors. 5 When he did, he decided it passed only one
part of the two-part test. Therefore, he declared it unconstitutional. He held that the government did have a
compelling interest in using affirmative action. Evidence of discrimination existed and Congress was
entitled to legislate preferences as a remedy. But the program in question was not narrowly tailored, mainly
because the definition of a disadvantaged business enterprise was too broad and gave unfair advantage to
affluent minorities and women.
Those who oppose affirmative action agree with Judge Kanes decision, believing that the Department of
Transportation plan was unfair to white contractors. Those who oppose the decision must argue that Judge
Kanes reasoning was bad when he applied the strict scrutiny test. They cannot make general or idealistic
arguments about the need for affirmative action. They need to read the decision and make an argument that
the strict scrutiny standard was wrongly applied. The gist of this argument has to be that there was no
better way of constructing the federal program, a program that allowed disadvantaging white-owned
contracting companies.

132 L. Ed. 2d 209 (1995).

132 L. Ed. 2d 213 (1995).

Adarand v. Pea, 965 F. Supp. 1556 (1997).

6. Do you believe that the Department of Transportations current rules for helping DBEs
get highway construction contracts pass the strict scrutiny requirement?
The revised rules back away from troublesome policies. First, instead of setting aside a pool of money to be
awarded only to DBEs, the rules now create only an aspirational goal for DBE contracts. Second, flatout preferences such as the bonus payment for picking a minority contractor instead of a white contractor
are eliminated. In their place, race-neutral ways of increasing the number of DBEs on highway projects are
required, mostly inoffensive measures such as outreach and training programs. And third, the nature of a
DBE is redefined to exclude wealthy and privileged minority business owners who do not need favoritism
and include, in theory, disadvantaged white-owned enterprises.
In 2000 a federal appeals court said that new highway contracting rules in Colorado, modified because of
Adarand, are constitutional. In 2001 the Supreme Court dismissed Adarands appeal challenging federal
rules, though on technical grounds.

1
8
Corporate Governance
SUMMARIZING OUTLINE
This chapter defines corporate governance. It sets forth its legal basis. It discusses the basic actors whose
evolving power relationships determine its character. And it acquaints readers with major issues concerning
shareholder rights, the duties of directors, and the compensation of executives.

The introductory story is about how the Hewlett-Packard board of directors fired CEO Marc
Hurd. It illustrates corporate governance in action.

Hurd was a strong CEO who executed well and raised HPs stock price.

His downfall was a questionable relationship with a woman he hired to help him at
marketing events. This woman accused him of sexual harassment. He denied it.

When the board of directors investigated, Hurd was found to have made deceptive expense
account claims and given deceptive answers to board members.

The boards decision to fire Hurd was criticized by some, who argued that its primary duty
was to protect the interests of stockholders and Hurd was making money for them.

The story illustrates corporate governance in action. It is also a sequel to the end-ofchapter case study about how the Hewlett-Packard board fired Carly Fiorina some years
before. It had hired Hurd to replace Fiorina.

Corporate governance is the exercise of authority over members of a corporate community based
on formal structures, rules, and processes.

This authority is exercised according to a body of rules that define the rights and powers of
shareholders, boards of directors, and managers. In Figure 18.2 these parties are depicted
as the corporate governance triangle.

The rules come from many sources including state charters, corporate bylaws, state and
federal laws, stock exchange listing standards, and corporate governance policies.

The authority to govern is granted by the corporate charter, a document issued by a state
to create a corporation.

The charter broadly specifies rights and responsibilities of stockholders, directors,


and officers. Charters may also include provisions about such matters as annual
meetings, the size of boards, and procedures for choosing or removing directors.

More detailed rules of corporate governance are found in bylaws.

By law, the line of authority in corporate governance descends in order from governments
to shareholders, to boards of directors, and then to management. In practice, power runs
from governments to the CEO, the board, and finally stockholders.

Stockholders own stock certificates, giving them limited, but important, rights. Their rights
are limited because they are legally not liable for corporate actions. Therefore, their control
over those actions is diminished. Their basic entitlements are to:

Sell their stock.

Vote to elect directors and on other issues.

Receive information about the corporation.

Receive dividends.

Sue the corporation if directors or officers commit wrongful acts.

Acquire residual assets in case of bankruptcy.

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Shareholders can also propose resolutions for a vote at the annual meeting. Such
resolutions must comply with Security and Exchange Commission rules. Most such
resolutions are opposed by management and fail to receive a majority vote. Even if they do
get a majority, they are nonbinding.

Although in theory shareholders have the voting power to influence or replace


management, in practice they rarely create an effective majority and are dominated by
management.

Federal regulation of governance has grown over the years. At first states defined the
requirements of corporate governance. But federal intervention came when business
ownership and activity began to cross state lines.

Beginning in the late 1880s, the size of firms grew. Their activities were no longer
mostly confined within state boundaries.

Bigger firms needed more capital. Ownership was dispersed among many small
investors in many states.

The stock market crash in 1929 revealed the need for more regulation to protect
stockholders. Congress passed the Securities Act of 1933, then the Securities and
Exchange Act of 1934.

At the turn of the century, when governance mechanisms, particularly boards of


directors, failed to prevent the bankruptcy of Enron and other bankruptcies and
financial frauds, Congress again legislated new governance requirements in the
Sarbanes-Oxley Act of 2002. The law has imposed heavy implementation costs
on corporations. Among its provisions are these.

It creates a Public Company Accounting Oversight Board to regulate


accounting firms.

It prescribes rules to improve auditing.

Boards of directors must have audit committees of independent directors.

It requires CEOs and CFOs to certify the accuracy of financial


statements.

It stipulates that executives forfeit profits from stock sales and bonuses
when earnings are restated because of fraud.

It prohibits boards from approving personal loans for executives.

It allows the SEC to bar offenders from serving as corporate directors or


officers.

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After the record bankruptcy of Lehman Brothers in 2008, again the result of failed
oversight by a board of directors, Congress passed the Dodd-Frank Act of 2010
with more governance reforms, including these.

Shareholders have the right to vote to approve executive compensation


and to approve special executive compensation in mergers or buyouts.

Members of board executive compensation committees must be


independent directors.

Companies must disclose the relationship between executive compensation


and financial performance.

If a company restates earnings, it must recoup any executive


compensation based on wrongly stated financial performance.

The structure, duties, and dynamics of boards of directors are discussed.

In theory, boards are tenacious, vigilant watchdogs over management. In practice, they
have many shortcomings.

Directors are often hand-picked by CEOs and unwilling to challenge them.

Boards depend on management for information and allow it to control agendas.

Board cultures are harmonious. Abrasive, confrontational directors are ostracized.

Many directors see board service as largely honorific and ceremonial and do not
work hard. Some dissipate their energies by serving on too many boards.

Many CEOs see their boards as unproductive and fail to demand much out of
them.

The duties of directors are enumerated. Among them are these.

Approving the issuance of securities.

Reviewing company goals and strategies.

Selecting, evaluating, and firing (if necessary) the CEO.

Creating governance policies.

Setting executive compensation.

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Evaluating fellow directors and the board as a whole.

Nominating candidates for election as directors.

The average board has 11 members who serve one-year terms. It meets 8 times a year.

Directors are chosen when nominated by the board and approved by a majority vote of
shareholders.

Directors who are employees of the company are called inside directors.

Directors who are not otherwise employed by the company are outside directors.

When outside directors have no important business dealings with the company
other than being on the board, they are called independent directors. Stock
exchange listing rules require regular meetings of independent directors away from
management. Many boards elect a lead director to preside over these sessions.

Boards are divided into committees. Due to statutory and stock exchange listing
requirements, most boards have audit, compensation, and nominating committees.

A perennial controversy is whether the board chair and CEO positions should be combined
in one person or split.

Advocates of greater board independence argue for a split. They believe it is a


conflict of interest for the CEO to chair (and perhaps dominate) the group that is
responsible for evaluating their performance.

Many CEOs oppose a split. They argue it can encourage conflict between the two
individuals, slowing decisions and confusing managers seeking guidance.

Executive compensation is based on policies devised by the board. If they are well devised, pay
follows performance. If not, pay may be unrelated to performance.

Total compensation is usually the sum of the following elements.

Base salary. It is often based on comparisons to peer companies. Base salaries for
CEOs are often near $1 million, the amount that is tax deductible.

Annual cash incentives. These are bonuses earned when performance targets are
met. The targets are usually financial goals.

Long-term stock-based incentives. There are several kinds.

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Stock options give an executive the right to buy the companys stock at a
fixed price or grant price in the future on a specified vesting date.

The grant price is the price at the close of the market on the grant
date.

The vesting date is the date, typically three to ten years in the
future, when the option holder can buy shares at the grant price.

On or before an expiration date, a specified date following the


grant date, the options must be exercised or they become
worthless.

A box explains backdating of options. It occurs when the


exercise price of stock options is set at the price on a date before
the date they were granted. This is done to lower the grant price.
It is illegal if not disclosed to shareholders.

Performance shares are awarded on a fixed future date if individual or


company performance goals are met. Part of the shares may be awarded if
goals are partly met.

Restricted stock is a grant of stock with restrictions. It cannot be sold


until certain conditions are met, most often the lapse of time. It is used to
retain promising executives.

Retirement plans. Executive pensions are often generous.

Perquisites. These include a range of benefits from gym memberships to life


insurance.

Five problems with CEO compensation are discussed.

First, some critics are outraged by extraordinary payouts that seem unfair in
relation to the pay of average workers. However, pay is often determined by
market forces and most top managers do not get the spectacular salaries of a few
that receive notice.

Second, compensation is not always aligned with performance. Often, however,


it is.

Third, compensation committees fail to design adequate compensation plans.


Some choose comparator groups of larger firms. Tootsie Roll Industries is given as
an example. This bloats executive pay. Others give in to CEOs demands.

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Fourth, top executives can inflate performance-based compensation by


manipulating accounting measures. For example, they can delay or accelerate
revenue to coincide with times when options vest.

Fifth, compensation policies are hard to understand. Shareholders, who vote to


approve them, are faced with lengthy, arcane discussions in proxy materials.

Two points are made in conclusion.

First, the governance triangle of stockholders, boards, and management is dominated by


management. Fortunately, most of the time management is trustworthy and proficient.

Second, after failures of governance the federal government has intervened to strengthen
the checks and balances between the parties in the governance triangle.

Note

158.

Case

HIGH NOON AT HEWLETT PACKARD


This case brings a board of directors to life for students to study. It describes boardroom politics behind the
firing of CEO Carly Fiorina and the subsequent pretexting scandals at Hewlett-Packard. It shows how
one board carried out its duties. It invites debate about the broad role of directors. It raises ethical issues
related to the leak investigations initiated by the board that subsequently embarrassed HP and led to the
resignation of the board chairman.

Answers to Case Questions


1. Over the time covered here, did Hewlett-Packards board of directors fulfill its duties to
the companys share owners? Explain how it met or did not meet basic duties.
Duties of directors are set forth in the chapter on page 652. As explained, boards have two overarching
duties and must perform a short list of more specific functions.

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The two basic duties are (1) to represent the interests of shareholders and (2) to watch over management.
The HP board carried out these duties. It closely watched CEO Carly Fiorina, reviewing her management
activities, offering advice, and then firing her. It acted to bring the companys share price out of a long
swoon.
The HP board also carried out the following more specific functions noted in the chapter.

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Review and approve major strategies and goals. It performed this function with care. For
example, it initially reviewed and approved Carly Fiorinas plans to restructure operations and
centralize management.

Select, evaluate, and remove the CEO. It performed these functions with Carly Fiorina. It also
selected a second CEO, Mark Hurd. Annual evaluation of the CEO was done formally by the
Organizational Review and Nominating Committee, later renamed the Nominating and Governance
Committee.

Give advice and counsel to management. It carried out this function with boundless enthusiasm. It
recommended acquiring Compaq. Directors Thomas Perkins and George Keyworth offered new
strategies and explored ideas for new products. There was disagreement over how closely the board
should enter into day-to-day management decisions. Even as Carly Fiorina balked, a majority on
the board approved detailed oversight. She argued that the board exceeded its authority. The
directors believed they were being conscientious. The board walked a fine line between helping her
and undermining her.

Create governance policies for the firm, including compensation policies. Especially after
passage of the Sarbanes-Oxley Act it put great energy into compliance with governance rules.
Some friction arose when Perkins and others came to believe that director Patricia Dunn allotted
too much of the boards time and energy to routine compliance matters. Much of the boards
governance work was done in its committees. Compensation for directors and officers was set by a
Compensation Committee.

Evaluate the performance of individual directors, board committees, and the board as a whole. It
carried out these tasks primarily through its nominating committee. This committee set criteria for
board membership, searched for nominees, and reviewed the performance of board members before
recommending them for continued service. The committee also reviewed the charters of each
committee, defined criteria for director independence, and evaluated Audit Committee members for
financial expertise.

Nominate candidates for board membership. It carried out this function through its nominating
committee. In practice, it had difficulty replacing members who retired or resigned because of
disagreements about the function of the board and the kind of directors who could best serve. One
faction sought CEOs of large firms who were knowledgeable about general management and
governance matters. Another sought directors who were technology experts. Because of this
disagreement the board shrank from 13 to 9 during the time covered in the case study.

Exercise oversight of ethics and compliance programs. It performed this function through its
Auditing Committee, which had responsibility for legal and regulatory compliance.

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2. What different perspectives on the role of the board are revealed in this story?
Two different perspectives emerge. They were defined in a Wall Street Journal column written by HP
director Tom Perkins.1
A guidance board, according to Perkins, is an older model based on venture capitalist practice. On such a
board the chair and CEO positions are separated. The directors main goal is to boost company
performance to benefit shareholders. The board is usually small and actively involved in strategy, tactics,
picking managers, and reviewing their decisions. In Silicon Valley directors on such a board have technical
expertise.
A compliance board, on the other hand, is defined by Perkins as a phenomenon that has emerged more
recently and become common among large corporations. Such boards no longer focus almost exclusively on
making money for shareholders. They accept other priorities, including gender and racial diversity of their
members. They emphasize obeying governance requirements. Instead of closely focusing on business
issues, they spend their time on conforming policies to legal requirements and stock exchange listing
standards.
Perkins was joined in his devotion to the guidance board model by fellow technologists Jay Keyworth and
Richard Hackborn. The Technology Committee they created had the characteristics of a guidance board. As
it grew influential it began to rival the full board as a forum for discussion and debate, becoming, in effect,
a board within a board, or more precisely, a guidance board within a compliance board.
Carly Fiorina and Patricia Dunn wanted a compliance board. They wanted to nominate CEOs of other large
corporations familiar with regulatory and governance issues. They wanted agenda time devoted to these
issues, not to the freewheeling strategy discussions favored by the technologists.
The opposing perspectives led to a power struggle. Either perspective could have been right or wrong for
Hewlett-Packard. However, each view had value to those who sought to increase their power over the
companys direction. Interest in self-aggrandizement underlay arguments on each side.
For Carly Fiorina a compliance board would focus on governance issues and broad matters of strategy,
meddling less in her day-to-day decisions. This would enhance her power to act independently and without
being second-guessed.
For Perkins and the other technologists a guidance board would legitimate their desire to share decisions
with Fiorina. They could force her to justify herself before she acted. They could make decisions about
hiring, firing, and daily operations with her.

1 Tom Perkins, The Compliance Board, The Wall Street Journal, March 2, 2007, p. A11.
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3. Was Carly Fiorina treated fairly by the board? Why or why not?
Her treatment seems fair. She was hired to be a change agent. Although changing the HP culture and the
Compaq Computer merger led to some organizational turmoil and conflicts between directors, most of the
board supported her until near the end. As the board lost confidence in her reorganization to centralize
authority in her office some directors sought to advise and redirect her. She resisted their efforts, sensing
intrusions on her independence that went beyond the proper role of the board. This led to a showdown. She
lost because as members of the Hewlett and Packard families and others left the board she was unable to
appoint new directors loyal to her and create a supportive bloc.

4. Were the leak investigations overseen by Patricia Dunn useful and important? Were they
ethical?
The leaks violated company policy. Directors also have a fundamental duty of confidentiality. Unless board
discussions are confidential directors will be reluctant to speak their mind. Stockholders are best served
when issues are fully and freely discussed. If directors believe their remarks can end up in the media they
might withhold opinions or be reluctant even to serve. Thus, leaks impair the functioning of a board.
Stopping the leaks was important to preserve confidentiality of deliberations. However, it was also
important to Carly Fiorina for another reason. The leaks originated in the power struggle between her and
the board. She believed the leakers were her opponents, including Perkins and Keyworth. If an investigation
proved this, she could get rid of her enemies. So, beyond the high ground of compliance with rules and
duty, the investigation was also founded on the pursuit of political advantage.
The leak investigations were questionably legal. It is unclear that Patricia Dunn would have been convicted
if her case had come to trial. Congress subsequently legislated to clarify that pretexting was illegal.
The investigations were not ethical. They involved actions that, when revealed, could not stand the light.
Two specific ethical wrongs were lying and invasion of privacy. The lying had to be renamed pretexting
so it could be rationalized. In these investigations the means were justified by the ends. Students can be
asked to debate whether lying and invasion of privacy were justified to protect the confidentiality of board
discussions.

5. Should George Keyworth have been asked to resign? Why or why not?
The resignation request was appropriate. Although his remarks to the reporter were mundane, he had
violated company policy and had breached his duty of confidentiality.
Perkins suggested simply a private scolding of Keyworth with a request to desist. In retrospect this was
probably preferable. The leak was immaterial. The power struggle with Fiorina was resolved and the
motive to leak to advantage the leaking party in board politics was lessened. Had Perkins not been angered,
he would not have had the same incentive to batter Dunn. Instead, Perkins resigned and used his knowledge
of the investigation to get revenge.

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6. How do you appraise the behavior of Tom Perkins? Was he a model director or a
renegade?
Perkins was forceful. As a former HP manager, he was exceptionally knowledgeable about the company. As
a wildly successful venture capitalist he was a sage about technology companies.
Wealth gave Perkins remarkable independence and he had a big ego. He was sure he knew what was best
for HP. In fact, after nearly six years of Fiorinas leadership the company was adrift. He pushed her, trying
to impose his will. She resisted. He organized the Technology Committee on the board. It was an effective
political tactic. Its meetings gave him a new platform to express his ideas. It provided formal legitimacy for
his cause. A committee now sanctioned his challenging agenda, making him less a lone dissenter.
He came to dominate the board and he won both of his main battles. He deposed Fiorina and inserted the
board more directly into HPs strategy and its execution. Picking Dunn as non-executive chairman of the
board was part of his plan. It separated the board chair and CEO positions, moving the HP board closer to
the model of a guidance board. As a director he was unable to control Dunn, but he ultimately destroyed her
from the outside after his resignation.
Political infighting and power struggles may be either functional or dysfunctional. Sometimes they are
necessary to realign and redirect a company. Powerful individuals associated with the status quo often see
change as a status threat. They resist it. Outsiders and mavericks such as Perkins may be best positioned to
see the need for change and to shove others toward it.
The case study asks what would happen if Perkins were put in a time machine and returned to the 1990s
for service on Enrons board. Students can be invited to predict the results. Would he have risen in anger as
astonishing financial transactions passed before his eyes? Could he have found political allies among
Enrons directors and challenged its top management even as its stock price soared?

7. What actions could have been taken to improve the functioning of the HP board?
Some believe the conflicts recounted in the case revealed a dysfunctional board. In fact, the board fulfilled
its range of functions. The presence of board politics and leaks reflected a significant power struggle. But
the board never suffered from the common problem of passivity.
One failure of the board may have been to allow airing of this power struggle in the media. However, it
would have been difficult to contain. HP is a large, well-known company. When the board hired Carly
Fiorina, it invited a spotlight on HP. She attracted a frenzy of attention as the first woman to head such a
large firm. She was engaging, dynamic, and photogenic. Some believe she reveled in her celebrity at the
expense of her work, traveling and speaking too much. When trouble with her performance surfaced it
became a big story.

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Also, the investigations were ultimately a bad way to handle board leaks. The leaks were a consequence of
political conflicts on the board and between the board and Fiorina. It was wrong for directors to violate
company policy and their basic duty of confidentiality with respect to board discussions. Fiorina was angry
about the leaks. At one point, she confronted the directors in a conference call and scolded them. This was a
factor in alienating Perkins and some others. She pursued a secretive investigation because she suspected
that her main antagonists, Perkins and Keyworth, were the leakers. If they were snared, they could be
forced to resign. This would be a political victory for her. After Fiorina was fired, the investigations had
some momentum and so they continued under Dunns direction.

8. Did gender play any role in the fortunes of Fiorina and Dunn?
Gender did play a role for Carly Fiorina. From the start she received more attention in the media than any
equally distinguished man might have. Media coverage often focused on her clothing, appearance, and
attractiveness. A false rumor that she had remodeled her office with a pink bathroom persisted. A man
would not have attracted similar coverage. Fiorina believes that this immediate and continuing focus on her
as a woman was a hindrance.
...[T]he coverage of my gender, my appearance and the perceptions of my personality would vastly
outweigh anything else... It is undeniable that the words spoken and written about me made my life
and my job infinitely more difficult. 2

The board ultimately evaluated Fiorina on her performance. When she was fired there were seven men and
two other women on the board. Two factors were central in her firing. First, she had alienated some in the
company and on the board by trying to centralize operations through her office. This went against the grain
of the HP Way. She believed that her gender was a factor. For example, as she reorganized, she removed
managers. She sensed that being a woman her actions were seen as cold-hearted because they went against
the stereotype of female compassion. She felt that a man taking the same actions would have been called
decisive. She was called abrasive. And second, the HP share price had dropped after the Compaq Computer
merger. The board lost faith in her ability to raise it. Some element of her failed performance may be
attributable to subtle gender biases that made the work she did more difficult because she was a woman.
Gender did not seem to play any special role in Dunns fortunes.

2 Carly Fiorina, Tough Choices: A Memoir (New York: Portfolio, 2006), p. 172.
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