BEYOND SCANDAL: THE REAL ETHICS CRISIS IN

BUSINESS

R. Edward FreemanThe Darden Schoolfreemane@darden.virginia.edu26May 2008

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts rese

rved

.

OUTLINE

The Call for a Revolution The Old Story The New Story of Business The Role of Responsibility, Sustainability, and

Ethics Creating Value in the New Story.

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

WE NEED A REVOLUTION IN BUSINESS

Unprecedented change. Old models, frameworks, and theories don’t

work very well. Continuous cycle of crisis, over response,

crisis. Lockheed, FCPA, Oil for Food Enron, Sarbox, mortgage meltdown Nothing new here.

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

THE CRISIS IS OUR STORY ABOUT BUSINESS:THE STANDARD STORY

1. Business is primarily about making money and profits.

2. The only constituency that really matters are shareholders.

3. Capitalism works because people are completely self-interested, and will only act for others if they have the proper incentives.

4. Given the opportunity, business people will cheat or cut corners.

5. Business works because people are competitive and greedy, and as if by an invisible hand: the greatest good emerges.

Read the papers, listen to the news, talk to your children’s teachers and friends. You’ll hear this story.

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

TOWARDS A NEW STORY ABOUT BUSINESS Business is primarily about making money and profits.

OR

Business is primarily about purpose. Money and profits follow.

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

TOWARDS A NEW STORY ABOUT BUSINESS The only constituency that really matters are

shareholders.

OR

Any business creates (or sometimes destroys) value for shareholders, as well as customers, employees, suppliers, and communities. Building and leading a business involve getting these interests going in the same direction.

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

TOWARDS A NEW STORY ABOUT BUSINESS Capitalism works because people are completely self-

interested, and will only act for others if they have the proper incentives.

OR

Capitalism works because we are complex creatures with many needs and wants, and we can cooperate to create value for each other. Sometimes we act for selfish reasons and sometimes for “other-regarding” interests. Incentives are important, but so are values.

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

TOWARDS A NEW STORY ABOUT BUSINESS

Given the opportunity, business people will cheat or cut corners.

OR

Most people tell the truth and keep their promises, and act responsibly most of the time. And, we need to expect that behavior

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

TOWARDS A NEW STORY ABOUT BUSINESS Business works because people are competitive and

greedy, and as if by an invisible hand: the greatest good emerges.

OR

Business and capitalism are the greatest system of social cooperation and value creation, ever invented. Competition is important in a free society, since it ensures options. But, the engine of capitalism is value creation.

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

TOWARDS A NEW STORY ABOUT BUSINESS

1. Business is primarily about purpose…money and profits follow.2. Any business creates (or sometimes destroys) value for

shareholders, as well as customers, employees, suppliers, and communities. Building and leading a business involve getting these interests going in the same direction.

3. Capitalism works because we are complex creatures with many needs and wants, and we can cooperate to create value for each other. Sometimes we act for selfish reasons and sometimes for “other-regarding” interests. Incentives are important, but so are values.

4. Most people tell the truth and keep their promises, and act responsibly most of the time. And, we need to expect that behavior.

5. Business and capitalism are the greatest system of social cooperation and value creation, ever invented. Competition is important in a free society, since it ensures options. But, the engine of capitalism is value creation.Let’s tell this story and expect it of businesspeople, and make it come true.

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

ELEMENTS OF THE NEW STORY

Lots of the elements of the old story plus… Corporate Responsibility Sustainability Ethics and Ethical Leadership “Social Entrepreneurship” Increased role for Civil Society

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

THE FOUR FORCES OF STAKEHOLDER CAPITALISM

VA

ValueCreation Responsibility

Sustainability Ethics

xxxx

* Value Creation for Stakeholders

* Corporate Stakeholder Responsibility and Responsible Stakeholders

*Sustainable Value Creation

*Ethical Value Creation

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

LISTEN TO WHAT CEOS AND OTHER BUSINESS LEADERS ARE SAYING…

A Brief Report from the Field

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

CORPORATE RESPONSIBILITY IS THE MOST IMPORTANT ISSUE OF THIS CENTURY. THE WINNERS WILL BE THOSE COMPANIES WHO ACT RESPONSIBLY AND ARE PERCEIVED TO ACT RESPONSIBLY.

---CEO NON US MULTINATIONAL FMCG

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

“A SOCIALLY RESPONSIBLE COMPANY STRIVES TO MEET A STANDARD THAT’S HIGHER THAN THE BOTTOM LINE, WE MUST REMEMBER THAT CORPORATIONS EXIST BECAUSE SOCIETY SAYS THEY CAN — AND SOCIETY ASSUMES THAT WE’LL CONTRIBUTE TO THE COMMON GOOD. THAT’S THE BARGAIN WE STRIKE. THE SOCIAL COMPACT.”

---CEO FINANCIAL SERVICES COMPANY

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

“WE OPERATE IN A VERY COMPETITIVE ENVIRONMENT AND THE PRESSURE TO PRODUCE IS INTENSE, BUT THE CONSISTENT MESSAGE TO MANAGERS AND SALES REPRESENTATIVES IS TO PRODUCE IN AN ETHICAL MANNER—FOLLOW ALL THE RULES AND LISTEN TO THE CUSTOMER.  ETHICAL TRADE-OFFS CAN APPEAR TO HAVE SHORT-TERM ADVANTAGES, BUT THEY USUALLY DON’T, AND THEY CERTAINLY DON’T IN THE LONG RUN.”

---CEO TECHNOLOGY COMPANY

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

“IN TODAY’S WORLD, THE RULES HAVE CHANGED AND WE ALL HAVE TO ADAPT TO THAT.”

---CEO MAJOR RETAILER

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

WE PUBLICIZE OUR ETHICS VIOLATIONS, EVEN WHEN OUR LAWYERS TELL ME WE SHOULDN’T. PEOPLE HAVE TO KNOW WE’RE SERIOUS ABOUT THESE ISSUES.

---CEO CHEMICAL INDUSTRY

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

WE HAVE TO PAY ATTENTION TO THESE THINGS. OUR RECRUITS ARE ASKING LOTS OF QUESTIONS. PLUS…WHOSE STANDARDS ARE RELEVANT TO US. WE’RE A GLOBAL COMPANY.

---CEO INDUSTRIAL PRODUCTS

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

YOU GET FIRED FOR MISSING ON INTEGRITY NOT FOR MISSING NUMBERS. HOW DOES THAT HELP US FIGURE OUT WHAT TO DO ALL OVER THE WORLD?

---CEO INDUSTRIAL PRODUCTS

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

IT’S TOUGH TO BE TOLD EVERY DAY THAT YOU’RE BEING STUPID. ACCOUNTANTS, CONSULTANTS, AND LAWYERS ARE FIGURING OUT WAYS FOR YOU TO DO STUFF THAT YOU REALLY DON’T UNDERSTAND. YOU HAVE TO ASK YOURSELF SOME PRETTY BASIC QUESTIONS TO CUT THROUGH THAT STUFF.

---POWER INDUSTRY CEO

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

I’M PRETTY SURE THAT THIS MEETING WITH A DISGRUNTLED EMPLOYEE LEADS NOWHERE. HE’S A KNOWN “TROUBLEMAKER”, BUT IF I DON’T SPEND TIME WITH HIM, THEN THE PERSON WHO HAS SOMETHING IMPORTANT TO SAY WON’T TELL ME.

---FINANCIAL SERVICES CEO

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

WE JUST DIDN’T SEE HOW LENDING OUR CUSTOMERS MONEY THAT THEY REALLY COULDN’T AFFORD TO PAY BACK WAS A GOOD IDEA. SO, WE REALLY DIDN’T GET CAUGHT VERY MUCH IN THIS SUBPRIME THING.

---CEO OF A BANK

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

PEOPLE DON’T HAVE TO DIE FROM AIDS. WHAT’S HAPPENING WITH HIV IN AFRICA IS A MORAL OUTRAGE…THERE IS ABSOLUTELY NO LEADERSHIP IN THE PHARMACEUTICAL INDUSTRY.

---FORMER PHARMACEUTICAL CEO

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

I THINK WE’RE PRETTY GOOD AT THIS STUFF. BUT, WHAT KEEPS ME AWAKE AT NIGHT IS THAT SOME ONE—MAYBE AN EMPLOYEE HALF A WORLD AWAY—IS GOING TO SEND ME TO JAIL AND BRING OUR COMPANY DOWN, AND I DON’T EVEN KNOW ABOUT IT.

---CONGLOMERATE CEO

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

I HAVE TO PAY MORE ATTENTION TO THE PROCESS BY WHICH WE HIRE PEOPLE. OUR BRAND IS AT RISK WITH EVERYONE WE HIRE.---TELECOM CEO

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

WHEN YOU ACTUALLY GO TO COUNTRY X AND YOU SEE THE CONDITIONS THAT PEOPLE LIVE IN, WE OWE THEM THE CHANCE TO DEVELOP THEMSELVES AND THEIR RESOURCES. BUT, WE CAN’T DO IT IN A WAY THAT IS NOT SUSTAINABLE.

---EUROPEAN AGRIBUSINESS EXECUTIVE

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

SUSTAINABILITY IS TODAY WHAT QUALITY WAS TO THE 1980S. WE THOUGHT THAT QUALITY HAD A COST ATTACHED TO IT AND FOUND OUT IT WAS PROFITABLE. IT IS SIMPLY A WAY OF BEING.

---ITALIAN EXECUTIVE, PACKAGING INDUSTRY

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

WE’RE TRYING TO FIX THE FACTORIES, EVEN THOUGH THEY BELONG TO OUR SUPPLIERS. NOW WE ARE GETTING PRESSURE TO FIX CHILD LABOR IN THE FLOWER FIELDS. THE DYE THAT GOES INTO OUR PRODUCTS COMES FROM THESE FLOWER FIELDS. I’M HAVING ENOUGH TROUBLE WITH THE FACTORIES. WHAT DO I DO ABOUT THE FLOWER FIELDS?---NIKE EXECUTIVE

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

YOU CAN’T RESPOND TO EVERY BIT OF NOISE THAT YOU HEAR—BUT IF YOU DON’T RESPOND TO THE “RIGHT” NOISE, THEN YOU GET HAMMERED.

---CHEMICAL INDUSTRY CEO

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

TODAY’S YOUNG EMPLOYEES WANT TO FEEL GOOD ABOUT THE COMPANIES THEY WORK FOR. SUSTAINABILITY, SOCIAL RESPONSIBILITY, AND ETHICS ARE NOT “NICE TO DO”. IF YOU WANT THE BEST TALENT THEY ARE BUSINESS IMPERATIVES.

---US FOOD INDUSTRY EXECUTIVE

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

IN THE WORDS OF ONE CEO, HOW DO I MAKE DECISIONS WHEN I DON’T EVEN KNOW HOW TO THINK ABOUT THIS ISSUE?

THINK ABOUT THESE CASES…

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

HIV IN AFRICA AND THE US BANK

A CEO of a large US Bank wondered how he should think about the issue of HIV in Africa. The bank had no operations in Africa, but it had many African American employees, a group of whom have come to the CEO and asked what the bank was doing on this issue. One leading industry executive and physician claimed that the scientists had turned HIV into a chronic disease like diabetes, yet thousands of people were dying daily of the disease in many parts of the world.

What advice would you give to this CEO

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

THE BUSINESS MODEL DILEMMA

Company A had a business model that depended on low wages and low benefits to employees. They employed the very best techniques of efficiency management to insure that employees were productive.

Company B in the same industry had a similar wage structure but paid educational and health benefits for all employees, even part time ones. Company B’s product mix was different from A, but the two competed for entry level employees.

How should Company A compete?

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

IN THE NEWS

Company X was a leading technology company in industry A. There technology was a key to improving the efficiency of the conversion of plant stocks to fuel. Company X had a worldwide reputation for social responsibility and stakeholder engagement. They awoke one morning to discover that were associated with poverty and hunger, simply because their technology helped make fuel from plants.

How should the executives at Company X think about this issue?

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

THE DEVELOPMENT PROGRAM

Company Y understands much of what we have talked about. They believe that they need to develop their managers to deal with this new world. But, they must continue to get results from the old business model built on shareholder value and relative predictability.

How should they think about this challenge?

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

A SIMPLE IDEA

Business is about creating value for stakeholders.

The only task of the executive is to create as much value for stakeholders as possible.

Suppliers, customers, employees, financiers, and communities determine the ultimate success of a company.

Great companies create win-win relationships with stakeholders that endure over time.

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

THE MANAGING FOR STAKEHOLDERS MINDSET:

TEN PRINCIPLES

1. Stakeholder interests go together over time.

2. We need to have a philosophy of volunteerism—to engage stakeholders and manage relationships ourselves, rather than leaving it to government.

3. We need solutions to issues that satisfy multiple stakeholders simultaneously.

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

THE MANAGING FOR STAKEHOLDERS MINDSET:

TEN PRINCIPLES

4. Everything that we do serves stakeholders. We never trade off the interests of one versus the other continuously over time.

5. We act with purpose that fulfills our commitment to stakeholders. We act with aspiration towards fulfilling our dreams and theirs.

6. We need intensive communication and dialogue with stakeholders—not just those who are friendly.

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

THE MANAGING FOR STAKEHOLDERS MINDSET: TEN PRINCIPLES

7. Stakeholders consist of real people with names and faces and children. They are complex.

8. We need to generalize the marketing approach.

9. We engage with both primary and secondary stakeholders.

10. We constantly monitor and redesign processes to make them better serve our stakeholders.

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

Enterprise Strategy

Stakeholdersand

Principles

Societal ContextAnd

Responsibility

Purpose and

Values

Ethical LeadershipEthical Leadership

Ethical LeadershipEthical Leadership

The Basic Value PropositionThe Basic Value Proposition

Principles for Sustained StakeholderPrinciples for Sustained StakeholderCooperationCooperation

Understanding the Broader SocietalUnderstanding the Broader SocietalPrinciples of Ethical LeadershipPrinciples of Ethical Leadership

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

ENTERPRISE STRATEGY

Stakeholdersand

Principles

Societal ContextAnd

Responsibility

PurposePurpose and and

ValuesValues

Ethical Leadership

Ethical Leadership

•Values/Aspirations•Making SH Better Off•Legacy

The Basic Business or

Value Proposition

Questions:• What do we stand for?• What are our aspirations?• For whom do we want to create value?• How do we make each stakeholder better off?• What do we want to leave behind for others?

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

Enterprise Strategy

StakeholdersStakeholdersand and

PrinciplesPrinciples

Societal ContextAnd

Responsibility

Purpose and

Values

•PVPs underlying all stakeholders•PVPs for specific stakeholders

Values driven Stakeholder Management

• What principles, values and policies are we committed to so that stakeholders can count on our support and our actions?

•Are there principles, values and policies that underlie all our stakeholder relationships?

Questions:• What are the major tradeoffs that we make in managing our stakeholder relationships?

•What are we doing to improve these tradeoffs?

Ethical Leadership

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

Enterprise Strategy

Stakeholdersand

Principles

Societal ContextSocietal ContextAnd And

ResponsibilityResponsibility

Purpose and

Values

Ethical Leadership

•Societal Trends•Critics•Governance

Stakeholder Dialogueand

Engagement

Questions:• What are our most vocal critics saying about us?• Is there a way of opening a dialogue with our critics so that we can learn from them how to realize our purpose and principles in a better way?• What issues are on the horizon in society that will affect the kind of company that we want to be in the next ten years?• What obligations, principles, and governance mechanisms do we want to use to interact with stakeholders who have become our critics (or stakeholders we have not explicitlyrecognized earlier)?

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.

“SERVING ALL YOUR STAKEHOLDERS IS THE BEST WAY TO PRODUCE LONG TERM RESULTS AND CREATE A GROWING, PROSPEROUS COMPANY…LET ME BE VERY CLEAR ABOUT THIS: THERE IS NO CONFLICT BETWEEN SERVING ALL YOUR STAKEHOLDERS AND PROVIDING EXCELLENT RETURNS FOR SHAREHOLDERS. IN THE LONG TERM IT IS IMPOSSIBLE TO HAVE ONE WITHOUT THE OTHER. HOWEVER, SERVING ALL THESE STAKEHOLDER GROUPS REQUIRES DISCIPLINE, VISION, AND COMMITTED LEADERSHIP.”

--BILL GEORGE, FORMER CEO MEDTRONIC

5/2

8/2

00

8(c) 2

00

8 R

. Ed

wa

rd F

ree

ma

n. A

ll righ

ts re

serve

d.