PART V

ETHICS AND RESPONSIBILITY

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Chapter 18

Corporate Social ResponsibilityThis chapter begins the explicitly normative part of the book. The purpose of the chapter is to raise the issue of the appropriate objectives of a firm and its responsibilities to its various constituencies. No particular set of objectives is advocated nor is a singular vision of those responsibilities presented. Instead, the chapter concludes that the content of social responsibility is found in ethics, which is the subject of the next two chapters. Chapter 21 presents a number of policies implemented by companies in accord with their conception of corporate social responsibility. Chapter 22 focuses on issues of ethics and corporate social responsibility in international business.

Corporate social responsibility is advocated by many firms but their actions vary considerably. With the pressures facing firms in an era of global competition, costly corporate social responsibility policies can harm competitiveness. For example, as indicated in Chapter 1 Ford Motor Company pledged to increase the fuel economy of its SUVs by 25 percent over 5 years. Ford found that achieving that objective would be considerably more difficult and costly than anticipated.

Some policies may improve competitiveness and profitability, and there remains the question of whether that represents social responsibility. The argument that it does not is simply that a firm whose only objective is to maximize profits would adopt the same policy. The adoption of a “socially responsible” policy that is also a profit-maximizing policy thus is not sufficient to conclude that the firm acted in a socially responsible manner. From a strategy perspective the issue is which policies and how much of an increase in value.

The section on the strategic uses of corporate social responsibility can serve as a basis for a general discussion of two points. First, do socially responsible policies and actions generate higher profits? Second, is it responsible to use so-called socially responsible policies and actions for strategic purposes?

Another factor in assessing a firm’s actions is causality. Some firms that are quite successful in their market environment have adopted “socially responsible” policies that may be thought of as philanthropy, since they involve using some of their profits for purposes other than future profitability. The direction of causality issue is whether the “socially responsible” policies are the result or the cause of profitability.

The Tuna and Dolphins example is intended to illustrate another dimension of the issue — whether an action taken as a result of pressure should be labeled as socially responsible or simply as a concession to a pressure group. This raises the issue of motivation for an action or policy.

The chapter sets the stage for a general discussion of what constitutes social responsibility. The efficiency perspective can also be labeled as the competitiveness perspective, since it identifies efficiency in its broadest sense as the objective and that which will make the firm the most

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competitive in its market environment. The social responsibility perspective is more difficult to define, but involves certain duties or responsibilities beyond efficiency.

It should be pointed out to students that Friedman requires firms to act in accord with the law and ethical custom. Thus, even if the value maximization (efficiency) perspective is adopted, there is a need to study ethics. Friedman argues, however, that there is no reason to label policies that increase profits as socially responsible.

The Business Roundtable statement takes the perspective of managerial capitalism, since managers are viewed as principals who have the responsibility for balancing the interests of stakeholders or constituents. The Roundtable intentionally chose not to be specific, since it is managers who are to decide what is an appropriate balancing of interests for any particular firm. Interestingly, management is to consider the interests of constituents without directly involving those constituents in decision-making. The stakeholder concept is central to this perspective, but the stakeholder relationship is reciprocal. This concept seems to help little in identifying corporate social responsibility other than to identify the importance of creating realistic expectations on both sides of the relationship.

My experience is that students find Friedman’s position clear and relatively unambiguous, whereas they find the Business Roundtable statement to be somewhat vague. Some students, who wish to argue that firms should do good, argue for the rhetoric of social responsibility and for the sacrifice of profits for the direct benefit of others.

What constitutes corporate social responsibility remains unclear from these characterizations, so examples are provided to help clarify the issues. The typology identifies motive as an important determinant of what constitutes social responsibility. Motives can be many and varied and are difficult to identify. One means of doing so is to distinguish between those cases in which pressure is being brought on the firm and those in which it is not. The other distinguishing factors are the effects of the action or policy on shareholder interests and society’s interests. Reasonable people can disagree about the examples which can be used to stimulate a discussion of corporate social responsibility.

One dimension of the responsibility issue involves representation and accountability. Legal accountability and responsibility rest primarily with the officers and the board of directors. Their duties are specified in the law but beyond compliance with the law and answerability to shareholders they may have additional responsibilities. A lecture could expand on the duties of directors and on the implications of the legal cases. The Enron case raises such issues.

A major feature in the social responsibility debate is the extent to which firms can pursue policies that reduce the value of the firm to pursue social objectives. The market for control disciplines management through the threat and reality of proxy contests and takeovers. The pressure comes from institutional investors and mutual and retirement funds. These pressures are for increased profits, and hence “socially responsible” policies that reduce profits are harder to sustain.

Transparencies providing an overview of ethics and responsibility are available in ethicsresponsibility.ppt.

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Cases

The Collapse of Enron: Governance and Responsibility

This case was written in February 2002, and much if not most is still unknown about the causes of the collapse of Enron. The Report of the Special Committee of the Board is a very readable account of the events leading up to the bankruptcy filing. (Dean Powers resigned from the Board shortly after the Report was released.) It, however, leaves a number of questions unanswered. Additional information will become available, particularly as lawsuits are prosecuted.

Class action and other civil lawsuits have been filed against Enron, and Bill Lerach of Milberg, Weiss is the lead attorney for the principal class action lawsuit. Lerach is the king of securities fraud litigation. (See the discussion of the Chapter 8 case Proposition 211: Securities Fraud Litigation (A)(B) for information about Mr. Lerach.) Many of the cases will likely be settled out of court, but some may go to trial. Settlements will be complicated because Enron is under the jurisdiction of the bankruptcy court. At the time of this writing Enron was believed to be negotiating with Andersen on the settlement of a lawsuit that Enron could file against its auditor.

In addition to the civil cases it is quite possible that criminal charges could be filed against former Enron officials. Certainly, the directors will be sued for a breach of their duties of care. The Van Gorkom and Hanson Trust cases suggest that the directors may be liable for failing to dig deeper into the establishment of the special-purpose enterprises and their transactions. The directors have D&O (directors and officers) insurance, but such policies have caps, and hence the directors may be personally liable.

After the bankruptcy filing Kenneth Lay resigned from the Board and the company, and outside management was brought in to attempt to right the ship. Many of the top officers of Enron resigned or were fired. Their replacements were generally the next in command.

Part of the explanation for Enron’s collapse was a series of bad investments which sapped capital from the company and may have provided incentives to structure transactions to give the appearance of strength when the reality was quite different. Whether this was the result of bad management is unclear. The purpose of the case is less to consider the quality of Enron’s management and more to consider the responsibilities of management and directors and governance structures.

One issue likely to be on students’ minds is the type of transactions Enron used and their purpose. The initial purpose was likely to have been to “manage” Enron’s financial statements to preserve the reported growth that gave Enron its value. This involved taking risks in energy projects and other investments, and Enron sought to insulate its financial statements from those risks. In addition, the special-purpose enterprises and their related transactions allowed Enron to raise more capital than it likely could have raised if all the investments and their financial were on its financial

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statements. Once some of the investments started to go bad and investors started to have concerns, the bubble burst.

The financial deals could be discussed with the purpose of showing how, for example, the Mahovia-Stonehill transaction was actually a loan and how the put options were risky.

The Mahovia-Stoneville transaction also drew other attention. In 1996 a copper trader for Sumitomo Corporation lost $2.6 billion in trading, and Sumitomo sued J.P. Morgan and Chase Manhattan charging that they provided loans disguised as trades that the trader used to cover up the trading losses. The same law firm representing Sumitomo filed a lawsuit against the merged J.P. Morgan Chase alleging fraud in disguising the Mahovia transaction as a trade rather than a loan. The bank stated, “Any prepaid commodity sale contract provides financing. There is nothing inappropriate about structuring transactions to satisfy the parties’ financial, tax, regulatory or accounting objectives within the relevant rules and standards.”1

The measures taken by Enron, and particularly by Fastow, were surely pushing the envelope too far and bordered on the criminal. The efforts to avoid disclosure by having Kopper manage Chewco and to provide the 3% outside equity were intentional efforts to avoid having to consolidate the transactions. Skilling and Lay presumably were aware of the transactions, although they may have been quite happy to have Fastow doing the work.

The governance of Enron is intended to serve the interests of shareholders and the interests of the public as it pertains to upholding the law. The duties of the officers and directors are discussed briefly in the chapter, and a business law textbook goes into those duties in more detail. In accord with the Van Gorkom and Hanson Trust decisions, Enron obtained valuations and fairness judgments from PricewaterhouseCoopers on some of the transactions, such as the Mahonia-Stoneville swap.

With respect to governance structures little information is currently available. The Special Report provides some information, and the outside Board members argued that the controls were adequate but that information was withheld from them. Certainly, some information was withheld, such as pertaining to the Barclays’ loan and Kopper’s involvement, but the Board appears not to have probed very deeply into the special-purpose enterprises and their transactions. What they could have accomplished is unclear, but even more questioning might have provided some discipline for management.

It does not appear that the Board probed very deeply into the Raptors and Chewco and how they were managed.

Although ethics is the subject of the following chapters, this case provides ample opportunities to assess whether Enron and its officials acted unethically based on standards of aggregate well-being, rights, and justice. The apparently unethical actions include violating the outside equity requirements, conflict of interest and self-dealing, touting Enron’s stock to employees, and misrepresenting information (possibly in violation of SEC requirements). Many actions are in gray areas. For example, assigning Kopper to head Chewco so as to avoid disclosure requirements may

1 The New York Times, February 25, 2002.

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have been within the law, but it is questionable from the perspective of justice and possibly utilitarianism. Some of the motivation for some unethical actions is understandable. Enron, in particular Lay, may have touted Enron’s stock to employees even though it knew that the Raptors were fragile because if he did not do so, it could have been a signal to Wall Street that Enron’s health was slipping. This would likely have accelerated the collapse.

A particularly troublesome ethics issue is the likely self-dealing in the LJMs. Fastow was apparently on both sides of the negotiations regarding the LJMs; i.e., he represented Enron and he represented the LJMs in negotiating the unwind. More troublesome was his own personal investment and enrichment from the deals. The LJM investment in the Raptors was guaranteed a return, and he and co-investors made large and undue profits. There seems to be little justification for this enrichment. Fastow’s defense might be that the outside equity had to come from people within the Enron family because otherwise there was a risk that information might leak to Wall Street about the deals and their purpose.

Another issue is whether Enron made insufficient disclosures or misrepresentations to its lenders and the limited partners in its special-purpose enterprises. At one level, it is the responsibility of those lenders and investors to be diligent in discovering information relevant to the transaction and to bargain with Enron over security and collateral. If a lender were concerned about the risk, it could either not lend to Enron, or as Citigroup did it could hedge its exposure. At another level if Enron misrepresented information, such as violating SEC requirements, it acted unethically and perhaps unlawfully. It would be interesting to know what Citigroup told those on the other side of its hedge.

An important public policy issue is whether the generally accepted accounting principles (GAAP) are adequate. One observation is that GAAP has never been able to keep up with financial innovation because that innovation takes place too rapidly. That is, as soon as new standards are established to cover a particular trouble area the Wall Street firms go to work to find a way around the new standard. This is a race that accounting may never be able to win.

Arthur Andersen is in a particularly difficult position because it is potentially liable both directly and as an abettor in a securities fraud lawsuit. (See the Chapter 8 case cited above.) Andersen has been losing clients and employees as a result of its involvement with Enron and will likely fail.

Discussion questions:1. What was the purpose of the special-purpose enterprises? 2. Why did Enron work so hard to keep assets and liabilities off its financial statements?3. What was the purpose of the Mahovia and Stoneville transaction?4. What might have been Fastow’s motives for establishing the LJM partnerships?5. What was required to keep Chewco, the Raptors, and LJM off the financial statements? 6. Were Lay, Skilling and the Board correct in determining that the partnerships did not adversely affect Enron?7. Was Enron really doing something wrong? Would it have been wrong if the special-purpose enterprises had been fully disclosed?8. What should the Board have done? 9. What responsibilities does Enron have with regard to its employees and their retirement funds?

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10. What was Arthur Andersen’s role in all of this? Why did it make so many “errors”?How adequate were the generally accepted accounting principles? 11. What would be required for an auditor to be truly independent?12. Why was Enron’s outside law firm willing to go along with the special-purpose enterprises?13. What public policy reforms should be instituted to reduce the likelihood of further cases like Enron? 14. What does this situation look like from the perspective of Arthur Andersen?

Copyright © 2002 by David P. Baron. All rights reserved. Reprinted with permission.

Advanced Technology Laboratories, Inc.

Transparencies are available for this case atl.ppt.

This is a case written about an issue—the use of ultrasound equipment for sex selection—and does not reflect the actual situation of Advanced Technology Laboratories (ATL Ultrasound). The case was written based on public sources of information and may not reflect actual problems faced by ATL. ATL is best thought of in this case as an example of a company that could face the issues identified in the case. ATL produces ultrasound equipment at the high end of the price scale, so its equipment is less likely than others, particularly locally-produced ultrasound equipment, to be used in sex selection. The handheld unit to be introduced by ATL has a greater potential to be used for sex selection. There is also an issue of whether handheld systems are sufficiently accurate for use in sex selection. The answer is “yes.”

This case can be used in conjunction with Chapter 18 with a focus on assessing the extent of ATL’s responsibility with respect to how its product is used. It can also be used in conjunction with Chapter 19 and 20 to apply specific ethical principles.

Ultrasound diagnostic equipment is a highly-valuable product with a wide variety of beneficial uses in a number of medical specialties. Moreover, advances in technology, and particularly digital technology, hold the promise for ultrasound as a primary care diagnostic instrument.

ATL is a small company specializing in digital ultrasound products. Its primary competitors are GE and Siemens, which dwarf ATL in resources. ATL has subsidiaries in the OECD countries and in Argentina, China, and India. The company in India is a joint venture with a local company. The most attractive markets are those with large populations and high growth rates in spending for medical care and services. China and India were particularly attractive markets.

Along with those markets, however, came a serious ethics issue resulting from the use of ultrasound equipment for fetus sex identification and abortion of female fetuses. This practice was culturally-based and stemmed from the importance of sons in caring for elderly parents and in carrying on the family name. In addition, daughters required a large dowry that could impose a substantial hardship on a family, particularly for families with more than one daughter. These

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cultural factors caused some families to invest more in sons than in daughters and abort female fetuses and in some cases kill female infants.

Sex selection was widely opposed by doctors, women’s groups, and official government commissions. India had passed a law banning abortions after sex identification and prohibiting the use of ultrasound for pregnant women except for those at high risk. There, however, was little enforcement of the law, and ultrasound equipment was not registered so it could not be traced back to the original purchaser. Despite the law, the practice of sex selection using ultrasound was widespread in certain parts of the country, and the practice was believed to have grown with the wider availability of ultrasound equipment. Presumably, the increase in abortions resulted in less female infanticide. Additional information on sex selection in India is provided in: “Amid Poor Villagers, Female Infanticide Still Flourishes in India,” The Wall Street Journal, May 9, 2000; “Abortions in India Spurred by Sex Test Skew the Ratio Against Girls,” The New York Times, April 22, 2001; “Means to Pick Baby’s Sex Sets Off Furor in India,” The New York Times, November 23, 2001; “Family pressures, unwanted girls,” The New York Times, May 13, 2001.

Sex selection is also practiced in developed countries. A San Jose, California doctor operates two ultrasound clinics using technologies that he claims allow him to identify the sex of a fetus at 12 weeks. Canadians of Asian decent began traveling to his clinic in San Jose. In response, Dr. Stephens opened a clinic in Blaine, Washington, just across the border from Vancouver, British Columbia. To attract business he advertised in Vancouver newspapers in both English and Punjabi.

Technological change may lessen the sex selection concerns by relying on techniques that separate the X-chromosome sperm (male) from the Y-chromosome sperm (female). A number of other methods were being developed. Ultrasound, however, is likely to maintain a considerable cost advantage.

The fundamental issues in the case is the extent, if any, of ATL’s responsibility for how its products are used and whether it has a duty to reduce the likelihood of its products being used for sex selection. In assessing responsibility and duty, it is always important to determine what the law requires. In this case the law in India seems to assign duty to those engaged in sex selection and not to the suppliers of ultrasound equipment that may find its way into such use. Consequently, it is necessary to look beyond the law to more fundamental considerations.

Several types of moral concerns can be raised in this case. One is the notion of selection of the sex of a child. A second pertains to the use of abortion as a selection instrument. A third is gender bias, since female fetuses and not male fetuses are aborted. A fourth is the underlying issue of the status of women in Indian society. Other concerns can be identified.

Sex selection may also be argued to have some benefits, given the culture in which it is practiced. It relieves impoverished families from the economic burden of the dowry system. Given the culture, it also may reduce the level of female infanticide and abandonments. These considerations raise the fundamental issue of whether culture should matter in determining the responsibility of a company. The notion of cultural relativism is considered in Chapter 22.

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Responsibility in this case could reside individually or jointly with the woman, the family, doctors, government, society, and equipment manufacturers.

From Friedman’s perspective responsibility seems to rest not with the manufacturers of ultrasound equipment, since it is the use of the equipment and not the equipment itself that is at fault. This perspective is based on the arm’s length nature of the sale, the use of a market, and the transfer of property rights associated with a sale. Moreover, the purchaser of the equipment is best placed to determine how it should be used. This, however, does not necessarily imply that if some other party is likely to violate a duty that the manufacturer does not have a duty to act to reduce the likelihood of that violation.

The Business Roundtable’s notion of a stakeholder seems not to be particularly helpful in this case, since it is difficult to see how a responsibility could arise to take into account the stake of that customer who intends to use an ultrasound unit for sex selection. Moreover, if ultrasound technology advances sufficiently rapidly that a clinic replaces its ultrasound equipment every few years and sells its old units, there is another party between the manufacturer and a purchaser who intends to use the old unit for sex selection.

The issue of the assignment of duty is complex and difficult and is considered in Chapters 19, 20, and 22. The Calabresi and Melamed principles presented in Chapter 11 and discussed in Chapter 19 provide one means of assigning duty. These principles imply that ATL is well placed to reduce the harm associated with the use of its products and hence it has a duty.

What specific steps could ATL take to reduce the likelihood that its products will be used in sex selection? There are a number that it can take to lessen the likelihood, recognizing that it is unlikely ever to be able to stop the use of sex selection using its products. First, it should keep records of who purchases each unit. Second, it could ask the purchaser to notify ATL if it sells the unit and identify the buyer. Third, it could ask the purchaser to sign a pledge not to use the equipment in sex selection. Fourth, it could sell only high-end products in India that would likely be too expensive for most of those engaged in sex selection. ATL could also attempt to organize industry-wide action to mitigate the problem and improve the situation of girls. The final question is whether ATL should use its good deeds in the promotion of its products. The discussion of the Body Shop in Chapters 3 and 21 provides instruction on this question.

The transparency on the positive role of ethics addresses predicting whether interests with be motivated on moral grounds to take nonmarket action against ATL.

The above discussion focuses directly on the issue of responsibility. The argument in the book is that responsibility is best identified by examining the implications of ethics systems. Those systems are considered in Chapters 19 and 20. Utilitarianism, moral rules and rights, and justice are briefly identified in the transparencies.

Teaching the case:The following questions can be used to lead the discussion.

1. Are these ultrasound units good products?

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2. What is the concern with them? (their use)3. Which products have the greatest potential for misuse? (low-priced, portable)4. What is the specific nature of the moral concern? Is it selecting based on sex, is it the use of abortion, is it gender bias, is it the status of women in Indian society?5. Does sex selection have any benefits? (relieves an economic burden on the poor, reduces female infanticide, avoids mistreatment of girls)6. What are the causes of this practice? (culture, poverty)7. Are the concerns about sex selection due to western paternalism?8. On whom is the legal duty placed in India to stop this practice? (doctors, women; apparently not on the manufacturers of ultrasound equipment)9. Does ATL have a responsibility for how its products are used?10. What do Friedman’s and the Business Roundtable perspectives imply about ATL’s responsibility?11. Is there a moral duty on ATL that derives from ethics systems?12. What if anything should ATL do? 13. Should ATL sell its handheld unit in India and China? 14. Could there be a nonmarket reaction against ATL?15. Suppose you were a large company such as Philips Electronics of the Netherlands and were considering buying ATL. Would you want to take the issue of responsibility and possible reactions into account?

The following (B) case can be used to continue the discussion.

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Advanced Technology Laboratories, Inc. (B)2

Vaira Mani recounted the death of a neighbor’s newborn baby, “It feels as if you’ve been turned inside out. You’ve just given birth and finally you feel emptied. You’re exhausted. Your breasts are painfully full of milk. And then you look at your baby. And you see that she’s a little girl. And you know you have to kill her.”3 The village of Usilampatti in the state of Tamil Nadu is in the center of the “killing fields of Madurai,” where female infanticide is still practiced.4 The practice is most common among poorer people, who did not have the resources to care for a girl, including her dowry, and cannot afford an ultrasound test to determine the sex of a fetus and the cost of an abortion. The government placed cradles in towns where babies could be deposited, but many women were reluctant to use them. In Dharmapuri 51% of the female infant deaths were estimated to be due to infanticide, and the female infant mortality rate was 131 per 1000 births compared to a male infant mortality rate of 69.5

Female infanticide had been prohibited since the British passed the Infanticide Regulation Act in 1870 and was defined in the Indian penal code as murder. The Indian government had announced that poor families would be eligible for 500 rupees (£8) a year to put a child through school. Despite measures taken by the government Ms. Sheela Rani Chunkath, Commissioner for Maternal and Child Health and Welfare, said that the practice of female infanticide had not declined but instead had spread to other areas.6

Preparation Questions:1. Does the contribution to reducing female infanticide outweigh the moral concerns about

aborting female fetuses? 2. In reasoning about the responsibilities of ATL should the culture (poverty, the dowry system,

sex preferences of parents) be accepted as given or do principles transcend culture?

2 Copyright 1998 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. Reprinted with permission. 3 London Times, March 12, 1997.4 Madurai is a holy city in Tamil Nadu. Female infanticide is also practiced in the north, particularly in Rajasthan, Bihar, and Uttar Pradesh. 5 The Hindu (India), March 30, 1997. 6 FT Asia Intelligence Wire, January 7, 1998.

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Developments:

ATL decided to spin off its handheld product, creating a company called SonoSite. SonoSite’s first product will sell for $15,000-20,000 and will have a number of high-end features. It will be used for gynecology diagnostics such as abdominal tumors and not for obstetrics. Later products will be designed for cardiology and radiology. SonoSite believes that its products will compete with those “on carts.” In expected that its product would be ready for market in late 1999 or 2000. In China and India SonoSite plans to sell through distributors that are “substantial companies.” High protective tariffs in China tend to keep low-end products out of China.

There is no evidence that any groups have actively undertaken action against ATL or any other manufacturer of ultrasound equipment. However, GE medical equipment was effectively boycotted by INFACT. INFACT targeted GE because of its role in nuclear weapons production and the boycott was directed at all of GE’s products. However, the most effective component of the boycott was the decision by European hospitals to not buy high-end GE medical systems. The boycott cost GE over $60 million in sales of medical devices. GE would seem to be particularly vulnerable to a boycott not only because of the large variety of consumer products it sells but also because it is specifically developing portable ultrasound machines for the Indian market. According to an article in Asiaweek (March 1, 1996) the “General Electric Co. recently unveiled the first ultrasound machine entirely developed and constructed in India. The device is fully portable at under 10 kilos and still provides the clarity of image usually produced by large, immovable machines.”

Right-to-life groups are a source of both threats and opportunities for ultrasound manufacturers. These groups effectively boycotted Hoechst Marion Roussel, the original producer of the abortion-inducing drug RU-486, causing it to cease production of the drug. Right-to-life groups have been working with ultrasound manufacturers to sell ultrasound devices at a discount to crisis centers. The strategy of the group is to have women seeking counseling view the image of their fetus on ultrasound equipment with the hope that the woman will choose not to abort it.

In August 1998 Philips Electronics NV acquired ATL for $800 million. A student who had worked on the sale of ATL to Philips commented that he had not heard the sex selection issue mentioned during the negotiations, although he believed it was implicit in the bargaining.

Headquarters Relocation: Kimberly-Clark and the State of Wisconsin

This case is intended to be used as a small group negotiations exercise, using the group assignments presented in the case. (The roles are hypothetical, as indicated in the case.) The casecan also be used as a basis for a discussion of the relocation issue from the perspectives of the company and of the governor.

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From Mr. Smith’s perspective, a move of the headquarters would make it easier to attract management talent but more importantly would make coordination of its activities more efficient. This includes reducing travel time. That travel time is important is indicated by Kimberly-Clark’sdecision to start an airline serving Neenah and the Fox River valley.

From the perspective of responsibility, Friedman’s position would call for the company to analyze the relocation alternative based on a profit-maximizing basis. The Business Roundtable position calls for a consideration of a broad set of stakeholders. Those stakeholder relationships are reciprocal. The case does not provide information on the stakeholder groups, but the central ones are the employees and the communities that might be affected. Even if the company has a responsibility to them, it can discharge that responsibility by compensating those whose stakes are diminished.

The governor’s basic problem is that the state is in a recession, companies have been leaving the rust belt and moving south and west, the demand for social services is high, the tax base is declining, and the state must have a balanced budget. The state eventually will want to attempt to attract new businesses to the state.

There is little that Kimberly-Clark can do directly to improve the business climate in Wisconsin, unless it decides to build a coalition or to take the issue directly to the public. (The state government understands the issues.) Also, a pledge by the governor, would have limited credibility unless the state legislature were on board.

There is also little likelihood that a move of the headquarters could be blocked by the state.

Teaching the case:

If small group negotiations are used, the remainder of the class session should involve a reporting of the outcome, the strategies used, and how the negotiations progressed.

If small group negotiations are not used, the following questions can be used.

1. How important is this issue to Kimberly-Clark?2. What responsibility, if any, does Kimberly-Clark have to the state of Wisconsin, to Neenah and the communities in which it has operations? To other stakeholders?3. Should Mr. Smith seek to extract concessions for Kimberly-Clark from the governor?4. Which of the alternatives should Kimberly-Clark take into the meeting with the governor?5. Should the governor make concessions to keep Kimberly-Clark in Wisconsin? How much latitude does the governor have?6. Should the governor seek a plant closing law for Wisconsin that would prevent Kimberly-Clark and other companies from leaving? (The answer is presumably “no,” since such a law would surely discourage other companies from locating in Wisconsin.)7. Should Mr. Smith take the issue of the business climate in Wisconsin to the public? What are the dimensions of the business climate that should be addressed?8. Is there a process that could lead to mutual accommodation?

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Outcome:

Kimberly-Clark and the state jointly commissioned a $175,000 study of the business climate in Wisconsin by Yankelovich, Skelley, and White. Kimberly-Clark paid $50,000 of the cost.

The economy in Wisconsin picked up, and the state eliminated the surcharge on income taxes when its revenues improved.

In 1985, Kimberly-Clark announced that it would move its corporate world headquarters to Irving, Texas, outside Dallas. Mr. Smith said that about 75 corporate staff members would work at the Irving site and that there was no intention to move any large number of employees from Neenah. The operations center remained in Neenah.

One interesting aspect of this case is that the airline, Midwest Express, that Kimberly-Clark established to link Neenah to other locations became quite successful and expanded service considerably.

Governor Earl was defeated in his reelection bid, as voters rejected his liberal policies and pronouncements.

Delta Instruments, Inc.

The two issues in this case are 1) what to do about the FATRs already submitted and about to be submitted to the DGSC and 2) what to do about the Director of Engineering. The first issue provides an opportunity to discuss the difference between self-interest, casuistry, and ethics. There is no ethics system that would justify not reporting the alterations of the data to the DGSC. An argument that no harm would be done by not disclosing the alterations, since the gauges would indeed meet the performance standards when delivered, is an example of casuist reasoning. That is, it would involve the false application of principles to a specific instance. (“Alterations but no harm done” is not a principle.) Even a claim that a utilitarian system that would conclude that the particular act of data alteration produces no harm and hence is acceptable does not hold. Surely, the party best placed to make the utilitarian analysis is the DGSC, and hence disclosure of the alterations is called for.

An argument that Delta and its employees might be harmed by disclosing the alterations is based on self-interest rather than principle. That is, an argument that Mr. Armstrong has a responsibility to Delta’s employees and hence is justified in violating ethical principles that call for disclosure of the alterations is casuistry. Not disclosing would involve compromising principles for some notion of responsibility for the well-being of those depending on him.

Students may be uncomfortable with the application of ethics principles in this case because they — in the position of Mr. Armstrong — are made worse off. There is little reason to believe that an ethical action makes everyone better off, however.

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The second issue is what should be done with the Director of Engineering. This is a matter of retributive justice. The first thing that Mr. Armstrong should do is determine if any laws have been violated, and if so the DGSC should be told of who violated the law. (It seems unlikely that criminal charges would be brought if Delta makes the disclosure voluntarily.) There seems to be no obligation to punish the Director of Engineering, but punishment such as a suspension for a fixed period would certainly be appropriate and firing would be acceptable. That might, however, be inconsistent with Delta’s corporate culture.

Of course, there is also the possibility that if Delta does not disclose the alterations that the DGSC will find evidence of alterations (e.g., through its own testing), that a Delta employee will blow the whistle, or that one of the independent testing labs may identify the alterations in their own test data.

Teaching the case:One approach to teaching this case is simply to ask what Mr. Armstrong should do. The basic approach in this case is to probe reasoning and decisions that reflect casuistry and/or self-interest.The following questions can be used to provide more structure to the discussion.

1. What decisions does Mr. Armstrong have to make?2. What ethics concerns are involved in these decisions?3. How should Mr. Armstrong reason about these decisions?4. What should Mr. Armstrong do?5. Should the DGSC be notified of the alterations?6. Should the Director of Engineering be disciplined?

Outcome:

Delta disclosed the alterations, and the government expressed no concern about them, since the final product was expected to meet the specifications. The Director of Engineering was fired. He was able to find employment at another firm in the Los Angeles area, and he obtained health insurance through his new employer.

In an interesting development, Mr. Armstrong was considering acquiring the firm the director of engineering had joined. When asked what he planned to do if he acquired the firm, Mr. Armstrong answered that he had thought about it and had not decided.

A Related Case:

In November 1992, Teledyne pleaded guilty to 35 counts of falsifying test data on electronic relay switches used by NASA and the Department of Defense. Teledyne paid a criminal fine of $17.5 million. Sentencing of Thomas L. McDowell, head of the relays division, who had pleaded guilty to two counts of making false claims, remained to be decided. He could be sentenced up to five years and fined up to $250,000 on each count.7

7 The Wall Street Journal, November 10, 1992.

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Teledyne also faced a civil suit under the False Claims Act, which allows employees to file whistle-blowing suits against defense contractors. Damages of $200 million were being sought on behalf of the customers of Teledyne.

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Chapter 19

Ethics Systems: UtilitarianismAs indicated in Chapter 18, the content of corporate social responsibility is found in ethics. The purposes of Chapter 19 are first to identify what ethics is and is not and to introduce the perspective taken in the book to the subject. Then the chapter presents the important ethics system—utilitarianism. Moral rights and Rawls’s theory of justice are considered in Chapter 20. A number of the cases in this chapter can be used in conjunction with Chapter 20, and a number of the cases in that chapter can be used in conjunction with this chapter.

Utilitarianism is the system that underlies welfare economics and serves as the justification for social cost-benefit analysis. Rights are also fundamental. Rawls’s framework for justice has been selected less because of how compelling it is and more because it addresses many of the considerations that intuition tells us are important. There are many other ethics systems that could also be considered, and some may be more compelling to some people than those considered here. These three, however, provide a rich enough set of ethics perspectives to permit a comprehensive analysis. One reason for discussing moral philosophy is to show students that ethics is not simply the application of one’s values.

The perspective taken here is that not all ethics systems yield the same evaluations of alternatives and indeed may yield conflicting evaluations. Moreover, people may not agree on which ethics system is appropriate. For these reasons, it is important to consider issues from each of the perspectives. Another reason for doing so is that those in the environment of a firm evaluate a firm’s actions and policies using a variety of ethics frameworks. Referring to the framework introduced in Figure 2-4, ethics systems and ethics analysis can be used in positive analysis to examine motivations for nonmarket behavior and to help predict the nature and extent of nonmarket actions.

The first part of the chapter is needed because some students take too casual an approach to ethics. They too often rely on values and on ex post justification of decisions made on other bases. The chapter argues that ethics is more than values and ex post rationalization. In particular, it argues that the application of ethics frameworks requires ethics reasoning from principles and that a number of difficult issues are often associated with that application.

The chapter discusses two types of reasoning that are not based on ethics reasoning. One is reasoning from one’s self-interest. For example, ethical behavior can make one worse off than less ethical behavior; i.e., good ethics can have a personal cost. Unethical behavior, however, often comes back to harm the person. The second is casuistry which is the art of bending, or making exceptions, to ethics principles in the interests of responsibility to constituents or shareholders.

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The discussion of ethics reasoning begins with the distinction between two categories of situations to which utilitarian analysis is applied. The first category includes those situations in which institutions are in place to align private and social well-being. In that case, utilitarian evaluation of alternatives and evaluation based on the self-interest in the firm are the same, so ethics analysis is relatively straightforward. (This is the world that Milton Friedman would like to have prevail.) The second category is that in which institutions are not present to align private and social well-being.

A lecture can begin with the perspective presented in Figures 19-1 through 19-4. Figures 19-2 and 19-3 are particularly important. The former is a useful reminder that the application of ethics is not a search through ethics systems for one that seems to justify an action that one wants to take for other reasons, such as self-interest. The latter is important to emphasize the imaginative generation of alternatives and the importance of reflection and experience in successfully reasoning from the perspective of ethics systems.

utilitarianism.ppt provides transparencies for a lecture on utilitarianism. A lecture could focus on the basic concepts and the application of utilitarianism. A particularly important distinction is between self-interest and utilitarianism. It is also important to discuss the conditions under which the two are the same. Numerical examples are useful to illustrate the utilitarian standard.

A difficult distinction is that between rule and act utilitarianism. The chapter discusses two conceptions of the difference. One is based on the classical distinction between a choice among actions in a particular situation and choice of a rule to guide behavior is many similar but not identical situations. The other is Harsanyi’s notion of rule utilitarianism corresponding to the simultaneous choice of actions for all parties involved. That simultaneous choice then becomes the rule for all to follow. Act utilitarianism is then utilitarianism applied to the situation holding the choices of other parties fixed at the actions they are likely to take for whatever reason. In Chapter 22 this approach is applied to the issue of bribery to address whether a company is morally justified in offering a bribe if it is known that a rival will be offering a bribe. Rule utilitarianism addresses the issue of whether any party is justified in offering a bribe and whether all the parties have a mutual duty to stop the practice of bribery. Such a mutual duty has been exercised resulting in an OECD code against bribery. Another difficult but important aspect of the application of utilitarianism is determining which party has a duty to take an action that would result in maximal aggregate utility. Another important issue that could be addressed in a lecture is the distinction between intrinsic and instrumental rights.

Cases

Living Benefits

From one perspective, firms like Living Benefits and Beat the Grim Reaper are ethics entrepreneurs that have identified a market opportunity that can be mutually beneficial to the policyholder and the

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firms. The issue for Prudential is whether it should enter this market niche or, more fundamentally, whether there is a moral imperative to enter it.

The practice in question can be said to be morally good for a number of reasons. First, the sale of a policy is mutually beneficial for the policyholder and for the firm. Second, the transaction is voluntary, since both parties have the right not to engage in it. Indeed, the sale of contracts is now commonplace. This includes winning lottery tickets and court awards and settlements of lawsuits where the proceeds are paid in installments. Third, the purchase of a policy clearly serves an important need whenever it allows an individual to continue to pay for medical treatment or other necessities. It particularly provides a major benefit when the policyholder would otherwise let the policy lapse.

The ethics objections to the sale of the insurance policies seem to center on the possibility of exploitation of the impaired facilities of the terminally ill. Another criticism is that an individual who would otherwise let his or her policy lapse would be in an unfavorable bargaining position which would allow the firm to capture much of the value of the policy. (Note that the best protection against exploitation is competition among a number of firms offering the same type of service, since competition would bid up the price of the policy.)

The objection that purchasing a policy gives a person an interest in someone else’s death seems spurious at best. If the policy were not sold, the named beneficiaries would have an interest in the policyholder’s death. Admittedly, the beneficiary may be a family member who wants the individual to live a long time, whereas the purchaser of the policy would be better off if theindividual were to die soon.

From a utilitarian perspective, Prudential should enter this line of business because doing so would provide a benefit to both sides of the transaction. As long as Prudential explains the transaction clearly and does not exploit the policyholder, offering to purchase the policies is welfare (utility) improving and should be done. Moreover, Prudential may be more efficient in this line of business and hence may be able to make Pareto superior deals with policyholders.

From a rights perspective, purchasing the life insurance policies of the terminally ill involves a voluntary transaction to which no one should object. The practice can also be argued to follow from a rule that is both universalizable and reversible. One can well imagine willing the transaction to be universal.

From a justice or fairness perspective such as that offered by Rawls, the principle of maximal liberty is surely respected as is the principle of equal opportunity. The difference principle compels a company to act to improve the situation of the least advantaged individual. The least advantaged individual is the one who is terminally ill and who faces high medical bills. The purchase of lifeinsurance policies seems consistent with all three principles. The principal qualification to this is that the company should not exploit the position of the individual.

Teaching the case:The discussion might be directed with questions such as the following.

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1. What are the objections to a beneficial service such as this?2. Is it objectionable that a third party has an interest in someone’s death?3. How should Prudential analyze the alternative of offering to purchase the life insurance policies of its policyholders who are terminally ill? 4. If Prudential decides to enter the market, should it offer to purchase only the policies of its policyholders or any policy?5. If Prudential decides to enter the market, how much risk should it take; e.g. should it restrict purchases to those with only six months or less to live? What percent of the face value of the face value should it pay to someone with less that six months to live? How should it make that decision?6. If you object to the purchase of the life insurance policies of the terminally ill, would you as Prudential write your insurance policies in such a way as to prohibit them from being sold?7. If you were responsible for giving an ethics award to a company, would you give it to Prudential (which did enter the market) or to an innovator such as Living Benefits?

Outcome:

Prudential entered this market by offering to purchase policies of its terminally-ill policyholders. It provided 95% of the face value of a policy for those with six months or less to live. It received the ethics award.

This market has expanded considerably with a number of new entrants, and the volume of insurance policies purchased increased to $100 million by 1992. The entrants included large firms such as New York Life and small firms such as Legacy Benefits, Accelerated Benefits, AffirmativeLifestyles, and Life Benefits.

With the growth in the industry, the term “viatical” has come to be used to characterize the practice. This is a “term derived from a Latin word for the purse an emperor gives to an ambassador before a journey.”8

The growth in viatical settlements led to regulation in the states of California, Kansas, and New Mexico and to calls for regulation in a number of other states.

The viatical settlements industry is composed of two types of firms. One type purchases the life insurance contracts and holds them. The other type acts as a broker by buying insurance contracts and selling them to investors. In August 1994 the SEC filed suit against Life Partners, Inc., alleging that the firm was actually selling unregistered securities.9 Bill Freeman, executive director of the National Association of People with AIDS said, “I believe that these companies provide a valuable service for people with AIDS. I think [the SEC’s action is] contemptible.”

In 1995 the House of Representatives passed “The Contract with America Tax Relief Act of 1995” which provided for tax-free treatment of funds received from “living benefits.” Mr. John Banks, CEO of Viaticus, Inc. took out an advertisement on the op ed page of The Wall Street Journal, May 19, 1995 urging the Senate to support this provision. The ad read in part, “A viatical settlement is

8 The Wall Street Journal, July 31, 1992.9 The Wall Street Journal, August 26, 1994.

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often the only remaining financial resource available to a terminally ill individual. But allowing the tax free treatment of viatical settlements and other “living benefits” is more than a financial issue--it addresses a fundamental human need which cannot be ignored.”

Pricing the Norplant System

This case raises normative issues of two types. The first is normative in the sense of strategy—to achieve improved performance, particularly in the market environment. The second is normative in the sense of ethics. In this second sense the case involves ethics with numbers, which provides an opportunity for students to be specific about tradeoffs.

One of the complicating features of this issue, and one that is present in most issues involving pharmaceuticals, is the distinction between ex ante and ex post. The cost structure of a pharmaceutical typically involves high ex ante costs for the development and testing of a drug through the lengthy FDA approval process and low ex post costs associated with the actual production and marketing of the drug and the related liability. Thus, when one examines patented drugs that are currently on the market, their ex post contribution to profits is very high. This means that there are frequently nonmarket pressures for lower prices, particularly when there are organized interest groups that recognize an opportunity to gain from reduced prices. In some cases, those interests groups are backed by public sentiment. In the case of Norplant, the clinics and interest groups working for birth control as well as advocacy groups for the poor are critical of the pricing of Norplant. The pricing of pharmaceuticals also attracts political entrepreneurs, and in this case Representative Wyden has assumed that role. Wyeth-Ayerst thus faces a decision about the pricing of Norplant as well as how to deal with the nonmarket pressure from the interest groups and their advocates.

Norplant had proven to be quite successful with sales in the United States exceeding forecasts by a considerable margin. Sales were also extensive outside the United States, where the drug has been in use for a number of years. (Many drugs developed by U.S. companies are approved in other countries long before they are approved in the United States.) Norplant will, however, face increased competition from new birth control drugs, including Depo-Provera and at some point RU-486.

The market for Norplant is segmented into physicians and clinics. It is customary to price discriminate by offering birth control drugs to clinics at discounted prices. Wyeth-Ayerst is breaking this tradition by refusing to give discounts to clinics. Through the Norplant Foundation, however, it is providing Norplant free to the indigent.

Wyeth-Ayerst’s rationale for not giving discounts is that it wishes to induce doctors to become trained. This produces two types of benefits. First, because the doctors have been trained, there will be fewer complications from the insertion and lower liability costs. Second, it gives the company an “installed base” of physicians who can sell the drug. (Physicians have an incentive to sell the drug because they receive income from the implantation of the capsules.)

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Does it matter that a portion of the development costs was paid for by public funds and private contributions through the Population Council? It is easy to construct arguments that it does matter, so I will offer arguments for why it either does not matter or has been adequately taken care of. First, the development of many drugs has benefited from government funding of research often through universities, and royalties are not paid to the government. There is thus nothing unusual about federal funding in this case. The use of private contributions through the Population Council is somewhat out of the ordinary, but the Population Council is being repaid through the royalties for its involvement. If sales of Norplant in its first three years reach $300 million as projected, the Population Council may have already received $15 million in royalties. Indeed, the Population Council is not only receiving the royalties, but it also has achieved its objective in having a new and effective birth control device brought to market. The Population Council’s involvement and investment certainly has resulted in a substantial return.

With respect to the pricing of Norplant, information on the demand function is not available nor did Wyeth-Ayerst have a good idea of what it was. In making its initial pricing decision, the company compared the effectiveness of Norplant with other birth control methods, and it compares quite favorably. Even at a price of $600 it is less expensive than other methods, with the exception of tubal ligation and vasectomy which are effectively irreversible. From the perspective of relative benefits a price of $600 certainly seems warranted. That price may be higher than the profit-maximizing price, however, and Wyeth-Ayerst chose a price of $350. One reason for this may have been to increase demand so that physicians would have a greater incentive to become trained in its use.

The other part of the pricing decision is whether it should price discriminate and charge a low price for clinics (presumably those not covered by health insurance) and a high price for other users (presumably those covered by health care insurance).

Ethics principles can be used to gain some insight into the pricing decision. It might be argued that women have a right to the availability of birth control measures so that they can exercise their autonomy. Whether this extends to the availability of birth control drugs without regard to price is debatable. If price is ignored, however, then the argument could be extended to most any good. In the case of Norplant, women have available a wide array of alternatives ranging from abstinence to pills to tubal ligation. Some of these, such as birth control pills, are available for virtually no cost through clinics. It might be argued that Norplant should be provided at a discounted price because it is more effective and has lower risks of side effects than other drugs, but the logic that leads to lower prices the more effective is a product seems curious. There seems to be no necessity to provide Norplant at a discounted price to clinics.

It might also be argued from a fairness perspective that Norplant should be priced so that it benefits the least advantaged women. Wyeth-Ayerst has in effect done this by providing it free to the indigent. The question then is how extensively it should be made available. In its first two years the Norplant Foundation provided 13,000 kits, so its program for providing Norplant to the indigent was active. In addition, the government could purchase the kits and provide them free to the indigent and to clinics.

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The principal ethics framework for pricing decisions is utilitarianism, which economists implement in various forms through the measure of consumers’ plus producers’ surplus. Ex post a price below $350 is probably warranted, since Wyeth-Ayerst is surely emphasizing profits over consumers’ surplus. The difficulty, however, is in determining socially efficient long-run pricing that recovers the development and testing costs of not just those drugs that are successful but those that are unsuccessful either in the marketplace or in testing. The price charged by Wyeth-Ayerst presumably takes into account these costs.

The economics of Norplant can be sketched. At projected sales of $165 million, approximately 450,000 kits would be sold in a year. The Population Council’s royalties could be as much as $8 million. Production and liability costs are approximately $22.5 million, and other annual costs, including the training of doctors, are $20 million. Total ex post costs thus are approximately $50 million, leaving a contribution of approximately $110 million. Information is not available on the costs of development and testing.

The nonmarket reaction to the pricing of Norplant stems from the burden on clinics and the desire of birth control advocates to make effective treatments as widely available as possible. This focus tends to be ex post, but it is also coupled with the argument that takes into account the ex ante research and development costs of drugs. That argument takes the form that the profits, as measured by return on assets or return on equity, of pharmaceutical companies are high. This is a claim that received some attention from congressional Democrats and from President Clinton in his failed 1993 attempt to restructure the health care and health care insurance systems.

The pricing of pharmaceuticals in the United States and in other countries is a continuing issue that largely reflects differences in health care delivery systems. Most other developed countries have government controlled health care delivery systems or government-mandated health care insurance systems that regulate the price of pharmaceuticals. Even with these systems, pharmaceutical prices are higher in countries that have a pharmaceutical industry than in those that do not. Unless the United States regulates pharmaceutical prices, comparisons between U.S. prices and prices elsewhere will reveal a substantial difference and will lead to criticism by some interest groups. Pharmaceutical companies are accustomed to this.

Some of the nonmarket reaction to the pricing of Norplant is morally motivated, based on considerations such as those discussed earlier. The sale of Norplant in Africa at $23 a kit is analogous to giving it to the indigent in the United States.

Teaching the case:The discussion can be guided using the following questions.

1. What criteria should Wyeth-Ayerst use in setting the price of Norplant?2. Were the types of comparisons made to other birth control alternatives appropriate?3. What ethics issues are involved here?4. Does it matter that this drug is for use by women? Do women have a right to use Norplant regardless of their willingness to pay?5. To what extent if any does it matter that the Population Council was involved in the development of Norplant? That some federal funds were used?

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6. What price should Wyeth-Ayerst have set initially for Norplant? Should it have offered discounts to clinics?7. What is motivating the nonmarket reaction to the pricing of Norplant? Is the nonmarket pressure serious?8. In light of the nonmarket pressure it is encountering, what should Wyeth-Ayerst do about the $350 price? What should it do about Representative Wyden’s hearings?

Outcome:

The case is set in 1993, which is when the Clinton administration was attempting to restructure the health care system. Part of the pressure Wyeth-Ayerst is receiving derives from this attempt. For a number of years pharmaceutical pricing had been under attack, and a number of companies had pledged not to raise prices by more than the rate of inflation. Consequently, pricing a drug low was risky because it could be difficult to increase the price later.

Wyeth-Ayerst came under attack from Surgeon General Joycelyn Elders, who stated in testimony before Representative Wyden’s subcommittee, “If reproductive choice is to be a reality in our country, reproductive choice must include access to the latest, most effective means ofcontraception.”10 In defending Wyeth-Ayerst’s pricing of Norplant, medical director Dr. MarcW. Deitch testified that Norplant was priced below oral contraceptives. (Depo Provera injections cost $120 per year. In 1994 the price of Norplant was $365.) He also argued that the high price gives doctors an incentive to become trained in the insertion of Norplant. He reaffirmed Wyeth-Ayerst’s intention to maintain the price of Norplant for the first five years it is on the market and then to lower the price in December 1995.

All birth control drugs have side effects, and Norplant was no exception. In 1994 Wyeth-Ayerst was the subject of class action lawsuits on behalf of women who complained of headaches, nervousness, dizziness, acne, weight gain, and discomfort from removal of Norplant. (The Norplant brochure given to women warned of the possible side effects, although it states that their “association with the Norplant system has been neither confirmed nor refuted.”) Apparently, removal of Norplant has been in some cases more complicated that had been anticipated. Moreover, the nonprofit Center for Reproductive Law and Policy reports that 20 percent of women have Norplant removed during the first year because of side effects or their desire to become pregnant. Later, women complained that small amounts of silicon were in Norplant, and with the attention being given to silicone breast implants (see Chapter 12), sales of Norplant plummeted.

GNC and Andro

GNC is in a difficult situation. It faces pressure from its francishees, and they and GNC are losing sales. These are not just the loss of andro sales, but some customers who purchase andro in other stores while there may purchase other products as well. Some of those customers may not return to GNC. The potential sales of andro are probably not very large, but the margin is undoubtedly high.

10 The New York Times, March 19, 1994. President Clinton fired Dr. Elders shortly after she took office.

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In addition to the pressure, the health effects of andro usage are not well understood. GNC also has a history of problems with claims made for products and could face civil or regulatory actions against the company. The fact that it is legal to sell and use andro is important but not a compelling guide for what GNC should do. The question is whether GNC should go beyond the law by refusing to sell andro, as it has in the past. To make this decision GNC should investigate andro further by convening a panel of doctors. Their advice would be an important guide. That the Olympics, the NFL, and the NCAA ban andro should be troubling to GNC.

Ethics analysis of this situation is complicated by the lack of information about the short- and long-term consequences of andro use. Taking that uncertainty as given, utilitarianism would allow people to make their own decisions given full disclosure about the uncertainties. That full disclosure could be provided by GNC, by government, or by patients. At a minimum GNC should provide warnings to users about the possible consequences and the lack of information about risks—and about effectiveness. Warnings would also provide a degree of protection in the event of lawsuits. At a maximum if GNC concludes that aggregate well-being would be improved by selling andro it should do so.

The case provides an opportunity to distinguish between utilitarianism and self-interest, since it is clearly in GNC’s self-interest to sell andro. (This would be true unless the possibility of lawsuits were significant.) Utilitarianism takes into account the consequences for everyone included the consumer.

If the case is being used in conjunction with both Chapters 19 and 20, rights and justice analysis should be under taken. From the perspective of Kantian rights little seems required beyond providing information and warnings, since selling andro does not restrict autonomy and treats people as ends that can make their own decisions.

From the point of view of justice as fairness, no fundamental rights would be violated by selling andro nor would equal opportunity be affected. There is little reason to believe that selling andro would disadvantage the most disadvantaged individuals. Justice provides little guidance in this case.

Discussion questions:1. Given that andro may be sold legally, why should not GNC sell it? 2. Are there any moral concerns about the sale of andro?3. Are there any concerns from the perspective of utilitarianism?4. Is there a possibility of private nonmarket action against GNC as the industry leader if it begins to sell andro? 5. Should GNC make andro available passively; i.e., not promote it?6. Should GNC attempt to restrict sales to those 18 and older (e.g., to avoid selling to high school athletes?7. What specifically should GNC do?

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Developments:

In April1999 GNC decided to sell andro but with warning labels. GNC CEO William Watts said, “Being on the high road made sense. … It isn’t worth any amount of short-term sales to do something that might put the entire brand in jeopardy. … I feel very good about the way our company handled this whole issue.”

In the summer of 1999 an Iowa State University research team that had conducted a controlled experiment on 30 men reported in the Journal of the American Medical Association that taking andro had no effect on muscle strength either before or after resistance training and supplementation.11 The researchers found that andro significantly decreased the level of good cholesterol and increased certain estrogen levels, which could lead to health problems. An editorial in JAMA concluded, “In the case of androstenedione, the study by King et al contributes to the evidence suggesting that the government should carefully consider intervening and remove androstenedione and its derivatives from the market.”12

In August 1999 Mark McGwire announced that he had not taken andro for four months. In 2002 Ken Caminiti admitted that he sued steroids in his league MVP year. Many major league baseball players were believed to use steroids and other substances.

11 JAMA, June 2, 1999. 12 JAMA, June 2, 1999.

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Chapter 20

Ethics Systems: Rights and JusticeThis chapter presents two important ethics systems—moral rules and rights and Rawls’s theory of justice. The chapter also distinguishes between consequentialist systems such as utilitarianism and deontological systems based on considerations independent of or in addition to consequences.

A lecture could focus on each of the types of ethics systems in the chapter with examples to illustrate the concepts. In addition to the examples presented in the chapter, the cases can be used as examples with the reasoning as discussed below in conjunction with each case.

The transparencies in rights.ppt provide information on ethics systems and rights. The distinction between consequentialist systems and deontological systems is useful to make to remind students that Kant’s system is fundamentally different from utilitarianism and hence can give different prescriptions. The transparencies identify types of ethics systems, characteristics of deontological systems, and difficulties in applying them. The distinctions between deontological and consequentialist systems can be made by distinguishing between intrinsic and instrumental rights. Figures 20-2 and 20-3 can be used to illustrate the difference at an abstract level.

Kant’s system is conceptually difficult and in addition is difficult to apply. It is a system that allows a relatively small set of intrinsic rights. The example of the price at which a product is to be sold is useful for making this point. The transparencies pertain to Kant’s system and also present the pricing example. The transparencies address intrinsic rights, present a moral rule, consider whether it is intrinsic or instrumental, and address applied rights analysis.

Conflicts between claimed rights are common in applications, and the rights table illustrated in Figure 20-4 is one approach for addressing those conflicts. A rights table is also presented for the chapter case Genetic Testing in the Workplace.

In two rulings in 2002 the Supreme Court limited the scope of the Americans with Disabilities Act. The Court in a 9-0 decision ruled that an individual must have substantial limitations on abilities that are “central to daily life” and not just to work life. In a 5-4 decision the Court ruled that seniority had precedent over the ADA. The Court held that an employer US Airways was not required to violate seniority to accommodate the need of a disabled employee by transferring him or her to another job.

Justice explicitly requires comparisons among individuals, whereas Kant’s system entertains no such comparisons.

Transparencies on justice are provided in justice.ppt. Rawls’s theory of justice is a distributive justice theory concerned with the distribution among individuals of the rewards and burdens of social interaction. The theory can be explained in terms of Figures 20-5 and 20-6.

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The transparencies address higher order moral standards and how utilitarianism, moral rights, and Rawls’s theory of justice meet those standards. The transparency on higher order standards is useful for reviewing the moral foundations for the three ethical systems considered in Chapters 19 and 20.

The last transparency presents Gert’s principles for reasoning about injustice. These principles are not to be used to provide ad hoc or ex post justification of actions one wants to take based on other grounds. Instead, they are intended to be used in the case of fundamental ethical dilemmas.

Cases

Genetic Testing in the Workplace

Transparencies are available for this case genetictesting.ppt.

This case is related to the integrity testing issue considered in Chapters 19 and 20, and the structure of the analysis of that case can be applied here. The case centers on a firm’s response to certain hazards in the workplace. A firm can address those hazards by changing the workplace and/or by changing the workforce. Changing the workforce so that workers are less susceptible to exposure in the workplace can be less costly than changing the workplace. Utilitarian analysis thus indicates that (unless there are external consequences) when it is less costly to change the workforce it is ethical to do so. (This conclusion is based on the supposition that the labor market is “efficient.”)

From a utilitarian perspective, the employer is presumably best-placed to make the assessment of whether the benefits from genetic testing outweigh the costs. Depending on the cost, reassignment of employees who are genetically susceptible may be warranted. Furthermore, genetic testing for the purpose of monitoring whenever there is a potential health problem due to workplace exposure would seem warranted. A transparency summarizes a utilitarian analysis for a screening rule that is intended to provide a more socially efficient matching of applicants to jobs. Another transparency presents a corresponding analysis for a monitoring rule. Another raises two questions about the utilitarian analysis. The answer to the first is “no,” and the answer to the second is “no” if doing so increases aggregate well-being. Safety itself is instrumental to well-being.

The alternative of changing the workforce has at least two dimensions. First, genetic testing may be used to assign existing workers to positions. Second, genetic testing may be used to rule out people at the hiring stage.

One unobjectionable policy seems to be using genetic testing to monitor workers to detect genetic damage. The worker could be informed of the test results, and the employee could choose whether to continue to be exposed to the hazard or not. (The employee would presumably take into account the possibility of suing the employer in the event that a disease resulted from the exposure. Any damages awarded would be a transfer and would net to zero in a utilitarian analysis.)

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From a rights perspective, the issues are similar to those discussed in Chapter 20 in the context of integrity tests. A transparency identifies a set of rights that might be claimed, and another evaluates a claim to safety from the perspective of Kant’s system. As indicated in the book, a right to safety seems to be instrumental rather than intrinsic; i.e., safety is like many other claimed economic rights.

In a deontological ethics system motive matters, and in this case the motive is to support autonomy by enabling individuals to make their own decisions about avoiding harm given knowledgeable of whether they are genetically susceptible to chemical agents present in the workplace. This supports the use of genetic testing by employers. Employees could prefer not to have a genetic test. In that case, the individual would be free to take a job elsewhere.

Many claims about rights can be made in this case, and those claimed rights can be in conflict. A rights table as introduced in the chapter provides one approach to resolving conflicts. A rights table for this case is presented in the transparencies. An important part of any testing program is to keep the results of test private.

A difficulty in applying this reasoning is that genetic characteristics could be correlated with individual characteristics such as race or sex. To the extent that individuals are disadvantaged because of discrimination based on their sex or race, genetic testing would further disadvantage them if it limited their set of opportunities. The evidence on the correlation between genetic characteristics and characteristics, such as race and sex, on which discrimination is based is surely limited, so the extent of the correlation, if any, remains a matter of speculation.

Another concern is that a genetic deficiency or problem may stigmatize an individual if the results become known. This could extend beyond the workplace and affect the individual’s eligibility for insurance and also affect other employment opportunities. One means of protecting an individual’s privacy is to maintain confidentiality of the information by having only the company physician and those who need to know to have access to the information; this may not include the employee’s immediate supervisor.

The transparencies provide one answer to the last preparation question from the perspective of utilitarianism. The probability r of exposure and the social cost C of the harm to someone who is genetically susceptible and becomes ill are not known, but a breakeven analysis can be conducted as illustrated at the bottom of the first figure. Comparing the alternative (1) of doing nothing to the alternative of installing additional equipment indicates that equipment should be installed if and only if rC is at least $33,000. The analysis presented in the second figure indicates that genetic testing is better than new equipment or robotics regardless of the value of rC. Moreover, it is better than doing nothing if rC is greater than $1,852. Genetic testing is thus the preferred alternative. If genetic testing were prohibited, robotics would be the preferred alternative if rC were higher than $111,111, new equipment is preferred if rC were between $1,852 and $111,111.

A testing program justified by a high risk r or a high cost C can be designed to capture many of the benefits from testing while still preserving rights. A rights-respecting genetic testing policy is:

1. Respect privacy

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(a) test results known only to the individual and, if the person accepts a hazardous position, to the relevant doctor

(b) information is kept separate from one’s employment record (to prevent possible discrimination)

2. Testing as a right to know

(a) for applicants offered a job with exposure, testing is mandatory as is testing for subsequent monitoring. Information is provided only to the individual, unless the applicant accepts the position and is then subject to 1.

(b) for job assignments to a job with exposure, testing is required with information made available to individual; i.e., the individual can choose whether to accept the risk (3. (b))

(c) for employees in jobs: require test for monitoring with information subject to 1.

3. Right to free contract(a) employer has right to hire the best qualified person (subject to law) and genetic testing takes

place only after the applicant has been offered the job(b) selected applicant/employee can choose whether to accept an offer for a hazardous position

with risk of exposure; rejection of the offer is governed by (c) (c) applicant/employee has opportunity to qualify for other positions

4. Safety (a) provide for safety to the point at which benefits equal the costs; i.e. social efficiency.

This policy is intended to provide information to the employee or selected applicant and to place on that person the responsibility for the decision of whether to accept a position with a risk of exposure. Privacy is respected by providing the information only to the individual and if the individual accepts the position to the doctor as well for use in a subsequent monitoring program. The employer makes the offer to the best qualified individual without knowledge of genetic susceptibility. The policy in 4. is based on the principles in Chapter 12.

An analysis of the ethics of genetic testing is provided by Joseph Kupfer, “The Ethics of Genetic Screening in the Workplace,” Business Ethics Quarterly, 3 (1993): 17-25.

Teaching the case:The following questions can be used to guide the discussion

1. What ethics concerns are associated with genetic testing?1. Isn’t genetic testing for the purposes of reducing the likelihood of damage to health obviously

beneficial?2. Evaluate genetic testing in the workplace from a utilitarian perspective.3. Which rights might be claimed to be violated by requiring a genetic test?4. Why is there a right to privacy in this situation?5. Is such a test objectionable from a deontological perspective if the motive or reason for the test

is to provide the individual information on which to make better-informed decisions on job selection?

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6. Is there a moral duty to make certain the individual is informed about his or her susceptibility when accepting or holding a position with exposure to particular chemical agents?

7. Is there a possibility that individuals can become stigmatized by their genetic characteristics?8. Is there a way of dealing with this concern by keeping the results of genetic testing

confidential?9. How should conflicts about claims about rights be resolved? 10. What would be the characteristics of a rights-respecting genetic testing policy? 11. How should the last preparation question be answered?.Developments:

In 1998 Vice President Gore proposed federal legislation on genetic testing in the workplace. It would bar requiring or requesting genetic test or genetic information as a condition of employment or benefits. For current employees genetic testing could not be used in a manner that would deprive an employee of opportunity. Exceptions would be made when workplace safety or health would be at risk.

Environmental Justice and Pollution Credits Trading Systems

Transparencies are available for this case environmentaljustice.ppt.

This case is based on public information and “Westco” is a composite of a group of oil companies that were the targets of the environmental justice lawsuits and activist strategies in the Los Angeles area.

The environmental justice campaign is led by activists outside of and within government. Activist groups have sought new ways of advancing their objectives of increasing protection of the environment and redistributing wealth and opportunity, and in this case pollution, in favor of the disadvantaged. (The strategies of activists and their private nonmarket action are considered in Chapter 4.) Within government the Clinton-Gore administration has sought to advance its corresponding goals without seeking new legislation from Congress, which beginning in 1995 had Republican majorities in both houses. In the environmental area EPA administrator Browner has started a number of innovative and controversial programs, as discussed in Chapter 12 of the book. The EPA’s environmental justice campaign and Clinton executive order are two examples of these initiatives.

The environmental justice issue arose in association with the siting of hazardous waste facilities and dumps. These facilities were naturally located where land was cheapest. People with low incomes also locate where land prices and housing are cheap. This means that these facilities would tend to be located disproportionately in low-income areas. To the extent that minorities and women are disproportionately represented among low-income people, there is a disparate effect on them. To the extent that there are health hazards or other risks associated with these facilities, low-

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income people could be disproportionately exposed to harm. Clinton’s executive order and Browner’s campaign addressed these concerns. This is thus an issue of distributive justice.

The lawsuits and activist actions in the Los Angeles area address quite a different issue—the distribution of pollution reduction. The pollution credits trading system in Los Angeles is used in conjunction with a pollution reduction program and is intended to achieve environmental objectives in a socially efficient manner. This type of trading system implements a utilitarian objective of aggregate welfare maximization by allowing low cost abaters to abate more and high cost abaters to abate less than the average required by the environmental objective. The way this is accomplished is by issuing permits for the emission of pollutants equal to the emissions allowed by the environmental objective and then allowing those who have low abatement costs to sell their excess permits to those with high abatement costs. This results in lower total costs of achieving the environmental objective. Because the aggregate cost of abatement is lower, the environmental objective can be more aggressive that it would have been had the aggregate cost of abatement been higher. These trading systems are discussed in Chapter 11 and an example is presented in the case. The general framework illustrated in Figures 11-1, 11-2, and 11-3 can be used as the basis for a lecture.

Numerical examples such as that presented in the case can be tricky because a holder of permits can enter on either side of the market for permits; i.e., it can buy or sell credits. The example is set up so that the incremental cost of abatement is 15 for both buying and selling and hence there is a unique price of 15 for a credit. That is, if the price of a credit were less that 15, b would buy credits rather than abate 100 pounds. If the price were above 15, b would increase its abatement from 100 pound to 200 pounds and sell its allocation of 100 permits. For example, suppose that the price p of a credit were p = 16. Then, b has an incentive to increase its abatement from 100 to 200 pounds because doing so costs 15 a pound and it can sell the permits it no longer has to use for 16. Thus, even though in equilibrium a sells credits to c, it is b’s costs that establish the equilibrium price for a credit.

The facts pertaining to the lawsuits and the allegations of the activists are unclear, but if the AQMD is to be believed, the trading systems is not associated with an increase in pollution but instead with a decrease in pollution. The AQMD states that the standards of the CAA are met and that the program is in full compliance with the law. Moreover, the AQMD has a separate rule to deal with hot spots. In addition, there is no indication that pollution emissions at the refineries and the marine terminals are higher than they were before. Under the trading system, however, they may not have had to reduce their emissions, since they could have purchased credits as did source c in the example. This is the likely situation.

The activists’ claims are probably strategic and intended to attract news media coverage of their campaign and to obtain sympathetic treatment of it. The activist’s objectives are probably for lower aggregate emissions in favor of the disadvantage and obtain compensation from the oil companies. They may be willing to trade higher aggregate pollution levels for redistribution; i.e., to move from a utilitarian outcome such as point C in Figure 20-6 to the Rawlsian point B. The redistribution in favor of the residents near the oil refineries and the marine terminals thus comes at the expense of the other residents of the Los Angeles basin.

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Note that the environmental justice campaign, at least as it affects trading systems, works against President Clinton’s program of promoting efficiency in environmental programs. For example, as discussed in Chapter 11, Clinton insisted that an emissions trading system be used by countries to achieve the reductions in emissions required by the Kyoto Protocol. The developing countries can turn the environmental justice argument against Clinton.

The activists’ strategy is not only to argue that the trading system results in violations of federal environmental standards but that it discriminates against minorities and women. The claimed legal basis for this argument is Title VI of the Civil Rights Act of 1964. Whether the courts will agree with this argument is problematic. Also, whether there is a greater incidence of certain diseases caused by hydrocarbon emissions around the facilities is unclear and requires a careful statistical study. The activists’ parading of ill people before the TV cameras is a standard strategy.

Without judging the merits of the lawsuits, the claims about the distribution of pollution reduction is a legitimate moral issue. As indicated above, a utilitarian system could yield a different conclusion than the Rawlsian system. Furthermore, if people have a moral right not to have their health harmed and if the facts are that there is harm, then a rights perspective could rule out some alternatives, including a trading system, as illustrated in Figure 20-3. Presumably, the AQMD’s separate rule for hot spots is intended to deal with such a health risk.

This issue could also be addressed from the perspective of the Coase theorem as discussed in Chapters 11 and 12. The rights in this case have been allocated to the refineries and marine terminals to emit pollutants in accord with established standards. The activists and the residents thus could pay the oil companies to reduce their emissions. Part of the activists’ strategy is to use the Civil Rights Act to change the assignment of rights. With the rights assigned to residents, the oil companies would be forced to pay the residents.

The business community has reacted strongly against the environmental justice campaign, and Congress has acted to slow its progress. Harry Alford has taken the point on this issue and argues that not only are the activists exploiting the civil rights laws but the campaign is likely to have adverse distributive consequences for people in the inner city and for poor people in other areas. He cites the adverse effect on the brownfields developments to provide jobs in cities, and the U.S. Conference of Mayors apparently agrees with him. Alford also points to the loss of jobs in low-income areas, as in the case of the Louisiana petrochemicals plant. The environmental justice campaign seems to require that a company whose facilities emits pollutants allowed under the law locates in an area where there were no low income people and where minorities and women are not disproportionately located.

Transparencies are provided for use in teaching the case.

Teaching the case: The following questions can be used to lead the discussion.

1. What is the moral justification for a pollution credits trading system? 2. How does such a system work to achieve social efficiency?

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3. How does a trading system affect the distribution of pollution compared to a command-and-control system in which each pollution source is required to meet the same emissions standard?

4. What are the moral claims of the activists? Are they morally valid? Under which ethical system? Are the rights implicitly claimed instrumental or intrinsic?

5. What strategy are the activists using to pursue their objectives? What are their objectives?6. Evaluate Alford’s arguments. Are they compelling? 7. If their claims were morally valid, what measures could be used to address the moral concerns?

Should a trading system be abandoned? Modified? 8. What should Bentley do?

Discussion: The moral issues in this case seem to be matters of justice rather than rights. That is, the hot spots policy is intended to deal with immediate health risks, and it is not the case that people have a well-established right to have their health protected from possible hazards of the type present in the case. If there is an imminent health risk, the AQMD should so determine and take action.

The principal issue is then social efficiency versus responding to the interests of low income people. More specifically, should a trading system than can yield major cost savings to society be sacrificed in favor of the disadvantaged. The answer seems to be “no.” There are likely to be better means of responding to the interests of the disadvantaged, if that is morally justified. One means is to provide them with cash. A second would be to move them from the areas around the refineries. A third would be to provide services including medical care for those who are ill.

Advanced Technologies, Inc. (ATI)

This case is based on a set of experiences of women executives primarily in Silicon Valley firms. A number of the women are entrepreneurs who started their own firms. Although many women have succeeded in starting their own firms and have succeeded in existing firms, Silicon Valley is viewed by many as very male and naturally very technically-oriented. Lange was a successful entrepreneur who sold her company to a larger company. This made her financially independent, but she stayed with the company as head of the software division both to see her networking vision realized and because she wanted to head a really large company.

The case was written to depict a number of issues that confront women managers, some of which also confront men. One background issue is Lange’s personal responsibilities as an (apparently) single parent. The explicit issues in the case include the following: 1) the promotion of Moore and more generally the prospects for women who choose her work habits, 2) the management style in the executive committee at ATI, 3) the request by Montgomery to join the sexual harassment committee for the Sanchez-Callahan case, and 4) the family-leave policy and Lange’s interactions with Goldberg. The case also has a number of implicit or more subtle issues associated with the responsibilities of a successful woman executive to those who come after her and with how women

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managers should and can deal with a set of complex multiple obligations centering on a management career and personal lifestyle. There are few easy solutions to these issues.

The explicit issue involving Moore centers on her future given her choice of a management style as a result of having a child. The implicit issues center on whether it is possible for woman managers to balance profession and family with less than a full-time commitment and whether there is something systematic or pervasive at ATI that limits the opportunities for women.

One issue centers on the aggressive style of the members of the executive committee and how she should handle her request for a budget larger than her fair share. The implicit issue is whether women have a different management style, and if so, whether that is advantageous or disadvantageous or more effective of less effective. With respect to the explicit issues, the question is whether this is something that is just uncomfortable (e.g., part of the normal post-acquisition blues) or is something that will affect her effectiveness, performance, and success.

The explicit issue in Montgomery’s request that she join the committee investigating the Sanchez-Callahan sexual harassment case is whether she should agree to do it. The implicit issues are whether she should personally take a leadership role within ATI to indicate the importance of the sexual harassment issue and whether this is an isolated incident or is an indication of a more systemic problem at ATI. (The authors of the case apparently chose to cast suspicion on the charge by writing that Sanchez had made earlier allegations that were not substantiated. They balanced this with the statement about earlier rumors about Callahan.)

The explicit issues regarding the family leave issue are whether she should fight to have ATI adopt the Networking Plus policy at a cost of some $2.5 million annually and how she should interact with Goldberg. The implicit issues include whether the ATI policy should be more accommodating to employees with family responsibilities and whether the ATI culture will now disappear in ATI. The other implicit issue is whether she should adopt a style similar to or different from that of Goldberg; e.g., should she serve as a mentor for younger women managers.

Teaching the case:The following questions can be used to lead the discussion.

1. What are the issues Lange faces? What are the causes of these issues?2. Are these largely post-acquisition blues?3. Should she expect the Network Plus culture to survive in ATI?4. Has Moore put herself on the mommy track? Should Lange advocate her promotion and fight for it when it is opposed?5. What type of personal style should she adopt? Does she have to be as aggressive as the men managers? 6. Should she become a leader within ATI on issues such as sexual harassment, opportunities to balance career and family, and organizational culture?7. What should she do about the explicit and implicit issues identified above?

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Outcome:

Since this is a composite case, there is no outcome. This case, however, was the subject of a discussion at a conference attended by 250 women MBA graduates from the Graduate School of Business of Stanford University. (A lengthy article on the conference and the attendees was published in the San Jose Mercury News, May 29, 1994.) The attendees generally concluded that no 9-to-5er, male or female, should expect to reach the highest levels of management. Others, however, lamented the implications of that conclusion for women who want both a management career and typical family involvement. With respect to the request by Montgomery to be on the sexual harassment committee, one attendee advised women to shun such tasks until they reach a very high level of management.

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Chapter 21

Implementing Ethics SystemsThis chapter addresses the implementation of ethical systems in the context of the methods developed in the book and through examples of company policies. The chapter begins with a return to the framework introduced in Chapter 2. The analysis stage of the framework calls for the prediction of nonmarket activity that is likely to arise in the context of a nonmarket issue. As indicated in Chapter 6, some nonmarket activity is motivated by moral concerns that individuals have about an issue or a practice of a firm. Ethics systems can be useful in understanding and predicting this activity by increasing the sensitivity of managers to ethics issues and more importantly by predicting the amount of political action.

Paternalism is a particular concern in responding to ethics issues, since it can mean that individuals are denied the opportunity to make decisions for themselves. Paternalism does not treat individuals as autonomous individuals capable of making their own decisions. The complication in many cases is that individuals may not have the requisite information to make the same decision they would make if they were perfectly informed. The difficulty with this perspective is that it allows people to claim that they know best in situations in which they have different preferences from those whom they claim to be protecting. Gert’s test is one means of distinguishing between warranted actions and unwarranted paternalism.

The section on corporate political action and restraint can be tied to the discussion in Chapter 7 of responsibility and the law pertaining to corporate political action.

Chapter 18 on corporate social responsibility concludes with the argument that the content of corporate social responsibility is to be found in ethics. The step from principles to practice is often a long one, however, and this chapter attempts to address the implementation of ethics principles systems by examining a set of corporate policies intended to guide managers in addressing issues involving responsibility and ethics. The examples of policies were selected to provide a range from those such as Our Credo that express a general perspective to those such as Cummins’ that provide specific guides (see also Chapter 22). Ethics programs implemented in the defense industries are discussed as a specific example of a response to a scandal. The chapter concludes with a brief discussion of some of the factors that can lead to unethical behavior.

The use of Figure 21-1 to summarize Levi Strauss & Co.’s decisions-making process can be expanded using the information in the cases in Chapters 21 and 22.

The British Petroleum example is one that can be followed up with current information obtained from its Internet site and from the news media. In particular, British Petroleum is playing a leading role in the politics and nonmarket action on the global climate change issue.

A lecture can supplement these examples and highlight other policies implemented by companies. The example of the Body Shop is useful as a reminder that using corporate social responsibility as a promotional tool can come back to haunt a company when its accomplishments fall short of its

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pronouncements. In February, 2002 Anita and Gordon Roddick resigned from the Board of Directors. They plus a friend controlled over 50% of the shares. The Body Shop had attempted to sell itself to a private equity fund, but there was little interest in the company.

This and the next chapter take a somewhat different approach to the application of ethics. They focus on particular managerial areas in which a variety of ethics issues arise.

Cases

Denny’s and Customer Service (A)

This case can be used to address issues of discrimination, diversity, the management of nonmarket issues, and the implementation of managerial policies. One objective of this case is to encourage students to think of these issues from a managerial perspective.

The following questions can be used to lead the discussion.

Teaching the case:

A. The first set of questions is intended to examine the “problem” and identify who has responsibility for dealing with it.1. What has happened (gone wrong) here? Are these incidents largely the result of bad service, employee surliness, and miscommunication? This would provide an opportunity to distinguish among the incidents (e.g., the secret service agents incident could have been the result of bad service and the choir incident could have been miscommunication; the prepayment required of blacks but not whites could be an example of “statistical discrimination;” i.e., the problem of people leaving without paying might have been more common among African-Americans than among others (this, of course, does not excuse the discriminatory practices either legally or morally but might “explain” why it happened. The blackout practice, however, is unambiguous and indicates that there is at least a fairly widespread pattern of discrimination at Denny’s.) The hope is that the discussion can identify a variety of ways that discriminatory behavior can occur and that it is not a trivial matter to distinguish it from other inadvertent behaviors. 2. What is the locus of these problems? The hope here is to get an answer such as: “These are problems caused by the behavior and practices of employees and managers at local franchised and owned restaurants.” The follow-up question then is, What responsibility does Flagstar management have? The objective is to have the students discuss the extent of managerial responsibility.

3. Is there a pattern of discrimination or are these a set of isolated incidents? The answer is probably that many are isolated incidents resulting from the actions of individual employees. The incidents are sufficiently numerous, however, that they are in all likelihood the result of organizational culture, insensitivity, and inattention by senior management. 4. Are practices such as the late night policy (prepayment) a good idea or do they invite problems? Does Denny’s face managerial challenges that McDonald’s does not face? The answer is yes. It

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has servers and they have degrees of discretion and action that behind the counter employees do not have. Moreover, managers can exercise more direct monitoring behind the counter. In addition, McDonald’s requires prepayment by all customers. 5. How serious an issue is this for Denny’s? morally—very serious commercially—very serious for Denny’s reputation and image? —crucial (the butt of Letterman jokes)6. Has Richardson been distracted from the issues at Denny’s? (probably)

B. The next question is intended to address whether there are any positive benefits of diversity to Denny’s.1. Can diversity within Denny’s be beneficial? There are a set of “standard” responses, such as “our workforce will be increasingly diverse and we will benefit from that diversity. Responses specific to the case are: a sensitivity to diversity issues throughout the organization will reduce, but not eliminate, incidents such as those in the case. a sensitivity to diversity issues throughout the organization will improve overall customer service. diversity in restaurant ownership and among franchisees will result in menus that are more responsive to local differences in tastes. (Denny’s has given restaurant managers more discretion in offering menu items to suit ethnic preferences.)

C. The next set of questions focuses on a strategy for addressing the issues as they stand at the end of the (A) case.

1. What objectives should Denny’s have? eliminate discriminatory practices treat all customers respectfully and efficiently resolve the lawsuits improve relations with the African-American community attempt to redress the public image disaster attempt to benefit from diversity2. What specifically should Denny’s do? How should it ensure that discriminatory policies are not employed by restaurant managers and Denny’s management? What should it do about the independently-owned restaurants? What constituencies should it address? How should it deal with the lawsuits—settle soon to get out of the media’s and public’s view How does it improve customer service3. How should it implement those policies?

D. The following two questions can be used to discuss how this all became a public issue.1. What is the origin of the issues that Denny’s faces? 2. What forces resulted in this issue becoming “public” rather than just a set of local incidents? The answer is that the issue became public and grew through communities, activists, class action lawyers and their networks, and, perhaps most importantly, the news media.

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Denny’s and Customer Service (B)13

In March 1993, Flagstar, Inc. entered into a consent decree with the Department of Justice to settle the federal charges of racial discrimination made against the Denny’s chain. Negotiations between the company and the Department had begun after a fifteen-month Department of Justice investigation into several reported incidents at various California Denny’s restaurants substantiated the allegations. In the agreement, which ironically was concluded later on the same day as the Annapolis incident, Denny’s acknowledged that there had been “isolated customer concerns” but that “the company from the beginning has denied any racially discriminatory pattern.” The company added that “any time such behavior is brought to our attention, very strong action, including termination of employees, has been taken.” Denny’s agreed to put an end to all practices in question and undertake a program to insure fair treatment of all customers regardless of their race. The program was to include public advertisements of the company’s non-discrimination policies and video training for all employees on how to avoid discriminatory actions. Flagstar also agreed to hire an administrator to monitor the program.

Five weeks after the filing of the suit by the Secret Service agents, Flagstar reached a far-ranging agreement with the National Association for the Advancement of Colored People (NAACP) to help revise its practices.14 The Fair Share Agreement with a value of $1.01 billion over seven years was applauded by both sides. Flagstar CEO Jerry Richardson stated, “This historic agreement—one that will be a model for other companies—is tangible evidence of Flagstar’s commitment to treating customers and employees fairly regardless of the color of their skin or their racial heritage. The partnership we began working on 18 months ago and have signed today with the NAACP is a loud and clear signal that Flagstar does not tolerate discrimination, that all people are welcome in our restaurants and that we are building a culturally diverse company.” He added, “We’re trying to make sure that everybody who does business with Denny’s knows that we want to treat everybody fairly. The NAACP will be very helpful in accomplishing our objectives.”

Dr. Benjamin F. Chavis, Jr., executive director of the NAACP, hailed the agreement as a “model for future relations between the civil rights movement and corporate America.” He said, “I am exceedingly pleased that after several months of negotiations, the NAACP and Flagstar, along with Richardson Sports, have today signed a number of historic agreements, unprecedented in scope and magnitude. This $1 billion package will set a standard for future relations between the Civil Rights Movement and Corporate America and will enhance the struggle of African Americans and other racial minorities for economic empowerment and racial justice.”15

The Fair Share Agreement is founded on three principles: “equal opportunity for all; non-discrimination; and providing a fair share of economic opportunities with Flagstar to minority businesses, individuals and institutions.”16 This was the first such agreement to include a third-party testing program in which Flagstar’s restaurants would be randomly checked to determine 13 This case was prepared from public sources by Abraham Wu under the supervision of Professor David P. Baron. Copyright ©1994 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. Reprinted with permission.14 Flagstar News Release, July 1, 1993.15 Flagstar News Release, July 1, 1993.16 Flagstar News Release, July 1, 1993.

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compliance with company policies. The third-party firm will report to both Flagstar and the NAACP and will report any “critical situations immediately.” In addition, Flagstar agreed to hire 325 African-American managers (at an average salary of $42,000 a year) into all Flagstar operations over the next eight years. Flagstar also agreed to increase the number of minority-owned outlets from the present 54 to 107 by 1997 and place 12% of its $800 million food, paper and supplies purchasing budget with minority enterprises each year through 1997 (compared with 2% currently), 10% of its annual $68 million advertising budget, and 15% of its $12.5 million legal, accounting and consulting budget with minority enterprises.17 A total of 120,000 employees are covered by the agreement. The NAACP also agreed to help Denny’s with sensitivity training for its employees. The agreement also covered Flagstar’s 200 El Polo Loco, 530 Hardee’s, and 215 Qunicy’s Family Steakhouse restaurants as well as its Canteen contract food, vending and recreational services company.18

Mr. Richardson admitted that he had not given enough attention to these issues, “I should have invested the time earlier, and I regret it.” Dr. Chavis commented, “I have observed in Richardson over the last two months a level of sincerity unmatched by a corporate executive.”19

In addition to the agreement between Flagstar and the NAACP, Mr. Richardson also reached an agreement with the NAACP regarding his NFL franchise bid. Richardson Sports pledged to "endeavor to achieve a level of 15% to 25% representation of African-Americans in its management ranks and 20% in non-management job categories” if it were successful in obtaining the franchise. After announcing the agreement with the NAACP in a news conference in Baltimore, Mr. Richardson and Dr. Chavis flew to Charlotte, North Carolina, the proposed home of Mr. Richardson’s Charlotte Panthers franchise, where they discussed the plans for the franchise. Mr. Richardson responded to the criticism by the Jacksons by stating, “Reverend Jackson had made it known to us through the press that he has some concerns about me personally. But I think the key issue is that we are confident that the agreement we will announce [today] will address all of his issues, and I’m confident he’ll be satisfied.”20

In addition to the NAACP agreement, Flagstar decided to run a media campaign to mend its image. The company leased satellite time so CEO Richardson could be interviewed across the country. In addition, Flagstar released in June a 60-second television commercial to run for at least two weeks in the 41 markets in which the restaurant chain operates. The unusual spot takes the form of a pledge which Denny’s says has been signed by all of its 46,000 employees and will be posted in each of its restaurants. The commercial began with a message from Richardson pledging that “everyone who comes to our restaurants deserves to be treated with respect.” Richardson is followed by a racially diverse succession of Denny’s employees: “I promise you a friendly greeting,” says a white hostess. “Good food, freshly made,” continues a white chef. "If there’s a delay, we’ll let you know,” says a black waitress. “If there’s a mix-up, we’ll apologize,” adds a white waitress. “And we’ll make it right,” promises a black manager. The spot comes closest to addressing the substance of the litigation when a black waiter says, “I am human,” and a white

17 Flagstar had been purchasing $13 million in supplies from minority firms. Flagstar had one African-American supplier who received orders for about $100,000 a year.18 Flagstar is the largest franchisee in the Hardee’s system, which is owned by Imasco Limited.19 Newsweek, July 19, 1993.20 The Wall Street Journal, July 1, 1993.

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waitress adds, “I will make mistakes,” while an Asian-American waitress concludes, “But please know they will never be intentional.”

In defending itself, Denny’s was in the delicate position of asserting that the occasional poor service at its restaurants was color-blind, affecting both African-Americans and whites. While conceding that in some instances African-Americans have received poor service at Denny’s, a company spokeswoman added that “unfortunately, others have had lengthy waits, too.” She also said that the company devised the commercial because it felt it had to act quickly to address the concerns of both customers and employees. “We can’t wait until the lawsuits are settled,” she said. However, some public-relations experts warned that the Denny’s commercial could easily backfire. They argued that “when you have a problem like Denny’s has, you have to clean up the problem before talking about it... first you establish a record, then you talk about the record.” However, David Hurwitt, Denny’s senior vice president of marketing, said the commercial was aimed at both customers and employees, “our employees are under a great deal of scrutiny and pressure. We want them to know we believe in them and are concerned with their feelings and morale.”

Preparation Questions:1) Was the agreement with the NAACP a good idea? What else, if anything, should Flagstar have done?2) What risks does Denny’s face from occasional bad service?3) How should Denny’s address its public image problem? Is the Denny’s advertisement likely to be effective? Might it backfire? How?

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Teaching the (B) case:The following questions can be used to guide the discussion of the (B) case:

1. Evaluate the actions Denny’s took to address this issue.2. What should it have done differently? What in addition should it have done? 3. Was the agreement with the NAACP wise? What if they have difficulty fulfilling their pledges? More generally, are fair share agreements good ideas? Denny’s was in a weak position morally, commercially, and with the public and found the fair share agreement a good way to resolve part of the problem it faced. What about for a company that does not have such problems?4. How should Denny’s make sure its employees conduct themselves in a nondiscriminatory and respectful manner? Is the advertisement a good idea? 5. Are these types of issues special to the United States or are they generic managerial issues?

Supplemental information and update:

The origin of Flagstar was with Spartan Foods, which was founded by Jerome J. Richardson and Charles Bradshaw in 1961, when Mr. Richardson invested in a Hardee’s franchise the $4,500 he had received for the Baltimore Colts’ victory over the New York Giants for the National Football championship. In 1979 they sold to Trans World Corporation, but continued to run Spartan. In 1986 Trans World spun off Spartan, which then bought Denny’s, as part of TW Services. In 1989 Coniston Partners headed a leveraged buyout of TW Services, and in 1992 Kohlberg, Kravis, Roberts & Company invested $300 million in Flagstar for a 47% interest. Coniston owned 27% and Mr. Richardson owned 1%.

In January 1994, Flagstar announced that it was taking a $225 million charge to cover the restructuring of its restaurant business. It planned to close 14% of its restaurants and embark on a remodeling and upgrading program. Of the 270 restaurants to be closed, 135 were Denny’s. It also wrote off $1.5 billion in goodwill. Flagstar continued to have financial difficulties.

In November 1994 Flagstar sold 17 Denny’s restaurants to an African-American owned company NDI Inc. with an option to buy 5 more and the right to build 25 restaurants in New York and New Jersey over the next five years. This agreement was one part of Flagstar’s attempt to fulfill its commitment to the NAACP.

Discrimination Lawsuits:

In May 1994, Denny’s reached an agreement with government lawyers and lawyers representing customers who had filed discrimination suits against the company. The agreement settled federal class action suits brought in California and Maryland and a suit in Virginia. (The federal class action suits were filed under Title II of the Civil Rights Act of 1964, known as the Public Accommodation Act.) Under the agreement Denny’s paid $54 million, part of which went to the original plaintiffs and the rest to individuals who allege discrimination. (The $54 million was tax deductible.) (In 1993 Shoney’s, a restaurant chain, paid $105 million to settle discrimination cases involving employees and job applicants.) An 800 number was established to allow individuals to obtain a claims form. In addition, Denny’s agreed to a program administered by a Los Angeles lawyer to monitor complaints and have African-Americans pose as customers to investigate

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whether Denny’s had discriminatory practices. Denny’s had earlier established training and random checking programs and had hired an African-American to head its human resources department. In addition to the lawsuits by customers, a former assistant manager of a Denny’s in San Jose, California, filed a discrimination complaint with the Equal Opportunity Commission alleging that Denny’s had a hostile work environment and discriminated against blacks in hiring and promotions.

To illustrate the nature of a financial settlement in a class action suit, the following is the distribution of the $54.4 million.21 California class action plaintiffs $26.975 million; class action plaintiffs in the other 49 states $17.7 million; named plaintiffs in California $975 million; attorneys for the class action plaintiffs $8.7 million; contingency fund $0.05 million.

The New York Times Magazine, November 6, 1994 carried a lengthy article on Denny’s entitled “Service with a Sneer.” The story includes details of the incidents in San Jose. In October 1993 Mr. Richardson’s syndicate was awarded an NFL franchise.

As indicated in the chapter in 2001 the parent of Denny’s was named the best company for minorities to work for.

British Petroleum (C): Social Responsibility

British Petroleum has embarked on a challenging program to act in a socially responsible manner. This has been led by The Lord Browne of Madingley, who has demonstrated a propensity for corporate statesmanship.22 One issue in the case is whether this program is a reflection of Lord Browne’s personal preferences or has been embraced throughout the company. Another issue is what precipitated this new commitment. BP had episodes, such as its experience in Columbia, that made it much more sensitive to nonmarket issues. In particular, it is sensitive to the media coverage of issues that might portray it in an unfavorable light. This is clear from the comments about the coverage of the experience in Columbia. One event that affected BP was Shell’s experience in the Brent Spar episode, as described in the Chapter 4 case.

BP and Shell had long had reputations for being environmentally responsible, which separated them to some extent from the rest of the major oil companies. One focus of discussion could be the difference between BP’s policies and Exxon Mobil’s policies. Lord Browne’s May 1997 pronouncement separated BP further from the other companies, particularly on the global climate change issue. As discussed in Chapter 11 BP has been implementing an aggressive CO2 emissions reduction program. Components of BP’s social responsibility program are discussed in Chapters 11 and 21.

21 The Wall Street Journal, June 15, 1994.22 John Browne first was knighted as Sir John Browne, and then was made a lord.

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The challenge for BP is not in the articulation of a clear commitment but instead is to be able to deliver on that commitment. This raises the central managerial focus of the case—implementation. The principal challenge is to get line management to embrace the goals, and this requires incentives and management. BP managers are concerned that if they pursue environmental goals they will be compromising profit goals, and the tradeoff between the two is the crux of the implementation challenge. One focus of the discussion can be on how that tradeoff should be identified. That is, how much should BP sacrifice profits for the social responsibility objectives. The case mentions that environmental objectives have been achieved at little if any cost. That, however, is unlikely to be the case in general and those cheap alternative will be quickly exhausted. The 36-page booklet is not enough.

Information is not available on the incentive structure at BP, but each manager has a “contract” that specifies goals. How those goals are weighted is unclear. An incentive system requires measurement, and measurement of social responsibility is inherently difficult. Indeed, economic theory predicts that the performance dimension that is better measured will receive more attention and greater effort. The measurement of profits is clearly more accurate than of social responsibility efforts. To address this problem, as indicated in Chapter 11, BP hired an outside firm to evaluate its CO2 and hydrocarbon emissions, and provide public reports. These can also be used for performance evaluation, but they are also important for reporting to external constituencies. (Safety can be evaluated ex post through the reporting of lost work days.)

Oversight of implementation progress is the responsibility of Regions & Policies, although it is not clear how much authority the Regional Directors have. It is clear than responsibility rests with line management.

One issue for discussion is whether the Finance and Control area with its objective of maximizing “long-term shareholder value” is in conflict with the other four commitments; i.e., whether there is a tradeoff between profits and performance in other areas.

Another issue is whether standards on social responsibility should differ across countries. Utilitarianism that evaluates actions in terms of the preferences of those affected suggests that standards should differ. For example, BP does not pay the same wages in every country, so should the same be true with respect to safety? Some issues such as reducing CO2 emissions may compel uniform standards, since global warming is a world rather than a local phenomenon.

One issue to discuss is whether BP corporate social responsibility policy will affect its product sales favorably. This is hard to predict.

The British Petroleum (A) and (B) cases are available through the Stanford Business School Case Series.

Discussion questions1. Does BP’s social responsibility commitment reflect the personal views of Lord Browne or does it reflect a broad commitment throughout the company? 2. Are the five areas of responsibilities appropriate? How much weight should each receive?

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3. Is BP right that a dimension of product differentiation is corporate social responsibility? That is, will consumers buy BP gasoline rather than other brands? 4. Should standards be the same everywhere in the world? 5. Should BP be in the solar power business?6. Should BP completely eliminate its political contributions? 7. Should BP and its executives speak out of public policy issues?8. Can BP lead the oil industry down a different path?

Developments:

Reports on performance can be found on BP’s Internet site: www.bp.com. In a speech at Stanford University in March 2002 Lord Browne announced that BP had already reached is greenhouse gasses reduction goal, some 8 years earlier than anticipated. He announced that BP would hold its emissions to current levels for the next 10 years despite an anticipated 5.5% increase in oil and gas production. He reported that it cost $100 million a year to achieve the reductions but that the cost was more than offset by energy savings. He also said that BP would not participate in the politics associated with drilling in the Artic National Wildlife Refuge, and if drilling were permitted, it would drill there only if drilling prospects were better than elsewhere in the world.23

The case mentions reducing gifts and political contributions, and in February 2002 BP announced that it would eliminate all political contributions including contributions to political parties.24

Levi Strauss & Co. Global Sourcing Guidelines

Transparencies are available for this case leviss.ppt.

Levi Strauss & Co. was the world’s largest apparel manufacturer and was highly respected for its commercial success and its principle-based conception of corporate social responsibility. It regularly ranked high in Fortune magazine’s annual survey of America most highly regarded companies. This case identifies the problem LS&CO. identified in its sourcing relationships and describes the process it undertook to develop its Global Sourcing Guidelines. The Terms of Engagement component of the Guidelines are presented in Chapter 20, and the Guidelines for Country Selection are presented in Chapter 22.

The case involves themes and issues from each of the chapters in Part V of the book. LS&CO.’s conception of corporate social responsibility is similar to that of the Business Roundtable in the sense that it considers in a serious manner the interests of stakeholders. It differs from the

23 San Jose Mercury News, March 12, 2002. 24 Contributions to political parties was practiced in the United Kingdom and through soft money contributions in the United States.

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Roundtable, however, by requiring that policies and actions be consistent with a set of ethics principles and values. Although those principles are not articulated in the language of moral philosophy, they clearly involve consideration of aggregate well-being, a respect for rights both instrumental and intrinsic, and a concern with fairness for those affected by its actions. Its principled reasoning approach is a process that focuses on reasoning based on its principles and its concept of corporate social responsibility. The principled reasoning process may be interpreted in terms of the framework presented in Chapter 2 and illustrated in Figure 2-4. This interpretation is presented in Chapter 21 in conjunction with Figure 21-1. It implements the policies resulting from this approach as indicated in this and the other Levi Strauss & Co. case and as considered in Chapters 21 and 22. Finally, the ethical issues addressed in the case pertain to the employment relationship through it global sourcing network, as well as to international business.

A notable feature of the principled reasoning approach is that although the company does not involve stakeholders in its policy formulation and decision-making process, it does interview stakeholders and obtain their reactions to major policy alternatives. The process is iterative and incorporates a screening phase in its Solution step. It also attempts to take into consideration both principles and interests in much the same way as in the approach presented in Chapter 20.

The case also illustrates how the nonmarket issues being addressed by LS&CO. arose from its (revised) market strategy. It also illustrates how a change in market strategy can jeopardize the principles under which LS&CO. strives to operate. That is, the regional LS&CO. managers responsible for sourcing basically were using local practices and costs as their criteria for selecting contractors.

It is important to note that LS&CO. is and always has been a family-controlled company. To a large extent its ethics principles and its conception of corporate social responsibility are a reflection of the personal principles and preferences of Levi Strauss and his descendants who run the company. An important issue for discussion is whether a publicly-owned company with CEOs coming from diverse backgrounds would have adopted the same principles and policies. One answer to this is that although the specific items in the Terms of Engagement and the Guidelines for Country Selection may be a reflection of the personal preferences of the Haas family and the culture it has created in the company, the need for guidelines transcends their specific content.

Chapter 22 describes an incident (slave labor in Saipan) involving the application of the Global Sourcing Guidelines.

Teaching the case:The following questions can be used to lead the discussion.

1. How did the need for global sourcing guidelines arise? (It resulted as a consequence of a change in its market strategy as the company decided to become more international and to extend its product lines in casual wear.)2. How serious are the concerns that LS&CO. has identified as a problem that needs attention? Is the identified problem primarily a reflection of the personal preferences of the Haas family?

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3. Are LS&CO.’s brand name and reputation likely to be susceptible to damage by the practices of its contractors or the countries in which they are located? (The Chapter 4 case Nike in Southeast Asia might be used to illustrate the type of events of concern to LS&CO. management.) 4. How far down the supply chain should its guidelines extend? 5. Evaluate the Business Partner Terms of Engagement and the Guidelines for Country Selection.6. To what extent do these guidelines respect local culture and practices? Do the guidelines represent paternalism?7. Should LS&CO. narrow the set of suppliers with which it deals so as to develop closer relationships similar to those it has with its U.S. suppliers, as Mr. Jacobi has suggested?8. Should LS&CO. provide aid to its suppliers in the form of higher contractor prices, loans, and guaranteed levels of purchases? 9. Is competitiveness improved or worsened by the application of the Global Sourcing Guidelines? 10. Would a publicly-owned company adopt LS&CO.’s guidelines? Would a producer of industrial products make the same choice? 11. Should LS&CO. have a policy governing in which countries its products are sold?

Discussion:

A remaining issue for LS&CO. is how to address the pollution issues associated with effluents from the washing operations in China, and elsewhere. LS&CO. planned to develop a policy for addressing that problem.

In a 1995 executive education session in which Levi Strauss’ Terms of Engagement were discussed, there was a sharp difference of opinion between American executives and executives from other countries. (The class had approximately 50% representation of each group.) Many of the Americans viewed the Terms, or at least some degree of responsibility, as appropriate. The foreign participants, however, were almost uniformly opposed to the Terms. Their opposition was largely due to concerns about paternalism and the imposition of developed country’s standards on countries that would not choose to have those standards. A number of participants said that many people in developing countries want to work more than sixty hours a week and many also want their children to work. One participant said that he had worked as a child and that it was a good thing for his family. Another said that it was better for prisoners to work rather than to be idle. Several foreign executives said they were concerned about the impact on costs and competitiveness of the country and the subsequent loss of jobs. By 2002 attitudes may have changed considerably.

Additional materials and discussion questions are contained in the Chapter 22 case Levi Strauss and Co. in China and in the discussion of that case in this manual.

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The Launch of Predictive Networks

Transparencies are available for this case predictivenet.ppt.

This case is related to the DoubleClick case in Chapter 13 and the discussion in this Manual. The setting here is after the uproar over DoubleClick’s planned merger of click-stream data with offline-data obtained through it Abacus Direct unit. Although Predictive Networks has not been a target, it could become one once its service is offered on the market. It is thus imperative that the company develop a credible privacy policy. On a number of dimensions the company has an advantage because it does not plan to use any personal information. (DoubleClick requires users to identify themselves so that the two databases can be merged.) Moreover, the planned users of its digital silhouette service will all have opted in, so participation is voluntary.

Teaching of this case could be like that of the Chapter 20 case Genetic Testing in the Workplace with the objective of ultimately arriving at a privacy policy and an implementation plan. This could involve the development of a rights table to identify the importance of various claimed rights. Given that this is an opt-in service, i.e., loading a CD or downloading from the Internet, there should be no objection from the perspective of Kantian rights. Some activists and commentators, however, referred to Predictive Networks’ technology as eavesdropping and wiretapping.

There also should be no objection from a utilitarian perspective, since individuals who elect this in conjunction with an ISP are in effect opting in to the service. There actions reveal their preferences for the ISP service and their associated privacy concerns.

Lauren Weinstein, founder of Privacy Forum, however, argued that the free-Internet service would attract lower-income people, and “a lot of people would be basically coerced into giving up their personal information.”25 This is a justice claim that borders on paternalism, and whether it has any validity is not clear. That is, individuals would choose to opt in to an ISP and would evaluate that decision relative other consumption decisions. Whether those using free Internet service are the least advantaged is unclear.

The service to be provided in conjunction with interactive TV may not be opt-in, although there is no information on how Microsoft will operate its service.

Even though Predictive Networks pledged not to obtain the identity of the user, the ISP or Microsoft could obtain that information whenever it chose to do so. Activists, the government, and some subscribers would understand this. The RealNetworks example mentioned in the DoubleClick case is an example of the concerns.

Predictive Networks remains a privately-held company financed by venture capital funds. Information on the company can be found on its Internet site www.predictivenetworks.com

Discussion questions:1. Does Predictive Networks’ technology have an advantage over DoubleClick’s technology with regard to the information collected?

25 The Wall Street Journal, May 1, 2000.

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2. Are there privacy concerns with Predictive Networks’ digital silhouette service?3. Should Predictive Networks collect the key words users enter when searching on the Internet? 4. Are there likely privacy objections to the use of Predictive Networks’ technology in interactive television? 5. Will Predictive Network’s potential customers be hesitant to use its digital silhouette technology? Should Microsoft use Predictive Networks’ technology? 6. What privacy policy should the company develop? What measures should it take to add credibility to that policy?

Developments:

Predictive Networks’ privacy policy has the following components:26

1. Voluntary in. Subscribers opt in in exchange for a benefit, so permission is granted and participation is voluntary.2. Voluntary out. Subscribers can opt out at any time. This could affect their arrangement with their ISP, however. 3. A subscriber’s Digital Silhouette is anonymous. Predictive Networks may require a subscriber’s ISP name and password for services provided beyond Internet access. 4. Subscribers must be 13 or over. The subscriber is to attest to this, since Predictive Networks’ technology is anonymous. 5. Subscribers can receive a copy of their Digital Silhouettes twice a year for free and more often for $50.00 per request.6. Any accounting and billing records are kept separate from the Digital Silhouette.7. Digital Silhouettes are not disclosed or sold to third parties nor merged with any other database.8. A Digital Silhouette contains only categories and probabilities and not personal information.9. Independent Privacy Board. Predictive Networks established an Independent Privacy Board headed by a civil rights lawyer with a long record of work on rights and ethics.

In the nonmarket environment there has not been a reaction against Predictive Networks. In part that could be due to the fact that it is still a privately-held company.

In the marketplace Predictive Networks’ biggest customer had been AT&T’s i495 Internet service, but AT&T closed the service. The company had already provided its technology to OpenTV which provides interactive TV services. In December 2001 Microsoft licensed Predictive Networks’ technology for use in its interactive TV service. The technology would be incorporated in the set-top box and would record the channels watched and whether a user actually watched an advertisement for a type of product or switched channels. PN receives $2 per subscriber per year. A spokesperson for Microsoft TV stated that PN provides the “technology and expertise needed to make personalization seamless for the consumer, while enabling incremental revenue-generating capabilities for network operators.”27

26 See the Predictive Networks Internet site.27 The Wall Street Journal, December 11, 2001.

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Neither Microsoft nor PN would collect personal information, and the digital silhouette would reside in the set-top box. It would be passed on to advertisers who would be able to target ads to the digital silhouette. David Hosea commented, “You know who they are in a behavioral sense—not in a nominal sense.”28

In January 2002 DoubleClick suspended its profiling service Intelligent Targeting. This was due to its pledge to turn a profit in 2002 and to the reluctance of customers to believe that online ads resulted in “conversion”; i.e., converting click through to sales. DoubleClick was prepared to restart its service as soon as the market picked up.

28 The Wall Street Journal, December 11, 2001.

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Chapter 22

Ethics Issues in International BusinessThis chapter addresses a set of ethics issues encountered in international business. Those issues include (1) international law and conflicts with domestic laws, (2) whether to abide by universal principles, host country custom and practice, or the custom and practice of one’s home country, (3) questionable foreign payments, and (4) operating in developing countries. Ethics principles are intended to be universal and not country specific, yet it is clear that there are differences in what are acceptable practices across countries. Ethics issues are thus often more difficult when they have international dimensions. The chapter provides a set of frameworks for addressing these issues.

International law is an evolving but expanding field that will surely become of increased importance. Its relation to national law remains tenuous, however, and enforcement powers are weak at best. One source of difficulty in international operations is conflicts among the domestic laws in different countries. This can increase compliance costs and in some instances force a firm to violate one set of laws in order to comply with another set.

A major source of difficulty in applying ethics analysis to issues in international business is culture. The chapter considers cultural relativism, the perspective that one should abide by local laws and customs, and how to reason when it should or should not be relevant. Transparencies in the file universitygames.ppt provide a summary of aspects of this treatment and can serve as the basis for a lecture. The transparencies also identify a set of special issues pertaining to doing business in other countries and cultures.

In a number of countries, facilitating payments to government officials are commonplace. In some cases, these payments are simply grease that cause officials to do what they are supposed to do. In other cases, the payments may cause the official to do something that the official is not supposed to do. The Foreign Corrupt Practices Act (FCPA) distinguishes between these cases and imposes certain reporting requirements. The FCPA, however, does not provide the clarity that some firms require, so many firms have developed company codes that go beyond the FCPA to address specific situations that their employees are likely to encounter.

The FCPA pertains only to foreign government officials, and Cummins’ Practices go farther to cover private firms as well. More importantly, Cummins’ Practices are unique in that they provide a framework for reasoning about questionable payments. This framework can be applied in the Complications in Marnera chapter case.

The nature of corruption in the extreme is described in “In Land Where Bribes Are Common, Mr. Lai Pushed the Envelope,” The Wall Street Journal, November 23, 2001.

As international trade with and foreign direct investment in a number of developing countries grew during the 1980s and 1990s, corruption and bribery became more widespread and more troublesome. The concern was not just with the countries in which corruption and bribery were widespread but also with the companies in developed countries that were paying the bribes. The

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publication of Transparency International’s corruption index for countries and its bribe payers index have has highlighted the issue. The concerns of U.S. and other companies that they were losing more business to bribes contributed to the calls for collective action. This resulted in the OECD code which went into effect in 1999. How effective enforcement of the code will be remains to be seen, but some companies appear to be responding to it. Marc Lassus, chairman of Gemplus, a French high-tech company said that in France “companies are more and more aware of the problems of bribery and are taking the puritanical approach, the American approach.”29

In May 2002 Transparency International released a survey of 800 business experts in 15 emerging markets which countries were the greatest payers of bribes. Russia and China were the worst bribers followed by Taiwan and South Korea. The least likely to bribe were Sweden and Australia. The United States was 13th of 21 from the top of the least propensity to bribe.

Operating in developing countries is more difficult in a number of dimensions than operating in developed countries because institutions are not in place to guide actions or to enable people to take the same care that people are able to take in developed countries. The Calabresi and Melamed principles introduced in Chapter 12 are one useful guide to reasoning about these situations.

Cases

Complications in Marnera

Transparencies are available for this casecomplications marnera.ppt.

This is a fictional case based on a number of incidents encountered by executives in a number of different countries. The case can either be used in conjunction with Chapter 22 with a focus on operating in developing countries with less fully-developed institutions compared to a developed country and with a degree of corruption. The case can also be used in conjunction with a session on utilitarianism in Chapter 19. The analysis presented here is primarily based on utilitarian considerations.

The case is organized around a set of incidents, as is the discussion here. The first incident is with the customs official. What is undoubtedly going on here is extortion by a low-level government employee, and what is sought is a payment in exchange for the official doing what he is supposed to do. This is undoubtedly illegal in Marnera, but is also likely to be common. Such facilitating payments are allowed by the U.S. FCPA and by the OECD agreement. From the perspective of utilitarianism, the customs official is acting immorally. From the perspective of injustice, a greater injustice would likely result if Liu had not made the payment, since the computers could have been held up for a long time. The public disclosure test can be used here in conjunction with the injustice principle. Would the publics in Marnera and the United States understand and approve of Liu’s payment if the situation had been explained to them. The answer may well be yes.

29 The Wall Street Journal, February 16, 1999.

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The tax system described is found in a number of countries, and it is customary to hire a tax attorney to handle the matter. The fee paid to the attorney is tax deductible, and part of the fee is passed on to NTS officials in exchange for a reasonable tax settlement. These payments are illegal and are unlikely to pass the public disclosure test. From a utilitarian perspective if the payment to the NTS official is a pure transfer then it has no effect in the utilitarian calculus. The payment, however, generates some transactions costs and also could distort economic transactions. This payment is thus immoral from a utilitarian perspective. If the payment is not large and does not result in favoring Bolton, then it may be legal under U.S. law and allowable under the OECD code. With all of these incidents Bolton and others have a moral duty to change the system to eliminate the corruption.

To begin the discussion of the safety issue it may be useful to first ask the question of whether Bolton should pay Marnera wages to its construction workers or whether it should pay a higher wage. This issue is part of the nonmarket issue over sweatshops and is discussed in the Nike in Southeast Asia case in Chapter 4 The answer given by utilitarianism is that the market wage should be paid if there is a functioning labor market, which there probably is. That is, utilitarianism evaluates alternatives in terms of individual’s preferences and if workers are willing to work at those wages, paying the market wage is justified. Some activists have argued based on justice considerations that companies from developed countries should instead pay a “living wage.” This is discussed in this manual in conjunction with the Nike case.

The safety issue is similar to the wage issue, since if workers are willing to work at the wage and safety conditions customary in Marnera, then the customary levels of safety may be the moral level. Some further analysis is required, however. The first centers on whether the workers understand the risks associated with the jobs. To choose local safety standards, utilitarianism requires that risks be voluntarily assumed by workers and that requires that they understand the risks. The duty falls on Bolton to inform them. If workers accept risks out of desperation, then the local standards may not be adequate.

The next issue is which party should bear the costs of injuries. Since there is no workers compensation system or liability system in place, the workers, the contractors, or Bolton could bear those costs. As indicated in the transparencies, the Calabresi and Melamed principles discussed in Chapters 11, 19, and 22 are applicable here and suggest that Bolton and the contractors should bear the cost. Hiring a relative may not be sufficient.

The analysis to this point suggests that local safety standards are appropriate. The transparencies pose a series of questions from the perspective of moral rights and justice. As argued in Chapter 20 safety is an instrumental right, and the voluntary assumption of risk is consistent with a deontological system such as Kant’s. A justice perspective would ask if workers are subsequently denied opportunity because of a disability incurred as a result of an injury on the job. If the answer is yes, the Calabresi and Melamed principles imply that the duty to provide compensation falls on Bolton.

Some readers may regard safety as an intrinsic right and hence that local safety standards are not acceptable. This leaves the question of at what level standards should be set. Utilitarianism provides a method to determine the level of a safety standard, but it does not acknowledge an

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intrinsic right to safety. Indeed, the liability and workers compensation systems indicate that safety is protected with a liability rule (in the language of the Coase theorem). As indicated in the section of the manual on the Nike case, Nike decided to use U.S. health standards for chemicals in the workplace. This may be the beginning of a movement to treat safety in the same manner as many companies already treat the environment. That is, they maintain the same environmental standards everywhere. If this is the right perspective, then Bolton bears the 5% additional cost.

The bidding mechanism, the belief that a European company will offer a bribe, and the invitation by the vice-minister all suggest that bribes may be used to influence the award of the contract. Regardless of whether others are offering bribes, the payment of a matching bribe by Bolton would be illegal under U.S. and Marnera law and would be in violation of the OECD code. Under the law of some European companies, such a payment would be legal and tax deductible if it were necessary to secure the contract; e.g., to match a payment by a rival.

The analysis of this type of situation from the perspectives of act and rule utilitarianism is presented in Chapter 22 and can be used at this point in the discussion. The transparencies summarize the conclusions from this analysis. Rule utilitarianism as applied to simultaneous choice implies that bribes are morally wrong. The more difficult issue is what to do if it were known that a rival would be offering a bribe. Act utilitarianism, i.e., holding constant that the rival is offering a bribe, implies that a bribe be offered only if doing so would increase aggregate utility, so this is not a decision based on self interest. If Bolton knew that it was better qualified than the company offering the bribe, then from an act utilitarian perspective a matching bribe would be warranted. The payment of the bribe is still morally wrong but is justified by the principle of avoiding a greater injustice. Note, however, that the injustice is to aggregate welfare and not to a bidder.

The reasoning consistent with act utilitarianism is a slippery slope because each bidder is likely as a result of hubris to believe it is the best qualified company and hence that it should make certain that it is not disadvantaged in the bidding by a bribe offered by another company. It is a short step to all bidders offering bribes, resulting in a competition in bribes rather than on the merits. It is this slippery slope, and how far some companies have slid down that slope, that provided the pressure to reach the OECD agreement.

Liu could also reason that a matching bribe should be offered because she has a duty to the Bolton employees who would lose their jobs if Bolton did not win the contract. This does not provide a utilitarian justification of offering a matching bribe, however, since if Bolton were to win, employees of some other company would lose their jobs. Reasoning that she should commit an immoral act because of a responsibility to Bolton’s employees is casuistry, as discussed in Chapter 19.

Rather than automatically offering a matching bribe when doing so is justified by act utilitarianism, Liu should explore other alternatives. In a standard bidding mechanism, Bolton could raise its bid price to compensate for a bribe offered by a rival. In this case, the first stage of the bid process does not involve bid prices, so this alternative is not available.30 Bolton should explore other alternatives, such as offering to ensure safety standards higher than provided by local practice. A transparency provides the more general perspective on what is required by utilitarianism.

30 This bidding process was used in Indonesia for the sale of some government-owned companies.

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The remaining issue is the temptation for the bidders to collude among themselves to confine their competition to the first stage of the process and then not compete aggressively in the second stage. The winner of the first stage competition then could get by with a lower bid in the second stage. A transparency summarizes the following analysis. Collusion would be illegal under Marnera law. Moreover, there is no utilitarian justification for collusion, since at best it simply affects the amount paid by the winner to Marnera. At worst it could result in the choice of a contractor who was not the best for the project. This could easily occur if the contractors competed with each other on many contracts and set up a system to determine who will win which contract. This is like the dango system discussed in Chapter 14.

Levi Strauss & Co. in China

The purposes of this case are to evaluate the implementation of the Guidelines for Country Selection (GCS), to examine the ethics dimensions considered, and to consider the alternative courses of action identified by Levi Strauss & Co. The case also illustrates the application of LS&CO.’s principled reasoning approach. That approach is described in more detail in the Chapter 21 case Levi Strauss & Co. Global Sourcing Guidelines.

The GCS contain a substantial human rights component, and China was identified as having clear human rights violations. The problem for LS&CO. was to determine if those violations were “pervasive” and if so what the company should do. The GCS state that LS&CO. will not do business in countries that violate its guidelines, which implies that a decision that the violations were pervasive should require withdrawal from sourcing arrangements in China. This would also mean that the company would not sell its products in China’s huge market. At a time at which U.S. companies were flocking to China, this would be an extraordinary action.

LS&CO.’s present stake in China is in sourcing, but it also recognizes the huge market potential as well. China is a very low cost, if not the lowest cost, source of garments, and the quality and delivery reliability are high. If it remains in China, LS&CO.’s plans to increase substantially its purchases from China. This is a clear indication that withdrawal from China will increase its costs significantly. The cost of withdrawing from China thus would be substantial and would be greater in the future, since its sourcing and sales would grow if it remained there. The GCS, however, do not mention a tradeoff of the principles in the guidelines against other factors, such as costs and profits. As indicated below, however, the principled reasoning approach does take these factors into consideration to some extent. In the end, however, CEO Robert Haas rejected the tradeoffs.

The other concern of LS&CO. is the possible harm to its reputation and/or brand name as a result of sourcing in China. LS&CO. executives differ on whether this is a nonnegligible risk. All view its brand name as an extremely important asset, but they differ regarding whether its activities in China pose a risk. With the widespread U.S. presence in China, and the likelihood that China will be admitted to the WTO, the likelihood of harm seems remote. (It would be interesting to know if

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the reputation of the firms that were in China prior to Tianenmen Square were harmed by the crushing of the protests and the loss of life.)

The China Study Group went beyond the GSG and chose to decide whether it was in keeping with LS&CO.’s principles to remain in China and work to improve the human rights situation or to withdraw. Many people believe that the surest path to improved human rights in China is through economic growth, particularly because China has decentralized and liberalized its economic policies. See Chapter 16.

The human rights concerns are at two levels. Some are at the level of the country and center on political and religious rights. The other is at the level of the workplace and focuses on prison labor, unionization, and the one-child-per-family law. If LS&CO. were to remain in China, it would have to take actions at both levels to be consistent with its principles and values.

One interesting aspect of the China Study Group’s analysis is the measures used to assess whether the human rights violations were pervasive. These measures, although hard to quantify, are well focused and get to the heart of what pervasive means. The final measure—whether the government was working to improve conditions—was important in the thinking of the study group. Many observers believed that human rights violations were getting worse in 1993.

The majority recommended “positive engagement” in which a firm’s economic presence in a country is used to improve conditions for citizens as well as for those immediately impacted by that presence. This is similar to the Sullivan Principles for operations in South Africa during the era of apartheid. The majority recommendation sought to address human rights concerns at both the level of the workplace and at the level of the nation. The recommended policy sought both to protect workers by not enforcing the one-child-per-family law and by helping employees subject to persecution. It also sought to address human rights concerns at the national level by supporting outside organizations working to improve conditions. If LS&CO. were able to convince contractors to abide by the conditions of the recommendations, which is not at all clear, it would also represent an example that others could emulate.

The minority recommendation can best be summarized by stating that LS&CO. adopted the GCS and it thus must abide by them. The China Study Group concluded that human rights violations were pervasive, and since the GCS require that the company not source in countries, the company must withdraw. Moreover, the GCS were written in part because of concerns about the effect of sourcing relationships on the company brand name and its reputation. The CEO agreed with this perspective and did not want to compromise the company’s reputation for abiding by principles.

Teaching the case:The following question may be used to lead the discussion.

1. Should a company have guidelines for determining in which countries it will operate? Does it matter that the United States has extended diplomatic recognition to China and extends it provisional most favored nation status? 2. Are LS&CO.’s Guidelines for Country Selection appropriate? What, if anything, should be changed?

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3. Are the China Study Group’s criteria appropriate for assessing whether human rights violations are pervasive? 4. In a country with a population of 1.2 billion, is the one-child-per-family law a practical necessity or is it a serious violation of fundamental rights?5. Is the majority’s recommendation realistic? Are contractors likely to agree to it?6. Is there really a risk that sourcing in China will damage LS&CO.’s brand name or reputation?7. What is LS&CO.’s social responsibility to its suppliers in China and their employees? How should it meet that responsibility?8. Did Robert Haas make the right decision in choosing the minority recommendation? 9. Should LS&CO. sell its products in China?

Outcome:

As indicated in the case, LS&CO. decided on a gradual withdrawal from China. It took one immediate action, however. It terminated relations with any supplier that used prison labor, since the prisoners might be there on political charges. The withdrawal covers sewing and finishing operations, and fabric purchases could be subject to the withdrawal in the future. By deciding to withdraw gradually, LS&CO. left itself the opportunity to reverse its decision. On the one hand, if the human rights conditions in China were to improve, LS&CO. could quickly reverse its decision, particularly because the withdrawal from China was taking place in stages. Even if human rights conditions do not improve, a decision by the Clinton administration to grant permanent Most Favored Nation status to China could cause the company to reconsider its decision. On the other hand, its commitment to the safety, health, and working conditions standards seems irreversible, given LS&CO.’s principles and its policies for its own facilities.

LS&CO. is wrestling with the issue of how to apply its pollution abatement standards to the laundries, many of which are small, that wash finished goods. Of immediate concern was stone washing of jeans with pumice, which produces harmful effluents in considerable volume. Extending its policies to laundries, fabric manufacturers, and others in the supply chain would increase its commitment and make it more difficult to reverse.

Update 1998:31

On April 8, 1998, LS&CO. announced it was ending its self-imposed restrictions on manufacturing in mainland China. All of the company’s regional businesses would now be free to consider Chinese companies as possible sources of manufacturing, provided they met the requirements of its sourcing standards. Only LS&CO.’s Asia Pacific Division (APD) would immediately begin to explore China as a manufacturing base, however. The APD would also conduct a study for expanding its marketing efforts in China, although it did not envision a broader marketing presence in the near term.

LS&CO. still retained a commitment to its Principled Reasoning Approach and to human rights. The company began in early 1997 its discussions on returning to China, and the process did not

31 Copyright © 1998 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. Reprinted with permission.

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conclude until a year later. LS&CO. even included a number of human-rights advocacy groups as stakeholders. The company admitted that its return to China might be short-lived if it found human rights conditions had not improved to the extent it believed. But several changes in the political and economic landscapes prompted a shift in strategy.

LS&CO. primarily believed that the environment in China had changed significantly enough such that the risks to the company’s reputation from operating in the country were minimal. This feeling came less from China’s overall human rights record than from a consensus that its local contractors could adhere to the company’s guidelines for labor conditions. In other words, LS&CO. employees and contractors in China would not be subject to human-rights abuses—the primary concern in 1993. The company felt confident in this assertion because of the relationships it had developed with its Chinese contractors. By 1996, LS&CO.’s phased withdrawal had resulted in a 70 percent decrease in direct sourcing in China, down to approximately 800,000 units of clothing annually or less than one percent of the company’s worldwide total. During the intervening years, however, LS&CO. had strengthened its ties with its remaining Chinese partners and identified others who were willing and able to adhere to its code. Additionally, improvements in LS&CO.’s contractor monitoring system and discussions between company executives and other multinationals doing business in Asia, including Motorola, Eastman Kodak and Coca-Cola, strengthened the idea that factories in China could be run humanely.

Recent actions by the Chinese government helped bolster this belief. LS&CO. was encouraged by steps China had taken in producing a workable legal framework and increasing the openness of its government. Chinese officials also had assisted the company in tracking down and rooting out manufacturers of counterfeit LEVI’S products. The smooth transition of Hong Kong to Chinese sovereignty not only impressed LS&CO., but gave the company a direct marketing and manufacturing presence in China and a compelling need to reassess business opportunities there. The warming relations between China and the United States did not play a direct role—President Clinton’s historic summit in China came only weeks after LS&CO.’s announcement—but made the company’s decision easier.

Moreover, LS&CO.’s decision reflected economic realities regarding the value of the Chinese market. Manufacturing costs were becoming too hard to ignore. Since the company first said it would leave China, its competitors from around the world, including the VF Corporation (parent of Lee Apparel) and Esprit, had established a strong foothold in the country. LS&CO. believed that China has the potential to become the key manufacturing nation for the company’s Japanese and South Korean markets, which generated two-thirds of its $468 million in Asian revenue.

The decision also came during a downturn in sales of the LEVI’S brand. LS&CO.’s worldwide sales dropped four percent to $6.9 billion last year, the first decline in thirteen years. In November 1997, the company announced plans to close eleven plants in the United States and cut one-third of its domestic work force of 19,000. This domestic over capacity problem had no bearing on the decision to re-enter China, and the company announced that these jobs would not be replaced by others in Southeast Asia or Mexico. Nevertheless, it became clear that rising competition in the jeans market was beginning to substantially affect the company. Not only were high-end designers like Tommy Hilfiger and Ralph Lauren cutting into sales, but consumers were also purchasing less expensive private-label jeans available from large department stores.

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University Games, Inc.

Transparencies are available for this case universitygames.ppt.

This case raises issues of responsibility for the operations of a supplier in a developing country. The issues are similar to those in the Chapter 4 case Nike in Southeast Asia and the California Space Heaters, Inc. (C) case in this manual. This case differs from the Levi Strauss & Co. cases in that the company in this case is small, lacks the resources to address the issues directly, and is locked into this supplier. University Games does not have the opportunity to follow guidelines such as those in the Levi Strauss & Co. Terms of Engagement. Those Terms, however, identify some issues that Moog should be concerned about. For example, what is the age of the young girls working at the factory?

The issue of who is responsible for the working conditions in the factory in Thailand has four possible answers: 1) the government of Thailand, 2) the factory owner, 3) the workers, and 4) its customers. The government of Thailand has limited resources to address safety and health issues in the workplace, and moreover, the conditions in the factory are little different from other factories in Northern Thailand. Indeed, in many respects the conditions are better. The workers could take matters into their own hands, but it is unlikely that they view the conditions at the factory as bad. As just observed, the factory and the working conditions are good by the standards of Northern Thailand. The employees appear to be healthy and happy.

The factory owner clearly has the responsibility in this case. He is rightly proud of his achievements. He has provided employment in the factory to 300 people, and he provides some work to the villages as well. He pays the prevailing wage rate, workers have rest and lunch breaks, and the work week is standard with one day a week off. A dormitory is provided for the employees, and it is in good condition. Although it may be a bit crowded, undoubtedly the houses in which their families work are also crowded. The employees seem happy in their work. There are a number of safety and health concerns in the factory, however, as identified in the case. Consequently, improvements could be made. The factory owner is unlikely to make them on his own, so the question is whether Bob Moog and University Games have any responsibility. This is a moral issue, and the conceptual framework that is helpful in reasoning about the issues from a utilitarian perspective is that embodied in the Calabresi and Melamed principles. Those principles ask which party is best positioned either to take actions itself or to induce the other party to take socially efficient measures to address the issues. University Games is a very small company without the resources to provide any significant direct assistance, so any changes would have to be borne by the factory owner. The question then is whether there is anything that Moog can do to get the factory owner to address the problems.

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One approach to this question is to ask if there are any mutually beneficial steps that could be taken; i.e., are there any Pareto superior measures that could be taken? Are there any measures that Bob Moog could suggest that would benefit the workers, benefit the factory owner, and also benefit University Games? The workers would benefit from improved safety and health conditions (e.g., the sawdust) and from less draconian disciplinary measures. The factory owner would benefit fromimproved productivity and lower spoilage. University Games would benefit by sharing some of the productivity gains. Bob Moog’s approach is presented below.

Teaching the case:The following questions can be used to guide the discussion.

1. Is there really anything to be concerned about here?2. Can a small company such as University Games be expected to be responsible for its suppliers?3. What specific issues should be of concern to Bob Moog?4. Should he be concerned about the wages being paid to the employees?5. Should he be concerned about the subcontracting to the villages and the working conditions there?6. What specifically should Bob Moog do?

Bob Moog’s approach: Because of the resistance of the factory owner to his suggestions for improving working conditions, Bob Moog tried another approach. After the exchange at the end of the case, he said to the plant owner, “Let’s not argue about this. Let’s approach this from a different point of view. Wouldn’t you like to make as much money as possible and have me as a satisfied customer?” He convinced the factory owner that they could work together to improve productivity, improve working conditions, and increase both their profits. This approach appealed to the factory owner, and Moog anticipated that over the next two years considerable progress could be made. “It’s nice when ethics and good business can go together,” he said. For example, they arranged for the factory over the next two years to buy new equipment that would make it cleaner as well as increase productivity.

He also took other actions on more immediate potential hazards. Bob verified that the previous owner of the Rain Tree rights had had all the paint used in the factory tested for lead and had found it to be lead-free. Bob checked all the doors and windows to make sure they were not locked, which they were not. To avoid forcing the plant to have to work overtime, Moog worked out quarterly production schedules and procedures for fixing monthly production schedules in advance so that the number of workers needed could be anticipated and overtime avoided. Instead of blaming the workers for production problems, the factory owner came to view the problems as something to be worked out between him and University Games. One specific action was to establish clear product standards and make product test samples available, so workers could see the standards they were expected to meet. This helped the owner deal with quality problems without firing workers.

There were no young children working in the factory, and the owner said that all the workers were at least 17.

As the transparencies indicate Moog found an ally in Preecha’s wife.

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Update: In 1999 Bob Moog and the manager in charge of the Rain Tree puzzles started a dotcom AreYouGame.com as the online partner of University Games. It offers the world’s largest selection of puzzles and games.

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Part V Integrative Case

Citigroup and Subprime Lending

This case has three purposes: (1) to assess the ethics of subprime lending, (2) to identify the moral motivations for nonmarket action, and (3) to consider what actions Citigroup should take once it and the rest of the industry come under fire.

The ethics of subprime lending involve well-being, rights, and justice considerations. From the perspective of utilitarianism, subprime lending fills a gap in the credit markets, allowing many people to obtain loans for which they would not otherwise qualify. Some of these loans are for home improvements, and others are used to restructure debts associated with credit cards and other borrowings. Such lending is important and increases well-being. Well-being is decreased, however, when people are misled and induced into borrowings that are disadvantageous to them. Since utilitarianism evaluates actions based on the preferences of individuals, there is nothing wrong with people freely choosing to take actions that are contrary to their apparent interests. Indeed, making judgments about what would be good for people can constitute paternalism.

The appropriate test from a consequentialist perspective seems thus to be whether the individuals would have borrowed the funds if the consequences were fully disclosed to them and they understood those consequences. If disclosure were complete and borrowers understood, there is nothing objectionable to the choice to borrow on the subprime market, according to utilitarianism. It seems clear, however, that disclosure was not complete and that some borrowers did not understand the consequences.

The appropriate action from a utilitarianism perspective is to correct the problems while preserving the market for subprime lending. The moral duty then is for lenders to fully disclose the consequences of borrowing and to avoid enticing people, e.g., some of the elderly, who are unlikely to understand the consequences. This can be accomplished by establishing an instrumental right to information and a corresponding duty of lenders to disclose that information.

From a Kantian rights perspective a violation of rights would be in failing to treat people as autonomous ends but rather treating them solely as a means to a profit. People, however, can exercise their autonomy by digging into the structure and terms of the loans offered. Thus, it is not clear that there is a violation of Kantian rights. There may, however, be a violation of instrumental rights as considered in the previous paragraph.

From a justice perspective the concerns focus on those who are already disadvantaged. This may be due to income, health, age, or a variety of other circumstances. Since subprime lending provides access to credit for people who would otherwise not have access to credit, Rawls’ principles would support preserving the market. His principles, however, would call for measures designed to protect those who are disadvantaged and unable to protect themselves. This might involve only the establishment of instrumental rights as identified above, but it might go beyond that to allowing, for example, people to get out of disadvantageous loans.

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Nozick, however, would ask for an inquiry into how the individuals got into their position of disadvantage. If, for example, a person had made bad decisions including not protecting herself against risks, Nozick would not conclude that a moral violation had resulted from subprime lending. Disadvantageous loans are a matter of choice.

This case also illustrates the moral motivations for private nonmarket action, as considered in Chapters 4 and 6. As is frequently the case activist and advocacy groups were already in place and had on their agenda the protection of those who were unable to protect themselves. ACORN had decades of experience dealing with matters involving financial institutions. It had made a practice of pressuring financial institutions and filing lawsuits against them to block mergers with the objective of obtaining lending commitments for local communities. Its strategy extracted many millions of dollars from financial institutions. It thus had experience and expertise to challenge subprime lending practices. This should have been evident to Citigroup prior to the acquisition.

Citigroup can take a variety of actions. One is to correct any abusive practices of the Associates. A second it to review those who have been involved in abusive practices. A third is to develop programs to relieve some borrowers who have been treated unfairly. A fourth is to decide which products it should offer; e.g., should it offer single-premium credit insurance. The actions taken by Citigroup are discussed below.

Whether Citigroup’s acquisition of the Associates was a bad investment is difficult to say with certainty, but it appears to be a failure at least initially. Citibank should have known ex ante that the Associates was engaging in questionable practices. It also should have known that activist groups were concerned with subprime lending practices. After the acquisition, the subprime lending bubble apparently burst in 2001 shortly after the acquisition. One company that had exploited subprime lending opportunities was Providian Financial that specialized in providing credit cards to high-risk people who would have been unable to obtain a credit card from the major issuers. Providian’s share price increased from under $15 in 1997 to a peak of $66.72 in October 2000. To maintain growth Providian began to issue cards to increasingly risky individuals. In the summer of 2001 it changed its accounting procedures revealing large credit losses. In was forced to disclose those losses in August, and its share price plummeted to below $5. Management was forced out, and a new CEO was brought in to attempt to rescue the company.32

Discussion questions:1. Is the subprime market beneficial from the point of view of aggregate well-being?2. Are the alleged abuses serious? 3. What are the objections to the practices from the perspective of utilitarianism?4. What are the objections to the practices from the perspective of Kantian rights?5. What are the objections to the practices from the perspective of justice as fairness?6. What actions if any should Citigroup take to address the objections?7. What should it do about the activists’ criticisms and actions?8. Should Citigroup have paid $31 billion for the Associates? What type of due diligence should Citigroup have conducted?9. Should Citigroup have anticipated actions from ACORN and other activist groups?

32 Fortune, March 4, 2002.

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Developments:

On November 7, 2000 Citigroup filed a statement with the regulators condemning abusive practices and announcing a set of measures to avoid abuses. The filing stated:

We condemn predatory practices such as “packing,” “equity-stripping,” and “flipping,” and our track record with our customers and regulators demonstrates that we excel at satisfying customers. We condemn targeting low- and moderate-income and minority customers for high cost credit, and our record demonstrates that we make our credit products available to customers, including low- and moderate-income and minority individuals, through any sales channel for which they qualify.

The filing listed a set of measures the merged CitiFinancial would take.

In March 2001 the FTC took action against Citigroup for the Associates’ predatory lending. Hughes resigned from Citigroup and announced that he would not stand for reelection to the board.

In June 2001 CitiFinancial announced it would stop selling single-premium credit insurance. In September 2001 Citigroup agreed to pay $20 million to the state of North Carolina to settle its lawsuit. By September 2001 Citigroup had settled over 200 lawsuits against the Associates and over 400 remained.

The Associates had over 6,000 brokers, and Citigroup began to review them in 2001. Initially, Citigroup suspended 1,575 brokers (put them on its “Do Not Buy List”) for a variety of reasons ranging from inactivity (663) to integrity and failure to provide update documentation (487) and compliance issues (102). In a second wave it suspended 2,525 brokers for failure to return Citigroup’s required Code of Conduct.33 Citigroup also suspended a number of the correspondents that had worked with the Associates.

In October 2001 CitiFinancial released its first annual report on its subprime lending performance. Its “Real Estate Lending Initiatives Progress Report” reported on CitiFinancial’s progress in implementing the reforms identified in its November 7, 2000 filing. In addition to suspending brokers and correspondents, Citigroup initiated a variety of programs to assist buyers. First, it reviewed all proposed foreclosures and suspended 1,484. Second, it began a graduation program that allowed borrowers whose credit rating had improved to move to lower cost conventional loans. Third, it initiated a similar program for credit applicants. Fourth, it broadened an Associates program to reduce the interest rate on the real estate loans for borrowers who had made payments on time.

In December 2001 the California Reinvestment Committee, an NGO supported by nonprofit organizations and public agencies, issued a report “Stolen Wealth: Inequities in California’s Subprime Mortgage Market” critical of subprime lending practices and also of the access to the prime lending market for failing to lend more to low-income, minority, and elderly people.

33 CitiFinancial, “Real Estate Lending Initiatives Progress Report,” October 2001.

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