business ethics - cengage

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Business ethics is a subset of ethics: no special set ofethical principles applies only to the world of busi-ness. Immoral acts are immoral, whether or not a

businessperson has committed them. In the last few years,countless business wrongs, such as insider trading, theBeech-Nut adulterated apple juice scandal, the Bhopaldisaster, the Dalkon Shield tragedy, and the savings andloan industry collapse have been reported almost daily.

Ethics can be defined broadly as the study of what isright or good for human beings. It attempts to determinewhat people ought to do, or what goals they should pur-sue. Business ethics, as a branch of applied ethics, is thestudy and determination of what is right and good in busi-ness settings. Business ethics seeks to understand themoral issues that arise from business practices, institu-tions, and decision making and their relationship to gen-eralized human values. Unlike legal analyses, analyses ofethics have no central authority, such as courts or legisla-tures, upon which to rely; nor do they follow clear-cut,universal standards. Nonetheless, despite these inherentlimitations, it still may be possible to make meaningful

ethical judgments. To improve ethical decision making, itis important to understand how others have approachedthe task.

Some examples of the many business ethics questionsmay help to clarify the definition of business ethics. In theemployment relationship, countless ethical issues ariseregarding the safety and compensation of workers, theircivil rights (such as equal treatment, privacy, and freedomfrom sexual harassment), and the legitimacy of whistle-blowing. In the relationship between business and its cus-tomers, ethical issues permeate marketing techniques,product safety, and consumer protection. The relationshipbetween business and its owners bristles with ethical ques-tions involving corporate governance, shareholder voting,and management’s duties to the shareholders. The rela-tionship among competing businesses involves numerousethical matters, including fair competition and the effectsof collusion. The interaction between business and societyat large presents additional ethical dimensions: pollutionof the physical environment, commitment to the commu-nity’s economic and social infrastructure, and depletion of

1. Describe the difference between law and ethics.2. Compare the various ethical theories.3. Describe cost-benefit analysis and explain when it

should be used and when it should be avoided.

4. Explain Kohlberg’s stages of moral development.5. Explain the ethical responsibilities of business.

L earn ing Ob j e c t i v e sAfter reading this chapter you should be able to:

Our characters are the result of our conduct.ARISTOTLE, IN NICOMACHEAN ETHICS (C. 335 B.C.)

Business Ethics

CHAPTER 2 BUSINESS ETHICS 17

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natural resources. Not only do all of these issues recur atthe international level, but additional ones present them-selves, such as bribery of foreign officials, exploitation ofless-developed countries, and conflicts among differing cul-tures and value systems. (See “The Aftermath of Bhopal.”)

In resolving the ethical issues raised by business con-duct, it is helpful to use a seeing-knowing-doing model.First, the decision maker should see (identify) the ethicalissues involved in the proposed conduct, including theethical implications of the various available options.Second, the decision maker should know (resolve) whatto do by choosing the best option. Finally, the decisionmaker should do (implement) the chosen option by devel-oping implementing strategies.

This chapter first surveys the most prominent ethicaltheories (the knowing part of the decision, on which thegreat majority of philosophers and ethicists have focused).The chapter then examines ethical standards in businessand the ethical responsibilities of business. It concludeswith five ethical business cases, which give the student theopportunity to apply the seeing-knowing-doing model.The student (1) identifies the ethical issues presented inthese cases; (2) resolves these issues by using one of theethical theories described in the chapter, some other ethi-cal theory, or a combination of the theories; and (3) devel-ops strategies for implementing the ethical resolution.

Ethics Resource Center: http://www.ethics.orgDePaul University Institute for Business and ProfessionalEthics: http://www.depaul.edu/ethics/resource.htmlCouncil for Ethics in Economics: http://www.businessethics.org/Business for Social Responsibility: http://www.bsr.org/International Business Ethics Institute: http://www.business-ethics. org/Center for Applied Ethics: http://www.ethics.ubc.ca/resources/business/Business Enterprise Trust: http://www.betrust.org/

LAW VERSUS ETHICSAs discussed in Chapter 1, moral concepts strongly affectthe law, but law and morality are not the same. Althoughit is tempting to say that “if it’s legal, it’s moral,” such aproposition is generally too simplistic. For example, itwould seem gravely immoral to stand by silently while ablind man walks off a cliff if one could prevent the fall byshouting a warning, even though one would not be legallyobligated to do so. Similarly, moral questions arise con-cerning “legal” business practices, such as failing to fulfilla promise that is not legally binding; exporting productsbanned in the United States to third world countries wherethey are not prohibited; or slaughtering baby seals for furcoats. The mere fact that these practices are legal does notprevent them from being challenged on moral grounds.

Just as it is possible for legal acts to be immoral, it isequally possible for illegal acts to seem morally preferableto following the law. For example, it is the moral convic-tion of the great majority of people that those who shel-tered Jews in violation of Nazi edicts during World War IIand those who committed acts of civil disobedience in the1950s and 1960s to challenge segregation laws in theUnited States were acting properly and that the lawsthemselves were immoral.

ETHICAL THEORIESPhilosophers have sought for centuries to develop depend-able and universal methods for making ethical judgments.In earlier times, some thinkers analogized the discovery ofethical principles with the derivation of mathematicalproofs. They asserted that people could discover funda-mental ethical rules by applying careful reasoning a priori.(A priori reasoning is based on theory rather than experi-mentation and deductively draws conclusions from causeto effect and from generalizations to particular instances.)In more recent times, many philosophers have concludedthat although careful reasoning and deep thought assistsubstantially in moral reasoning, experience reveals thatthe complexities of the world defeat most attempts to fash-ion precise, a priori guidelines. Nevertheless, a review ofthe most significant ethical theories is useful in the analy-sis of issues of business ethics.

Ethical FundamentalismUnder ethical fundamentalism, or absolutism, individualslook to a central authority or set of rules to guide them inethical decision making. Some look to the Bible; others lookto the Koran or the writings of Karl Marx or to any num-ber of living or deceased prophets. The essential character-istic of this approach is a reliance upon a central repositoryof wisdom. In some cases, such reliance is total. In others,followers of a religion or a spiritual leader may believe thatall members of the group are obligated to assess moraldilemmas independently, according to each person’s under-standing of the dictates of the fundamental principles.

Ethical RelativismEthical relativism is a doctrine asserting that actionsmust be judged by what individuals feel is right or wrongfor themselves. It holds that when any two individuals orcultures differ regarding the morality of a particular issueor action, they are both correct because morality is rela-tive. However, though ethical relativism promotes open-mindedness and tolerance, it has limitations. If eachperson’s actions are always correct for that person, then

The Aftermath of Bhopal

MANAGERIAL insight

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issues related to political, social, and cultural differences amongcountries. Take, for example, the case of Union Carbide.

In 1984, the multinational chemical company had interestsin thirty-five countries and, at least in the United States,boasted one of the best safety records among major manufac-turers of chemical products. That was before the tragedy atBhopal, India.

Union Carbide owned nearly 51 percent of Union CarbideIndia Limited (UCIL), a publicly traded corporation in Indiathat ranked at the time as the country’s twenty-first largestcompany. At the urging of the Indian government, UCIL wentinto the pesticide business in the 1960s, a time when India wasattempting to modernize its agricultural base and producemore food. Also, at the government’s urging, UCIL located inIndia’s Bhopal region, a densely populated but extremelyimpoverished area. In addition, the subsidiary installed a man-ually operated safety system at the Bhopal plant, rather than anautomatic one. (The manual system provided more jobs, a goalof the Indian government.) By the early 1980s, the UCIL plantwas losing money. Squeezed by a drop in the demand for pes-ticides, the plant was operating at only 40 percent of its capac-ity. It also had taken steps to cut costs. One was tomanufacture the commonly used pesticide, Sevin, in bulk quan-tities, from start to finish, at the plant. This required UCIL notonly to make large quantities of methyl isocyanate (MIC) butalso to store the highly dangerous, extremely volatile chemicalon-site. The company also cut its workforce, which impairedplant maintenance.

Not long before midnight on Sunday, December 2, 1984, aBhopal plant engineer, Suman Dey, noticed that the pressureand temperature gauges on tank E610, which held some forty-five tons of MIC, had climbed to the boiling point. The nor-mally refrigerated tank held the chemical, deadly in its gaseousstate, in a cool, liquid form. But now the tank had lost itsrefrigeration. Employees had reason to believe that the gaugesdid not work properly, yet they searched for a leak anyway.Then, shortly after midnight, Dey heard what sounded like an

explosion in the tank. Within seconds, a toxic cloud of MICescaped. The silent, deadly fog enveloped the area close to theplant and then rolled down toward Bhopal’s railroad stationand its main city.

The UCIL plant had been built in what was, at the time, anopen area, but by the time of the accident, a large, densely pop-ulated shantytown had grown up around it. Squatters hadmoved in as close as the plant’s gate. In the early morninghours of December 3, many of these squatters died where theyfell, their lungs seared by MIC. Others were killed in the stam-pede to escape the deadly gas. As the cloud drifted overBhopal, more victims fell in its wake. Of those who survived,many were permanently blinded or otherwise disabled. In all,approximately 200,000 people were injured. Today, estimatesof the death toll range from more than 2,000 victims to asmany as 30,000 victims.

When Union Carbide’s chairperson, Warren M. Anderson,arrived in Bhopal shortly after the disaster, he was arrested andcharged with homicide. In the United States, the companyfaced a takeover bid from GAF Corporation, which it avoidedonly by selling off its consumer products division, maker ofPrestone antifreeze, Eveready batteries, and Glad Bags.

In 1989, the Indian Supreme Court ordered Union Carbide,now only a shadow of its former self, to pay $470 million tocompensate Bhopal victims. Criminal charges against the com-pany and its officials, though, were dropped.

For a multinational corporation like Union Carbide, the les-son of Bhopal is simple: Be careful. Yet how careful should acompany be? Should multinational corporations maintain intheir overseas plants safety standards the same as those theymaintain in their U.S. operations? Or should the governmentsof host countries determine required safety standards?

Whatever the answers, any corporation doing business inanother country should consider the following: To operate suc-cessfully in a foreign land requires a deep understanding of thepolitical, social, and cultural differences among countries.Often, such an enterprise also demands a keen sense ofadvanced technology’s impact on underdeveloped nations.

his behavior is, by definition, moral and, therefore,exempt from criticism. Once a person concludes thatcriticizing or punishing behavior in some cases is appro-priate, he abandons ethical relativism and faces the taskof developing a broader ethical methodology.

Although bearing a surface resemblance to ethical rel-ativism, situational ethics actually differs substantially.Situational ethics holds that developing precise guidelines

for effectively navigating ethical dilemmas is difficultbecause real-life decision making is so complex. Tojudge the morality of someone’s behavior, the personjudging must actually put herself in the other person’sshoes to understand what motivated the other to choosea particular course of action. Situational ethics, how-ever, does not cede the ultimate judgment of the propri-ety of an action to the actor; rather, it insists that, prior


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to evaluation, a person’s decision or act be viewed fromthe actor’s perspective.

UtilitarianismUtilitarianism is a doctrine that assesses good and evil interms of the consequences of actions. Those actions thatproduce the greatest net pleasure compared with net painare better in a moral sense than those that produce lessnet pleasure. As Jeremy Bentham (http://www.utm.edu/research/iep/b/bentham.htm), one of the most influentialproponents of utilitarianism, proclaimed, a good or moralact is one that results in “the greatest happiness for thegreatest number.”

The two major forms of utilitarianism are act utilitari-anism and rule utilitarianism. Act utilitarianism assesseseach separate act according to whether it maximizespleasure over pain. For example, if telling a lie in a par-ticular situation produces more overall pleasure thanpain, then an act utilitarian would support lying as themoral thing to do. Rule utilitarians, disturbed by theunpredictability of act utilitarianism and its potential forabuse, follow a different approach. Rule utilitarianismholds that general rules must be established and followedeven though, in some instances, following rules may pro-duce less overall pleasure than not following them. Itapplies utilitarian principles in developing rules; thus, itsupports rules that on balance produce the greatest satis-faction. Determining whether telling a lie in a giveninstance would produce greater pleasure than telling thetruth is less important to the rule utilitarian than decidingwhether a general practice of lying would maximize soci-ety’s pleasure. If lying would not maximize pleasure gen-erally, then one should follow a rule of not lying eventhough on occasion telling a lie would produce greaterpleasure than would telling the truth.

Utilitarian notions underlie cost-benefit analysis, an ana-lytical tool used by many business and government man-agers today. Cost-benefit analysis first quantifies inmonetary terms and then compares the direct and indirectcosts and benefits of program alternatives for meeting aspecified objective. Cost-benefit analysis seeks the greatesteconomic efficiency, according to the underlying notionthat, given two potential acts, the act achieving the greatestoutput at the least cost promotes the greatest marginal hap-piness over the less-efficient act, other things being equal.

The chief criticism of utilitarianism is that in someimportant instances it ignores justice. A number of situa-tions would maximize the pleasure of the majority atgreat social cost to a minority. Another major criticism ofutilitarianism is that measuring pleasure and pain in thefashion its supporters advocate is extremely difficult, ifnot impossible.

DeontologyDeontological theories (from the Greek word deon,meaning duty or obligation) address the practical prob-lems of utilitarianism by holding that certain underlyingprinciples are right or wrong regardless of any pleasureor pain calculations. Believing that actions cannot bemeasured simply by their results but must be judged bymeans and motives as well, deontologists judge themorality of acts not so much by their consequences butby the motives that lead to them. A person not onlymust achieve just results but also must employ theproper means.

The best-known deontological theory was proffered bythe eighteenth-century philosopher Immanuel Kant (http://www.utm.edu/research/iep/k/kantmeta.htm). Under Kant’scategorical imperative, for an action to be moral it (1)must potentially be a universal law that could be appliedconsistently and (2) must respect the autonomy andrationality of all human beings and not treat them as anexpedient. That is, one should not do anything that he orshe would not have everyone do in a similar situation. Forexample, you should not lie to colleagues unless you sup-port the right of all colleagues to lie to one another.Similarly, you should not cheat others unless you advo-cate everyone’s right to cheat. We apply Kantian reason-ing when we challenge someone’s behavior by asking:What if everybody acted that way?

Under Kant’s approach, it would be improper to asserta principle to which one claimed personal exception, suchas insisting that it was acceptable for you to cheat but notfor anyone else to do so. This principle could not be uni-versalized because everyone would then insist on similarrules from which only they were exempt.

Kant’s philosophy also rejects notions of the end justi-fying the means. To Kant, every person is an end in him-self or herself. Each person deserves respect simplybecause of his or her humanity. Thus, any sacrifice of aperson for the greater good of society would be unac-ceptable to Kant.

In many respects, Kant’s categorical imperative is avariation of the Golden Rule; and, like the Golden Rule,the categorical imperative appeals to the individual’s self-centeredness.

As does every theory, Kantian ethics has its critics. Justas deontologists criticize utilitarians for excessive prag-matism and flexible moral guidelines, utilitarians and oth-ers criticize deontologists for rigidity and excessiveformalism. For example, if one inflexibly adopts as a ruleto tell the truth, one ignores situations in which lyingmight well be justified. A person hiding a terrified wifefrom her angry, abusive husband would seem to be actingmorally by falsely denying that the wife is at the person’s

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house. Yet a deontologist, feeling bound to tell the truth,might ignore the consequences of truthfulness, tell thehusband where his wife is, and create the possibility of aterrible tragedy. Another criticism of deontological theo-ries is that the proper course may be difficult to determinewhen values or assumptions conflict.

Social Ethics TheoriesSocial ethics theories assert that special obligations arisefrom the social nature of human beings. Such theoriesfocus not only on each person’s obligations to othermembers of society but also on the individual’s rightsand obligations within the society. For example, socialegalitarians believe that society should provide each per-son with equal amounts of goods and services regardlessof the contribution each makes to increase society’swealth.

Two other ethics theories have received widespreadattention in recent years. One is the theory of distributivejustice proposed by Harvard philosopher John Rawls(http://www.geocities.com/Athens/Parthenon/1643/rawls.html), which seeks to analyze the type of societythat people in a “natural state” would establish if theycould not determine in advance whether they would betalented, rich, healthy, or ambitious, relative to othermembers of society. According to distributive justice,the society contemplated through this “veil of igno-rance” is the one that should be developed because itconsiders the needs and rights of all its members. Rawlsdid not argue that such a society would be strictly egal-itarian, and that it would unfairly penalize those whoturned out to be the most talented and ambitious.Instead, Rawls suggested that such a society wouldstress equality of opportunity, not of results. On theother hand, Rawls stressed that society would pay heedto the least advantaged to ensure that they did not suf-fer unduly and that they enjoyed society’s benefits. ToRawls, society must be premised on justice. Everyone isentitled to his or her fair share in society, a fairness allmust work to guarantee.

In contrast to Rawls, another Harvard philosopher,Robert Nozick (http://www.fas.harvard.edu/~phildept/frames/html/body_faculty_pages_7.html), stressed lib-erty, not justice, as the most important obligation thatsociety owes its members. Libertarians stress market out-comes as the basis for distributing society’s rewards.Only to the extent that one meets market demands doesone deserve society’s benefits. Libertarians oppose socialinterference in the lives of those who do not violate therules of the marketplace, that is, in the lives of those whodo not cheat others and who disclose honestly the natureof their transactions with others. The fact that some end

up with fortunes while others accumulate little simplyproves that some can play in the market effectively whileothers cannot. To libertarians, this is not unjust. What isunjust to them is any attempt by society to take wealthearned by citizens and distribute it to those who did notearn it.

These theories and others (e.g., Marxism) judge societyin moral terms by its organization and by the way inwhich it distributes goods and services. They demonstratethe difficulty of ethical decision making in the context ofa social organization: behavior that is consistently ethicalfrom individual to individual may not necessarily producea just society.

Other TheoriesThe preceding theories do not exhaust the possibleapproaches to evaluating ethical behavior; several othertheories also deserve mention. Intuitionism holds that arational person possesses inherent powers to assess thecorrectness of actions. Though an individual may refineand strengthen these powers, they are just as basic tohumanity as our instincts for survival and self-defense.Just as some people are better artists or musicians, somepeople have more insight into ethical behavior than oth-ers. Consistent with intuitionism is the good person phi-losophy, which declares that if individuals wish to actmorally, they should seek out and emulate those whoalways seem to know the right choice in any given situ-ation and who always seem to do the right thing. Onevariation of these ethical approaches is the “TelevisionTest,” which directs us to imagine that every ethicaldecision we make is being broadcast on nationwide tel-evision. An appropriate decision is one we would becomfortable broadcasting on national television for allto witness.

ETHICAL STANDARDS IN BUSINESSIn this section we will explore the application of the the-ories of ethical behavior to the world of business.

Choosing an Ethical SystemIn their efforts to resolve the moral dilemmas facinghumankind, philosophers and other thinkers havestruggled for years to refine the various systems previ-ously discussed. All of the systems are limited, however,in terms of applicability and tend to produce unaccept-able prescriptions for action in some circumstances. Butto say that each system has limits is not to say it is use-less. On the contrary, a number of these systems provideinsight into ethical decision making and help us formu-late issues and resolve moral dilemmas. Furthermore,


Preconventional (Childhood) Self Punishment/RewardConventional (Adolescence) Group Group NormsPostconventional (Adulthood) Universal Moral Principles

Levels Perspective Justification

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concluding that moral standards are difficult to articu-late and that moral boundaries are imprecise is not thesame as concluding that moral standards are unneces-sary or nonexistent.

Research by the noted psychologist LawrenceKohlberg provides some insight into ethical decisionmaking and lends credibility to the notion that moralgrowth, like physical growth, is part of the human con-dition. Kohlberg observed that people progress throughsequential stages of moral development (http://moon.pepperdine.edu/gsep/class/ethics/kohlberg/) accordingto two major variables: age and reasoning. During thefirst level—the preconventional level—a child’s conductis a reaction to the fear of punishment and, later, to thepleasure of reward. Although people who operate at thislevel may behave in a moral manner, they do so withoutunderstanding why their behavior is moral. The rulesare imposed upon them. During adolescence—Kohlberg’s conventional level—people conform theirbehavior to meet the expectations of groups, such asfamily, peers, and eventually society. The motivation forconformity is loyalty, affection, and trust. Most adultsoperate at this level. According to Kohlberg, some reachthe third level—the postconventional level—where theyaccept and conform to moral principles because theyunderstand why the principles are right and binding. Atthis level, moral principles are voluntarily internalized,not externally imposed. Moreover, individuals at thisstage develop their own universal ethical principles andmay even question the laws and values that society andothers have adopted (see Figure 2-1).

Kohlberg believed that not all people reach the third,or even the second, stage. He therefore argued that essen-tial to the study of ethics was the exploration of ways tohelp people achieve the advanced stage of postconven-tional thought. Other psychologists assert that individualsdo not pass sequentially from stage to stage but ratherfunction in all three stages simultaneously.

Whatever the source of our ethical approach, we can-not avoid facing moral dilemmas that challenge us to rec-ognize and to do the right thing. Moreover, for those whoplan business careers, such dilemmas necessarily will haveimplications for many others—employees, shareholders,suppliers, customers, and society at large.

Corporations as Moral AgentsBecause corporations are not persons but artificial entitiescreated by the state, whether they can or should be heldmorally accountable is difficult to determine. Though,clearly, individuals within corporations can be held morallyresponsible, the corporate entity presents unique problems.

Commentators are divided on the issue. Some insistthat only people can engage in behavior that can bejudged in moral terms. Opponents of this view concedethat corporations are not persons in any literal sense butinsist that the attributes of responsibility inherent in cor-porations are sufficient to justify judging corporatebehavior from a moral perspective.

ETHICAL RESPONSIBILITIESOF BUSINESSMany people assert that the only responsibility of busi-ness is to maximize profit and that this obligation over-rides any ethical or social responsibility. Although oureconomic system of modified capitalism is based on thepursuit of self-interest, it also contains components tocheck this motivation of greed. Our system has alwaysrecognized the need for some form of regulation,whether it be by the “invisible hand” of competition, theself-regulation of business, or government regulation.

Regulation of BusinessAs explained and justified by Adam Smith in The Wealthof Nations (1776), (http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/smith/index.html) the capitalistic systemis composed of six “institutions”: economic motivation,private productive property, free enterprise, free markets,competition, and limited government. As long as all theseconstituent institutions continue to exist and operate inbalance, the factors of production—land, capital, andlabor—combine to produce an efficient allocation ofresources for individual consumers and for the economyas a whole. To achieve this outcome, however, Smith’smodel requires that a number of conditions be satisfied:“standardized products, numerous firms in markets, eachfirm with a small share and unable by its actions alone to

Figure 2-1 Kohlberg’s Stages ofMoral Development


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exert significant influence over price, no barriers to entry,and output carried to the point where each seller’s mar-ginal cost equals the going market price.” E. Singer,Antitrust Economics and Legal Analysis.

History has demonstrated that the actual operation ofthe economy has satisfied almost none of these assump-tions. More specifically, the actual competitive processfalls considerably short of the assumptions of the classiceconomic model of perfect competition:

Competitive industries are never perfectly competitive in thissense. Many of the resources they employ cannot be shiftedto other employments without substantial cost and delay.The allocation of those resources, as between industries or asto relative proportions within a single industry, is unlikely tohave been made in a way that affords the best possibleexpenditure of economic effort. Information is incomplete,motivation confused, and decision therefore ill informed andoften unwise. Variations in efficiency are not directlyreflected in variations of profit. Success is derived in largepart from competitive selling efforts, which in the aggregatemay be wasteful, and from differentiation of products, whichmay be undertaken partly by methods designed to impair theopportunity of the buyer to compare quality and price.

C. Edwards, Maintaining Competition

In addition to capitalism’s failure to allocate resourcesefficiently, it cannot be relied on to achieve all of the socialand public policy objectives a pluralistic democracyrequires. For example, the free enterprise model simplydoes not address equitable distribution of wealth, nationaldefense, conservation of natural resources, full employ-ment, stability in economic cycles, protection against eco-nomic dislocations, health and safety, social security, andother important social and economic goals. Increased reg-ulation of business has occurred not only to preserve thecompetitive process in our economic system but also toachieve social goals extrinsic to the efficient allocation ofresources, the “invisible hand” and self-regulation by busi-ness having failed to bring about these desired results. Suchintervention attempts (1) to regulate both “legal” monop-olies, such as those conferred by law through copyrights,patents, and trade symbols, and “natural” monopolies,such as utilities, transportation, and communications; (2)to preserve competition by correcting imperfections in themarket system; (3) to protect specific groups, especiallylabor and agriculture, from marketplace failures; and (4) topromote other social goals. Successful government regula-tion involves a delicate balance between regulations thatattempt to preserve competition and those that attempt toadvance other social objectives. The latter should notundermine the basic competitive processes that provide anefficient allocation of economic resources.

Corporate GovernanceIn addition to the broad demands of maintaining a com-petitive and fair marketplace, another factor demandingthe ethical and social responsibility of business is thesheer size and power of individual corporations. The fivethousand largest U.S. firms currently produce more thanhalf of the nation’s gross national product.

In a classic study published in 1932, Adolf Berle andGardner Means concluded that great amounts of eco-nomic power had been concentrated in a relatively fewlarge corporations, that the ownership of these corpora-tions had become widely dispersed, and that the share-holders had become far removed from active participationin management. Since their original study, these trendshave continued steadily. Thus, vast amounts of wealthand power are controlled by a small number of corpora-tions, which are in turn controlled by a small group ofcorporate officers.

These developments raise a large number of social, pol-icy, and ethical issues about the governance of large, pub-licly owned corporations. Many observers insist thatcompanies playing such an important economic roleshould have a responsibility to undertake projects thatbenefit society in ways that go beyond mere financial effi-ciency in producing goods and services. In some instances,the idea of corporate obligations comes from industrial-ists themselves.

Corporate Governance OECD: http://www.oecd.org/daf/corpo-rate-affairs/governanceCorporate Governance Network: http://www.corpgov.net/The Business Roundtable: http://www.brtable.org/issue.cfm/2

Arguments Against Social ResponsibilityA number of arguments oppose business involvement insocially responsible activities: profitability, unfairness,accountability, and expertise.

Profitability As Milton Friedman (http://www-hoover.stanford.edu/BIOS/friedman.html) and others haveargued, businesses are artificial entities established to per-mit people to engage in profit-making, not social, activi-ties. Without profits, they assert, there is little reason fora corporation to exist and no real way to measure theeffectiveness of corporate activities. Businesses are notorganized to engage in social activities; they are struc-tured to produce goods and services for which theyreceive money. Their social obligation is to return asmuch of this money as possible to their direct stakehold-ers. In a free market with significant competition, the self-ish pursuits of corporations will lead to maximizingoutput, minimizing costs, and establishing fair prices. All


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other concerns distract companies and interfere withachieving these goals.

Unfairness Whenever companies stray from their desig-nated role of profit-maker, they take unfair advantage ofcompany employees and shareholders. For example, acompany may support the arts or education or spendexcess funds on health and safety; however, these fundsrightfully belong to the shareholders or employees. Thecompany’s decision to disburse these funds to others whomay well be less deserving than the shareholders andemployees is unfair. Furthermore, consumers can expresstheir desires through the marketplace, and shareholdersand employees can decide privately if they wish to makecharitable contributions. In most cases, senior manage-ment consults the board of directors about supportingsocial concerns but does not seek the approval of thecompany’s major stakeholders, thereby effectively disen-franchising these shareholders from actions that reducetheir benefits from the corporation.

Accountability Corporations, as previously noted, areprivate institutions that are subject to a lower standard ofaccountability than are public bodies. Accordingly, a com-pany may decide to support a wide range of social causesand yet submit to little public scrutiny. But a substantialpotential for abuse exists in such cases. For one thing, acompany could provide funding for a variety of causes itsemployees or shareholders did not support. It also couldprovide money “with strings attached,” thereby control-ling the recipients’ agendas for less than socially beneficialpurposes. For example, a drug company that contributesto a consumer group might implicitly or explicitly condi-tion its assistance on the group’s agreement never to criti-cize the company or the drug industry.

This lack of accountability warrants particular concernbecause of the enormous power corporations wield inmodern society. Many large companies, like GeneralMotors or Exxon, generate and spend more money in ayear than all but a handful of the world’s countries. Ifthese companies suddenly began to vigorously pursuetheir own social agendas, their influence might well rival,and perhaps undermine, that of their national govern-ment. In a country like the United States, founded on theprinciples of limited government and the balance of pow-ers, too much corporate involvement in social affairsmight well present substantial problems. Without clearguidelines and accountability, companies pursuing theirprivate visions of socially responsible behavior might welldistort the entire process of governance.

There is a clear alternative to corporations engaging insocially responsible action. If society wishes to increasethe resources devoted to needy causes, it has the power to

do so. Let the corporations seek profits without the bur-den of a social agenda, let the consumers vote in the mar-ketplace for the products and services they desire, and letthe government tax a portion of corporate profits forsocially beneficial causes.

Expertise Even though a corporation has an expertisein producing and selling its product, it may not possess atalent for recognizing or managing socially useful activi-ties. Corporations become successful in the marketbecause they can identify and meet the needs of their cus-tomers. Nothing suggests that this talent spills over intononbusiness arenas. In fact, critics of corporate participa-tion in social activities worry that corporations will proveunable to distinguish the true needs of society from theirown narrow self-interests.

Arguments in Favor of Social ResponsibilityFirst, it should be recognized that even the critics of busi-ness acknowledge that the prime responsibility of busi-ness is to make a reasonable return on its investment byproducing a quality product at a reasonable price. Theydo not suggest that business entities be charitable institu-tions. They do assert, however, that business has certainobligations beyond making a profit or not harming soci-ety. Such critics contend that business must help to resolvesocietal problems, and they offer a number of argumentsin support of their position.

Codes of Conduct: http://condor.depaul.edu/ethics/codes1.html

The Social Contract Society creates corporations andgives them a special social status, including the granting oflimited liability, which insulates owners from liability fordebts their organizations incur. Supporters of social rolesfor corporations assert that limited liability and otherrights granted to companies carry a responsibility: corpo-rations, just like other members of society, must contributeto its betterment. Therefore, companies owe a moral debtto society to contribute to its overall well-being. Societyneeds a host of improvements, such as pollution control,safe products, a free marketplace, quality education, curesfor illness, and freedom from crime. Corporations canhelp in each of these areas. Granted, deciding which socialneeds deserve corporate attention is difficult; however, thischallenge does not lessen a company’s obligation to choosea cause. Corporate America cannot ignore the multitudeof pressing needs that remain, despite the efforts of gov-ernment and private charities.

A derivative of the social contract theory is thestakeholder model for the societal role of the business


Figure 2-2 The Stakeholder Model

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corporation. Under the stakeholder model a corporationhas fiduciary responsibilities—duty of utmost loyaltyand good faith—to all of its stakeholders, not just itsstockholders. Historically, the stockholder model for therole of business has been the norm. Under this theory, acorporation is viewed as private property owned by andfor the benefit of its owners—the stockholders of thecorporation. (For a full discussion of this legal model,see Chapter 36.) The stakeholder model, on the otherhand, holds that corporations are responsible to societyat large and more directly to all those constituencies onwhich they depend for their survival. Thus, it is arguedthat a corporation should be managed for the benefit ofall of its stakeholders-stockholders, employees, cus-tomers, suppliers, and managers, as well as the localcommunities in which it operates. (See Figure 2-2; com-pare it with Figure 36-1.)

Less Government Regulation According to anotherargument in favor of corporate social responsibility, themore responsibly companies act, the less the governmentmust regulate them. This idea, if accurate, would likelyappeal to those corporations that typically view regula-tion with distaste, perceiving it as a crude and expensiveway of achieving social goals. To them, regulation oftenimposes inappropriate, overly broad rules that hamperproductivity and require extensive recordkeeping proce-

dures to document compliance. If companies can usemore flexible, voluntary methods of meeting a socialnorm such as pollution control, then government will beless tempted to legislate norms.

The argument can be taken further. Not only doesanticipatory corporate action lessen the likelihood ofgovernment regulation, but also social involvement bycompanies creates a climate of trust and respect thatreduces the overall inclination of government to inter-fere in company business. For example, a governmentagency is much more likely to show some leniencytoward a socially responsible company than toward onethat ignores social plights.

Long-Run Profits Perhaps the most persuasive argu-ment in favor of corporate involvement in social causes isthat such involvement actually makes good business sense.Consumers often support good corporate images and avoidbad ones. For example, consumers generally prefer topatronize stores with “easy return” policies. Even thoughsuch policies are not required by law, companies institutethem because they create goodwill—an intangible thoughindispensable asset for ensuring repeat customers. In thelong run, enhanced goodwill often rebounds to strongerprofits. Moreover, corporate actions to improve the well-being of their communities make these communities moreattractive to citizens and more profitable for business.


CHAPTER SUMMARY

Definitions

Ethical Theories

Ethical Standards inBusiness

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Ethical Fundamentalism individuals look to a central authority or set of rules to guidethem in ethical decision making

Ethical Relativism asserts that actions must be judged by what individuals subjectivelyfeel is right or wrong for themselves

Situational Ethics one must judge a person’s actions by first putting oneself in the actor’ssituation

Utilitarianism moral actions are those that produce the greatest net pleasure comparedwith net pain

• Act Utilitarianism assesses each separate act according to whether it maximizes pleas-ure over pain

• Rule Utilitarianism supports rules that on balance produce the greatest pleasure forsociety

• Cost-Benefit Analysis quantifies the benefits and costs of alternativesDeontology holds that actions must be judged by their motives and means as well astheir results

Social Ethics Theories focus on a person’s obligations to other members in society andon the individual’s rights and obligations within society

• Social Egalitarians believe that society should provide all its members with equalamounts of goods and services regardless of their relative contributions

• Distributive Justice stresses equality of opportunity rather than results• Libertarians stress market outcomes as the basis for distributing society’s rewards

Other Theories

• Intuitionism a rational person possesses inherent power to assess the correctness ofactions

• Good Person individuals should seek out and emulate good role models

Ethics study of what is right or good for human beings

Business Ethics study of what is right and good in a business setting

Choosing an Ethical System Kohlberg’s stages of moral development is a widely acceptedmodel (See Figure 2-1.)

Corporations as Moral Agents because a corporation is a statutorily created entity, it isnot clear whether it should be held morally responsible

Regulation of Business governmental regulation has been necessary because all the con-ditions for perfect competition have not been satisfied and free competition cannot byitself achieve other societal objectives

Corporate Governance vast amounts of wealth and power have become concentrated ina small number of corporations, which are in turn controlled by a small group of corpo-rate officers

EthicalResponsibilities ofBusiness


PROBLEMS

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1. You have an employee who has a chemical imbalancein the brain that causes him to be severely unstable.The medication that is available to deal with thisschizophrenic condition is extremely powerful anddecreases the taker’s life span by one to two years forevery year that the user takes it. You know that hisdoctors and family believe that it is in his best interestto take the medication. What course of action shouldyou follow?

2. You have an employee from another country who isvery shy. After a period of time, you notice that thequality of her performance is deteriorating rapidly.You find an appropriate time to speak with her anddetermine that she is extremely distraught. Sheinforms you that her family has arranged a marriagefor her and that she refuses to obey their contract.She further informs you that she is contemplating sui-cide. Two weeks later, after her poor performancecontinues, you determine that she is on the verge of anervous breakdown; and once again she informs youthat she is going to commit suicide. What should youdo? Consider further that you can petition a court tohave her involuntarily committed to a mental hospi-tal. You know, however, that such a commitmentwould be considered an extreme insult by her family

and that they might seek retribution. Does this alteryour decision?

3. You receive a telephone call from a company younever do business with requesting a reference on oneof your employees, Mary Sunshine. You believe Maryperforms in a generally incompetent manner andwould be delighted to see her take another job. Yougive her a glowing reference. Is this right? Explain.

4. You have just received a report suggesting that achemical your company uses in its manufacturingprocess is very dangerous. You have not read thereport, but you are generally aware of its contents.You believe that the chemical can be replaced fairlyeasily, but that if word gets out, panic may set inamong employees and community members. Areporter asks if you have seen the report, and you sayno. Is your behavior right or wrong? Explain.

5. Joe Jones, your neighbor and friend, and you boughtlottery tickets at the corner drugstore. While watchingthe lottery drawing on TV with you that night, Joeleaped from the couch, waved his lottery ticket, andshouted, “I’ve got the winning number!” Suddenly, heclutched his chest, keeled over, and died on the spot.You are the only living person who knows that Joe,

Arguments Against Social Responsibility

• Profitability because corporations are artificial entities established for profit-makingactivities, their only social obligation should be to return as much money as possible toshareholders

• Unfairness whenever corporations engage in social activities, such as supporting thearts or education, they divert funds rightfully belonging to shareholders and/oremployees to unrelated third parties

• Accountability a corporation is subject to less public accountability than public bodiesare

• Expertise although a corporation may have a high level of expertise in selling itsgoods and services, there is absolutely no guarantee that any promotion of social activ-ities will be carried on with the same degree of competence

Arguments in Favor of Social Responsibility

• The Social Contract because society allows for the creation of corporations and givesthem special rights, including a grant of limited liability, corporations owe a responsi-bility to society

• Less Government Regulation by taking a more proactive role in addressing society’sproblems, corporations create a climate of trust and respect that has the effect ofreducing government regulation

• Long-Run Profits corporate involvement in social causes creates goodwill, which sim-ply makes good business sense


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not you, bought the winning ticket. If you substitutehis ticket for yours, no one will know of the switchand you will be $10 million richer. Joe’s only livingrelative is a rich aunt whom he despised. Will youswitch his ticket for yours? Explain.

6. Omega, Inc., a publicly held corporation, has assets of$100 million and annual earnings in the range of $13to $15 million. Omega owns three aluminum plants,which are profitable, and one plastics plant, which islosing $4 million a year. Because of its very high oper-ating costs, the plastics plant shows no sign of everbecoming profitable, and there is no evidence that theplant and the underlying real estate will increase invalue. Omega decides to sell the plastics plant. Theonly bidder for the plant is Gold, who intends to usethe plant for a new purpose, to introduce automation,and to replace all existing employees. Would it be eth-ical for Omega to turn down Gold’s bid and keep theplastics plant operating indefinitely, for the purpose ofpreserving the employees’ jobs? Explain.

7. You are the sales manager of a two-year-old electron-ics firm. At times, the firm has seemed on the brink offailure, but recently it has begun to be profitable. Inlarge part, the profitability is due to the aggressive andtalented sales force you have recruited. Two monthsago, you hired Alice North, an honors graduate fromthe State University, who decided that she was tired ofthe Research Department and wanted to try sales.

Almost immediately after you sent Alice out fortraining with Brad West, your best salesperson, hebegan reporting to you an unexpected turn of events.According to Brad, “Alice is terrific: she’s confident,smooth, and persistent. Unfortunately, a lot of ourbuyers are good old boys who just aren’t comfortablearound young, bright women. Just last week, HiramJones, one of our biggest customers, told me that hesimply won’t continue to do business with ‘youngchicks’ who think they invented the world. It’s notthat Alice is a know-it-all. She’s not. It’s just that theseguys like to booze it up a bit, tell some off-color jokes,and then get down to business. Alice doesn’t drink,and, although she never objects to the jokes, it’s clearshe thinks they’re offensive.” Brad felt that severalpotential deals had fallen through “because the moodjust wasn’t right with Alice there.” Brad added, “Idon’t like a lot of these guys’ styles myself, but I goalong to make the sales. I just don’t think Alice isgoing to make it.”

When you call Alice in to discuss the situation, sheconcedes the accuracy of Brad’s report but indicatesthat she’s not to blame and insists that she be kept onthe job. You feel committed to equal opportunity but

don’t want to jeopardize your company’s ability tosurvive. What should you do?

8. Major Company subcontracted the development of partof a large technology system to Start-up Company, asmall corporation specializing in custom computer sys-tems. The contract, which was a major breakthroughfor Start-up Company and crucial to its future, providedfor an initial development fee and subsequent progresspayments, as well as a final date for completion.

Start-up Company provided Major Companywith periodic reports indicating that everything wason schedule. After several months, however, the statusreports stopped coming, and the company misseddelivery of the schematics, the second major mile-stone. As an in-house technical consultant for MajorCompany, you visited Start-up Company and foundnot only that it was far behind schedule but that it hadlied about its previous progress. Moreover, you deter-mined that this slippage put the schedule for the entireproject in severe jeopardy. The cause of Start-up’s slip-page was the removal of personnel from your projectto work on short-term contracts to obtain money tomeet the weekly payroll.

Your company decided that you should stay atStart-up Company to monitor its work and to assist inthe design of the project. After six weeks and someprogress, Start-up is still way behind its delivery dates.Nonetheless, you are now familiar enough with theproject to complete it in-house with Major’s personnel.

Start-up is still experiencing severe cash flowproblems and repeatedly requests payment fromMajor. But your CEO, furious with Start-up’s lies anddeceptions, wishes to “bury” Start-up and finish theproject using Major Company’s internal resources.She knows that withholding payment to Start-up willput it out of business. What do you do? Explain.

9. A customer requested certain sophisticated tests onequipment he purchased from your factory. Such testsare very expensive and must be performed by a thirdparty. The equipment met all of the industry standardsbut showed anomalies, which could not be explained.

Though the problem appeared to be very minor,you decided to inspect the unit to try to understand thetest data—a very expensive and time-consumingprocess. You informed the customer of this decision. Aproblem was found, but it was minor and was highlyunlikely ever to cause the unit to fail. Rebuilding theequipment would be very expensive and time consum-ing; moreover, notifying the customer that you wereplanning to rebuild the unit would also put your over-all manufacturing procedures in question. Whatshould you do—fix it, ship it, inform the customer?


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10. a. You are a project manager for a company mak-ing a major proposal to a Middle Eastern coun-try. Your major competition is from Japan. Yourlocal agent, who is closely tied to a very influen-tial sheik, would receive a 5 percent commissionif the proposal were accepted. Near the date forthe decision, the agent asks you for $150,000 togrease the skids so that your proposal is accepted.What do you do?

b. What if, after you say no, the agent goes to yourvice president, who provides the money? Whatdo you do?

c. Your overseas operation learns that most otherforeign companies in this Middle Eastern loca-tion bolster their business by exchanging cur-rency on the gray market. You discover that yourdivision is twice as profitable as budgeted due tothe amount of domestic currency you havereceived on the gray market. What do you do?

Internet Exercise Find and identify some websites pertaining to business ethics that contain

(a) political, social, or economic bias, (b) codes ofconduct for companies, associations, or users, and (c) other significant material.

http://


B U S I N E S S E T H I C S C A S E S

Attribute/Years Ago 1 2 3 4 5 6 7 8

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TotalEmployment 3,273 3,079 2,765 2,372 1,927 1,619 1,306 1,192

Minority 272 238 196 143 109 75 53 32Employment (8.35%) (7.7%) (7.15%) (6.0%) (5.7%) (4.6%) (4.1%) (2.7%)

Revenue($ million) 3,481 3,087 2,702 2,184 1,750 1,479 1,214 986

Profit($ million) 1,106 1,021 996 869 724 634 520 340

R, D & M Budget($ million) 403 381 357 274 195 126 96 79

BackgroundWilliam Wilson, senior vice president of research, develop-ment, and medical (R, D & M) at Pharmakon Drug Company,received both his Ph.D. in biochemistry and his M.D. from theUniversity of Oklahoma. Upon completion of his residency,Dr. Wilson joined the faculty at Harvard Medical School. Heleft Harvard after five years to join the research group atMerck & Co. Three years later, he went to Burroughs-Wellcome as director of R, D & M, and, after eight years, Dr.Wilson joined Pharmakon in his current position.

William Wilson has always been highly respected as a sci-entist, a manager, and an individual. He has also been an out-standing leader in the scientific community, particularly in theeffort to attract more minorities into the field.

Pharmakon concentrates its research efforts in the areasof antivirals (with a focus on HIV), cardiovascular, respira-tory, muscle relaxants, gastrointestinal, the central nervoussystem, and consumer health care (that is, nonprescription orover-the-counter medicines). Dr. Wilson is on the board ofdirectors of Pharmakon and the company’s executive com-mittee. He reports directly to the chairman of the board andCEO, Mr. Jarred Swenstrum.

Declining GrowthDuring the previous eight years, Pharmakon experiencedtremendous growth: 253 percent overall with yearly growthranging from 12 percent to 25 percent. During this period,Pharmakon’s R, D & M budget grew from $79 million to$403 million, and the number of employees rose from 1,192to 3,273 (see Table 1). During the previous two years, how-ever, growth in revenue and earnings had slowed consider-ably. Moreover, in the current year, Pharmakon’s revenues of$3.55 billion and earnings before taxes of $1.12 billion wereup only 2 percent from the previous year. Furthermore, bothrevenues and earnings are projected to be flat or declining forthe next five years.

The cessation of this period’s tremendous growth andthe likelihood of future decline have been brought aboutprincipally by two causes. First, a number of Pharmakon’smost important patents have expired and competition fromgenerics has begun and could continue to erode its prod-ucts’ market shares. Second, as new types of health-caredelivery organizations evolve, pharmaceutical companies’revenues and earnings will in all likelihood be adverselyaffected.

Pharmakon Drug Company

The business ethics cases that follow are based on the kinds ofsituations that companies regularly face in conducting busi-ness. You should first read each case carefully and in itsentirety before attempting to analyze it. Second, you shouldidentify the most important ethical issues arising from the sit-uation. Often it is helpful to prioritize these issues. Third, youshould identify the viable options for addressing these issues

and the ethical implications of the identified options. Thismight include examining the options from the perspectives ofthe various ethical theories as well as the affected stakeholders.Fourth, you should reach a definite resolution of the ethicalissues by choosing what you think is the best option. Youshould have a well-articulated rationale for your resolution.Finally, develop a strategy for implementing your resolution.

Table 1 Pharmakon Employment


Figure 1 Pharmakon AffirmativeAction Program

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Problem and Proposed SolutionsIn response, the board of directors has decided that the com-pany must emphasize two conflicting goals: increase thenumber of new drugs brought to market and cut back on theworkforce in anticipation of rising labor and marketing costsand declining revenues. Accordingly, Dr. Wilson has beeninstructed to cut costs significantly and to reduce his work-force by 15 percent over the next six months.

Dr. Wilson called a meeting with his management team todiscuss the workforce reduction. One of his managers,Leashia Harmon, argued that the layoffs should be made “sothat recent gains in minority hiring are not wiped out.” Thepercentage of minority employees had increased from 2.7percent eight years ago to 8.3 percent in the previous year(see Table 1). The minority population in communities inwhich Pharmakon has major facilities has remained over theyears at approximately 23 percent. About 20 percent of theR, D & M workforce have a Ph.D. in a physical science or inpharmacology, and another 3 percent have an M.D.

Dr. Harmon, a Ph.D. in pharmacology and head of clin-ical studies, is the only minority on Dr. Wilson’s seven-member management team. Dr. Harmon argued that R, D& M has worked long and hard to increase minority employ-ment and has been a leader in promoting Pharmakon’s affir-mative action plan (see Figure 1). Therefore, she asserted, all

layoffs should reflect this commitment, even if it meant dis-proportionate layoffs of nonminorities.

Dr. Anson Peake, another member of Dr. Wilson’s man-agement team and director of new products, argued thatPharmakon’s R, D & M division has never discharged aworker except for cause and should adhere as closely as pos-sible to that policy by terminating individuals solely based onmerit. Dr. Rachel Waugh, director of product development,pointed out that the enormous growth in employmentover the last eight years—almost a trebling of the work-force—had made the company’s employee performanceevaluation system less than reliable. Consequently, shecontended that because laying off 15 percent of her groupwould be extremely difficult and subjective, she preferredto follow a system of seniority.

Dr. Wilson immediately recognized that any system ofreducing the workforce would be difficult to implement.Moreover, he was concerned about fairness to employeesand maintaining the best qualified group to carry out thearea’s mission. He was very troubled by a merit or senior-ity system if it could not maintain the minority gains. Infact, he had even thought about the possibility of using thisdifficult situation to increase the percentage of minorities tobring it more in line with the minority percentage of thecommunities in which Pharmakon had major facilities.

POLICYIt is the policy of Pharmakon Drug Co. to provide equal employment opportunities withoutregard to race, color, religion, sex, national origin, sexual preference, disability, and veteran sta-tus. The Company will also take affirmative action to employ and advance individual applicantsfrom all segments of our society. This policy relates to all phases of employment, including, butnot limited to, recruiting, hiring, placement, promotion, demotion, layoff, recall, termination,compensation, and training. In communities where Pharmakon has facilities, it is our policy tobe a leader in providing equal employment for all of its citizens.

RESPONSIBILITY FOR IMPLEMENTATIONThe head of each division is ultimately responsible for initiating, administering, and controllingactivities within all areas of responsibility necessary to ensure full implementation of this policy.The managers of each location or area are responsible for the implementation of this policy.All other members of management are responsible for conducting day-to-day activities in a man-ner to ensure compliance with this policy.

Pharmakon Drug CompanyEqual Employment Opportunity

Affirmative Action Program


Mykon’s Dilemma

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ceuticals, Inc., sat at his desk and scratched his head for thethousandth time that night. His friends never tired of tellinghim that unless he stopped this habit he would remove whatlittle hair he had left. Nevertheless, he had good reason to beperplexed—the decisions he made would determine thefuture of the company and, literally, the life or death of thou-sands of people.

As a young, ambitious scientist, Spratt had gained interna-tional fame and considerable fortune while rising quicklythrough the ranks of the scientists at Mykon. After receiving adegree from the Executive MBA program at the Kenan-FlaglerBusiness School, University of North Carolina at Chapel Hill,he assumed, in rapid succession, a number of administrativepositions at the company, culminating in his appointment asCEO. But no one had told him that finding cures for previouslyincurable diseases would be fraught with moral dilemmas.Although it was 3:00 in the morning, Spratt remained at hisdesk, unable to stop thinking about his difficult choices. Hispreoccupation was made worse by the knowledge that pressurefrom governments and consumers would only increase eachday he failed to reach a decision. This pressure had mountedrelentlessly since the fateful day he had announced that Mykonhad discovered the cure for AIDS. But the cure brought with ita curse: there was not enough to go around.

Company BackgroundMykon, a major international research-based pharmaceuticalgroup, engages in the research, development, manufacture,and marketing of human health-care products for sale inboth the prescription and over-the-counter (OTC) markets.The company’s principal prescription medicines include arange of products in the following areas: antiviral, neuro-muscular blocking, cardiovascular, anti-inflammatory,immunosuppressive, systemic antibacterial, and central nerv-ous system. Mykon also manufactures other products such asmuscle relaxants, anti-depressants, anti-convulsants, and res-piratory stimulants. In addition, the company markets drugsfor the treatment of congestive heart failure and the preven-tion of organ rejection following transplant.

Mykon’s OTC business primarily consists of cough andcold preparations and several topical antibiotics. The com-pany seeks to expand its OTC business in various ways,including the reclassification of some of its prescription drugsto OTC status. Mykon’s OTC sales represented 14 percent ofthe company’s sales during last year.

Mykon has a long tradition of excellence in research anddevelopment (R & D). The company’s expenditures on R & Dfor the last three financial years constituted 15 percent of itssales.

Mykon focuses its R & D on the following selected thera-peutic areas, listed in descending order of expenditure amount:anti-virals and other antibiotics, cardiovascular, central nerv-ous system, anti-cancer, anti-inflammatory, respiratory, andneuromuscular.

Mykon sells its products internationally in more than 120countries and has a significant presence in two of the largestpharmaceutical markets—the United States and Europe—and a growing presence in Japan. It generated approximately43 percent and 35 percent of the company’s sales from theprevious year in the United States and Europe, respectively.The company sells essentially the same range of productsthroughout the world.

ProductionMykon carries out most of its production in Rotterdam in theNetherlands and in Research Triangle Park, North Carolina,in the United States. The latter is the company’s world head-quarters. The company’s manufacturing processes typicallyconsist of three stages: the manufacture of active chemicals,the incorporation of these chemicals into products designedfor use by the consumer, and packaging. The firm has anongoing program of capital expenditure to provide up-to-dateproduction facilities and relies on advanced technology,automation, and computerization of its manufacturing capa-bility to help maintain its competitive position.

Production facilities are also located in ten other countriesto meet the needs of local markets and to overcome legalrestrictions on the importation of finished products. Thesefacilities principally engage in product formulation and pack-aging, although plants in certain countries manufactureactive chemicals. Last year, Mykon had more than 17,000employees, 27 percent of whom were in the United States.Approximately 21 percent of Mykon’s employees wereengaged in R & D, largely in the Netherlands and the UnitedStates. Although unions represent a number of the firm’semployees, the firm has not experienced any significant labordisputes in recent years, and it considers its employee rela-tions to be good.

Research and DevelopmentIn the pharmaceutical industry, R & D is both expensive andprolonged, entailing considerable uncertainty. The process ofproducing a commercial drug typically takes between eightand twelve years as it proceeds from discovery throughdevelopment to regulatory approval and finally to the prod-uct launch. No assurance exists that new compounds willsurvive the development process or obtain the requisite regu-latory approvals. In addition, research conducted by other


Figure 2Mykon R & DExpenditures

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pharmaceutical companies may lead at any time to the intro-duction of competing or improved treatments.

Last year Mykon incurred approximately 95 percent of itsR & D expenditures in the Netherlands and the United States.Figure 2 sets out the firm’s annual expenditure on R & Din dollars and as a percentage of sales for each of the lastthree financial years.

Jack SprattEvery society, every institution, every company, and mostimportant, every individual should follow those precepts thatsociety holds most dear. The pursuit of profits must be con-sistent with and subordinate to these ideals, the most impor-tant of which is the Golden Rule. To work for the bettermentof humanity is the reason I became a scientist in the firstplace. As a child, Banting and Best were my heroes. I couldthink of no vocation that held greater promise to helpmankind. Now that I am CEO I intend to have these beliefsincluded in our company’s mission statement.

These sentiments, expressed by Jack Spratt in a news-magazine interview, capture the intensity and drive that ani-mate the man. None who knew him was surprised when heset out years ago—fueled by his prodigious energy, guided byhis brilliant mind, and financed by Mykon—for the innerreaches of the Amazon Basin to find naturally occurringmedicines. Spratt considered it to be his manifest destiny todiscover the cure for some dread disease.

His search was not totally blind. Some years earlier, FransBerger, a well-known but eccentric scientist, had writtenextensively about the variety of plant life and fungi thatflourished in the jungles of the Bobonaza River region deep

in the Amazon watershed. Although he spent twenty yearsthere and discovered nothing of medical significance, the vastnumber and intriguing uniqueness of his specimens con-vinced Spratt that it was just a matter of time before a majorbreakthrough would occur.

Spratt also had some scientific evidence. While working inMykon’s laboratory to finance his graduate education inbiology and genetics, Spratt and his supervisors had noticedthat several fungi could not only restore damaged skin but,when combined with synthetic polymers, had significanteffects on internal cells. Several more years of scientific expe-ditions and investigations proved promising enough forMykon to send Spratt and a twenty-person exploration teamto the Amazon Basin for two years. Two years became five,and the enormous quantity of specimens sent back eventuallytook over an entire wing of the company’s sizable laborato-ries in Research Triangle Park, North Carolina.

Upon Spratt’s return, he headed up a group of Mykonscientists who examined the Amazonian fungi for pharma-cological activity. After several years of promising begin-nings and disappointing endings, they discovered that onefungus destroyed the recently identified virus HIV. Yearslater, the company managed to produce enough of the drug(code named Sprattalin) derived from the fungus to informthe Food and Drug Administration (FDA) that it was testingwhat appeared to be a cure for HIV. It was the happiestmoment of Jack Spratt’s life. The years of determined effort,not to mention the $800 million Mykon had invested,would now be more than fully rewarded.

Spratt’s joy was short lived, though. Public awareness of thedrug quickly spread, and groups pressured the FDA to shortenor eliminate its normal approval process, which ordinarily


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takes more than seven years. People dying from the virus’seffects demanded immediate access to the drug.

The DrugMirroring the insidiousness of HIV itself, the structure ofSprattalin is extraordinarily complex. Consequently, it takesfour to seven months to produce a small quantity, only 25percent of which is usable. It is expensive; each unit ofSprattalin costs Mykon $20,000 to produce. The projecteddosage ranges from ten units for asymptomatic HIV-positivepatients who have normal white blood cell counts to fiftyunits for patients with low white blood cell counts and full-blown AIDS. The drug appears to eliminate the virus from allpatients regardless of their stage of the disease. However, itdoes not have any restorative effect on patients’ compro-mised immune systems. Accordingly, it is expected thatasymptomatic HIV-positive patients will revert to their nor-mal life expectancies. It is not clear what the life expectancywill be of patients with full-blown AIDS, although it isalmost certain that their life expectancy would be curtailed.

Supply of Sprattalin The company has estimated thatthe first two years of production would yield enoughSprattalin to cure 20 percent of all asymptomatic HIV-posi-tive patients. Alternatively, the supply would be sufficient totreat 14 percent of all patients with full-blown AIDS.

Interested parties have argued that the solution to pro-duction problems is clear: build larger facilities. However,even with production levels as low as they are, the bottleneckin supply occurs elsewhere. The fungus on which the wholeprocess depends is incredibly rare, growing only in two smallregions near Jatun Molino, Ecuador, along the BobonazaRiver. At current harvesting rates, scientists predict that allknown deposits will be depleted in three years, and many ofthem insist that production should be scaled back to allowthe fungus to regenerate itself.

Presently there are no known methods of cultivating thefungus in the laboratory. Apparently, the delicate ecologythat allows it to exist in only one region of the earth issomehow distressed enough by either transport or lab con-ditions to render it unable to grow and produce the drug’sprecursor. Scientists are feverishly trying to discover thosefactors that will support successful culture. However, withlimited quantities of the starting material and most of thatpressured into production, the company has enjoyed nosuccess in this endeavor. Because of Sprattalin’s complexity,attempts to synthesize the drug have failed completely,mainly because, like aspirin, it is not known how the drugworks; thus, Sprattalin’s effectiveness remains shrouded inmystery.

Allocation of Sprattalin In response to the insufficientsupply, a number of powerful consumer groups have madepublic their suggestions regarding the allocation of Sprattalin.

One proposition advanced would use medical records to estab-lish a waiting list of possible recipients based on the length oftime they have been in treatment for the virus. The argumentis that those people who have waited the longest and are mostin danger of dying should be the first to find relief.

Other groups propose an opposite approach, arguing thatbecause supply is so drastically short, Mykon should makeSprattalin available only to asymptomatic HIV patients.They require the least concentrations of the drug to becomewell, thus extending the drug’s supply. They also have thegreatest likelihood of returning to full life expectancies.Under this proposal, people who have full-blown AIDSwould be ineligible for treatment. Such patients have previ-ously come to terms with their impending mortality, havefewer psychological adjustments to make, and represent, ona dosage basis, two to five healthier patients. In meting thedrug out in this manner, proponents argue, the drug canmore readily meet the highest public health objectives toeradicate the virus and prevent further transmission.

Others propose that only patients who contracted thevirus through no fault of their own should have priority. Thisapproach would first make Sprattalin available to childrenwho were born with the virus, hemophiliacs and others whogot the virus from blood transfusions, rape victims, andhealth-care workers.

One member of Sprattalin’s executive committee has sug-gested a free market approach: the drug should go to thehighest bidder.

Pricing of Sprattalin In addition to supply problems,Mykon has also come under considerable criticism for its pro-posed pricing structure. Because of extraordinarily high devel-opment and production costs, the company has tentativelypriced the drug at levels unattainable for most people afflictedwith HIV. Perhaps never before in the history of medicine hasthe ability to pay been so starkly presented as those who canpay, live, while those who cannot, die.

Even at these prices, though, demand far exceeds supply.Jack Spratt and the rest of the Mykon executives predict thatthe company could easily sell available supplies at twice theproposed price.

A growing number of Mykon executives disagree withthe passive stance the company has taken in pricing theproduct. In their view, a 20 percent markup represents ameager return for the prolonged risk and high levels ofspending that the company incurred to develop the drug.Moreover, it leaves little surplus for future investment.Furthermore, eight years is too long to amortize the R & Dexpenses because Sprattalin, though the first, is unlikely tobe the last anti-HIV drug, now that Mykon has blazed apath. Other, more heavily capitalized companies are racingto reverse engineer the drug, and the availability of com-peting drugs remains only a matter of time. Accordingly,the company cannot realistically count on an eight-yearwindow of opportunity.


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BackgroundPaul Oliver, Sr., immigrated to the United States in 1930 fromGreece. After working for several wineries, he started OliverWinery, Inc., which eventually found a market niche in non-varietal jug wines. Through mass-marketing techniques, thecompany established a substantial presence in this segment ofthe market. Ten years ago, Paul, Jr., joined the firm afterreceiving a degree in enology (the study of wine making). Heconvinced his father of the desirability of entering a differentsegment of the wine market: premium varietals. To do this,the company needed a large infusion of capital to purchaseappropriate vineyards. Reluctantly, Paul, Sr., agreed to takethe company public. The initial public offering succeeded and40 percent of the company’s stock went into outsiders’ hands.Also, for the first time, outsiders served on the board of direc-tors. Although Paul, Jr., wanted to use a new name for thepremium varietal to appeal to a more upscale market, hisfather insisted on using the name Oliver.

Board MeetingThe board of directors met, along with Janet Stabler, thedirector of marketing of Oliver Winery, Inc. In attendancewere:

Paul Oliver, Sr.,Chairman of the board and founder of the company

Paul Oliver, Jr., CEO,has an advanced degree in enology

Cyrus Abbott, CFO,has an MBA

Arlene Dale, comptrollerhas a CPA with a master’s degree in accounting

Raj Ray, COO,has a master’s degree in industrial engineering

LaTasha Lane, VP Legal,has a J.D. degree

Elisabeth Constable, union representative to the board, has a GED degree

Rev. John W. Calvin, outside director, has a Doctor of Divinity degree

Carlos Menendez, outside director,has an MFA degree

Oliver, Sr.: The next item on the agenda is a proposal todevelop a new line of wines. Janet Stabler will briefly presentthe proposal.

Stabler: Thank you. The proposal is to enter the fortifiedwine market. It’s the only type of wine in which unit sales areincreasing. We’ll make the wines cheaply and package themin pint bottles with screw-on caps. Our chief competitors areCanandaigua with Richard’s Wild Irish Rose, Gallo withThunderbird and Night Train Express, and Mogen Davidwith MD 20/20. We’ll market the wine with little or nomedia advertising by strategically sampling the product totargeted consumers. That’s it in a nutshell.

Oliver, Sr.: Any questions before we vote?Menendez: Who’ll buy this wine?Calvin: From what I know about the consumers of your

competitors, it appears to me that it’s bought by homelesswinos.

Stabler: Not entirely. For example, pensioners on a fixedincome would find the price of the wine appealing.Thunderbird has been recently introduced into England andhas become very popular with the yuppie crowd.

Calvin: Then why put it in pint bottles?

Oliver Winery, Inc.

Foreign markets further exacerbate the pricing perplexity.Other countries, with less privatized health care, havealready promised their citizens access to Sprattalin at anyprice. Some first world countries, for instance, are willing topay up to $2 million per patient. They do not, however, wishto subsidize the drug for the United States. At the same time,some voices in the United States insist that supplies should gofirst to U.S. citizens.

On the other hand, countries with the most severe concen-tration of the HIV infection cannot afford to pay evenMykon’s actual costs. Some regions in Africa and Asia haveexperienced rapid growth of the disease, reporting 50 percentto 80 percent of their population at some stage in the HIVcycle. Jack Spratt feels a very real moral obligation to help atleast some of these people, whether they can pay or not.

Making the DecisionIn the last few months, Jack Spratt had seen many aspectsof the most important project in his life become not onlypublic knowledge but also public domain. Because of theenormous social and political consequences of the discov-ery, it is unlikely that the government will allow Mykon tocontrol the destiny of either Sprattalin or ultimately thecompany.

Addressing the public’s concern over access to the drugwhile ensuring future prosperity of his company had becomelike walking a tightrope with strangers holding each end ofthe rope. He knew of no way to satisfy everyone. As JackSpratt sat at his desk, sleep remained an eon away.


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Stabler: For the convenience of consumers.Menendez: Why would pensioners want a small bottle?Calvin: Homeless people want it in pints so they can fit it

in their hip pockets. They obviously don’t have a wine cellarto lay away their favorite bottles of Mad Dog.

Stabler: The pint size also keeps the price as low as possible.Calvin: Translation: The homeless don’t have to panhandle

as long before they can make a purchase. Also, why wouldyou increase the alcoholic content to 18 percent and make itso sweet if it weren’t for the wino market?

Stabler: Many people like sweet dessert wines and 18 per-cent is not that much more than other types of wines thathave 12 percent alcohol.

Menendez: Is it legal?Lane: Sure. We sell to the retailers. It may be against the

law to sell to intoxicated persons, but that’s the retailers’business. We cannot control what they do.

Calvin: Isn’t this product intended for a perpetually intoxi-cated audience that many people consider to be ill? Wouldn’twe be taking advantage of their illness by selling highly sugaredalcohol that suppresses their appetite? I’ve spoken to drinkerswho claim to live on a gallon of this type of product a day.

Oliver, Jr.: What will this do to our image? We’re still try-ing to get our premium wines accepted.

Stabler: Of course we won’t use the Oliver name on thesewines. We will use another name.

Menendez: Is it OK to do that?Stabler: Why not? Canandaigua, Gallo, and Mogen David

all do the same thing. None of them put their corporate nameon this low-end product.

Abbott: We’re getting away from the crux of the matter.Profit margins would be at least 10 percent higher on this linethan our others. Moreover, unit sales might increase overtime. Our other lines are stagnant or decreasing. The publicshareholders are grousing.

Dale: Not to mention that our stock options have becomealmost worthless. I’m only a few years from retirement. Weneed to increase the profitability of the company.

Ray: Operationally, this proposal is a great fit. We can usethe grapes we reject from the premium line. It will also insu-late us from bad grape years because any grape will do forthis wine. We can fill a lot of our unused capacity.

Constable: And hire back some of the workers who werelaid off!

Stabler: It’s a marketing dream. Just give out some sam-ples to “bell cows.”

Menendez: What are bell cows?Stabler: Opinion leaders who will induce other consumers

to switch to our brand.Calvin: You mean wino gurus?Oliver, Sr.: Look, if we don’t do it, others will. In fact, they

already have.Abbott: And they’ll get richer and we’ll get poorer.Lane: Gallo pulled out of several of these skid row mar-

kets as did Canandaigua. Little good it did. The alcoholicsjust switched to malt liquor, vodka, or anything they couldget their hands on.

Dale: I think our concern is misplaced. These people arethe dregs of society. They contribute nothing.

Calvin: They’re human beings who need help. We’re prof-iting off their misfortune and misery.

Oliver, Sr.: We can take that up when we decide on whatcharities to support. Anyone opposed to the proposal?

Calvin: Is this a done deal? I believe we should con-tribute half of our profits from this product to supporthomeless shelters and other programs that benefit indigentand homeless people. If not, I must resign from this board.

Sources

Carrie Dolan, “Gallo Conducts Test to Placate Critics of Its CheapWine,” The Wall Street Journal, June 16, 1989, p. B3.

Alix M. Freedman, “Winos and Thunderbird Are a Subject Gallo Doesn’tLike to Discuss,” The Wall Street Journal, February 25, 1988, p. 1.

Frank J. Prial, “Experiments by a Wine Maker Fails to Thwart StreetDrunks,” New York Times, February 11, 1990, p. A29.

JLM, Inc.

BackgroundSitting in her office, Ellen Fulbright, director of humanresources for JLM, Inc., thought over the decisions con-fronting her. To help her decide, she mentally reviewed howthey had arisen.

After receiving her MBA and J.D. degrees from a highlyregarded university, she joined a prestigious New York lawfirm where she specialized in employment law. After sevenyears at the law firm, she was hired by one of the firm’s

clients as general counsel. When that company was acquiredby JLM, she joined its legal staff and within a few years hadbeen promoted to her current position.

Fulbright’s rapid advancement resulted from her havingmade a positive impression on Rasheed Raven, JLM’s CEO.Raven is a hard-driving, bottom-line-oriented pragmatist inhis early forties. Raven, a graduate of Howard University,had begun his business career on Wall Street, which heastounded by his aggressive but successful takeover strategies.After acquiring fifteen unrelated manufacturing companies,


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he decided to try his hand at the turnaround business. Heorganized JLM as an umbrella for his acquired companies.Soon he earned the reputation as the best in the business bytransforming JLM into the leader in the industry.

JLM is a highly successful turnaround company. Typically,JLM purchases companies that are in serious financial trou-ble and manages them until they become successful compa-nies. At that time, JLM either retains them in its ownportfolio of companies or sells them off to other enterprises.

Reference Letter PolicyAbout a year after Fulbright had become director of humanresources (HR), Raven called her into his office and showedher a newspaper article. It reported, in somewhat sensationalfashion, that several defamation suits had resulted in multi-million dollar judgments against companies that had writtennegative letters of references about former employees. Raventold her that he was concerned about this and that he wantedher to develop an HR policy covering letters of reference.

In researching the issue, she discovered several articles inwhich the authors decried the recent spate of companies thathad decided to stop writing letters of reference. According totheir data, they believed that these companies had overre-acted to the actual risk posed by defamation suits. Based onthese articles and her own inclination toward full disclosure,she proposed that the company continue to permit letters ofreference but that all letters with negative comments must bereviewed by her.

Raven did not receive her proposal favorably and sought asecond opinion from her old law firm. His analysis of thefirm’s advice was: “We get nothing but brownie points forwriting reference letters, but we face the possibility of incur-ring the cost of a legal defense or, worse yet, a court judgment.This is a ‘no-brainer.’ We have no upside and all downside.”Raven ordered that, henceforth, company employees wouldno longer write letters of reference but would simply verifydates of employment.

Although Fulbright was personally and professionallymiffed by his decision, she drew up the policy statement asdirected. Fulbright believed that because JLM frequently tookover companies that needed immediate downsizing, this policywould be unfair and extremely detrimental to longtimeemployees of newly purchased companies.

Takeover of Diversified Manufacturing,Inc.After a number of years of steady growth, DiversifiedManufacturing began experiencing huge financial losses andits immediate survival was in serious doubt. After carefulconsideration, Raven decided that Diversified was an idealtakeover target in that its core businesses were extremelystrong and presented great long-term economic viability.

Upon acquiring Diversified, JLM quickly decided that ithad to rid Diversified of some of its poorly performing com-panies and that it had to reduce the size of Diversified’s homeoffice staff by 25 percent. Raven relentlessly orchestrated thereduction in force, but at Fulbright’s urging he provided thedischarged executives with above average severance packages,including excellent outplacement services.

The ProblemThe reduction in force was disruptive and demoralizing in allthe usual ways. But for Fulbright there was a further compli-cation: the no reference letter policy. She was extremely trou-bled by its application to three discharged Diversifiedemployees and to one discharged JLM employee.

The Salacious Sales Manager Soon after taking overDiversified, Fulbright became all too aware of the story ofKen Byrd, Diversified’s then national sales manager. Ken isan affable man of fifty who had been an unusually effectivesales manager. Throughout his career, his sales figures hadalways doubled those of his peers. He achieved rapidadvancement despite a fatal flaw: he is an inveterate andindiscreet womanizer. He could not control his hands,which slapped backs so well, nor his tongue, which per-suaded so eloquently. He had two approaches to women.With a woman of equal or superior rank in the company, hewould politely, but inexorably, attempt to sweep her off herfeet. With these women, he would be extremely charmingand attentive, taking great care to avoid being offensive orharassing. In contrast, with a woman of subordinate rank,he would physically harass her. Less openly, but much toooften, he would come up behind a woman, reach aroundher, and grab her. He invariably found this amusing—hisvictims, however, did not.

Fulbright could not believe that such a manager hadstayed employed at Diversified so long, let alone been con-tinually promoted to positions of greater responsibility andpower. As Fulbright investigated the situation, she discoveredthat numerous sexual harassment complaints had been filedwith Diversified concerning Byrd’s behavior. To protect Byrd,Diversified dealt with these complaints by providing moneyand undeserved promotions to the complainants to smoothover their anger. Thus, Diversified successfully kept the com-plaints in-house and away from the courts and the EqualEmployment Opportunity Commission.

After JLM’s takeover of Diversified, Fulbright quickly dis-charged Byrd. Her satisfaction in getting rid of him was shortlived, however. His golden tongue and stellar sales recordhad landed him several job offers. Her dilemma was that shewas uncomfortable about loosing this deviant on an unsus-pecting new employer. But JLM’s policy forbade her fromwriting any letters or answering questions from prospectiveemployers.


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The Fruitless Juice Melissa Cuthbertson had been avice president in procurement for Diversified’s Birch-Wooddivision with direct responsibility over the ordering of sup-plies and raw materials. Birch-Wood manufactured a fullline of baby food products, including fruit juices that werelabeled “100% fruit juice.” To cut costs, Stanley Aker, thedivision’s president, had arranged for an unscrupulous sup-plier to provide high-fructose corn syrup labeled as juiceconcentrate. Because standard testing in the industry wasunable to detect the substitution, the company did not getcaught. Emboldened, Aker gradually increased the propor-tion of corn syrup until there were only trace amounts offruit juice left in the “juice.” A company employee discov-ered the practice and after the takeover brought the matterto Fulbright’s attention through JLM’s internal whistle-blowing channel, which Fulbright had established. Shereferred the matter to Raven, who called Aker andCuthbertson in and confronted them with the accusation.They admitted it all, explaining that nutritionally the cornsyrup was equivalent to the fruit juice. But at 60 percent ofthe cost of fruit juice, the corn syrup made a big differenceto the bottom line. Raven told them that such conduct wasnot permitted and that they must properly dispose of theadulterated juice.

That night Aker and Cuthbertson had the juice movedfrom Birch-Wood’s New York warehouse and shipped to itsPuerto Rico warehouse. Over the course of the next fewdays, the “juice” was sold in Latin America as “applejuice.” Aker reported to Raven that the juice had beenproperly disposed of and that Birch-Wood had sustainedonly a small loss during that quarter. When Raven discov-ered the truth, he immediately discharged Aker andCuthbertson, telling them “that if he had anything to dowith it, neither of them would ever work again.” Fulbrightwas to meet soon with Raven to discuss what should bedone about Aker and Cuthbertson.

The Compassionate CFO Jackson Cobb, JLM’s formerchief financial officer, is a brilliant analyst. Through hardwork he had earned an excellent education that honed hisinnate mathematical gifts. His natural curiosity led him to readwidely, and this enabled him to bring disparate facts and con-cepts to bear on his often novel analyses of financial matters.But he had no interest in implementing his insights, for hisonly enjoyment was the process of discovering connections.Fortune—or fate—had brought him together with Raven, whois twenty years younger than Cobb. Theirs was definitely acase of opposites attracting. Raven cared little about ideas; hecared primarily about money. Cobb cared little about money;he cared primarily about ideas. Raven took Cobb’s insightsand translated them into action with spectacular success. Theirrelationship brought new meaning to the concept of synergy.When Raven formed JLM, he brought Cobb on as chief finan-cial officer and installed him in an adjoining office.

Their relationship continued to flourish, as did JLM’s bot-tom line, until Cobb’s wife became terminally ill. During theeighteen months she languished, Cobb spent as much time ashe could taking care of her. After forty years of marriage, hewas unwilling to leave her welfare to the “kindness ofstrangers.” At his own expense, he installed a state-of-the-artcommunication center in his home. By virtue of computers,modems, video cameras, faxes, copiers, mobile telephones, andthe like, he had available to him the same data and informa-tion as he had at his office. He could be reached by telephoneat all times. But he was not in the office next to Raven; he wasnot present at Raven’s daily breakfast meetings; he was not onthe corporate jet en route to business meetings. After theirmany years of working together, Raven was enraged at the lossof immediate access to Cobb. He felt that Cobb had betrayedhim and demanded that Cobb resume his old working hours.Cobb refused, and Raven fired him. Because of his age, Cobbwas experiencing difficulty in finding new employment, andFulbright wanted to write a letter on his behalf.

Sword Technology, Inc.

BackgroundSitting in his office, Stephen Hag, CEO of Sword Technology,Inc., contemplated the problems that had been perplexing himfor some time now. They had begun when he took his com-pany international, and they kept coming. But today he was nomore successful in devising a solution than he had been previ-ously. Slowly, his thoughts drifted to those early days years agowhen he and his sister Marian started the company.

The company’s first product was an investment newsletterstressing technical analysis in securities investing. A few years

later, he developed what became a “killer app”: a computerprogram that defines an entirely new market and through cus-tomer loyalty substantially dominates that market. His soft-ware program enabled investors to track their investments instocks, bonds, and futures. By combining powerful analyticaltools with an accessible graphical interface, it appealed toboth professional and amateur investors. Moreover, itrequired users to download information from the company’sdatabase. With one of the most extensive databases and thecheapest downloading rates in the industry, the company sooncontrolled the U.S. market. Sword then went public through


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a highly successful IPO (an initial public offering of the com-pany’s common stock), and its stock is traded on the over-the-counter market. The company is required to file periodicreports with the Securities and Exchange Commission.

The company used cash from sales of software, on-linecharges, and the IPO to try to enter the hardware side of thecomputer industry. It began manufacturing modems andother computer peripherals. A nagging problem, however,plagued the company’s manufacturing efforts. AlthoughSword’s modem could convert data more quickly and effi-ciently than most of its competitors, because of high laborcosts it was unable to market its modem successfully. Toreduce manufacturing costs, especially labor costs, the com-pany decided to move its manufacturing facilities overseas.And that’s when the trouble began.

Stephen’s thoughts returned to the present. He reopenedthe folder labeled “Confidential: International Issues” andbegan perusing its contents.

Transfer PricingThe first item he saw was an opinion letter from the com-pany’s tax attorney. It dealt with Excalibur Technology, thefirst overseas company Sword established. Excalibur, awholly owned subsidiary of Sword, is incorporated inTolemac, an emerging country with a rapidly growing econ-omy. To encourage foreign investment, Tolemac taxes corpo-rate profits at a significantly lower rate than the UnitedStates and other industrialized nations. Excalibur manufac-tures modems for Sword pursuant to a licensing agreementunder which Excalibur pays Sword a royalty equal to a spec-ified percentage of the modems’ gross sales. Excalibur sellsall of its output at a fair market price to Sword, which thenmarkets the modems in the United States. Stephen had beenclosely involved in structuring this arrangement and hadinsisted on keeping the royalty rate low to minimize taxableincome for Sword. Stephen reread the opinion letter:

Section 482 of the Internal Revenue Code authorizes theInternal Revenue Service to allocate gross income, deduc-tions, credits, and other common allowances among two ormore organizations, trades, or businesses under commonownership or control whenever it determines that this actionis necessary “in order to prevent evasion of taxes or clearlyto reflect the income of any such organizations, trades, orbusinesses.” IRS Regulation 1.482-2(e) governing the sale ortrade of intangibles between related persons mandates anappropriate allocation to reflect the price that an unrelatedparty under the same circumstances would have paid, whichnormally includes profit to the seller. The Regulations pro-vide four methods for determining an arm’s length price. Inour opinion, under the only method applicable to the cir-cumstances of Sword Technology, Inc., and ExcaliburTechnology, the royalty rate should be at least three times thecurrent one. If the IRS were to reach the same conclusion,

then the company would be liable for the taxes it underpaidbecause of the understatement of income. Moreover, thecompany would be liable for a penalty of either 20 percent or40 percent of the tax deficiency, unless the company canshow that it had reasonable cause and acted in good faith.

Stephen had spoken to the tax attorney at length andlearned that the probability of an audit was about 10 percentand that many multinational companies play similar “games”with their transfer pricing. The attorney also told him that hebelieved that if the company were audited, there was at leasta 90 percent probability that the IRS would agree with hisconclusion and at least a 70 percent probability that it wouldimpose a penalty. Because the dollar amount of the contingenttax liability was not an insignificant amount, Stephen hadbeen concerned about it for the six weeks since he hadreceived the letter.

Customs and CustomsSoon after Excalibur had manufactured the first shipment ofmodems, a new problem arose: getting them out of Tolemac.It took far too long to clear customs, thus undermining theircarefully planned just-in-time manufacturing schedules.Stephen hired a local export broker, who distributed cashgifts to customs officials. Miraculously, the clearance timeshortened and manufacturing schedules were maintained.The export broker billed the company for his services andthe amount of the cash gifts. Although the broker assuredStephen that such gifts were entirely customary, Stephen wasnot entirely comfortable with the practice.

The Thorn in His SideTolemac was not Stephen’s only problem. Six months aftercommencing operations in Tolemac, Sword began seriousnegotiations to enter the Liarg market. Liarg is an undevel-oped country with a large population and a larger nationaldebt. Previously, Sword had encountered great difficulties inexporting products to Liarg. Stephen’s sister, Marian, COO ofSword, took on the challenge of establishing a Liarg presence.

They decided that setting up a manufacturing facility inLiarg would achieve two objectives: greater access to theLiarg marketplace and lower-cost modems. At first, the Liarggovernment insisted that Sword enter into a joint venture,with the government having a 51 percent interest. Sword wasunwilling to invest in such an arrangement, countering witha proposal for a wholly owned subsidiary. Marian conductedextensive negotiations with the government, assisted by aLiarg consulting firm that specialized in lobbying govern-mental officials. As part of these negotiations, Sword madecontributions to the reelection campaigns of key Liarg legis-lators who were opposed to wholly owned subsidiaries offoreign corporations. After the legislators’ reelection, thenegotiations quickly reached a successful conclusion. Onclosing the contract, Sword flew several Liarg officials and


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their wives to Lake Tahoe for a lavish, three-day celebration.All of these expenses were reported in the company’s finan-cial statements as payments for legal and consulting fees.

Marian then hired an international engineering firm tohelp design the manufacturing plant. Two weeks later, theysubmitted plans for the plant and its operations that fullycomplied with Liarg regulations regarding worker health andsafety as well as environmental protection. But, as Marianhad explained to Stephen, the plant’s design fell far short ofcomplying with U.S. requirements. Marian noted that, underthe proposed design, the workers would face exposure tomoderately high levels of toxic chemicals and hazardousmaterials. The design also would degrade the water supply ofnearby towns. However, the design would generate very sig-nificant savings in capital and operational costs as comparedwith the design used in their U.S. facility. Marian assuredStephen that all quality control systems were in place so themodems produced in this plant would be indistinguishablefrom their U.S. counterparts. Stephen and Marian have hadlong discussions about what to do about the plant.

Stephen then took from the folder an article that hadappeared in a number of U.S. newspapers.

Children and ChipsA twelve-year-old Liarg child recently spoke at an interna-tional conference in New York denouncing the exploitationof children in the Liarg computer chip industry. The childinformed the outraged audience that he had worked in sucha plant from age four to age ten. He asserted that he was justone of many children who were so employed. He describedthe deplorable working conditions: poor ventilation, longhours, inadequate food, and substandard housing. The paywas low. But, because their families could not afford to keepthem at home, the children were hired out to the factory own-ers, who especially wanted young children because theirsmall fingers made them adept at many assembly processes.

Stephen had read the article countless times, thinking abouthis own children. He knew that if they set up a plant in Liarg,they would have to buy chip components from Liarg suppliers.He also knew that there would be no way for Sword to ensurethat the chips had not been made with child labor.

He was also troubled by another labor issue. Marian toldhim that she had met considerable resistance from the Liargexecutives they had hired when she suggested that womenshould be hired at the supervisory level. They maintainedthat it was not done and would make it impossible to hireand control a satisfactory workforce at the plant. Moreover,they insisted on hiring their relatives as supervisors. WhenMarian protested this nepotism, they assured her that it wascustomary and asserted that they could not trust anyone notrelated to them.

On top of all these concerns had come a letter from thecompany’s outside legal counsel regarding payments made toforeign officials.

Memorandum of LawThe Foreign Corrupt Practices Act makes it unlawful forany domestic company or any of its officers, directors,employees, or agents or its stockholders acting on its behalfto offer or give anything of value directly or indirectly toany foreign official, political party, or political official forthe purpose of

1. influencing any act or decision of that person or party in his or its official capacity,

2. inducing an act or omission in violation of his or its lawful duty, or

3. inducing such person or party to use its influence to affect a decision of a foreign government in order to assist thedomestic concern in obtaining or retaining business.

An offer or promise to make a prohibited payment is aviolation even if the offer is not accepted or the promise is notperformed. The 1988 amendments explicitly excluded facili-tating or expediting payments made to expedite or secure theperformance of routine governmental actions by a foreignofficial, political party, or party official. Routine governmen-tal action does not include any decision by a foreign officialregarding the award of new business or the continuation ofold business. The amendments also added an affirmativedefense for payments that are lawful under the written lawsor regulations of the foreign official’s country. Violations arepunishable by fines of up to $2 million for companies; indi-viduals may be fined a maximum of $100,000 or imprisonedup to five years, or both. Fines imposed upon individuals maynot be paid directly or indirectly by the domestic company onwhose behalf they acted. In addition, the courts may imposecivil penalties of up to $10,000.

The statute also imposes internal control requirements onall reporting companies. Such companies must

1. make and keep books, records, and accounts, that in rea-sonable detail, accurately and fairly reflect the transac-tions and dispositions of the assets of the company; and

2. devise and maintain a system of internal controls thatensure that transactions are executed as authorized andrecorded in conformity with generally accepted account-ing principles, thereby establishing accountability withregard to assets and ensuring that access to those assets ispermitted only with management’s authorization.

Any person who knowingly circumvents or knowinglyfails to implement a system of internal accounting controls orknowingly falsifies any book, record, or account is subject tocriminal liability.

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business ethics - cengage

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