ISL452U-BUSINESS ETHICS
Chapter 2: The Role of Business in Society
Agency Theory
The primary concern of the agency theory is monitoring within organizations and their external relationships with stakeholders. The leading problem agency theory focuses on is the relationship or the contract between the principal and the agent. Divergence from the mutual goals and the risk preferences are two potential pitfalls that emanate agency problems. These two pitfalls are also compounded by information asymmetry favoring the agent. Finding the most effective form of governing the organization is the theory’s ultimate goal.
To grasp the logic behind agency theory, it is necessary to start with the definition of authority. Authority is defined as “the power to hold people accountable for their actions and to make decisions concerning the use of organizational resources.” Authority is concentrated at the top of the organization. Coherent with the definition of hierarchy, the stakeholders positioned at the top of the organization have more authority than those located at the lower levels. Within the organization, organizational members are working under the chain of command.
Original foundations of the agency theory are based on the idea that the agent will not act according to the principals’ best interest. Owners or shareholders are the primary principals. Managers who use the authority on behalf of the owners are called agents. Principals delegate their authority to the agent and expect the agent will act accordingly. The agency problem arises when the principal determines managers’ accountability while delegating authority. Agency problems will develop when the principal’s interests are not coherent with the manager’s interest, and the manager begins to pursue self- interest instead of the owners’ best interests.
Principal-agent problem is enlargement of the distance between the operation and the principal’s position as the organization grows, therefore putting them in an even more disadvantaged situation.
There is an inherent conflict of interest between the agent and the principal. Once the organization’s ownership and management are separated, conflict of interest may arise, resulting in opportunistic behaviors. Knowing that people can be greedy beings, opportunistic behavior may end in pursuing his/ her self-interest rather than the organizations or the owners’. Opportunistic behaviors may be surfaced both in the action and attitudes of the managers. It is hard for the owners to foresee who will act opportunistically and when? The managers’ reputation can be seen as an indicator, but history is full of corrupt managers known as honest people before taking the leadership position. Control mechanisms, labeled under corporate governance, should be set to control opportunistic behaviors. These mechanisms will not allow managers to make decisions alone, making consultation a priori. All in all, we should acknowledge that when decision-making power is delegated, then the conflict of interest is inevitable.
Although the agency relationship can occur in any organization, the corporation is among the most dominant business entities today. Specific characteristics of the corporation make agency-principal interaction, an interesting and complicated one. Corporations are artificial persons in the eyes of the law and corporations owned by the shareholders but exist independently. Moreover, managers have fiduciary responsibility for protecting the shareholders’ interest within the corporations. Therefore, understanding the top-management hierarchy within the context of the corporation is crucial for fully grasping the agency theory in action.
The stakeholder group having the ultimate authority in any organization is shareholders. Shareholders literally own the organization and exercise control over it through their representatives, the board of directors. The Board of directors is the administrative body responsible for selecting and appointing the managers who use the delegated authority and responsibility to use the organization’s resources to create value and meet organizational goals. Having authority and responsibility, managers become accountable for their actions, using organizational resources and the amount of value created during their incumbency. According to Robbins et al. (2017: 40), talented managers do matter. Based on the Gallup research report, the most critical variable in employee productivity and loyalty is the quality of the relationship between the employees and their direct supervisors.
Among the C-level managers, the chief executive officer, the CEO, is the one that you most probably heard about more than any other executive roles. CEOs in the US’ largest firms made 271 times the typical worker’s annual average pay. Although the CEO reports to the board’s chair, he/she is the most powerful manager in an organization. There are many responsibilities conducted by the CEO affecting the organization’s efficiency and effectiveness, such as setting organizational goals and designing its structure, forming the top management team by appointing other managers, designing rewards and incentives for other top managers, and being the face of the organization they are leading. Having a highly reputable CEO will create a competitive advantage to attract resources with better terms and conditions. On the other hand, if the CEO is known to be dishonest, then most probably, the organization will face difficulties attracting resources from external sources.
Why does the principal appoint someone to do something on behalf of them? The principal thinks that a person, the agent, has to be an expert in his/her field. Moreover, there is always a time lag between the agent’s decisions and their final implications, making it more uncertain for the principal to control the agent’s actions. For instance, you may be familiar with professional football clubs, once demonstrating superior performance, then they went bankrupt. Most probably during the club’s heydays, managers spent too much on expenses without considering
the long-term impact. Fans are happy in the short run, but the club’s reputation will inevitably be depreciated in the long-run. For the reasons stated above, when a principal delegates his/her authority, they lose most of their ability to influence managerial decision making. Information asymmetry, the imbalanced level of knowledge that favors one part of the relationship, occurs. Shareholders do not know, and it is difficult for them to judge what is happening, and when they do know, it is generally too late.
Having the agency problem’s general conditions in mind, when the conditions given below exist, the moral hazard problem arises:
1. The principal finds it very difficult to evaluate how well the agent has performed because of the information asymmetry. 2. The agent has an incentive to pursue goals and objectives different from the principal’s goals and objectives.
Stakeholder Theory
Stakeholder theory is a more up-to-date version of the traditional management model. In traditional management, interaction only occurs between the corporation and the shareholders. Other relations are one-way in which corporations are affecting customers, employees, and suppliers. Stakeholder theory offers an alternative model to the shareholder centered principal-agent relations. Instead of prioritizing the owners, stakeholder theory puts the organization into a more balanced position among many stakeholders. Owners/shareholders are only one among the many. Employees, suppliers, and the public are all among the stakeholder groups affected by the organization’s actions. According to stakeholder theory, any party that affects the organization’s continuance and performance are called as stakeholders. Stakeholder theory views the organization as an entity having ongoing interactive relations with all stakeholders. This ongoing interaction is detrimental to an organization’s performance.
Criticisms for the stakeholder theory are not rare. A broader view of responsibility towards multiple stakeholders assigns newer roles to management. Therefore, the stakeholder theory puts too much emphasis on the role of the managers. Creating shareholder value is quite a clear purpose, but satisfying various stakeholders’ expectations almost simultaneously can be a challenging task. It is recommended for managers to take most of the stakeholders’ interests into consideration and aim for long-term accomplishments, which increase the long-term value of the organizations rather the short-term. Stakeholder democracy is the term offered by Crane and Matten (2016: 65) that allows stakeholders to influence and control decisions that can be seen as a starting point to overcome current criticism. Even Edwards et al. (2010: 28) do not embrace the idea of prioritization; authors argue that “a stakeholder approach to business is about creating as much value as possible for stakeholders, without resorting to trade-offs.
Corporate Social Responsibility
Understanding and clarifying the role of businesses in society is a significant struggle both for academics and practitioners.
The discussion on corporate social responsibility revolves around “why?” and “how?” questions. A considerable number of studies were conducted to determine the relationship between corporate social responsibility and its financial success. Many of them found a low level of a positive correlation between these two variables, but the moderating/ mediating effects of the organization’s size, sectoral characteristics, economic conditions, and legal regulations remained unknown. More important than the correlation, causation between the two variables seems to be an ongoing debate. Therefore, we cannot argue that corporate social responsibility is the main reason for any organization’s financial performance. One can also argue that since the business is thriving, it can carry a corporate social responsibility agenda. Otherwise, these efforts can be considered a luxury attempt for businesses that lack excess financial resources. Whether organizations should conduct corporate social responsibility activities, thus become socially responsible, or organizations should stick to increasing shareholder value is the foundation of the debate about the opposing views. On the one side, there are societal benefits created through carrying a social responsibility agenda, and on the other, the cost of the agenda sets the stage of the conflict. These two views are now labeled as the classical view and the modern view of corporate social responsibility. The classical view is structured based on the ideas of Milton Friedman, and the figurehead of the latter view is Archie B. Carroll. Although these two scholars’ views do not overlap in many perspectives, the only argument they share is the effect of corporate social responsibility on the organizations’ overall profitability level.
Greenwashing is a concept that means espousing the rhetoric of corporate social responsibility while minimizing its practice. Greenwashing can be viewed as intentionally seeking to convey the image of a socially responsible organization when the evidence of their practices does not support this conclusion (Carroll et al., 2018: 49). It can be called fake corporate social responsibility. In this sense, corporate social responsibility is used as a window-dressing tool having no fundamental contribution to society.
Here we should acknowledge four possible approaches that stand for different levels of social responsibility. The obstructionist stance is the lightest green version. As the name suggests in this stance business does as little as possible and may involve attempts to deny or cover-up. For example, a business pays less than the minimum wage to the employees but may avoid this wrongdoing on official papers. A little bit greener version is called a defensive stance, in this approach, there is no violation of rules, but the business only meets the legal requirements,
nothing more. Tax avoidance is a perfect example of this approach. On the greener side lies an accommodative stance. In this approach, businesses never violate legal regulations, and if specifically asked to do so, exceed the legal minimum by taking part in other social responsibility activities. For example, if businesses are asked to build a school in the underdeveloped region of a country, they accept and provide all or partial resources for that purpose. Finally, the greenest of all are proactive stands, which means, as can be guessed from its name, businesses actively try to search for opportunities to contribute to society’s well-being. For instance, a business foundation formed to increase the literacy of girls in society will proactively and continuously look for opportunities for fulfilling its founding mission.
Being socially responsible creates additional costs, and most of the resources are scarce. A sound roadmap should be created for any organization based on the applicability and resources that can be spared for social responsibility activities. It is advised that managers follow principles given below while crafting their social responsibility strategy (Certo and Certo, 2014: 81):
1. Businesses should comply with all rules and regulations. 2. Businesses should search for the feasibility of voluntary social responsibility activities that are not required by the law. 3. Businesses should prioritize some of the social responsibility areas they will focus on and announce it publicly
Triple bottom line (TBL) requires businesses to be socially, ecologically, and economically responsible in a balanced manner. Being part of society, businesses should be indebted to the wealth and financial resources accumulated through their operations. For the sake of balancing their commitment and fair return, it is expected from them to be socially responsible. In addition to improving society’s well-being, businesses are also in a suitable position where they can reach the masses via advertisements, public relations activities, social media campaigns, etc. to trigger further developmental goals and create awareness. According to corporate social responsibility advocates, any business operation’s primary responsibilities can be summarized in three broad categories. As the name implies, TBL requires businesses to be socially, ecologically, and economically responsible in a balanced manner. With the rise of environmental awareness and various forms of green movements, it is expected that TBL will be an immutable part of business strategy configurations.
Corporate Citizenship
To make sense of corporate citizenship, one should go back to Milton Friedman’s classical view. Friedman argues for a strict division of labor among the businesses and government. Businesses should pursue economic
goals, whereas the government should be responsible for social goals. However, recent developments challenged this configuration fundamentally. Today we see governments retreating from catering to social needs. Public utilities, electricity, transportation, health care, public safety, and telecommunication were traditionally catered by governments most of the 20th century. However, with the rising of privatization, governments are no longer acting in these realms. Private organizations now cater to these public services. In less-developed contexts, governments cannot address the social needs; thus, businesses play the role of government where they invest and conduct their operations to fulfill public expectations.
Sustainability
Today we face various impacts caused by the business on society. For example, environmental pollution and its effects on climate change, excess waste and waste disposal, downsizing and outsourcing related job losses, and local cultures’ erosion. These impacts are far-reaching and profound, thus making the context a risk society. In a risk society, life-threatening disasters cannot be controlled within a specific territory. According to Elkington (1999: 37) “sustainability is a 2 + 2 = 5 (even 50) game,” thus needs further scrutiny.
Sustainability should be seen as “system-wide maintenance, ensuring our actions do not impact upon the system in such a way that its long-term viability is threatened.” It is self-evident that the long-term continuation of corporate social responsibility activities requires long-term organizational success. The term sustainability comes into the scene at this point. Sustainability is a philosophy that we cannot avoid. In the world of business, using natural resources while protecting the environment, recycling, protecting endangered species should all be taken into consideration by today’s businesses. Climate change and all the potential drawbacks started to take more part in popular media, political agenda, and hence increased the public awareness towards these issues. Businesses cannot deny their role in creating the problems making the word unsustainable and held accountable for the future. Sustainability has become one of the primary variables for managers while making strategic decisions. It is believed that sustainable solutions will provide a competitive advantage, thus creating economic value. Sustainability is defined as “the long- term maintenance of systems according to environmental, economic, and social considerations.” Sustainable development derived from sustainability is “a pattern of resource use that aims to meet human needs while preserving the environment so that these needs can be met not only in the present but also for future generations.” Although environmental sustainability is initially considered, the concept encompasses economic as well as social sustainability. Like the discussion we have seen on corporate social responsibility’s economic effects, sustainability suffers from the same debate. Sustainable
management means organizations try to make their ongoing business activities more sustainable. Sustainable markets include a vast number of opportunities. While taking technological and market limitations into account, organizations’ sustainable management will open up new horizons for the businesses. Ever since the Rio Earth Summit of 1992, the concept of sustainability has become an essential framework for assessing social and economic activities, including business operations (Crane and Matten, 2016: 31). Traditionally sustainability can be regarded as the continuation of business operations. However, today, sustainability, correctly speaking sustainable development, is about meeting today’s needs without compromising the ability of future generations to meet their own needs. The term sustainable development was coined in the paper Our Common Future, released by the Brundtland Commission chaired by Gro Harlem Brundtland in 1987. In this sense, the world is not inherited from our ancestors for free, but it is a treasure that we need to keep it as it is for the upcoming generations. In this way, sustainable development will secure intergenerational equity. From a managerial perspective, managers should consider sustainability while making strategic decisions. Sustainable businesses try to avoid excess in every sense. Resources, conversion processes, products, and after-life of the products are designed to be sustainable.
Businesses should continuously innovate, and serendipitously, they may come across better alternative solutions. A roadmap for becoming a sustainable business is as follows:
1. Determining focused sustainability goals, 2. Employing people who are wholeheartedly committed to sustainable development, 3. Employees who contributed to the sustainable development goals of the organization should be rewarded and 4. The results should be closely monitored and shared with the stakeholders.
Keeping the triple bottom line in mind, businesses should configure their sustainability strategies balancing environmental, economic, and social expectations— environmental sustainability concerns mainly with effective use of physical resources to be conserved for future generations. Approaching the issue from this perspective will make us scrutinize the logic behind growth. The economic perspective emphasized the world’s carrying capacity if the growth rate continues as it is today. It is expected that continued growth will eventually decline, leading to decreasing living standards in the future. On the other hand, the less debated part of sustainability’s triple bottom line is social purposes. The critical issue here is creating, maintaining, and protecting social justice. A quick look at the United Nations Sustainable Development Goals will provide a guideline
for sustainable management of the upcoming decades for the novice manager.
Being sustainable in all of the areas covered by the triple bottom line can be regarded as too much, and there are only a few businesses that can claim to be fully sustainable in all of them. Businesses should acknowledge that transformation toward a sustainable business does not happen in a day. It is an ongoing evolutionary transformation. Short-term success or loss is not a correct determinant. Long-term outlook and societal expectations should be seen as a better compass. Corporate Knights, a media, research, and financial information products company based in Toronto, Canada, ranks corporations based on their sustainability performance. Corporate Knight considers all corporations having a market capitalization of more than 2 Billion US Dollars and ranks them according to 12 key performance indicators. These key performance indicators are: Energy productivity, carbon productivity, water productivity, waste productivity, innovation capacity, percentage tax paid, CEO to average worker pay, pension fund status, safety performance, employee turnover, leadership diversity, clean capitalism pay link.