Chapter 1: Law, Ethics, and Business: An Introduction I.

Introduction: In this course will be examining the legal environment and ethical challenges of management and organizations. We will also analyze approaches to enhance corporate accountability, foster an ethical work environment, ensure legal compliance, and provide effective leadership in an organization. II. Overview. A. Law. 1. Standards for Behavior: While the concept of law is by no means static, it does have aspects where it appears to be cut and dry. Law sets standards for behavior and brings with it punishment when that law is broken. 2. Creation, Enforcement, & Interpretation: The creation, enforcement, and interpretation of law are all in a constant state of change, much of which is influenced by power relations that surround it. 3. Our Requirements: Within the legal system, we are well aware of our requirement to meet the standards of law or risk facing a penalty. B. Ethics. 1. What We Should Do: On the other side of the coin, ethics presents a clearly different set of circumstances. While law tells us what we MUST do, ethics tells us what we SHOULD do. 2. Ethical Preferences: Ethical preferences are not given to use by magistrates, officers of the law, or politicians. They involve what is known as critical consciousness, which forces us to reason and use emotion in any particular situation. 3. May Not Conform to Our Groups: The ethical way to behave may not necessarily conform to the standards of our community or religious affiliation. a. When Law Does Not Cover: This idea is especially pertinent in cases where the law does not extend far enough for there to be a clear cut boundary on a particular issue. C. Business Environment. 1. Diverse Cultures: To complicate matters more, the question of what should be done in a certain situation can be altered by diverse cultural standards. Add to that the fact that the business environment is made up almost fifty-percent multinational companies and the issue becomes even more complex. 2. Finding Areas of Agreement: When dealing with these diverse cultures, it is important to find areas of agreement not only in ethical terms, but legal terms as well. 3. Concentrating on Values & Finding a Balance: We will concentrate on values, including the tension between values, that will serve as a theme throughout the course. The dilemma is to find the right balance between maximizing the individual freedom of choice and our duty as human beings to care for one another and thrive together.

II. Freedom vs. Responsibility. A. Introductory Question: If you were walking down the street and saw an infant lying face down in a puddle of water, flailing its little arms and clearly about to drown, would you have to rescue her? B. Duty to Rescue: As a general rule, within the U.S. legal system, we do not have a legal responsibility to rescue those who find themselves in danger. There are both philosophical and practical reasons against imposing what is called the duty to rescue. 1. Yania v. Bigan (PA 1959). Questions 1. What happened? Why did Yania jump? Yania was on his friend Bigans property, was asked to help with the pump. It then appears as though Bigan dared Yania to jump across the trench, and Yania must have decided to try, even though he couldnt swim. Explain the pre-trial dismissal that leaves us with only the widows version of the facts. Discuss the fact that the judge considered only the widows version of the facts because the judge was considering whether to dismiss the case without a trial. The judge determined that even if everything the widow alleged in the complaint were true, there was no basis upon which she could win and that the case should, therefore, be dismissed without a trial. 2. Identify arguments made by Yania's widow and how judge responded. That Bigan effectively forced Yania to jump by teasing and taunting him. The judge explains that although a child or a mentally deficient person might have had their will overcome in this way, "an adult in full possession of his mental faculties" could not have been induced to jump. That Bigan as a landowner had an obligation to warn Yania of any dangerous conditions on his property. The facts established, however, that Yania was also a coal strip-mine operator, and would have been aware of any dangers in the water-filled trench. Additionally, an employee who is injured on the job generally receives workers compensation payments even if the employees own negligence caused the injury. Accordingly, if Yania had been an employee of Bigan, compensation would have been available. 3. Under what circumstances might Bigan have been liable? If Yania had been a child or mentally deficient, or if Bigan had failed to warn him of a danger of which Yania was unaware. 2. Philosophical Reasons Against: From a philosophical perspective, requiring that people help one another in emergencies would infringe upon individual freedom of choice. In addition, imposing such as standard would mean that attempting to rescue someone is ALWAYS the right thing to do. 3. Practical: From the practical side of things, one must look at how the rule would be enforced, where lines would be drawn, the ramifications of a rescuer being hurt, and how do you determine the rescuer from a group of people.

4. The American tradition of emphasizing individual freedom is a major reason why our legal system demands no duty to rescue. C. Support for Duty to Rescue: The duty to rescue concept does find support, however, from several avenues. 1. Communitarians: Communitarians are concerned with reviving the notion of shared responsibility and interconnectedness. Communitarian theory sees the argument for the duty to rescue as a means of protecting individual rights and as a positive human good. 2. Natural Rights: Natural rights theorists believe that individuals enter into society to preserve their lives, liberties, and properties. Under what is known as a social contract, citizens obtain a right to protection by the community against violence. 3. Advocates of a duty to rescue typically concede that it must be restricted to cases in which one can act with little or no inconvenience to oneself. Example Massachusetts passed the following in 1983, in response to a notorious incident in which a woman went into a bar to buy cigarettes and was gang-raped on the pool table while customers watched and, in some cases, cheered. No one, including the bartender, called the police or did anything to intervene: Whoever knows that another person is the victim of aggravated assault, rape, murder, manslaughter or armed robbery and is at the scene of said crime shall, to the extent that said person can do so without danger or peril to himself or others, report said crime to an appropriate law enforcement official as soon as reasonably practicable. Any person who violates this section shall be punished by a fine of not less than five hundred nor more than two thousand and five hundred dollars. C.268 Ann. Laws of Mass. Sec 40. III. Ethical Decision Making. A. Introduction: We have been looking at the way U.S. law addresses the question of balancing two important values, that of freedomthe freedom of individuals to choose not to help in an emergencyand that of responsibilitythe responsibility we might have to respond to one another in certain circumstances. We now alter the scenario: Suppose a business strategy, although legal, happens to have harmful effects on certain people. Again, there is an interplay between freedom and responsibility, but here the focus will be more on ethics than on law. Ethical analysis can be a very complex concept, fortunately, we do have tools at our disposal to deal with such murky issues. B. Free Market Ethics. 1. Introduction: A basic assumption of classic microeconomic theory is that the overriding goal of any business is to be profitable. As trustees (fiduciaries) of the shareholders, managers have a primary responsibility to try to improve the value of shareholder investment. In fact, under the law of corporations, managers are answerable to the owners of a companyits stockholdersif they fail to take reasonable care in running it. 2. Milton Friedman: In a free society, there is one and only one social responsibility of

businessto use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud. a. Friedman argues it is wrong for managers to use corporate resources to deal with problems in society at large. Decisions regarding what might be best for society should be made in the political arena, and implementation of policies agreed upon there should be funded by tax dollars. For managers to make those kinds of decisions themselves, and to use corporate monies to pay for them, is the equivalent of theft theft of stockholders resources. B. Utilitarianism. 1. Overview: According to the principle of utilitarianism, a concept brought forth by Jeremy Bentham and pushed further by John Stuart Mill, the right way to behave in a given situation is to choose the alternative that is likely to produce the greatest overall good. 2. Compare Harms and Benefits: Utilitarianism asks us to compare the harms and benefits of all persons who will be affected by the decision. 3. Complexity Issues: The problems with this concept is that it becomes complex when you arent dealing with numbers that can be easily tallied. The question becomes: How can you assess harm when it is emotional? Example The federal government requires that new drugs be tested on humans after they have been tested on animals. Drug companies must advertise widely and offer to pay as much as $250 a day to attract test subjects. But one company, Eli Lilly, does not have to advertise and pays only $85 per day, because most of its subjects are homeless alcoholics recruited through word-of-mouth from soup kitchens, shelters, and prisons across the country. What happens when we run this arrangement through the utilitarian analysis? Where is the harm? New drugs are brought to market, benefiting the publicLilly developed Prozac, for example. Cost savings may not be passed on to consumers, but they enhance corporate profits, benefiting the employees and stockholders. Alcoholism in volunteers does not skew the companys data, since those with severe liver disease will fail the initial screening process and be excluded in the first place. Even the test subjects are comfortable: Those who have participated in Lillys program describe themselves as happy with the easy money they can earnas much as $4,500 when the testing continues over months. Is this an ethical outcome? Arguably it is, on utilitarian grounds. We might wonder if the homeless alcoholics are capable of making decisions that are truly voluntary. We may wonder if it is fair to use a small number of relatively desperate people in this way, even if the results benefit many more people. C. Deontology. 1. Overview: A contrast to the utilitarian approach is known as deontology. At the heart of this approach is the idea that making ethical choices is an understanding that moral action should be guided by certain overriding rights and duties. 2. Immanuel Kant: Immanuel Kant, the most famous proponent of this way of thinking,

believed that human beings could reason their way to a set of absolute rules for right behavior. He believed that moral behavior is a matter of holding to certain principles, never lying for instance, without exception. Example Suppose someone running away from a murderer tells you where he is going to hide, and then the murderer rushes up to ask you where the first person went. Wouldnt this be a good time to lie? Kant would say there is never a good time 3. Categorical Imperatives: Kant believed in a concept known as categorical imperatives. One of these imperatives states that people should be willing to live in a world where the action they take would be repeated for the same reasons when the same situation arose, even if they were on the receiving end of that situation. Another imperative states that we should have respect for the intrinsic value of other people and not just use them as a means to achieve our own purposes. 4. Conflicting Universal Rights: The problem that arises with deontology is the confusion that is created when different universal rights and duties crop up in the same ethical problem, and seem to conflict with one another. Example Consider the intensity of conflicting beliefs on the question of abortion. Both the right-tolife and the pro-choice factions are convinced that their points of view derive from natural rights; both embrace referents that each of them consider beyond debate, beyond compromise. How do we resolve competing claims of this type? The war on terror presents us with other examples of clashing rights and duties, such as lengthy detentions under the USA PATRIOT Act of suspects not charged with any crime, proposals to allow the Pentagon to randomly monitor personal e-mail, and problems with prisoner abuse in Afghanistan and Iraq. Conflicting views here pit the right to life and safety against the right to privacy, the duty to be fair, and the categorical imperative to respect othersincluding those of Middle Eastern origin or beliefsas equals. D. Virtue Ethics. 1. Overview: Virtue ethics directs our attention to what human beings are capable of being, and how they can cultivate habits of good character that will naturally lead them to their fullest potential. 2. Aristotle: Aristotle argued that people developed their virtues through training. For instance, we learn to be courageous, generous, just, honest, and cooperative. 3. Defining Moral Character: The question that arises within this concept is: what does it mean to define moral character in terms of ones community? Example As the new millennium unfolds, too many Americans are living in family environments in which relatedness endures in spite of severe economic and psychological stresses. Half the population of the world lives in poverty. If children grow up in hardship, where the natural environment is harshly degraded and the social fabric is weakened, does the transmittal of

virtuous habit become a luxury? If families cannot effectively teach virtue to their young, what are the alternatives? Schools? Religious communities? And when these are in such diverse formssometimes in sharp oppositionhow do we judge which moral community is best? E. Ethic of Care. 1. Overview: A different approach to ethics assumes that people are deeply connected to each other in webs of relationships, and that ethical decisions cannot be made outside the context of those relationships. This has become known as the ethic of care, and it was developed by feminist theorists the likes of Carol Gilligan. 2. Non-Violence: According to Gilligan, an ethic of care rests on the premise of nonviolence, that no one should be hurt. One of the hallmarks of the ethic of care is a willingness to be concerned with particulars of a situation, and from there an interest in discovering compromisecreative ways to find a solution that might work for all the stakeholders. F. Why Be Familiar with These Theories: Being familiar with the theories we have just discussed will lend support in two distinct ways. 1. Spark Creative Thinking: First, the models for analysis can spark creative thinking, as we brainstorm ways of handling dilemmas. 2. Provide Explanations for Thinking: Second, they provide us with a way of explaining our reasoning to others. Questions Assume you are the chief executive officer of a large drug company. You are deciding what price to charge for a new drug that promises to be effective against lung cancer. Assume that insurers would be willing to pay a large price for the drug and that some uninsured members of society could afford to purchase the drug. Some uninsured people, however, would simply be unable to purchase it. Discuss a criteria to determine the price for the drug. Discuss whether it should be offered at a lower price to some members of society. One theory is that of free market ethics. Milton Friedman is a well-known free market economist and supporter of that view. Under the free market view, the primary responsibility of a corporation is to improve the value of the investment of shareholders while obeying the law. Decisions regarding society should be made in the political arena and funded by tax dollars. Friedman strongly voiced that view in 1970 when he stated, . . . In a free society, there is one and only one social responsibility of business --- to use its resources and engage in activities designed to increase its profits so long as it stays with the rules of the game, which is to say, engages in open and free competition without deception or fraud. Under the theory of utilitarianism, the consequences of an act to all those affected by it are considered. A proponent of that theory would try to determine the alternative likely to produce the greatest overall good to all those who would be affected by the decision. In this hypothetical that would include stockholders of the company, individuals who need the drug, employees of the company, and insurers. Another theory to consider is that of deontology which is marked by steadfastness to universal principles. Principles are arrived at by means of categorical imperatives one of which states that individuals should be willing to have the reasons for their actions become universal principles. Under the theory of deontology, other people should not be used merely as a means to achieve a purpose

with no mutual benefit attached. The virtue ethics theory focuses on what human beings are capable of being and on how they can cultivate habits of good character that will naturally lead them to their fullest potential. Virtue ethics focuses on moral characteristics engrained within a community. What would the corporate culture or community be for the drug company? The ethic of care assumes that individuals are connected in webs of relationships and that ethical decisions cannot be made outside of that context. The ethic of care is based on caring for others. IV. Corporate Governance. A. Shareholders: Shareholders, as a collective group, are the owners of a corporation. B. Board of Directors: The board of directors is elected by shareholders is held a duty of loyalty. They cannot interfere with corporate opportunities, compete with the corporation, or take secret profits. They are also bound by a duty of care, which is a requirement to act in good faith and as reasonably prudent persons in their role as directors. These two duties are collectively known as fiduciary duties. C. Derivative Lawsuit: A shareholders derivative lawsuit can be initiated by individual shareholders on behalf of the corporation as a whole against persons that have harmed the company. D. Business Judgment Rule: Generally, board members are protected from individual liability by the business judgment rule, which provides a presumption that in making a business decision the directors of a corporation acted on a informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company. E. McSparran v. Larson (USDC IL 2006). Questions 1. What are shareholder derivative suits? A derivative action is brought by individual shareholders on behalf of a corporation. Plaintiffs filed a Verified Shareholders' Consolidated Derivative Complaint (Complaint) on behalf of Career Education Corporation (CEC), suing every member of CEC's Board of Directors and certain key officers. CEC is a provider of private, for-profit post secondary education, with 51 campuses located throughout the United States, Canada, France, the United Kingdom, and the United Arab Emirates. Plaintiffs claim that defendants violated their fiduciary duty and other laws resulting in damages to CEC of several million dollars in legal and other fees and a significantly diminished business reputation. The gravamen of plaintiffs Complaint is that defendants artificially inflated CEC's stock price so that they could sell their holdings of CEC's stock at a higher price than the true value of the company would warrant. The plaintiffs allege defendants engaged in various instances of improper conduct to implement this scheme. Alternatively, the plaintiffs allege that, if defendants lacked knowledge of the alleged fraud at CEC, they were woefully inadequate in fulfilling their oversight duties. 2. What is the business judgment rule? The business judgment rule provides a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that

the action taken was in the best interests of the company. Absent an abuse of discretion, that judgment will be respected by the courts. Plaintiffs relied on the board's alleged failure to act in the face of allegations of wrongdoing by CEC employees The Amended Complaint pleads that the defendants improperly overvalued the company in order to raise the stock price and then sold their stock for a large profit. Defendants were allegedly either active participants in a scheme to report false accounting of revenues and enrollment figures so that they could sell their holdings of CEC stock at inflated prices, or they failed to act in the face of evidence that should have prompted remedial measures. Nevertheless, individual liability for directors can result from two possible contexts: (i) such liability can follow from a board decision that results in a loss because that decision was ill advised negligent, or intentionally adverse to the best interests of the company and (ii) that liability may arise from an unconsidered failure of the board to act in circumstances in which due attention would, arguably, have prevented the loss. 3. Compensation of Corporate Directors and Business Judgment Rule This is a very telling question and one that is prevalent in the board rooms of many corporations. High rates of compensation have the potential for clouding business judgment and create possibilities of self-dealing or approving decisions that allow for continued retention in a lucrative position. Under these circumstances, there can be a blurred line between where the company and the directors interests lie. Given the wide latitude afforded directors decisions, directors must employ the highest ethical standards in exercising their respective duties. 4. Harm to the CEC? This is a difficult claim to articulate. One might argue that harm caused a material adverse impact on the business, results of operations, cash flows, and financial position. Another potential claim would be for waste and an argument these activities should not be covered by the business judgment rule. V. Corporate Social Responsibility. A. Integrating Business and Society: Successful corporations need a healthy society. Education, health care, and equal opportunity are essential to a productive workforce. Safe products and working conditions not only attract customers but lower the internal costs of accidents. Efficient utilization of land, water, energy, and other natural resources makes business more productive. Good government, the rule of law, and property rights are essential for efficiency and innovation. Strong regulatory standards protect both consumers and competitive companies from exploitation. Ultimately, a healthy society creates expanding demand for business, as more human needs are met and aspirations grow. Any business that pursues its ends at the expense of the society in which it operates will find its success to be illusory and ultimately temporary. B. Choosing Which Social Issues to Address. 1. Introduction: No business can solve all of societys problems or bear the cost of doing so. Instead, each company must select issues that intersect with its particular business. The essential test that should guide CSR (Corporate Social Responsibility) is not whether a

cause is worthy but whether it presents an opportunity to create shared valuethat is, meaningful benefit for society that is also valuable to the business.

2 Framework: Social issues affecting a company fall into three categories that distinguish between the many worthy causes and the narrower set of social issues that are both important and strategic for the business. Every company will need to sort social issues into these three categories for each of its business units and primary locations, and then rank them in terms of potential impact. Into which category a given social issue falls will vary from business unit to business unit, industry to industry, and place to place. a. Generic Social Issues: May be important to society but are neither significantly affected by the companys operations nor influence the companys long-term competitiveness. b. Value Chain Social Impacts: Are those that are significantly affected by the companys activities in the ordinary course of business. c. Social Dimensions of Competitive Context: Factors in the external environment that significantly affect the underlying drivers of competitiveness in those places where the company operates. Examples Carbon emissions may be a generic social issue for a financial services firm like Bank of America, a negative value chain impact for a transportation-based company like UPS, or both a value chain impact and a competitive context issue for a car manufacturer like Toyota. The AIDS pandemic in Africa may be a generic social issue for a U.S. retailer like Home Depot, a value chain impact for a pharmaceutical company like GlaxoSmithKline, and a competitive context issue for a mining company like Anglo American that depends on local labor in Africa for its operations. C. Strategic CSR: For any company, strategy must go beyond best practices. It is about choosing a unique positiondoing things differently from competitors in a way that lowers costs or better serves a particular set of customer needs. Strategic CSR moves beyond good corporate citizenship and mitigating harmful value chain impacts to mount a small number of initiatives whose social and business benefits are large and distinctive. Example Toyotas Prius, the hybrid electric/gasoline vehicle, is the first in a series of innovative car models that have produced competitive advantage and environmental benefits. Hybrid engines emit as little as 10% of the harmful pollutants conventional vehicles produce while consuming only half as much gas. Voted 2004 Car of the Year by Motor Trend magazine, Prius has given Toyota a lead so substantial that Ford and other car companies are licensing the technology. Toyota has created a unique position with customers and is well on its way to establishing its technology as the world standard. D. Creating a Social Dimension to the Value Proposition: At the heart of any strategy is a unique value proposition: a set of needs a company can meet for its chosen customers that others cannot. The most strategic CSR occurs when a company adds a social dimension to its value proposition, making social impact integral to the overall strategy.

Example Consider Whole Foods Market, whose value proposition is to sell organic, natural, and healthy food products to customers who are passionate about food and the environment. Social issues are fundamental to what makes Whole Foods unique in food retailing and to its ability to command premium prices. The companys sourcing emphasizes purchases from local farmers through each stores procurement process. Whole Foods commitment to natural and environmentally friendly operating practices extends well beyond sourcing. Stores are constructed using a minimum of virgin raw materials. Spoiled produce and biodegradable waste are trucked to regional centers for composting. Whole Foods vehicles are being converted to run on biofuels. Even the cleaning products used in its stores are environmentally friendly. In short, nearly every aspect of the companys value chain reinforces the social dimensions of its value proposition, distinguishing Whole Foods from its competitors.

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