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Submitted To: Dr. Faridullah

:Submitted By
Sana Munir
Midhat Batool
Mohammad Faisal Moin
Nasarullah Khan

Discipline: MBO – 1st semester


2 ............................................................................ETHICS AND CHOICES 1

4.......................................................................................... ................Ethics 2.1
6...................................................................... .........Corporate Ethics Policies 2.2
7................................................................ ......Corporate Social Responsibility 2.3
8..........................................Economist View of Corporate Social Responsibility 2.4
9......................................................................... .......Corporate Policy Setting 2.5
10...............................................................................................Diversity of Input 2.5.1
10..................................................................................................Legal standards 2.5.2
10.................................................................................................Business Norms 2.5.3
11...................................................................................................Press Standard 2.5.4
12 ............................................................................. ETHICAL BEHAVIOR 3
12............................................... Organizational Culture And Ethical Behavior 3.1
13......................................... .......Mechanism for Encouraging Ethical Behavior 3.2
14......................................................................................................Repeat Sales 3.2.1
14.........................................................................................................Warranties 3.2.2
14.........................................................................................Third- Party Monitors 3.2.3
14........................................................................................................ Disclosure 3.2.4
15...........................................................................................Ownership Structure 3.2.5
15................................ ..................Promoting an Ethical Climate by Employees 3.3
18 ...................................................................................CODE OF ETHICS 4
20 .........................................................................................CONCLUSION 5
21 .....................................................................................BIBLIOGRAPHY 6


People make choices to maximize their utility. Individuals have preferences over
just about everything and choose how much to spend on food, transportation, housing,
charitable contributions, and other purchases. People choose how to allocate their
time between leisure and charitable activities as well as how to allocate their time

among alternative leisure activities e.g. watching television, playing golf, or attending
a symphony concert.

Economics is the study of how people make choices; it is basically a descriptive study
to explain people's observed decisions. The analysis has to be made on descriptive
rather than on normative study.

Much of the study of ethics specifically focuses on how people should make choices.
It is the study of those behaviors people should pursue. Holistically, ethics is
normative, not descriptive. When philosophers speak of ethics, they are dealing with
25-century old discipline that seeks to identify those behaviors which are right or
wrong, good or bad, virtue or vice. Moral philosophers have been debating ethics
since ancient times. And all religion involves statements of which behaviors are
ethical and which are unethical. All major religions – Buddhism, Christianity,
Confucianism, Hinduism, Islam, and Judaism – espouse the Golden Rule: Do unto
others as you would have them do unto you. Western religions based on 10
commandments, code of ethical behavior.

Behaviors, such as lying, cheating, stealing and killing are almost universally viewed
as wrong – except under mitigating circumstances. However others view certain
behaviors viewed as wrong by some as right. Conflicts exist regarding birth control
and a person's right to die. In these cases there is simply no universally accepted code
of ethics on which one can rely to assess right and wrong.

Business ethics seeks to prescribe those behaviors in which business should not
engage. Such actions range from the giving or taking of gifts, bribing government
officials, misrepresenting data, discriminatory hiring practices and boycotting third
parties. For example, some deemed it unethical for a company to do a business in
South Africa while that country practiced apartheid.

This part of business ethics overlaps with the philosophy of business, one of the aims
of which is to determine the fundamental purposes of a company. If a company's main
purpose is to maximize the returns to its shareholders, then it could be seen as
unethical for a company to consider the interests and rights of anyone else.
Corporate social responsibility or CSR: an umbrella term under which the ethical
rights and duties existing between companies and society is debated.

 Issues regarding the moral rights and duties between a company and its
shareholders: fiduciary responsibility, stakeholder concept v. shareholder concept.

 Ethical issues concerning relations between different companies: e.g. hostile take-
over, industrial espionage.

 Leadership issues: corporate governance.

 Political contributions made by corporations.

 Law reform, such as the ethical debate over introducing a crime of corporate

 The misuse of corporate ethics policies as marketing instruments.

The historical and global importance of religious views on business ethics is

sometimes underestimated in standard introductions to business ethics. Particularly in
Asia and the Middle East, religious and cultural perspectives have a strong influence
on the conduct of business and the creation of business values.

Examples include:

 Islamic banking, associated with the avoidance of charging interest on loans.

 Traditional Confucian disapproval of the profit-seeking motive.

 Quaker testimony on fair dealing

Scholars defined business ethics as it is a form of the art of applied ethics that
examines ethical principles and moral or ethical problems that can arise in a business
environment. In the increasingly conscience-focused marketplaces of the 21st century,
the demand for more ethical business processes and actions (known as ethicism) is
increasing. Simultaneously, pressure is applied on industry to improve business ethics
through new public initiatives and laws (e.g. higher UK road tax for higher-emission

Business ethics and organizational architecture are independent. Organizational

architecture establishes incentives and thus affects the decisions of the managers and
employees. If it is important for business people to behave ethically in their roles as
managers and employees, it is important that the organization be structures to foster
ethical behavior.


2.1 Ethics
Ethics is a major branch of philosophy, encompassing right conduct and good life. It
is significantly broader than the common conception of analyzing right and wrong. A
central aspect of ethics is "the good life", the life worth living or life that is satisfying,
which is held by many philosophers to be more important than moral conduct.

Ethics denotes the theory of right and wrong actions, while morals indicate their
practice within guidelines. "Moral" has a dual meaning. Personal ethics signifies a
moral code applicable to individuals, while social ethics means moral theory applied

to groups. Social ethics can be synonymous with social and political philosophy, in as
much as it is the foundation of a good society or state.

Ethics is not limited to specific acts and defined moral codes, but encompasses the
whole of moral ideals and behaviors, a person's philosophy of life

To Socrates, a person must become aware of every fact relevant to his existence, if he
wishes to attain self-knowledge. He posited that people will naturally do what is good,
if they know what is right. Evil or bad actions are the result of ignorance. If a criminal
were truly aware of the mental and spiritual consequences of his actions, he would
neither commit nor even consider committing them. Any person who knows what is
truly right will automatically do it, according to Socrates. While he equated
knowledge with virtue, he similarly equated virtue with happiness. The truly wise
man will know what is right, do what is good and therefore be happy.

Aristotle posited an ethical system that may be termed "self-realizations". When a

person acts in accordance with his nature and realizes his full potential, he will do
well and be content. At birth, a baby is not a person, but a potential person. In order to
become a "real" person, the child's inherent potential must be realized. Unhappiness
and frustration are caused by the unrealized potential of a person, leading to failed
goals and a poor life. Aristotle said, "Nature does nothing in vain." Therefore, it is
imperative for persons to act in accordance with their nature and develop their latent
talents, in order to be content and complete. Happiness was held to be the ultimate
goal. All other things, such as civic life or wealth, are merely means to the end. Self-
realization, the awareness of one's nature and the development of one's talents, is the
surest path to happiness.

Aristotle asserted that man had three natures: vegetable (physical), animal (emotional)
and rational (mental). Physical nature can be assuaged through exercise and care,
emotional nature through indulgence of instinct and urges and mental through human
reason and developed potential. Rational development was considered the most
important, as essential to philosophical self-awareness and as uniquely human.
Moderation was encouraged, with the extremes seen as degraded and immoral. For
example, courage is the moderate virtue between the extremes of cowardice and
recklessness. Man should not simply live, but live well with conduct governed by
moderate virtue. This is regarded as difficult, as virtue denotes doing the right thing,
to the right person, at the right time, to the proper extent, in the correct fashion, for the
right reason.

Hedonism posits that the principal ethic is maximizing pleasure and minimizing pain.
There are several schools of Hedonist thought ranging from those advocating the
indulgence of even momentary desires to those teaching a pursuit of spiritual bliss. In
their consideration of consequences, they range from those advocating self-
gratification regardless of the pain and expense to others, to those stating that the most
ethical pursuit maximizes pleasure and happiness for the most people.
When it comes to defining the ethics of the organizations like public corporations that
encompass large groups of people, there is bound to be confusion. A corporation, after
all, is simply a collection of individuals – or, more precisely, a set of contracts that
bind together individuals with different, often conflicting, interests. In this sense,
organizations themselves do not behave ethically or unethically, - only individuals do.

2.2 Corporate Ethics Policies

As part of more comprehensive compliance and ethics programs, many companies

have formulated internal policies pertaining to the ethical conduct of employees.
These policies can be simple exhortations in broad, highly-generalized language
(typically called a corporate ethics statement), or they can be more detailed policies,
containing specific behavioral requirements (typically called corporate ethics codes).
They are generally meant to identify the company's expectations of workers and to
offer guidance on handling some of the more common ethical problems that might
arise in the course of doing business. It is hoped that having such a policy will lead to
greater ethical awareness, consistency in application, and the avoidance of ethical

An increasing number of companies also requires employees to attend seminars

regarding business conduct, which often include discussion of the company's policies,
specific case studies, and legal requirements. Some companies even require their
employees to sign agreements stating that they will abide by the company's rules of

Many companies are assessing the environmental factors that can lead employees to
engage in unethical conduct.

Not everyone supports corporate policies that govern ethical conduct. Some claim that
ethical problems are better dealt with by depending upon employees to use their own

Others believe that corporate ethics policies are primarily rooted in utilitarian
concerns, and that they are mainly to limit the company's legal liability, or to curry
public favor by giving the appearance of being a good corporate citizen. Ideally, the
company will avoid a lawsuit because its employees will follow the rules. Should a
lawsuit occur, the company can claim that the problem would not have arisen if the
employee had only followed the code properly.

Sometimes there is disconnection between the company's code of ethics and the
company's actual practices. Thus, whether or not such conduct is explicitly sanctioned
by management, at worst, this makes the policy duplicitous, and, at best, it is merely a
marketing tool.

To be successful, most ethicists would suggest that an ethics policy should be:

 Given the unequivocal support of top management, by both word and


 Explained in writing and orally, with periodic reinforcement.

 Doable....something employees can both understand and perform.

 Monitored by top management, with routine inspections for compliance
and improvement.

 Backed up by clearly stated consequences in the case of disobedience.

 Remain neutral and nonsexist.

2.3 Corporate Social Responsibility

Corporate social responsibility (CSR, also called corporate responsibility, corporate

citizenship, and responsible business) is a concept whereby organizations consider the
interests of society by taking responsibility for the impact of their activities on
customers, suppliers, employees, shareholders, communities and other stakeholders,
as well as the environment. This obligation is seen to extend beyond the statutory
obligation to comply with legislation and sees organizations voluntarily taking further
steps to improve the quality of life for employees and their families as well as for the
local community and society at large.

The practice of CSR is subject to much debate and criticism. Proponents argue that
there is a strong business case for CSR, in that corporations benefit in multiple ways
by operating with a perspective broader and longer than their own immediate, short-
term profits. Critics argue that CSR distracts from the fundamental economic role of
businesses; others argue that it is nothing more than superficial window-dressing; still
others argue that it is an attempt to pre-empt the role of governments as a watchdog
over powerful multinational corporations.

An approach for CSR that is becoming more widely accepted is community-based

development projects, such as the Shell Foundation's involvement in the Flower
Valley, South Africa. Here they have set up an Early Learning Centre to help educate
the community's children, as well as develop new skills for the adults. Marks and
Spencer is also active in this community through the building of a trade network with
the community - guaranteeing regular fair-trade purchases. Often alternative
approaches to this are the establishment of education facilities for adults, as well as
HIV/AIDS education programs. The majority of these CSR projects are established in
Africa. A more common approach of CSR is through the giving of aid to local
organizations and impoverished communities in developing countries. Some
organizations do not like this approach as it does not help build on the skills of the
local people, whereas community-based development generally leads to more
sustainable development.

The definition of CSR used within an organization can vary from the strict
"stakeholder impacts" definition used by many CSR advocates and will often include
charitable efforts and volunteering. CSR may be based within the human resources,
business development or public relations departments of an organization, or may be
given a separate unit reporting to the CEO or in some cases directly to the board.
Some companies may implement CSR-type values without a clearly defined team or

CSR is often used to promote voluntary corporate initiatives, as an alternative to
additional or existing mandatory regulations. The International Chamber of
Commerce has aggressively promoted a standards-free concept of "corporate
responsibility" that enables companies to proclaim their "responsibility" without
necessitating companies to meet minimum standards.

Accordingly, many non-governmental organizations are suspicious of the CSR

"movement" as corporate PR or regulation-dodging. The burgeoning industry known
as corporate social responsibility - or CSR ... is now seen as a vital tool in
promoting and improving the public image of some of the world's largest companies
and corporations," Christian Aid stated, in its report scutinising the record of several
major companies. "The image of multinational companies working hard to make the
world a better place is often just that - an image ... What's needed are new laws to
make businesses responsible for protecting human rights and the environment
wherever they work," Christian Aid argued.

For example The ICI Pakistan’s commitment to the development of the Country and
the Community, as a responsible corporate citizen, has always remained significant
and a guiding principle of its doing business., over the years, has supported and
encouraged social development initiatives, which include improving and enhancing
infrastructure facilities in the health care and education sectors of the Country. The
Company provides significant financial support to various institutes of excellence, all
over the Country. Pursuing further the initiatives it supports the local institutions in
and around Khewra, Sheikhupura, Lahore and Karachi where major operations and
manufacturing sites of the Company are located.

2.4 Economist View of Corporate Social Responsibility

Corporations intend to maximize the firm value generally find it in their interest to
devote resources to non-investor stakeholder such as employees, customers, suppliers,
and local communities.

For example, a company with a large plant in an inner city might decide that investing
corporate resources and personnel to improve area schools leads to better trained job
applicants, more productive employees, and lower cost products. Giving money to the
local university might benefit the firm by improving in R&D, increasing its access to
top graduates, or enhancing cultural and educational opportunities for its employees.
Improving the environment lowers the company's legal exposure to damage claims
and also might reduce its wage bill to the extent that a cleaner local environment
lowers the cost of attracting and retaining employees.

Maximizing the firm’s value requires expanding the firm’s resources on members of
each important corporate constituency to improve the terms on which they contract
with the company to maintain the firm’s reputation and to reduce the threat to
restrictive regulation. It means allocating corporate resources to all groups or interest
that effect the value of the firm – but only to the point where the incremental benefits
from such expenditures at least equal their additional costs.

Many managers are inclined to endorse Milton Freidman's perception that the social
mission of the corporation is “to make as much as money for its owners as possible
while conforming to the basic rules of society.” Some companies will find it in their
shareholders’ interest to invest in” social” causes of various kinds, but corporate
investment that systematically fail to provide adequate long term returns to provide
investors are wealth transfer that end up reducing social as well as private wealth.

Absent tax benefits, it usually is more efficient for the corporation to focus on
creating wealth and let its shareholders, managers, employees and customers the
beneficiaries of their charitable contributions. By maximizing their shareholder’s
wealth, corporations effectively enlarge the pool of individual (non corporate)
resources available for charity.

People who advocate ever-larger corporate contributions to charities and social causes
such as retraining displaced workers and environmental cleanup (without
consideration of their own long-run profitability) are effectively calling for their
higher implicit taxes on corporations. If all companies are so taxed, the taxes are
borne ultimately by shareholders in the form of lower returns to capital, by employees
in the form of lower wages, and by the customers in the form of higher prices. Thus,
ironically, the potential social consequences of such an increase in corporate social
responsibility are lower rates of economic growth, lower corporate values, lower
employment and even overall reduction in charitable donations(if reductions in
donations by individuals more than offset the increases in corporate giving).

2.5 Corporate Policy Setting

Once a corporation has determined its mission, implementing the mission requires a
set of operating policies. Again, ethical issues arise. It is futile to think that one can
reduce excruciatingly difficult corporate policy issues to simple, universally
applauded policy decisions. Consider questions like

 Should we use laboratory animals for product testing?

 Should we market infant formula in central Africa?

 Should we do business with a company that employs child labor in its

Asian textile factory?

 Should we adopt different procedures for handling and disposing of

hazardous wastes in Latin American plants than we use in the United

 Should we pay "fees" to expedite paper work for export permits to an

African market?

 Should we tow are obsolete North Sea oil rig to deep water and sink it?

There is no widely embraced definition of ethical behavior. These problems require

careful analysis in establishing appropriate corporate policy. In particular, managers

should be careful to collect data for estimating the total costs and benefits of
alternative actions, including costs of adverse publicity, tarnished reputation, and lost
customers. Although solving the problem is difficult but steps to help craft the
appropriate policy can be taken.

2.5.1 Diversity of Input

It is particularly important to obtain input from a broad cross section of potentially

affected stakeholders in the firm. Here, diversity in perspective can be especially
valuable in identifying potentially sensitive areas, which require additional analysis
prior to setting policy. Diversity in background can help the management to better
Asses the total potential costs of alternative policies.

2.5.2 Legal standards

It is important to understand the legal consequences of policy choices. First, it is to

understand that actions are taken Legal? Yet this knowledge alone is generally far
from sufficient to frame the policy.

For example, after the United States bombed Libya in 1986, some US banks faced a
dilemma: The US Federal Reserve and the State Department required that Libyan
funds in US banks be frozen. But the Central Bank of Greece simultaneously
announced that under Greek law Any Libyan funds on deposit in Greece must be
available on demand. If Libya had funds on deposit in Citibank's Athens branch and
requested the funds, the bank would have to choose between violating US law or
Greek Law. Or, consider the potential consequences of hiring a child labor in textile
mill in Pakistan, even if its is legal in territory, some customers might object because
the practice would be illegal in United States or Europe

Moreover, illegality may not be the determining factor. For example, it is doubtful
that the federal express would adopt a policy of firing a driver who violates the law by
receiving parking tickets. Hence it is important to understand what sanctions might be
imposed if a law is violated.

Finally, laws are not constant over time. For instance, although the 1955 congress
rolled back certain environmental regulation, some firms, appear reluctant to take
advantage of the entire range of newly allowed activities. They appear to be
concerned that if the political pendulum swings back, they might face future liability.

2.5.3 Business Norms

In the business community there are exceptions in transactions that do not have the
force of law but nonetheless represent behavior. These norms are rarely written down;
knowledge of them accumulates primarily with experience. These issues can be
especially important when entering a new market.

For instance, when Lincoln Electric decided to expand into Japan, it encountered
unexpected difficulties in selling products. Lincoln's managers had not appreciated the
strong preference accorded long standing business patterns by Japanese companies.

In special cases, these norms are codified. Adopting procedures developed by an

external group to handle sensitive issues can be quite useful. For example, standards
for using laboratory animals in product testing are established by the US Department
of Agriculture, the National Institutes of Health, and the Public Health Service. Most
organizations that undertake animal research adhere to these standards.
Nongovernmental groups also participate in this process. For instance, firms in the
motion picture industry frequently voluntarily adopt standards developed by the
American Society for the Prevention of Cruelty to Animals. By simply stating that
you adhere to the ASPCA code, a film company may be able to deflect much

2.5.4 Press Standard

Another useful device manager’s use in determining the ethical issues in setting
corporate policies involves assessing the public’s likely reaction. The example of
Pioneer Hi-bred International’s withdrawal of support for Planned Parenthood
illustrates the often-important interaction among ethics, public relations, and the
media. Ethic consultants regularly counsel corporate managers to apply the press
standard to help determined which behaviors are ethical. This criterion suggests that
to judge whether an action is ethical, you should ask yourself whether you would be
comfortable reading about your decision on the front page of the newspaper or seeing
it reported on television. Suggesting that a decision is a good idea only if it is kept
confidential is quite likely to be a mistake. Remember, the business press is quite
sophisticated. Counting on a questionable decision being overlooked or ignored might
be characterized well as wishful thinking than thoughtful analysis.

Using publication of your behavior as an ethical benchmark for judging a decision

highlights the linkage between ethical behavior and reputation. Below, we discuss
market forces that create incentives for people and firms to behave ethically. The
argument is that unethical behavior adversely affects reputation, and one way to
assess a decision’s reputation effects is to ask how it would read in The Wall Street
Journal or the Financial Times.


3.1 Organizational Culture And Ethical Behav ior

"Do organizations vary in the 'ethical climates' they establish for their members? The
answer to the question is yes, and it is increasingly clear that the ethical tone or
climate of organizations is set at the top. What top managers do, and the culture they
establish and reinforce, makes a big difference in the way lower-level employees act
and in the way the organization as a whole acts when ethical dilemmas are faced. For
example, there was no doubt in anyone's mind at Johnson & Johnson what to do when

the infamous Tylenol poisoning took place. Company executives immediately pulled
their product from the marketplace they knew that "the J & J way" was to do the right
thing regardless of its cost. What they were implicitly saying was that the ethical
framework of the company required that they act in good faith in this fashion.

The ethical climate of an organization is the shared set of understandings about what
is correct behavior and how ethical issues will be handled. This climate sets the tone
for decision making at all levels and in all circumstances. Some of the factors that
may be emphasized in different ethical climates of organizations are (Hunt, 1991;
Schneider and Rentsch, 1991):

• Personal self-interest
• Company profit
• Operating efficiency
• Individual friendships
• Team interests
• Social responsibility
• Personal morality
• Rules and standard procedures
• Laws and professional codes

As suggested by the prior list, the ethical climate of different organizations can
emphasize different things. In the Johnson & Johnson example just cited, the ethical
climate supported doing the right thing due to social responsibility--regardless of the
cost. In other organizations--perhaps too many--concerns for operating efficiency may
outweigh social considerations when similarly difficult decisions are faced.

When the ethical climate is not clear and positive, ethical dilemmas will often result
in unethical behavior. In such instances, an organization's culture also can predispose
its members to behave unethically. For example, recent research has found a
relationship between organizations with a history of violating the law and continued
illegal behavior (Baucus and Near, 1991). Thus, some organizations have a culture
that reinforces illegal activity. In addition, some firms are known to selectively recruit
and promote employees who have personal values consistent with illegal behavior;
firms also may socialize employees to engage in illegal acts as a part of their normal
job duties (Conklin, 1977; Geis, 1977). For instance, in his account of cases
concerning price fixing for heavy electrical equipment, Geis noted that General
Electric removed a manager who refused to discuss prices with a competitor from his
job and offered his successor the position with the understanding that management
believed he would behave as expected and engage in price-fixing activities (Geis,
1977, p. 124; Baucus and Near, 1991).

Pressure, opportunity, and predisposition can all lead to unethical activities; however,
organizations must still take a proactive stance to promote an ethical climate. The
final section provides some useful suggestions available to organizations for creating
a more ethical climate.

3.2 Mechanism for Encouraging Ethical Behav ior

Ethical lapses generally are manifestations of conflicts of interest –incentive

problems. As stated earlier, in most market exchanges, parties to the contracts have
incentives to devise mechanisms to reduce contracting costs, thereby raising the prices
they receive for their product or services. For example, when taking their firms public
for the first time, founders of companies frequently retain large positions in the stock
and voluntarily impose restrictions as their own future sales to help ensure that their
interests are consistent with those of their new investors. Such arrangements
effectively raise the price investors are willing to pay.

Likewise, external public auditors voluntarily prohibit themselves from owning stock
in the companies they audit. By not owning any stock, auditors do not gain by with-
holding unfavorable financial information. This increases their independence from
their clients, raises the value of the audit, and hence increases the price firms are
wiling to pay for it.

As we noted earlier, because reputation capital is an important determinant of future

earnings, market forces provide incentives for firms and individuals to behave
ethically. But the effectiveness of market forces in controlling conflicts of interest and
enforcing contracts varies among different kinds of transactions. Among the most
important characteristics of such transactions are the difficulty of ascertaining product
quality prior to purchase and the likelihood that the transaction would be repeated.

Take the case of buyer purchasing products. For products whose quality can be
determined at low cost prior to purchase, markets readily solve this problem. If buyers
can cheaply monitor quality, they will do so. For example a buyer negotiating a
purchase of silver for Kodak can confidently and cheaply ascertain its quality by

For some products, quality is virtually impossible to determine prior to purchase. For
example, you can know the quality of an airplane ticket only after the plane has
landed, it's parked at the gate, and you have deplaned and retrieved your luggage.
Although sellers have incentives to cheat on quality when quality is expensive to
measure, rational sellers will provide products of lower-than-promised quality only if
the expected gains exceed the expected costs.

3.2.1 Repeat Sales

One important constraint on such cheating is the potential for future sales. Moreover,
corporations with established market positions and valuable brand names face higher
costs of cheating and hence are less likely to cheat than startup firms. The costs of
cheating on quality also are higher if the information about such activities is more
rapidly and widely disturbed to potential future customers. For example, in markets
like the diamond trade in New York, which is dominated by a close-knit community
of Hasidic Hews, cheating on quality is extremely rare.

3.2.2 Warranties

Seller-provide product warranties are another mechanism to reduce the likelihood of

cheating. Since sellers bear higher warranty costs if they cheat on quality, they have
less incentive to cheat. Seller warranties will be most prevalent when product failures
result from factors those are under the firm’s control. In this casem warranties directly
impose the cost of failure on the parties who have the most control over product quilty
or failure. However, when failures are due primarily to factors that are under the
customers’ control (such as the way the product is used or maintained), the moral-
hazard problems will be greater and warranties are less useful as a quality-assurance

3.2.3 Third- Party Monitors

In some markets, specialized information services monitor the market, certify quality,
and help ensure contract performance.

For example, Consumer Reports evaluates products from toasters to automobiles, the
Investment Dealer Digest details activities of investment bankers, and A.M Best
Company rates financial conditions of insurance companies. These third party
information sources lower the costs for potential customers to determine the quality
and so increase the expected costs of cheating.

In credit markets, specialized credit information services like Moody’s and Dun &
Bradstreet perform both a monitoring and a dissemination function. The existence of
such intermediaries provides an opportunity for the firm to guarantee quality. For this
reason, corporate issuers pay Moody’s to have their debt rated over the life of the
bond issue. By issuing rated public debt, a firm lowers the costs to other potential
corporate claimholders (including potential customers) of ascertains the firm’s
financial condition.

3.2.4 Disclosure

The required level of Disclosure in markets can also be important in determining

quality. For example, a study of two wholesale used-car markets with different levels
of require disclosure found higher prices in the market with more required disclosure.
The ability to “precommit” to disclose information reduces the potential information
disparity between buyer and seller and so reduces the discount buyers apply to their
demand prices. Also,, the online auction website, encourages
participants to write message about their experiences with their partner in the
transactions. This provides future participants with more information about the
performance of a potential trader and thus enables them to have more confidence in
their transactions. Moreover, by creating this feedback mechanism, eBay provides
sellers with a means of developing a reputation. This improves the performance of
auction participants.

3.2.5 Ownership Structure

Incentives to provide high-quality products vary across ownership structure. Take the
case of franchise companies such as fast food and lawn-care firms. Such companies

typically franchise some units rather than own all their stores in order to take
advantage of the incentive benefits of decentralized ownership while retaining scale
economies in advertising and brand name promotion.

Yet outlets that have little repeat business create a special problem. The franchise
owners of these stores have an incentive to cheat on quality because they can benefit
from a steady stream of one-time sales while reducing the reputation of the entire
organization; this is another example of the standard free rider problem. At these
locations, the central company is more likely to own the unit than to franchise it, in
part because a salaried manager has fewer incentives to cheat on quality.

Companies with large amounts of debt in their capital structure can face a significant
probability of financial distress. Such firms are more likely to cheat on quality than
financially healthy firms because repeat sales are less likely. Therefore, some firms
“bond” product quality by adopting conservative financial polices. Since financial
distress is more closely for firms that market products polices that lead to a lower
probability of firms have incentives to adopt financing polices that lead to a lower
probability of financial distress__ polices such as lower leverage, fewer leases and
more hedging.

3.3 Promoting an Ethical Climate by Employees

Chief executives should encourage ethical consciousness in their organizations from

the top down showing the support and care about ethical practices. Second, formal
processes should be used to support and reinforce ethical behavior. For example,
internal regulation may involve the use of codes of corporate ethics, and the
availability of appeals processes. Finally, it is recommended that the philosophies of
top managers as well as immediate supervisors focus on the institutionalization of
ethical norms and practices that are incorporated into all organizational levels.

Nielsen (1989) has stressed the importance of managerial behavior in contributing to

ethical or unethical behavior. According to Nielsen, manager behaving unethically
contrary to their ethical philosophies represents a serious limit to ethical reasoning in
the firm. Much of the research cited in the above paragraph implicitly and explicitly
states that ethical philosophies will have little impact on employees' ethical behavior
unless they are supported by managerial behaviors that are consistent with these
philosophies. Managers represent significant others in the organizational lives of
employees and as such often have their behavior modeled by employees.

One of the most basic of management principles states that if you desire a certain
behavior, reinforce it. No doubt, how ethical behavior is perceived by individuals
and reinforced by an organization determines the kind of ethical behavior exhibited by
employees. As a result, if business leaders want to promote ethical behavior they must
accept more responsibility for establishing their organization's reinforcement system.
Research in ethical behavior strongly supports the conclusion that if ethical behavior
is desired, the performance measurement, appraisal and reward systems must be
modified to account for ethical behavior

In many cases, mangers choose to do, go along with or ignore the unethical...because
they want to avoid the possibility of punishments (or) to gain rewards.

Organizations and their managers must understand that the above recommendations
are key components in the development and maintenance of an ethically-oriented
organizational culture. Organizations can also enhance an ethically-oriented culture
by paying particular attention to principled organizational dissent. Principled
organizational dissent is an important concept linking organizational culture to ethical
behavior. Principled organizational dissent is the effort by individuals in the
organization to protest the status quo because of their objection on ethical grounds, to
some practice or policy (Graham, 1986). Organizations committed to promoting an
ethical climate should encourage principled organizational dissent instead of
punishing such behavior.

Organizations should also provide more ethics training to strengthen their employees'
personal ethical framework. That is, organizations must devote more resources to
ethics training programs to help its members clarify their ethical frameworks and
practice self-discipline when making ethical decisions in difficult circumstances.
What follows is a useful seven-step checklist that organizations should use to help
their employees in dealing with an ethical dilemma (Schermerhorn, 1989; Otten,

 Recognize and clarify the dilemma.

 Get all the possible facts.
 List your options--all of them.
 Test each option by asking: "Is it legal? Is it right? Is it beneficial?"
 Make your decision.
 Double check your decision by asking: "How would I feel if my family found
out about this? How would I feel if my decision was printed in the local
 Take action.

An effective organizational culture should encourage ethical behavior and discourage

unethical behavior. Admittedly, ethical behavior may "cost" the organization. An
example might be the loss of sales when a multinational firm refuses to pay a bribe to
secure business in a particular country. Certainly, individuals might be reinforced for
behaving unethically (particularly if they do not get caught). In a similar fashion, an
organization might seem to gain from unethical actions. For example, a purchasing
agent for a large corporation might be bribed to purchase all needed office supplies
from a particular supplier. However, such gains are often short-term rather than long-
term in nature. In the long run, an organization cannot operate if its prevailing culture
and values are not congruent with those of society. This is just as true as the
observation that, in the long run, an organization cannot survive unless it produces
goods and services that society wants and needs. Thus an organizational culture that
promotes ethical behavior is not only more compatible with prevailing cultural values,
but, in fact, makes good sense.

Although much remains to be learned about why ethical behavior occurs in
organizations and creating and maintaining organizational cultures that encourage
ethical behavior, organizations can benefit from the following suggestions:

 Be realistic in setting values and goals regarding employment relationships. Do

not promise what the organization cannot deliver.

 Encourage input throughout the organization regarding appropriate values and

practices for implementing the cultures. Choose values that represent the views of
employees at all levels of the organization.

 Do not automatically opt for a "strong" culture. Explore methods to provide for
diversity and dissent, such as grievance or complaint mechanisms or other internal
review procedures.

 Insure that a whistle-blowing and/or ethical concerns procedure is established for

internal problem-solving

 Provide ethics training programs for all employees. These programs should
explain the underlying ethical and legal (Drake and Drake, 1988) principles and
present practical aspects of carrying our procedural guidelines. Understand that
not all ethical situations are clear-cut. Like many basic business situations, the
organization should recognize that there are ambiguous, grey areas where ethical
tradeoffs may be necessary. More importantly, some situations have no simple

 Integrate ethical decision-making into the performance appraisal process.

In the context of a code adopted by a profession or by a governmental or quasi-
governmental organ to regulate that profession, an ethical code may be styled as a
code of professional responsibility, which may dispense with difficult issues of what
behavior is "ethical".

Codes of ethics are often promulgated by the (quasi-)governmental agency

responsible for licensing a profession. Violations of these codes may be subject to
administrative (e.g. loss of license), civil or penal remedies. Other codes can be
enforced by the promulgating organization alone; violations of these codes are usually
limited to loss of membership in the organization. Other codes are merely advisory
and there are no prescribed remedies for violations or even procedures for
determining whether a violation even occurred.

A code of ethics is often a formal statement of the organization's values on certain

ethical and social issues. Some set out general principles about an organization's
beliefs on matters such as quality, employees or the environment. Others set out the
procedures to be used in specific ethical situations - such as conflicts of interest or the
acceptance of gifts, and delineate the procedures to determine whether a violation of
the code of ethics occurred and, if so, what remedies should be imposed. The
effectiveness of such codes of ethics depends on the extent to which to management
supports them with sanctions and rewards. Violations of a private organization's code
of ethics usually can subject the violator to the organization's remedies (in an
employment context, this can mean termination of employment; in a membership
context, this can mean expulsion). Of course, certain acts that constitute a violation of
a code of ethics may also violate a law or regulation and can be punished by the
appropriate governmental organ.

The important aspects of the corporate ethics problem primarily are viewed as
problems of controlling incentive problems. There are several potential ways to
control them. One way to control incentive problems would be to get corporate
managers and employees to voluntarily adopt higher, more stringent ethical standards.
Second is to use contracts that better align the interests of managers and employees
with those of shareholders.

Examples of such contracts in corporations are executive or employee stock options,

bonus plans, and profit-sharing arrangements. Both more cost-effective incentive
contracts and higher ethical standards can be expected to lead to lower contracting
costs, greater corporate efficiency, higher corporate values, and greater social welfare.

Many companies and most professions have written codes of conduct, and some
companies also have educational programs dealing with ethics for their employees.
Such codes and programs regularly emphasize the following:

 Employees must obey the laws and observe statutory regulations.

 Customer relations in terms of the reputation and integrity of the company

are of great importance.

 Employees must support the company’s policies to customers.

 Conflicts of interest between the company and the employees must be


 Confidential information gained in the course of business must not be used


 Its improper to conceal dishonesty and protect others in their dishonesty

 Advice to customers should be restricted to facts about which the

employee is confident.

Why have corporations adopted such code? The most cynical view is that a corporate
code of ethics is nothing more than a document that helps the firm defend itself
against charges of illegal behavior. Sentencing guidelines issued by the U.S.
Sentencing Commission in Nov 1991 strongly encourage corporations to establish and
communicate compliance standards and procedures for employees and other agents
through training programs and publications.

For example, when an individual is found guilty of wrongdoing, the organization also
might be vulnerable to federal sanctions such as fines.

These penalties can be reduce by more then 50% simply by demonstrating that the
organization has a compliance program that meets the Sentencing Commission’s
standards. A compliance program consists at least of a code of ethics and a training
program. These federal Sentencing guidelines thus have blurred the lines between
legal and ethical issues.

But corporate ethical codes also have the potential to perform the economically
valuable function of reducing the costs of monitoring and enforcing contracts. To the
extent they reduce managerial and employee opportunism, better ethical standards
enhance the organization’s reputation and hence increase shareholder’s wealth.


Ethics starts with the business owner and needs to be stated clearly. But it also needs
to be embedded in the culture of the business through policies as well as actions by
the leadership, and in the rewards and remuneration program.

Ethical problems in organizations continue to greatly concern society, organizations,

and individuals, the potential impact that organizational culture can have on ethical
behavior has not really been explored. The challenge of ethical behavior must be met
by organizations if they are truly concerned about survival and competitiveness. What
is needed in today's complicated times is for more organizations to step forward and
operate with strong, positive, and ethical cultures.

Organizations have to ensure that their employees know how to deal with ethical
issues in their everyday work lives. As a result, when the ethical climate is clear and
positive, everyone will know what is expected of him or her when inevitable ethical
dilemmas occur. This can give employees the confidence to be on the lookout for
unethical behavior and act with the understanding that what they are doing is
considered correct and will be supported by top management and the entire



• "Managerial Economics" by Brickley, Smith and Zimmermen