CHAPTER 5

CORPORATE SCANDALS

The corporate scandals that have recently rocked the businesses of the world are
not only mind-boggling and gargantuan, but mostly shocking as they really destroyed
respectable and large corporations that used to be the models of ethics and good
governance.

But before several cases of corporate scandals are presented, a look into certain
realities that take place in the pursuit of economics and business, may well enlighten
us how they affect the lives of people within a spectrum.

Crony Capitalism

Crony capitalism is a pejorative term describing an allegedly capitalist economy in

which success in business depends on close relationships between business people and
government officials usually exhibited by favoritism in the distribution of legal permits,
government grants, special tax breaks, and others.

It corrupts economic and political ideas because of the ill effects of the self-serving
friendships and family ties between business and government or the collusion among
market players. These corrupt actions are contrasted against the legal practices of
certain networks that prevent entrance of new competitors into a given market such
as the keiretsu of Japan, the chaebol of South Korea, and the powerful families who
control certain businesses in Latin America.

Corporate Welfare

Corporate welfare is a pejorative term describing a government’s bestowal of

money grants, tax breaks, or other special favorable treatment on corporations or
selected corporations. It compares corporate subsidies and welfare payments to the
poor, and implies that corporations are much less needy of such treatment than the
poor.

Corporate welfare also comes in the form of subsidies considered excessive,

unwarranted, wasteful, unfair, inefficient, or bought by lobbying. It is also often used
to expose projects purported to benefit the general welfare that spend a
disproportionate amount of funds on large corporations, and often uncompetitive, or
anti-competitive ways.

Iron Triangle

Iron triangle is a term used by political scientists to describe the policy-making

relationship among congressional committees, the bureaucracy or executive or
government agencies, and interest groups

The congressional committees fund government programs and operations as well

provide oversight of them; the federal agencies regulates the affected industries; and
the industries themselves as well as their trade associations and lobbying groups which
benefit, or seek benefit, from these operations and programs.
Government Owned Corporation

A government-owned corporation is also known as a state-owned enterprise, state

enterprise, or government business enterprise and refers to a legal entity created by
government to undertake commercial activities on behalf of an owner government and
usually considered to be an element or part of the state. It is different from other
government agencies or state entities which are established to pursue purely non-
financial objectives that have no need or goal of satisfying the shareholders with return
on their investments through price increases or dividends.

Global Corporate Scandals

A corporate scandal is a scandal involving allegations of unethical behavior by

people acting within or on behalf of a corporation. A corporate scandal sometimes
involves accounting fraud of some sort. A wave of such scandals swept many
companies across the globe and had caused many of these companies to crumble and
close.

A corporate scandal is also known as an accounting scandal, corporate crime,

corporate fraud, or white collar crime and some other nomenclatures. But by whatever
name it is referred to, there is no mistake about its effects on corporations and
business organizations. It kills corporate life.

An accounting or corporate scandal is a political or business scandal which arises

with the disclosure of misdeeds by trusted executives of large public corporations.
Misdeeds are typically complex methods of misdirecting funds such as, but not limited
to the following:
 overstating revenues
 understating expenses
 overstating the value of corporate assets
 underreporting the existence of liabilities, sometimes with the cooperation of
officials in other corporations or affiliates.

Creative Accounting is used in public companies which borders on what is legal and
fraudulent. When there is suspicion of fraud, oversight agencies such SEC of US,
typically launch investigations.

Unfortunately most scandals that are exposed are just tips of the iceberg – which
represent only the visible catastrophic failures – because some abuses can be
completely legal or quasi-legal.

Information Asymmetry

An information asymmetry is a condition in which at least some relevant

information is known to some but not all parties involved. It causes markets to become
inefficient, since all the market participants do not have access to the information they
need for their decision making processes. The opposite of this which is ideal – is
information symmetry.

Information asymmetry also enables top executives to reduce the price of his
company’s stock prices, most often by manipulation of its records. They can:
 accelerate accounting of expected expenses
 delay accounting of expected revenues

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 engage in off-balance sheet transactions to make the company’s profitability
appear temporarily poorer or
 promote simply and report severely conservative (eg. pessimistic) estimates of
future earnings.

News of adverse earnings will likely or at least temporarily reduce share prices.
Again due to information asymmetries, top executives can commonly do everything
they can to window dress earnings’ forecasts, such as the following:
 Avoid or carry few legal risks, typically, by being “too conservative” in their
accounting and estimates of earnings.
 Make their company an easier “takeover target” with reduced share prices. When
a company gets bought out (or taken private) – at a dramatically lower price – the
“takeover artist” gains a windfall from the former top executive’s actions to
surreptitiously reduce share price. This can represent tens of billions of dollars
(questionably) transferred from previous shareholders of the takeover artist.
 The former top executive is then rewarded with a golden handshake for presiding
over the ‘firesale” that can sometimes be in the hundreds of millions of dollars for
one or two years of work. (This is nevertheless an excellent bargain for the
takeover artist, who will tend to benefit from developing a reputation of being very
generous to parting top executives).

Similar issues occur when a publicly held asset or non-profit organization

undergoes privatization.
 Top executives often reap tremendous monetary benefits when a government
owned or non-profit entity is sold to private hands. Just as in the example above,
they can facilitate this process by making the entity appear to be in financial crisis
- this reduces the sale price (to the profit of the purchaser), and makes non-profits
and governments more likely to sell.
 Ironically, it can also contribute to a public perception that private entities are more
efficiently run reinforcing the political will to sell the public assets.
 Again, due to asymmetric information, policy makers and the general public see a
government owned firm that was a financial 'disaster' - miraculously turned around
by the private sector (and typically resold) within a few years.

Notable Accounting Scandals

 Barlow Clowes (1988) UK - gifts management service £110 million missing
 Xerox (2000) KPMG, USA - falsifying financial results
 Enron (2001) Arthur Andersen, USA -hid billions of debts from failed projects
 AOL (2002) Ernst & Young, USA - inflated sales
 Bristol-Myers Squibb, Pricewaterhouse Coopers, USA – inflated revenues
 CMS Energy (2002) Arthur Andersen, USA – round trip tirades
 Kmart (2002) Pricewaterhouse, Coopers, USA – Misleading accounting practices
 Merck & Co (2002), USA – recorded co-payments that were not collected
 Merrill Lynch (2002), Deloitte & Touche, USA – conflict of interest
 AIG (2004) Pricewaterhouse, Coopers, USA – accounting structured financial deals

Notable Outcomes
 The Enron scandal resulted in the indictment and criminal conviction of the Big Five
auditor Arthur Andersen on June 15, 2002.
 Although the conviction was overturned on May 31, 2005 by the Supreme Court
of the United States, the firm ceased performing audits and is currently
unwinding its business operations.

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 On July 9, 2002 George W. Bush gave a speech about recent accounting scandals
that have been uncovered. In spite of its stern tone, the speech did not focus on
establishing new policy, but instead focused on actually enforcing current laws,
which include holding CEOs and directors personally responsible for accountancy
fraud.
 In July, 2002, WorldCom filed for bankruptcy protection, in what was considered
the largest corporate insolvency ever at the time.
 These scandals reignited the debate over the relative merits of US GAAP, which
takes a "rules-based" approach to accounting, versus International Accounting
Standards and UK GAAP, which takes a "principles-based" approach. The Financial
Accounting Standards Board announced that it intends to introduce more
principles-based standards. More radical means of accounting reform have been
proposed, but so far have very little support. The debate itself, however, overlooks
the difficulties of classifying any system of knowledge, including accounting, as
rules-based or principles-based.
 On a lighter note, the 2002, the Nobel Prize in Economics went to the CEOs of
those companies involved in the corporate accounting scandals of that year for
"adapting the mathematical concept of imaginary numbers for use in the business
world".
 In 2005, after a scandal on insurance and mutual funds the year before, AIG is
under investigation for accounting fraud. The company already lost over 45 billion
US dollars worth of market capitalisation because of the scandal. This was the
fastest decrease since the WorldCom and Enron scandals. Investigations also
discovered over a billion US dollars worth of errors in accounting transactions.
Future outcome for the company is still pending.

Fifteen Biggest Corporate Implosions Compiled by HR World Editors (2008)

After reading the foregoing scandalous events involving what used to be venerable
corporate institutions, let us now further study the biggest corporate implosions of
scandals that took place across countries and over the years compiled by HR World
Editors as of 2008 … “Whether its bankruptcy, heavy competition, fraud or typical
market forces, some companies are destined to fail. Some do it more spectacularly
than others. And believe it or not, business debacles have occurred all over the globe
for centuries. Here is our list of at least 15 biggest corporate implosions ever.”

Pre-20th Century

Overend, Gurney and Company: Overend, Gurney and Company was a London
wholesale discount bank that fell to pieces in 1866 owing about 11 million pounds
(£828 million at 2003 prices). It collapsed in 1866 and bank officials were charged
with fraud. After one of the partner’s, Samuel Gurney, retirement the bank took on
substantial investments in railways and other long term investments, which lead to
liabilities of around £4 million and liquid assets of only £1 million. To catch up, the
business was incorporated as a limited company in July 1865 and sold its £15 shares
at a £9 premium. It still couldn’t make ends meet, however, and looked to the Bank
of England for a bailout. They were refused, and panic ensued among its bank
members. The bank rate subsequently rose to 10 percent for three months, and more
than 200 companies, including other banks, broke down. Bank officials were charged
with fraud based on false statements in the prospectus for the 1865 offering of shares,
but later acquitted.

1950s

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IG Farben: IG was a collection and monopoly of dye and chemical companies in
Germany. During World War II and the Nazi regime, it used slave labor and
manufactured Zyklon B, a poison used in the gas chambers at concentration camps
Auschwitz and Majdanek. In 1951, the Allied Forces split up the original main
companies of IG, three of which remain today. The company was officially liquidated
in 1952, but continued to be traded on the Frankfurt Stock Exchange as a trust until
November 2003. It had contributed 500,000 DM (£160,000 or €255,646) towards a
foundation for former captive laborers under the Nazi regime.

1970s

United Fruit Company: This major American corporation traded tropical fruitgrown
in developing countries and sold in the U.S. and Europe. The United Fruit Company
allegedly partook in several questionable activities, including bribing government
officials and exploiting its workers. Workers in Central and South America went on
strike several times, most notably during the Banana Massacre of 1928, in which
dozens died after Colombian Army troops opened fire. In 1970, United merged with
AMK to become the United Brands Company. In 1984, United Brands was changed to
the well-known Chiquita Brands International.

Franklin National Bank: This Long Island, NY bank was once the country’s 20th
largest. Its October 1974 demise was at the time the largest bank failure in the history
of the country. Michele Sindona, an Italian banker involved with the Mafia, a fake
Freemasonic lodge called P2 and the Nixon administration allegedly mismanaged funds
and committed fraud involving losses in foreign-currency speculation and poor loan
policies. Several bank officers were convicted of falsifying financial records, and
Sindona was extradited to Italy, where he died of cyanide poisoning while serving a
life sentence. European American Bank, which was later acquired by Citigroup, bought
Franklin's assets.

1980’s

Crazy Eddie: The Northeastern U.S. consumer electronics chain Crazy Eddie operated
43 stores in four states and brought in more than $300 million in sales. But the
company came under some crazy heat in 1987 after the New Jersey district attorney’s
office initiated a federal grand-jury investigation into the financial activities. Certain
Crazy Eddie officers and employees were suspected of violating federal securities laws.
In December 1986, co-founder Eddie Antar gave himself a Christmas present of
millions of dollars worth of stock and resigned from the company. The company’s board
of directors approved its sale in November 1987, but the new owners were unable to
recover funds from the fraud, declared bankruptcy and ended business in 1989. Antar
was eventually charged with a series of crimes. After escaping to Israel in February
1990, he was extradited back to the U.S. where he stood trial for fraud. Though his
conviction was overturned in 1993, Antar pleaded guilty in 1996. He served two years
in prison.

ZZZZ Best: ZZZZ Best was a carpet-cleaning company lead by ex-convict turned
religious leader Barry Minkow. It became ZZZZ worst after its 1987 collapse, which
cost investors an estimated $100 million. Minkow was convicted of fraud and several
other offenses related to his venture’s demise and served seven years of a 25-year

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prison sentence. In the slammer, Minkow found God and now serves as senior pastor
of the Community Bible Church in San Diego. He turned his devious past into a divine
calling by also becoming an expert on fraud, which he speaks about to college students
and business professionals across the country.

1990s

Bre-X: This junior Canadian mining company bought a purported gold-deposit site at
Busang, Indonesia in March 1993 and in October 1995 announced the discovery of a
veritable treasure chest. Initially a penny stock, Bre-X's stock price soared to CAD
$286.50 on the TSX (Toronto Stock Exchange) with a total capitalization of over CAD
$6 billion. Bre-X's gold resource at Busang was actually found to be the most elaborate
mining scandal of all time, which lead to an equally colossal stock scandal. Workers
had falsified crushed core samples by salting with placer or supergene gold constitutes.
Bre-X fell down the mine shaft in 1997 after its shares became worthless.

Barings Bank: The bookkeepers at London’s Barings Bank, the oldest merchant bank
in the City of London, the Queen's personal bank and the financier of the Napoleonic
Wars, wrote the book on accounting fraud. Over a period of three years, Singapore-
based management employee Nick Leeson squandered £827 million, the equivalent of
$1.4 billion, on futures contract speculation, masked by manipulated records. In
February 1995, the losses came to light, and Barings Bank defaulted on its accounts.
The scandal became a turning point in the history of banking, resulting in more
oversight of accounting practices. After fleeing, Nick Leeson was later arrested in
Germany and extradited back to Singapore, where he was convicted of fraud and
sentenced to six and a half years in prison. Barings Bank does not exist on its own
corporately, but Barings endures as the MassMutual subsidiary Baring Asset
Management.

BCCI (Bank of Credit and Commerce International): BCCI became the world's
worst financial scandal in 1991 in when at least $13 billion was found to be
unaccounted for in their records. U.S. and U.K. regulators discovered money
laundering, bribery, support of terrorism, arms trafficking, the sale of nuclear
technologies, the commission and facilitation of tax evasion, smuggling, illegal
immigration and the illicit purchases of banks and real estate.

The 2000s

Parmalat: This Italian company presided as the leading global producer of UHT (Ultra
High Temperature) milk and also made food until its downfall. Accusations of financial
wrongdoing befell founder Calisto Tanzi in 2003 when a €14 billion hole was discovered
in Parmalat's accounting records, leading to one of the biggest corporate scandals in
history. The company’s questionable accounting practices included selling itself credit-
linked notes. Tanzi was jailed and reportedly admitted that he had diverted funds from
Parmalat into Parmatour, its travel unit, and elsewhere. The company, however, didn't
fully implode and continues its operations today.

BANINTER (Banco Intercontinental): BANINTER was the second-largest privately-

held commercial bank in the Dominican Republic before its 2003 demise resulting from
fraud and political corruption. Fraudulent bookkeeping and political influence had
apparently lasted for many years and through the administrations of all major
Dominican political parties. The bungling of the situation by former President Hipólito
Mejía’s administration helped send the Dominican economy into a steep decline. The

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$2.2 billion deficit resulting from the scandal was equal to 12 to 15 percent of the
Dominican national GDP (gross domestic product).

Adelphia Communications Corp.: Pennsylvania-based Adelphia Communications

ranked as the fifth largest cable company in the country before internal corruption and
a $2.3 billion debt led to its 2002 bankruptcy. The Adelphia founders were charged
with securities violations. Five officers were indicted and two, John and Timothy Rigas,
were sentenced to 15 years and 20 years in prison, respectively. The Rigases secured
$100 million for themselves through a complicated cash-management system that
spread money around to various family-owned entities. Time Warner Cable was
allowed to distribute approximately $6 billion in shares to Adelphia stakeholders and
succeed the company as a publicly traded corporation in February 2007.

Global Crossing Ltd: In terms of assets, this computer-networking services

company’s bankruptcy was the seventh largest filing in American history. Its filing
listed total assets of $22.4 billion and debts amounting to $12.4 billion, amassed
largely by gross corporate and executive spending. Four of Global Crossing's CEOs
received at least $23 million in personal, ultimately forgiven, loans from the company.
The organization, however, is additional proof that an incredible implosion is not
necessarily the end of the business road. Since 2004, it has been able to improve
margins and take steps toward gaining cash flow. In late 2006, the company
announced acquisitions of FiberNet, a U.K. provider of private-network services, and
Impsat, a South American Internet provider.

HIH Insurance: Australia’s second-largest insurance company entered into

provisional liquidation in 2001 with losses totaling $5.3 billion. Its corporate downfall
is considered the largest in Australia's history. In 2005, former HIH director Rodney
Adler was sentenced to four and a half years jail after pleading guilty to criminal
charges including obtaining money by false or misleading statements and failing to
discharge his duties as a director in good faith and in the best interests of the company.
HIH insurance is now in runoff, which means it is managing its outstanding claims and
not writing any new business, which could take as long as a decade to complete.

Urban Bank: One of the largest banks in the Philippines before PDIC (Philippine
Deposit Insurance Corp.) closed it on the basis of illiquidity in 2000, Urban Bank
merged with Export and Industry Bank in 2001. Don’t let the liquidation grounds fool
you, though. Urban’s officers were later criminally charged with economic sabotage
related to the company submitting falsified SES (supervision and examination sector)
reports to the Monetary Board.

CHAPTER 6

OTHER CORPORATE SCANDALS AND UNETHICAL PRACTICES

The discussion of ethics will be more fruitful if a distinction between personal ethics
and business ethics is made. The former is the set of values an individual uses to
influence and guide his personal behavior. It is usually developed early in his life such
as the values of honesty, trust, responsibility and character ingrained in him as a child.

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But the degree that these values are reinforced and strengthened during his trying,
adolescence years and early adulthood will vary from person to person. In many
cases, these traits are lost over the temptations of power, greed and control.

Business ethics focus on the behaviors or an individual as it pertains to his work

environment. The differences between personal and business ethics may, however,
be both subtle and far-reaching. Individuals who are unfaithful to their spouses may
intensely impact relationships as devastating, life altering, and even life-threatening.
But if the same individuals embezzle huge sums of money from organizations, the
impact on a personal level may be less while those affected such as employees,
investors, and stockholders, could be substantial.

These defined – it is established that ethics do influence the event of scandals

because executives with a questionable sense of ethics usually take advantage of
situations such lack of government regulations and poor implementation of laws. Most
of those involved in these scandals used a wide variety of accounting irregularities in
their illegal schemes. Among the most common of these uncommon practices are:
 Overstating revenues
 Understating expenses
 Inflating profits
 Underreporting liabilities
 Misdirecting of funds
 Artificially inflating stock prices
 Overstating the value of assets

Fun with Accounting Definitions

 Balance Sheet – a place to hide the other side of a fictitious transaction.
 Income Statement – a description of the money that companies do not really make,
but show to investors.
 Cash Flow Statement – a description of how companies take money from their
investors and give it to their top executives.
 Accountant – someone hired to explain how companies really made more money
than they actually did.
 Accounting Standards – a group of words that allow companies to do anything they
want to do.
 Big Bath – how companies take a $2 share loss and make it into a $4 share loss
so next year’s loss would not look nearly so bad.
 Bottom Line – the tip of the iceberg.
 Derivative – a financial instrument that is derived with the idea of stealing your
money.
 Financial Instrument – similar to a medical instrument used for small, dark places.
 Off Balance-Sheet Financing – a technique used when you cannot find a reasonable
place to put the other side of the entry.
 Principles vs. Rules – a choice of ways that accountant and companies can use
accounting standards to confuse investors.
 Smoothing – a technique of reversing reserves that should not have been recorded
in the first place.
 Stock Options – a financial instrument where the company has the option of
screwing the IRS or the investors.

Eleven More Scandals to Learn Lessons From

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 Again on a more serious note, thhe following are narration of ten (10) of the most
glaring cases of scandalous and unethical business practices:

The RadioShack Case

The RadioShack Corporation, headquartered in Forth Worth, Texas, offers

consumer electronics through hundreds of its retail stores. In May 2005, David
Edmondson became RadioShack's Chief Executive Officer (CEO) after having been
groomed for the job for years prior. The company did not fare well under Edmondson.
Sales and stock price both dropped. Employee morale was low, both for non-
supervisory personnel whose employee stock purchase plan was cancelled, and for
managers who were subjected to a controversial "Fix 1500" initiative in which the
lowest rated 1500 store managers out of 5000 were on notice to improve or else.

Edmondson's final undoing was due less to his corporate performance and more
due to a personal lack of ethics. Police arrested Edmondson for driving under the
influence in early 2006 at about the same time reporters learned he had misstated his
academic record on his resume. Edmondson claimed he had earned degrees in
theology and psychology from the Heartland Baptist Bible College when, in fact, school
records showed he had attended only two semesters and was never even offered a
course in psychology. On February 20, 2006, a company spokesperson announced that
David Edmondson had resigned over questions raised by his falsified resume. The
company struggled through all of 2006 attempting to recover its financial health.

Edmondson's civil indiscretions are small in comparison to the criminal behavior of

other executives described in this section. Still, it points out how unethical behavior
by even one key individual can have far reaching effects on a company and its
employees, including all those working in the IT department.

The Tyco International Case

The scandal at Tyco International, a diversified manufacturing conglomerate whose

products include toys, plastics and household goods, was far more significant than that
experienced by RadioShack and eventually led to criminal prosecutions. CEO L. Dennis
Kozlowski and Chief Financial Officer (CFO) Mark Swartz had both enjoyed highly
regarded business reputations before their fall from grace. Business Week magazine,
in its January 14, 2002 edition, even listed Kozlowski as one of the top 25 corporate
managers of 2001. By September 2005 both were being led away in handcuffs to begin
serving between 8-1/3 to 25 years in prison.

On June 17, 2005 a Manhattan, New York jury found Kozlowski and Swartz guilty
of stealing more than $150 million (U.S. dollars) from Tyco. Specific counts included
grand larceny, conspiracy, falsifying business records and violating business law.
Judge Michael J. Obus, who presided over the trial, ordered them to pay back to Tyco
$134 million. In addition, the judge fined Kozlowski $70 million and Swartz $35 million.

The case came to represent the pervasive impression of greed and dishonesty that
characterized many companies who enjoyed brief periods of prosperity through
devious means. When some of Kozloski's extravagances came to light during trial, they
only served to fuel this notion. These included him buying a shower curtain for
$6,000.00 and throwing a birthday party for his wife on an Italian island for $2 million,
all paid for with Tyco funds.

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The WorldCom Case

On November 10, 1997, WorldCom and MCI Communications merged to form the
US$37 billion company of MCI WorldCom, later renamed WorldCom. This was the
largest corporate merger in United States history. The company's subsequent
bankruptcy in 2003 arising from accounting scandals was symptomatic of the dotcom
and Internet excesses of the late 1990s.

After its merger in 1997, MCI WorldCom continued on with more ambitious
expansion plans. On October 5, 1999 it announced a US$129 billion merger agreement
with Sprint Corporation. This would have made MCI WorldCom the largest
telecommunications company in the United States, eclipsing AT&T for the first time.
But the US Department of Justice and the European Union (EU), fearing an unfair
monopoly, applied sufficient pressure to block the deal. On July 13, 2000 the Board of
Directors of both companies acted to terminate the merger; later that year MCI
WorldCom renamed itself WorldCom.

The failure of the merger with Sprint marked the beginning of a steady downturn
of WorldCom's financial health. Its stock price was declining, and banks were
pressuring CEO Bernard Ebbers for coverage of extensive loans that had been based
on over-inflated stock. The loans financed WorldCom expansions into non-technical
areas such as timber and yachting that never proved to be profitable. As conditions
worsened, Ebbers continued borrowing until finally WorldCom found itself in an almost
untenable position. In April 2002 Ebbers was ousted as CEO, and replaced with John
Sidgmore of UUNet Technologies.

Beginning in 1999 and continuing through early 2002, the company used
fraudulent accounting methods to hide its declining financial condition by presenting a
misleading picture of financial growth and profitability. In addition to Ebbers, others
who perpetuated the fraud include CFO David Sullivan, Controller David Myers and the
Director of General Accounting Buford Yates.

In June 2002 internal auditors discovered some $3.8 billion of fraudulent funds
during a routine examination of capital expenditures and promptly notified the
WorldCom board of directors. The board acted swiftly: Sullivan was fired, Myers
resigned and Arthur Anderson (WorldCom's external auditing firm) was replaced with
KPMG. By the end of 2003, it was estimated that WorldCom's total assets had been
inflated by almost $11 billion.

On July 21, 2002 WorldCom filed for Chapter 11 bankruptcy protection in the
largest such filing in United States history. The company emerged from bankruptcy as
MCI in 2004 with approximately $5.7 billion in debt and $6 billion in cash. On February
14, 2005 Verizon Communications bought MCI for $7.6 billion. In December 2005
Microsoft announced MCI would join them by providing Windows Live Messenger
customers with voice over the Internet protocol (VoIP) service for calls around the
world. This had been MCI's last totally new product called "MCI Web Calling," and has
now been renamed "Verizon Web Calling." It continues to be a promising product for
future markets.

CEO Bernard Ebbers was found guilty on March 15, 2005 of all charges and
convicted of fraud, conspiracy and filing false documents with regulators. He was
sentenced to 25 years in prison. He began serving his sentence on September 26,

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2006 in Yazoo City, Mississippi. The other executives who co-conspired with Ebbers all
pled guilty to various charges and were given slightly reduced sentences.

There are many lessons to be learned from this case, but two elements especially
stand out. One is that the fraudulent accounting was found during a routine
examination of company records, indicating a fair degree of arrogance on the part of
the conspirators as little was done to conceal the irregularities. Second, it marked a
rare instance of a reputable external accounting firm being involved, at least
peripherally, with suspicious activities. But the tarnishing of Arthur Anderson's
reputation was only beginning as we will see in the next section.

The Enron Case

The most famous case of corporate fraud during this era was that of the Enron
Energy Corporation headquartered in Houston, Texas. It resulted in itself and its
external auditing firm both being put out of business. Never before in United States
business have two major corporations fallen more deeply or more quickly. This case
epitomizes how severe the consequences can become as a result of unethical business
practices.

Enron enjoyed profitable growth and a sterling reputation during the late 1990s. It
pioneered and marketed the energy commodities business involving the buying and
selling of natural gas, water and waste water, communication bandwidths and
electrical generation and distribution, among others. Fortune magazine named Enron
"America's Most Innovative Company" for six consecutive years from 1996 to 2001. It
was on Fortune's list of the "100 Best Companies to Work for in America" in 2000.

But by 2001 Enron's global reputation was becoming undermined by persistent

rumors of bribery and strong-armed political tactics to secure contracts in Central
America, South America, Africa, and the Philippines. In July 2001 Enron admitted to
incurring a $102 million loss and in November of the same year Enron admitted to
hiding hundreds of millions more. By the end of 2001 the financial collapse of Enron
as a corporation was in full effect and its stock price plummeted to less than one dollar.

In 2002 a complex network of suspicious offshore partnerships and questionable

accounting practices surfaced. The mastermind behind these activities was Enron CFO
Andrew Fastow. He was indicted on November 1, 2002, by a federal grand jury in
Houston on 78 counts including fraud, money laundering and conspiracy. He and his
wife Lea Fastow, former assistant treasurer, accepted a plea agreement on January
14, 2004. Andrew Fastow agreed to serve a ten-year prison sentence and pay $23.8
million and his wife agreed to a five-month prison sentence. In exchange, both would
testify against other Enron corporate officers.

Federal prosecutors issued indictments against dozens of Enron executives. Key

among these were Kenneth Lay, the former Chairman of the Board and Chief Executive
Officer and Jeffrey Skilling, former Chief Executive Officer and Chief Operating Officer.
They were served in July 2004 with a 53-count, 63-page indictment covering a broad
range of financial crimes. Among these was bank fraud, making false statements to
banks and auditors, securities fraud, wire fraud, money laundering, conspiracy and
insider trading.

Lay pled not guilty to his eleven criminal charges claiming he had been misled by
those around him. His wife, Linda Lay, also claimed innocence to a bizarre set of

11
associated circumstances. On November 28, 2001, Linda Lay sold approximately
500,000 shares of her Enron stock (when its value was still substantial) some 15
minutes before news was made public that Enron was collapsing at which time the
stock price sunk to under one dollar.

After a highly visible and contentious trial of Lay and Skilling, the jury returned its
verdicts on May 25, 2006. Skilling was convicted on 19 of 28 counts of securities fraud
and wire fraud and acquitted on the remaining nine, including insider trading. He was
sentenced to 24 years, 4 months in prison which he began serving on October 23,
2006. Skilling was also ordered to pay with his own money $26 million to the Enron
pension. Lay was convicted of all six counts of securities and wire fraud and sentenced
to 45 years in prison. On July 5, 2006, Lay died at age 64 after suffering a heart attack
the day before.

American Airlines

American Airlines was fined $7.1 M for continuing to fly airliners even after safety
problems and drug-testing violations were reported. The Texas-based company
continued to fly two mid-sized airliners (MD-80s) for 58 times even after problems
were reported with their autopilot systems.

The Federal Aviation Administration (FAA) believes the fine is appropriate because
there was conscious awareness of the problems, yet maintenance efforts were not
undertaken, in violations of important safety regulations to protect both passengers
and crew.

The fine is the second largest accorded to an airline company. Southwest Airlines
was earlier fined $10.2 M for failure to undertake mandatory inspections. However,
the same is still under negotiations between Southwest and the FAA.

Southwest Air Agrees to Pay $7.5M Fine (John Hughes)

March 2 (Bloomberg) -- Southwest Airlines Co. agreed to pay a $7.5 million penalty
for flying jets without fuselage inspections in 2006 and 2007, which would be the
largest fine collected from an airline by the Federal Aviation Administration.

The amount could double if the Dallas-based carrier fails to take steps outlined to
protect safety, the FAA said in a statement today in Washington. The agency had
proposed a record $10.2 million fine a year ago, saying Southwest operated 46 Boeing
Co. 737s on 59,791 flights without full checks for cracks.

The settlement ends a dispute dating back to March of last year, when the FAA
announced the initial penalty, and comes after the airline continued negotiating past
an Aug. 29 deadline for paying the fine. Southwest, the biggest low-fare carrier, has
said safety wasn’t compromised by flying the planes.
“Southwest Airlines is pleased that we have been able to resolve all outstanding
issues,” the carrier said in a statement. “This settlement with the FAA will allow us to
focus on safety going forward rather than on issues that are behind us.”
The carrier must meet 13 new requirements related to personnel, manuals and
procedures as a condition of the agreement, the statement said. Among those is a
measure to increase the number of on-site personnel for large-scale maintenance
vendors to 35 from 27 within 30 days.

12
 “Some of those safety measures exceed FAA regulations,” Acting Administrator
Lynne A. Osmus said in the statement.

Southwest shares fell 37 cents to $5.52 at 4:15 p.m. in New York Stock Exchange
composite trading. The shares have fallen 36 percent this year

Spy Scandal at Deutsche Bank

Deutsche Bank has confirmed it faces a possible criminal investigation into spying
allegations.

Germany's largest lender is accused of spying on two board members it suspected

of leaking sensitive details, as well as one critical shareholder.
State prosecutors are now trying to establish whether to launch a formal criminal
investigation.

The bank refused to comment on reports that it had dismissed two of its staff
members in connection with the claims.

American Insurance Group (Robert Reich)

The real scandal of AIG isn't just that American taxpayers have so far committed
$170 billion to the giant insurer because it is thought to be too big to fail -- the most
money ever funneled to a single company by a government since the dawn of
capitalism -- nor even that AIG's notoriously failing executives, at the very unit
responsible for the catastrophic credit-default swaps at the very center of the debacle
-- are planning to give themselves $100 million in bonuses. It's that even at this late
date, even in a new administration dedicated to doing it all differently, Americans still
have so little say over what is happening with our money.

The administration is said to have been outraged when it heard of the bonus plan
last week. Apparently Secretary of the Treasury Tim Geithner told AIG's chairman,
Edward Liddy (who was installed at the insistence of the Treasury, in the first place)
that the bonuses should not be paid. But most will be paid anyway, because, according
to AIG, the firm is legally obligated to do so. The bonuses are part of employee
contracts negotiated before the bailouts. And, in any event, Liddy explained, AIG
needed to be able to retain talent.
AIG's arguments are absurd on their face. Had AIG gone into chapter 11
bankruptcy or been liquidated, as it would have without government aid, no bonuses
would ever be paid; indeed, AIG's executives would have long ago been on the street.
And any mention of the word "talent" in the same sentence as "AIG" or "credit default
swaps" would be laughable if it weren't already so expensive.

Apart from AIG's sophistry is a much larger point. This sordid story of government
helplessness in the face of massive taxpayer commitments illustrates better than
anything to date why the government should take over any institution that's "too big
to fail" and which has cost taxpayers dearly. Such institutions are no longer within the
capitalist system because they are no longer accountable to the market. So to whom
should they be accountable? When taxpayers have put up, and essentially own, a large
portion of their assets, AIG and other behemoths should be accountable to taxpayers.
When our very own Secretary of the Treasury cannot make stick his decision that AIG's
bonuses should not be paid, only one conclusion can be drawn: AIG is accountable to
no one. Our democracy is seriously broken.

13
Salad Oil Scandal

The Salad Oil Scandal, also referred to as the "Soybean Scandal," was a major
corporate scandal in 1963 that ultimately caused over $150 million (~$1.1 billion in
2008 dollars[1]) in losses to corporations including American Express, Bank of America
and Bank Leumi, as well as many international trading companies. The scandal's ability
to push otherwise cautious and conservative lenders into increasingly risky practices
has prompted some comparisons to recent financial crises including the 2007-2008
subprime mortgage financial crisis.

The scandal involved the company Allied Crude Vegetable Oil in New Jersey, led by
Tino De Angelis, which discovered that it could obtain loans based upon the inventory
of its salad oil.

Ships apparently full of salad oil would arrive at the docks, and inspectors would
confirm that the ships were indeed full of oil, allowing the company to obtain millions
in loans. In reality, the ships were mostly filled with water, with a only a few feet of
salad oil on top. Since the oil floated on top of the water, it appeared to inspectors
that these ships were loaded with oil. The company even transferred oil between
different tanks while entertaining the inspectors at lunch.

Once the scandal was exposed, American Express was one of the biggest casualties.
Its stock dropped more than 50% as a result of the scandal, which cost the company
nearly $58 million. Tino De Angelis was convicted of fraud and conspiracy charges in
connection with the scandal and served seven years in prison, gaining his release in
1972.

Arthur Andersen Case

Arthur Andersen realized before the rest of the big five that business consulting
was a very lucrative business. They were: Arthur Andersen, Deloitte & Touche, Ernst
& Young, KPMG, and PriceWaterhouseCoopers.

In 1989, Arthur Andersen and Andersen Consulting became separate units of Andersen
Worldwide. Andersen began using its accounting services as a springboard to sign up
clients for Andersen Consulting' more lucrative business.

Arthur Andersen and Andersen Consulting spent the 1990s in a bitter dispute. The
Andersen Consulting group saw a enormous growth in profits during 90's from the
business it was receiving from Arthur Andersen.

However, the consultants at Andersen Consulting felt they were being underpaid for
the work they were doing. In 2000 an international arbitrator granted Andersen
Consulting its independence.

As a result, in 2001, Andersen Consulting was forced to change its name to

Accenture. Accenture agreed to pay $1.2 billion in past payments to the Arthur
Andersen firm.

Accounts vary on why the split occurred — executives on both sides of the split
cited greed and arrogance on the part of the other side.

14
 Executives with Andersen Consulting maintained breach of contract when Arthur
Andersen created a second consulting group, AABC (Arthur Andersen Business
Consulting) which began to compete directly with AC in the marketplace.

In 2002, Andersen was convicted of witness tampering for shredding documents

related to its audit of Enron. Since the Securities and Exchange Commission does not
allow convicted felons to audit public companies, the firm agreed to surrender its
licenses and its right to practice.

In 2005, the Supreme Court of the United States unanimously overturned

Andersen's conviction due to flaws in the jury instructions.

In the court's view, the instructions allowed the jury to convict Andersen without
proving that the firm knew it broke the law or that there was a link to any official
proceeding that prohibited the destruction of documents.

The opinion was also highly skeptical of the government's definition of "corrupt
persuasion"--persuasion with an improper purpose even without knowing an act is
unlawful.

Despite this ruling, it is highly unlikely Andersen will ever return as a viable
business.

The firm lost nearly all of its clients when it was indicted, and there are over 100
civil suits pending against the firm related to its audits of Enron and other companies.

It began winding down its American operations after the indictment. From a high
of 28,000 employees in the US and 85,000 worldwide, the firm is now down to around
200 based primarily in Chicago. Most of their attention is on handling the lawsuits.

XEROX IN $2 B Scandal

Dollar plunges as firm admits exaggerating revenues. Corporate America suffered

a fresh accounting scandal as Xerox, the photocopying and printing giant, admitted it
had overstated its revenues during the past five years by almost $2B (£1.3bn).

The revelation, following the alleged frauds at WorldCom and Enron, threatens
further damage to confidence in the US economy, Wall Street’s integrity and the dollar,
which came within a fraction of parity with the euro yesterday amid further heavy
selling pressure.

Meanwhile, Sir David Tweedie, the Scot who heads the international accounting
standards board, warned in an interview with today's Guardian that the UK is not
immune from huge accounting failures such as the $4bn apparent fraud at WorldCom.

“People are saying this couldn’t happen in Britain.” Oh yes it could, said Sir
David. “Its corporate governance failures, it could happen to us too.”

The UKs chief financial regulator, the financial service authority, acknowledged the
wide concerns yesterday as it tried to bolster confidence in the fragile stock market by

15
changing solvency rules that could have forced insurance companies, among the
biggest equity investors, to dump shares in a failing market. The move appeared to
work as the FTSE 100 index rose 115.8 points to 4656.4.

The scandal at Xerox, though, is doubly shocking because its problems seemed to
have been resolved by an investigation in April by the Securities and Exchange
Commission, the Chief US financial watchdog. That audit estimated that Xerox’s
overstatement of revenues, achieved by bringing forward equipment sales, was $3 B.
Under the new accounts the equivalent figure is $6.4 B, which sent Xerox’s shares
tumbling 10% yesterday.

The company, however, was able to claim that the net overstatement of revenues
was $1.9 b because of various other revisions to its accounts. Nevertheless, it still
admits that its profits during 1997-2001 were overstated by $1.4 b.

Xerox founded in 1906, has almost 80,000 employees around the world, including
3000 at its European head office in Uxbridge.

Its accounting scandal erupted last year and its auditor, KPMG, was fired after
working for the firm for 30 years. The SEC accused Xerox of having "misled and
betrayed investors" via a series of accounting tricks designed to manipulate its
earnings and enrich top executives. One Xerox accounting scheme was known
internally as "project Mozart" because of its supposed creative brilliance. Xerox agreed
to pay a $10m fine to settle the charges but the SEC has still told a number of former
executives and KPMG that it is considering filing civil charges against them.

Although the Dow Jones was barely affected by the Xerox scandal in early trading
in New York, concern over the dollar is mounting. Intervention by the Bank of Japan,
which is concerned about the impact on Japan's export-led recovery, reversed the
dollar's slide in afternoon trading but it is becoming clear that financial institutions
outside the US are losing faith in the currency.

CHAPTER 7

SPORTS AND COLLEGE SCANDALS

College Sports Scandals

The American way can be summed up in many ways, expressions, and thoughts,
but the one thing that will always remain is victory. It can be traced back to the
beginning of our civilization. Victory brings us joy, happiness, and a sense of
fulfillment, but at what price? The lengths of winning take hard work and dedication,
and can bring together an entire community, state, or even nation. Unfortunately,
there are some out there who will take winning a little too far. After careful research
and analysis we have assembled the top 5 scandals in college sports history.

University of Minnesota Men’s Basketball Academic Cheating Scandal

Under coach Clem Haskins, the UM basketball program was turned around into a
very successful program in a very short period of time. However, this came at a price.
In 1999, the day before the Gophers were to start their quest at the NCAA Tournament
against Gonzaga, the academic scandal came to surface.

16
 Jan Gangelhoff, a former UM office manager, admitted to writing over 400 term
papers for at least 20 men’s basketball players over the years. The program
immediately suspended 4 players before the Gonzaga game. As a result, the Gophers
lost in the first round.

The players had systematically committed academic fraud year after year,
tarnishing many at the university, including most of the coaching staff, professors,
advisors, and the team. The university was given many sanctions upon completion of
an investigation by the NCAA, as well as an embarrassing blow to the school’s
reputation. As a result, all awards and titles were stripped from the program between
1993 and 1998. They were also put on probation for 4 years starting the 1999-2000
season, and lost 5 scholarships over the next three seasons. Haskins came out after
he was dismissed in 2000 and admitted to paying Gangelhoff $3,000 for the work. The
Gophers were a basket away from the Final Four just 3 years before this debacle.

This story was somewhat over shadowed by the NCAA Tournament at the time,
but is a lesson that some will do whatever it takes to win, despite the consequences.
The Gophers men’s basketball program has never fully recovered from this
embarrassment. This is happening all to often in not only College Basketball, but all
over Collegiate athletics. The rules established by the NCAA are there for a reason.
This is a very serious infraction because these kind of actions aren’t helping the
student/athlete, community, or making a positive role on the youth.

Memphis Tigers SAT Scandal

The final verdict so to speak is still out on this roller coaster. After recording a
NCAA record in wins (38) for men’s basketball in 2007-08, allegations arose
surrounding this program. The issue formulated when an undisclosed player was
accused of having another person take his SAT in Detroit, so he could become eligible
as a Freshmen, after failing the ACT three times. The wins were taken away from the
Tigers because they were using an academically ineligible player. Memphis president
Shirley Raines appealed the ruling claiming it to be an unfair penalty. She was quoted
as saying, “We Know the Rules” .

The speculated player used was Derrick Rose, now a starting point guard for the
Chicago Bulls. Rose is the only player for Memphis who just played in that 07-08
season. This is a well documented case and was a big story for the media. Former
coach John Calipari, seems to have left the program at the perfect time, as he accepted
a new position as the coach of University of Kentucky at the end of the season. This is
the second time Calipari has had wins and awards taken away from his team, the first
of which was with the University of Massachusetts in 1996. The classic Camby/Kellogg
team had their Final Four banner taken down.

An athlete who is dishonest should not have any place in sports. We are sending
a message that it is alright to lie, cheat, or steal as long as one is an athlete. This
should stop because we are giving something to someone without making them truly
earn it, much less deserve it.

ASU Point-Shaving Scheme

This scandal was definitely the headliner of the 90’s. Not since the Pete Rose era
had something this drastic happened, but this was on the Collegiate level which raised

17
eyebrows all across the country. In 1993 Stevin “Hedake” Smith was one of College
Basketball’s best athletes as he dazzled crowds and piled up points almost effortlessly.
Smith attended Arizona State University during this time and ended his career as one
of ASU’s top all-time scorers.

The scheme was arranged by Benny Silman, who was a local student bookie.
Smith’s motivation was a $10,000 gambling debt to Silman. Silman and his sports
booking business got in contact with a group who had ties with the mob. Stevin Smith
was not alone in this process as teammate Issac Burton was also a culprit in helping
him fix games. The deal was very lucrative for Smith who received $20,000 per game.
Issac Burton received $4,300 per game in the 2 games he participated.

The scheme was when ASU was the favorite to win a game, they would win by less
than the (betting) line. The scheme was discovered when Nevada sports bookies
noticed suspicious betting patterns on ASU games. The casinos notified the Pac-10
Conference administration and an investigation took place. The case went to trial and
6 convictions were given. Among those Benny Silman got the most severe sentence:
46 months in prison and a $250,000 fine. Stevin “Hedake” Smith received one year in
prison, three years probation, and a $8,000 fine.

Smith claimed, after the fact, during an interview that he made more defensive
mistakes rather than offensive. His nickname ,“Hedake” was given to him because it
was rumored he would give defenses a headache when he handled the basketball on
offense. After his conviction, it’s safe to say Smith had a headache of his own.

This is a true tragedy of a collegiate star who had it all but simply threw it away
for a quick buck. He should be playing in the NBA (or retired from), but one idiotic
decision cost him his dream and future. There haven’t been too many other findings
of sports gambling scams since this incident. This is a classic example of how greed
gets a person nowhere.

Southern Methodist University Football Scandal

The SMU Mustangs had one of the most prominent programs in college football. A
history that included national titles in 1935 and 1982, 10 Conference titles, and 11
Bowl appearances. Their historic program included names such as Eric Dickerson and
legendary Heisman trophy winner Doak Walker.

As a smaller school, SMU found it hard to compete with larger schools when it came
to recruiting the nations top players out of high school. They had to do something to
continue the success of the program, so they began walking the ethical line in the
recruitment of their players.

In June of 1986, a tip was revealed about a David Stanley, who played Linebacker
from 1983 to 1984. Stanley claimed that SMU athletic officials paid him $25,000 to
sign with the team, and continued paying him while he played on the squad. It should
also be known that SMU was also on probation at the time.

After an investigation was completed, it was found that 13 players received

$61,000 in payments from 1985-1986. This was known as a “slush fund”, in which
boosters were paying cash to players to get them committed to play at SMU. The

18
Southern Methodist Mustangs were punished severely for violating numerous NCAA
rules and regulations. The NCAA gave the university a “Death Penalty”, in which it
cancelled SMU’s entire 1987 scheduled games. SMU didn’t participate in the 1988
season either, due to the magnitude of their situation. This still reigns as the most
severe penalty handed down to a Division-I program ever.

Every SMU player was granted a full release from the team in 1988 and were
allowed to transfer to another school. 250 recruiters from 80 schools came on campus
to recruit the former SMU players.

This is rather unknown for most college students today, but it seems the NCAA was
making an example out of this program. The Mustangs have never recovered from this
scandal, especially athletically. Most would ask why go to SMU, when Texas, Texas
A&M, and Texas Tech are in the area. It’s hard to consume the fact that the school
didn’t play college football for two whole years after the incident. No college or
university would want to have this devastation to bear with, especially with the amount
of revenue college sports teams bring in for their school. Bribery is a very serious
issue, not only in college sports, but for students as well.

City College of New York Basketball Scandal

In the late 1940’s and early 1950’s there was a thriving basketball scene in the
New York City area. In 1950, the City College of New York, one of the nation’s top
basketball programs at that time, became the first and only team to win both the NCAA
and NIT championships in the same year. It was a great time for basketball in New
York, however, soon after, a great downfall would begin.

A shocking story arose from rumors and mobs ties. The scandal first came to light
when New York City District Attorney Frank Hogan arrested seven men in January
1951, including three star players of the CCNY 1950 championship team, after an
undercover sting operation.

CCNY Players are Booked for Fixing Games

The initial arrests uncovered a widespread scheme of fixing games for betting
purposes. Many top players and teams were invloved, including CCNY, Manhattan
College, NYU, Long Island University, Bradley, Kentucky, and the University of Toledo.
The players accepted payoffs from gamblers and in return they wouldn’t allow their
teams to cover the point spread. In all, 33 players were involved, as well as members
of organized crime groups, with fixing 86 games between 1947 and 1950.

Eventually City College of New York was banned from Madison Square Garden.
The NCAA tournament was moved away from the NYC area for fear of a repetitive
occurrence happening. The NCAA tournament championship game left the New York
area for nearly 50 years, until 1996 when games were played at East Rutherford, New
Jersey. The NIT, however was the more sought after tournament in that era. Many
believe the scandal is a huge reason why the NCAA tournament is where it is today,
and vice versa for the NIT.

This was the first really big altercation since possibly the Black Sox era. It marked
the first major debacle in college sports as well. There must have been some serious
connections if 7 teams and 33 players were in on it. It makes one wonder, what if that

19
happened in our era? How would the NCAA handle it, and who would be held
accountable?
In closing, that was the Top 5 College Sports Scandals of all-time (in our opinion).
Why must a player, coach, or whomever feel justified to take the easy way out (or so
they thought)? It seems every decade going back to the 1950’s has a scandal to go
along with it, and about every decade another scandal will surface. What will be the
post-2010 scheme? In competition, and in sports for that matter there is always a
constant case, people will cheat to win, but will not win in the end. As the saying goes:
Cheaters never prosper.

The 10 Biggest College Scams of All-Time

University of Missouri Email Harvesting Scam

From 2001 to 2004, two former University of Missouri students operated a national
email scam that targeted more than 2,000 colleges and universities, illegally collecting
over 8 million student email addresses. They used the email addresses to send
targeted spam emails to students, selling various products and services, earning them
a total of $4.1 million.

One of the students, a computer science major, developed email extraction

programs used to harvest the email addresses. The pair used computer networks at
the University of Missouri to carry out the operation of sending out massive amounts
of spam emails.

The University of Missouri became aware of the incident when they noticed huge
slow-downs in the school's network and, upon further investigation, observed huge
flows of spam-related traffic going on. Network administrators pinpointed the network
activity to a classroom where the perpetrator was apparently found with a laptop
connected to the Internet.

Even though their operation had been exposed by the university, the scammers
continued spamming students at other colleges, using programs to disguise the emails
so that they appeared to be affiliated with the college or university the recipient was
attending. Although the emails sent out had less than a 1% response rate, it still
garnered the scammers enough money ($4.1 million) to be able to by cars and houses
on the easily obtained funds from illegal solicitation.

Nearly every college and university in the United States was impacted by this scam.
In response to the incident, many schools invested major dollars to beef-up the online
security of their networks. Upon issuing a search warrant, authorities found more than
3 million student email addresses harvested from 2002, 5 million harvested from 2003,
and 37.5 million AOL email addresses, 33.7 million MSN addresses, 10.8 million
Hotmail addresses, 5.2 million Yahoo addresses, and more than 4 million UK email
addresses.

Four people were charged in the incident under the CAN-SPAM Act of 2003, which
regulates the sending of commercial emails. Under the act, email fraud, which includes
anonymous unsolicited bulk messages, is a federal crime. The defendants face up to
10 years in prison, in addition to the forfeiture of more than $4 million and their cars
and homes.

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Rio Salado Community College Financial Aid Scam

136 people in Arizona took part in a scam pretending to be college students in

order to obtain $538,932 in student aid.

The mastermind behind the scam was a woman who would recruit and charge fees
to participants who would pretend to enroll at Rio Salado College in order to illegally
collect financial aid. These fake students would pay her $500 to $1,500 each in
exchange for her help in applying for Pell Grants and Stafford Loans, and creating fake
documents, including high school diplomas and tax forms. The students would keep
most of the financial aid, but never attend class.

The scheme was discovered when an employee at Rio Salado noticed that several
financial aid applications appeared to have similar handwriting, and these "fake
students" were enrolling in the same online courses.

The woman who led the operation was arrested on charges of conspiracy, mail
fraud, financial aid fraud and making false statements. She is accused of creating
bogus documents to help people enroll in online classes over a 15-month period
beginning in July 2006.

65 were indicted because of their involvement in the scam. Most are charged with
financial aid fraud, a felony, and false statements in connection with financial aid, a
misdemeanor. Each charge of conspiracy and financial aid fraud carries a maximum
penalty of five years in prison and/or a $250,000 fine.

Las Vegas Woman Scams Nearly $1 Million in Student Aid

A Las Vegas woman, and her four children and three grandchildren, defrauded the
U.S. Department of Education of almost $1 million in student loans and grants by using
dozens of fraudulent ID's.

From January 2000 to March 2004, the defendants obtained personal information
for various persons, using it to apply for federal student loans and grants in distance
learning institutions in several states. The perpetrator would complete fake financial
aid applications which were submitted by fax and email. Financial aid checks were
received through the mail and the funds were obtained through the use of false
identification documents.

She assumed the identities of more than 65 people to obtain student aid at online
colleges in Arizona, Colorado, Maryland, Nevada and Texas. The scheme came to
surface when a financial aid officer noticed that a number of students were applying
for financial aid using the same addresses and telephone numbers.

The woman behind the scam pleaded guilty to one count of conspiracy to commit
student loan fraud and one count of student loan fraud, and received 57 months in
prison, 3 years of supervised release, and ordered to pay $662,081 in restitution.

Purdue Student Textbook Scam

A student at Purdue University devised a scheme to defraud Half.com users looking

to purchase textbooks.

21
 The scammer opened 384 phony bank accounts for fake employees and created
568 seller accounts at Half.com. He advertised the college textbooks for sale on all of
the phony Half.com seller accounts he had created. Buyers, believing they were
purchasing books from Half.com seller accounts, sent in over $5.3 million dollars in
payments. The student would take the illegally obtained funds and wire it back home
to bank accounts in Malaysia. The fraud was obviously discovered when none of the
students received the textbooks they had ordered.

The scammer was charged on December 19, 2007 in a 12 count indictment with
wire fraud.

Princeton Officials Hack into Yale Admissions Website

In 2002, Princeton’s Director of Admissions used the personal information of

Princeton applicants, including social security numbers, to gain illegal access to a Yale
admissions website.

Princeton personnel hacked into the system to see if Yale was offering prospective
students admission. Princeton admissions officers gained repeated, unauthorized
access to check the admission status of 11 applicants in April 2002. If applicants had
been accepted, the director either tried to steer them away from Yale or scratched
them off Princeton's admissions list. The incentive for Princeton was to protect its yield
by rejecting or wait-listing students it thought would choose Yale, or it could match or
top Yale's financial aid packages to coveted students.

Princeton claimed the act was just an innocent way to check the security of the
website.

Upon logging in to this Yale admissions website, accepted applicants would be

greeted by a display of fireworks on their computer screen. Because this welcome
screen would only display once, some applicants were left in the dark on their
admission status because officials at Princeton had already logged in using their
credentials.
Because of the violation and misuse of personal information, the case was further
reviewed by the FBI. The Director was removed from his position in the Princeton
Admission Office. Following the incident, Yale vowed to make its website more secure.

Clemson Manipulates US News College Rankings

When Clemson president James Barker took office in 2001, his stated goal was to
move Clemson into the top 20 public research universities. At that time Clemson was
ranked 38th.

By 2008, Clemson’s ranking jumped to 22nd in the nation, a surge that outside
observers say is improbable without massive capital investments in new faculty and
curriculum overhauls. The University managed to move up 16 spots in a ranking that
typically does not change all that much.

22
 Clemson admitted to "moving things around to make them look best" in the
rankings. Their approach in the rankings “walked the fine line between illegal, unethical
and really interesting.”

Clemson brought up their ranking by using several tactics:

 They focused on bringing classes of 20 and 25 students down to 18 or 19. This

significantly increased the proportion of its classes with fewer than 20 students,
one key U.S. News indicator of a strong student experience.
 They ceased to admit full-time, first-time undergraduates who were not in the top
third of their high school classes. Along the admissions process they constantly re-
assessed the SAT average of the incoming class (in an effort to increase
accumulative SAT score).
 They exaggerated the faculty salaries it reports to U.S. News by about $20,000,
which was achieved by actually increasing spending (paid for largely through
increased tuition).
 They rated all programs other than Clemson below average in the US News
rankings' peer reputation survey, which counts for 25 percent of the score, to make
the university look better.

The story received much media attention surrounding the manipulation of the
rankings, getting some to believe the methodology and criteria of the US News ranking
are fundamentally flawed if it can be manipulated this easily.

80,000 Students Duped in £16m College Fraud

According to prosecutors, three men in the UK conned over 80,000 students out of
more than £16 million by getting them to enroll in a fake college.

The alleged mastermind behind the scheme created a long-distance learning

college based in Middlesbrough, England. During the three years from 1999 to 2001,
over £16 million flooded into the accounts of the college, making the scamsters very
rich. Although millions of pounds were paid into the college, only 18 students gained
recognized qualification from the college.

The college claimed to be accredited, when it was not, and used the word "national"
in the title to give an impression of a long-established and recognized institution. It
also sent out worthless and forged certificates.

The college received £10m from students and £6m in grants from the Department
for Education, which the fraudsters used to carry out a high-roller lifestyle, using the
money for gambling and other personal interests.

The company went bust in November 2001, unable to pay creditors more than
£3.5m and unable to continue classes, leaving the students high and dry.

The scam came to light when in 2002, Police received a complaint of fraud from
the Department of Education regarding the college. The perpetrator was convicted of
fraud and money laundering and was jailed for 7 years.

Terrorists Enroll in Fake Colleges to Gain Student Visas into UK

23
 Thousands of young Pakistan civilians exploited a hole in Britain’s immigration
system to enroll themselves as students at a network of fraud colleges.

A Pakistani gang earned millions setting up fake colleges in the UK, allowing young
men from the heartland of al-Qaida to enroll and gain entry on student visas. Hundreds
of men paid at least £1,000 to the gang to be admitted into sham colleges. Some paid
£2,500 for fake diplomas, attendance records and degrees. This allowed the students
to extend their stay in Britain and enabled the fraudsters to make almost £2m in less
than two years.

8 terrorist suspects were arrested April 2009 for an alleged al-Qaeda bomb plot in
Manchester and Liverpool. All of the suspects claimed to attend the same college. This
bogus college had three small classrooms and three teachers for the 1,797 students
on record. Authorities soon found of another college claiming to have 150 students,
while secretly enrolling 1,178. An investigation uncovered ties between 11 colleges in
London, Manchester and Bradford, all formed within a few years and controlled by
three young Pakistani businessmen. Each of the three men entered the country on a
student visa. One has fled to Pakistan after earning an estimated £6 million from the
scam.

Because of the immigration loopholes in UK, UK Border Agency introduced stricter

rules on the admission of international students, in an effort to crack down on bogus
colleges and immigration loopholes.

University of Illinois Admissions Scandal

On May 29, 2009, the Chicago Tribune broke the news that some applicants to the
University of Illinois "received special consideration" for admission between 2005 and
2009, despite having sub-par qualifications. Many of these students were being
admitted after influence from state lawmakers and university trustees.

In one case, a relative of Tony Rezko, political fundraiser for former Governor Rod
Blagojevich, got admitted after University of Illinois President B. Joseph White wrote
an e-mail stating that the governor "has expressed his support, and would like to see
admitted" Rezko's relative and another applicant. The Rezko relative allegedly had a
"pretty low" ACT score and other credentials.
Since 2005, about 800 undergraduate students received special consideration in
admission by being placed on a "Clout" list. Some even had their rejections reversed
during an unadvertised appeal process. When a clout admissions process like this
happens, the student typically takes the spot of someone who is more qualified.
The investigation found:

 University officials recognized that certain students were underqualified, but

admitted them anyway.
 Admissions officers complained as their recommendations were overruled.
 Trustees pushed for preferred students, some of whom were friends, neighbors
and relatives.
 Lawmakers delivered admission requests to University of Illinois lobbyists, whose
jobs depend on pleasing the lawmakers.
 University officials delayed admissions notifications to weak candidates until the
end of the school year. One example cites the admittance of a student with "terrible
credentials", who was admitted after she got help from a University Trustee on an
appeal. To avoid drawing attention at the applicant's high school, where the

24
 acceptance of a "poor student" could raise eyebrows, the university waited until
the end of the school year to notify the applicant.
 One student was accepted into the business school after having been rejected three
times.
 University Officials forced the Law School to admit 30 applicants, in a law school
that is typically very competitive to get into. These are applicants who otherwise
would not have been admitted by the admissions office.
 A 2009 log managed by the university's government affairs office tracked nearly
80 applicants pushed by politicians. During the last five years, 114 elected officials
logged 481 admission inquiries. Some even spoke of blackmail, where lawmakers
threatened to change laws pertaining to university policy if their admission
requests weren't pushed through.

The admissions scandal forced the resignations of many trustees. A reconstructed

Board of Trustees voted to formally abolish "clout" admissions, and the office for
Governmental Relations is specifically prohibited from having any role in admissions.

The chairman of the board, Niranjan Shah, announced his resignation from the
board amid allegations of his involvement in admissions and that he pressured the
university to hire one his relatives. Shah's companies had received millions in state
contracts, and he had personally contributed more than $50,000 to Rod Blagojevich,
the indicted governor who appointed him to the Board.

University of Illinois President B. Joseph White and University Chancellor Richard

H. Herman both resigned because of the scandal.

Former applicants who were denied admission to the school filed a class-action
lawsuit against the university.

Student Loan Scandal

In early 2007, an investigation into the student loan industry by New York Attorney
General Andrew Cuomo uncovered illegal practices and conflicts of interest in the
relationships between colleges and lenders. The investigation uncovered revenue
sharing agreements with multiple colleges, in which lenders paid the colleges a
percentage of the loans the school sent their way. The investigation also found many
lenders provided gifts, all-expense-paid trips, and other perks to financial aid officials
in exchange for placement on preferred lender lists. It was revealed that some financial
aid officials also owned financial stake in a private loan company they were promoting
to students.

Over 100 schools were investigated in an effort to end corruption in the student
loan industry. Some of the notable schools involved included USC, Penn, NYU,
Syracuse, and Johns Hopkins.
New York Attorney General Andrew Cuomo did charge about a dozen colleges and
lenders, such as student loan giant Sallie Mae, with violating federal and state laws,
and filed lawsuits against them. Many of the parties involved reached settlements with
the Office of the Attorney General in New York, with the money going to a national
fund aimed at educating students and families about their financial aid options.

25
 Many colleges who participated in the "Preferred Lender" returned some of the
money to the students who had been guided into student loans with less favorable
rates. The University of Pennsylvania, Syracuse University, and New York University
are a few of the schools who agreed to reimburse students.
Colleges and lenders have reformed their practices in the face of new regulations.
Cuomo established a "College Code of Conduct" for best practices in student lending
and got many colleges to agree to it. Twenty-six schools and thirteen lenders have
now reached agreements with Cuomo.

The Student Loan Sunshine Act was passed in May 2007 which included provisions
banning gifts, perks, and revenue-sharing agreements between lenders and schools

CHAPTER 8

GOOD GOVERNANCE IN THE EYES OF IMF AND THE WORLD BANK

Recently the terms “governance” and “good governance” are increasingly used in
development literature because its opposite – “bad governance” is increasingly
regarded as one of the root causes of all evils within our societies.

Major donors and international institutions increasing base their decisions on the
grant of aids and loans on the condition that reforms that ensure good governance are
undertaken by the governments concerned.

Governance is not new. As a matter of fact, governance is as old as human

civilization. It is a process of decision-making and the process through which these
decisions are implemented or not implemented. History is replete of many cases of
both good governance and bad governance starting from the years before Christ up to
the present times.

Good governance is used in the following contexts: (1) corporate governance; (2)
international governance; (3) national governance; and (4) local governance.

26
 Based on these contexts, governance should be analyzed by focusing on the
following rationales so that the concept can be better appreciated and understood:

 the formal and informal actors involved in decision-making and implementing the
decisions made; and
 the formal and informal structures that have been set in place to arrive at and
implement the decision

On the other hand, the actors are:

 Government – the actors in here may vary based on the level of government that
is under discussion.
 Rural Areas – the actors may vary based on their role such as:
 Influential landlords, associations of peasant farmers, cooperatives, NGOs,
research institutes, religious leaders, finance institutions, political parties, the
military, etc.
 Local powerful families may make or influence decision-making
 Informal decision-making is often the result of corrupt practices or leads to
corrupt practice
 Urban Areas – the actors here vary much more in the rural areas because situations
are more complex and the interconnections between the actors involved in urban
governance are illustrated in Figure 1 for better appreciation and understanding:

A look at Figure 1 below will show the following observations:

 The actors at the national level who play a role in decision-making or in influencing
the decision-making process may include the media, lobbyists, international
donors, multinational corporations, etc.
 Formal Government – its structures are one of the means by which decisions
are arrived at and implemented
 Civil Society – grouping together of all actors other than government and the
military
 Organized Crime Syndicates – also influence decision-making especially in
urban areas and at the national level such as a “land-mafia”
 Similarly formal government structures are one means by which decisions are
arrived at and implemented.
 At the national level, informal decision-making structures, such as "kitchen
cabinets" or informal advisors may exist.
 In urban areas, organized crime syndicates such as the "land Mafia" may
influence decision-making.
 In some rural areas locally powerful families may areas locally powerful families
may make or influence decision-making.
 Such, informal decision-making is often the result of corrupt practices or leads to
corrupt practices.

Figure 1 – The Urban Actors

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Eight Major Characteristics of Good Governance

There are eight major characteristics of good governance – each an important

element to achieve success in its practice regardless of the context under which it is
employed by the leaders of managers concerned:

 Participatory
 Consensus Oriented
 Accountable
 Transparent
 Responsive
 Effective and efficient
 Equitable and Inclusive
 Follows the Rule of Law

The faithful practice of good governance may assure that (a) corruption is
minimized; (b) the views of minorities are taken into account; (c) the voice of the most
vulnerable in society are heard in decision-making; and (d) there is responsiveness to
the present and future needs of society.

Participation

 Key cornerstone of good governance, thus, needs the participation of both men
and women
 Could either be direct or through legitimate intermediate institutions or
representatives

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 Representative democracy does not necessarily mean that the concerns of the
most vulnerable in society would be taken into consideration in decision-making
 Must be informed and organized – means freedom of association and expression
on the one hand and an organized civil society on the other hand.

Equity and Inclusiveness

 A society’s well being depends on ensuring that all its members feel that they have
a stake in it and do not feel excluded from the mainstream of society.
 This requires all groups, but particularly the most vulnerable, have opportunities
to improve or maintain their well being.

Effectiveness and efficiency

 Good governance means that processes and institutions produce results that meet
the needs of society while making the best use of resources at their disposal.
 The concept of efficiency in the context of good governance also covers the
sustainable use of natural resources and the protection of the environment.

Accountability

 Accountability is a key requirement of good governance. Not only governmental

institutions but also the private sector and civil society organizations must be
accountable to the public and to their institutional stakeholders.
 Who is accountable to whom varies depending on whether decisions or actions
taken are internal or external to an organization or institution.
 In general an organization or an institution is accountable to those who will be
affected by its decisions or actions.
 Accountability cannot be enforced without transparency and the rule of law.

Clearly, good governance is an ideal which is difficult to achieve in its totality

because very few countries and societies have come close to it. However, to ensure
sustainable human development, actions must be taken to work towards this ideal
with the aim of making it a reality.

The International Monetary Fund (IMF)

IMF’s Role in Governance Issues

 IMF seeks to help countries to improve governance, to limit the opportunity for
corruption, and to increase the likelihood of exposing instances of poor governance.
 It also addresses issues of poor governance including corruption when they have
been judged to have significant macroeconomic impact.

Principles of Good Governance (Paula Dobiansky, Undersecretary of State Guild

Affairs)

 Development cannot flourish where people cannot make their voices heard, human
rights are not respected, information does not flow, and civil society and the
judiciary are weak (Paula)

Millennium Challenge Account

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 Distributed to nations that govern justly, invest in their people, and encourage
economic freedom – given only to countries which has evidence that it practices
good and just governance.

Most Basic and Important Principle of Good Governance:

 A nation’s political institutions be democratic.

 Democracy – a form of government “of the people, by the people, and for the
people.
 Basic Human Right – the right of an individual to speak freely about his government
that arises from every person’s worth as a human being, as has been recognized
by nations all over the world.

Five Key Principles of Good Governance

Free and Fair Elections

 Legal safeguards and rights must exist to have a functional democracy – such as
country’s commitment to citizen’s political rights
 Means that voters have a right to information regarding candidates’ platforms so
they can make intelligent choices before voting
 Elections should be unrestricted and free from government coercion and
interference; free of discrimination based on sex, race or ethnicity
 Accountable leadership and fulfillment of the will of the people are essential to
ensuring that elections are a means to a democratic society, not an end in
themselves.

Independent Judiciary and Rule of Law

 Presence of constitutional limits on the extent of government power:

 Periodic elections
 Guarantees of civil rights
 Independent judiciary, which allows citizens to seek protection of their rights
and redress against government actions.
 The limits help make branches of government accountable to each other and to the
people:
 An independent judiciary is important for preserving the rule of law
 It takes more than strong courts to ensure that a nation’s laws are enforced
constantly and fairly – all branches must be willing bound by the law
 Rule of law is also the basis for fussiness formation and the establishment of
capital markets which underpin economic development
 Citizens or their elected reps should be involved in all levels of lawmaking –
participation in the process gives people a stake in the law and confidence that
the law will preserve their personal and property rights.
 The law should not only be enforced, but it should also be enforced fairly and
without discrimination
 God governance means equal protection for men and women and minorities
and open and fair access to judicial and administrative systems
 Political and civil rights should not be denied citizens because of their sex, race or
ethnicity – a nation’s court should be open to all, not to a select few only.
 Government agencies should allow appeals of regulations as well as citizen
participation in their decision-making process and citizens should be granted
access to these bodies in a timely and easy manner

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Freedom of Speech and Press

 A just and democratic society can function properly only if there is a free exchange
of information and ideas
 Best realized in the creation of a free and open press and the freedoms of speech
and expression
 A free press provides voters with the information they need to make informed
decisions
 Facilitates the exchange of political discourse, creating a “marketplace of ideas”
where no view is stifled and the best are chosen
 Serves as a check on government power ensuring that public officials and
institutions remain accountable to the voters
 Preserves public trust in the markets and for attracting foreign and domestic
investment
 The right of the press to freely publish, to editorialize, to critique, and to inform
is a fundament principle of democracy.

Fighting Corruption

 GG means the absence of corruption

 Governments must strive to rid themselves of bribery and graft
 Corruption damages economic development and reform impedes the ability of
developing countries to attract foreign investment, hinders the growth of
democratic institutions and concentrates power in the hands of a few
 The best way to combat corruption is for governments to be open and transparent
– it can retain secrecy and confidentiality – but it must at the same time be
sensitive to the citizen’s right to know
 Strong laws against corruption and the presence of law enforcement agencies that
work against corruption demonstrates a government’s commitment to this principle

Investing in People

 Good governance requires that governments invest in their people and work to
preserve the welfare of their citizens, without regard to gender, race, or ethnicity.
 Governments should devote resources to health care, education, and combating
poverty.
 Governments should strive to create an economic environment where people can
find jobs and establish businesses.
 Along with other measures, a government's ability to provide for its people is
considered by the MCA in determining governmental effectiveness.
 Governments also have a duty to protect their citizens from criminal violence,
especially the practice of trafficking of persons. Women and girls are most
vulnerable to this illegal trade, which can only be stopped by diligent law
enforcement.

Conclusions:

 Practicing these principles of good and just governance results in a free and open
society where people can pursue their hopes and dreams. This will facilitate the

31
 creation of robust and open economies, which are trusted by investors and financial
institutions.
 Development cannot flourish where people cannot make their voices heard, human
rights are not respected, information does not flow, and civil society and the
judiciary are weak.
 The United Nations Development Program (UNDP) and the World Bank, among
others, have come to realize that development assistance that focuses only on
economic governance at the expense of democratic governance fails.
 All the worlds richest countries, except two, have the most democratic regimes of
the world. 42 of 49 high human development countries on UN Development Index
are democracies.
 It is America's hope that by promoting good governance in our foreign policy,
particularly through the MCA, the condition of citizens' lives worldwide will be
enhanced through the creation of strong democratic nations with prosperous
economies and improved standards of living.
 Americans have a deep appreciation for the freedoms and opportunities they enjoy
and believe the principles that underlie our democratic institutions and vibrant civil
society are the best way to achieve sustainable economic growth.
 The President's MCA initiative marries the commitment of developing nations that
govern justly with the commitment of the United States to support their reform
efforts and to help fulfill the dreams of freedom-loving people throughout

The Asian Development Bank (ADB)

 Governance describes the process of decision-making and the process by which

decisions are implemented (or not implemented).
 Public institutions conduct:
 public affairs
 manage public resources, and
 guarantee the realization of human rights.
 Good governance accomplishes this in a manner essentially:
free of abuse and corruption, and
with due regard for the rule of law.
 Good governance defines an ideal which is difficult to achieve in its totality.
However, to ensure sustainable human development, actions must be taken to
work towards this ideal.
 Major donors and international financial institutions, like the IMF or World Bank,
are increasingly basing their aid and loans on the condition that reforms ensuring
good governance are undertaken.
 A basic practical example of good governance would be where a member of a
committee, with a vested interest in a topic being discussed at committee, would
absent themselves from the discussion and not attempt to exert influence.

Related Terms of Good Governance

 Due Diligence – the performance of an act with a certain standard of care; to do

everything possible to get a desired state
 Diligence of a Father – the kind of care and concern given by a father to his children
 Good Government – a government that meets its legitimate objectives or one who
most effectively secures the rights of the people and the rewards of their labor,
which promotes their happiness and also does their will.
 Peace, Order, and Good Government – an expression used in law to express the
legitimate objects of legislative powers conferred by statute.

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 Worldwide Governance Indicators – the six key dimensions of governance
 Voice and accountability
 Political stability and lack of violence
 Government effectiveness
 Regulatory quality
 Rule of Law
 Control of Corruption

ADB is Dedicated to:

 combating the region’s poverty in all its aspects,

 fostering growth
 social development and
 good governance

Good Governance as it Pertains to Asian Development Bank (ADB)

 Strategic Priority – eliminate poverty in Asia and the Pacific by assisting developing
countries improve their governance.
 ADB knows that poor governance holds back and distorts development process and
has disproportionate impact on poorer and weaker sections of society.

ADB Working for Asia and Pacific's Poor

 Asia and the Pacific – a region which is home to 2/3 of the world’s poor and where
poverty remains the most pressing issue today.
 ADB is dedicated to combating the region's poverty in all its aspects, fostering
growth, social development and good governance to boost incomes and
opportunities, improve living conditions, and provide the basic services many in
richer countries take for granted.
 The Three Pillars of the Framework for Poverty Reduction of ADB are pro-poor,
sustainable, socially inclusive development:
 Economic growth
 Social development
 Good governance
 The overreaching goal of ADB today is reduction of poverty, which is no longer just
one of its five objectives – a fundamental shift that will affect every aspect and
level of its operations.
 Poverty Reduction Strategy of ADB
 Uses good governance, one of the three pillars, as a Core Strategic Area of
Intervention under its Long-term Strategic Framework (2001 – 2015)
 Recognizes the importance of capacity development and identifies four key
interrelated elements that are considered necessary to sustain efforts and
ensure results:
 Accountability
 Participation
 Predictability
 Transparency

Accountability

 Public officials must be answerable for government behavior, and responsive to the
entity from which their authority is derived.

33
 ADB's efforts towards promoting accountability in governments build the capacity
to undertake economic reforms, implement them successfully, and provide citizens
with an acceptable level of public services. Criteria are established to measure the
performance of public officials, and oversight mechanisms set up to make sure the
standards are met.

Participation

 Participation refers to the involvement of citizens in the development process.

Beneficiaries and groups affected by the project need to participate so that the
government can make informed choices with respect to their needs, and social
groups can protect their rights.
 ADB promotes participation in governments by
 Encouraging the participation of project beneficiaries and affected groups
 Improving the interface between the public and private sectors
 Empowering local government by letting them take ownership of the project
 Using NGOs as vehicles for mobilizing and reaching project beneficiaries

Predictability

 A country's legal environment must be conducive to development. A government

must be able to regulate itself via laws, regulations and policies, which encompass
well-defined rights and duties, mechanisms for their enforcement, and impartial
settlement of disputes. Predictability is about the fair and consistent application of
these laws and implementation of government policies.
 Transparency refers to the availability of information to the general public and
clarity about government rules, regulations, and decisions. It can be strengthened
through the citizens´ right to information with a degree of legal enforceability.
Transparency in government decision-making and public policy implementation
reduces uncertainty and can help inhibit corruption among public officials.
The Core Areas of Intervention

 Core Areas
 Sustainable economic growth
 Inclusive social development
 Governance for effective policies and institutions
 ADB has undertaken significant work in these areas, strengthening
accountability institutions such as audit agencies, anticorruption commissions,
and the judiciary.
 ADB’s support for judicial reform in India, Pakistan, and Philippines is strengthening
the rule of law, which is crucial to encourage private sector investment and combat
corruption.

Accountability Institutions

 Audit agencies
 Anticorruption commissions
 The Judiciary - support for judicial reform comes in strengthening the rule of law
which is crucial to encourage private sector investment and combat corruption.

Framework for Action on Good Governance by ADB

34
 The strategic framework for action which guides its governance and anticorruption
work is provided by ADB’s governance and anticorruption policies and Second
Governance and Anticorruption Action Plan (GACAP II).
 GACAP II outlines a comprehensive risk-based approach to managing governance
and fighting corruption, refocusing efforts to achieve results in three priority areas
in the sectors where ADB operates
 improving public financial management
 strengthening procurement systems
 combating corruption
 ADB recognizes that a “one-size fits all” approach does not work and has partnered
with other development institutions and developing member country (DMC)
colleagues to develop innovative interventions to meet the unique needs of DMC
countries and specific sectors.

CHAPTER 9

GOOD GOVERNANCE PRINCIPLES AND PRACTICEs

Ethical Imperatives Over Legal Considerations (Carly Florina – American

Politician and Businesswoman)

The Winning Companies

 Ultimately, what we are seeing in today’s marketplace is that the winning companies
of this century will be those who increase social value at the same time.
 More and more shareowners, customers, partners and employees will begin
rewarding companies that fuel social change through business initiatives.

It is an incumbent responsibility of management and of corporate officers:

 To lead by example.
 To be accountable to the organization, to serve at the pleasure and the benefit of
their shareowners, customers, and employees and not the other way around.
 To manage the risks in today’s global economy by managing its reputation – and
to know the difference between the legal thing to do and the moral thing to; and
that to do what is profitable without doing right is ultimately to do the wrong.

35
 To give importance, more than ever before, in a world defined by the newest
technology – to the oldest values of trust, honest, integrity, accountability and
responsibility - as they have never been considered before.
 To take ownership of the problems of accounting and financial deceptions and
manipulations regardless of whether or not the company is touched by scandals.

Characteristics of Abuse, Unethical Practice or Corporate Scandal

 In every company accused of abuse, the traits are all the same: abuses of power,
breach of ethics, undermining of honest accounting, deception of both public and
private watchdog groups and, sometimes, the willing cooperation of such groups.
 In each case, the checks and balance failed, and people tried to get away with
gains made at somebody else’s expense.
 It is also true that these abuses occurred in an era when many quarters – some
media, some analysts, some management teams – seemed to forget their
fundamentals: real profit, real cash flow, and real balance sheets matter –
fundamentals like trust, integrity and responsibility matters.
 The New York Times pointed out “many issues have been blended together in the
public mind-set – from cooking the books and stealing corporate cash to excessive
pay and perks” – making no distinction between crime and common practices.
That’s because, to many, there are no distinctions.
 As is their role, into this breach, regulators and government official have stepped
in with ideas for new regulation and legislation.
 While the US government has taken a hammer to conflicts of interest among
auditors and executives, the New York Stock Exchange has done the same thing
for boards of directors.
 From the integrity of certified financial audits to appropriate accounting principles
and auditing standards, what used to be the legal ceiling is increasingly becoming
the legal floor.
 True leadership for a new Age of Reform must come from corporations themselves
as it did 100 years ago following a similar decline in public trust.

Some Consequences of Unethical Practice:

 Enron took a billion-dollar write-down of investments. Within three weeks, it

reported it overstated its earnings since 1987 by $586M. Within 6 weeks, it –
which was valued at more than $60 B – filed for bankruptcy.
 The stunning collapse of Enron not only cast a long shadow over capital markets,
it quickly gave way to headlines that more Enrons were to come. And sure enough,
they have come – more than 10 in all – leading one newspaper to refer to the
parade of fallen business leaders at the “corporate perp walk” led by Arthur
Andersen
 Lets call this scandal what it really is: it is greed, pure and simple.

Concepts and Practices of Corporate Governance:

 Stewardship Responsibility of Corporate Directors

 To provide oversight in fostering the implementation of the goals and strategies
of the company.
 To provide leadership by using its inherent powers to improve shareholder
value and to support a continuing commitment to growth.
 To coordinate the relationship among the various participants in determining
the direction and performance of the corporation.

36
 The art and science of managing the government of the corporation.
 A style of leadership set by the Board of Directors characterized by a high degree
of cooperation existing between them and senior management.
 A relationship among stakeholders that is used to determine a firm’s direction
and to control the company’s performance.
 A system where shareholders, creditors and other stakeholders of a corporation
ensure that management enhances the value of the corporation as it competes
in an increasingly global marketplace.

 A traditional view of corporate governance which has three basic assumptions:

 Primacy of the shareholder.
 Diversity of the shareholder group.
 The maximization of shareholder wealth as a fundamental “raison d ‘etre
(reason for being or an emotional attraction to a course of action or in Japan
‘ikigai’)

 A shareholder-centric approach concerned with the following:

 Investor protection
 Management accountability
 Transparency
 Shareholder activism
 Providing adequate incentives to management
 Disciplining and replacing bad management
 Enhancing corporate performance
 Improving access to capital markets
 Promoting long-term investment
 Encouraging innovation

 A field of economics that investigates the ways to secure or motivate efficient

management of corporations through the use of incentive mechanisms like
contracts, organizational designs and legislation.

 It deals with ways in which suppliers of finance to corporations assure themselves

of getting a return on their investment.

 A system through which business corporations are directed and controlled and is
defined narrowly – as the relationship of a company to its shareholders, or more
broadly, the relationship of a company to society.

 Promotes corporate fairness, transparency and accountability and a fancy term for
the way in which directors and auditors handle their responsibilities towards the
shareholders.

 Synonymous to shareholder democracy.

 A system within an organization that protects the interests of its diverse

stakeholders.

Values of Corporate Governance

 Accountability
 Trust

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 Transparency
 Integrity
 Honesty
 Responsibility
 Leadership by Example
 Ethical Standards

Global Perspectives on Corporate Governance

Organization for Economic Cooperation and Development (OECD) Principles of Good

Governance
1. Corporate Objective
 To optimize over time the returns of the shareholders
 To achieve this – the corporation should endeavor to ensure the long-term
viability of its business, and to manage effectively its relationships with
stakeholders, that is those with legitimate interest in the operation of the
business such as employees, customers, suppliers, creditors, and the
communities in which the company operates.
2. Communications and Reporting: Disclosure and Transparency
 Corporations should disclose accurate, adequate and timely information to allow
investors to make informed
3. Voting Rights
 Ordinary shares should feature one vote for each share
 Corporations should act to ensure the owners right to vote
 Fiduciary investors have a responsibility to vote and regulators and law should
facilitate voting rights and timely disclosure of the levels of voting
 Changes should not be made without prior approval of shareholders
 Use of telecommunications and other electronic channels should be allowed
 Transparency requires that meeting procedures ensure that votes are properly
counted and recorded, and that a timely announcement of the outcomes be
made.
4. Corporate Boards
 The board of directors or supervisory board as an entity and each of its members
as an individual is a fiduciary for all shareholders, and should be accountable to
the shareholder body as a whole.
 Fiduciary – a term derived from Roman Law which means that a person holding
the character of a trustee, or a character analogous to that of a trustee, in
respect to the trust and confidence involved in it, and the scrupulous good faith
and candor which it requires.
 Fiduciary Capacity – means that each director holds in trust the money of
investors and should, therefore, take care of it as if it is their own.
 Disclose information on the identities, core competencies, professional and other
backgrounds; factors affecting independence, and overall qualifications of board
members and nominees so as to enable investors to weigh the value they add
to the company. Appointment procedure should also be disclosed annually.
 Boards should include a number of independent non-executive members with
appropriate competencies.
 Responsibilities include monitoring and contributing effectively to the strategy
and performance of management, staffing key committees of the board, and
influencing the conduct of the board as a whole.
 Audit, remuneration and nomination board committees should b composed
wholly or predominantly of independent non-executives.
5. Corporate Remuneration Policies

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  Remuneration of corporate directors or supervisory board members and key
executives should be aligned with the interests of the shareholders.
 Board should disclose policies on remuneration broken-up per individual board
member and top executives, so investors can judge whether corporate pay
policies and practices meet the standard.
 Broad based employee share ownership plans or other profit-sharing programs
are effective market mechanism that promote employee participation.
6. Strategic Focus
 Board should notify shareholder and get their approval if major strategic
modifications will be made
 Equally major corporate changes which in substance or effect materially dilute
or erode the economic interests of share ownership rights of existing
shareholders should not be made without prior shareholder approval of the
change.
 Shareholders should be given sufficient information about any such proposal,
sufficiently early, to allow them to make an informed judgment and exercise
their voting rights.
7. Operating Performance
 Board should focus attention on optimizing over time the company’s operating
performance, in particular, to excel in specific sector peer group comparisons.
8. Shareholder Returns
 Board should optimize over time the returns to shareholders and, in particular,
should strive to excel in comparison with the specific equity sector peer group
benchmark

9. Corporate Citizenship
 Corporations should adhere to all applicable laws of the jurisdictions in which
they operate.
 Board that strive for active cooperation between them and stakeholders will
most likely create wealth, employment and sustainable economies.
 Board should be accountable to shareholders and responsible for managing
successful and productive relationships with the corporation’s stakeholders.
 Performance-enhancing mechanisms promote employee participation and align
shareholder and stakeholder interests – such as employee share ownership
plans or other profit sharing programs.
10. Corporate Governance Implementation
 Codes of best governance practice must be developed if it does not exist yet,
however, if exists, it must be practiced pragmatically.
 Corporate governance issues between shareholders, the board and
management should be pursued by dialogue and where appropriate, with
government and regulatory representatives, as well as other concerned bodies,
so as to resolve disputes, if possible through negotiation, mediation or
arbitration.
 When these fail, more forceful actions should be possible – such as the right of
investors to sponsor resolutions or convene extraordinary meetings.

Developments in Corporate Governance

Developments that Forced Corporations to Rethink their Concepts of Corporate

Governance
1. Globalization
2. Emerging Markets

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3. A Networked Economy
4. Changing Ideas at Responsibility

Types of Current Discussions on Governance

1. Regulatory and compliance rules imposed on publicly traded companies or larger
corporations
2. Tool for growth and sustainability for companies
3. Governance is central not only to the success and failure of companies, but of
industries and economies

Emerging Practices in Corporate Governance

1. Has lot to do with transparency, integrity, accountability, communication, and
decision-making
2. Growing interest in the general connection between good governance practices and
corporate performance
3. Goes beyond the simple concept of who is in charge and who is in control
4. Improves shareholder value as a goal and support for continuing commitment to
growth
5. Becomes a business reality in the different markets in the world
6. However, it is viewed that “natural governance” should be essentially the same in
all markets – emerging and developed
7. Commentators suggest that “one size doe not fit all” when it comes to governance
8. Distinctions in the stages of evolution of start-up companies in the “new economy“
against those in the “old economy” are emblematic (symbolic or representative) of
the view that governance is more than shareholder/management alignment or
about who is in control
 New Economy – two broad trends that have been underway for several years –
the globalization of business (spread of capitalism – introduction of market
forces, freer trade, and deregulation) and the revolution of information
technology (fax, personal computers, modems, internet, but more than these,
the digitalization of information – words, pictures, data and so on.
 Digital Technology – creates new companies and new industries – in Silicon
Valley alone there are 11 new companies born weekly, although not all of them
succeed.
 These trends can combine in powerful ways to raise Americans' standard of
living, create jobs, spur entrepreneurial effort--and do all this without boosting
inflation.
9. Governance structures of “new economy” companies must change and react to
rapidly evolving changes in control – old economy companies typically evolve
control structures and governance practices much more slowly
10. Start of trends of “holistic governance
 Traditional concepts of governance – about mere financial return, efficiency in
which companies are operated in the interests of the shareholder, fair treatment
of minority shareholders or other shareholders
11. New thinking in governance
 Company strategy and life cycle development
 Management discipline
 Social responsibility

Holistic Governance – more complex and can be uncovered by asking the

following questions:
1. What are the companies’ primary activities?
2. What is its stage of development?

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3. What is its ownership structure and how will it evolve?
4. Where has it raised capital?
5. Is there a controlling strockholder/s?
6. How big is its revenues, employees, locations?
7. Where is its head office?
8. Where does it carry on business?
9. Where does it sell products/services?
10. What are its human capital needs?
11. How positive is its relationship with its stockholders?
12. How positive is it in encouraging innovation?

Context of Governance Mechanisms - is the concept and practice of separation of

ownership from management,
1. Modern companies are characterized by an agency relationship that is created
when one party (firm owners) hires and pays another party (top-level managers)
to use its decision-making skills
2. Owners (principals) hire managers (agents) to make decisions to maximize the
firm’s value
3. As risk-bearing specialists, owners diversify their risk by investing in multiple
corporations with different risk profiles
4. As decision-making specialist, owner expect their agents (top level managers) to
make decisions that will lead to maximization of the firm’s values

The Governance Mechanisms in the Modern Corporation:

1. Internal Mechanism
 Board of Directors
 Ownership Concentration
 Executive Compensation
2. External Mechanism – market for corporate control

The Internal Mechanisms

Board of Directors

 A governance mechanism that shareholders expect to represent their collective

interests
 A group of elected individuals whose primary responsibility is to act in the owner’s
interests by formally monitoring and controlling the corporation’s top executives
 Have the power to direct the affairs of the organization, punish and reward
managers, and protect shareholders’ rights and interests, thus, an appropriately
structured and effective BOD protects owners from managerial opportunism
 Board members are stewards of their company’s resources, and the way they carry
out these responsibilities affects the society in which their firm operates

Classes of Board Members

 Insiders are active top-level managers in the corporation who are elected to the
board because they are a source of information about the firm’s day-to-day
operations
 Related outsiders have some relationship with the firm, contractual or otherwise,
that may create questions about their independence, but they are not involved with
the corporation’s day-to-day activities

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 Outsiders provide independent counsel to the firm and may hold top-level
managerial positions in other companies or may have been elected to the board
prior to the beginning of the current CEO tenure
Poor Corporate Practices
 Many do not fulfill their primary fiduciary duty to protect shareholders
 Many boards are a managerial tool – they do not question managers’ actions
 Readily approve managers’ self-serving initiatives
 Inside directors who are top-level managers dominate the boards and exploit their
personal ties with them
 Those with significant percentage of its membership from the firm’s top executives
tends to provide relatively weak monitoring and control of managerial decisions
 Boards have not been vigilant enough in hiring and then monitoring the behavior of
CEOs

Reforms are being advocated that to ensure the independence of the board a
significant majority of the total membership of the board should be outsiders and
independent.

Ownership Concentration

 Ownership Concentration – defined by both the number of large-block shareholders

and total percentage of shares they own
 Large-block shareholders – typically own at least 5 percent of a corporation’s issued
shares.
 Institutional owners are financial institutions such as stock mutual funds and
pension funds that control large-block shareholder positions
 As a governance mechanism has received considerable interest because they
are increasingly active in their demands that corporations adopt effective
governance mechanisms to control managerial decisions
 Diffuse Ownership – in general – large numbers of shareholders with small
shareholdings and few, if any, large-block shareholders – produces weak monitoring
of managers’ decisions
 Makes it difficult for owners to effectively coordinate their actions
 Diversification of the product lines beyond the shareholders’ optimum level might
result from weak monitoring of managers’ decisions
 Higher levels of monitoring could encourage managers to avoid strategic decisions
that do not create greater shareholder value
 Research evidence shows that ownership concentration is associated with lower
levels of firm’s diversification
 With high degree of ownership concentration, the probability is greater that
manager’s strategic decisions will be intended to maximize shareholder value
 The US SEC issued several rulings that support shareholder involvement and control
of managerial decisions
 Ex. SEC eased its rule regarding communications among stockholders – now they
can by simple communication to the SEC can call and convene a shareholders’
meeting to discuss the corporation’s strategic direction – if a consensus exists,
shareholders can vote as a block

Executive Compensation

 A governance mechanism that seeks to align the interests of managers and owners
through salaries, bonuses, and long-term incentive compensation such as stock
options

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 Stock options are mechanisms used to link executives’ performance to the
performance of their company’s stock
 Increasingly long term incentive plans are becoming a critical part of compensation
packages in US firms
 The use of longer-term pay helps firms cope with or avoid potential agency
problems
 Because of this the stock market generally reacts positively to the introduction of
long-range incentive plan for top executives
 The primary reasons for compensating executives in stock is that the practice
affords them with an incentive to keep the stock price high and hence aligns
managers’ interests with shareholders interests
 However, managers who own greater than 1 per cent of their firm’s stock may be
less likely to be forced out of jobs, even when the firm is performing poorly
 Research show that the firm size accounts for more than 40% of the variance in
total CEO pay, while firm performance accounts for less than 5% of the variance
 Thus, the effectiveness of pay plans as governance mechanism is suspect
 Another way to compensate executives is through loans with favorable or no
interest for the purpose of buying the corporation’s stocks
 It aligns executives priorities with the shareholders in that the executives hold
stocks, not just options. The downside is when the price of the stock tumbles, the
executives may not be able to pay the loan

Executive Compensation in International Strategies

 Governance mechanism particularly challenging to firms implementing international

strategies
 Ex. the interests of owners of multinational corporations may be best served when
there is less uniformity among the firm’s foreign subsidiaries’ compensation plans
 Levels of pay vary by regions of the world – managers in the US is paid higher than
in Asia
 As corporations acquire firms in other countries, the managerial compensation
puzzle becomes more complex and may cause additional top executives turnover
 Ex. Daimler-Benz acquired Chrysler, the executives of the former were receiving
less, but the executives of the latter ended up reporting to the executives of
Daimler-Benz.
 Lately, executive pay is under fire because it increased by 571% between 1990 and
end of 2000
 In 2000 when Standard & Poor’s stock index of 500 corporations suffered a loss of
10%, this trend of CEO pay continued
 Average workers pay barely outpaced inflation over the same decade; it increased
by 37% vs. inflation of 32%. The discrepancy between their pay and the executive’s
pay defy logic.
 Board of Directors of any large publicly owned corporation make executive pay
decisions, typically through an executive compensation committee
 1990’s – competitive benchmarking – setting standards based on those of
competitors – became widespread
 It is estimated that 96% of the companies in S&P’s 500 stock index used such
benchmarking to set executive pay.
 Executive compensation committees rationalize that if their CEOs do not earn as
much as their peers, they may seek a position in another company
 Research has shown that this approach has led to underperforming executives
getting increased pay regardless of their performance

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External Mechanisms

Market for Corporate Control

 An external governance mechanism that becomes active when a firm’s internal
controls fail.
 It is triggered by a corporation’s poor performance relative to industry
competitors.
 It is shown up by the firm’s earning below-average returns.
 Or that the internal corporate governance mechanisms failed to produce
managerial decisions that maximized shareholder value.
 Composed of firms and individuals who buy ownership positions to take over the
undervalued corporations. Its executives are replaced because they are held
accountable for their firm’s poor performance.

Corporate Governance and Risk Management

Corporate governance has become an issue for a growing number of risk managers
because of the skyrocketing directors’ and managers’ liability premiums.
 Companies are self-insuring an increasingly large amount of this exposures due to
both higher deductibles and lower coverage levels.
 The current climate makes it increasingly difficult for companies to attract and even
retain top-notch directors, executives and employees, especially if they sense a
company’s corporate governance process is not well defined or well respected.
 The situation put the “risk manager in a place of authority to play a part in managing
corporate governance standards – they ask the following questions:
1. Do we have corporate governance process and, if so, how much effective are
they?
2. Do we need to improve them and, if so, in which specific areas to prevent losses?
3. How can we improve our corporate governance to improve the long-term
sustainability of our organization?

Strategic Role of Risk Managers

Risk managers can play a valuable strategic role in the company by helping to develop
more efficient processes to monitor risks and by strongly supporting a companywide
culture of sound corporate governance, as follows:
 Champion the reasons why corporate governance is critical to a company’s well-
being
 Prevents CEOs and CFOs from having to testify in Congress or being led away
in handcuffs
 Important element of meeting legal requirements and upholding fiduciary
responsibilities to investors
 Helps attract and retain good employees, officers and directors
 Makes the company an attractive business alliance partner and generate
community support
 Good governance is clearly the ethical thing to do – it yields improve shareholder
returns, making the effort well worth the cost
 Corporate governance is now more pro-active and continuous process that
assesses, sources, measures and manages risks across the enterprise
 Instills a culture of sound practices and ethics
 Fosters an understanding of company risks and how to manage them
 Puts in place efficient, appropriately executed processes to manage and monitor
risk on an ongoing basis

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 New requirements place additional responsibility on the board of directors to
implement strong risk management processes, which more often include more
progressive internal auditing
 Helps companies shift their corporate governance focus from legal and
regulatory compliance to broader-based business risks
 Compels risks managers to work with audit and information technology teams
as well as operating management to deliver this strategic approach to risk
management

Seven Commandments of Good Corporate Governance

1. Board of Directors and Committees

 Oversees strategic development and the operational and financial performance
of the organization as well as its conduct and corporate governance practices
 By-laws describe the technical execution of this responsibility, yet good
governance also depends on the attitude, competencies and independent voices
of individual directors and their chemistry as a group

2. Legal and Regulatory

 Defines the boundaries based on current laws and regulation at the
international, national, and local levels
 Covers the rights of shareholders and legal responsibilities of management and
the board of directors
3. Business Practices and Ethics
 Business ethics are the moral boundaries or values a firm believes it should
work within
 Provide general guidance to employees for situations not explicitly anticipated
by company policy and procedures
 Business practices are the specific ways business ethics are acted upon in a
given circumstances
 Codes of conduct is a cornerstone in the communication of business practices
and ethics
 Senior management needs to show strong support for ethical behavior in words
and action and must visibly and consistently discipline any breaches
4. Disclosure and Transparency
 Executive certification of financial statement required of all publicly trade
companies in the US
 Reporting should clearly reflect business reality – should be timely, relevant
and easily understandable to users
 The principles apply to information that companies provide to important
stakeholders other than investors and creditors
5. Enterprise Risk Management (ERM0
 Covers risks that cannot be insured in the financial markets
 A future oriented mechanism that symbolically identifies and assess all risks
that threaten to prevent an organization from achieving its mission and
business strategies
 Encompasses the design, implementation and monitoring of strategies to
reduce, transfer or avoid each significant risk
 A proactive ERM process reduces the likelihood that uncontrolled business risks
will cause unexpected losses, reputational damage or strategic detours and
setbacks.
6. Monitoring

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  Activities that ensures all other parts of the corporate governance framework
are working as expected – includes internal audit, legal, regulatory and ethical
compliance functions, management performance reporting and analysis, and
board assessment processes
 Ongoing periodic evaluation and testing help create an ever-improving and
sustainable process
 Collaboration with these groups by risk managers can improve corporate
governance and reduce risk management costs over time
7. Communication
 Communication is the motor oil that makes the six components (parts of the
engines) work effectively without locking up.

Risk Manager’s Role

1. Risk Management – the fundamental strategy for ensuring strong corporate

governance and perpetuation of the business which creates an opening for risk
managers to demonstrate their additional value to the board of directors
2. Proactive role of risk managers can incorporate each component of the corporate
governance system – how to identify and assess risks, how to develop and
implement efficient processes to manage and monitor risks, and support a
company-wide culture of sound business practices and ethics

The Board of Directors

Role and Function of the Board

1. Overseeing management, reviewing performance, and ensuring that the various
activities of a company are socially responsible and in compliance with the law
(Korsch and Maclaver)
2. A proactive view more in terms of establishing strategic direction and overseeing
company strategy, assessing and monitoring performance, but also, and especially
in the case of executive directors, becoming involved in action to ensure
implementation (Tricker)
3. The legal and formal accountabilities to stakeholders are established by the
legislative and regulatory framework within which the company has incorporated

The Elements of Corporate Governance

 Determining what needs to be done

 Provide and maintain a purpose for the company, a reason for its continued
existence
 Determine, articulate, communicate and share a distinctive and compelling
vision
 Establish, review and communicate clear goals, values, and objectives derived
from the vision
 Ensure that the visions, any associated mission, and the goals, values and
objectives of the company are consistent with the needs, interests, and
requirements of its various stakeholders
 Formulate, review and communicate realistic strategies for the achievement of
the defined goals, values and objectives
 Creating the capability to do what needs to be done
 Ensure that the company has adequate funds, people, organization, support
technology and management and business processes to implement the agreed
strategies and subsequent plans

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  Appoint a management team and establish the values, principles of conduct,
and policies that define the framework within management operates
 Appointment of a new CEO is a key opportunity to influence the future direction
and performance of a company
 Establish and maintain partnership relationships with people and organizations
whose cooperation will be required if the visions, goals, values, and objectives
are to be achieved (supply-chain, joint-venture)
 Deciding how to do what needs to be done
 Establish and allocate clear roles and responsibilities with the boardroom team
particularly the Chairman and the Chief Executive and to allocate
responsibilities for the key cross-functional and inter-organizational processes
that deliver the value that is sought by customers
 Delegate responsibilities as appropriate to the management team and ensure
that these, together with the operating framework and environment of the
company, and understood by management
 Ensure members of the management team are involved, empowered, and
equipped to do what is expected of them
 Ensuring that what needs to be done actually is done
 Examine proposals and approve and review various plans submitted by the
management team
 Monitoring performance against agreed “output targets, taking corrective
action when appropriate”
 Identify and initiate steps to overcome specific obstacles or barriers that hinder
the achievement of corporate goals and objectives
 Ensure that what is done and how it is done satisfies legal and other
requirements
 Ensure that the business of the company is conducted in an ethical and
responsible way, even if this involves a conflict with economic objectives
 Ensure that all activities of the company observes the laws of those countries
within which it operates and are compatible whenever possible with local
customs
 Ensure observance of those laws which particularly relate to companies and
the duties and responsibilities of company directors
 Reporting to stakeholders upon what has been achieved
 Sustain relationships with the stakeholders in the company – the need and
requirements and priorities can change over time
 Report performance to the stakeholders in the company and company owners
 Maintain a balance between the various stakeholders in the company, including
a duty of care to the company itself
 Maintain a balance between short – medium – and long-term pressures and
requirements
 Maintain the capacity to care and cope in the face of adversity, uncertainty and
surprise, and the will to confront what is new, daunting and unfamiliar

Board Review Process

 Comprehensive – all major accountabilities of the board and key requirements of

stakeholders
 Understood by all members and each director should understand their roles and
responsibilities in relation to the process
 All directors should be committed to its success – and treat it as important
 No room for cosmetics, everything should be real

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 Tough and not rushed – if process is quick and easy it is probably not implemented
with the required vigor
 Sequential – not build on “foundations of sand”
 Focused – that the customer is the source of all value
 Facts rather than opinion – discussions based on evidence and informed comment
rather that uninformed opinion
 Supported by sub-processes and documents that assist understanding – not
relevant information should be avoided
 Actionable – outputs of the review process should be capable of implementation
 Documented – a record should be kept of process outputs and “next-step”
accountabilities

Board Accountability
 Company itself
 Shareholders
 Parent company
 Bankers
 Employees
 Social partners
 Customers
 Suppliers
 Business partners
 Government and public bodies
 Financial advisers
 Local communities
 The public at large

Director’s Must
 Understand the distinct interests, needs and requirements of each group of
stakeholders
 Communicate and establish relationships with them
 Be sensitive to differences of view and perspective within particular groups where
the stakeholders are not homogeneous
 Understand the minimum requirements of each group, in order to judge such factors
as how far each can be pushed or to what extent each should be satisfied
 Appreciate the relative power of these groups in terms of the sanctions they could
wield
 Where necessary, establish priorities and the basis for trading of the interests of
one group of stakeholders against another
 Ensure that any review process used by the board and the allocation of the roles
and responsibilities in the board room are such that all accountabilities are covered
 Ensure that the resources and management and business processes are in place to
deliver

Culture, Attitudes, and Values

 Culture embraces both attitudes and values and has grown in importance
 Boards attempt to define a unique culture so it can differentiate the company from
competitors in the marketplace
 Without common visions and shared goals and values, a network organization could
fragment, as members of the network compete rather than cooperate
 Board of an international company may be so concerned that the culture and style
of the firm is harnessed to obtain the commitment and talents of those from a
variety of national, religious, ethnic and cultural backgrounds

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 Board could seek to match the values of a company to those of particular groups,
to attract certain types of potential employees, build closer relationships with
customers, or to demonstrate to a local community that the company is concerned
about their environment

The climate and opinion and tone of a company can be set by the board. Values can
also be an important differentiator:
 A business philosophy and corporate values can exist in a company as a pious
resolution
 Lip service might be paid to values by some companies thus, are conveniently
forgotten when it is thought they could get in the way of a profitable deal
 There are other companies that do not allow trade-offs against what are regarded
as core corporate values

All these things are value less without the support of the board.

Legal Constraints

 A board may be subject to operational and moral constraints that are, to a degree,
self-imposed.
 It is also subject to other constraints that are imposed and must be accepted as
given
 Internal – articles of incorporation, by-laws, memorandum and articles of
association
 External – corporation code and law on agency, companies act, insolvency act,
financial services act, and other legislations placing specific duties and
responsibilities upon directors and boads
 Public Sector in RP – constitution, anti graft and corrupt practices law, code of
conduct for public official act, by its statutory charter, contractual relationship with
government, etc.

Duties and Responsibilities of Directors

Conflict of Interest
 Happens when an individual member of the board might have separate interests in
and obligations to a company by virtue of being a director, an employee or manager,
and owner and these roles are combined.

Disqualification of Directors
 Provided by the corporation code of the Philippines

Perils of Insolvency
 When experiencing financial difficulties, directors should take particular care not to
trade wrongfully or fraudulently, or to enter into transactions at an “undervalue” or
which give a preference. (In RP – criminal liabilities may attach to fraudulent acts
under pertinent laws)

Legal Responsibilities of Directors

 The members of the board are concerned with the direction and governance of the
company
 They also must ensure the accuracy of financial information, and the accuracy of
the financial recording and reporting system, requires them to have some
understanding of the principles of accounts and financial reporting.

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Role of the Chairman
 Ensure that all directors understand the purpose and function of the board and their
legal duties and responsibilities
 Create excellence within the board room

Directorial Qualities
 Strategic awareness and planning
 Objectivity – ability to see company as a whole
 Long-term vision
 Ultimate responsibility of the company
 Commanding respect/leadership
 Decision/policy making
 Anticipate changing trends
 Delegation
 Lateral thinking
 Responsibility to shareholders

Myth and Reality

 Myth - directors are directed towards the outside world while managers are directed
to internal environment
 Reality – directors are directed to outside world, while managers are directed to
internal environment and outside environment

Relationship Between Directors and Managers

 There should be mutual understanding, trust and respect, and the commitment of
all directors and managers, however, it should not be forgotten that the authority
of the managers derives from the board.

Corporation

 An artificial being created by operation of law, having the right to succession and
the powers, attributes and properties expressly authorized by law or incident to its
existence.

Attributes of a Corporation
 Artificial Being – it comes into existence and becomes an artificial being by operation
of law.
 Corporate Law – says that it is a being with legal personality of its own,
independent, separate and distinct of the incorporators or founding
stockholders, and the shareholders who may buy in after its incorporation
 Like a natural person – with the attributes of an individual, with the same
capacity of a natural person to enter into contractual or legal relations, and to
possess the right to sue and be sued and to have the right of succession
 Man-made Creature of Law – it comes into existence by virtue of mere registration
with the Securities and Exchange Commission – it assumes that the incorporators
have entered into an agreement among themselves to form a corporation.
 Right of Succession – stockholders may come and go, buy into the corporation and
sell out of it, but the corporation continues to exist because it is an artificial being
with personality separate and distinct from its stockholders
 Limited Power – express powers, implied powers and incidental powers granted by
the corporation code.
 Ultra vires – outside its powers

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  Intra vires – within its powers

Corporate Charter
 The constitution of the corporation is the articles and by-laws.

Articles of Incorporation
 A basic contract document which defines the charter of the corporation and is
declared as a contract between three parties:
 Between the state and the corporation
 Between the stockholders and the state
 Between the corporation and the stockholders
 An article of incorporation is a legal document that establishes the structure and
purpose of a corporation. It is submitted to a regulatory authority. Sometimes it is
also called a "Certificate of Incorporation."

By-Laws
 The rules and regulations or private law enacted by the corporation to regulate,
govern and controls its own actions, affairs, and concerns, and its stockholders or
members and directors/trustees and officers with relation thereto and among
themselves in their relation to it
 Relatively permanent and continuing rules of action adopted by the corporation for
its own government and that of the individual comprising it and having direction,
management, and control of its affairs, in whole or in part, in the management and
control of its affairs and activities.
 Purpose is to regulate the conduct and define the duties of the members towards
the corporation and among themselves. It is self-imposed, and, although adopted
pursuant to statutory authority, it has not status as public law.

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 CHAPTER 10

MANAGEMENT

Contemporary Concepts of Management

Definition of Management
 Coordinating and overseeing the work activities of others so that their activities
are completed efficiently and effectively.
 The art of getting things done through other people.

The Difference Between Efficiency and Effectiveness

 Efficiency (Do Things Right) – using least resources to achieve maximum results.
 Effectiveness (Do the Right Things) – to achieve maximum results.

The Management Gurus

 Peter F. Drucker (Guru of Management Gurus)
 Mary Parker Follett (Prophet of Management)

Drucker Avers that:

 Management is not only business management because it applies as well to
government and non-profit organizations.
 Management is the specific and distinguishing organ of any kind of organization.
 Management principles apply to all kinds of organizations and the difference exists
only in the way it is applied to different organizations.
 City Manager or the word ‘manager” was first used by the government in the 205h
century.

Mary Parker Follet

 Never differentiated between business and non-business organizations because
she believed that the same management principles are applied to all organizations.

Other Names of Management as Applied

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 Public Administration – management of the public sector as distinguished from
business with its own university, terminologies, and career ladders.
 Hospital Administration – management of hospitals.
 Schools of Management – used more today than business management to correct
misimpressions – while others are “non-profit management” or “executive
management programs.”

Concept of an Organization
 A collection of people and activities formed for a specific goal and deliberately
structured which includes a hierarchy of authority, a chain of command and
responsibility, and a definition of particular roles and tasks which may refer to a
business, a company, a corporation, a firm or an enterprise.
 A process or organizing people and other resources of a firm to carry out tasks
efficiently and effectively.

Management
 Exists to achieve the goals of an organization through its four functions: planning,
organizing, leading, and controlling while using resources with efficiency and
effectiveness.
Organization and Management
 Drucker states that “there is no one right organization” because each one has its
own distinct strengths, distinct limitations, and specific applications – the same
principles apply, only the application differs.
 Organization is a tool to make people productive while working together – but no
organization is absolute – each one first a certain task under certain conditions and
at certain times.

Goals and Objectives

 A goal is a desired future state the organization attempts to realize – it is where
management wants the organization to go or a future outcome or end result that
an organization wishes to achieve.
 A goal is a general statement of what is to be accomplished, while an objective is
more specific, measurable, attainable, realistic, and time-bounded – quantifiable
and qualitatively benchmarked target.

What is a Role?
 A role is a set of expectations from a person’s behavior. It is expected behavior
from a person based on his demographic profile. There are 3 Managerial Behaviors
and 10 Roles of Managers (Henry Mintzberg)

BEHAVIOR ROLE ACTIVITIES OR TASKS

Interpersonal Figurehead  Perform ceremonial and symbolic duties of
legal and social nature such as greeting
visitors, officials, or dignitaries
 Handling out awards of recognition, signing
documents
 Opening a conference or meeting
 Handing out bonuses on Christmas and
anniversary celebrations
 Tendering a party
Leader  Direct, motivate, and build relationships with
subordinates

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  Train, counsel, coach, mentor, inspire, and
communicate with subordinates to achieve
organizational goals and vision
Liaison  Build and maintain network of contacts or
information links both inside and outside the
organization
 Use mail, phone calls, or meetings
 Establish and maintain global links through
telefax, email, and internet
Informational Monitor  Seek and receive information
 Scan periodicals, reports, journals, other print
and broadcast media, internet or websites for
issues and developments that affect the
organization
 Maintain environmental scanning and personal
contacts
Disseminator  Forward information to others in the
organization
 Send memos and reports, make phone calls,
use telefax, email, and internet to transmit
information affecting the organization
Spokesperson  Transmits information to others through
speeches, reports, memos, email, press
conference, print and broadcast media
Decisional Entrepreneur  Acts as initiator, conceptualizer, designer, and
champion of change and innovation
 Trigger or identify innovative ideas, programs,
and projects
 Create a team and delegate responsibility to
others
Disturbance  Take corrective action during disputes or crises
Handler situations
 Resolve conflicts among subordinates
 Adapt to environmental crises
Resource  Decide who gets resources, how much, when
Allocator and where; schedule, budget, and set priorities
Negotiator  Represent department or organization during
negotiation of union contracts, sales, purchase,
budgets
 Represent department or organizational
interests in dealing with stakeholders

The Organizational Stakeholders

 Customers
 Social and Political Action Group
 Competitors
 Trade and Industry Association
 Government
 Media
 Suppliers
 Communities
 Shareholders

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 Unions
 Employees

Analyzing the Decision Process

Steps in the Decision Process Questions to be Answered

Identify Issues What exactly has to be decided?
Undertake Analysis What are the alternatives?
Evaluate Options What are the pros and cons?
Identify Choices Which alternative is the best?
Implement Plans What action needs to be taken?

The Thinking Process

Rational Thinking (Left Side) Intuitive Thinking (Right Side)

Uses knowledge, skills, and experience Coming to conclusions by hunch
Applies logic to reach conclusions Being led by emotion and sensitivity
Analyzes issues to see the whole picture Using imagination to create

Using Hunch and Logic

 The Intuitive Decision Maker (Right Side of the Brain) – decides creatively and
spontaneously – the location of emotion, imagination, intuition, and creativity
 The Logical Decision Makers (Left Side of the Brain) – works rationally or fact-based
judgment – the site of logic, language, mathematics, and analysis
 People tend to have a dominant side, but this does not mean that people fall into
two categories.
 Whichever side your natural decision-making style leans towards to – always aim
to balance hunch with sound logical analysis – or always aim to balance between
both sets of faculties – because both can contribute to form a balanced picture.

The Corporate Culture

 Learning what is acceptable and what is always ruled out by the organization
because these are issues and options that affect decision-making.
 “Challenge the Culture” - if necessary in the cause of good decision-making.

Different Corporate Styles

 Authoritarian and Conformist Culture – will probably be bound by bureaucracy and
restrict the ability to make dynamic decisions.
 Innovative and Progressive Culture – expects you to be more adventurous and to
take decisions on your own initiative.
 Risk-Averse and Ambitious Culture – in companies that alternate being risk-averse
and being ambitious, try to sense the prevailing climate and act accordingly.

Overcoming Resistance
 Risk-averse firm may need to be coaxed into taking unprecedented action is order
to stay ahead of the competition sometimes. On the other hand, bold decisions of
risk taking firms may have to be curbed, if they outrun available resources. In
either case – identify the levers of power and influence and form firm alliance with
those people who are best placed to overcome the various obstacles that may be
encountered.

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 The artful decision-maker should learn to manipulate the system, whenever
necessary.
 Marry intellect with intuition in decision making.
 Be aware of the politics behind decision making.
 Always weigh up the impact of decision on all your colleagues.

The Culture that Dominates the Organization

 A firm is either risk-averse pf adventurous – a mixture of two elements – one that
is over-cautious some of the time and over-confidence the rest of the time.

RISK AVERSE ADVENTUROUS

New ideas are often dismissed
The organization is not always drive by
external needs
The emphasis within the organization is
on dealing with problems
Stability and experience are the most
valued attributes of the organization
The good of the company is put before
the success of the individual
Command and control appear to be the
dominant processes
It is almost impossible to change the
corporate mind-set
If you agree with most of the definitions
above, your company is definitely
averse to taking risks. Decisions
involving new ideas and technologies
are not welcomed readily
New and creative ideas are welcomed
Organization focuses mainly on the needs
of the customer
The corporate emphasis is on taking
advantage of new opportunities
Motivation and innovation are among the
most valued characteristics
Corporate and individual aims are largely
aligned
All staff are allowed autonomy and are
able to show their initiative
Minds and policies are frequently changed
according to circumstances
If you agree with most of the definitions
above, your company is forward-thinking,
not afraid of change, and happy to take
bold decisions that create success.

Functions of Management
 Planning – the process of defining goals for future organizational performance and
deciding on what tasks and resources to be used to attain the objectives.
 Organizing – the process of identifying the tasks, grouping the tasks into units,
assigning the tasks, and allocating the resources to the units or departments.
 Leading – the process of using influence to motivate employees to achieve the
goals of the organization under a shared culture and values, communicating goals
to all employees thorough the firm, and infusing into the employees a desire to
perform at high levels.
 Controlling – the process of monitoring, observing, evaluating, and correcting the
work of employees to ensure that the organization is on the right tract toward the
achievement of its goals.

Management Vertical Levels and their Management Skills

Top Management Conceptual Skills

Middle Management Human Skills
Lower-level Management Technical Skills

Management Horizontal Level

 Functional Manager – responsible for a department that performs a single
functional task and has employees with similar training and skills.

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 General Manager - responsible for several departments that perform different
functions.

LEADERSHIP
 The art of process of influencing people to strive willingly and enthusiastically
toward the achievement of group goals.
 Influence – action or examples of behavior that cause a change is the attitude
or behavior of another person or group.
 Influencing – process of guiding the activities or organizational members in
appropriate directions involving the four management activities of: Leading,
motivating, considering groups, and communicating.
 Appropriate Direction – the attainment of managerial objectives.
 Leadership is -.
 The process of directing and influencing the task-oriented activities of group
members.
 The relationship where one person (leader) influences others to work together
willingly on related tasks to attain the goals desired by the leader of the group.
 The process of directing the behavior of others towards the accomplishment of
some objectives.
 Directing – causes individuals to act in a certain way to follow a particular
course.
 Course – must be perfectly consistent, ideally, with established organizational
policies, procedures and job descriptions.
 Central Theme of Leadership – to get things done to achieve a firm’s goal.
 The ability to consistently deliver extraordinary results by making decisions about
values and resources.
 Capacity for Setting Strategy – allocating scarce resources in a differentiated
manner that leads to sustainable results.
 Execution – the most important element of leadership because it ensures that
a company’s tactics and everyday activities reflect the strategy.
 The ability, art and process of getting people do or not do certain activities directed
towards the achievement of organizational goals.

Nature and Meaning of Power and Authority

Power
 Ability to command or apply force but needs to be accompanied with authority.
 Ability or capacity to influence others to do something they would not otherwise do,
or the extent to which a person is able to influence others so that they can respond
to him.

Authority
 Exists in formal organizations because it is inherent to the positions in it.
 The authority exercised which depends on the amount of coercive, reward, and
legitimate power ingrained in a certain position.
 The right to perform, command or issue directives and expand resources.

The Five Sources of Power

 Legitimate Power – the authority granted to the position in the organization that a
person occupies.
 Reward Power – the ability and authority of a person to provide rewards to people
who comply with his wishes, orders or commands.
 Coercive Power – the authority to punish or recommend punishment.

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  Subordinate follows out of fear or to avoid punishment, or some other negative
outcomes.
 The basis of the disciplinary policies of organizations.
 Expert Power – based on the special skills, expertise, or knowledge that a person
possesses.
 Referent Power – based on the characteristics that command the subordinates’
identification with, respect, and admiration for, and desire to emulate the leader.
 Exemplified by the charismatic individual who has unusual traits that allow that
person to control situations.

Understanding of the Powers

 Coercive, Reward and Legitimate Powers – external sources of power which are
given legal basis primarily due to the position of a person in a formal organization.
 Personal, Expert and Referent Powers – internal sources of power coming from the
individual’s knowledge or personal characteristics - the personal powers are tools
of al leader while externally-sourced powers are instruments of a manager.
 Legitimate and Reward Powers – most likely to generate compliance – which means
that workers will obey orders and carry out instructions although they may
personally disagree with them and may not be enthusiastic.
 Coercive Power – often creates resistance – which means that workers will
deliberately try to avoid carrying out instructions or will attempt to disobey orders.
 Expert and Referent Powers – generate commitment – means that workers will
share the leader’s point of view and enthusiastically carry out instructions.
 Commitment is particularly important when change is the desired outcome of a
leader’s instructions because change carries risk and uncertainty – and assists
the followers in overcoming fear of change.

Two Classes of Leaders

1. Formal – power generated from the organization which is inherent on the position
held by a person either by appointment or by election.
2. Informal – emerges from an informal group – attributed to a person seen by the
group as the most capable of satisfying its needs – thus, power comes from the
group.

Functions of a Manager
1. Exercises leadership behavior.
2. Influences subordinates.
3. Achieves goal-oriented results.

\Warren Bennis also identified six basic characteristics of leaders:

Integrity
 Alignment of words and actions with inner values. Sticking to these values even
when an alternative path may be easier or more advantageous.
 A leader with integrity can be trusted and will be admired for sticking to strong
values. They also act as a powerful model for people to copy, thus building an
entire organization with powerful and effective cultural values.

Dedication
 Spending whatever time and energy on a task is required to get the job done,
rather than giving it whatever time you available.

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 The work of most leadership positions is not something to do “if time”. It means
giving your whole self to the task, dedicating yourself to success and to leading
others with you.

Magnanimity
 A magnanimous person gives credit where it is due. It also means being gracious
in defeat and allowing others who are defeated to retain their dignity.
 Magnanimity in leadership includes crediting the people with success and accepting
personal responsibility for failures.

Humility
 Humility is the opposite of arrogance and narcissism. It means recognizing that
you are not inherently superior to others and consequently that they are not
inferior to you. It does not mean diminishing yourself, nor does it mean exalting
yourself.
 Humble leaders do not debase themselves, neither falsely nor due to low self-
esteem. They simply recognize all people as equal in value and know that their
position does not make them a god.

Openness
 Openness means being able to listen to ideas that are outside one's current mental
models, being able to suspend judgment until after one has heard someone else's
ideas.
 An open leader listens to their people without trying to shut them down early,
which at least demonstrates care and builds trust. Openness also treats other ideas
as potentially better than one's own ideas. In the uncertain world of new territory,
being able to openly consider alternatives is an important skill.

Creativity
 Creativity means thinking differently, being able to get outside the box and take a
new and different viewpoint on things.
 For a leader to be able to see a new future towards which they will lead their
followers, creativity provides the ability to think differently and see things that
others have not seen, and thus giving reason for followers to follow.

Peter F Drucker
 Management cannot create leaders because it can only create the conditions under
which potential leadership qualities become effective or it can stifle potential
leadership.
 There is no substitute for leadership – it requires aptitude.

Leadership Requires Attitude

 No such things as “leadership traits” or “leadership characteristics”
 Of course, some people are better leaders than others. By an large, though, we
are talking about skills that perhaps cannot be taught but they can be learned by
most of us
 True, some people genuinely cannot learn the skills. They may not be important
to them. But most of us can learn them.
 The leaders who work most effectively, it seems to me, never say “I”. They think
“we”; they think “team”.

Basic Competence of a Leader

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 The willingness, ability, and self-discipline to listen
 Listening is not a skill; it’s a discipline. Anybody can do it. All you have to do
is keep your mouth shut.
 The willingness to communicate, to make yourself understood.
 That requires infinite patience. We never outgrow age three in that respect.
You have to tell us again and again. And demonstrate what you mean.
 The willingness to realize how unimportant you are compared to the task.
 Leaders need objectivity, a certain detachment. They subordinate themselves
to the task, but do not identify themselves with the task. The task remains
bigger than they are, and different.

The Seven C’s of Leadership (Emmanuel T. Santos)

 Competence – basis of expert power
 Character – anchored on the values of integrity, honesty, honor, courage
 Commitment – adherence to principles, beliefs, values, vision, mission
 Communication – connecting with significant others
 Capacity for listening – learning from others
 Capability for leadership presence – looking, smelling, acting, behaving, speaking,
and listening like a leader
 Charisma and passion – having that attractive, magnetic, and hypnotizing appeal
anchored on the pursuit of a vision, the unreachable star, with all one’s heart, mind
and soul

Empowerment

 Empowerment is a best practice of leadership.

 It is the ability to make decisions that affect one’s life or capacity to design
one’s future.
 It is the power that enables a person to assert his individual sovereignty and
carve his own destiny
 the power that enables him to put into play his ability,
 to achieve his full potential and
 to attain the fullest development of his personality.
 Empowerment, as applied to management, is delegation of power and authority not
to a subordinate alone, but to a subordinate and others who comprise the team
which can produce the desired outcome or result.
 The days of prima donnas with bloated egos are over.
 Empowerment fosters productivity, quality management, and excellence.
 A leader cannot accomplish much and attain his objectives without
empowerment of his people who work with him to accomplish the goal that leads
to realization of the vision of the organization.

Theories of Leadership
1. Trait Theory
2. Behavioral Theories
3. Situational/Contingency Theories
4. Integrated Model of Leadership Style

Trait Theories
 Trait Theory – holds that certain distinguishing physical, psychological and
intellectual characteristics or traits differentiate leaders from their groups.
 Great Man Theory – holds that leaders are born, not made (dates back to Greeks
and Romans).

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 The ‘great man’ theory was focused on the personal traits of leaders and attempted
to identify a set of individual characteristics or traits that distinguished (1) leaders
from followers, and (2) successful leaders from unsuccessful ones.

Stodgill’s Trait Factors – Conclusions in Five General Areas of Leadership

1. Intelligence and Scholarship –

 Leaders tend to be more intelligent, perform better academically, and have
superior judgment and decision-making abilities than followers, however, high
intelligence gaps may create problems between leaders and followers in terms
of cooperation and coordination of performance.
 Leaders smarter than group members may have difficulty empathizing and
communicating with followers that may lead to impatience or conflicts.
2. Physical Traits –
 Height, weight, age, strength and attractiveness have some relationships to
leadership presence but contradictory to effective leadership style.
3. Personality –
 Many leaders appear to have a personality that is characterized be self-
confidence, honesty, integrity, creativity, and initiative
 This is certainly not consistent across the board, but most of the findings
suggest that leaders posses a distinguishable personality that is influential and
important in leadership capability
4. Social Status and Experience –
 In attempting to link education, socioeconomic status, and mobility with leader
effectiveness, studies have suggested that leaders are more educated today
and that higher socioeconomic status can be an advantage to leadership status.
5. Task Orientation –
 Leaders appear to be characterized by a high need for assuming responsibility
and achieving specific tasks: they are highly motivated to set goals and reach
them consistently. This was more uniform finding than any of the other trait
relationships reviewed by Stogdill. In all the others, there were substantial
inconsistencies to prevent any concrete conclusions concerning the
identification of universal leadership traits.

John C. Maxwell identifies 21 indispensable qualities of a leader.

 Character – be a piece of the rock
 Charisma – the firs impression can seal the deal
 Commitment – it separates does from dreamers
 Communication – without it you travel alone
 Competence – if you build it, they will come
 Courage – one person with courage is a majority
 Discernment – put an end to unsolved mysteries
 Focus – the sharper it is the sharper you are
 Generosity – you candle loses nothing when you light another
 Initiative – you wont leave home without it
 Listening – to connect with their hearts, use your ears
 Passion – take this life, and love it
 Positive Attitude - if you believe you can, you can
 Problem Solving – you cant let your problems be a problem
 Relationships – if you get along, they will go along
 Responsibility – if you wont carry the ball, you cant lead the team
 Security – competence never compensates for insecurity
 Self-Discipline – the first person you lead is you

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 Servanthood – to get ahead, put others first
 Teachability – t keep leading, keep learning
 Vision – you can seize only what you can see

Stephen Covey’s Characteristics of Principled Centered Leadership

 Principle-centered leaders are continually learning
 Service-oriented
 Radiate positive energy
 Believe in other people
 Lead balanced lives
 See life as an adventure
 Synergistic
 Exercise for renewal

Principle-Centered Leadership
 Introduces a new paradigm
 Correct principles are like compasses that are always pointing the way
 Principles are self-evident, self-validating natural laws. They operate in obedience
to natural laws regardless of conditions.
 Principles apply at all times in all place. They surface in the form of values, ideals,
norms, and teaching that uplift, ennoble. Fulfill, empower and inspire people.

Behavioral Theories of Leadership Style (Kurt lewin, Lippit and White)

 Autocratic Style
 Tends to centralize authority and relies on legitimate, rewards, and coercive
power to manage subordinates
 Has little trust on group members
 Believes that money is the only reward that will motivate workers
 Issue orders to be fulfilled with no questions asked
 Laissez-Faire Style
 Has little or no self-confidence on his or her ability
 Sets no goals for the group
 Minimizes communication and group interaction
 Characterized by low concern for people and low concern for tasks or production
because he does not take leadership.
 Also called Impoverished Management
 Democratic Style
 Delegates authority, encourages participation, and relies on expert and referent
power to manage subordinates
 Shares decision making with group members
 Explains to the group reasons for personal decisions when necessary
 Objectively communicates criticism and praise to subordinates

Ohio State University Study Model

 Initiating Structure (Task-Centered/Oriented Leadership)
 Task Orientation – a management style that emphasizes control, rather than
encouragement of employees’ work, focusing on work results, task
responsibilities, and work standards
 Degree to which leaders are concerned with:
o Organizational structure
o Definition of the jobs to be done
o Pressure for work output
o Definition of communication channels

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 o Evaluation of group output

 Consideration (People-Oriented Leadership)

 Em0ployee (People) Orientation – a management style that emphasizes
motivation, social cohesion, and a concern for employees.
 Involves the leader’s
o concern for mutual trusting and respectful relationships, friendship employee
support
o concern for effective informal communication

Blake and Mouton”s Five Major Leadership Styles – presented in a managerial grid
which has two dimensions:
 Horizontal –concern for production reflects focus on operational task results
 Vertical – a concern for people which indicates a manager’s perception that
interpersonal relationships are important.

ATTITUDE OF LEADER LEADERSHIP STYLE EFFECTIVENESS

Little concern either for Impoverished Laissez- Worst leadership, no
production or people Faire management philosophy
Lowest concern for Country-club Peope-oriented
production, highest for
people
Highest concern for Autocratic Production oriented,
production, lowest for efficiency focused
people
Comfortable concern for Middle-of-the-Road Maintain present balance
both production and style
people
Highest concern for both Team Management Peak leadership and most
production and people effective

Likert’s System 4 Management

System 1 - Exploitive-Authoritative Leadership

 Fear is used as the motive
 Communication mostly downward
 Decisions and orders made mostly solely by the leader
 Productivity is mediocre

System 2 – Benevolent-Authoritative Leadership

 Uses economic rewards more than fear to motivate
 Communication slightly better than system 1
 Productivity is fair to good – there is still much room for improvement
 Managers are benevolent but still autocratic
 Decision making is structured along hierarchical lines but a mellowing of relationship
allows for productive interaction between levels.

System 3 - Consultative Leadership Style

 Considered the ideal leadership style
 Productivity good
 Control still primarily at the top but shared with middle and lower managers
 Goals are set after discussion with subordinates

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 Operating decisions made at lower levels
 Managers are consultative and tend to include subordinates in decisions – seldom
makes decisions unilaterally
 Communication more open
 Subordinates are brought into the problem-solving process

System 4 – Participative Leadership Style

 Optimal approach to leading all people in our dynamic and educated society
 Motivational forces come from ego, economics, and group involvement in decision-
making and goal-setting
 Extensive interaction with a high degree of mutual trust and respect
 Productivity is excellent
 Managers have fully a participative style and rely on team building approaches
rather than stratified methods of organization
 Subordinates are part of the decision-making and problem-solving processes
 Consensus among group members is crucial

Situational Theories
 Successful leadership depends on the relationship between the organization
situation and the leader’s style
 The organizational situation can include such variables as the climate, managers’
and subordinates’ values, attitudes, and experience, the nature of the particular
work to be accomplished including time and money

General Models of Leader Behavior According to the Maturity of Subordinates

 Delegating
 Managers adopt low-profile style that provides support and little direction for
subordinates who are given the responsibility for carrying out plans
 Subordinates at high maturity levels – they are confident and neither need nor
want direction or support
 Participating
 Managers work with groups at this moderately high maturity level a motivation
problem
 Subordinates are capable but lack the confidence to take full responsibility for
performing expected tasks
 Managers are most effective in this mode when they participate with their
subordinates, supporting their efforts to carry out plans
 Employees need and want support but not direction
 Selling
 Selling style of leadership – try to get workers buy into desired performance
through support tempered by direction
 Subordinates willing but not necessarily able to take responsibility for carrying
out plans – they need support and want to accept responsibility, but also require
direction
 Telling
 Managers assume maximum responsibility for subordinates who lack both the
ability and the willingness to carry out plans
 Workers cannot take responsibility and have not matured enough
psychologically to want to
 They are insecure about assuming the responsibilities, they expect direction and
may view supportive behavior as permissiveness

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Contingency Approach to Leadership
 An approach that suggests the most effective management behavior depends on
adaptation to circumstances in a variety of situations
 Describes the relationship between leadership styles and specific organizational
situation
 Theorist believe that circumstances dictate the best style to which managers
determine how to behave toward subordinates in each situation rather than
emphasizing that there is “one best leadership style” for every situation.
The Three Forces of Leadership Style

Forces in the Leader

 Values system of a manager
 Personal attitudes re delegation of authority and responsibility
 Degree of confidence in subordinates’ ability to handle authority and responsible
tasks
 Personal feeling of insecurity in certain crisis on non-routine situations
 Inclination toward a more autocratic or democratic leadership style

Forces in the Subordinates

 Refer to their need for freedom versus careful direction and control
 Degree of understanding and identification with the company goals
 Willingness and readiness to accept additional responsibility
 Degree of interest in and expectation of sharing in organizational problem solving
and decision making

Forces in the Situation

 Time pressures and deadlines
 Demands from higher management levels
 Type of organizational structure – centralized or decentralized
 Synergistic cooperation and effectiveness of work group
 Specific knowledge and experience for solving specific problems

Kinds of Leadership

Transactional Leadership
 Occurs when a person takes the initiative in making contact with others for the
purpose of an exchange of valued things – economic, financial, political or
psychological in nature.
 The exchange can be a swap of goods or of money for one good; a trading of votes
between candidate and voter
 Bargainers have no enduring purpose that holds them together in a mutual and
continuing pursuit of a higher purpose

Enlightened Transactional Leaders

 Those who guide or motivate their followers in the direction of established goals by
clarifying role and task requirements

Transformational Leaders
 Leaders with a vision, translates it into action and outcomes and sustains it
 Motivates individuals to perform beyond normal expectations by inspiring
subordinates to focus on broader missions that transcend their own immediate self-
interests, to concentrate on intrinsic higher level goals rather than lower-level goals,

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 and to have confidence in their abilities to achieve the extraordinary missions
articulated by the leader
 Occurs when on or more persons engage with others in such a way that leaders and
followers raise one another to higher levels of motivation and morality; their
purposes though different at the onset fuse – power bases are linked not as
counterweight but as mutual support for common purposes
 Other names are elevating, mobilizing, inspiring, uplifting, preaching, exhorting,
evangelizing leaders
 Relationship can be moralistic but ultimately becomes moral in that it raises the
level of human conduct and ethical aspiration of both leader and the led, and thus
it has a transforming effect on both

Transcending Leadership
 A variant of transformational leadership – which is dynamic in the sense that the
leader throw themselves into a relationship with followers who will feel “elevated”
by it and often become more active themselves, thereby creating cadres of leaders
– it is engaged leadership.

Revolutionary Leadership
 One who seeks pervasive, profound, and radical transformation of the entire social,
economic or political system

Current Leadership Styles

 Visionary – moves people toward shared dreams and appropriate when changes
require new vision, or when a clear direction is needed and produces a strongly
positive climate
 Coaching – connects what a person wants with the organizational goals and
appropriate to help an employee build performance by building long-term
capabilities – climate is highly positive
 Affiliative – creates harmony by connection people with each other in a positive
climate and appropriate to heal rifts in a team, motivate during stressful times, or
strengthen connections.
 Democratic – values people’s output and get commitment through participation in
a positive climate and appropriate to build buy-in or consensus, or get valuable
input from employees.
 Pacesetting – meets challenging and exciting goals, climate often highly negative
because too fre4quently poorly executed, and appropriate to get high-quality
results from a motivated and competent team
 Commanding – soothes fear by giving clear directions in an emergency, climate is
highly negative because so often misused, and appropriate in a crisis, to kick-start
a turn-around, or with problem employees.

Concept and Nature of Controlling

Controlling
 The process managers go through to find out what has been accomplished
compared to the predetermined targets
 Systematic effort to compare company performance to pre-determined goals,
objectives or standards in the plan to determine whether performance is in line
with those standards or there are gaps or deviations to be corrected

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Standard
 The level of activity established to serve as a model for evaluating organizational
performance.

The Functions of Management Form a Process – Both Inter-Related and Integrated:

 Planning – the initial management function begins the process by setting goals and
objectives which serve as standards or benchmarks against which performance are
measured or evaluated through the managerial function of controlling
 Organizing – mobilizes and assembles resources – human, financial, physical,
informational, technological – needed to achieve the goals and objectives
 Leadership – provides the element necessary to accomplish the planned goals and
objectives with efficiency and effectiveness
 Controlling – ensures that things are working out as planned during through
observation, monitoring, correcting, redirecting, and evaluating the work
performed during the execution.

Management Organization

Organization
 Exists when two or more people coordinate their efforts on an ongoing basis, to
strive for a common purpose
 A deliberate arrangement of people to accomplish some specific purpose
 A social entity that is goal directed and deliberately structured
 The structure of relationships that exists when two or more people mutually
cooperate to pursue common objectives

Elements of an Organization
 People
 A purpose
 Division of tasks
 A system to coordinate tasks
 A definable boundary separating those inside from those outside the organization

Structure and Lines of Authority

 Organizational Structure – a pattern of task groupings, reporting relationships, and
authority within an organization.
 Organizational Chart – a diagram of the oppositions and reporting relationships
within an organization
 Provides a graphic presentation of how an organization is structured
 Positions at the top have more formal authority than those on the lower levels
 Lines joining boxes indicate operating relationships and the chain of command
 Chain of Command – the vertical reporting and authority relationships in an
organization chart

The Principles of Organization Design

 Essence of structuring an organization lies in dividing labor into tasks to be
performed and in regrouping these tasks to achieve coordinated action
 The goal of balancing these competing needs underlies the design of all
organizations

Division of Labor

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 Allows complex organizations to function by breaking tasks down into smaller
segments that can be handled by one person or by members of a single department
 Allows individuals to become expert in particular areas and also cuts down on the
amount of equipment necessary to do a job
 Once tasks grow beyond what one person can handle, applying the concepts of
specialization and division of labor usually improves productivity more that it raises
costs
 Advantages
 Efficient use of labor
 Reduced training costs
 Increased standardization and output uniformity
 Increased expertise due to task repetition
 Disadvantages
 Routine, repetitive jobs
 Reduced job satisfaction
 Lower worker involvement and commitment
 Increased worker alienation

Departmentalization
 The arranging of divided tasks into meaningful groups
 Four basic departmentalization methods
 By function
 By product or service
 By customer
 By location
 Functional Departments – groups tasks according to the basic business functions
with which they are associated – marketing, finance, engineering and production
 Product/Service Departments – groups tasks according to the product or service
with which they are involved such as GM – Chevorlet, Cadillac, etc
 Customer Departments – arranges employees according to the particular groups of
customers they serve – commercial division for business, consumer division to
handle personal loans, and agricultural section to deal with farm loans – by a bank
 Location Departments – arranges groups according to the physical location of
people doing tasks such as regional units, etc.
 Multiple Departmentalization – a mixture in one firm of two or more forms of
departmentalization – common in large organizations
 Centralization – an organizational arrangement in which all decisions are passed
along to top management before being implemented,
 Decentralization – an arrangement in which decisions are pushed down the
organization to the level where the functional expertise lies.
 Centralized Tall Organization
 Decentralized Flat Organization
 Delegation – involves the assignment of varying degrees of decision-making
authority to subordinates.

Form of Organizations
 Line Organization
 Oldest and simplest structure
 An organizational structure in which top management has total, direct control
and each subordinate reports to a single supervisor
 Workers are called line employees
 Line Managers – have line authority, the risk to make decisions that directly
affect the firms output.

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 Functional Organization
 A system in which the various functions involved in supervising a worker are
divided into separate tasks performed by specialists
 Line and Staff Organization
 Staff – refers to employees and managers not directly involved in producing or
distributing the goods and services an organization sells.
 They supply support, information and advise to line personnel
 Matrix-Structured Organization
 One that combines horizontal and vertical lines of authority and also functional
and product departments.
 Project Management – another name for a matrix-structured organization
 Formal Organization
 Informal Organization
 A behind-the-scenes network based on voluntary personal relationships rather
than formal authority
 Made up of friendship groups that cut across hierarchical distinctions and
technical specialties
 Grapevine – the informal, unofficial communication network within an
organization. Nothing moves faster than the grapevine, the informal, unofficial
communication network within an organization. Contrary to popular belief, the
grapevine tends to be quite accurate.

Eight Effectiveness Criteria to Determine if an Organization is Effective

1. Innovativeness
2. Value as long-term investment
3. Community and environmental responsibility
4. Ability to attract, develop and keep talented people
5. Financial soundness
6. Use of corporate assets
7. Quality of management
8. Quality of product or services

ORGANIZATIONAL DEVELOPMENT

Organizations need to be change for various reasons such as when it is no longer

responsive to the current demands that will make it a viable company:
 Impact of foreign competition
 Technology changes
 Changing life-styles of the work force
 Economic trends

Organizational Development
 As a field, defies precise definitions.
 In general, it consists of values, assumptions, theories and techniques all oriented
toward the planned changed of organizations.
 As a behavioral science, the conceptual foundations of OD guide actions designed
to improve both the long term performance of the organization and the quality of
working life for the individual organizational member.
 It is a planned process in which behavioral science principles and practices are used
to improve organizational functioning.
 It is a process that affects the organization as a whole as well as its individual
members – involves the application of behavioral science to process the functioning

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 and the management of the organization, especially its response to changes in the
environment.

Assumptions of OD
 The organization’s functioning cannot be altered unless the behavior of its members
are altered

Delimitation of OD
 The perspective limits the set of planned change activities that can be called OD to
those which focus on the organization as a system and which also somehow affect
the behavior of individual organizational members.

Organizational Framework: Open System

 Conceptualize exactly what an organization is before we can develop techniques
and approaches to change it.
 Open Systems Theory – an approach that is a useful method for representing
organizations in a manner that minimizes their complexities.

System and Open System

 System – a set of objects, each of which possesses certain attributes and certain
interconnections with other parts of the system.
 Open System – a special kind of system, is open to its environment; that is, it has
boundaries that are permeable to inputs from its environment such as materials,
people, or the information needed to sustain itself. In return for these inputs, an
open system exports outputs (products) which in turn generate new inputs and so
on.
 Analysis can be made on three things:
 Target system – the organizational system consisting of all the activities,
processes, and components that make up the organization
 Subsystem – the larger system in which the target system is embedded – the
environment in which the organization operates; other companies in its
industry, the marketplace, its stockholders, the government, the communities
surrounding its facilities, the social culture in which its functions, and so on.
 Major Subsystem – one of the key component parts that make up the whole –
consists of the people in the organization and their behavior.
 All three systems influence each other however, the dominant effect flows
downward.
 The organizational system provides the context in which the organizational
member operates, and to a large degree it determines job behavior.
 Recent thinking in psychology believes that a person’s environment plays a key
role in influencing his or her behavior.
 The characteristics of the organizational system then will play a key role in
determining what people do at work.
 If follows, therefore, that if managers want to change the work-related behavior
of their employees, they must in some way alter the environments the
employees work in rather than try to change them directly.
 The key characteristics of the organizational environment must, therefore, be
identified, before discussing any concepts of planned organizational change.

Four Components of the Organizational System

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1. Organizing arrangements – consist of all the formalized guidelines for coordinative
action in the system
2. Human Factors – people-oriented characteristics and processes of the organization
that make up the human factors component
3. Technology – describes all aspects of the process through which system inputs are
transformed into system outputs
4. Physical Setting – includes the physical environment people work in.

Purpose
 The four components are coordinated and held together by the purpose of the
system
 The purpose is the fundamental glue that bonds the organization by providing a
definition of the system’s reason for being
 A clearly defined organizational purpose will result in high levels of integration
across the four areas and high levels of coordinated action
 An unclear purpose leads to confusion about what each component should look and
how the components should interrelate, and this confusion causes different parts of
the organization to pull in different directions, making the overall organization
relatively inefficient.

The Management Process

 What Managers Can Change – they exercise influence and decision-making power
over the definition of the organization’s purpose and the four components of the
organizational system
 What Managers Cannot Do Much – they can do little either to directly manage the
organization’s external environment or directly change subordinates’ behavior in
the long run
 What Managers Can Use to Effect Change – consequently, the leverage points for
change available to any manager are the organizational system components – and
it is primarily through their alteration that managers influence the behavior of
individuals within the organization.
 Role of Manager’s Behavior – on an everyday basis, therefore, managers through
their behavior affect the four key organizing subsystems
 Result – new work environment and work behavior: their alteration, in turn,
constitutes a new work environment for the individual organizational member.

The Organizational Development Process

 OD Intervention Process – is rooted in a broader model of change originally
formulated in the 40’s by Kurt Lewin, who proposed that change consisted of three
broad phases:
 Unfreezing Stage – in which the current behavior, assumptions, attitudes, and
so on of a social system are openly questioned and a desire for change is
generated
 Changing Stage – in which these same factors are consciously altered in a
planned direction
 Refreezing Stage – in which the new forms of operation becomes part of the
normal functioning of the system
 Steps in Action Research Process
 Decision to Change – an awareness that problems or opportunities exist in the
functioning of the organization and that a need is felt to do something about
them.
 Data Gathering – determine the underlying dimensions of the present situation
and provide a foundation for action.

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  Feedback and Diagnosis – generated data are then reported to all relevant
organizational members (key managers and employees involved in the change),
who analyze the information and decide what actions to take.
 Action Planning and Action – implementation of desired actions follows and
continues until the new situation is stabilized
 Stabilization and Evaluation - assessments to determine the characteristics of
the new organizational state are made and compared with the goals of the
change planning, typically. Trigerring a new cycle of change.

Lewinian Model of Change Action Research Process

Unfreezing Decision to Change
Data Gathering
Feedback and Diagnosis
Changing Action Planning
Action
Refreezing Stabilization
Evaluation

Technology of OD
 The methods used for diagnosing and taking action are commonly called the
technology of OD
 The technology of OD is defined as the particular procedures, techniques, or
activities that exist in the field and that have gained relatively wide acceptance as
effective tools for precipitating change in organizations.

Approaches of OD Technology
 Diagnostic Activities – refers to those approaches for collecting and analyzing
information about the broader problems of the target organization.
 Once problems are clearly understood, an intervention approach consists of a
coherent set of activities designed for dealing with them.

Diagnostic Technology
 Begins with a framework that specifies the more prominent areas to target for
scrutiny, ones that provide a basis for assessing key problems and opportunities in
the system
 Analysis should cover interconnections because if a problem is solved and
interconnecting problems are not – the action would still be ineffective.

Intervention Technology
A diagnosis becomes the basis for action – action using any of a wide array of change
technologies – to solve problems such as the inability of members in a work team
to communicate effectively with each other or dealing with the ineffective flow of
information across an entire organization.

Organizing Arrangement Interventions

 This set of interventions focuses on altering the formalized coordinating
mechanisms of a system, that is, its organizing arrangements
 Focused on changing the structure, policies and procedures, administrative and
reward systems, or goals and strategies of the organization.
 Open Systems Planning (OSP) – a representative organizing-arrangements
intervention technique is one that impacts the goals and strategies of the
organization.

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