The Role and

Responsibility of
Business in Society
CHAPTER II
 Chapter Objectives
•Understand the role and responsibility of business in society
•Understand the corporate governance structure and its mechanism
•Identify the different layers of shareholders and stakeholders and understand
their roles and responsibilities.
•Identify the causes and effects of the global financial crisis and be aware of its
impacts on corporate governance and investors.
•Understand the general approaches of the “Smart Regulation”, to address the
global financial crisis.
•Be aware of the main objectives of the corporate governance reforms.
•Recognize that effective corporate governance is established through power
sharing among all participants, particularly shareholders, boards of directors, and
management.
 Key Terms
•Board of directors
•Conflicts of interest
•Corporation
•Corporate governance
•Corporate Governance
Reforms
•Earnings Guidance
•Financial Analysts
•Financial interest
•Institutional investors
•Investors
•Liquidity
•Majority Voting Lite:
•Mandatory Disclosure
•Management
•Smarter Regulation plan:
•Stakeholders
•Voluntary Disclosure
The Role and Responsibility of Business
in Society
 The Role and Responsibility
Corporate stakeholders are classified into several layers and are categorized
into three general tiers. Eight layers of shareholders and stakeholders:
 The Role and Responsibility
3 tiers of corporate stakeholders:

The Third Tier:

Others
The First Tier:
Investors

The Second Tier:

Creditors
 Financial System and Markets
•Public companies are vital to the nation’s economic growth and prosperity.
•Sustainable performance of public companies depends on the willingness of
investors to invest in them.
•Public companies rely on public sources of funding through issuing stocks as
opposed to private funding through banks or selected groups of investors.
•For this open financial system to function effectively there should be an
appropriate system of checks and balances, namely an effective corporate
governance structure.
•The separation of ownership and control in the open financial system can
result in the agency problem between management and shareholders, where
management’s interests may not be aligned with those of shareholders, or
where management withholds important information from shareholders
(information asymmetry).
•Under the open system, shareholders invest in a corporation and elect the
board of directors, which then hires management to run the corporation.
 Accountability System
•Investors are responsible for providing needed capital to facilitate the effective
operation of the company and have a right to elect their representatives, the
company’s board of directors.
•The board of directors is authorized to make decisions on behalf of its
constituents (investors) and is directly responsible for selecting and
continuously monitoring management’s decisions and actions without
micromanaging.
•Management is authorized to run the company and is responsible and
accountable for decisions made and actions taken with the primary purpose of
creating and enhancing sustainable shareholder value.
•Corporate governance provides the opportunity for shareholders to monitor the
company’s board of directors and enables the board to monitor management
and facilitate management’s decision-making process, which creates
shareholder value.
 Shareholder and Stakeholder Primacy
• Under the shareholder primacy model the primary purpose of a corporation is to generate
returns for shareholders, and thus managerial decisions and actions should be focused on
creating shareholder value.
• The stakeholder primacy model of corporations and related corporate governance measures
intended to fundamentally rebalance power among stakeholders.
• This suggests that corporations in the long-term must not only secure financial returns for
shareholder but must also make a positive contribution to society and the environment.
Several initiatives are taken to move away from the shareholder primacy and towards
stakeholder primacy under the new corporate governance model including:
1. The board fiduciary duty should be extended to all stakeholders and the board of
directors should be accountable to all stakeholders not just shareowners.
2. Corporate purpose statements should specifically state that corporations positively
benefit society in the context of creating shared value for all stakeholders.
3. Multiple stakeholders including employees should be represented on corporate boards;
and
4. Large corporations should be required to charter federally, to enable the accountable
governance reforms that require responsibility to all stakeholders.
 Statement on the Purpose of Corporations
1. On August 19, 2019, the Business Roundtable announced the adoption of a new
Statement on the Purpose of a Corporation, signed by 181 well-known, high-powered
CEOs.
2. The Statement “moves away from shareholder primacy” as a guiding principle and
outlines in its place a “modern standard for corporate responsibility” that makes a
commitment to all stakeholders.
3. the theory of “shareholder primacy—that corporations exist principally to serve
shareholders”—and relegated the interests of any other stakeholders to positions
that were strictly “derivative of the duty to stockholders.”
4. Americans deserve an economy that allows each person to succeed through hard
work and creativity and to lead a life of meaning and dignity.
5. We believe the free-market system is the best means of generating good jobs, a
strong and sustainable economy, innovation, a healthy environment and economic
opportunity for all.
6. Businesses play a vital role in the economy by creating jobs, fostering innovation and
providing essential goods and services. Businesses make and sell consumer products;
manufacture equipment and vehicles; support the national defense; grow and
produce food; provide health care; generate and deliver energy; and offer financial,
communications and other services that underpin economic growth.
 Stakeholder Primacy
1. Delivering value to customers. This will further the tradition of American
companies leading the way in meeting or exceeding customer expectations.
2. Investing in employees. This starts with compensating them fairly and providing
important benefits. It also includes supporting them through training and
education that help develop new skills for a rapidly changing world. This means
fostering diversity and inclusion, dignity and respect.
3. Dealing fairly and ethically with suppliers. Being dedicated to serving as good
partners to the other companies, large and small, that help them meet their
missions.
4. Supporting the communities in which the company works by respecting the
people in communities and protecting the environment by embracing
sustainable practices across businesses.
5. Generating long-term value for shareholders, who provide the capital that
allows companies to invest, grow and innovate. Being committed to
transparency and effective engagement with shareholders.
 Stakeholder Capitalism
•There is a general move toward stakeholder capitalism of creating long-term
sustainable shared value for all stakeholders from shareholders to creditors,
employees, customers, suppliers, regulators, society and the environment.
• Public companies, their board of directors and executives can communicate
the commitment to sustainability in creating shared value for stakeholders
through an integrated sustainability reporting focusing on measuring and
disclosing both financial economic sustainability performance (ESP) and
non-financial ethical, environmental, governance and social (EEGS).
•The Board’s Role Under Stakeholder Primacy/Capitalism as Opposed to
Shareholder Primacy/Capitalism is oversee managerial function of focusing
on the long-term sustainability performance, effectively communicating
sustainability performance information to all stakeholders.
•The financial and non-financial key performance indicators (KPIs) should be
identified, measured and disclosed through metrics that reflect corporate
value and long-term investment and innovation on ESG initiatives.
 Benefit Corporations
•Benefit corporations” (BCs) have been formed as legal entities by legislation
in many states, including the Delaware General Corporation Law.
•Under convectional corporations (CCs) ,the primary goal of corporations has
been to maximize profit and to increase shareholder wealth.
•Under BCs, corporations are responsible and accountable to all stakeholders
including shareholders.
•The major characteristics of the BCs’ form are:
1. a requirement that a BC must have a corporate purpose to create a material
positive impact on society and the environment;
2. an expansion of the duties of directors to require the consideration of non-
financial stakeholders as well as the financial interests of shareholders;
3. an obligation to report on their overall social and environmental
performance using a comprehensive, credible, independent, and
transparent third-party standard.
 Drivers of Long-Term Value
•Talent - employees can significantly influence a company’s ability to generate
long-term value by implementing its strategy, improving operational
effectiveness and developing new ideas for success and growth.
•Innovation and Consumer Trends- companies should ensure that their
innovation is meeting evolving demands by customers and other stakeholders
and continuously interact with them to assess their innovation and develop
related metrics
•Society and the Environment- the concept of impact investing of focusing on
both financial returns and social and environmental impacts of business
organization is gaining momentum with investors.
•Corporate Governance- There has been much progress on corporate governance
and its measures in the past two decades. However, corporate governance is a
process (journey) that needs continuous improvements.
 Global Financial Crises
•The 2007-2009 global financial crisis and resulting economic meltdown are
caused by a variety of factors including ineffective corporate governance and
troubled financial institutions.
•It has been caused by many factors including the subprime crisis in US and
other global financial challenges of substantial public borrowing by EU
members (Spain, Portugal, Greece) and thus requires regulatory responses
and bold coordinated actions on the part of governments, central banks,
regulators, and the business community worldwide.
•a combination of many macroeconomic and microeconomic factors as well as
governmental and regulatory decisions have contributed to the crisis
including greedy and incompetent executives; subprime mortgage crisis,
government policies promoting home ownership; securitization of mortgage-
backed assets; inadequate risk assessment of business transactions; and
ineffective global regulation and supervision of banks among others.
 Lesson Learned
Understand the global nature of business markets and economy. There is an urgent need for
convergence in corporate governance reforms, including regulations.
Better understanding of both magnitude and nature of financial risks by policymakers, regulators, banks, financial
institutions and corporations.

Make regulatory reforms globally enforceable. There is a Continue support for more global regulations and lessen
deregulations and the move towards International Financial Reporting Standards (IFRS).

Strengthen transparency of financial markets through enhanced disclosure of complex financial

products by changing the corporate culture and board structure, improving accountability by ensuring
proper risk assessment and enhancing sound, cost-effective, efficient and scalable regulations by
ensuring all financial markets, products and participants are regulated or subject to effective oversight
(example: regulatory oversight over credit rating agencies, mutual funds).
Promote integrity in financial markets to protect investors, avoid conflicts of interest, prevent illegal market
manipulations, and prevent fraudulent activities and abuse by convergence in international regulations and related
enforcements and promoting corporate culture of integrity, competency, sustainability and ethical behavior.

Hold financial institutions and banks accountable for their lending activities. The fact that the Bank of America
reached a settlement in 2014 with Department of Justice (DoJ) for alleged $16.65 billion financial fraud suggests
difficulties in lending activities.

Recent alleged sexual harassment by senior executives, improper workplace, unethical business practices have
caused concerns by investors as to the healthy corporate culture and the board of directors oversight responsibility to
ensure legal compliance and proper corporate culture that is aligned with and supports the company’s long-term
business strategy that mitigation the risks associated with the business image and reputation.
 Definition of Corporate Governance
• A process of managing and running the company for the benefit of its owners.

• The process affected by a set of legislative, regulatory, legal, market

mechanisms, listing standards, best practices, and efforts of all corporate
governance participants, including the company’s directors, officers, auditors,
legal counsel, and financial advisors, which creates a system of checks and
balances with the goal of creating and enhancing enduring and sustainable
shareholder value, while protecting the interests of other stakeholders.
 Corporate governance Role
Corporate governance should create an appropriate balance of power-sharing that:
Provides shareholder democracy in freely electing directors (e.g., the majority voting
system).
Enables the board of directors to make strategic decisions and oversee and consult with
management without micromanaging.
Empowers management to run the company.
The separation of ownership and control in the modern corporate structure, the diffuse
nature of ownership, and the focus on protecting the interests of a wide range of
stakeholders (investors, creditors, employees, management, customers, suppliers,
government, and others) necessitate the need for an effective corporate governance
structure that addresses, manages, and minimizes potential conflicts of interest among
corporate governance participants.
 Information Asymmetry
• Information asymmetry can exist between management and investors regarding long-
term strategic decisions, performance and disclosures.
• Management has incentives to focus on short-term plans and performance that could be
detrimental to the long-term and sustainable performance.
• Management may also be motivated to withhold some damaging bad news from
investors.
• This perceived information asymmetry can be minimized when management provides:
1. Disclosure beyond mere compliance with regulatory requirements (add to public
information or present additional context to existing disclosures).
2. Contextualized disclosures to enable investors assessed the publicly disclosed
financial information.
3. Integrated reports on economic financial sustainability performance information and
non-financial environmental, social, ethical and governance sustainability
performance information.
4. Forward-looking and futuristic disclosures on both financial and non-financial
information.
 Sources of Information to the Capital Markets
Information from public companies flows into the marketplace from three
fundamental sources: regulated disclosures, voluntary disclosures, and research
analyst reports.
Mandatory Disclosures-Regulated disclosures include filings with the SEC of annual
audited financial statements on Form 10-K, quarterly reviewed financial reports on
Form 10-Q, extraordinary transactions on a current basis on Form 8-K (e.g., auditor
changes, resignation or death of a director or an officer, bankruptcy), and internal
control reports for large public companies (Sections 302 and 404).
Voluntary Disclosures-Public companies often voluntarily release earnings guidance
regarding projected performance and other financial and nonfinancial information in
addition to their mandated disclosures.
Research Analyst Reports-Financial analysts who follow and project companies’
future earnings and evaluate their short-term quarterly performance are an important
source of information and are essential to transparent and efficient capital markets.
Analysts forecast for both long-term and short-term earnings quality and quantity.
 Chapter Summary
• The role of corporations has advanced from profit maximization to increasing wealth for
shareholders and in recent years, to the creation of shared value for all stakeholders with a
focus on profit-with-purpose mission.
• Corporate governance participants must structure the process to ensure the goals of both
shareholder value creation and stakeholder value protection for public companies.
• The corporate governance structure is shaped by internal and external governance
mechanisms, as well as policy interventions through regulations.
• Corporate governance mechanisms are viewed as a nexus of contracts that is designed to
align the interests of management with those of the shareholders.
• The effectiveness of both internal and external corporate governance mechanisms
depends on the cost–benefit trade-offs among these mechanisms and is related to their
availability, the extent to which they are being used, whether their marginal benefits
exceed their marginal costs, and the company’s corporate governance structure.
• The concept of profit-with-purpose corporation is gaining attention in recent years, which
suggests that public companies play much more important role of just making profit for
their shareholders as their social and environmental impacts can make them sustainable.
 Chapter Summary
• There are three aspects of corporate governance: the shareholder aspect, the
stakeholder aspect, and the integrated aspect.
• Corporate governance structure should be based on the principles of value-adding
philosophy, ethical conduct, accountability, shareholder democracy and fairness,
integrity of financial reporting, transparency, and independence.
• A well-balanced operation of the seven corporate governance functions—oversight,
managerial, compliance, internal audit, legal and financial advisory, external audit,
and monitoring— can contribute toward effective corporate governance.
• Corporate governance effectiveness is defined as the extent to which the company’s
corporate governance is achieving its objectives in three categories: (1) promoting
efficient and effective operational, financial, and social performance; (2) creating
shareholder value while protecting the interests of other stakeholders (employees,
suppliers, customers, and creditors); and (3) ensuring the integrity, quality, reliability,
and transparency of financial reporting.
 Key Points
•Corporations with an entrepreneurial spirit are the main engines that drive the nation’s
economy and its capital markets to long-term sustainable prosperity.
•Public companies have a set of contractual relationships with a broad range of
participants, including shareholders, creditors, vendors, customers, employees,
governmental agencies, auditors, and global communities and societies.
•Public companies should consider their financial, social and environmental impacts.
•Sustainable shared value creation enables business organizations to integrate financial
with non-financial factors into business culture and corporate environment.
•The existence and persistence of global financial scandals create poor corporate
culture that negatively affects corporate governance and thus investor confidence in
the global financial markets.
•Regulations must be proactive, cost-effective, efficient, and scalable.
•Information from public companies flows into the marketplace from three fundamental
sources: regulated disclosures, voluntary disclosures, and research analyst reports.
Concluding Remarks and
Questions?
Thank you for your Attention