Chapter 10 Ethical Problems of Organizations Contents

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Chapter 10
Ethical Problems of Organizations
Contents: (Please note: the Instructor Guide for every chapter will follow this structure.)

  1. Chapter Outline

  2. Teaching Notes

  3. In-Class Exercises

  4. Homework Assignments

  5. Additional Resources

Chapter Outline

  1. Introduction

  1. Managing Stakeholders

  1. Ethics and Consumers

  1. Conflicts of Interest

    1. Enron

    2. Marsh & McLennan

  2. Product Safety

    1. Johnson & Johnson

    2. Toyota

  3. Advertising

    1. Pharmaceutical Companies

  1. Ethics and Employees

  1. Employee Safety

    1. Johns Manville

    2. McWane, Inc.

  2. Employee Downsizings

    1. Scott Paper

    2. Lincoln Electric

  1. Ethics and Shareholders

  1. Salomon Brothers

  2. AIG

  1. Ethics and the Community

  1. EXXON

  1. Why Are These Ethical Issues?

  1. Costs

  1. Conclusion

  1. Discussion Questions

  1. Short Cases

  1. Conflict of Interest

  2. Product Safety

  3. Advertising

  4. Product Safety and Advertising

  5. Shareholders

  6. Community

Teaching Notes - Discussion Questions
1. What factors contributed to Johns Manville's long silence on the dangers of asbestos?
Chapter 3 may hold some clues, as to why successive top managers at Manville kept quiet. They may have felt an "illusion of optimism" and believed that the problems would not turn out to be as bad as they appeared to be. That illusion may have led to "escalation of commitment," where top managers kept getting more involved in stonewalling, in an attempt to justify the original decisions made about nondisclosure. Hindsight being 20/20, it is still difficult to understand how this could have happened.
2. What role do you think the personality of a CEO plays in the handling of an ethical problem?
The CEO's personality can play a tremendous role in how ethical dilemmas are handled. Executives with a background in marketing and communications (like James Burke, the former CEO of Johnson & Johnson) are more comfortable with the media and are knowledgeable about what it takes to sell a message. Technical or engineering types, with little or no background in communications or media relations, can have an extremely difficult time dealing with the public relations aspect of a crisis and can therefore appear to be stonewalling, or unsympathetic to the press and the public.
3. When other firms in your industry are behaving unethically, how can you buck the trend and position your company to value ethical behavior? Why is that important? Will it damage your company’s competitiveness?
It is extremely difficult to buck a trend, if an entire industry is engaged in unethical behavior. We are reminded of a money management firm in New York that described the lavish entertaining of clients that was (and perhaps still is) typical in their industry. “We’ll have some state treasurer call and tell us when he’s landing, so that we can have a limo there to pick him up. Then he tells us where he wants to go to dinner and what shows he expects tickets to, etc.” The firm went on to say that they feel extremely uncomfortable complying with the demands of this customer. However, they believed that if they did not provide these little perks, other companies would be happy to do so. Apparently, a prior executive had refused such favors and had quickly lost a lot of business to other firms. After that, the company just went along with client demands.
That said, we believe that there is a business advantage to bucking this kind of trend. One of the best ways to buck a trend is to start a new one. One of the reasons industry groups exist is to create standards that all companies can agree are important. If other industries can come together and agree to live by certain standards – the pharmaceutical, defense, and chemical industries are three we know of who have done this – then companies in the financial industry can do it, too.
4. Imagine that you are the CEO of a large firm like any of the ones described in this chapter. What concrete steps would you take to restore your company's reputation?
When disaster strikes, company lawyers generally urge caution and try to put a lid on communication. That may be a good approach from a legal standpoint, but it is disastrous from a public relations standpoint. Obviously, a company needs to find out exactly what happened as soon as possible. So, fact gathering is paramount after a disaster. Simultaneously, executives need to mobilize their public relations and communications professionals, to begin the process of notifying and/or keeping the media and other stakeholder groups informed, in order to maintain or regain credibility. The CEO needs to be accessible to the press, honest (if he or she does not know the answer to a question, admit it), provide plentiful and accurate information, admit mistakes, if they have occurred, and promise restitution to any affected stakeholders.
Probes to Stimulate Discussion

  • "What specific steps can a top manager take to restore credibility?"

  • "Can you develop a road map that could be used in any corporate disaster?"

  • "Are there three or four key steps that could be taken in any ethical debacle?"

5. How much testing is enough when launching a new product?
It probably depends on the product. But, the decision-making guidelines that are adopted are extremely important. And, they should be adopted in advance, not during a financial (final?) crunch. For example, you might want to develop the “family member rule.” Ask yourself, “How much testing is enough, if a member of my family were going to use this product, fly on this airplane, etc.?”
However, it also can be extremely difficult for a company to know when “user error” morphs into “product defect.” Apparently, this was one of the issues behind Toyota’s slow response in addressing problems with sudden vehicle acceleration. They heard reports about a problem, but assumed that it was a driver issue, because they were confident of their quality controls. Every product has some issues and it is generally more art than science to determine whether there really is a problem with a product.

Probes to Stimulate Discussion

  • "What safeguards could a company implement, to ensure that new products are properly evaluated before they are released?"

  • "Should research and development professionals be allowed to participate in decisions to release a new product?"

  • "Does just one negative evaluation forever taint a product's reputation?"

  • “How can a company overcome a negative evaluation?"

6. How can the interests of multiple stakeholders be balanced?
This is a key question that has not yet been adequately addressed in the stakeholder literature . Recently, Mitchell, Agle, and Wood (Academy of Management Review, 1997, pp. 853-886), proposed that managers pay attention to stakeholders, based upon something they termed “stakeholder salience.” Stakeholder salience is based upon stakeholder power, legitimacy, and the urgency of the stakeholder claim. These combine to make stakeholders’ claims more or less salient to managers. The approach is meant to be descriptive; it describes what managers actually do. But, we also need to think about what managers should do. What if a stakeholder has a morally legitimate claim, but is not powerful? For example, a poor community has a stake in not living next to a toxic waste dump, but little power to fight it. Should not managers still pay attention to this stakeholder’s needs? Somehow, managers need to combine the moral legitimacy of stakeholders’ claims, with the realities of balancing multiple claims in a complex, competitive global business context.
7. Do long prison sentences really help deter corporate criminals?
This is a tough question. Certainly a lot of senior executives, like most other people, have a hard time believing that they will ever get caught and go to jail. As a result, it may be naïve to think that an executive will be deterred from wrongdoing, by thinking about Bernie Ebbers and his 25-year prison sentence. However, it is not unreasonable to believe that the investing public needs the huge jail terms. In 2001 and 2002 – right after September 11 and when companies were being indicted right and left – U.S. investors (and indeed, investors around the world) suffered a huge loss of confidence in the integrity of the financial markets. Convictions and hefty jail sentences surely have played a role in the small increases of investor confidence over the last few years. That loss of confidence pales in comparison to what has happened to investors, since the financial crisis of 2008. A significant portion of small investors have not reinvested, since losing so much money in 2007 and 2008. They sit on the sidelines, not trusting the markets and the large investors who influence those markets. Perhaps one reason small investors are so gun-shy, is that no one to date has been jailed because of the activities that brought the markets down in 2008.
Probes to Stimulate Discussion

  • What message would be sent by the courts, if executives convicted of fraud (or another corporate crime) were given probation or suspended sentences?

  • Aside from lengthy jail sentences, what other measures could be taken to deter corporate crime?

  • What other measures could be taken to increase investor confidence in the integrity of markets and large corporations?

  • Why has no one been charged with fraud as a result of the financial crisis of 2008?

  • Some experts claim that more than half of the small investors who were invested in the markets when they tanked in 2008 have yet to reenter the stock market. Do you think they would, if some of the folks involved in the crisis were tried and convicted?

8. How does a company’s reputation play a role in your purchasing decisions?

Who wants to buy something from a crook? If Enron still existed, who would want to buy their power? Who would go to Drexel Burnham Lambert or E.F. Hutton (once vibrant financial firms that were driven out of business by ethical debacles in the 1980s) for financial services or to Arthur Andersen for accounting services? Put simply: the marketplace has shown repeatedly that few companies can survive catastrophic ethical disasters. Consumers simply do not trust them or their products.

Probes to Stimulate Discussion

  • What kind of products and services would you continue to purchase from a company that has been involved in an ethical disaster?

  • What products and services would you NOT purchase from a company that had been involved in an ethical disaster?

  • What could a company do to get back in your good graces?

  • Is there a particular type of ethical misbehavior that is unforgivable? That would prevent you from ever being a company’s customer again?

In-Class Exercises
Case #1 -- Conflict of Interest:
Big Company is a large manufacturer of health care products that is under fire from the government to lower costs. Big Company has an excellent reputation and is widely acknowledged as one of the best-managed companies in the country. In spite of its reputation, however, Wall Street has reacted negatively to government efforts to reform the health care industry as a whole, and Big Company's stock price has lost 30% of its value in the last year. To counter the effect of possible government intervention, Big Company has just purchased Little Company, a discount health care supplier. Wall Street has greeted the acquisition with enthusiasm and Big Company's stock price has rebounded by more than 10%, since news of the acquisition was made public.
While this acquisition could provide Big Company with a foothold in a growing part of the health care industry, a real problem lies in the mission of Little Company. Little has made its reputation by providing objective health care advice to its customers. Now that it is owned by Big Company, customers have expressed doubts, about how objective Little can be in recommending health care products, if it is owned by a health care giant.

Will Little Company be pressured to recommend the products offered by Big Company, its parent? Or will Little Company’s advice remain objective?
As the senior executive charged with bringing Little Company into the corporate fold, how do you proceed? What are your obligations to Big Company, Little Company, and the customers of both? What do you owe to shareholders and the financial community? Are there other stakeholders and what do you owe to them? What provisions would you include in an ethics code for Little Company?

As a senior executive, you should make every effort to ensure that the objectivity of Little is not compromised by the merger. You need to orient the Little employees into the Big Company fold, while making sure that Little employees know they are a separate entity. Your obligations to all stakeholders, including the ones mentioned, involve helping the companies and employees avoid conflicts of interest. You should be very specific in Little's ethics code that conflicts of interest are prohibited. You should also include wording reinforcing Little's independence.

Case #2 -- Product Safety:
As a brand manager at a large food manufacturer, you are positioning a new product for entry into the highly competitive snack food market. This product is low-fat and low-calorie, and should prove to be unusually successful, especially against the rapidly-growing pretzel market. You know that one of your leading competitors is preparing to launch a similar product at about the same time. Since market research suggests that the two products will be perceived as identical, the first product to be released should gain significant market share.

A research report from a small, independent lab - Green Lab - indicates that your product causes dizziness in a small group of individuals. Green has an impressive reputation and their research has always been reliable in the past. However, the research reports from two other independent labs do not support Green's conclusion. Your director of research assures you that any claims of adverse effects are unfounded and the indication of dizziness is either extremely rare, or the result of faulty research by Green Lab. Since your division has been losing revenue, because of its emphasis on potato chips and other high-fat snack food, it desperately needs a low-fat money maker. Since you were brought into the division to turn it around, your career at the company could depend on the success of this product.

What are your alternatives? What is your obligation to consumers? Who are your other stakeholders and what do you owe them? What is your obligation to your employer and to other employees at your company? What should your course of action be? How can you apply the due care theory to this case?

There are a number of alternatives. You could hold the product until further testing is completed, release the product as planned, or perhaps even issue a consumer warning (such as the one on packs of cigarettes) on the product. (Obviously, that might place a real damper on sales.) Your obligation to your company and coworkers is to honestly evaluate the merits of a product and withhold it from the market, if you think that is appropriate. In one large manufacturing company, management has taken steps to ensure the objectivity of such decision making. Management has established teams of employees from a range of disciplines, to judge whether or not a product is ready for release. The key to the process is that no employee involved in the product's development is allowed to be part of the decision-making process (because of their likely bias).

Interestingly, when this scenario is used with students and business people, the students are more likely to release the product than the business people are. The business people seem to favor some kind of "final" test, in an effort to resolve the safety issue. Usually about half of any given student group wants to go ahead and release the product now with no further testing.

Case # 3 -- Advertising:
As a bottler of natural spring water, your advertising department has recently launched a campaign that emphasizes the purity of your product. The industry is highly competitive, and your organization has been badly hurt by a lengthy strike of unionized employees. The strike seriously disrupted production and distribution, and it caused your company to lose significant revenues and market share. Now that the strike is over, your company will have to struggle to recoup lost customers, and will have to pay for the increased wages and benefits called for in the new union contract. The company's financial situation is precarious to say the least.

You and the entire senior management team have high hopes for the new ad campaign, and initial consumer response has been positive. You are shocked when your head of operations reports to you that an angry worker has sabotaged one of your bottling plants. The worker introduced a chemical into one of the machines, which in turn contaminated 120,000 bottles of the spring water. Fortunately, the chemical is present in extremely minute amounts - no consumer could possibly suffer harm, unless he or she drank in excess of 10 gallons of the water per day over a long period of time. Since the machine has already been sterilized, any risk of long-term exposure has been virtually eliminated. But, of course, the claims made by your new ad campaign could not be more false.

List all of the stakeholders involved in this situation. Do any stakeholder groups have more to gain or lose than others? Develop a strategy for dealing with the contamination. How much does a company's financial situation determine how ethical dilemmas are handled?

The stakeholders in this scenario include not only consumers of the spring water, but also employees, the company shareholders, the community where the company is located, other bottlers of spring water, the press, and regulatory agencies. Since the chances of harm are so slim, the stakeholders with the most to lose are probably the employees, the shareholders, and other bottlers of spring water, who might see the image of their industry sullied. The company's financial situation would probably have a significant bearing on this situation, just as Beech-Nut's had a profound effect on its actions with the bogus apple juice concentrate. If a company is very profitable, it can afford to lose money on a noble gesture. If it is on the ropes because of a huge debt burden (like Beech-Nut), or struggling to survive after a strike as in this case, it is much harder to do the right thing.

However, there is little choice in this case. The CEO has to recall the contaminated water, not only because it is the right thing to do (it would be dishonest to do otherwise), but also because the company's reputation would be dealt a crippling blow, if the public ever discovered the problem. While the company might suffer in the short term by addressing the problem, a recall is certainly the most sound management approach for the long term. The company might even come out ahead of the competition by announcing a recall -- "because this water isn't pure enough by our standards. It's almost impossible for any of our customers to be harmed by our water, but we won't risk hurting our customers for any reason." So, a good strategy might include, asking the ad agency that developed the new ad campaign to design a strategy for the recall that would tie into the new ads.
Case #4 – Product Safety and Advertising
For years, arthritis sufferers have risked intestinal bleeding from consistently taking non-steroidal, anti-inflammatory drugs (NSAIDs) like Advil, which are used to ease chronic joint pain. Your company, Big Pharma, introduced a new type of painkiller, a COX-2 inhibitor that addressed the pain without these gastrointestinal effects. To get the word out , Big Pharma decided to market the new painkiller directly to consumers, so that they could ask their doctors about it. The marketing was extraordinarily successful, ultimately creating a multi-billion dollar market. Over 100 million prescriptions were written in just five years and the drug was a big contributor to your company’s bottom line. Patients and doctors seemed grateful for the alternative and doctors began using it to treat all kinds of pain. Then, complaints began coming in about cardiovascular events (heart attacks), associated with taking the new drug. Early scientific studies suggested that there might be a problem, but the science remained inconclusive. It appeared that many of these patients had other health problems that may have caused their heart attacks. So, your company undertook a more definitive double-blind placebo controlled study (the only kind that can truly demonstrate cause and effect), which eventually showed a link between your drug and increased risk of cardiovascular events, if the drug was taken consistently for more than 18 months. The Food and Drug Administration suggested a stronger black box warning on the drug packaging, to warn of the potential for cardiovascular side effects from prolonged use. Your senior management team met to discuss what to do. Should you follow the FDA’s advice or do something else? The discussion included reference to your company’s values and strong commitment to integrity and human welfare. You also referred to the famous Johnson & Johnson Tylenol incident, and the success of their recall effort. After much discussion, you decided to recall the drug and cease manufacturing it. The negative reactions were instantaneous. In stinging press reports and Congressional hearings, at which your CEO had to appear, your company was criticized for not recalling sooner, based upon the earlier evidence. And, the lawsuits began. It seemed that anyone who had ever taken your company’s drug and then had a heart attack was bringing suit. Ironically, on the other side, patients and doctors who had been using the drug successfully also complained. They thought you should return the drug to the market with a stronger warning, so that they could do their own risk assessment. Nothing else worked for some patients and they were suffering. But, after careful deliberation, you decided to stick to the recall decision and fight (rather than settle) the lawsuits. Early in the fight, your company won some lawsuits and lost some, but vowed to continue fighting them all, because you were convinced that you had done nothing wrong. The fight was costly in dollars and reputation. Eventually, after several years and winning more lawsuits than you lost, you decided to settle all remaining lawsuits and move on, a decision that was considered to be wise in the business community. Your company’s financial performance took a big hit, but it is now rebounding and the future looks more hopeful with some promising new treatments on the horizon.

Who are the stakeholders in this situation? Experts claim that there is always a risk, when people take prescription drugs. How much risk is too much? How widely do drug companies need to publicize the risks of prescription medications? Or, is that the doctor’s responsibility? Do consumers really understand these risks? Do drug companies have an obligation to ensure that doctors do not overprescribe their drugs? Is that a reasonable expectation? Was direct-to-consumer marketing appropriate for this type of drug? When is it, or is it not, appropriate? Do drug companies have a bigger obligation to explain the risks of the drugs that they heavily market directly to consumers, because such consumers are more likely to ask their doctors for these drugs? Why do you think the reaction to the decision to recall in this case was so different, compared to the Tylenol situation? Should senior management have expected the reactions they got? Is there anything they could have done to change them?

This is actually the Vioxx case that Merck dealt with for a number of years. In spite of its best efforts, there were still issues with this drug and its adverse effects on some patients.

Case #5 -- Shareholders:
You work for an investment bank that provides advice to corporate clients. The deal team you work on also includes Pat, a marketing manager, and Joe, who serves as the credit manager for the team, as well as several other professionals. Just before your team is scheduled to present details of a new deal to senior management, Pat suggests to Joe that the deal would have a better chance of being approved, if he withheld certain financials. "If you can't leave out this information," Pat says, "at least put a positive spin on it so they don't trash the whole deal."

The other team members agree that the deal has tremendous potential, not only for the two clients, but also for your company. The financial information Pat objects to – though disturbing at first glance -- would most likely not seriously jeopardize the interest of any party involved. Joe objects and says that full disclosure is the right way to proceed, but that if all team members agree to the "positive spin," he will go along with the decision. Team members vote and all agree to go along with Pat's suggestion -- you have the last vote. What do you do?
In this hypothetical case, what is your obligation to the shareholders of your organization and to the shareholders of the two organizations that are considering a deal? Are shareholders a consideration in this case? Are customers? Are employees? Could the survival of any of the three companies be at stake in this case? In a situation like this one, how could you best protect the interests of key stakeholder groups?

You and Joe should insist that full disclosure is the only alternative. Senior management needs all of the information, in order to make the best decision. If the others do not agree, politely but firmly insist that a senior manager make the decision.

Case #6 -- Community:
You have just been named CEO of a small chemical refinery in the Northeast. Shortly after you assume your new position, you discover that your three predecessors have kept a horrifying secret. Your headquarters location sits atop 30 5,000-gallon tanks that have held a variety of chemicals - from simple oil to highly toxic chemicals. Although the tanks were drained over 20 years ago, there is ample evidence that the tanks themselves have begun to rust and leak sludge from the various chemicals into the ground. Because your company is located in an area that supplies water to a large city over 100 miles away, the leaking sludge could already be causing major problems. The costs involved in a clean-up are estimated to be astronomical. Because the tanks are under the four-story headquarters building, the structure will have to be demolished, before clean-up can begin. Then, all 30 tanks will have to be dug up, disposed of, and all of the soil around the area cleaned.

You are frankly appalled that the last three CEOs did not try to correct this situation, when they were in charge. If the problem had been corrected 15 years ago, before the building had been erected, the costs would be substantially less than they will be now. However, as frustrated as you are, you are also committed to rectifying the situation. After lengthy discussions with your technical and financial people, you decide that a clean-up can begin in two years. Obviously, the longer you wait to begin a clean-up, the riskier it becomes to the water supply. Before you begin the clean-up, it is imperative that you raise capital, and a stock offering seems to be the best way to do it. However, if you disclose news of the dump problem now, the offering will likely be jeopardized. But the prospect of holding a news conference and explaining your role in keeping the dump a secret, keeps you up at night.
Who are the stakeholders in this situation? What strategy would you develop for dealing with the dump and its disclosure? Are you morally obligated to disclose the dump right away? How will Wall Street react to this news? Does your desire to correct the situation justify keeping it a secret for another two years?
Think about the due care theory presented earlier in this chapter. Can we draw parallels between due care for the consumer and due care for the environment? What if the oil tank dump mentioned in the hypothetical case, was located in a foreign subsidiary of a U.S. company and the country in which it was located had no laws against such a dump? Would the CEO be under any obligation to clean it up? Should American companies uphold U.S. laws concerning the environment in non-U.S. locations? How much protection is enough?


Just as in the earlier case concerning contaminated spring water, this CEO does not have much of a choice. By the time his/her firm has enough capital to make the cleanup financially more "comfortable," the contaminated water might seriously harm countless people in the large city. The CEO needs to contact the proper authorities (the Environmental Protection Agency and local officials) and explain the problem. He or she needs to hire the best experts to assess the problem as best they can, to determine the extent of the damage and perhaps put a figure on the cost of the clean-up. With all of that information gathered, he or she can begin a relocation and clean-up strategy. If a CEO self-reports to the EPA, perhaps the EPA will make the news public with the company executives. The reputation of the company may not be damaged in such a scenario and a successful stock offering might be a real possibility. Investors in the past have been willing to take a chance on a company that has a sound plan for recovery from a difficult situation. For example, investors, who bought Chrysler bonds when the company was on the ropes, made out very well.

Homework Assignments
1. Case Analysis

One effective homework assignment is to have students analyze any of the short cases at the end of the chapter, which are also described under In-Class Exercises in this Instructor’s Manual.

2. Real Case Analysis or Classic Case Update

Another homework assignment involves asking students to either choose a company that is currently going through an ethics crisis (Toyota, BP, Goldman Sachs, AIG, etc.), or to update one of the classic cases outlined in the chapter.

Additional Resources:
There are a number of videos available through YouTube on these various ethics disasters. Since some of these may not be available when you look for them, we are not providing links. To find available videos, go to YouTube and search for any of the disasters in this chapter.

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