CORPORATE ETHICS AND SHAREHOLDER WEALTH MAXIMIZATION

Transcription

1 CORPORATE ETHICS AND SHAREHOLDER WEALTH MAXIMIZATION Donald R. Chambers and Nelson J. Lacey Introduction, Greg Emery IN THIS ARTICLE FINANCE PROFESSORS Donald R. Chambers and Nelson J. Lacey present us with a view of business ethics as seen from the perspective of the corporation and its owners: the stockholders. Developing an argument not unlike that of Milton Friedman s in The Social Responsibility of Business Is to Increase Its Profits, Chambers and Lacey argue that the overriding legal and ethical responsibility of the managers of any corporation is not some kind of social responsibility aimed at increasing the overall good of society, but rather is to carry out the wishes of the stockholders the owners of that company. And generally, stockholders are interested in maximizing their wealth, a desire which is, according to Chambers and Lacey, ethically defensible. Chambers and Lacey, striving for analytic rigor, begin their discussion by saying that corporations (which are not persons but are merely contracts between persons) cannot act unethically. Ethical, or unethical, decisions can be made only by people who have voluntarily contracted with each other, perhaps through a corporation. In other words, corporations are legal abstractions and it is not possible for an abstraction to do anything right or wrong. Only persons have that capability. Continuing, and in an attempt to unpack the implications of this position, Chambers and Lacey provide what they consider to be two general approaches to (business) ethics. First, there is the contractual-rights approach, which maintains that ethics is a matter of contract, a matter of honoring an agreement freely undertaken between rational individuals. Under the contractual-rights approach, in which the autonomous integrity of the individual reigns supreme, an ethical action is one in which both parties in the contract hold up their end of an agreed-upon transaction. Second, there is the societal-good approach, a utilitarian ethic which claims that ethics are decided in terms of whether something is viewed as being good or bad for society. Chambers and Lacey unequivocally favor the contractual-rights approach because, they claim, the United States was founded upon it. Fur-

2 CORPORATE ETHICS AND SHAREHOLDER WEALTH MAXIMIZATION ther, they argue that most proponents of the societal-good argument desire to undemocratically, and hence unethically, force a fairer distribution of wealth. While Chambers and Lacey agree that it is certainly commendable to be concerned about the plight of the underprivileged or disenfranchised, to be concerned about the good of society, they also point out that such forced attempts for a fairer distribution of wealth can, and often do, violate individuals rights. The societal-good approach to corporate ethics, (also called the stakeholder view of the corporation) attempts to force the shareholders as individuals to do the good deeds that other people, nonshareholders (stakeholders), would like to see done. Further, the societal-good approach seems to say that while normal persons, have a right to personal property, the shareholders of a corporation somehow do not have the same right to corporate property. The societal-good approach seems to sanction a forced distribution of corporate-based wealth. Countering the societal-good approach, although it may not be pleasing to the ears of those who are concerned with the good of society, Chambers and Lacey emphatically argue that contractual rights (which include the right to own property) belong to everyone the poor and the rich (for example stockholders). They assert, [A]ccording to the U.S. Constitution individual rights belong to everyone even shareholders! The contractual-rights approach does not stand in the way of helping the poor, but rather it says that it is wrong to force people to help the poor. And, Chambers and Lacey are quick to point out, the United States, under a system of contractual rights, has one of the highest levels of philanthropic giving in the world. They then draw a distinction between the concepts of what they call oughttas and gottas, seeking to differentiate conduct that is required (the got tos or gottas) from conduct not required (the ought tos or oughttas). The distinction here is between what a person should (ethically) do and what a person can be forced (legally) by society to do. Or as Chambers and Lacey say, the distinction here is between two types of decisions: personal ethical decisions and public-policy decisions. With the distinction of outghtas and gottas in mind, Chamber s and Lacey then return to the issue of whether or not stockholder wealth maximization is an ethical goal. According to them, shareholders do have the right to seek maximization of their wealth as long as this does not include a violation of society s gottas. In particular and again, they base their argu-

3 CORPORATE ETHICS AND SHAREHOLDER WEALTH MAXIMIZATION ment on the fact that the U.S. Constitution protects the right to ownership of private property, and shareholders are no exception. While reading this article, you should ask whether the authors have adequately thought through the relationship between the ethical and the legal. Are they saying, for example, that ethics is merely a personal matter? Correspondingly, do they claim that it is a mute point to hold public-policy issues to ethical standards; that is are they saying that if it is legal it is ethical (when it comes to public-policy decisions)? Consider other reasons why the corporation (or its managers, in any case) may in fact have obligations to society, and not to just its shareholders. For example, doesn t the corporation benefit from the resources available in the communities within which it operates? That is, don t corporations benefit from employees educated in the pubic-education system, and so on? Hence, if corporations benefit from societal goods, shouldn t they be responsible to society as well? You should also consider whether Chambers and Lacey s argument, that the contractual-rights approach is preferable to the societal-good approach because the United States was founded upon the contractual-rights approach amounts to a non sequitur. CAN CORPORATIONS ACT ETHICALLY? We often hear news or commentary that suggests that a certain corporation is practicing unethical behavior. Is this possible? The answer is, no! Ethical decisions can be rationally viewed only as being between the people who contract through the corporation, including managers, employees, shareholders. bondholders, customers and suppliers. [A] corporation is a set of contracts linking people together. Corporations, like all forms of business organizations, are legal abstractions that do not have the ability to hurt or to be hurt. Pieces of paper and documents do not have feelings, emotions, or nervous breakdowns they can only serve as conduits from one person to another. It is not possible for a legal abstraction to do something right or wrong. Questions of corporate ethical behavior are therefore questions of actions by one person or group of persons within the corporation with Corporate Ethics and Shareholder Wealth Maximization, Donald R. Chambers and Nelson J. Lacey, reprinted from Modern Corporate Finance, Theory and Practice, Second Edition, 1999, Addison-Wesley, pp

4 CORPORATE ETHICS AND SHAREHOLDER WEALTH MAXIMIZATION respect to their effect on another person or group of persons. For example, we may ask if it is ethical of shareholders (people) to seek wealth maximization. In a similar way, we can ask if bondholders (people) are acting ethically by taking control of the firm when it is in financial trouble. Discussing whether a specific company (e.g., Exxon) is unethical, however, must be viewed as imprecise and requires further specification in order to identify clearly the people involved. TWO APPROACHES TO CORPORATE ETHICS The philosophical underpinnings of ethical thought date back over centuries. [We here discuss] these underpinnings around two general approaches. The first is the contractual-rights approach, in which ethical decisions are applied based upon rights and how those rights should be preserved. The second approach is the societal-good approach, wherein ethical decisions are applied based upon whether or not something is viewed as being good for society rather than upon rights. For example, let us consider the topic of drug testing in the work place, for which the typical question is should employers be allowed to administer drug testing on current or prospective employees? Advocates of the contractual-rights approach would explore this issue by questioning whether employees have a right not to be drug tested and whether employers have a right to hire and retain anyone they want. Advocates of the societal-good approach would explore this issue from the perspective of when and if drug testing leads to a better or worse society. Other examples of topics involving ethical decisions include universal health care, family leave in the work place, and minimum wage laws, and can be analyzed from the perspective of these two approaches.... THE CONTRACTUAL-RIGHTS APPROACH TO CORPORATE ETHICS The contractual-rights approach to corporate ethics analyzes behavior on the basis of individual rights, contractually retained. For instance, is it a person s right to drug-test an employee or does it violate the employee s rights? Is health care a right of each employee? Within the contractual-rights approach there is little or no emphasis on whether or not the behavior is good for society. In discussions of contractual rights, it becomes clear that people differ on what they feel is a true right. For example, from the following two lists ask yourself which group, List 1 or List 2, represents true rights of individuals.

5 CORPORATE ETHICS AND SHAREHOLDER WEALTH MAXIMIZATION LIST 1 LIST 2 1. The right to a decent job. 2. The right to basic health care. 3. The right to quality child care. 1. The right to unionize. 2. The right to own property. 3. The right to pay an agreed-upon wage. Within the contractual-rights view of business ethics, there is general agreement that List 2 represents true rights and List 1 does not. For example, in the United States the discussion of contractual rights is greatly simplified because many of the rights of people are clearly understood. Individual rights in the United States are set forth in the U.S. Constitution and the constitutions of the states. The Constitution declares that people have a right to own, keep, and control the property they have earned in exchange for their labor or which they have been lawfully given by others (e.g., parents). In contrast, the rights in List 1 have not been contracted. Further, List 1 forces people to supply resources against their will to other people. For example, the right to health care or child care is tantamount to forcing other people to provide it or to pay for it. Thus, the rights in List 1 are examples of attempts to violate the rights of other persons. The rights in List 2 are contractual, as they represent the rights of people to control their own bodies and property, when rights are defined in their traditional and constitutional sense. THE SOCIETAL-GOOD APPROACH TO CORPORATE ETHICS The second approach to corporate ethics is the societal-good approach, in which ethically correct decisions are defined as those that produce the greatest overall benefit to society. Politicians often use this approach when debating or determining matters of public policy. For example, most people support the idea that corporations should be required to pay at least some minimum wage, based on the idea that it is only fair that a corporation provide this minimum pay to its employees. Notice that this argument focuses on what seems fair rather than on whether society has a right to interfere with the wage rate that the corporation s shareholders pay.

6 CORPORATE ETHICS AND SHAREHOLDER WEALTH MAXIMIZATION Returning to the drug-testing example, advocates of the societal-good approach would debate whether the responsibilities of certain jobs, such as those of airline pilots or other jobs that put people at risk of injury, are important enough to society that testing should be required. If so, testing would become a requirement for these jobs but not for others. DEBATING THE TWO APPROACHES TO CORPORATE ETHICS Despite the widespread usage and appeal of the societal-good approach, the debate must be analyzed carefully. Consider the fact that the United States was founded by applying the contractual-rights approach. The rich and the poor provide a fertile ground for debating the two approaches to business ethics. Compassionate people hate to see groups suffer in poverty while others live in opulence. In fact, it is the desire to force a fairer distribution of wealth that lies at the heart of most societal-good arguments. What many people fail to see, however, is that actions designed to alleviate the economic conditions of the poor can violate individual rights. Contractual rights belong to everyone from the poorest to the wealthiest individuals in society. The view that I have a right to my property but shareholders of a corporation do not have the same right to their property is implicit in many widely held viewpoints. It is essential as we explore business ethics that we keep reminding ourselves that according to the U.S. Constitution individual rights belong to everyone even shareholders! Does this mean that in order to adhere to contractual rights a person must stop caring about the poor and doing things for them? The answer is, no! The contractual-rights approach does not stand in the way of helping the poor, but rather it says that it is wrong to pass laws that force people to help the poor. Indeed, the United States, under a system of contractual rights, has one of the highest levels of philanthropic giving in the world. UNREQUIRED BEHAVIOR VERSUS REQUIRED BEHAVIOR: OUGHTTAS VERSUS GOTTAS Before addressing questions of corporate ethics directly, it is useful to draw a distinction between the concepts oughttas and gottas. We seek to differentiate ethical conduct we require from other people (the got tos or gottas) from the ethical conduct we do not require from others (the ought tos or oughttas). Helping an elderly person cross a street is an oughtta. Not running an elderly person over in a crosswalk with your car is a gotta.

7 CORPORATE ETHICS AND SHAREHOLDER WEALTH MAXIMIZATION Keeping these two concepts separate in our minds helps develop a reasoned approach to corporate ethics. This begins by separating behavior that we pursue ourselves and wish others would pursue from behavior that we require of other people. We can thus categorize a particular ethical dilemma as involving either an oughtta or a gotta.... OUGHTTAS We start with oughttas, or conduct a person believes is morally correct but which is not legally required. Virtually everyone would agree that, in business, there are many oughttas. For example, people operating within the firm should be courteous to customers and co-workers saying please and thank you. In addition, people operating within the firm should not knowingly sell a product or service that entails certain dangers without providing an appropriate warning. We could cite many more examples of what most people would agree the corporation ought to do.... GOTTAS Gottas represent required behavior. For example, we require people not to murder or steal. While a discussion of oughttas is fun because no one is being forced to do or not do anything, a discussion of gottas is less fun because it often poses the risk of the denial of one or more persons rights.... This discussion of oughttas and gottas may seem a little unnecessary for understanding business ethics, but it is essential in drawing a clear line between what a person should do and what a person can be forced by society to do. [This] helps divide the discussion of ethics into two types of decisions: personal ethical decisions and public-policy decisions. PERSONAL VERSUS PUBLIC-POLICY DEBATES We now use the ethical approaches of contractual rights and societal good and the concepts of oughttas and gottas, to clarify the issues of corporate ethics.... [Ethical] dilemmas are faced almost daily by individuals and groups of individuals within the corporation. For instance, shareholders face ethical decisions regarding pollution, the fair treatment of customers, the fair treatment of employees, and so forth.

8 CORPORATE ETHICS AND SHAREHOLDER WEALTH MAXIMIZATION PERSONAL ETHICAL DECISIONS [Many] ethical decisions do not involve illegal behavior; rather, they are personal decisions such as those found in office politics. Most of these issues come down to a conflict between helping yourself and doing what is right for others. How individuals reach a particular decision involves their own ethical belief system (i.e., their own beliefs regarding right or wrong conduct).... PUBLIC-POLICY ETHICAL DECISIONS A different type of ethical decision is a public-policy ethical decision. Public policy decisions use the government to turn an oughtta into a gotta. As citizens, we participate in making laws subject to the limits placed by the Constitution, and we can even change the Constitution itself by amending it (with the approval of 75 percent of the states). In terms of public-policy decisions, think of the government as a set of contracts through which people formulate gottas, which require certain type of behavior. Many of the current public-policy debates regarding corporations involve the passage of laws to force some type of behavior. For example, the Family Leave Act was passed by the federal government to require that employers grant particular rights and privileges to employees. Other examples of this type include the Americans with Disabilities Act, the Civil Rights Act, and the Clean Air Act. As long as the piece of legislation is constitutional, discussing ethical conduct through these laws is a debate of what is good or bad for society, both within and outside the corporation.... CORPORATE ETHICS AND SHAREHOLDER WEALTH MAXIMIZATION A popular debate in corporate ethics concerns the purpose or goal of a corporation. [Debating] the purpose of the corporation, when this is interpreted literally, does not make a great deal of sense because a corporation is simply a nexus or set of contracts, not a set of people. Although we could detail the goals of all people who contract through corporations, including employees, customers, suppliers, and creditors, we are concerned primarily with discussing the shareholders because they own the corporation. The key question involves the goal of the shareholders with respect to their decision to contract through a particular corporation.

9 CORPORATE ETHICS AND SHAREHOLDER WEALTH MAXIMIZATION The goal of any person is to make decisions that produce what they perceive to be the most desirable results. Thus, the goal of a corporation is to achieve the most desirable results for its shareholders, which may or may not include concern for other people, depending upon the shareholders ethical beliefs. [We] would generally expect shareholders to desire the greatest possible market value to their stock and therefore their wealth. Do shareholders have the right to seek maximization of their wealth? The answer based on contractual rights is clearly, yes! Shareholders can do whatever they want with their wealth as long as that does not include a violation of society s gottas. The concept of individual private property rights makes the goal of assets or contracts clear: The goal is set by the owner subject to the required behavior or gottas of the society. Shareholders will determine the goal of a corporation because they own the corporation. Of course, we assume that shareholders fulfill their contracts with others (e.g., stakeholders) and that contracts are freely negotiated. The societal-good approach to corporate ethics, which is often referred to as the stakeholder view of the corporation, attempts to force the shareholders to do the good deeds that other people would like to see done. The word stakeholder originates from the concept that anybody affected by a corporation has a stake in the corporation and should therefore be given the right to influence the corporation. [We] can think of stakeholders as the different groups that contract through the corporation. Thus, while stakeholders have contracts, it is the shareholders that have a residual claim on the firm s cash flows and own the firm. Arguing against shareholder control is implicitly arguing that society itself owns the property and therefore has the right to determine or influence the corporation s goal. This argument can be presented with great intentions, but as the contractual-rights view points out, the stakeholder view violates the rights of the shareholders. Given the background of oughttas and gottas, and of personal and public-policy decisions, let us now work through some actual ethical situations facing shareholders within corporations. For example, let us consider the following five corporate ethical questions: 1. Advertising products that some consider to be harmful. 2. Smoking in the workplace. 3. Issuing high-risk bonds, sometimes referred to as junk bonds. 4. Equal opportunity in hiring practices, especially company policy regarding minority applicants.

10 CORPORATE ETHICS AND SHAREHOLDER WEALTH MAXIMIZATION 5. The disposal of hazardous waste products. How would these two approaches societal good and contractual rights attempt to resolve these ethical issues? The societal-good approach would examine whether laws should be passed to control these behaviors based upon what is best for society. For example, it might be argued that (1) advertising harmful products such as cigarettes and alcoholic beverages might be interpreted as a stamp of approval for their use, (2) second-hand smoke adversely affects the health of all employees, (3) junk bonds have a destabilizing effect on the economy, (4) employment practices need to be fair and equitable, and (5) the local environment must be protected. If widespread agreement exists on these points of view, then people might be tempted to work through government and pass laws that guarantee leaves of absence, that ban all smoking in the workplace, that restrict the issuance of certain types of bonds, that require that certain products not be advertised, and that restrict haphazard disposal of waste. In contrast, the contractual-rights approach first asks whether or not these issues restrict individual rights protected by the Constitution. In other words, does the U.S. Constitution allow governments to interfere with these rights? If the answer is no, then from the point of view of contractual rights, people cannot force other people to do these good deeds. If the answer is yes, then from the point of view of contractual rights, people can come together to work through government to regulate certain corporate behavior. In the United States, the Constitution protects the right to ownership of private property. Shareholders are no exception. Thus, corporations cannot be forced to hire or retain people who smoke cigarettes. Further, shareholders have the right to issue debt including junk debt. Because no such contracts exist involving smoking and junk bonds, these situations fall in the category of personal ethical decisions that the corporation s shareholders must make. Shareholders within one corporation could decide to allow cigarettesmoking while shareholders within another corporation could decide to restrict such behavior. In the areas of hiring practices and hazardous waste disposal, however, laws have been passed specifying gottas. Society has acted through government to legislate certain corporate conduct, perhaps because of infringements on the right of people to life and property.... In the cases of advertising and hazardous waste disposal, the corporation faces penalties if specific guidelines are not followed.

11 CORPORATE ETHICS AND SHAREHOLDER WEALTH MAXIMIZATION CORPORATE ETHICS AND MARKET VALUES We previously discussed whether shareholders have the right to seek maximization of their wealth. We will now discuss whether shareholder wealth maximization is an ethical goal. Some would argue that this goal drives corporations toward highly unethical, and perhaps even illegal, activity. An essential point, however, is that market values can price ethics just as they can price all other expected cash flows to the firm. Thus, a corporation that maximizes shareholder wealth by maximizing the firm s stock price is making the stock as desirable as possible to investors. If investors care about ethical issues, then they will find the stock of an unethical firm to be less desirable and its stock price will be lower than if it were an ethical firm. It has become increasingly clear that many investors do care about ethics. With divestiture from certain countries leading the way, ethical concerns have entered corporate boardrooms throughout the world. Throughout our society we find that ethics are priced. For example, hiring someone to perform an unethical task generally costs more than hiring someone to do honorable work. Are shareholders any different? If not, then the goal of shareholder wealth maximization forces corporate decisions to be made in a way that most satisfies these investors including their ethical concerns.... Regardless of whether or not shareholders have standards that encourage managers to act ethically, there are other market pressures exerted on a corporation s ethical conduct. For instance, a corporation labeled with bad ethical conduct can be hurt by boycotts or other activist activities. There is also some anecdotal evidence that firms can use stated ethical objectives to achieve success in the marketplace. Ben & Jerry s Homemade, the Vermont ice cream producer... has achieved phenomenal growth due in part to their business philosophy known as caring capitalism. For Ben & Jerry s, however, as well as for any other corporation, this does not mean that the objective of the firm has changed.