Ethical Obligations

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Quiz 3 :

Organizational Ethics and Corporate Governance

Quiz 3 :

Organizational Ethics and Corporate Governance

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Bhopal, India: A Tragedy of Massive Proportions We are citizens of the world. The tragedy of our times is that we do not know this. Woodrow T Wilson (1856-1924), 28th president of the United States At five past midnight on December 3, 1984, 40 tons of the chemical methyl isocynate (MIC), a toxic gas, started to leak out of a pesticide tank at the Union Carbide plant in Bhopal, India. The leak was first detected by workers about 11:30 p.m. on December 2, 1984, when their eyes began to tear and burn. According to AcuSafe, 1 "in 1991 the official Indian government panel charged with tabulating deaths and injuries counted more than 3,800 dead and approximately 11,000 with disabilities." However, estimates now range as high as 8,000 killed in the first three days and over 120,000 injured. 2 There were 4,000 deaths officially recorded by the government, although 13,000 death claims were filed with the government, according to a United Nations report, and hundreds of thousands more claim injury as a result of the disaster. 3 On June 7, 2010, an Indian court convicted eight former senior employees of Union Carbide's Indian subsidiary to two years in jail each for causing "death by negligence" over their part in the Bhopal gas tragedy in which an estimated 15,000 people died more than 25 years ago. While the actual numbers may be debatable, there can be no doubt that the Bhopal incident raises a variety of interesting ethical questions, including: • Did the company knowingly sacrifice safety at the Bhopal plant? • Did the Indian government properly oversee the functioning of the plant consistent with its regulatory authority? • Did the company react quickly enough to avoid sustained health problems to those injured by the leak of toxic fumes? • In the aftermath of the disaster, were the disclosures made by Union Carbide sufficiently transparent to enable a concerned public to understand the causes of the leak and the steps that the company was taking to address all the issues? • Did the company and the Indian government reach a fair resolution of the thousands of claims filed by Indian citizens? • Is "business risk" a valid basis on which to make business decisions? You make up your own mind as you read about the tragedy that is Bhopal. In the Beginning On May 4, 1980, the first factory exported from the West to make pesticides using MIC began production in Bhopal, India. The company planned to export the chemicals from the United States to make the pesticide Sevin. The new CEO of Union Carbide came over from the United States especially for the occasion. 4 As you might expect, the company seemed very concerned about safety issues. "Carbide's manifesto set down certain truths, the first being that 'all accidents are avoidable provided the measures necessary to avoid them are defined and implemented.'" The company's slogan was "Good safety and good accident prevention practices are good business." Safety Measures The Union Carbide plant in Bhopal was equipped with an alarm system with a siren that was supposed to be set off whenever the "duty supervisor in the control room" sensed even the slightest indication that a possible fire might be developing "or the smallest emission of toxic gas." The "alarm system was intended to warn the crews working on the factory site." Even though thousands of people lived in the nearby bustees (shantytowns), "none of the loudspeakers pointed outward" in their direction. Still, they could hear the sirens coming from the plant. The siren went off so frequently that it seemed as though the population became used to it and weren't completely aware that one death and several accidental poisonings had occurred before the night of December 2, and there was a "mysterious fire in the alpha-naphtol unit." In May 1982, three engineers from Union Carbide came to Bhopal to evaluate the plant and confirm that everything was operating according to company standards. However, the investigators identified more than 60 violations of operational and safety regulations. An Indian reporter managed to obtain a copy of the report that noted "shoddy workmanship," warped equipment, corroded circuitry, "the absence of automatic sprinklers in the MIC and phosgene production zones," a lack of pressure gauges, and numerous other violations. The severest criticism was in the area of personnel. There was "an alarming turnover of inadequately trained staff, unsatisfactory instruction methods, and a lack of rigor in maintenance reports." The reporter wrote three articles proclaiming the unsafe plant. The third article was titled "If You Refuse to Understand, You Will Be Reduced to Dust." Nothing seemed to matter in the end because the population was assured by Union Carbide and government representatives that no one need be concerned because the phosgene produced at the plant was not a toxic gas. The Accident The accident occurred when a large volume of water entered the MIC storage tanks and triggered a violent chain reaction. Normally, water and MIC were kept separate, but on the night of December 2, "metal barriers known as slip blinds were not inserted and the cleaning water passed directly into the MIC tanks." It is possible that additional water entered the tanks later on in the attempts to control the reaction. Shortly after the introduction of water, "temperatures and pressures in the tanks increased to the point of explosion." The report of consultants that reviewed the facts surrounding the accident indicates that workers made a variety of attempts to save the plant, including: 5 • They tried to turn on the plant refrigeration system to cool down the environment and slow the reaction, but the system had been drained of coolant weeks before and never refilled as a cost-saving measure. • They tried to route expanding gases to a neighboring tank, but the tank's pressure gauge was broken, indicating that the tank was full when it was really empty. • They tried other measures that didn't work due to inadequate or broken equipment. • They tried to spray water on the gases and have them settle to the ground, but it was too late as the chemical reaction was nearly completed. The Workers and Their Reaction It was reported that the maintenance workers did not flush out the pipes after the factory's production of MIC stopped on December 2. This was important because the pipes carried the liquid MIC produced by the plant's reactors to the tanks. The highly corrosive MIC leaves chemical deposits on the lining of the tanks that can eventually get into the storage tanks and contaminate the MIC. Was it laziness, as suggested by one worker? Another worker pointed out that the production supervisor of the plant left strict instructions to flush the pipes, but it was late at night and neither worker really wanted to do it. Still, they followed the instructions for the washing operation, but the supervisor had omitted the crucial step to place solid metal discs at the end of each pipe to ensure hermetically sealed tanks. The cleansing operation began when one worker connected a hosepipe to a drain cock on the pipework and turned on the tap. After a short time, it was clear to the worker that the injected water was not coming out of two of the four drain cocks. The worker called the supervisor, who walked over to the plant and instructed the worker to clean the filters in the two clogged drain cocks and turn the water back on. They did that, but the water did not flow out of one drain. After informing the supervisor, who said to just keep the water flowing, the worker left for the night. It would now be up to the night shift to turn off the tap. The attitude of the workers as they started the night shift was not good as Union Carbide had started to cut back on production and lay off workers. They wondered if they might be next. The culture of safety that Union Carbide tried to build up was largely gone, as the workers typically handled toxic substances without protective gear. The temperature readings in the tanks were made less frequently, and it was rare when anyone checked the welding on the pipework in the middle of the night. Even though the pressure gauge on one of the tanks increased beyond the "permitted maximum working pressure," the supervisor ignored warnings coming from the control room because he was under the impression that Union Carbide had built the tanks with special steel and walls thick enough to resist even greater pressures. Still, the duty head of the control room and another worker went to look directly at the pressure gauge attached to the three tanks. They confirmed the excessive pressure in one tank. The duty head climbed to the top of that tank, examined the metal casing carefully, and sensed the stirring action. The pressure inside was increasing quickly, leading to a popping sound "like champagne corks." Some of the gas then escaped, and a brownish cloud appeared. The workers returned to where the pipes had been cleaned and turned off the water tap. They smelled the powerful gas emissions, and they heard the fizzing, which sounded as if someone was blowing into an empty bottle. One worker had a cool enough head to sound the general alarm, but it was too late for most of the workers and many of those living in the shantytowns below the plant. The Political Response Union Carbide sent a team to investigate the catastrophe, but the Indian government had seized all records and denied the investigators access to the plant and the eyewitnesses. The government of the state of Madhya Pradesh (where the plant was located) tried to place the blame squarely on the shoulders of Union Carbide. It sued the company for damages on behalf of the victims. The ruling Congress Party was facing national parliamentary elections three weeks after the accident, and it "stood to lose heavily if its partners in the state government were seen to be implicated, or did not deal firmly with Union Carbide." 6 The government thwarted early efforts by Union Carbide to provide relief to the victims to block its attempt to gain the goodwill of the public. The strategy worked: the Congress Party won both the state legislative assembly and the national parliament seats from Madhya Pradesh by large margins. Economic Effects The economic impact of a disaster like the one that happened in Bhopal is staggering. The $25 million Union Carbide plant in Bhopal was shut down immediately after the accident, and 650 permanent jobs were lost. The loss of human life means a loss of future earning power and economic production. The thousands of accident victims had to be treated and in many cases rehabilitated. The closure of the plant had peripheral effects on local businesses and the population of Bhopal. It is estimated that "two mass evacuations disrupted commercial activities for several weeks, with resulting business losses of $8 to $65 million." In the year after the accident, the government paid compensation of about $800 per fatality to relatives of the dead persons. About $100 apiece was awarded to 20,000 victims. Beginning in March 1991, new relief payments were made to all victims who lived in affected areas, and a total of $260 million was disbursed. Overall, Union Carbide agreed to pay $470 million to the residents of Bhopal. By the end of October 2003, according to the Bhopal Gas Tragedy Relief and Rehabilitation Department, compensation had been awarded to 554,895 people for injuries received and 15,310 survivors of those killed. The average amount that families of the dead received was $2,200. Union Carbide's Response Shortly after the gas release, Union Carbide launched what it called "an aggressive effort to identify the cause." According to the company, the results of an independent investigation conducted by the engineering consulting firm Arthur D. Little were that "the gas leak could only have been caused by deliberate sabotage. Someone purposely put water in the gas storage tank, causing a massive chemical reaction. Process safety systems had been put in place that would have kept the water from entering the tank by accident." 7 A 1993 report prepared by Jackson B. Browning, the retired vice president of Health, Safety, and Environmental Programs at Union Carbide Corporation, stated that he didn't find out about the accident until 2:30 a.m. on December 3. He claims to have been told that "no plant employees had been injured, but there were fatalities-possibly eight or twelve-in the nearby community." A meeting was called at the company's headquarters in Danbury, Connecticut, for 6 a.m. The chair of the board of directors of Union Carbide, Warren M. Anderson, had received the news while returning from a business trip to Washington, DC. He had a "bad cold and a fever," so Anderson stayed at home and designated Browning as his "media stand-in" until Anderson could return to the office. 8 At the first press conference called for 1:00 p.m. on December 3, the company acknowledged that a disaster had occurred at its plant in Bhopal. The company reported that it was sending "medical and technical experts to aid the people of Bhopal, to help dispose of the remaining [MIC] at the plant and to investigate the cause of the tragedy." Notably, Union Carbide halted production at its only other MIC plant in West Virginia, and it stated its intention "to convert existing supplies into less volatile compounds." Anderson traveled to India and offered aid of $1 million and the Indian subsidiary of Union Carbide pledged the Indian equivalent of $840,000. Within a few months, the company offered an additional $5 million in aid that was rejected by the Indian government. The money was then turned over to the Indian Red Cross and used for relief efforts. The company continued to offer relief aid with "no strings attached." However, the Indian government rejected the overtures, and it didn't help the company to go through third parties. Union Carbide believed that the volatile political situation in India-Prime Minister Indira Gandhi had just been assassinated in October-hindered its relief efforts, especially after the election of Rajiv Gandhi shortly after the assassination on a government reform platform. It appeared to the company that Union Carbide was to be made an example of as an exploiter of Indian natural resources, and it suspected that the Indian government may have wanted to "gain access to Union Carbide's financial resources." Union Carbide had a contingency plan for emergencies, but it didn't cover the "unthinkable." The company felt compelled to show its "commitment to employee and community safety and specifically, to reaffirm the safety measures in place at their operation." Anderson went to West Virginia to meet with the employees in early February 1985. At that meeting, as "a measure of the personal concern and compassion of Union Carbide employees," the workers established a "Carbide Employees Bhopal Relief Fund and collected more than $100,000 to aid the tragedy's victims." 9 Analysis of Union Carbide's Bhopal Problems Documents uncovered in litigation 10 and obtained by the Environmental Working Group of the Chemical Industry Archives, an organization that investigates chemical company claims of product safety, indicate that Union Carbide "cut corners and employed untested technologies when building the Bhopal Plant." The company went ahead with the unproven design even though it posed a "danger of polluting subsurface water supplies in the Bhopal area." The following is an excerpt from a document numbered UCC 04206 and included in the Environmental Working Group Report on Bhopal, India. 11 It also reveals the indifferent attitude of the Indian government toward environmental safety. "The systems described have received provisional endorsement by the Public Health Engineering Office of the State of Madhya Pradesh in Bhopal. At present, there are no state or central government laws and/or regulations for environmental protection, though enactment is expected in the near future. It is not expected that this will require any design modifications." Technology Risks "The comparative risk of poor performance and of consequent need for further investment to correct it is considerably higher in the [Union Carbide-India] operation than it would be had proven technology been followed throughout... the MIC-to-Sevin process, as developed by Union Carbide, has had only a limited trial run. Furthermore, while similar waste streams have been handled elsewhere, this particular combination of materials to be disposed of is new and, accordingly, affords further chance for difficulty. In short, it can be expected that there will be interruptions in operations and delays in reaching capacity or product quality that might have been avoided by adoption of proven technology. [Union Carbide-India] finds the business risk in the proposed mode of operation acceptable, however, in view of the desired long-term objectives of minimum capital and foreign exchange expenditures. SO long as [Union Carbide-India] is diligent in pursuing solutions, it is their feeling that any shortfalls can be mitigated by imports. Union Carbide concurs." As previously mentioned, there were one death and several accidental poisonings at the Bhopal plant before December 3, 1984. The International Environmental Law Research Center prepared a Bhopal Date Line showing that the death occurred on December 25, 1981, when a worker was exposed to phosgene gas. On January 9, 1982, 25 workers were hospitalized as a result of another leak. On October 5, 1982, another leak from the plant led to the hospitalization of hundreds of residents. 12 It is worth noting that the workers had protested unsafe conditions after the January 9, 1982, leak, but their warning went unheeded. In March 1982, a leak from one of the solar evaporation ponds took place, and the Indian plant expressed its concern to Union Carbide headquarters. In May 1982, the company sent its U.S. experts to the Bhopal plant to conduct the audit previously mentioned. Union Carbide's reaction to newspaper allegations that Union Carbide-India was running an unsafe operation was for the plant's works manager to write a denial of the charges as baseless. The company's next step was, to say the least, bewildering. It rewrote the safety manuals to permit switching off of the refrigeration unit and a shutdown of the vent gas scrubber when the plant was not in operation. The staffing at the MIC unit was reduced from 12 workers to 6. On November 29, 1984 three days before the disaster, Union Carbide completed a feasibility report and the company had decided to dismantle the plant and ship it to Indonesia or Brazil. India's Position The Indian government has acknowledged that 521,262 persons, well over half the population of Bhopal at the time of the toxic leak, were "exposed" to the lethal gas. 13 In the immediate aftermath of the accident, most attention was devoted to medical recovery. The victims of the MIC leak suffered damage to lung tissue and respiratory functions. The lack of medical documentation affected relief efforts. The absence of baseline data made it difficult to identify specific medical consequences of MIC exposure and to develop appropriate medical treatment. Another problem was that malnourishment of the poor Indians affected by the tragedy added to the difficulty because they already suffered from many of the postexposure symptoms such as coughing, breathlessness, nausea, vomiting, chest pains, and poor sight. 14 In a paper on the Bhopal tragedy written by Pratima Ungarala, a student at Hindu University, he analyzed the Browning Report and characterized the company's response as one of public relations. He noted that the report identified the media and other interested parties such as customers, shareholders, suppliers, and other employees as the most important to pacify. Ungarala criticized this response for its lack of concern for the people of Bhopal and the Indian people in general. Instead, the corporation saw the urgency to assure the people of the United States that such an incident would not happen here. 15 Browning's main strategy to restore Union Carbide's image was to distance the company from the site of the disaster. He points out early in the document that Union Carbide had owned only 50.9 percent of the affiliate, Union Carbide India Ltd. He notes that all the employees in the company were Indians and that the last American employee had left two years before the leak. The report contended that the company "did not have any hold over its Indian affiliate." This seems to be a contentious issue because while "many of the day-to-day details, such as staffing and maintenance, were left to Indian officials, the major decisions, such as the annual budget, had to be cleared with the American headquarters." In addition, according to both Indian and U.S. laws, a parent company (United Carbide in this case) holds full responsibility for any plants that it operates through subsidiaries and in which it has a majority stake. Ungarala concluded that Union Carbide was trying to avoid paying the $3 billion that India demanded as compensation and was looking to find a "scapegoat" to take the blame. 16 After the government of Madhya Pradesh took over the information Web site from Union Carbide, it began to keep track of applications for compensation. Between 1985 and 1997, over 1 million claims were filed for personal injury. In more than half of those cases, the claimant was awarded a monetary settlement. The total amount disbursed as of March 31, 2003, was about $345 million. 17 An additional $25 million was released through July 2004, at which time the Indian Supreme Court ordered the government to pay the victims and families of the dead the remaining $330 million in the compensation fund. Lawsuits The inevitable lawsuits began in December 1984 and March 1984, when the government of India filed against Union Carbide-India and the United States, respectively. Union Carbide asked for the case filed in the Federal District Court of New York to be moved to India because that was where the accident had occurred and most of the evidence existed. The case went to the Bhopal District Court-the lowest-level court that could hear such a case. During the next four years, the case made "its way through the maze of legal bureaucracy" from the state high court up to the Supreme Court of India. The legal disputes were over the amount of compensation and the exoneration of Union Carbide from future liabilities. The disputes were complicated by a lack of reliable information about the causes of the event and its consequences. The government of India had adopted the "Bhopal Gas Leak Disaster Ordinance-a law that appointed the government as sole representative of the victims." It was challenged by victim activists, who pointed out that the victims were not consulted about legal matters or settlement possibilities. The result was, in effect, to dissolve "the victims' identity as a constituency separate and differing from the government." 18 In 1989, India had another parliamentary election, and it seemed a politically opportune time to settle the case and win support from the voters. It had been five years since the accident and the victims were fed up with waiting. By that time, "hundreds of victims had died and thousands had moved out of the gas-affected neighborhoods." Even though the Indian government had taken Union Carbide to court asking for $3 billion, the company reached a settlement with the government in January 1989 for $470 million; the agreement gave Union Carbide immunity from future prosecution. In October 1991, India's Supreme Court upheld the compensation settlement but cancelled Union Carbide's immunity from criminal prosecution. The money had been held in a court-administered account until 1992 while claims were sorted out. By early 1993, there were 630,000 claims filed, of which 350,000 had been substantiated on the basis of medical records. The numbers are larger than previously mentioned because the extent of health problems grew continuously after the accident and hundreds of victims continued to die. Despite challenges by victims and activists to the settlement with Union Carbide, at the beginning of 1993, the government of India began to distribute the $470 million, which had increased to $700 million as a result of interest earned on the funds. 19 What Happened to Union Carbide? Not surprisingly, the lawsuits and bad publicity affected Union Carbide's stock price. Before the disaster, the company's stock traded between $50 and $58 a share. In the months immediately following the accident, it traded at $32 to $40. In the latter half of 1985, the GAF Corporation of New York made a hostile bid to take over Union Carbide. The ensuing battle and speculative stock trading ran up the stock price to $96, and it forced the company into financial restructuring. The company's response was to fight back. It sold off its consumer products division and received more than $3.3 billion for the assets. It took on additional debt and used the funds from the sale and borrowing to repurchase 38.8 million of its shares to protect the company from further threats of a takeover. The debt burden had accounted for 80 percent of the company's capitalization by 1986. At the end of 1991, the debt levels were still high-50 percent of capitalization. The company sold its Linde Gas Division for $2.4 billion, "leaving the company at less than half its pre-Bhopal size." The Bhopal disaster "slowly but steadily sapped the financial strength of Union Carbide and adversely affected" employee morale and productivity. The company's inability to prove its sabotage claim affected its reputation. In 1994, Union Carbide sold its Indian subsidiary, which had operated the Bhopal plant, to an Indian battery manufacturer. It used $90 million from the sale to fund a charitable trust that would build a hospital to treat victims in Bhopal. Two significant events occurred in 2001. First, the Bhopal Memorial Hospital and Research Centre opened its doors. Second, the Dow Chemical Company purchased Union Carbide for $10.3 billion in stock and debt, and Union Carbide became a subsidiary of Dow Chemical. Subsequent to the initial settlement with Union Carbide, the Indian government took steps to right the wrong and its aftereffects caused by the failure of management and the systems at Union Carbide in Bhopal. On August 8, 2007, the Indian government announced that it would meet many of the demands of the survivors by taking legal action on the civil and criminal liabilities of Union Carbide and its new owner, Dow Chemical. The government established an "Empowered Commission" on Bhopal to address the health and welfare needs of the survivors, as well as environmental, social, economic, and medical rehabilitation. On June 26, 2012, Dow Chemical Co. won dismissal of a lawsuit alleging polluted soil and water produced by its Union Carbide's chemical plant in Bhopal, India, injured area residents, one of at least two pending cases involving the facility known for the 1984 disaster that killed thousands. U.S. District Judge John Keenan in Manhattan ruled that Union Carbide and its former chairman, Warren Anderson, weren't liable for environmental remediation or pollution- related claims made by residents near the plant, which had been owned and operated by a former Union Carbide unit in India. Questions 1. Evaluate the actions of the workers and management of Union Carbide in this case from the perspectives of System 1 and System 2 thinking that was discussed in Chapter 2. 2. The document uncovered by the Environmental Working Group Report refers to the acceptable "business risk" in the Bhopal operation due to questions about the technology. Is it ethical for a company to use business risk as a measure of whether to go ahead with an operation that may have safety problems? How would you characterize such a thought process from the perspective of ethical reasoning? 3. Evaluate management decision making in the Bhopal case from a corporate governance perspective. Compare the decision-making process used by Union Carbide to deal with its disaster with that of Ford Motor Co. in the Pinto case and Johnson Johnson in the Tylenol incident as described in this chapter. How do you assess stakeholder responsibilities in each of these cases? 1 AcuSafe is an Internet resource for safety and risk management information that is a publication of AcuTech, a global leader in process safety and security risk management located in Houston, Texas; see www.acusafe.com/Incidents/Bhopal1984/incidentbhopal1984.htm. 2 According to CorpWatch, www.corpwatch.org/. 3 United Nations, United Nations University Report (UNU Report) on Toxic Gas Leak , www.unu.edu/unupress/unupbooks/uu21le/uu211eOc.htm. 4 Dominique LaPierre and Javier Moro, Five Past Midnight in Bhopal (New York: Warner Books, 2002). 5 Ron Graham, "FAQ on Failures: Union Carbide Bhopal," Barrett Engineering Consulting, www.tcnj.edu/rgraham/failures/UCBhopal.html. 6 United Nations, United Nations University Report (UNU Report) 7 After the leak, Union Carbide started a Web site, www.bhopal.com, to provide its side of the story and details about the tragedy. In 1998, the Indian state government of Madhya Pradesh took over the site. 8 Jackson B. Browning, The Browning Report , Union Carbide Corporation, 1993, www.bhopal.com/pdfs/browning.pdf. 9 The Browning Report , p. 8. 10 Bano et al. v. Union Carbide Corp Warren Anderson, 99cv11329 SDNY , filed on 11/15/99. 11 Environmental Working Group, Chemical Industry Archives , www.chemicalindustryarchives.org/dirtysecrets/bhopal/index.asp. 12 S. Muralidhar, "The Bhopal Date Line," International Environmental Law Research Centre, www.ielrc.org/content/n0409.htm. 14 Paul Shrivastava, "Long-Term Recovery from the Bhopal Crisis," The Long Road to Recovery: Community Responses to Industrial Disaster (New York: United Nations University, 1996). 15 Pratima Ungarala, Bhopal Gas Tragedy: An Analysis , Final Paper HU521/Dale Sullivan 5/19/98, www.hu.mtu.edu/hu_ept/tc@mtu/papers/bhopal.htm. 16 Ungarala. 17 Madhya Pradesh Government, Bhopal Gas Tragedy Relief and Rehabilitation Department, www.mp.nic.in/bgtrrdmp/facts.htm. 18 Michael R. Reich, Toxic Politics: Responding to Chemical Disasters (Ithaca, NY: Cornell University Press, 1991). 19 United Nations Report.
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1. System 1 style thinking is fast and intuitive. System 2 style is slow and require longer considerations. The case presents management as having applied system 2 style thinking to safety when it initially set up operations in the foreign country. It argued for setting safety standards at the highest priority. However, as the parent company rolled back operations in the country, it seemed to have adopted system 1 style thinking. The case portrays the company as only wanting to maintain operations but not improve safety standards. 2. The use of business risk is a utilitarianism approach. Sometimes it is appropriate if there are no serious consequences from the risk, e.g. when human lives and safety are not involved. However, the use of business risk by the company seemed unethical in this case because the risk involved human lives. 3. The case portrayed the company in only trying to give money and defending itself publicly. The company was unable to recover from the incident and was purchased by another chemical company. This may be due to the fact that many deaths were involved at once unlike the cases of the car companies.

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In the accounting fraud at the cable company Adelphia, top management had established a "cash management" system that enabled the founder of Adelphia and former CEO and chair of the board of directors, John Rigas, to dip into the fund for personal expenses whenever he wanted. The final approval for such expenditures rested with Timothy Rigas, the son of John Rigas and Adelphia's CEO during the final years that fraud had occurred. What's wrong with the founder of a company, its former CEO and board chair, using corporate assets for personal reasons? Can you think of any circumstances where it would be permissible? That is, what would have to happen for this to be acceptable?
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Corporate assets are assets such as cash accounts, inventory, that are used to generate revenue for the corporation. When a member of the board takes corporate asset for his own use he is breaching his fiduciary duties to protect asset and ensure revenues for the owners of the firm. When firms are small, that is the owner is the sole proprietor, then corporate assets may not be as well defined from owner's assets. The owners may sometimes take money out of the firm's account for personal use, in that case the owner should reflect the money he takes out on accounting records, e.g. the money taken out can be considered income. Other gray areas for sole proprietors are purchases of items for business use that are sometimes used personally, e.g. printer, laptop, etc.

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In her book The Seven Signs of Ethical Collapse , Jennings explains: "When an organization collapses ethically, it means that those in the organization have drifted into rationalizations and legalisms, and all for the purpose of getting the results they want and need at almost any cost." Discuss what you think Jennings meant by this statement.
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The quote is related to a theme of ethical fading. Ethical fading occurs when companies no longer consider ethical implications of their actions. The quote goes further and states that these companies and their employees will "rationalize" and resort to "legalism" to replace the void in ethics. For example, an unethical company employee may rationalize their unethical action as one out of business necessity explaining that it's not illegal to do so, or even if they get caught it's not that big of a deal.

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Hewlett-Packard 1 Legal Settlement On December 8, 2006, California's attorney general announced a settlement with Hewlett-Packard (HP) over its corporate spying scandal. The civil settlement involved a lawsuit that the state filed against the computer giant in Santa Clara County Superior Court. Under the agreement, HP paid $13.5 million to create a "privacy and piracy" fund to help state and local law enforcement fight privacy and intellectual property violations. The company also paid $650,000 in civil penalties and $350,000 to cover expenses of the investigation. The scandal broke in September 2006 when HP acknowledged in an SEC filing that investigators probing internal HP leaks to the media had gained access to board members' personal phone records by impersonating the board members, a practice known as "pretexting." HP's investigators also conducted physical and electronic surveillance of board members and reporters, according to HP documents. Pretexting violates a California criminal law banning the use of "false and fraudulent pretenses" to obtain confidential information from a phone company, stated Attorney General Bill Lockyer. California civil law also considers criminal acts unlawful business practices, which was the basis of the state's civil action. Mark V. Hurd, HP's chair and chief executive, hailed the deal. "We are pleased to settle this matter with the attorney general and are committed to ensuring that HP regains its standing as a global leader in corporate ethics and responsibility," he said. The HP Investigation An article in January 2006 by CNET reporter Dawn Kawamoto discussed confidential information available only to HP's board. The CNET article reignited the leak investigation. Recognizing the potential legal problems that board- level leaks could pose for HP, chairwoman Patricia Dunn immediately initiated a new investigation of the leak and expressed her urgency to HP's general counsel, Ann Baskins. The second and far more intrusive investigation extended from January through March and included the following: • Reviewing the company email accounts, company phone records, and computer hard drives of every member of HP's "Executive Council" • Hiring a private investigation firm, which in turn subcontracted the job of obtaining the private telephone records of select board members and nine journalists, including Kawamoto • Surreptitiously following Kawamoto and suspected board members in public (and apparently searching through their trash) • Setting up a "sting" in which investigators sent Kawamoto an email containing fake tips about HP and an attachment whose tracking software would trace the email's path after it reached Kawamoto's computer Insider Trading HP investors sued some of the computer maker's directors, claiming they sold $38 million in company stock shortly before publicly acknowledging an internal probe into boardroom leaks. The directors, including CEO Mark Hurd, exercised options and sold shares during a 2 ½-week period beginning August 21, 2006. HP began its internal investigation after boardroom discussions about ex-CEO Carly Fiorina were quoted in news stories. The flap over the probe cost chairwoman Dunn and two HP executives their jobs and sparked investigations by U.S. regulators. The company said on November 16 that the SEC stepped up its examination of the company's tactics and the Federal Communications Commission (FCC) had requested documents related to the leak probe. California prosecutors had charged Dunn, HP's former CEO, with conspiracy and fraud for directing the boardroom spying. They also charged Kevin Hunsaker, an in-house lawyer and former director of ethics, as well as three private investigators who participated in the probe. Board members, worried about negative publicity over the leak probe, took steps to protect the company's stock by approving a $6 billion share buyback program less than a month before the spying became public. That brought the amount of shares that HP was authorized to buy back to $11.7 billion, according to the complaint. The investors alleged that the share buybacks were prompted by defendants' illegal misconduct. Ethics Compliance Officer Having a chief ethics officer didn't help HP. Chairwoman Dunn lost her job after hiring private investigators to find leakers on HP's board. The spying scandal that ensued led to Dunn's indictment and an investigation by the House Energy and Commerce Committee. Even Hurd, who had replaced Dunn as chair, has been implicated in the scandal. And it all happened under the watch of Kevin Hunsaker, HP's senior counsel and chief ethics officer. He resigned in September 2006. Corporate Governance and Ethics Issues The original lawsuit claimed "breach of fiduciary responsibilities" by HP executives. It alleged that the executives' spylike tactics to uncover boardroom leaks harmed the company, and that they engaged in insider trading just before news of the spying incident became public. Specifically, the suit claims that they sold off $41.3 million worth of stock two weeks before the scandal broke. The lawsuit also alleged that the executives approved stock buybacks in the months preceding the scandal in an effort "to keep the company's stock price propped up while insiders were selling." HP also agreed to strengthen in-house monitoring to ensure that future investigations launched by HP or its contractors would comply with legal and ethical standards and protect privacy rights. HP further agreed to hire an independent director, expand the duties of its chief ethics officer and chief privacy officer, beef up staff ethics training, and create a compliance council to set policies for ethics programs. In the lawsuit, Attorney General Bill Lockyer was quoted as saying: With its governance reforms, this settlement should help guide companies across the country as they seek to protect confidential business information without violating corporate ethics or privacy rights. The new fund will help ensure that when businesses cross the legal line they will be held accountable. Fortunately, Hewlett-Packard is not Enron. I commend the firm for cooperating instead of stonewalling, for taking instead of shirking responsibility, and for working with my office to expeditiously craft a creative resolution. The settlement's corporate governance reforms aimed to strengthen in-house monitoring and oversight to ensure compliance with legal and ethical standards, and protection of privacy rights, during any investigations launched by HP or outside firms hired by HP. "This settlement creates a template for other companies seeking to protect confidential business information without violating corporate ethics or privacy rights," stated Lockyer. Major Governance Reforms The major governance reforms included the following: • A new independent director will serve as the board's watchdog on compliance with ethical and legal requirements. The director will have specific responsibilities in carrying out that oversight function and report violations to the board, other responsible HP officials, and the attorney general. • HP's chief ethics and compliance officer (CECO) will have expanded oversight and reporting duties. The CECO will review HP's investigation practices and make recommendations to the board on how to improve the practices by July 31, 2007. The CECO, who previously reported only to the general counsel, now also will report to the board's audit committee. In addition, the CECO will have authority to retain independent legal advisors. • HP will expand the duties and responsibilities of its chief privacy officer to include review of the firm's investigation protocols to ensure that they protect privacy and comply with ethical requirements. • HP will establish a new Compliance Council, headed by the CECO and also comprised of the chief privacy officer, deputy general counsel for compliance, head of internal audit, and ethics and compliance liaisons. The council will develop and maintain policies and procedures governing HP's ethics and compliance program, and provide periodic reports to the CEO, audit committee, and board. • HP will beef up the ethics and conflict-of-interest components of its training program. The training redesign will be directed and monitored by the CECO, Compliance Council, independent director, and chief privacy officer. HP also will create a separate code of conduct, for use by outside investigators that addresses privacy and business ethics issues. The HP scandal ended on December 14, 2012, when Bryan Wagner, a player in the explosion of corporate drama that rocked HP, was sentenced to three months in jail. He had pleaded guilty in 2007 to charges of aggravated identity theft and faced a minimum sentence of two years in prison. Wagner was the only player in the pretexting scandal to see the inside of a prison cell. Others who were criminally sentenced received probation. Questions 1. The original lawsuit filed in the HP case claimed that the executives breached their fiduciary responsibilities. What are the fiduciary responsibilities of executives and members of the board of directors to shareholders? How were these obligations violated in the HP case? 2. Describe how ethical fading influenced the actions taken in the pretexting scandal, including those identified in the HP investigation. Are there similarities between the actions of management in the HP case and those in the Challenger Shuttle Disaster? 3. Recently, in 2011, Hewlett-Packard Vice President and Chief Ethics and Compliance Officer Jon Hoak talked about renewing HP's commitment to a culture of integrity at a meeting with members of the Business and Organizational Ethics Partnership at the Markkula Center for Applied Ethics at Santa Clara University. In his presentation that addressed the pretexting scandal, Hoak said "The people involved were only concerned about whether pretexting was legal. Nobody asked, 'Even if it's legal, is it the right thing to do?' What is the relationship between legality and what is the right thing to do in making business decisions?
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Bennie and the Jets Bennie Gordon is a CPA and a member of the AICPA. Gordon works as an accounting manager at the division level at Jet Energy Company, a publicly owned company headquartered in South Carolina. Jet Energy is a regulated utility company by the state and provides electricity to 7 million customers in southern states. Jet Energy is allowed a rate of return on operating income at a maximum rate of 12.5 percent on electricity it sells. If the company is earning more than that, regulators can cut the rate that it charges to customers. Gordon reports to Sarah Higgins, the controller of the division. Higgins holds the Certificate in Management Accounting (CMA) and is a member of the IMA. Higgins reports to Sam Thornton, the chief financial officer, who is a CPA. In turn, Thornton reports to Vanessa Jones, the CEO of the company. Joan Franks is the chief compliance officer. The company has an audit committee of three members, all of whom sit on the board of directors. Gordon has identified irregular accounting entries dealing with the reclassification of some accounting items to make its returns lower so state regulators would not cut rates. One example is that Jet Energy often gets rebates from insurers of its nuclear plants based on safety records. Although the cost of the premiums is expensed to the electricity business, the rebates-approximately $26 million to $30.5 million each-were not booked back to the same accounts. On a number of occasions, they were booked below operating income in a nonoperating account. The moves kept Jet Energy from exceeding its allowable returns and kept the states from reducing electricity rates. After two years of being silent, Gordon decided it was time to address the issue. Questions 1. What steps should Bennie Gordon take to ensure that the accounting matter is adequately addressed by the company? Why do you suggest those steps be taken? What are the ethical obligations of Bennie Gordon, Sarah Higgins, and Sam Thornton? 2. Assume that Gordon made a strong case that the accounting did not comply with GAAP, but his superiors said that the decisions already made were final. They never offered an explanation. What would you do next if you were Gordon? Would you blow the whistle and, if so, how would you do it? Explain your answer in terms of ethical reasoning.
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Explain the "say on pay rule" and whether you believe that it is likely to have an effect on large compensation packages of CEOs.
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The following questions deal with issues related to executive compensation: a. What is the business judgment rule and how does it relate to executive compensation? b. On August 9, 2005, Chancellor William B. Chandler III of the Delaware Chancery Court 104 ruled that the directors of the Walt Disney Company acted in good faith when Michael Ovitz was hired in 1995 to be the CEO of Disney and then allowed to walk away 15 months later with a severance package valued at $130 million after being fired by Michael Eisner, the chair of the Disney's board of directors. Is it "fair" that Ovitz was allowed to walk away with such a lucrative severance package only 15 months after being fired? Include in your discussion what constitutes fairness in this instance from an ethical perspective.
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Disclosure of Steve Jobs's Health as Apple CEO: A Public or Private Matter? An important issue within the scope of corporate governance is whether a company should disclose the health problems of its CEO and how much information should be disclosed. The sensitivity of this issue is exemplified at Apple Inc., where CEO Steve Jobs faced numerous questions regarding his health and the impact that his sudden departure would have on the company. In October 2003, Jobs was diagnosed with pancreatic cancer. No public announcement was made, although the board of directors was notified of his condition. The specific form of cancer was rare but considered treatable, with the majority of patients who undergo surgery experiencing a survival rate of more than 10 years. On July 31, 2004, Jobs entered Stanford Hospital for treatment. The following day, Jobs sent an email to Apple employees stating, "This weekend I underwent a successful surgery to remove a cancerous tumor from my pancreas.... I will be recuperating during the month of August, and expect to return to work in September. While I'm out, I've asked Tim Cook [executive vice president of sales and operations] to be responsible for Apple's day-to-day operations, so we shouldn't miss a beat." A copy of the message was distributed to the Associated Press. It was the first public disclosure of his condition. Given Jobs's strategic and visionary role at Apple, it is perhaps not surprising that when trading resumed the next day, Apple stock fell 2.4 percent almost immediately. The issue of Jobs's health resurfaced in June 2008, when he appeared noticeably thin at a public appearance. A company spokeswoman responded to inquiries by stating that Jobs had "a common bug... He's been on antibiotics and getting better day by day and didn't want to miss [the event]. That's all there is to it." When analysts asked for more information during an earnings conference call, Apple CFO Peter Oppenheimer declined to elaborate: "Steve loves Apple. He serves as the CEO at the pleasure of Apple's board and has no plans to leave Apple. Steve's health is a private matter." In January 2009, Apple released another letter from Jobs in which he explained that his recent weight loss was due to a "hormone imbalance." According to the letter, "The remedy for this nutritional problem is relatively simple and straightforward, and I've already begun treatment... I will continue as Apple's CEO during my recovery." Concurrently, the board of directors issued a statement that "[Jobs] deserves our complete and unwavering support during his recuperation. He most certainly has that from Apple and its Board." However, the company announced 10 days later that Jobs would take another leave of absence. According to Jobs, "during the past week I have learned that my health-related issues are more complex than I originally thought. In order to take myself out of the limelight and focus on my health... I have decided to take a medical leave of absence until the end of June." No elaboration was offered. Cook, then chief operating officer (COO), would resume leadership of the company. In the two-week period surrounding these announcements, Apple stock fell 17 percent. Jobs returned to work as scheduled six months later. Two weeks prior to his return, however, news leaked that Jobs had received a liver transplant at a Tennessee hospital the previous April. A company spokeswoman declined to comment other than to say, "Steve continues to look forward to returning at the end of June, and there's nothing further to say." Doctors unaffiliated with the case explained that tumors associated with the pancreatic cancer that Jobs was originally diagnosed with often metastasize in another organ, commonly the liver. The hospital where Jobs received the transplant stated that his prognosis was "excellent." In January 2011, Jobs took a third leave of absence. In an email to employees, he explained that he would "continue as CEO and be involved in major strategic decisions" but that Cook would be responsible for "day-to-day operations." Jobs said he would be back with the company as soon as he could. "In the meantime, my family and I would deeply appreciate respect for our privacy." When asked for additional comment, an Apple spokeswoman replied, "We've said all we're going to say." Jobs died on October 5 of that year, due to complications from pancreatic cancer that led to respiratory arrest. Questions 1. Were the shareholders of Apple entitled to receive information about the health of Jobs? What about the general public? Of what value is such information? How might the company benefit from the disclosure of such information, and how might it suffer? How might the shareholders benefit, and how might they suffer? 2. From a corporate governance perspective, what issues are important in determining whether there should be disclosure of the health problems of a CEO? Is it an ethical matter? 3. Should information about the health of other senior managers, such as the five most highly compensated senior managers or the vice chair of the board of directors, be disclosed? Should other information be disclosed about the CEO of a public company, such as being involved in a contentious divorce that distracts from day-to-day management of the company?
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According to the IIA Code of Ethics, internal auditors should make a balanced assessment of all the relevant circumstances and should not be unduly influenced by their own interests or by others in forming judgments. Which interests are being referred to in that statement, and how might they influence the ethical decisions of a member of the IIA?
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The Parable of the Sadhu Bowen H. McCoy Reprinted with permission from "The Parable of the Sadhu," by Bowen H. McCoy, Harvard Business Review. Last year, as the first participant in the new six-month sabbatical program that Morgan Stanley has adopted, I enjoyed a rare opportunity to collect my thoughts as well as do some traveling. I spent the first three months in Nepal, walking 600 miles through 200 villages in the Himalayas and climbing some 120,000 vertical feet. My sole Western companion on the trip was an anthropologist who shed light on the cultural patterns of the villages that we passed through. During the Nepal hike, something occurred that has had a powerful impact on my thinking about corporate ethics. Although some might argue that the experience has no relevance to business, it was a situation in which a basic ethical dilemma suddenly intruded into the lives of a group of individuals. How the group responded holds a lesson for all organizations, no matter how defined. The Sadhu The Nepal experience was more rugged than I had anticipated. Most commercial treks last two or three weeks and cover a quarter of the distance we traveled. My friend Stephen, the anthropologist, and I were halfway through the 60-day Himalayan part of the trip when we reached the high point, an 18,000-foot pass over a crest that we'd have to traverse to reach the village of Muklinath, an ancient holy place for pilgrims. Six years earlier, I had suffered pulmonary edema, an acute form of altitude sickness, at 16,500 feet in the vicinity of Everest base camp-so we were understandably concerned about what would happen at 18,000 feet. Moreover, the Himalayas were having their wettest spring in 20 years; hip-deep powder and ice had already driven us off one ridge. If we failed to cross the pass, I feared that the last half of our once-in-a-lifetime trip would be ruined. The night before we would try the pass, we camped in a hut at 14,500 feet. In the photos taken at that camp, my face appears wan. The last village we'd passed through was a sturdy two-day walk below us, and I was tired. During the late afternoon, four backpackers from New Zealand joined us, and we spent most of the night awake, anticipating the climb. Below, we could see the fires of two other parties, which turned out to be two Swiss couples and a Japanese hiking club. To get over the steep part of the climb before the sun melted the steps cut in the ice, we departed at 3.30 a.m. The New Zealanders left first, followed by Stephen and myself, our porters and Sherpas, and then the Swiss. The Japanese lingered in their camp. The sky was clear, and we were confident that no spring storm would erupt that day to close the pass. At 15,500 feet, it looked to me as if Stephen was shuffling and staggering a bit, which are symptoms of altitude sickness. (The initial stage of altitude sickness brings a headache and nausea. As the condition worsens, a climber may encounter difficult breathing, disorientation, aphasia, and paralysis.) I felt strong-my adrenaline was flowing-but I was very concerned about my ultimate ability to get across. A couple of our porters were also suffering from the height, and Pasang, our Sherpa sirdar (leader), was worried. Just after daybreak, while we rested at 15,500 feet, one of the New Zealanders, who had gone ahead, came staggering down toward us with a body slung across his shoulders. He dumped the almost naked, barefoot body of an Indian holy man-a sadhu-at my feet. He had found the pilgrim lying on the ice, shivering and suffering from hypothermia. I cradled the sadhu's head and laid him out on the rocks. The New Zealander was angry. He wanted to get across the pass before the bright sun melted the snow. He said, "Look, I've done what I can. You have porters and Sherpa guides. You care for him. We're going on!" He turned and went back up the mountain to join his friends. I took a carotid pulse and found that the sadhu was still alive. We figured he had probably visited the holy shrines at Muklinath and was on his way home. It was fruitless to question why he had chosen this desperately high route instead of the safe, heavily traveled caravan route through the Kali Gandaki gorge. Or why he was shoeless and almost naked, or how long he had been lying in the pass. The answers weren't going to solve our problem. Stephen and the four Swiss began stripping off their outer clothing and opening their packs. The sadhu was soon clothed from head to foot. He was not able to walk, but he was very much alive. I looked down the mountain and spotted the Japanese climbers, marching up with a horse. Without a great deal of thought, I told Stephen and Pasang that I was concerned about withstanding the heights to come and wanted to get over the pass. I took off after several of our porters who had gone ahead. On the steep part of the ascent where, if the ice steps had given way, I would have slid down about 3,000 feet, I felt vertigo. I stopped for a breather, allowing the Swiss to catch up with me. I inquired about the sadhu and Stephen. They said that the sadhu was fine and that Stephen was just behind them. I set off again for the summit. S tephen arrived at the summit an hour after I did. S till exhilarated by victory, I ran down the slope to congratulate him. He was suffering from altitude sickness-walking 15 steps, then stopping, walking 15 steps, then stopping. Pasang accompanied him all the way up. When I reached them, Stephen glared at me and said: "How do you feel about contributing to the death of a fellow man?" I did not completely comprehend what he meant. "Is the sadhu dead?" I inquired. "No," replied Stephen, "but he surely will be!" After I had gone, followed not long after by the Swiss, Stephen had remained with the sadhu. When the Japanese had arrived, Stephen had asked to use their horse to transport the sadhu down to the hut. They had refused. He had then asked Pasang to have a group of our porters carry the sadhu. Pasang had resisted the idea, saying that the porters would have to exert all their energy to get themselves over the pass. He believed they could not carry a man down 1,000 feet to the hut, reclimb the slope, and get across safely before the snow melted. Pasang had pressed Stephen not to delay any longer. The Sherpas had carried the sadhu down to a rock in the sun at about 15,000 feet and pointed out the hut another 500 feet below. The Japanese had given him food and drink. When they had last seen him, he was listlessly throwing rocks at the Japanese party's dog, which had frightened him. We do not know if the sadhu lived or died. For many of the following days and evenings, Stephen and I discussed and debated our behavior toward the sadhu. Stephen is a committed Quaker with deep moral vision. He said, "I feel that what happened with the sadhu is a good example of the breakdown between the individual ethic and the corporate ethic. No one person was willing to assume ultimate responsibility for the sadhu. Each was willing to do his bit just so long as it was not too inconvenient. When it got to be a bother, everyone just passed the buck to someone else and took off. Jesus was relevant to a more individualistic stage of society, but how do we interpret his teaching today in a world filled with large, impersonal organizations and groups?" I defended the larger group, saying, "Look, we all cared. We all gave aid and comfort. Everyone did his bit. The New Zealander carried him down below the snow line. I took his pulse and suggested we treat him for hypothermia. You and the Swiss gave him clothing and got him warmed up. The Japanese gave him food and water. The Sherpas carried him down to the sun and pointed out the easy trail toward the hut. He was well enough to throw rocks at a dog. What more could we do?" "You have just described the typical affluent Westerner's response to a problem. Throwing money-in this case, food and sweaters-at it, but not solving the fundamentals!" Stephen retorted. "What would satisfy you?" I said. "Here we are, a group of New Zealanders, Swiss, Americans, and Japanese who have never met before and who are at the apex of one of the most powerful experiences of our lives. Some years the pass is so bad no one gets over it. What right does an almost naked pilgrim who chooses the wrong trail have to disrupt our lives? Even the Sherpas had no interest in risking the trip to help him beyond a certain point." Stephen calmly rebutted, "I wonder what the Sherpas would have done if the sadhu had been a well-dressed Nepali, or what the Japanese would have done if the sadhu had been a well-dressed Asian, or what you would have done, Buzz, if the sadhu had been a well-dressed Western woman?" "Where, in your opinion," I asked, "is the limit of our responsibility in a situation like this? We had our own wellbeing to worry about. Our Sherpa guides were unwilling to jeopardize us or the porters for the sadhu. No one else on the mountain was willing to commit himself beyond certain selfimposed limits." Stephen said, "As individual Christians or people with a Western ethical tradition, we can fulfill our obligations in such a situation only if one, the sadhu dies in our care; two, the sadhu demonstrates to us that he can undertake the two- day walk down to the village; or three, we carry the sadhu for two days down to the village and persuade someone there to care for him." "Leaving the sadhu in the sun with food and clothing-where he demonstrated hand-eye coordination by throwing a rock at a dog-comes close to fulfilling items one and two," I answered. "And it wouldn't have made sense to take him to the village where the people appeared to be far less caring than the Sherpas, so the third condition is impractical. Are you really saying that, no matter what the implications, we should, at the drop of a hat, have changed our entire plan?" The Individual versus the Group Ethic Despite my arguments, I felt and continue to feel guilt about the sadhu. I had literally walked through a classic moral dilemma without fully thinking through the consequences. My excuses for my actions include a high adrenaline flow, a superordinate goal, and a once-in-a-lifetime opportunity-common factors in corporate situations, especially stressful ones. Real moral dilemmas are ambiguous, and many of us hike right through them, unaware that they exist. When, usually after the fact, someone makes an issue of one, we tend to resent his or her bringing it up. Often, when the full import of what we have done (or not done) hits us, we dig into a defensive position from which it is very difficult to emerge. In rare circumstances, we may contemplate what we have done from inside a prison. Had we mountaineers been free of stress caused by the effort and the high altitude, we might have treated the sadhu differently. Yet isn't stress the real test of personal and corporate values? The instant decisions that executives make under pressure reveal the most about personal and corporate character. Among the many questions that occur to me when I ponder my experience with the sadhu are: What are the practical limits of moral imagination and vision? Is there a collective or institutional ethic that differs from the ethics of the individual? At what level of effort or commitment can one discharge one's ethical responsibilities? Not every ethical dilemma has a right solution. Reasonable people often disagree; otherwise there would be no dilemma. In a business context, however, it is essential that managers agree on a process for dealing with dilemmas. Our experience with the sadhu offers an interesting parallel to business situations. An immediate response was mandatory. Failure to act was a decision in itself. Up on the mountain, we could not resign and submit our resumes to a headhunter. In contrast to philosophy, business involves action and implementation-getting things done. Managers must come up with answers based on what they see and what they allow to influence their decision-making processes. On the mountain, none of us but Stephen realized the true dimensions of the situation we were facing. One of our problems was that as a group, we had no process for developing a consensus. We had no sense of purpose or plan. The difficulties of dealing with the sadhu were so complex that no one person could handle them. Because the group did not have a set of preconditions that could guide its action to an acceptable resolution, we reacted instinctively as individuals. The cross-cultural nature of the group added a further layer of complexity. We had no leader with whom we could all identify and in whose purpose we believed. Only Stephen was willing to take charge, but he could not gain adequate support from the group to care for the sadhu. Some organizations do have values that transcend the personal values of their managers. Such values, which go beyond profitability, are usually revealed when the organization is under stress. People throughout the organization generally accept its values, which, because they are not presented as a rigid list of commandments, may be somewhat ambiguous. The stories people tell, rather than printed materials, transmit the organization's conceptions of what is proper behavior. For 20 years, I have been exposed at senior levels to a variety of corporations and organizations. It is amazing how quickly an outsider can sense the tone and style of an organization and, with that, the degree of tolerated openness and freedom to challenge management. Organizations that do not have a heritage of mutually accepted, shared values tend to become unhinged during stress, with each individual bailing out for himself or herself. In the great takeover battles we have witnessed during past years, companies that had strong cultures drew the wagons around them and fought it out, while other companies saw executives-supported by golden parachutes-bail out of the struggles. Because corporations and their members are interdependent, for the corporation to be strong, the members need to share a preconceived notion of correct behavior, a "business ethic," and think of it as a positive force, not a constraint. As an investment banker, I am continually warned by well-meaning lawyers, clients, and associates to be wary of conflicts of interest. Yet if I were to run away from every difficult situation, I wouldn't be an effective investment banker. I have to feel my way through conflicts. An effective manager can't run from risk either; he or she has to confront risk. To feel "safe" in doing that, managers need the guidelines of an agreed-upon process and set of values within the organization. After my three months in Nepal, I spent three months as an executive-in-residence at both the Stanford Business School and the University of California at Berkeley's Center for Ethics and Social Policy of the Graduate Theological Union. Those six months away from my job gave me time to assimilate 20 years of business experience. My thoughts turned often to the meaning of the leadership role in any large organization. Students at the seminary thought of themselves as antibusiness. But when I questioned them, they agreed that they distrusted all large organizations, including the church. They perceived all large organizations as impersonal and opposed to individual values and needs. Yet we all know of organizations in which people's values and beliefs are respected and their expressions encouraged. What makes the difference? Can we identify the difference and, as a result, manage more effectively? The word ethics turns off many and confuses more. Yet the notions of shared values and an agreed-upon process for dealing with adversity and change-what many people mean when they talk about corporate culture-seem to be at the heart of the ethical issue. People who are in touch with their own core beliefs and the beliefs of others and who are sustained by them can be more comfortable living on the cutting edge. At times, taking a tough line or a decisive stand in a muddle of ambiguity is the only ethical thing to do. If a manager is indecisive about a problem and spends time trying to figure out the "good" thing to do, the enterprise may be lost. Business ethics, then, has to do with the authenticity and integrity of the enterprise. To be ethical is to follow the business as well as the cultural goals of the corporation, its owners, its employees, and its customers. Those who cannot serve the corporate vision are not authentic businesspeople and, therefore, are not ethical in the business sense. At this stage of my own business experience, I have a strong interest in organizational behavior. Sociologists are keenly studying what they call corporate stories, legends, and heroes as a way organizations have of transmitting value systems. Corporations such as Arco have even hired consultants to perform an audit of their corporate culture. In a company, a leader is a person who understands, interprets, and manages the corporate value system. Effective managers, therefore, are action-oriented people who resolve conflict, are tolerant of ambiguity, stress, and change, and have a strong sense of purpose for themselves and their organizations. If all this is true, I wonder about the role of the professional manager who moves from company to company. How can he or she quickly absorb the values and culture of different organizations? Or is there, indeed, an art of management that is totally transportable? Assuming that such fungible managers do exist, is it proper for them to manipulate the values of others? What would have happened had Stephen and I carried the sadhu for two days back to the village and become involved with the villagers in his care? In four trips to Nepal, my most interesting experience occurred in 1975, when I lived in a Sherpa home in the Khumbu for five days while recovering from altitude sickness. The high point of Stephen's trip was an invitation to participate in a family funeral ceremony in Manang. Neither experience had to do with climbing the high passes of the Himalayas. Why were we so reluctant to try the lower path, the ambiguous trail? Perhaps because we did not have a leader who could reveal the greater purpose of the trip to us. Why didn't Stephen, with his moral vision, opt to take the sadhu under his personal care? The answer is partly because Stephen was hard-stressed physically himself and partly because, without some support system that encompassed our involuntary and episodic community on the mountain, it was beyond his individual capacity to do so. I see the current interest in corporate culture and corporate value systems as a positive response to pessimism such as Stephen's about the decline of the role of the individual in large organizations. Individuals who operate from a thoughtful set of personal values provide the foundation for a corporate culture. A corporate tradition that encourages freedom of inquiry, supports personal values, and reinforces a focused sense of direction can fulfill the need to combine individuality with the prosperity and success of the group. Without such corporate support, the individual is lost. That is the lesson of the sadhu. In a complex corporate situation, the individual requires and deserves the support of the group. When people cannot find such support in their organizations, they don't know how to act. If such support is forthcoming, a person has a stake in the success of the group and can add much to the process of establishing and maintaining a corporate culture. Management's challenge is to be sensitive to individual needs, to shape them, and to direct and focus them for the benefit of the group as a whole. For each of us, the sadhu lives. Should we stop what we are doing and comfort him; or should we keep trudging up toward the high pass? Should I pause to help the derelict I pass on the street each night as I walk by the Yale Club en route to Grand Central Station? Am I his brother? What is the nature of our responsibility if we consider ourselves to be ethical persons? Perhaps it is to change the values of the group so that it can, with all its resources, take the other road. Questions 1. According to the Ethical Dissonance Model, the ethical person-organization fit helps to define the ethical culture of an organization and one's role in it. The ethics of an individual influences the values one brings to the workplace and decision making, while the ethics (through culture) of the organization influences that behavior. Throughout The Parable of the Sadhu, Bowen McCoy refers to the breakdown between the individual and corporate ethic. Explain what he meant by that and how, if we view the hikers on the trek up the mountain in Nepal as an organization, the ethical person-organization fit applied to the decisions made on the climb. 2. Evaluate the actions of McCoy and Stephen from the perspective of Kohlberg's model of moral development. At what stage did each reason throughout the trek? Do you think there was a bystander effect in how McCoy and the others acted? 3. What role did ethical fading have on the decision making of Bowen and other members of the group? How is utilitarian thinking involved in ethical fading? 4. McCoy concludes that the lesson of the sadhu is that "in a complex corporate situation, the individual requires and deserves the support of the group. When people cannot find such support in their organizations, they don't know how to act." What support in organizations do you think McCoy is referring to? If such support is not found, what should individuals do when they have an ethical dilemma such as that in the sadhu case? 5. What is the moral of the story of the sadhu from your perspective?
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COSO explains the importance of the control environment to internal controls by stating that it sets the tone of an organization, influencing the control consciousness of its people. It is the foundation for all aspects of internal control, providing discipline and structure. Explain what is meant by this statement.
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Distinguish between agency theory, stakeholder theory, and stewardship theory with respect to controlling the actions of managers.
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United Thermostatic Controls United Thermostatic Controls is a publicly owned company that engages in the manufacturing and marketing of residential and commercial thermostats. The thermostats are used to regulate temperature in furnaces and refrigerators. United sells its product primarily to retailers in the domestic market, with the company headquartered in San Jose, California. Its operations are decentralized according to geographic region. As a publicly owned company, United's common stock is listed and traded on the NYSE. The organization chart for United is presented in Figure 1. Frank Campbell is the director of the Southern sales division. Worsening regional economic conditions and a reduced rate of demand for United's products have created pressures to achieve sales revenue targets set by United management nonetheless. Also, significant pressures exist within the organization for sales divisions to maximize their revenues and earnings for 2013 in anticipation of a public offering of stock early in 2014. Budgeted and actual sales revenue amounts, by division, for the first three quarters in 2013 are presented in Exhibit 1. Campbell knows that actual sales lagged even further behind budgeted sales during the first two months of the fourth quarter. He also knows that each of the other three sales divisions exceeded their budgeted sales amounts during the first three quarters in 2013. He is very concerned that the Southern division has been unable to meet or exceed budgeted sales amounts. He is particularly worried about the effect this might have on his and the division managers' bonuses and share of corporate profits. In an attempt to improve the sales revenue of the Southern division for the fourth quarter and for the year ended December 31, 2013, Campbell reviewed purchase orders received during the latter half of November and early December to determine whether shipments could be made to customers prior to December 31. Campbell knows that sometimes orders that are received before the end of the year can be filled by December 31, thereby enabling the division to record the sales revenue during the current fiscal year. It could simply be a matter of accelerating production and shipping to increase sales revenue for the year. Reported sales revenue of the Southern division for the fourth quarter of 2013 was $792,000. This represented an 18.6 percent increase over the actual sales revenue for the third quarter of the year. As a result of this increase, reported sales revenue for the fourth quarter exceeded the budgeted amount by $80,000, or 11.2 percent. Actual sales revenue for the year exceeded the budgeted amount for the Southern division by $14,000, or 0.5 percent. Budgeted and actual sales revenue amounts, by division, for the year ended December 31, 2013, are presented in Exhibit 2. During the course of their test of controls, the internal audit staff questioned the appropriateness of recording revenue of $150,000 on two shipments made by the Southern division in the fourth quarter of the year. These shipments are described as follows: 1. United shipped thermostats to Allen Corporation on December 31, 2013, and billed Allen $85,000, even though Allen had specified a delivery date of no earlier than February 1, 2014, to take control of the product. Allen intended to use the thermostats in the heating system of a new building that would not be ready for occupancy until March 1, 2014. 2. United shipped thermostats to Bilco Corporation on December 30, 2013, in partial (one-half) fulfillment of an order. United recorded $65,000 revenue on that date. Bilco had previously specified that partial shipments would not be accepted. Delivery of the full shipment had been scheduled for February 1, 2014. During their investigation, the internal auditors learned that Campbell had pressured United's accounting department to record these two shipments early to enable the Southern division to achieve its goals with respect to the company's revenue targets. The auditors were concerned about the appropriateness of recording the $150,000 revenue in 2013 in the absence of an expressed or implied agreement with the customers to accept and pay for the prematurely shipped merchandise. The auditors noted that, had the revenue from these two shipments not been recorded, the Southern division's actual sales for the fourth quarter would have been below the budgeted amount by $70,000, or 9.8 percent. Actual sales revenue for the year ended December 31, 2013, would have been below the budgeted amount by $136,000, or 4.9 percent. The revenue effect of the two shipments in question created a 5.4 percent shift in the variance between actual and budgeted sales for the year. The auditors felt that this effect was significant with respect to the division's revenue and earnings for the fourth quarter and for the year ended December 31, 2013. The auditors decided to take their concerns to Tony Cupertino, director of the internal auditing department. Cupertino is a licensed CPA and holds the CIA designation. Cupertino discussed the situation with Campbell. Campbell informed Cupertino that he had received assurances from Sam Lorenzo, executive vice president of sales and marketing, that top management would support the recording of the $150,000 revenue because of its strong desire to meet or exceed budgeted revenue and earnings amounts. Moreover, top management is very sensitive to the need to meet financial analysts' consensus earnings estimates. According to Campbell, the company is concerned that earnings must be high enough to meet analysts' expectations because any other effect might cause the stock price to go down. In fact, Lorenzo has already told Campbell that he did not see anything wrong with recording the revenue in 2013 because the merchandise had been shipped to the customers before the end of the year and the terms of shipment were FOB shipping point. At this point, Cupertino is uncertain whether he should take his concerns to Walter Hayward, the CFO, who is also a member of the board of directors, or take them directly to the audit committee. Cupertino knows that the majority of the members of the board, including those on the audit committee, have ties to the company and members of top management. Cupertino is not even certain that he should pursue the matter any further because of the financial performance pressures that exist within the organization. However, he is very concerned about his responsibilities and obligations to coordinate the work of the internal auditing department with that of the external auditors. Questions 1. Identify the stakeholders in this case. Identify their interests and United's obligations to satisfy those interests from an ethical perspective. 2. Describe the ethical responsibilities of Tony Cupertino as a CPA and CIA. How do these responsibilities effect whom Cupertino should approach in United based on the organization chart? 3. Assume that Tony Cupertino decides to delay contacting Walter Hayward. Instead, he contacts the CFO of Bilco Corporation and offers a 20 percent discount on the total $130,000 cost of merchandise if Bilco agrees to approve the partial shipment on December 30, 2013. Cupertino adds that the $26,000 would be deducted from the remaining $65,000 to be shipped during January 2014. Evaluate Cupertino's actions with respect to the following: a. Is the offer ethical or unethical? Why? b. Has Cupertino violated any of his reporting responsibilities in directly contacting the CFO of Bilco?
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Do you believe that a member of the audit engagement team servicing a client should also serve on the audit committee of the board of directors of the client entity? Why or why not?
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IRS Whistleblower and Informing on Tax Cheats On October 4, 2012, the Internal Revenue Service (IRS) paid a $2 million reward to a whistleblower that exposed an alleged tax avoidance scheme by Illinois Tool Works Inc. (ITW) that cost the U.S. Treasury hundreds of millions of dollars. The scheme involved ITW enlisting a Swiss bank to fabricate unauthorized tax deductions by duplicating its own tax deductions in order for ITW, as a client and unrelated taxpayer, to claim the same deductions as an offset to ITW's otherwise taxable income. As a result of tax audits, ITW wrote down its deferred tax asset by $383 million. Whether motivated by a sense of justice or the pursuit of a seven-figure reward, the Wall Street insider known only as "Mr. ABC" has demonstrated the huge return on investment available to IRS whistleblowers that provide information under a program that pays out between 15 percent to 30 percent of any recovery, without any monetary cap on the amount of the reward. It was the third time that Mr. ABC had received an IRS whistleblowing award, including $1.1 million in 2004, when he provided information about abusive tax shelters that helped Enron avoid taxes on more than $600 million of taxable income, and $1.24 million in another case. In testimony before the 2004 U.S. Senate Finance Committee, Mr. ABC proceeded to explain his motivation to blow the whistle by criticizing the government's ability to identify and investigate sophisticated tax shelters. "When I looked through all the financial engineering and big words, I believed it was just a fake deduction scheme," he testified. The IRS refused to comment, noting confidentiality issues. Questions 1. Should we regard Mr. ABC as a new "caped crusader" or an opportunist? Explain the reasons for your response. 2. Is it ethical for a Wall Street insider to analyze financial data of an unrelated company in order to identify corporate wrongdoing, report it to the appropriate authorities, and then receive a whistleblowing reward? 3. Consider Mr. ABC's motivation for blowing the whistle in the ITW case and the fact that it was the third time he had engaged in whistleblowing to the IRS. Using Kohlberg's model of moral development, at what stage of ethical reasoning would you say Mr. ABC was at? Why?
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Five months before the new 2002 Lexus ES hit showroom floors, the company's U.S. engineers sent a test report to Toyota City in Japan: The luxury sedan shifted gears so roughly that it was "not acceptable for production." The warning was sent to Toyota executive vice president Katsuaki Watanabe on May 16, 2001. Days later, another Japanese executive sent an email to top managers saying that despite misgivings among U.S. officials, the 2002 Lexus was "marginally acceptable for production." The new ES went on sale across the nation on October 1, 2001. In years to come, thousands of Lexus buyers would discover firsthand that the vehicle's transmission problems, which caused it to hesitate when motorists hit the gas, or lurch forward unintentionally, were far from fixed. The 2002-2006 ES models would become the target of lawsuits, federal safety investigations, and hundreds of consumer complaints, including claims of 49 injuries. In an August 15, 2005, memo explaining the company's position, a staff attorney wrote: "The objective will be to limit the number of vehicles to be serviced to those owners who complain and to limit the per-vehicle cost." In 2010, Toyota was fined a record $16.4 million for delays in notifying federal safety officials about defects that could lead to sudden acceleration. The reaction of a Toyota spokesperson was: "Given the concerns raised by some customers about this drivability issue, we did not meet the very high customer satisfaction standards we set for ourselves. However, we fully stand behind the engineering and production quality of the vehicle, as well as our after-sale customer service and technical support." Evaluate Toyota's actions from a corporate governance perspective. How would you characterize the ethical culture at Toyota, at least with respect to the Lexus incident? Can you draw any parallels between the Toyota experience and how Ford handled the matter with the Pinto?
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Amgen Whistleblowing Case Amgen, a Thousand Oaks, California-based company, has been dealing with lawsuits and whistleblower claims for years over its marketing tactics. The following describes the lawsuits, language from the legal filings against Amgen, and a statement made by the company on October 24, 2012, about its settlements in its earnings announcement for the third quarter of 2012. Whistleblower Shawn O'Brien In 2009, the company was embroiled in lawsuits filed by 15 states alleging a Medicaid kickback scheme. 106 Two additional whistleblowing lawsuits were filed against the company in Ventura County. The whistleblowing complaints, which don't appear related to the fraud alleged by the group of states, were brought by former employees who said they had uncovered wrongdoing at the biotech giant and were terminated after they raised red flags to superiors. One employee alleged that the company violated federal law by underreporting complaints and problems with the company's drugs after they hit the market. Former Amgen employee Shawn O'Brien sued Amgen for wrongful termination on October 9, 2009, alleging that he was laid off in October 2007 in retaliation for raising concerns about how the company reported complaints and problems with drugs already on the market. O'Brien worked as a senior project manager for Amgen's "Ongoing Change Program," according to the lawsuit filed in Ventura County Superior Court. His job was to improve Amgen's "compliance processes with high inherent risk to public safety, major criminal and civil liability, or both," according to the lawsuit. The lawsuit alleged that in April 2007, Amgen's board of directors flagged the company's process for dealing with postmarket complaints about drugs as a potential problem. Federal law requires drug companies to track and report to the FDA any problems with their drugs after they hit the market. In June 2007, O'Brien was put on the case. He soon uncovered facts that Amgen was not adequately and consistently identifying phone calls or mail related to postmarket product complaints. That year, O'Brien warned the company about the seriousness of the issues but, he claims, the company would not take any action or offer any support. In August 2007, O'Brien took his complaint to a senior executive/corporate officer (unnamed) and warned that Amgen's process for dealing with postmarket problems wasn't adequate. In early September 2007, O'Brien's managers instructed him to stop all work and not discuss the issues any further with anyone. Approximately four weeks later, he was informed that he was being terminated as part of Amgen's October 12, 2007, reduction in the workforce. Whistleblower Kassie Westmoreland On October 22, 2012, Amgen announced it had set aside $780 million to settle various federal and state investigations and whistleblower lawsuits accusing it of illegal sales and marketing tactics. Amgen said it had reached an agreement in principle to settle criminal and civil investigations that had been under way for several years by the U.S. Attorney's offices in Brooklyn and Seattle. On December 18, 2012, the company pleaded guilty to a federal misdemeanor of misbranding its anemia drug Aranesp and has agreed to pay $762 million in fines and penalties. The information below describes the proceedings leading up to the legal action. The federal investigations, according to Amgen, involved the marketing, pricing, and dosing of its anemia drugs, Aranesp and Epogen, and its dissemination of information about clinical trials on the safety and efficacy of those drugs. Numerous current and former executives had received civil and grand jury subpoenas. One whistleblower lawsuit 107 that was unsealed accused the company of overfilling vials of Aranesp, essentially providing doctors with free amounts of the drug to give patients and then charge to Medicare, Medicaid, or private insurers. The lawsuit, filed by Kassie Westmoreland, a former Amgen sales representative and Aranesp product manager fired from Amgen, said that Amgen tried to persuade doctors to use Aranesp rather than Procrit, a rival drug sold by Johnson Johnson, by pointing to the extra profits the doctors could make by using the overfill and billing for it. The federal government declined to join the lawsuit, but more than a dozen states did, including New York and California. Westmoreland is entitled to part of any settlement under whistleblower statutes. The court has not released the amount of the whistleblower award. Legal Filings The filing in the Kassie Moreland case included the following statement by the court in response to how Amgen dealt with warnings of the FDA about the safety of its products: In addition to causing damage to programs such as Medicare, Defendants' actions have also put patient safety and health at risk. The population of patients for whom Aranesp is indicated is especially vulnerable. Though Amgen was aware of issues earlier, beginning on or about March 9, 2007, the FDA issued a series of black box warnings for Aranesp when used in kidney and cancer patients, the most serious warning available on a drug's label. The black box warned of increased risk of death, of serious cardiovascular or thromboembolic events, and more rapid tumor progressions. The new warnings cautioned physicians to administer the lowest dose possible in order to bring red blood cell counts to the lowest level necessary to avoid blood transfusions. The FDA imposed a "Risk Evaluation and Mitigation Strategy" on Amgen for Aranesp in February 2010. This action resulted from concerns that, rather than helping patients, Aranesp can increase the risk of tumor growth and shorten survival in patients with cancer, and increase the risk of heart attack, heart failure, stroke, and blood clots in other patients. One of Amgen's responses to the black box warnings appears to have been to treat them as humorous. A script for a July 2007 meeting of Amgen's Nephrology Business Unit from the files of Amgen Vice President of Sales Leslie Mirani included a joke about "black box warnings," following up on the FDA's February 2007 warning about potential harm from Aranesp. Questions 1. The following is from Amgen's values statement: Our Values form a deeply held belief system that guides our behavior, helps us make the right decisions and builds the framework for our daily interactions with each other. We value people, integrity, and results. This combination is essential in accomplishing our primary purpose of using science to dramatically improve people's lives. (www.amgen.com/about/compliance_summary.html). What is the role of a "values statement" in creating an ethical organization environment? Comment on the lawsuits described above and whistleblowing with respect to Amgen's values statement. What message do you get about what drives Amgen's operations when compared to a company like Alcoa and its values statement discussed in this chapter? 2. Evaluate the actions of Amgen and the two whistleblowers from an ethical perspective including motivation for action and ethical reasoning. 3. The following statement appears in Amgen's code of ethics with respect to "making ethical decisions" (http://www.ifpma.org/fileadmin/content/About%20us/2%20Members/Companies/Code-Amgen/Amgen-EN-Code.pdf): No code of conduct can cover every situation. When you face ethical issues which are difficult to resolve, ask yourself these questions to help you: Is it legal and ethical?; Is it consistent with Amgen's Code of Conduct and company policies?; Is it consistent with the Amgen Values?; Would I be comfortable explaining it to my family and friends, and if it appeared on television or in a newspaper?" The Code goes on to say if unsure about what to do, seek additional guidance about the ethics and legality of a matter before proceeding and "Do the Right Thing." What are the similarities between steps 8 and 10 of the Comprehensive Ethical Decision-Making Model discussed in chapter 2 and these statements in the Amgen Code? How does organizational dissonance relate to the actions taken by management of Amgen in light of these statements?
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The 2011 National Business Ethics Survey defines "active social networkers" as people who spend more than 30 percent of the workday participating on social networking sites. Such employees are much more likely to view their current jobs as temporary; 72 percent of active social networkers polled said they plan to change employers within the next five years, compared to 39 percent of nonactive social networkers. That feeling of transience may lead to such workers thinking that it's no big deal to swipe a few things from the office supply cabinet: 46 percent of active social networkers said that they thought it was acceptable to take a copy of work software home and use it on their personal computers, while just 7 percent of nonactive social networkers said the same. Why do you think there is a difference in responses with respect to the use of company software at home on personal computers between active and nonactive social networkers? Do you believe that it is an ethics failing to take software home without asking for the company's permission? What about simply checking your Facebook page once a day at work?
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Exxon-XTO Merger ExxonMobil Corporation (Exxon) is the world's largest corporation in terms of revenue and one of the largest in market capitalization. It had sales of $486 billion in 2011, giving it the number one position on the Fortune 500 list in that category. In recent years, Exxon has expanded its operations into hydraulic fracking. By pumping water, sand, and chemicals into a well at high pressure, cracks develop in the stone where gas is trapped, and the process allows it to flow out. There were more than 493,000 active natural-gas wells across 31 states in the United States in 2009, almost double the number in 1990. Around 90 percent have used fracking to get more gas flowing, according to the drilling industry. By 2015, the United States will produce more oil from unconventional methods like fracking than conventional means, according to a 2012 report from the economic forecasting firm IHS Global Insight. Nationwide, residents living near fracked gas wells have filed over 1,000 complaints regarding tainted water, severe illnesses, livestock deaths, and fish kills. Fracking is controversial because the chemicals, mixed with water, may find their way into aquifers that supply drinking water. Oil companies say that fracking is safe and poses no threat to drinking water. Right now, few groups are calling for an outright ban on fracking. However, shareholders want companies to issue full disclosure about individual fracking operations and the chemicals used during the process. Some companies counter that they already abide by environmental laws and regulations and that further disclosure is not necessary. On June 24, 2010, Exxon completed a $41 billion merger with XTO Energy, in large part to buy the company's hydraulic- fracking expertise and gain access to its 45 trillion cubic feet of gas. The terms of the merger called for Exxon to issue 0.7098 common shares for each common share of XTO. The merger augments Exxon's total production of energy resources by increasing natural gas production to 50 percent of the total, and its reserves will go up 50 percent as well. Breach of Fiduciary Duties The merger was not without its critics, in part because of the way the deal was structured and the role of XTO's management and board of directors. On December 17, 2009, the Shareholders Foundation, Inc., 1 filed a lawsuit in Tarrant County (Texas) District Court on behalf of current investors in XTO Energy who purchased their XTO shares before December 14, 2009, over alleged breach of fiduciary duty by the board of directors of XTO Energy. The plaintiff alleged breaches of fiduciary duty by the board of directors of XTO Energy arising out of the company's attempt to sell XTO Energy to ExxonMobil. In addition, the plaintiff claims that the XTO management and directors agreed to sell the company through "an unfair process," and that XTO Energy is worth more because of likely future global warming regulations that could curtail carbon emissions. Previous investigations by law firms examined the following: (1) whether the XTO Energy board of directors breached their fiduciary duties to XTO shareholders by agreeing to sell XTO at an unfair price, thereby harming the company and its shareholders; (2) whether the directors of XTO may have breached their fiduciary duties by not acting in XTO shareholders' best interests; and (3) whether the company may not have adequately shopped itself around before entering into this transaction and, pursuant to this proposed transaction, ExxonMobil may be underpaying for XTO, thereby unlawfully harming XTO shareholders. After the announcement, Exxon's shares fell 4.3 percent, to $69.69, while XTO shares jumped more than 15 percent, to $47.86 on the NYSE. Payments Made to Officers and Members of the Board of Directors of XTO An important part of the merger agreement was payments made to officers and members of the board of directors at XTO. Given the distaste for large payout packages to corporate insiders during the period of the financial crisis in 2007-2008, there was some concern whether Congress would approve the merger. The issue was the arrangements detailed in Exhibit 1. At the end of its investigation, Congress approved the merger, although it raised concerns about disclosures to shareholders. SEC Financial Disclosures Rule In 2011, shareholders of Exxon voted not to require company officials to disclose more information about fracking, although 30 percent of the shareholders voted to increase disclosures, indicating some concern whether investors receive sufficient information for their decision-making needs. The SEC requires that publicly traded companies release and provide for the free exchange of all material facts that are relevant to their ongoing business operations. From an ethical perspective, the general need in business transactions is for both parties to tell the whole truth about any material issue pertaining to the transaction. The SEC requires full disclosure from public companies that wish to be publicly traded on the major U.S. exchanges. By enforcing this rule, the SEC attempts to instill confidence in investors that the financial marketplace is efficient and transparent so that individual investors can take part in it for material profit. The rule is often referred to as providing "full and fair disclosure." Waiver of Rights Under Outside Directors Severance Plan The Outside Directors Severance Plan provides that, upon a change in control, each nonemployee director will receive a lump sum cash payment equal to three times the sum of the annual cash retainer and value of the company's common stock most recently granted to the nonemployee director. In February 2009, each nonemployee director received a grant of 4,166 fully vested shares of the company's common stock. The nonemployee directors received an annual cash retainer of $180,000 in respect of services performed in 2009. On December 13, 2009, all nonemployee members of the company's board of directors voluntarily waived their rights to receive the payments that otherwise would have become payable to them upon the completion of the merger under XTO Energy. Absent such a waiver, based on the closing price of the company's common stock on December 1, 2009 ($42.93), each nonemployee director was entitled to receive a lump sum cash payment of approximately $1,000,000 upon completion of the merger. Questions 1. The lawsuit filed by the Shareholders Foundation alleged that the board of directors of XTO breached its fiduciary duties. What are the fiduciary duties of the board? Identify the duties allegedly violated in the XTO case. Do you think the board acted in accordance with a shareholder or stewardship perspective? 2. Much has been said during the recent financial crisis about top executive salaries being way too large, especially in those companies receiving a government bailout. The Obama administration sought to rein them in through threats of taxation or other forms of moral suasion. Do you believe that the government has an ethical right to intervene in a company's executive compensation program? Support your answer with reference to ethical reasoning. Review Exhibit 1. Do you believe that the agreement in the Form 8-K about payments to officers and board members raises any ethical issues? What is the role of the business judgment rule in such decisions? 3. One aspect of being an ethical corporation is to operate in a socially responsible way. The Corporate Social Responsibility Initiative at Harvard University 2 defines corporate social responsibility strategically: "Corporate social responsibility encompasses not only what companies do with their profits, but also how they make them. It goes beyond philanthropy and compliance and addresses how companies manage their economic, social, and environmental impacts, as well as their relationships in all key spheres of influence: the workplace, the marketplace, the supply chain, the community, and the public policy realm." The ethics of fracking is an issue raised in a number of articles and in the blog of one of the authors of this book. According to Mintz, 3 "From an ethical perspective, we might look at the harms and benefits of fracking. In other words, do the potential dangers of fracking, including contamination of water supplies, outweigh the potential benefits of producing badly needed oil and gas resources at a time when our national security may be in jeopardy because of our continued reliance on unreliable sources of energy? Is U.S. energy independence more important than the potential for harm to those affected by fracking procedures? Do jobs and economic growth trump health and safety concerns?" 4. Evaluate the ethics of fracking from a moral reasoning perspective using the methods discussed in Chapter 1. Going forward, do you believe that fracking should continue without regulation? Why or why not? 1 The Shareholders Foundation, Inc., is an investor advocacy group that does research related to shareholder issues and informs investors of securities class actions, settlements, judgments, and other legal related news to the stock/financial market. The group offers help, support, and assistance for every shareholder, and investors find answers to their questions and equitable solutions to their problems. 2 www.hks.harvard.edu/m-rcbg/CSRI/init_define.html. 3 www.ethicssage.com/2011/12/the-ethics-of-fracking.html
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Accountability of Ex-HP CEO in Conflict of Interest Charges How could a CEO and chairperson of the board of directors of a major company resign in disgrace over a personal relationship with a contractor that led to a sexual harassment charge and involved a conflict of interests, a violation of the code of ethics? It happened to Mark Hurd on August 6, 2010. Hurd was the former CEO for Hewlett-Packard (HP) for five years and also served as the chair of the board of directors for four years. On departure from HP, Hurd said he had not lived up to his own standards regarding trust, respect, and integrity. In 2006, Hurd led the company out of disgrace when it was found guilty of spying on its own members of the board of directors in a "pretexting case" where the company gained access to board members' personal phone records by impersonating the board members. The goal of obtaining information under false pretenses, was to plug leaks from the board by using private detectives to spy on directors, employees, and journalists who covered the company. The scandal resulted in the removal of then-chair Patricia Dunn and vaulted Hurd into the board chair position after assuming the CEO role in 2005. The facts of the pretexting situation are discussed in Case 3-4. The board of directors of HP began an investigation of Hurd in response to a sexual harassment complaint by Jodie Fisher, a former contractor, who retained lawyer Gloria Allred to represent her. While HP did not find that the facts supported the complaint, they did reveal behavior that the board would not tolerate. Subsequent to Hurd's resignation, a severance package was negotiated granting Hurd $12.2 million, COBRA benefits, and stock options, for a total package of somewhere between $40 and $50 million. In a letter to employees of HP on August 6, interim CEO Cathie Lesjak outlined where Hurd violated the "Standards of Business Conduct" and the reasons for his departure. Lesjak wrote that Hurd "failed to maintain accurate expense reports, and misused company assets." She indicated that each was a violation of the standards and "together they demonstrated a profound lack of judgment that significantly undermined Mark's credibility and his ability to effectively lead HP." The letter reminded employees that everyone is expected to adhere strictly to the standards in all business dealings and relationships and senior executives should set the highest standards for professional and personal conduct. The woman who brought forward the sexual harassment complaint was a "marketing consultant" who was hired by HP for certain projects, but she was never an employee of HP. During the investigation, inaccurately documented expenses were found that were claimed to have been paid to the consultant for her services. Falsifying the use of company funds violated the HP Standards of Business Conduct. On December 30, 2011, a letter from Allred about Fisher's responsibilities was leaked to the Associated Press during the trial in a Delaware court. The letter showed that in an effort to impress Fisher, who was hired as an event hostess (not a true marketing consultant), Hurd showed her his checking account balance holding over $1 million. The Delaware court had ruled that the disclosure of the letter did not violate Delaware laws. In rejecting efforts by Hurd's lawyers to keep it confidential, the court concluded that the letter did not contain trade secrets, nonpublic financial information, or third-party confidential information. The ruling said information that is only "mildly embarrassing" is not protected from public disclosure. Some sentences concerning Hurd's family were ordered redacted from the letter, however. 1 Allred alleged in the letter that, while Fisher was ostensibly hired as an HP event hostess in late 2007, she was really brought on to accompany Hurd to HP events held out of town. In a serious corporate allegation, during a trip to Madrid in March 2008, Hurd allegedly called Fisher's room and told her about a then-undisclosed deal in the works, in which HP was going to acquire the tech consulting firm EDS. Fisher had heard of the company, having lived before in Dallas. Hurd told her to keep what she knew about the deal secret. As for the sexual harassment claim, Allred alleged in the letter that Hurd harassed Fisher at meetings and dinners over a several year period during which time Fisher experienced a number of unwelcome sexual advances from Hurd including kissing and grabbing. Fisher said that this continual sexual harassment made her uncertain about her employment status. Questions 1. What is the role of trust in business? How does trust relate to stakeholder interests? How does trust engender ethical leadership? Evaluate Mark Hurd's actions in this case from a trust perspective. 2. Define conflict of interests in a business sense. How does Hurd's actions and relationship with Jodie Fisher in the case create a conflict of interest? Did the conflict of interest and trust issue contribute the possibility that sexual harassment may have existed? Why or why not? 3. Leo Apotheker, the former CEO of HP who succeeded Mark Hurd, resigned in September 2011, after just 11 months on the job-but he left with a $13.2 million severance package. Hurd left with a package between $40 million and $50 million. What is the role of a severance package in hiring a CEO? Do you think the size of the severance package given to Hurd was ethical? Does the Hurd case affect your views about the "say on pay" rule? 1 The letter is Available at http://www.scribd.com/doc/76795283/Allred-Letter-Redacted-New.
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