Corporate Ethics and Governance

By Kyle Hubbard, Ph.D., Assistant Professor of Philosophy | August 3, 2017

Every few months we become aware of another major corporate ethics scandal. From Enron and Tyco to Volkswagen and Wells Fargo everyone recognizes the scandals as significant ethical failings. What is not as obvious is that these corporate scandals (misleading shareholders, lying to customers, etc.) are also governance failures. While many ethical failings in business have to do with individuals making poor choices, the more significant and widespread failings occur because the governance structures in the organizations are either broken or were never established properly in the first place. The Wells Fargo scandal is a perfect example of how corporate governance failures cause ethical problems. Many commentators have placed blame on Wells Fargo's decentralized governance structure and the lack of oversight from the board and top executives at the firm. 

It is because of how interrelated corporate ethical failings are with failures in governance that the Ethics in Governance forum focuses on both issues. While some topics may be more explicitly ethical in nature and others may focus more on governance issues, in actual practice ethics and governance issues are inseparable. A company that consistently makes ethical decisions is one that is well-run with open lines of communication, clear expectations of its board, executives, and lower-level employees, and everyone in the organization will understand how the corporation makes decisions. It is thus essential for the forum to address questions of governance alongside ethical questions. A closer look at the main theories of corporate governance illustrates how interrelated governance questions are with ethical ones.               

Corporate governance concerns the people and processes that run organizations. For much of the last century the prevailing theory of corporate governance was called the "agency theory." The agency theory holds that the role of the firm's management is to act as an agent of the owners or shareholders. It is thus closely related to the shareholder theory of the modern corporation which claims that the purpose of a firm is to act in the shareholders' interests. Often the owners or shareholders are most interested in profit but not necessarily. The owners of a for-profit social enterprise, for example, may decide that their main purpose is to achieve some social mission, say reducing poverty or helping the environment (e.g. Patagonia).  While the agency theory has been the dominant theory of corporate governance, beginning in the 1980's some management theorists began to question agency theory. These critics attacked agency theory for, among other things, encouraging firms to focus on short-term profit above all else and for only looking to the owners' interests. These criticisms of agency theory have led to some to look to other theories of corporate governance. 

The major opposing theory is stakeholder theory. According to stakeholder theory, the purpose of a firm is to balance the interests of the firm's various constituentsd, all those with a legitimate stake in the corporation. These stakeholders include employees, customers, suppliers, the surrounding community, in addition to shareholders. Management, on this view, tries to figure out how to balance the (sometimes) competing interests of the various stakeholders.    

Stakeholder theory rests on a number of assumptions that are different from the agency theory. First, the theory does not assume that everyone (including managers) inevitably acts out of self-interest. Stakeholder theory assumes it is possible for managers, without overbearing oversight, to attempt to balance the interests of the organization's constituents without privileging their own position. Also, stakeholder theory assumes the purpose of the firm is not maximization of short-term profit. Because the organization is governed in such a way where the interests of the employees, customers, suppliers, surrounding community, andshareholders are taken into account, it is necessary to focus more on long-term sustainability than on short-term profit. Stakeholder theory advocates claim the theory itself encourages long-term sustainable thinking instead of short-term approaches.   

Another assumption of stakeholder theory is that the stakeholders are not necessarily in inevitable conflict.  Sure, there is an argument to be made that any time a dividend goes to shareholders, that is money that does not go back to employees in the form of wages or to customers in the form of lower prices. Yet, stakeholder theorists claim that if the long-term health of organizations is the focus, then each group will recognize that such an outcome can only be achieved by balancing the interests of all the stakeholders.  

In the economy advocates of each of these views are often at loggerheads. For example according to a recent column in the New Yorker, "[w]hen American Airlines agreed to give raises to its pilots and flight attendants in April, analysts at a handful of investment banks reacted bitterly. 'This is frustrating,' a Citigroup analyst named Kevin Crissey wrote in a note that was sent to the bank's clients. 'Labor is being paid first again. Shareholders get leftovers.' Jamie Baker, of JPMorgan, also chimed in: 'We are troubled by AAL's wealth transfer of nearly $1 billion to its labor groups.'"[1] Crissey and Baker seem to be perfectly expressing the agency theory of management. According to agency theory, the managers should have been focused on the interests of the shareholders exclusively.  If there is a disagreement between the shareholders and other interested parties in the organization, then management must act in the interests of the shareholders. However, advocates of stakeholder theory would argue that management's role is to maintain the long-term health of the organization by balancing employee, shareholder, and customer interests. This brief description of the prevailing governance theories illustrates how governance issues are inevitably ethical ones. Advocates of stakeholder theory cast their defense in ethical terms, but the same goes for agency theorists who argue that capital is what drives business so managers should work in the service of the owners' capital. Additionally, when we talk about ethical issues in the workplace, from lying about profits to sexual harassment, there is inevitably a governance component. For example, a healthy company will have clear and consistent policies on sexual harassment, open lines of communication open for employees to report harassment, and consistently act on filed complaints. Business ethics issues do not simply occur on an individual level. Companies that have public ethical failings and those that do things right do so because of how they are governed. For this reason, the Ethics and Governance forum does not see ethics and governance as separate issues, but always related in the corporate context.


[1] Sheelah Kolhatkar, "Is Socially Responsible Capitalism Losing?," June 5, 2017, accessed July 7, 2017, http://www.newyorker.com/magazine/2017/06/05/is-socially-responsible-